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**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

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**FORM 10-K**

 
| x                                                    | **ANNUAL  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**     |
|------------------------------------------------------|---------------------------------------------------------------------------------------------------------------|
| ** **                                           |
| **For the fiscal year ended December 31, 2009** |
| ** **                                           |
| **OR**                                               |
| ** **                                           |
| o                                                    | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |

 

**For the transition periodfrom         to           **

 

**Commissionfile number 333-73012-04**

 

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**ONEBEACON U.S. HOLDINGS, INC.**

(Exact name of Registrant asspecified in its charter)

 

| **Delaware**  (State or other jurisdiction of  incorporation or organization)            | ** ** | **52-2272489**  (I.R.S. Employer  Identification No.) |
|------------------------------------------------------------------------------------------|------------|-------------------------------------------------------|
| ** **                                                                               | ** ** | ** **                                            |
| **601 Carlson Parkway  Minnetonka, Minnesota**  (Address of principal executive offices) | ** ** | **55305**  (Zip Code)                                 |

 

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

 

Securities registered pursuant to Section 12(b) of the Act:

 
| **Title  of each class** | ** ** | **Name  of each exchange on which registered** |
|--------------------------|------------|------------------------------------------------|
| None                     |       | None                                           |

 

Securities registered pursuant to Section 12(g) of the Act

 

**5.875% Senior Unsecured Notes due 2013 of OneBeacon U.S.Holdings, Inc.**

 

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Indicate by check mark if the Registrant is a well-known seasonedissuer, as defined in Rule 405 of the Act. Yes o  No x

 

Indicate by check mark if the Registrant is not required to filereports pursuant to Section 13 or Section 15(d) of the ExchangeAct. Yes o  No x

 

Indicate by check mark whether the Registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the ExchangeAct during the preceding 12 months (or for such shorter period that theRegistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. Yes x  No o

 

Indicate by check mark whether the Registrant has submittedelectronically and posted on its corporate Web site, if any, every InteractiveData File required to be submitted and posted pursuant to Rule 405 ofRegulation S-T (§232.405 of this chapter) during the preceding 12 months (orfor such shorter period that the registrant was required to submit and postsuch files). Yes o No o

 

Indicate by check mark if disclosure of delinquent filers pursuant toItem 405 of Regulation S-K is not contained herein, and will not be contained,to the best of the Registrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of this Form 10-K orany amendment to this Form 10-K. x

 

Indicate by check mark whether the Registrant is a large acceleratedfiler, an accelerated filer, a non-accelerated filer, or a smaller reportingcompany. See the definitions of “large accelerated filer,” “accelerated filer,”and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

| Large accelerated filer o    |   | Accelerated filer o         |
|------------------------------|--------|----------------------------------|
| Non-accelerated filer x |   | Smaller reporting company o |

 

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

 

The aggregate market value of voting shares of Common Stock held bynon-affiliates of the Registrant as of June 30, 2009 was $0, because allof the outstanding shares of Common Stock were owned by OneBeacon U.S.Enterprises Holdings, Inc., an indirect wholly-owned subsidiary ofOneBeacon Insurance Group, Ltd.

 

As of March 19, 2010, there were 505 outstanding shares of CommonStock, $1.00 par value per share, of the Registrant.

 

The Registrant meets the conditions set forth in GeneralInstruction (I) (1) (a) and (b) of Form 10-K andis therefore filing this Form with reduced disclosure format.

 

 

 

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| ** **        | ** **                                                                                                                     | ** ** | **Page** |
|-------------------|--------------------------------------------------------------------------------------------------------------------------------|------------|----------|
| **PART I**   |
| ITEM 1.           | Business*                                                                                                                      |       | 1        |
|              | Overview                                                                                                                       |       | 1        |
|              | Insurance  Operations                                                                                                          |       | 3        |
|              | Other Operations                                                                                                               |       | 16       |
|              | Investments                                                                                                                    |       | 17       |
|              | Regulatory Matters                                                                                                             |       | 18       |
|              | Ratings                                                                                                                        |       | 21       |
|              | Employees                                                                                                                      |       | 21       |
|              | Available  Information                                                                                                         |       | 21       |
| ITEM 1A.          | Risk Factors                                                                                                                   |       | 21       |
| ITEM 1B.          | Unresolved Staff  Comments                                                                                                     |       | 31       |
| ITEM 2.           | Properties*                                                                                                                    |       | 31       |
| ITEM 3.           | Legal Proceedings                                                                                                              |       | 32       |
| ITEM  4.          | **                                                                                                                             |       |     |
| **PART II**  |
| ITEM 5.           | Market for the  Company’s Common Equity, Related Shareholder Matters and  Issuer Purchases of Equity Securities |       | 32       |
| ITEM  6.          | **                                                                                                                             |       |     |
| ITEM 7.           | Management’s  Discussion and Analysis of Financial Condition and Results of Operations*                                   |       | 33       |
|              | Non-GAAP  Financial Measures                                                                                                   |       | 51       |
|              | Liquidity and Capital Resources                                                                                                |       | 51       |
|              | Critical Accounting Estimates                                                                                                  |       | 57       |
|              | Forward-Looking  Statements                                                                                                    |       | 76       |
| ITEM 7A.          | Quantitative  and Qualitative Disclosures About Market Risk                                                                    |       | 77       |
| ITEM 8.           | Financial  Statements and Supplementary Data                                                                                   |       | 79       |
| ITEM 9.           | Changes in and Disagreements With  Accountants on Accounting and Financial Disclosure                                          |       | 79       |
| ITEM 9A.          | Controls and  Procedures                                                                                                       |       | 79       |
| ITEM 9B.          | Other Information                                                                                                              |       | 80       |
| **PART III** |
| ITEM  10.         | **                                                                                                                             |       |     |
| ITEM  11.         | **                                                                                                                             |       |     |
| ITEM  12.         | **                                                                                                                             |       |     |
| ITEM  13.         | **                                                                                                                             |       |     |
| ITEM 14.          | Principal  Accountant Fees and Services                                                                                        |       | 80       |
| **PART IV**  |
| ITEM 15.          | Exhibits and  Financial Statement Schedules                                                                                    |       | 81       |
| CERTIFICATIONS    |                                                                                                                           |       | C-1      |

 

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*                                         Item prepared in accordancewith General Instruction I (2) of Form 10-K

 

**                                  Item omitted inaccordance with General Instruction I (2) of Form 10-K

 

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**PART I**

 

**ITEM1.  BUSINESS**

 

**Overview**

 

OneBeacon U.S. Holdings, Inc., (OBH or the Company, andcollectively with its subsidiaries, OB Holdings, we, us, or our), formerlyknown as Fund American Companies, Inc., was created in 2000 by WhiteMountains Insurance Group, Ltd. (White Mountains) to acquire andsubsequently be the holding company for OneBeacon Insurance Group LLC(together with its subsidiaries, OneBeacon). White Mountains is a holdingcompany whose businesses provide property and casualty insurance, reinsuranceand certain other products. On June 1, 2001, OBH acquired OneBeacon fromAviva plc (Aviva, formerly CGNU), (the OneBeacon Acquisition).

 

During 2006, White Mountains undertook an internal reorganization andformed OneBeacon Insurance Group, Ltd. (OBIG) for the purpose of holdingcertain of its property and casualty insurance businesses. As part of thisreorganization, certain of White Mountains’ businesses that were historicallyindirect wholly-owned subsidiaries of White Mountains, including OBH, becameindirect wholly-owned subsidiaries of OBIG. During the fourth quarter of 2006,White Mountains sold 27.6 million or 27.6% of OBIG’s common shares in aninitial public offering. As of December 31, 2009, White Mountains owned75.4% of OBIG’s common shares.

 

We are a property and casualty insurance writer that provides a rangeof insurance products and services. We have historically offered a range ofspecialty, commercial and personal products and services sold primarily throughselect independent agents and brokers. However, we have recently entered intotwo transactions that will transform us into a specialty lines company. On December 3,2009, we sold the renewal rights to our non-specialty commercial lines businessand on February 2, 2010, we entered into a definitive agreement to sellour personal lines business. With roots dating back to 1831, we have beenoperating for more than 175 years and have relationships with many independentagencies and brokers. Our headquarters are located at 1 Beacon Lane, Canton,Massachusetts 02021 and our principal executive office is located at 601Carlson Parkway, Minnetonka, Minnesota 55305.

 

Our reportable segments are Insurance Operations, formerly known asPrimary Insurance Operations, and Other Operations. We currently manage ourInsurance Operations segment through a specialty lines underwriting unit and apersonal lines underwriting unit, nearly all of which is subject to thepersonal lines transaction described below. The Insurance Operations segmentalso includes run-off business, which primarily consists of non-specialtycommercial lines business which is being transferred to The Hanover InsuranceGroup (The Hanover), as described below, and other run-off business. Certainother activities are conducted through our holding company, OBH, and areincluded in our Other Operations segment.

 

Our specialty lines businesses are national in scope, while ourpersonal lines business has been exclusively available in the eightNortheastern states (the New England states, New York and New Jersey). We haveadded, and expect to continue to add, new specialty businesses both organicallyand through acquisition, guided by our focus on profitable growth whileprudently managing underwriting risk.

 

Our principal operating subsidiaries are rated “A” (Excellent, thethird highest of fifteen financial strength ratings) by A.M. Best Company,Inc. (A.M. Best), “A” (Strong, the sixth highest of twenty-one financialstrength ratings) by Standard & Poor’s Rating Service (Standard &Poor’s), “A2” (Good, the sixth highest of twenty-one financial strengthratings) by Moody’s Investors Service, Inc. (Moody’s) and “A” (Strong, thesixth highest of twenty-one financial strength ratings) by Fitch, Inc.(Fitch).

 

In 2009, our net written premiums totaled approximately$1.9 billion and we had total assets of approximately $7.5 billionand total OB Holdings’ shareholder’s equity of approximately $1.4 billionat December 31, 2009.

 

**Recent Developments**

 

We have recently entered into two transactions that will transform usinto a specialty lines insurance company. The transactions will free upsignificant capital, increase our financial flexibility and also substantiallyreduce our catastrophe exposure.

 

*Commercial lines.* On December 3, 2009, we sold therenewal rights to approximately $490 million in premiums from our non-specialtycommercial lines business to The Hanover. The transaction includes smallcommercial accounts and

 

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thenon-specialty portion of the middle-market business, beginning with January 1,2010 effective dates (the Commercial Lines Transaction). As consideration, wereceived $23.2 million and will receive an additional 10% of premiums renewedin excess of $200 million for the first renewal period. We will continue tomanage claims from business written prior to the Commercial Lines Transactionand for business written by The Hanover through June 1, 2010. The Hanoverwill reimburse us for our expenses incurred to provide the claimsadministration services.

 

*Personal lines.* On February 2, 2010, we entered into adefinitive agreement to sell our personal lines business to Tower Group, Inc.(Tower) (the Personal Lines Transaction). The Personal Lines Transactionincludes the sale of two insurance companies containing the personal linesbusiness, two attorneys-in-fact managing the reciprocal insurance exchanges(reciprocals) that write the personal lines business in New York and NewJersey, and the surplus notes issued by each of the reciprocals. Net writtenpremiums for the affected books total approximately $420 million for the yearended December 31, 2009. As consideration, we will receive an amount equalto the statutory surplus in the reciprocals (approximately $103 million at December 31,2009, including the par value of the surplus notes issued by the reciprocals),the GAAP equity in the insurance companies and attorneys-in-fact (approximately$45 million at December 31, 2009), plus $32.5 million. AutoOne Insurance(AutoOne) is not being sold as part of this transaction. The sale is subject tocertain state regulatory approvals and is expected to close in the secondquarter of 2010.

 

**Our Business Focus**

 

We are a specialty company as demonstrated by our focus on certaincustomer groups and/or geographic territories where we believe our targetedproducts, pricing and expertise deliver a competitive advantage. In personallines, our flagship package product has provided a specialized approach to themarket by bundling automobile, home, liability, watercraft and other coveragesin a single policy. We believe that our proprietary knowledge regarding ourtargeted industries, classes 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.

 

**Our Operating Principles**

 

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

 

**Underwriting Comes First.**  An insurance enterprise must respect thefundamentals 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.

 

**Maintain a Disciplined Balance Sheet.**  The first concern here is that insuranceliabilities must always be fully recognized. Loss reserves and expense reservesmust be solid before any other aspect of the business can be solid. Pricing,marketing and underwriting all depend on informed judgment of ultimate losscosts and that can be managed effectively only with a disciplined balancesheet.

 

**Invest for Total Return.**  Historical insurance accounting tends to hideunrealized gains and losses in the investment portfolio and over-rewardreported investment income (interest and dividends). Regardless of theaccounting, we must invest for the best growth in after tax value over time. Inaddition to investing our bond portfolios for total after tax return, that willalso mean prudent investment in a balanced portfolio consistent with leverageand insurance risk considerations.

 

**Think Like Owners.**  Thinking like owners has a value all its own.There are stakeholders in a business enterprise and doing good work requiresmore than this quarter’s profit. But thinking like an owner embraces all thatwithout losing the touchstone of a capitalist enterprise.

 

**Property and Casualty Insurance Overview**

 

Generally, property and casualty insurance companies write insurancepolicies in exchange for premiums paid by their customers (the insured). Aninsurance policy is a contract between the insurance company and the insuredwhere the insurance company agrees to pay for losses suffered by the insuredthat are covered under the contract. Such contracts often are subject tosubsequent legal interpretation by courts, legislative action and arbitration.Property insurance generally covers the financial consequences of accidentallosses to the insured’s property, such as a home and the personal property init, or a business’ building, inventory and equipment. Casualty insurance (oftenreferred to as liability insurance) generally covers the financial consequencesof a legal liability of an individual or an organization resulting fromnegligent acts and omissions 

 

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causingbodily injury and/or property damage to a third party. Claims on propertycoverage generally are reported and settled in a relatively short period oftime, whereas those on casualty coverage can take years, even decades, tosettle.

 

We derive substantially all of our revenues from earned premiums,investment income and net realized and unrealized gains and losses oninvestment securities. Earned premiums represent premiums received frominsureds, which are recognized as revenue over the period of time thatinsurance coverage is provided (i.e., ratably over the life of thepolicy). A significant period of time normally elapses between the receipt ofinsurance premiums and the payment of insurance claims. During this time, weinvest the premiums, earn investment income and generate net realized andunrealized investment gains and losses on investments.

 

Insurance companies incur a significant amount of their total expensesfrom policyholder losses, which are commonly referred to as claims. In settlingpolicyholder losses, various loss adjustment expenses (LAE) are incurred suchas insurance adjusters’ fees and litigation expenses. In addition, insurancecompanies incur policy acquisition expenses, such as commissions paid to agentsand premium taxes, and other expenses related to the underwriting process,including their employees’ compensation and benefits.

 

The key measure of relative underwriting performance for an insurancecompany is the combined ratio. An insurance company’s combined ratio underaccounting principles generally accepted in the United States (GAAP) iscalculated by adding the ratio of incurred loss and LAE to earned premiums (theloss and LAE ratio) and the ratio of policy acquisition and other underwritingexpenses to earned premiums (the expense ratio). A combined ratio under 100%indicates that an insurance company is generating an underwriting profit.However, when considering investment income and investment gains or losses,insurance companies operating at a combined ratio of greater than 100% can beprofitable.

 

**InsuranceOperations**

 

Our Insurance Operations segment provides specialty lines and personallines insurance products and services. The Insurance Operations segment alsoincludes run-off business, which primarily consists of non-specialty commerciallines business which is being transferred to The Hanover, as well as nationalaccounts, certain specialty programs and regional agency business transferredto Liberty Mutual Insurance Group (Liberty Mutual) effective November 1,2001. See “Business—Run-off”.

 

Forthe years ended December 31, 2009, 2008 and 2007, our net written premiumsby line of business were as follows:

 
| ** **   | ** ** | **Year ended December 31,** | ** ** |
|--------------|------------|----------------------------------|------------|
| ** **   | ** ** | **2009**                         | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **   | ** ** | **($ in millions)**         | ** ** |
| Specialty(1) |       | $                                | 946.2      |   | $ | 836.9 |   | $ | 654.0 |   |
| Personal     |       | 508.7                            |       | 618.7 |   | 690.4 |   |
| Run-off(2)   |       | 451.8                            |       | 507.5 |   | 520.0 |   |
| Total        |       | $                                | 1,906.7    |   | $ | 1,963.1 |   | $ | 1,864.4 |   |

 

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(1)                                  Specialty linesnow includes Technology, Financial Services, OneBeacon Specialty Property andProperty and Inland Marine which were formerly reported in commercial lines. Priorperiods have been reclassified to conform to the current presentation.

 

(2)                                  Run-offincludes non-specialty commercial lines business subject to the CommercialLines Transaction and other run-off business. See “Business—Run-off.” Priorperiods have been reclassified to conform to the current presentation.

 

Specialty lines is a collection of niche businesses that focus onsolving the unique needs of particular customer or industry groups on anational scale. We provide distinct products and offer tailored coverages andservices, managed by seasoned teams of market specialists. These businessesmaintain stand-alone operations and distribution channels targeting theirspecific customer groups. Our specialty lines include several businessesfocused on smaller property-casualty insurance segments where particularexpertise and relationships with similarly focused distribution partners hasresulted historically in strong operating results. These businesses maintaintheir competitive advantage through a deep knowledge of their respectivecustomers and markets. Our specialty lines businesses currently include:

 

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·                  *OneBeaconProfessional Insurance (OBPI): *OBPI, formerlyknown as OneBeacon Professional Partners, specializes in professional liabilityinsurance products for an increasingly broad range of industry groups. OBPI’soriginal focus on health-care related liability insurance continues whileexpansion into non-health-care related liability insurance segments hasincreased over the last five years. Medical liability insurance for health-careindustry segments, including hospitals, physician groups, managed careorganizations, long-term care facilities and other non-hospital medicalfacilities, represents the most significant share of OBPI’s business.Additionally, OBPI offers stop loss insurance to certain health-care providersthrough its provider excess insurance and HMO reinsurance products. Errors andomissions liability insurance coverage is also provided to business segmentsincluding design professionals for the construction industry, law firms,in-house counsel, realtors and media organizations. Management liabilitycoverage, specifically directors and officers and employment practicesinsurance, is offered on a limited basis to some of the business segments notedabove. Underwriting, claims and risk control services are managed internally.OBPI’s policies are primarily issued on a “claims made” basis, which coverslosses reported during the time period when a liability policy is in effect,regardless of when the event causing the claim actually occurred.

 

·                  *CollectorCars and Boats: *In the secondquarter of 2008, we began to provide property and casualty insurance solutionsthrough an exclusive partnership with Hagerty Insurance Agency and HagertyClassic Marine Insurance Agency (Hagerty), the nation’s premier collector carand classic boat agencies. Hagerty’s specialty services include collector carand wooden boat insurance, automotive museum insurance, restoration shopinsurance, vehicle valuation, financing and roadside assistance, as well as avariety of useful information resources. Its Hagerty Plus community ofcollector-car enthusiasts has over 280,000 members. Hagerty works proactivelyon hobby advocacy and supports the Collectors Foundation, a nonprofitorganization formed by Hagerty and dedicated to the preservation of the hobby.

 

·                  *InternationalMarine Underwriters (IMU): *A leadingprovider of marine insurance, this business traces its roots back to the early1900s. IMU coverages include physical damage or loss and general liability forcargo and commercial hull, both at primary and excess levels. IMU also offerscoverage for marinas, including a “package” product with comprehensive propertyand liability coverage, and yachts, the offerings for which were strengthenedby IMU’s acquisition in October 2006 of yacht-specialist National MarineUnderwriters, Inc., a yacht insurance managing general agency. IMU doesnot offer offshore energy products. Target customers include ferry operatorsand charter boats (hull), marina operators and boat dealers (package product)and private-pleasure yachts.

 

·                  *Technology: *Technology’s customer groupsinclude hardware manufacturers, software companies, and telecommunicationsservice providers. Our custom @vantage for Technology policies providescoverage for technology customers’ unique needs including specializedprofessional liability such as data privacy, communications and errors andomissions liability, both domestically and internationally. Within theTechnology segment, we also specialize further with a product tailored formedical technology customers available on a claims-made or occurrence basis andthat also provides protection worldwide. Within this class, we target medicaldevice manufacturers and operations.

 

·                    *Propertyand Inland Marine (PIM): *The PIM segment provides monoline property and inland marineproducts. Our property focus is on the real estate, health care, education,aviation, municipality and manufacturing sectors, while inland marine targetsthe construction, transportation and fine arts segments. We deliver creativeand tailored solutions that fit our customers’ unique needs through broadcoverage forms, specialized risk control and claims handling capabilities.

 

·                  *A.W.G.Dewar (Dewar): *A leadingprovider of tuition reimbursement insurance since 1930, Dewar’s productprotects both schools and parents from the financial consequences of a student’swithdrawal or dismissal from school. The tuition refund plan reimburses parentsup to 100% of tuition, room and board fees when a student is obliged to leaveschool due to covered reasons, such as medical or expulsion. Dewar providescustomized policies to independent schools and colleges in North America.

 

·                  *SpecialtyAccident and Health (A&H): *A&Hprovides accident insurance principally to employer groups, associations andaffinity groups. A&H’s products include corporate accident, travel accidentand occupational accident coverage which is primarily targeted to the truckingindustry. In the fourth quarter of 2008, A&H launched OneBeacon Services toprovide employer and affinity groups with access to a suite of services to helpmanage today’s emerging issues. Services include a discounted prescription drugprogram, identity theft 

 

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resolution services and travel assistance services. The A&H groupdistributes products through independent agents and brokers, and selectivelymarkets directly to customers.

 

·                  *EntertainmentBrokers International Insurance Services (EBI): *Acquired in the third quarter of 2008, EBI provides specializedcommercial insurance products, including professional liability coverages, forthe entertainment, sports and leisure industries. EBI continues to operate as amanaging agency with a network of 500 independent agents and brokers. EBI alsooperates a brokerage operation offering excess workers compensation coveragesand a high value homeowners product.

 

·                    *FinancialServices: *The FinancialServices segment commenced operations in October 2005 by targeting a broadrange of financial services companies including credit unions, investmentadvisors, securities broker/dealers, insurance companies and commercial banks.Through our @vantage for Financial Services product we provide customers withbroad property and general liability protection. For community banks with under$3 billion in assets, the product may be augmented with specializedprofessional liability coverages.

 

·                    *OneBeacon Specialty**Property (OBSP): *OBSP provides protection 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-medium manufacturing, retail/wholesale and public entity andeducational institutions. OBSP targets customers with low catastrophe-exposedrisks. Our OBSP solutions are provided primarily through surplus lineswholesalers in all 50 states and the District of Columbia.

 

·                  *OneBeaconGovernment Risks (OBGR): *Formed in March 2007,this group offers property and casualty products for government entities. Theproducts include automobile, property, general liability and professionalliability coverages. The professional liability offerings consist of lawenforcement, public officials and employment practice coverage. Markets servedinclude cities, towns, townships, counties, transit authorities, governmentagencies, special districts and pools (groups of public entities). OBGR strategicallydistributes its products through agents and brokers.

 

·                   *OneBeaconEnergy (OBEG): *OBEG beganoffering property and casualty products in July 2009 to companies engagedin traditional upstream and midstream oil and gas production, storage anddistribution and companies who use renewable energy resources to generate poweror produce alternative fuels. OBEG’s coverages include monoline property,monoline general liability, general liability combined with automobileliability and lead umbrella. All coverages offered are specifically tailoredfor these markets and risks. OBEG does not offer offshore energyproducts. Market-leading agents and brokers that specialize in the energybusiness strategically distribute OBEG’s products throughout the United States.

 

For the years ended December 31, 2009, 2008 and 2007, our specialtylines net written premiums were as follows:

 
| ** **                  | ** ** | **Year ended December 31,(1)** | ** ** |
|-----------------------------|------------|-------------------------------------|------------|
| ** **                  | ** ** | **2009**                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                  | ** ** | **($ in millions)**            | ** ** |
| OBPI                        |       | $                                   | 266.9      |   | $ | 239.9 |   | $ | 213.9 |   |
| Collector cars and boats(2) |       | 144.8                               |       | 110.0 |   | — |   |
| IMU                         |       | 135.5                               |       | 157.0 |   | 158.6 |   |
| Other specialty lines(3)    |       | 399.0                               |       | 330.0 |   | 281.5 |   |
| Total specialty lines       |       | $                                   | 946.2      |   | $ | 836.9 |   | $ | 654.0 |   |

 

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(1)                                  Specialty linesnow includes Technology, Financial Services, OBSP and PIM which were formerlyreported in commercial lines. Prior periods have been reclassified to conform tothe current presentation.

 

(2)                                  Collector carsand boats began writing premiums in the second quarter of 2008.

 

(3)                                  Other specialtylines includes EBI, A&H, OBGR, OBEG, Dewar, Technology, Financial Services,OBSP and PIM. No individual business included in other specialty linesgenerated greater than $85 million in annual net written premiums.

 

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***Personal lines***

 

Our personal lines underwriting unit is comprised of traditionalpersonal lines, which is subject to the Personal Lines Transaction, andAutoOne. The Personal Lines Transaction is subject to certain state regulatoryapprovals and is expected to close in the second quarter of 2010.

 

·                   *Traditional personal lines*:  Our traditional personal lines has provided acomprehensive suite of personal insurance products sold through selectindependent agents with a focus on eight Northeastern states. Our personallines products include:

 

·                  *Automobile: *consists of physical damageand liability coverage. Automobile physical damage insurance covers loss ordamage to vehicles from collision, vandalism, fire, theft or other causes.Automobile liability insurance covers bodily injury of others, damage to theirproperty and costs of legal defense resulting from a collision caused by theinsured.

 

·                  *Homeowners: *covers losses to an insured’shome, including its contents, as a result of weather, fire, theft and othercauses, and losses resulting from liability for acts of negligence by theinsured or the insured’s immediate family. We also offer identity theftresolution assistance and identity theft expense reimbursement coverage as partof our homeowners policies.

 

·                 *Package: *consists of customized combinationpolicies offering home and automobile coverage with optional umbrella andboatowners coverage.

 

Within traditional personal lines, in addition to automobile,homeowners and package policy offerings, we also include management servicesprovided to reciprocals and the consolidation of the reciprocals describedbelow.

 

·                  *Traditionalpersonal lines excluding reciprocals: *To maintain ahigh degree of flexibility, in 2004 we created a highly segmented productsuite, called OneChoice, under which we offer risk-adjusted product and pricingto our customers. 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 such as OneChoice CustomPac, our flagship package policy.OneChoice products rely on multiple, objective pricing tiers and rules-basedunderwriting that enable agents to offer OneBeacon solutions to a broad arrayof their customers and increase our market penetration. We regularly refine ourproduct features and rating plans to optimize target market production. Ease ofuse is a critical aspect of this business. Investments in technology haveprovided opportunities for agents to access OneChoice through either ourweb-based proprietary agent portal or through comparative raters.

 

·                  *Reciprocals: *We provide managementservices for a fee to three reciprocal insurance exchanges, which we refer toas reciprocals. The reciprocals offer the OneChoice product as described above.We have created and capitalized the reciprocals by lending them funds inexchange for surplus notes. Reciprocals are policyholder-owned insurancecarriers organized as unincorporated associations. We have no ownershipinterest in these reciprocals. As required by GAAP, our consolidated financialstatements reflect the consolidation of these reciprocals. See Note 14—“VariableInterest Entities” of the accompanying consolidated financial statements.

 

·                  *AutoOne: *AutoOne is a market leaderin “assigned risk” business in New York. Assigned risk plans provide automobileinsurance for individuals unable to secure coverage in the voluntary market.Insurance carriers are obliged to accept future assignments from state assignedrisk pools as a condition of maintaining a license to write automobile businessin the state. However, carriers may satisfy their assigned risk obligation bybuying out of their assignments through an agreement with an approved AssignedRisk Servicing Company or limit their assignments through the purchase andtransfer of “credits” (for example, take-out, territorial and youthful drivercredits). AutoOne offers services known as Limited Assignment Distribution, orLAD, and Commercial Limited Assignment Distribution, or CLAD, and creditprograms to insurance carriers. AutoOne provides 28 LAD and CLAD programs in 21states and the District of Columbia where assigned risk obligations may beassumed by a servicing carrier under a negotiated fee arrangement.

 

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AutoOne also writes “voluntary take-out business” (policies “taken out”of the assigned risk pool and written in the voluntary market) by selectingpolicies from the assigned risk business it has assumed for its clients andfrom select insurance brokers that replace their clients’ assigned riskpolicies with AutoOne policies. AutoOne receives credits for all premium takenout of the assigned risk plan which it can use either to reduce its futureassigned risk obligations or sell to other carriers that can use the credits toreduce their own quota obligations.

 

Forthe years ended December 31, 2009, 2008 and 2007, our personal lines netwritten premiums were as follows:

 
| ** **                                       | ** ** | **Year ended December 31,** | ** ** |
|--------------------------------------------------|------------|----------------------------------|------------|
| ** **                                       | ** ** | **2009**                         | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                       | ** ** | **($ in millions)**         | ** ** |
| Traditional personal lines excluding reciprocals |       | $                                | 225.5      |   | $ | 296.4 |   | $ | 338.0 |   |
| Reciprocals                                      |       | 194.4                            |       | 203.2 |   | 221.3 |   |
| Traditional personal lines                       |       | 419.9                            |       | 499.6 |   | 559.3 |   |
| AutoOne                                          |       | 88.9                             |       | 119.9 |   | 134.6 |   |
| Total personal lines(1)                          |       | $                                | 508.7      |   | $ | 618.7 |   | $ | 690.4 |   |

 

----

(1)                                  Includeselimination between traditional personal lines and AutoOne.

 

***Run-off***

 

Run-off consists of non-specialty commercial lines business included inthe Commercial Lines Transaction, as well as national accounts, certainspecialty programs and regional agency business transferred to Liberty Mutualeffective November 1, 2001.

 

On December 3, 2009, we sold the renewal rights to ournon-specialty commercial lines business to The Hanover. The transactionincludes small commercial accounts and the non-specialty portion of themiddle-market business, beginning with January 1, 2010 effective dates(commercial run-off). We will continue to manage claims from our non-specialtycommercial lines policies written prior to the January 1, 2010 effectivedate of the Commercial Lines Transaction.

 

Beginning in 2001, national accounts and certain specialty programswere discontinued. 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 Liberty Agreement pro-rated results so that OneBeacon assumed approximatelytwo-thirds of the operating results from renewals through October 31, 2002and approximately one-third of the operating results from renewals through October 31,2003. The renewal rights under the Liberty Agreement expired on October 31,2003. We continue to manage claims from the discontinued national accounts andspecialty programs business as well as the claims related to the business thatwas subject to the Liberty Agreement (legacy run-off).

 

Forthe years ended December 31, 2009, 2008 and 2007, our net written premiumsfrom run-off were as follows:

 
| ** **    | ** ** | **Year ended December 31,(1)** | ** ** |
|---------------|------------|-------------------------------------|------------|
| ** **    | ** ** | **2009**                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **    | ** ** | **($ in millions)**            | ** ** |
| Total run-off |       | $                                   | 451.8      |   | $ | 507.5 |   | $ | 520.0 |   |
|               |            |                                     |            |  |  |  |  |  |  |  |

 

----

(1)                                  Run-offincludes non-specialty commercial lines business subject to the CommercialLines Transaction and other run-off business. Prior periods have beenreclassified to conform to the current presentation.

 

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**Geographic Concentration**

 

Our net written premiums are derived solely from business produced inthe United States.

 

Business from specialty lines was produced in the following states:

 
| ** **    | ** ** | **Year ended December 31,(1)** | ** ** |
|---------------|------------|-------------------------------------|------------|
| ** **    | ** ** | **2009**                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| California    |       | 12.8                                | %          | 12.1 | % | 10.0 | % |
| New York      |       | 9.0                                 |       | 9.2 |   | 8.5 |   |
| Texas         |       | 7.0                                 |       | 6.5 |   | 5.2 |   |
| Florida       |       | 5.5                                 |       | 5.7 |   | 8.1 |   |
| Massachusetts |       | 5.5                                 |       | 5.2 |   | 7.1 |   |
| New Jersey    |       | 4.3                                 |       | 4.4 |   | 4.6 |   |
| Other(2)      |       | 55.9                                |       | 56.9 |   | 56.5 |   |
| Total         |       | 100.0                               | %          | 100.0 | % | 100.0 | % |

 

----

(1)                                  Specialty linesnow includes Technology, Financial Services, OBSP and PIM which were formerlyreported in commercial lines. Prior periods have been reclassified to conformto the current presentation.

 

(2)                                  No individualstate was greater than 4% of net written premiums, except as noted above.

 

Business from personal lines was produced in the following states:

 
| ** **    | ** ** | **Year ended December 31,** | ** ** |
|---------------|------------|----------------------------------|------------|
| ** **    | ** ** | **2009**                         | ** ** | **2008** | ** ** | **2007** | ** ** |
| New York      |       | 39.2                             | %          | 41.5 | % | 40.3 | % |
| Massachusetts |       | 21.4                             |       | 22.5 |   | 23.0 |   |
| New Jersey    |       | 13.6                             |       | 13.0 |   | 12.0 |   |
| Connecticut   |       | 10.7                             |       | 9.1 |   | 6.5 |   |
| Maine         |       | 7.1                              |       | 7.9 |   | 7.7 |   |
| Rhode Island  |       | 3.8                              |       | 3.6 |   | 3.3 |   |
| Other(1)      |       | 4.2                              |       | 2.4 |   | 7.2 |   |
| Total         |       | 100.0                            | %          | 100.0 | % | 100.0 | % |

 

----

(1)                                  No individualstate was greater than 3% of net written premiums.

 

Business from run-off was produced in the following states:

 
| ** **    | ** ** | **Year ended December 31,(1)** | ** ** |
|---------------|------------|-------------------------------------|------------|
| ** **    | ** ** | **2009**                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| California    |       | 18.6                                | %          | 14.6 | % | 14.3 | % |
| Massachusetts |       | 15.4                                |       | 17.0 |   | 17.1 |   |
| New York      |       | 13.8                                |       | 13.5 |   | 14.2 |   |
| Maine         |       | 7.9                                 |       | 8.4 |   | 7.3 |   |
| New Jersey    |       | 6.2                                 |       | 6.6 |   | 6.3 |   |
| Connecticut   |       | 5.8                                 |       | 6.8 |   | 6.9 |   |
| Other(2)      |       | 32.3                                |       | 33.1 |   | 33.9 |   |
| Total         |       | 100.0                               | %          | 100.0 | % | 100.0 | % |

 

----

(1)                                  Run-offincludes non-specialty commercial lines business subject to the CommercialLines Transaction and other run-off business. Prior periods have beenreclassified to conform to the current presentation.

 

(2)                                  No individualstate was greater than 3% of net written premiums.

 

As a result of the Commercial LinesTransaction and the Personal Lines Transaction, we expect our geographicpremium distribution going forward to be consistent with our historicalspecialty lines premiums.

 

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**Marketing and Distribution**

 

We offer our products through a network comprised of independentagents, regional and national brokers and wholesalers. Our distributionrelationships consist of approximately 3,400 agencies and brokers. In recentyears, we have expanded our distribution channels to include select managinggeneral agencies (MGAs), either through acquisitions or exclusiverelationships. These MGAs focus on a particular customer group with tailoredproducts and services, and related expertise.

 

Our specialty lines businesses are managed from locations logisticallyappropriate to their target markets. OBPI is based in Avon, Connecticut anddistributes its products through select national and regional brokers andagents. IMU is headquartered in New York City and operates through tenlocations throughout the United States. Its products are distributed through anetwork of select agencies that specialize in marine business. Our collector cars and boats business iswritten through an exclusive MGA relationship with Hagerty. This relationshiphas an initial term of 5 years and will be up for renewal in the second quarterof 2013. Dewar’s affiliate, A.W.G. Dewar Agency, which is located in Quincy,Massachusetts, distributes tuition refund products to independent schools andcolleges throughout North America. A&H conducts business throughindependent agents and brokers and selectively markets directly to customers.EBI, an MGA, sells directly and through a network of independent agents throughlocations in New York City and California. OBGR strategically distributes itsproducts through agents and brokers. OBEG sells through a network of regionalagencies and brokers that specialize in the energy industry. Technology,Financial Services, PIM and OBSP are distributed through a network of selectindependent insurance agencies.

 

Personal lines products are exclusively available in the eightnortheastern states through a network of select independent insurance agencies.

 

We protect the integrity of our franchise value by selectivelyappointing agents that demonstrate business and geographic profiles that alignwith our target markets and specialized capabilities. We believe in the addedvalue provided by independent insurance agents and brokers as they conduct morecomplete assessments of their clients’ needs, which result in more appropriatecoverages and prudent risk management. We also believe that independent agentsand brokers will continue to be a significant force in overall industry premiumproduction.

 

New York-based AutoOne markets its LAD and CLAD services and New Yorktake-out credits directly to insurance carriers seeking assigned risksolutions. AutoOne generates take-out credits by writing policies from selectinsurance brokers that were previously in the New York Automobile InsurancePlan (NYAIP), and sells these credits to insurance companies subject to NYAIPassignments.

 

**Underwriting and Pricing**

 

We believe there must be a realistic expectation of attaining anunderwriting profit on all the business we write, as well as a demonstratedfulfillment 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 the exposure.

 

We use tiered rating plans in personal lines that permit us to offermore tailored price quotes to our customers based on underwriting criteriaapplicable to each tier. The enhanced accuracy and precision of our rate plansenable us to more confidently price our products to the exposure, and therebypermit our agency partners to deliver solutions to a broader range ofcustomers.

 

We also actively monitor pricing activity and measure usage of tiers,credits, debits and limits. In addition, we regularly update base rates toachieve targeted returns on capital and attempt to shift writings away fromlines and classes where pricing is inadequate. To the extent changes in premiumrates, policy forms or other matters are subject to regulatory approval (see “RegulatoryMatters—General” and “Risk Factors—Regulation may restrict our ability tooperate”), we proactively monitor our pending regulatory filings to facilitate,to the extent 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 in achievingsatisfactory underwriting results. We maintain an experienced staff ofappraisers, medical specialists, managers, staff attorneys and field adjustersstrategically located 

 

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throughoutour operating territories. We also maintain a special investigative unitdesigned to detect insurance fraud and abuse and support efforts by regulatorybodies and trade associations to curtail fraud.

 

Claims are separately organized by the respective operations. Through2009, claims have been organized by specialty, commercial, personal and run-offoperations. (No change has been made within claims management related tobusiness subject to the Commercial Lines Transaction.) This approach allows usto better identify and manage claims handling costs. In addition, a sharedclaims service unit manages costs related to both staff and vendors. We alsoadopted a total claims cost management approach that gives equal importance tocontrolling claims handling expenses, legal expenses and claims payments,enabling us to lower the sum of the three. This approach requires theutilization of a considerable number of conventional metrics to monitor theeffectiveness of various programs implemented to lower total loss cost. Themetrics are designed to guard against implementation of expense containmentprograms that will cost us more than we expect to save.

 

Our claims department utilizes a claims workstation to record reserves,payments and adjuster activity and, with support from expert tools, assistseach claim handler in the identification of recovery potential, estimatingproperty damage, evaluating claims and identifying fraud. Our commitment andperformance in fighting insurance fraud has reduced claim costs and aided lawenforcement investigations. Under our staff counsel program, our in-houseattorneys defend the majority of new lawsuits, which has resulted in savingswhen compared to the cost of using outside counsel.

 

Calendar year reported claims in our legacy run-off operations, whichexcludes business subject to the Commercial Lines Transaction, were 1,387 in2009, compared to 1,600 in 2008, a 13% reduction, in part due to the lapse oftime and the nature of these run-off operations. These levels of reportedclaims are down from 1,800 in 2007, 2,400 in 2006 and 3,400 in 2005. Total openclaims for legacy run-off operations were 3,963 at December 31, 2009,compared to 4,600 at December 31, 2008, a 14% reduction, which reflectsthe success of our focus on settling claims from our legacy run-off operations.Total open claims for legacy run-off operations were 5,500, 7,300 and 10,200 asof December 31, 2007, 2006 and 2005, respectively.

 

In connection with the OneBeacon Acquisition, Aviva caused us topurchase a reinsurance contract with National Indemnity Company (NICO) to helpprotect against potential asbestos and environmental (A&E) claims relatingto the pre-acquisition period prior to 2001 (the NICO Cover). See “Business—ReinsuranceProtection and Catastrophe Management.” NICO has retained a third partyadministrator (TPA), Resolute New England (Resolute), formerly Cavell USA, tomanage the claims processing for A&E claims reinsured under the NICO Cover.Our claims department personnel are consulted by NICO and Resolute on majorclaims. As with all TPAs, claims department personnel continually monitorResolute to ensure its controls, processes and settlements are appropriate. See“Management’s Discussion and Analysis of Financial Condition and Results ofOperations—Critical Accounting Estimates—Asbestos and Environmental Reserves.”

 

**Reinsurance Protection and Catastrophe Management**

 

In the normal course of our business, we purchase reinsurance fromhigh-quality, highly rated, third party reinsurers in order to minimize lossfrom large risks or catastrophic events.

 

The timing and size of catastrophe losses are unpredictable and thelevel of losses experienced in any year could be material to our operatingresults and financial position. Examples of catastrophes include losses causedby earthquakes, wildfires, hurricanes and other types of storms and terroristacts. The extent of losses caused by catastrophes is a function of the amountand type of insured exposure in an area affected by the event as well as theseverity of the event. We use models (primarily AIR Version 11) to estimate theprobability of the occurrence of a catastrophic event as well as potentiallosses under various scenarios. We use this model output in conjunction withother data to manage our exposure to catastrophe losses through individual riskselection and by limiting our concentration of insurance written incatastrophe-prone areas such as coastal regions. In addition, we impose winddeductibles on existing coastal windstorm exposures. We believe that ourlargest single event natural catastrophe exposures are Northeastern UnitedStates windstorms and California earthquakes.

 

We seek to further reduce our potential loss from catastrophe exposuresthrough the purchase of catastrophe reinsurance. Effective July 1, 2009,we renewed our property catastrophe reinsurance program through June 30,2010. The program provides coverage for our personal and commercial propertybusiness as well as certain acts of terrorism. Under the program, the first$100 million of losses resulting from any single catastrophe are retained andthe next $750 million of losses resulting from the catastrophe arereinsured. Any loss above $850 million would be retained. In the event ofa catastrophe, our property catastrophe reinsurance program is reinstated forthe remainder of the original contract term by paying a reinstatement premiumthat is based on the percentage of coverage reinstated and the originalproperty catastrophe coverage 

 

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premium.We anticipate that the $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).

 

Effective January 1, 2009, we entered into a quota share agreementwith a group of reinsurers to cede 30% of written premiums from our Northeasthomeowners business written through OneBeacon Insurance Company (OBIC) and itssubsidiary companies, along with Adirondack Insurance Exchange (AdirondackInsurance) and New Jersey Skylands Insurance Association (New Jersey Skylands)in New York and New Jersey, respectively. The program provides supplementalprotection to previously established reinsurance described above. Thereinsurers are all rated “A” (Excellent, the third highest of fifteen financialstrength ratings) or better by A.M. Best. Effective January 1,2010, we renewed the quota share agreement.

 

Our property catastrophe reinsurance program does not cover personal orcommercial property losses resulting from nuclear events or biological,chemical or radiological terrorist attacks or losses resulting from acts ofterrorism as defined under the Terrorism Risk Insurance Act of 2002 (theTerrorism Act or TRIA), as amended, committed by an individual or individualsacting on behalf of any foreign person or foreign interest. See “Business—Terrorism.”

 

As described above, in December 2009, we completed the CommercialLines Transaction. This business will run off throughout 2010, reducing ouroverall catastrophe profile. We anticipate that the Commercial LinesTransaction will result in a reduction in our exposure to Northeast windstormlosses in 2010. Additionally, in February 2010, we announced the PersonalLines Transaction. The closing of the Personal Lines Transaction is subject tocertain regulatory approvals and is expected to close in the second quarter of2010. Upon closing, we anticipate that the Personal Lines Transaction willsignificantly reduce our Northeast windstorm exposures.

 

We also purchase individual property reinsurance coverage for certainrisks to reduce large loss volatility. The property-per-risk reinsuranceprogram reinsures losses in excess of $10 million up to $100 million.Individual risk facultative reinsurance may be purchased above$100 million where we deem it appropriate. The property-per-risk treatyalso provides one limit of reinsurance protection for losses in excess of$10 million up to $100 million on an individual risk basis forterrorism losses. However, nuclear, biological, chemical and radiologicalterrorist attacks are not covered.

 

We also maintain a casualty reinsurance program that providesprotection for individual risk or catastrophe losses involving workers compensation,general liability, automobile liability, professional liability or umbrellaliability in excess of $6 million up to $81 million. Corporate accidentlosses are covered up to $95 million excess of $35 million. This programprovides coverage for terrorism losses but does not provide coverage for lossesresulting from nuclear, biological, chemical or radiological terrorist attacks.

 

In addition, we have reinsurance contracts with two reinsurancecompanies rated “AA+” (Very Strong, the second highest of twenty-one financialstrength ratings) by Standard & Poor’s and “A++” (Superior, thehighest of fifteen financial strength ratings) by A.M. Best. One is thereinsurance cover with NICO which entitles us to recover up to$2.5 billion in ultimate loss and LAE incurred related primarily toA&E claims arising from business written by our predecessor prior to 1992and 1987, respectively and certain other exposures. As of December 31,2009, we have ceded estimated incurred losses of approximately$2.2 billion to the NICO Cover. Net losses paid totaled $1.2 billionas of December 31, 2009, with $118.0 million paid in 2009. The othercontract is a reinsurance cover with General Reinsurance Corporation (GRC) forup to $570 million of additional losses on all claims arising fromaccident years 2000 and prior (the GRC Cover). As of December 31, 2009, wehave ceded estimated incurred losses of $550 million to the GRC Cover.Pursuant to the GRC Cover, we are not entitled to recover losses to the fullcontract limit if such losses are reimbursed by GRC more quickly thananticipated at the time the contract was signed. We intend to seekreimbursement from GRC only for claims which result in payment patterns similarto those supporting our recoverables recorded pursuant to the GRC Cover. Theeconomic cost of not submitting certain other eligible claims to GRC isprimarily the investment spread between the rate credited by GRC and the rateachieved by us on our own investments. This cost, if any, is expected to benominal.

 

Reinsurance contracts do not relieve us of our obligations. Therefore,collectibility of balances due from reinsurers is critical to our financialstrength. See Note 4—“Reinsurance” of the accompanying consolidatedfinancial statements.

 

**Terrorism**

 

Since the terrorist attacks of September 11, 2001, we have soughtto mitigate the risk associated with any future terrorist attacks by limitingthe aggregate insured value of policies in geographic areas with exposure tolosses from terrorist attacks. This is accomplished by either limiting thetotal insured values exposed, or, where applicable, through the use ofterrorism exclusions.

 

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In December 2007, the United States government extended theTerrorism Act for seven more years until December 31, 2014. The TerrorismAct, originally enacted in 2002, established a federal “backstop” forcommercial property and casualty losses, including workers compensation,resulting from acts of terrorism by or on behalf of any foreign person orforeign interest. As extended, the law now also covers domestic acts ofterrorism. The law limits the industry’s aggregate liability by requiring thefederal government to share 85% of certified losses once a company meets aspecific retention or deductible as determined by its prior year’s directwritten premiums and limits the aggregate liability to be paid by thegovernment and industry without further action by Congress at $100 billion. Inexchange for this “back-stop,” primary insurers are required to make coverageavailable to commercial insureds for losses from acts of terrorism as specifiedin the Terrorism Act. The following types of coverage are excluded from theprogram: commercial automobile, burglary and theft, surety, farmownersmulti-peril and all professional liability coverage except directors andofficers coverage.

 

We estimate our individual retention level for commercial policies subjectto the Terrorism Act to be approximately $177 million in 2010. The federalgovernment will pay 85% of covered terrorism losses that exceed our or theindustry’s retention levels in 2010, up to a total of $100 billion.

 

Our current property and casualty catastrophe reinsurance programsprovide coverage for both “certified” and “non-certified” events as definedunder the Terrorism Act provided such losses are not the result of a nuclear,biological, chemical or radiological terrorist attack, or for “certified” actscommitted by an individual or individuals acting on behalf of any foreignperson or foreign interest. See “Business—Reinsurance Protection andCatastrophe Management.”

 

We closely monitor and manage our concentration of risk by geographicarea. Our guideline is to control our exposures so that our total maximumexpected loss from a likely terrorism event within any half-mile radius in ametropolitan area or around a target risk will not exceed $200 million, or$300 million in all other areas. Reports monitoring our terrorismexposures are generated quarterly, and the exposure of potential new businesslocated in areas of existing concentration or that individually presentsignificant exposure is evaluated during the underwriting process. As a result,we believe that we have taken appropriate actions to limit our exposure tolosses from terrorist attacks and will continue to monitor our terrorism exposure in the future. Nonetheless, risksinsured by us, including those covered by the Terrorism Act, remain exposed toterrorist attacks and the possibility remains that losses resulting from futureterrorist attacks could prove to be material.

 

We expect that theCommercial Lines Transaction will reduce the terrorism exposure profile as thisbusiness runs off throughout 2010.

 

**Lossand LAE Reserves**

 

We establish loss and LAE reserves that are estimates of amounts neededto pay claims and related expenses in the future for insured events that havealready occurred. The process of estimating reserves involves a considerabledegree of judgment by management and, as of any given date, is inherentlyuncertain. See “Management’s Discussion and Analysis of Financial Condition andResults of Operations—Critical Accounting Estimates.”

 

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The following tables summarize our loss and LAE reserve activities forthe years ended December 31, 2009, 2008 and 2007:

 

| **Year ended December 31, 2009**                            | ** ** | ** **                | **Insurance  Operations** | ** ** | **Other  Operations(1)** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------------------|------------|---------------------------|---------------------------|------------|--------------------------|------------|------------------|------------|
| ** **                                                       | ** ** | **($ in  millions)** | ** **                |
| Gross beginning balance                                          |       | $                         | 4,504.5                   |       | $                        | (210.5     | )                | $          | 4,294.0 |   |
| Less beginning reinsurance recoverable on unpaid  losses         |       | (2,708.4                  | )                         | 205.1      |                     | (2,503.3   | )                |
| Net loss and LAE reserves                                        |       | 1,796.1                   |                      | (5.4       | )                        | 1,790.7    |             |
| Loss and LAE incurred relating to:                               |       |                      |                      |       |                     |       |             |
| Current year losses                                              |       | 1,205.3                   |                      | —     |                     | 1,205.3    |             |
| Prior year losses                                                |       | (83.4                     | )                         | —     |                     | (83.4      | )                |
| Total incurred loss and LAE                                      |       | 1,121.9                   |                      | —     |                     | 1,121.9    |             |
| Accretion of fair value adjustment to net loss and  LAE reserves |       | —                    |                      | 5.4        |                     | 5.4        |             |
| Loss and LAE paid relating to:                                   |       |                      |                      |       |                     |       |             |
| Current year losses                                              |       | (499.3                    | )                         | —     |                     | (499.3     | )                |
| Prior year losses                                                |       | (676.8                    | )                         | —     |                     | (676.8     | )                |
| Total loss and LAE payments                                      |       | (1,176.1                  | )                         | —     |                     | (1,176.1   | )                |
| Net ending balance                                               |       | 1,741.9                   |                      | —     |                     | 1,741.9    |             |
| Plus ending reinsurance recoverable on unpaid  losses            |       | 2,383.4                   |                      | (190.5     | )                        | 2,192.9    |             |
| Gross ending balance                                             |       | $                         | 4,125.3                   |       | $                        | (190.5     | )                | $          | 3,934.8 |   |

 

| **Year ended December 31, 2008**                            | ** ** | ** **                | **Insurance  Operations** | ** ** | **Other  Operations(1)** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------------------|------------|---------------------------|---------------------------|------------|--------------------------|------------|------------------|------------|
| ** **                                                       | ** ** | **($ in  millions)** | ** **                |
| Gross beginning balance                                          |       | $                         | 4,718.8                   |       | $                        | (238.5     | )                | $          | 4,480.3 |   |
| Less beginning reinsurance recoverable on unpaid  losses         |       | (2,850.6                  | )                         | 221.1      |                     | (2,629.5   | )                |
| Net loss and LAE reserves                                        |       | 1,868.2                   |                      | (17.4      | )                        | 1,850.8    |             |
| Loss and LAE incurred relating to:                               |       |                      |                      |       |                     |       |             |
| Current year losses                                              |       | 1,188.2                   |                      | —     |                     | 1,188.2    |             |
| Prior year losses                                                |       | (62.0                     | )                         | —     |                     | (62.0      | )                |
| Total incurred loss and LAE                                      |       | 1,126.2                   |                      | —     |                     | 1,126.2    |             |
| Accretion of fair value adjustment to net loss and  LAE reserves |       | —                    |                      | 12.0       |                     | 12.0       |             |
| Loss and LAE paid relating to:                                   |       |                      |                      |       |                     |       |             |
| Current year losses                                              |       | (495.1                    | )                         | —     |                     | (495.1     | )                |
| Prior year losses                                                |       | (703.2                    | )                         | —     |                     | (703.2     | )                |
| Total loss and LAE payments                                      |       | (1,198.3                  | )                         | —     |                     | (1,198.3   | )                |
| Net ending balance                                               |       | 1,796.1                   |                      | (5.4       | )                        | 1,790.7    |             |
| Plus ending reinsurance recoverable on unpaid  losses            |       | 2,708.4                   |                      | (205.1     | )                        | 2,503.3    |             |
| Gross ending balance                                             |       | $                         | 4,504.5                   |       | $                        | (210.5     | )                | $          | 4,294.0 |   |

 

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| **Year ended December 31, 2007**                            | ** ** | ** **                | **Insurance  Operations** | ** ** | **Other  Operations(1)** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------------------|------------|---------------------------|---------------------------|------------|--------------------------|------------|------------------|------------|
| ** **                                                       | ** ** | **($ in  millions)** | ** **                |
| Gross beginning balance                                          |       | $                         | 5,108.2                   |       | $                        | (270.5     | )                | $          | 4,837.7 |   |
| Less beginning reinsurance recoverable on unpaid  losses         |       | (3,079.7                  | )                         | 237.1      |                     | (2,842.6   | )                |
| Net loss and LAE reserves                                        |       | 2,028.5                   |                      | (33.4      | )                        | 1,995.1    |             |
| Loss and LAE incurred relating to:                               |       |                      |                      |       |                     |       |             |
| Current year losses                                              |       | 1,138.1                   |                      | —     |                     | 1,138.1    |             |
| Prior year losses                                                |       | (48.3                     | )                         | —     |                     | (48.3      | )                |
| Total incurred loss and LAE                                      |       | 1,089.8                   |                      | —     |                     | 1,089.8    |             |
| Accretion of fair value adjustment to net loss and  LAE reserves |       | —                    |                      | 16.0       |                     | 16.0       |             |
| Loss and LAE paid relating to:                                   |       |                      |                      |       |                     |       |             |
| Current year losses                                              |       | (527.1                    | )                         | —     |                     | (527.1     | )                |
| Prior year losses                                                |       | (723.0                    | )                         | —     |                     | (723.0     | )                |
| Total loss and LAE payments                                      |       | (1,250.1                  | )                         | —     |                     | (1,250.1   | )                |
| Net ending balance                                               |       | 1,868.2                   |                      | (17.4      | )                        | 1,850.8    |             |
| Plus ending reinsurance recoverable on unpaid  losses            |       | 2,850.6                   |                      | (221.1     | )                        | 2,629.5    |             |
| Gross ending balance                                             |       | $                         | 4,718.8                   |       | $                        | (238.5     | )                | $          | 4,480.3 |   |

 

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(1)                                  In connectionwith purchase accounting for the OneBeacon Acquisition, we were required toadjust to fair value our loss and LAE reserves and the related reinsurancerecoverables by $646.9 million and $346.9 million, respectively, onour acquired balance sheet as of June 1, 2001. This net reduction to lossand LAE reserves of $300.0 million is being accreted through an incomestatement charge ratably with and over the period the claims are settled.

 

The following information presents (1) our reserve developmentover the preceding 10 years and (2) a reconciliation of reserves inaccordance with accounting principles and practices prescribed or permitted byinsurance authorities (statutory basis) to such reserves determined inaccordance with GAAP, each as prescribed by Securities Act Industry Guide No. 6.

 

Section I of the 10-year table shows the estimated liability thatwas recorded at the end of each of the indicated years for all current andprior accident year unpaid loss and LAE. The liability represents the estimatedamount of loss and LAE for claims that were unpaid at the balance sheet date,including incurred but not reported, or IBNR, reserves. In accordance withGAAP, the liability for unpaid loss and LAE is recorded in the balance sheetgross of the effects of reinsurance with an estimate of reinsurancerecoverables arising from reinsurance contracts reported separately as anasset. The net balance represents the estimated amount of unpaid loss and LAEoutstanding as of the balance sheet date, reduced by estimates of amountsrecoverable under reinsurance contracts.

 

Section II shows the cumulative amount of net loss and LAE paidrelating to recorded liabilities as of the end of each succeeding year. Section IIIshows the re-estimated amount of the previously recorded net liability as ofthe end of each succeeding year. Estimates of the liability for unpaid loss andLAE are increased or decreased as payments are made and more informationregarding individual claims and trends, such as overall frequency and severitypatterns, becomes known. Section IV shows the cumulative net(deficiency)/redundancy representing the aggregate change in the liability fromoriginal balance sheet dates and the re-estimated liability through December 31,2009. Section V shows the re-estimated gross liability and re-estimatedreinsurance recoverables through December 31, 2009. Section VI showsthe cumulative gross (deficiency)/redundancy representing the aggregate changein the liability from original balance sheet dates and the re-estimatedliability through December 31, 2009.

 

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| ** **                                                                                                                                                                      | ** ** | **Insurance  Operations Loss and LAE (1)(2)  Year ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                                                                                                                                                                      | ** ** | **1999**                                                               | ** ** | **2000** | ** ** | **2001** | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** | **2006** | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** |
|                                                                                                                                                                            |       | **($ in  millions)**                                              |       |
| I.              Liability for unpaid loss and LAE:                                                             |       |                                                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Gross  balance                                                                                                                                                                  |       | $                                                                      | 6,276.0    |   | $ | 6,875.4 |   | $ | 8,320.2 |   | $ | 7,507.0 |   | $ | 6,109.0 |   | $ | 5,328.2 |   | $ | 5,713.4 |   | $ | 5,108.2 |   | $ | 4,718.8 |   | $ | 4,504.5 |   | $ | 4,125.3 |   |
| Less  reinsurance recoverable on unpaid loss and LAE                                                                                                                            |       | (1,262.7                                                               | )          | (1,252.1 | ) | (3,591.5 | ) | (3,534.4 | ) | (2,954.8 | ) | (2,670.9 | ) | (3,382.0 | ) | (3,079.7 | ) | (2,850.6 | ) | (2,708.4 | ) | (2,383.4 | ) |
| Net  balance                                                                                                                                                                    |       | $                                                                      | 5,013.3    |   | $ | 5,623.3 |   | $ | 4,728.7 |   | $ | 3,972.6 |   | $ | 3,154.2 |   | $ | 2,657.3 |   | $ | 2,331.4 |   | $ | 2,028.5 |   | $ | 1,868.2 |   | $ | 1,796.1 |   | $ | 1,741.9 |   |
| II.           Cumulative amount of net liability paid  through:                                                               |       |                                                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 1 year  later                                                                                                                                                              |       | 1,938.1                                                                |       | 1,965.3 |   | 1,851.6 |   | 1,610.2 |   | 1,421.1 |   | 1,146.7 |   | 1,004.6 |   | 772.0 |   | 700.9 |   | 681.2 |   |   |   |
| 2 years  later                                                                                                                                                             |       | 3,065.1                                                                |       | 3,153.0 |   | 3,039.5 |   | 2,764.2 |   | 2,274.5 |   | 1,833.5 |   | 1,547.8 |   | 1,227.3 |   | 1,114.5 |   |   |   |   |   |
| 3 years  later                                                                                                                                                             |       | 3,824.9                                                                |       | 3,984.7 |   | 3,963.6 |   | 3,489.6 |   | 2,809.9 |   | 2,264.2 |   | 1,897.6 |   | 1,540.0 |   |   |   |   |   |   |   |
| 4 years  later                                                                                                                                                             |       | 4,330.3                                                                |       | 4,596.8 |   | 4,529.5 |   | 3,941.0 |   | 3,135.9 |   | 2,536.1 |   | 2,131.1 |   |   |   |   |   |   |   |   |   |
| 5 years  later                                                                                                                                                             |       | 4,666.9                                                                |       | 4,957.3 |   | 4,876.0 |   | 4,209.3 |   | 3,347.5 |   | 2,713.6 |   |   |   |   |   |   |   |   |   |   |   |
| 6 years  later                                                                                                                                                             |       | 4,887.2                                                                |       | 5,194.4 |   | 5,092.4 |   | 4,385.4 |   | 3,487.6 |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 7 years  later                                                                                                                                                             |       | 5,044.7                                                                |       | 5,351.0 |   | 5,233.9 |   | 4,508.5 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 8 years  later                                                                                                                                                             |       | 5,149.1                                                                |       | 5,461.4 |   | 5,343.1 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 9 years  later                                                                                                                                                             |       | 5,228.5                                                                |       | 5,549.5 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 10 years  later                                                                                                                                                            |       | 5,297.7                                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| III.        Net Liability re-estimated as of:                                                                                                |       |                                                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 1 year  later                                                                                                                                                              |       | 5,829.0                                                                |       | 4,730.8 |   | 4,781.3 |   | 4,110.3 |   | 3,253.4 |   | 2,763.2 |   | 2,354.3 |   | 1,980.2 |   | 1,806.2 |   | 1,712.7 |   |   |   |
| 2 years  later                                                                                                                                                             |       | 4,942.0                                                                |       | 4,824.2 |   | 5,059.4 |   | 4,227.0 |   | 3,380.4 |   | 2,765.5 |   | 2,387.2 |   | 1,932.5 |   | 1,724.2 |   |   |   |   |   |
| 3 years  later                                                                                                                                                             |       | 4,927.0                                                                |       | 5,294.3 |   | 5,143.8 |   | 4,344.8 |   | 3,396.2 |   | 2,852.7 |   | 2,350.7 |   | 1,873.4 |   |   |   |   |   |   |   |
| 4 years  later                                                                                                                                                             |       | 5,221.8                                                                |       | 5,336.0 |   | 5,222.8 |   | 4,365.1 |   | 3,520.4 |   | 2,835.1 |   | 2,316.0 |   |   |   |   |   |   |   |   |   |
| 5 years  later                                                                                                                                                             |       | 5,165.8                                                                |       | 5,383.6 |   | 5,244.3 |   | 4,497.0 |   | 3,521.5 |   | 2,839.4 |   |   |   |   |   |   |   |   |   |   |   |
| 6 years  later                                                                                                                                                             |       | 5,197.2                                                                |       | 5,385.8 |   | 5,372.8 |   | 4,501.3 |   | 3,520.5 |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 7 years  later                                                                                                                                                             |       | 5,169.2                                                                |       | 5,490.1 |   | 5,372.9 |   | 4,513.4 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 8 years  later                                                                                                                                                             |       | 5,242.0                                                                |       | 5,492.0 |   | 5,386.1 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 9 years  later                                                                                                                                                             |       | 5,335.4                                                                |       | 5,506.8 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 10 years  later                                                                                                                                                            |       | 5,349.6                                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| IV.        Cumulative net (deficiency)/  redundancy(3)                                                                                       |       | $                                                                      | (336.3     | ) | $ | 116.5 |   | $ | (657.4 | ) | $ | (540.8 | ) | $ | (366.3 | ) | $ | (182.1 | ) | $ | 15.4 |   | $ | 155.1 |   | $ | 144.0 |   | $ | 83.4 |   |   |   |
| Percent  (deficient)/ redundant                                                                                                                                                 |       | (6.7                                                                   | )%         | 2.1 | % | (13.9 | )% | (13.6 | )% | (11.6 | )% | (6.9 | )% | 0.7 | % | 7.6 | % | 7.7 | % | 4.6 | % |   |   |
| 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                                                                                                                                   |       | $                                                                      | 9,471.2    |   | $ | 9,690.1 |   | $ | 10,005.4 |   | $ | 9,078.2 |   | $ | 7,400.0 |   | $ | 6,347.5 |   | $ | 5,711.7 |   | $ | 4,934.6 |   | $ | 4,557.4 |   | $ | 4,412.7 |   |   |   |
| Reinsurance  recoverable latest re-estimate                                                                                                                                     |       | (4,121.6                                                               | )          | (4,183.3 | ) | (4,619.3 | ) | (4,564.8 | ) | (3,879.5 | ) | (3,508.1 | ) | (3,395.7 | ) | (3,061.2 | ) | (2,833.2 | ) | (2,700.0 | ) |   |   |
| Net  unpaid loss and LAE latest re-estimate                                                                                                                                     |       | $                                                                      | 5,349.6    |   | $ | 5,506.8 |   | $ | 5,386.1 |   | $ | 4,513.4 |   | $ | 3,520.5 |   | $ | 2,839.4 |   | $ | 2,316.0 |   | $ | 1,873.4 |   | $ | 1,724.2 |   | $ | 1,712.7 |   |   |   |
| VI.        Cumulative Gross (deficiency)/redundancy                                                                                          |       | $                                                                      | (3,195.2   | ) | $ | (2,814.7 | ) | $ | (1,685.2 | ) | $ | (1,571.2 | ) | $ | (1,291.0 | ) | $ | (1,019.3 | ) | $ | 1.7 |   | $ | 173.6 |   | $ | 161.4 |   | $ | 91.8 |   |   |   |
| Percent  (deficient)/ redundant                                                                                                                                                 |       | (50.9                                                                  | )%         | (40.9 | )% | (20.3 | )% | (20.9 | )% | (21.1 | )% | (19.1 | )% | 0.0 | % | 3.4 | % | 3.4 | % | 2.0 | % |   |   |

 

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(1)                                  This tablereflects the effects of the NICO Cover and the GRC Cover as if they had been ineffect for all periods presented.

 

(2)                                  The 10-yeartable is reflective of activity related to our loss and LAE reserves from ourInsurance Operations segment and does not include the effect of any reserveactivity from the affiliate quota share agreements or other operations.Affiliate quota shares refer to two quota share reinsurance agreements weentered into with subsidiaries of White Mountains primarily for White Mountains’capital management purposes. These agreements were commuted in the fourthquarter of 2006 in connection with OBIG’s initial public offering.

 

(3)                                  Our December 31,2008 net liability for unpaid loss and LAE for our Insurance Operations segmentre-estimated as of one year later resulted in a net redundancy of$83.4 million.

 

The cumulative net redundancy/(deficiency) in the table above reflectsreinsurance recoverables recorded under the NICO Cover and the GRC Cover. Thesecovers apply to losses incurred in 2000 and prior years. As a result, they havethe effect of significantly increasing our reinsurance recoverables in 2001 andreducing our net reserve deficiency for each of the years presented prior to2001 by the amount of the gross reserves ceded at the time these covers werepurchased. See “Management’s Discussion and Analysis of Financial Condition andResults of Operations—Critical Accounting Estimates.”

 

In 2005, weincreased our best estimate of gross losses related to the NICO contract by$841 million ($353 million net of other third party reinsurance) as a result ofa study of our A&E exposures. This had the effect of increasing the grossreserve deficiency for calendar years 2004 and prior. During 2008, wecompleted a new study of our A&E exposures. This

 

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did not result in asignificant change to our best estimate of gross losses related to the NICOcontract. As a result of the study, we increased our best estimate ofincurred losses ceded to NICO, net of underlying reinsurance, by $83.4million. See “Management’s Discussion and Analysis of Financial Conditionand Results of Operations—Critical Accounting Estimates.”

 

The following table reconciles loss and LAE reserves for our InsuranceOperations determined on a statutory basis to loss and LAE reserves determinedin accordance with GAAP at December 31, as follows:

 
| ** **                                  | ** ** | **December 31,**    | ** ** |
|---------------------------------------------|------------|--------------------------|------------|
| ** **                                  | ** ** | **2009**                 | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                  | ** ** | **($ in millions)** | ** ** |
| Statutory reserves                          |       | $                        | 3,285.4    |   | $ | 3,465.0 |   | $ | 3,564.5 |   |
| Reinsurance recoverable on unpaid losses(1) |       | 866.9                    |       | 1,073.9 |   | 1,190.9 |   |
| Other(2)                                    |       | (27.0                    | )          | (34.4 | ) | (36.6 | ) |
| GAAP reserves                               |       | $                        | 4,125.3    |   | $ | 4,504.5 |   | $ | 4,718.8 |   |

 

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

 

(2)                                  Representslong-term workers compensation loss and LAE reserve discount in excess ofstatutorily defined discount.

 

**OtherOperations**

 

Our Other Operations segment consists of the activities of our holdingcompany, OBH. Our Other Operations segment primarily consists of financingactivities, purchase accounting adjustments relating to the OneBeaconAcquisition, other assets and liabilities, and general and administrativeexpenses incurred at the holding company level.

 

In May 2003, OBH issued $700.0 million face value of seniorunsecured notes (the Senior Notes) through a public offering, at an issue priceof 99.7%. The Senior Notes bear an annual interest rate of 5.875%, payablesemi-annually in arrears on May 15 and November 15, until maturity onMay 15, 2013. During 2009, OBH repurchased $10.6 million of outstandingSenior Notes for $8.1 million,which resulted in a $2.5 million gain. During 2009, OBICpurchased $58.3 million of outstanding Senior Notes for $55.0 million, whichresulted in a $2.9 million gain. During 2008, OBH repurchased $24.0 million ofthe outstanding Senior Notes for $22.3 million, which resulted in a $1.6million gain.

 

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 WhiteMountains a specified fee in the amount of 25 basis points per annum on theoutstanding principal amount of the Senior Notes. We have further agreed thatif White Mountains’ voting interest in OBIG ceases to represent more than 50%of all OBIG’s 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 and Analysis ofFinancial Condition and Results of Operations—Financing”.

 

As part of the financing for the OneBeacon Acquisition, BerkshireHathaway, Inc. (Berkshire) invested a total of $300 million in cash,of which (1) $225 million was for the purchase of cumulativenon-voting preferred stock of OBH (the Berkshire Preferred Stock), which had a$300 million redemption value; and (2) $75 million was for thepurchase of warrants to acquire 1,724,200 common shares of White Mountains. TheBerkshire Preferred Stock was entitled to a dividend of no less than 2.35% perquarter through May 31, 2008. The Berkshire Preferred Stock was redeemedin the second quarter of 2008 for $300 million, its redemption value.

 

In connection with OBIG’s initial public offering and as part of thereorganization at White Mountains, we created an irrevocable grantor trust andfunded it with assets sufficient to provide for the remaining dividend andredemption payments for the $300 million Berkshire Preferred Stock. Thecreation and funding of the trust did not legally defease the preferred stocknor create any additional rights for the holder of the preferred stock eitherin the trust or otherwise, although the assets in the trust were segregatedfrom our other general assets and were not available for any use other than thepayment of the Berkshire Preferred Stock. The assets held in trust were used toredeem the Berkshire Preferred Stock in May 2008 for $300 million, itsredemption value. See “Management’s Discussion and Analysis of FinancialCondition and Results of Operations—Economic Defeasance”.

 

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**Investments**

 

*Overview*

 

Our long-term investment philosophy has historically been to maximizeour after tax total risk-adjusted return. Under this approach, each dollar ofafter tax investment income and realized and unrealized gains and losses isvalued equally. In the second half of 2008, we shifted our investmentphilosophy from a total return focus to a capital preservation focus inresponse to the significant declines and high volatility in equity markets, the lack ofliquidity in the credit markets and the widening of credit spreads on fixedincome securities. In particular, we significantly reduced the size of ourequity portfolio and now have a larger percentage of our invested assets incash and short-term investments than we have in the past under a total returnapproach. As overall financial markets and our investment results continue tostabilize, we are gradually shifting back from a focus on capital preservationto our traditional total return investment philosophy.

 

Our investment portfolios are managed under agreements with WhiteMountains Advisors LLC (WM Advisors) a registered investment advisor thatis owned by White Mountains, and Prospector Partners, LLC (Prospector), aregistered investment advisor. See Note 16—“Related Party Disclosures” ofthe accompanying consolidated financial statements. Our investment portfoliomix as of December 31, 2009 consisted in large part of high quality, fixedmaturity investments and short-term investments, as well as a smallerallocation to equity investments which are comprised of common stock,convertible bonds and other investments such as hedge funds and private equityfunds. Our management believes that prudent levels of investments in commonequity securities, convertible bonds and other investments within ourinvestment portfolio are likely to enhance long-term after tax total returnswithout significantly increasing the risk profile of the portfolio.

 

*Fixed Income and Other Investments*

 

WM Advisors manages our fixed income portfolio, which includes bothfixed maturity and short-term investments, and our other investments portfolio.WM Advisors’ overall fixed maturity investment strategy is to purchasesecurities that are attractively priced in relation to credit risks. WMAdvisors generally manages the interest rate risk associated with holding fixedmaturity investments by actively maintaining the average duration of theportfolio to achieve an adequate after tax total return without subjecting theportfolio to an unreasonable level of interest rate risk.

 

*CommonStock and Convertible Bonds*

 

Prospector managesour common stock and convertible bond portfolios. Prospector’s investmentstrategy is to maximize absolute total return through investments in a varietyof equity, equity-related and convertible bond 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.

 

*SecuritiesLending*

 

We participated in asecurities lending program as a mechanism for generating additional investmentincome on our fixed maturity and common equity portfolios. Under the securitieslending arrangements, certain of our fixed maturity and common equityinvestments were loaned to other institutions for short periods of time througha lending agent. We maintained control over the securities we loaned, retainedthe earnings and cash flows associated with the loaned securities and receiveda fee from the borrower for the temporary use of the asset. Collateral, in theform of cash and United States government securities, was required at a rate of102% of the fair value of the loaned securities. An indemnification agreementwith the lending agent protected us in the event a borrower became insolvent orfailed to return any of the securities on loan. In the event of a shortfall inthe collateral amount required to be returned to the securities lendingcounterparty (e.g., as a result of investment losses), we were obligated tomake up any deficiency.

 

Prior to February 2009,the collateral was controlled by the lending agent. The lending agent managedthe investment of the cash collateral, however, other than in the event ofdefault by the borrower, this collateral was not available to us and wasremitted to the borrower by the lending agent upon the return of the loanedsecurities. Because of these restrictions, we considered our securities lendingactivities to be non-cash transactions. The fair value of the securitieslending collateral was recorded as both an asset and liability on the balancesheet.

 

In February 2009,we amended the terms of the securities lending program to give us more controlover the investment of borrowers’ collateral and to separate the assetssupporting that collateral into a segregated account. Pursuant to theamendment, (i) the guidelines for the investment of any new cashcollateral as well as the reinvestment of cash were narrowed to permitinvestment in only cash equivalent securities, (ii) we have the authorityto direct the lending agent to both 

 

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sell specific collateralsecurities in the segregated account and to not sell certain collateralsecurities which the lending agent proposes to sell, and (iii) we and thelending agent agreed to manage the securities lending program towardan orderly wind-down. In May 2009, we instructed the lending agent not tomake any additional loans of securities and to recall all of the securities onloan and fund the return of collateral to the borrower. As of December 31,2009, $1.7 million in collateral had not been returned to the borrower. As aresult of the actions described above, the securities lending assets are nolonger segregated and are included within our investment securities.

 

At December 31, 2008, prior to the amendment of the terms of thesecurities lending program, the total market value of our securities on loanwas $107.7 million with corresponding collateral of $100.7 million,resulting in an unrealized loss of $7.0 million recorded in change in netunrealized investment gains and losses, a component of net realized andunrealized investment gains (losses). In 2009 prior to exiting the securitieslending program, we recorded $3.9 million of net realized and unrealized gains.Subsequent to exiting the program, we recorded $0.8 million of net realized andunrealized gains on the securities returned to us, resulting in a total of $2.3million of net realized and unrealized losses in connection with our exitingfrom the program. The securities lending program has generated $18.1 million ofadditional investment income for us since inception in 2001.

 

**RegulatoryMatters**

 

*General*

 

Our insurance operations are subject to regulation and supervision ineach of the jurisdictions where they are domiciled and licensed to conductbusiness. Generally, state regulatory authorities have broad supervisory andadministrative powers over such matters as licenses, standards of solvency,premium rates, policy forms, investments, security deposits, methods ofaccounting, form and content of the consolidated financial statements, reservesfor unpaid loss and LAE, reinsurance, minimum capital and surplus requirements,dividends and other distributions to shareholders, periodic examinations andannual and other report filings. In general, such regulation is for theprotection of policyholders rather than shareholders.

 

*State Accreditation and Monitoring*

 

Overthe last several years most states have implemented laws that establishstandards for current, as well as continued, state accreditation. In addition,the National Association of Insurance Commissioners (NAIC) has adoptedrisk-based capital (RBC) standards for property and casualty companies, whichare designed to determine minimum capital requirements and to raise the levelof protection that statutory surplus provides for policyholder obligations. TheRBC formula for property and casualty insurance companies measures three majorareas of risk facing property and casualty insurers: underwriting, whichencompasses the risk of adverse loss developments and inadequate pricing;declines in asset values arising from market and/or credit risk; andoff-balance sheet risk arising from adverse experience from non-controlledassets, guarantees for affiliates or other contingent liabilities and excessivepremium growth. Under laws adopted by individual states, insurers having lesstotal adjusted capital than that required by the RBC calculation will besubject to varying degrees of regulatory action, depending on the level ofcapital inadequacy. Our current RBC ratios are satisfactory.

 

The NAIC has developed a set of financial relationships or tests knownas the Insurance Regulatory Information System to assist state regulators inmonitoring the financial condition of insurance companies and identifyingcompanies that require special attention or action by insurance regulatoryauthorities. Insurance companies generally submit data annually to the NAIC,which in turn analyzes the data using prescribed financial data ratios, eachwith defined “usual ranges.” Generally, regulators will begin to investigate ormonitor an insurance company if its ratios fall outside the usual ranges forfour or more of the ratios. If an insurance company has insufficient capital,regulators may act to reduce the amount of insurance it can issue. We are notaware that any of our insurance companies are currently subject to regulatoryinvestigation based on these ratios.

 

State insurance laws require us to analyze the adequacy of our reservesannually. Our actuaries must submit an opinion that our reserves, whenconsidered in light of the assets we hold with respect to those reserves, makeadequate provision for our contractual obligations and related expenses.

 

Effective January 1,2010, the NAIC adopted amendments to the Annual Financial Reporting ModelRegulation, or the Model Audit Rule (MAR). The amendments to the MARinclude provisions very similar to Sarbanes-Oxley requirements for publiccompanies and require certain insurance companies to appoint audit committeesto oversee accounting and financial reporting processes as well as the audit ofthe financial statements of the insurer. Audit committees also are required toappoint independent auditors, among other things. The designated auditcommittee must receive reports regarding 

 

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significant deficiencies,material weaknesses and solvency concerns at the insurance companylevel. Certain insurance companies also will be required to file amanagement report on internal control over financial reporting annuallybeginning with the fiscal year ending December 31, 2010.

 

Many states have laws and regulations that limit an insurer’s abilityto exit a market. For example, certain states limit a private passengerautomobile insurer’s ability to cancel or renew policies. Furthermore, certainstates prohibit an insurer from withdrawing from one or more lines of insurancebusiness in the state without the state regulator’s approval. State regulatorsmay refuse to approve withdrawal plans on the grounds that they could lead tomarket disruption.

 

*Mandatory Shared Market Mechanisms*

 

As a condition of our license to do business in certain states, we arerequired to participate in mandatory shared market mechanisms. Each statedictates the types of insurance and the level of coverage that must beprovided. The most common type of shared market mechanism in which we arerequired to participate is an assigned risk plan. Many states operate assignedrisk plans. The NYAIP and New Jersey commercial automobile insurance plans aretwo such shared market mechanisms in which we are required to participate. Theseplans require insurers licensed within the applicable state to accept theapplications for insurance policies of customers who are unable to obtaininsurance in the voluntary market. The total number of such policies an insureris required to accept is based on its market share of voluntary business in thestate. Underwriting results related to assigned risk plans are typicallyadverse. Accordingly, we may be required to underwrite policies with a higherrisk of loss than we would otherwise accept.

 

Reinsurance facilities are another type of shared market mechanism.Reinsurance facilities require an insurance company to accept all applicationssubmitted by certain state designated agents. The reinsurance facility thenallows the insurer to cede some of its business to the reinsurance facility sothat the facility will reimburse the insurer for claims paid on ceded business.Typically, however, reinsurance facilities operate at a deficit, which isfunded through assessments against the same insurers. The MassachusettsCommonwealth Automobile Reinsurers is one such reinsurance facility in which weare required to participate.

 

*Guaranty Associations*

 

The insurance laws of many states generally provide that property andcasualty insurers doing business in those states belong to a statutory propertyand casualty guaranty association. The purpose of these guaranty associationsis to protect policyholders by requiring that solvent property and casualtyinsurers pay certain insurance claims of insolvent insurers. These guarantyassociations generally pay these claims by assessing solvent insurersproportionately based on the insurer’s share of voluntary written premiums inthe state. While most guaranty associations provide for recovery of assessmentsthrough rate increases, surcharges or premium tax credits, there is noassurance that insurers will ultimately recover these assessments. At December 31,2009, our aggregate reserve for such assessments totaled $17.2 million.

 

*Pricing, Investment and Dividends*

 

Nearly all states have insurance laws requiring property and casualtyinsurers to file price schedules, policy or coverage forms, and otherinformation with the state’s regulatory authority. In most cases, such priceschedules and/or policy forms must be approved prior to use. While pricing lawsvary from state to state, their objectives are generally to ensure that pricesare adequate, not excessive and not discriminatory. For example, Massachusetts,a state where we have a sizable presence, had previously set virtually allaspects of automobile insurance rates, including agent commissions. While thestate has transitioned to a system of managed competition, existing regulationscontinue to challenge an insurer’s ability to adequately price its product,which often leads to unsatisfactory underwriting results.

 

We are subject to state laws and regulations that require investmentportfolio diversification and that limit the amount of investment in certaincategories. Non-compliance may cause non-conforming investments to benon-admitted in measuring statutory surplus and, in some instances, may requiredivestiture.

 

One of the primary sources of cash inflows for us is dividends receivedfrom our operating subsidiaries. Under the insurance laws of the jurisdictionsunder which our insurance subsidiaries are domiciled, an insurer is restrictedwith respect to the timing or the amount of dividends it may pay without priorapproval by regulatory authorities. During 2009, our first-tier insurancesubsidiaries declared and paid $80.0 million in cash and non-cashdividends to OneBeacon Insurance Group LLC (OneBeacon LLC). Our first tierinsurance subsidiaries have the ability to pay dividends of approximately$157 million to their parent in 2010 without approval of regulatory authorities.

 

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*Holding Company Structure*

 

We are subject to regulation under certain state insurance holdingcompany acts. These regulations contain reporting requirements relating to ourcapital structure, ownership, financial condition and general businessoperations. These regulations also contain special reporting and prior approvalrequirements with respect to certain transactions among affiliates. Since weare an insurance holding company, the domiciliary states of our insurancesubsidiaries impose regulatory application and approval requirements onacquisitions of common shares which may be deemed to confer control over thosesubsidiaries, as that concept is defined under the applicable state laws.Acquisition of as little as 10% of our common shares may be deemed to confercontrol under the insurance laws of some jurisdictions, and the applicationprocess for approval can be extensive and time consuming.

 

*Terrorism*

 

While the federal government does not directly regulate the insurancebusiness, federal legislation and administrative policies affect the insuranceindustry. The Terrorism Act established a federal “backstop” for commercialproperty and casualty losses, including workers compensation, resulting fromacts of terrorism by or on behalf of any foreign person or foreign interest. Asextended in December 2007, the law also covers domestic acts of terrorism.See “Business—Reinsurance Protection and Catastrophe Management” and “—Terrorism”.We are actively complying with the requirements of the Terrorism Act in orderto ensure our ability to be reimbursed by the federal government for any losseswe may incur as a result of future terrorist acts.

 

*Legislation*

 

In addition, legislation has been introduced in recent years that, ifenacted, could result in the state and federal government assuming a moredirect role in the regulation of the insurance industry. Furthermore, a numberof additional enacted and pending state and Federal legislative measures couldlead to increased consolidation and increased competition for business and forcapital in the financial services industry. We cannot predict whether any stateor Federal measures will be adopted to change the nature or scope of theregulation of the insurance business or what effect such measures may have onour insurance operations.

 

*Environmental*

 

Both federal and state laws and regulations govern the environmentalcleanup of contaminated sites by, or for the account of, potentiallyresponsible parties (PRPs). Superfund and comparable state statutes can imposeliability for the entire cost of clean-up upon any responsible party,regardless of fault. The insurance industry in general is involved in extensivelitigation regarding coverage issues arising out of the cleanup of such sitesby insured PRPs and as a result has disputed many such claims. From time totime, comprehensive Superfund reform proposals are introduced in Congress, butnone has yet been enacted. At this time, it remains unclear as to whetherSuperfund reform legislation will be enacted or that any such legislation willprovide for a fair, effective and cost-efficient system for settlement of Superfundrelated claims. The NICO Cover includes coverage for such exposures at ourcompany, however, there can be no assurance that the coverage provided underthe NICO Cover will ultimately prove to be adequate for our incurredenvironmental losses.

 

**Competition**

 

Property and casualty insurance is highly competitive. Our competitorsinclude numerous domestic and international insurers, including regionalcompanies, mutual companies, specialty insurance companies, underwritingagencies and diversified financial services companies, some of which havegreater financial and marketing resources. The more significant competitivefactors for most insurance products we offer are price, product terms andconditions, agency and broker relationships, and claims service. Ourunderwriting principles and dedication to independent distribution partners areunlikely to make us the low-cost provider in most markets. While it is oftendifficult for insurance companies to differentiate their products, we believethat providing superior specialty products to satisfy well-defined marketneeds, relying on agents and brokers who value our targeted expertise, superiorclaims service, we establish our competitive advantage. The continued existenceof carriers operating with lower cost structures places ongoing pressure on ourpricing and terms and conditions, which may impact our ability to compete.

 

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**Ratings**

 

Insurance companies are evaluated by various rating agencies in orderto measure each company’s financial strength. Higher ratings generally indicatefinancial stability and a stronger ability to pay claims. We believe thatstrong ratings are an important factor in the marketing of insurance productsand services to agents and consumers. These financial strength ratings do notrefer to our ability to meet non-insurance obligations and are not arecommendation to purchase or discontinue any policy or contract issued by us.

 

Thefollowing table presents the financial strength ratings assigned to ourprincipal insurance operating subsidiaries as of March 19, 2010.

 
| ** ** | ** ** | **A.M. Best(1)**          | ** ** | **Standard & Poor’s(2)** | ** ** | **Moody’s(3)**   | ** ** | **Fitch(4)**           | ** ** |
|------------|------------|---------------------------|------------|---------------------------------------------|------------|-----------------------|------------|------------------------|------------|
| Rating     |       | “A” (Excellent) |       | “A” (Strong)                      |       | “A2” (Good) |       | “A” (Strong) |       |
| Outlook    |       | Stable                    |       | Watch Negative(5)                           |       | Negative              |       | Negative               |       |

 

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(1)                                  “A” is thethird highest of fifteen financial strength ratings.

 

(2)                                  “A” is thesixth highest of twenty-one financial strength ratings.

 

(3)                                  “A2” is thesixth highest of twenty-one financial strength ratings.

 

(4)                                  “A” is thesixth highest of twenty-one financial strength ratings.

 

(5)                                  Placed on WatchNegative on February 2, 2010.

 

The 5.875% Senior Notes due 2013 of OBH are currently rated “bbb” (Good,the ninth highest of twenty-two creditworthiness ratings) with a stable outlookby A.M. Best, “BBB” (Adequate, the ninth highest of twenty-twocreditworthiness ratings) on watch negative by Standard & Poor’s, “Baa2”(Medium Grade, the ninth highest of twenty-one creditworthiness ratings) with anegative outlook by Moody’s, and “BBB” (Good, the ninth highest of twenty-threecreditworthiness ratings) with a negative outlook by Fitch.

 

**Employees**

 

As of December 31, 2009, we employed approximately 2,100 persons.We believe that we have satisfactory relations with our employees.

 

**AVAILABLEINFORMATION**

 

In May 2003, OBH issued $700 million of public notes pursuantto a Form S-3 filing made jointly by White Mountains and OBH. Prior toOBIG’s initial public offering, OBH was exempt from filing its own annual andquarterly reports with the Securities and Exchange Commission (SEC). Condensedconsolidating financial information for OBH was included in White Mountains’ Form 10-Kand Form 10-Q filings. Subsequent to OBIG’s initial public offering, OBHis subject to the informational reporting requirements of the SecuritiesExchange Act of 1934. In accordance therewith, we file reports and otherinformation with the SEC. These documents are available free of charge at www.onebeacon.comas soon as reasonably practicable after such material is electronically filedwith or furnished to the SEC. In addition, the Code of Business Conduct as wellas the charters of the Board Committees of our ultimate parent, OBIG, are availablefree of charge at www.onebeacon.com.

 

We will provide, upon request and without charge, copies of thesedocuments (excluding any applicable exhibits unless specifically requested).Written or telephone requests should be directed to Investor Relations,OneBeacon Insurance Group, Ltd., 1 Beacon Lane, Canton,MA 02021, (877) 248-8765. Additionally, all such documents arephysically available at the Company’s headquarters at 1 Beacon Lane,Canton, MA 02021.

 

**ITEM1A.  RISK FACTORS**

 

The information contained in this report may contain “forward-lookingstatements” within the meaning of Section 27A of the Securities Act of1933 and Section 21E of the Securities Exchange Act of 1934. *See***“FORWARD-LOOKINGSTATEMENTS”** (page 76) *forspecific important factors that could cause actual results to differ materiallyfrom those contained in forward-looking statements.* The Company’sactual future results and trends may differ materially depending on a varietyof factors including, but not limited to, the risks and uncertainties discussedbelow.

 

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**Risks Relating to Our Business**

 

***Our loss reserves may be inadequateto cover our ultimate liability for losses and as a result our financialresults could be adversely affected.***

 

We are required to maintain adequate reserves to cover our estimatedultimate liabilities for loss and LAE. Loss and LAE 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 IBNR reserves, which include a provision for expected futuredevelopment on case reserves. These reserves are estimates based on actuarial,claims and underwriting assessments 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 LAE reserves,we cannot be certain that our reserves are adequate and actual claims and claimexpenses paid might exceed our reserves due to the uncertainties that surroundestimating loss and LAE reserves. For example, we have a large number ofworkers compensation permanent disability claims. These claims involve medicalpayments that will be made far into the future and therefore the impact ofmedical inflation including increased utilization could have a material adverseimpact on the ultimate amount of losses paid.

 

We had established gross loss and LAE reserves of $3,934.8 million and$4,294.0 million as of December 31, 2009 and 2008, respectively. For theyears ended December 31, 2009, 2008, and 2007, we recorded favorable lossreserve development of $83.4 million, $62.0 million and $48.3 million,respectively, net of reinsurance, related to the re-estimation of previouslyestablished reserves.

 

If in the future we determine that our reserves are insufficient tocover our actual loss and LAE, we would have to strengthen our reserves, whichcould have a material adverse effect on our financial condition and results ofoperations.

 

For additional information relating to loss and LAE reserverequirements, see “Regulatory Matters.” For further discussion of our loss andLAE reserves, including our A&E reserves, see “Business—Loss and LAEReserves” and “Management’s Discussion and Analysis of Financial Condition andResults of Operations—Critical Accounting Estimates.”

 

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

 

Estimating our exposure to A&E claims is subject to a particularlyhigh degree of uncertainty. If we have not established adequate loss and LAEreserves to cover future claims, our financial condition and results ofoperations could be materially adversely affected.

 

To help protect against potential A&E claims relating to the periodprior to 2001, we have a reinsurance contract from NICO, rated “AA+” (VeryStrong, the second highest of twenty-one financial strength ratings) byStandard & Poor’s and “A++” (Superior, the highest of fifteenfinancial strength ratings) by A.M. Best. We refer to this reinsurancecontract as the NICO Cover. Under the NICO Cover, we are entitled to recover upto $2.5 billion from NICO for (1) all asbestos claims arising frombusiness written by us in 1992 and prior, (2) all environmental claimsarising from business written by us in 1987 and prior, and (3) certainother latent exposures. In September 2008, we completed a study of ourA&E exposures. Based on the study, we increased our best estimate ofincurred losses ceded to NICO, net of underlying reinsurance, by $83.4 millionto $2.2 billion. See “Management’s Discussion and Analysis of FinancialCondition and Results of Operations—Insurance Operations—Year ended December 31,2008 versus year ended December 31, 2007—Asbestos and EnvironmentalExposures”.  As of December 31,2009, we have ceded estimated incurred losses of approximately $2.2 billionto the NICO Cover, leaving remaining protection under the NICO Cover of$320.2 million. Net losses paid totaled $1.2 billion as of December 31,2009, with $118.0 million paid in 2009. Due to exclusions in policy languageand changes 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, 2009, we had established gross loss and LAEreserves for asbestos claims of $985.6 million. Approximately 99% of theseloss and LAE reserves are covered under reinsurance arrangements. Our net lossand LAE reserves for asbestos claims after giving effect to third partyreinsurance other than the NICO Cover was $688.8 million at December 31,2009. Our net loss and LAE reserves for asbestos claims after giving effect toboth third party reinsurance and the NICO Cover was $6.5 million at December 31,2009.

 

Estimating our future exposure to asbestos claims is subject toconsiderable uncertainty due to tort liability reform in various states, thedifficulty of predicting jury awards in such matters and diverging legalinterpretations and rules in different jurisdictions. These uncertaintiesalso include, among other things:

 

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·                  the extent ofcoverage under insurance policies;

 

·                  whether or not particularclaims are subject to an aggregate limit;

 

·                  the number of occurrencesinvolved in particular claims; and

 

·                  new theories of insured andinsurer liability.

 

The ultimate liability for our asbestos claims remains uncertain andcould exceed the coverage under our reinsurance arrangements and our net lossand LAE reserves.

 

Insurers, including us, experienced an increase in the number of newasbestos-related claims in recent years, in particular in 2002 and 2003. Weexperienced a 12% increase in the number of accounts with asbestos-relatedclaims reported during 2002 as compared to 2001 and another 51% increase in thenumber reported in 2003 from the level reported in 2002. We believe thisincrease was attributable to, among other things, more intensive advertising bylawyers seeking asbestos claimants, the increasing focus by plaintiffs on newand previously peripheral defendants, an acceleration of claims prior to thepotential enactment of U.S. federal asbestos legislation, and an increase inthe number of entities seeking bankruptcy protection as a result ofasbestos-related liabilities. During 2004, we started to experience a decreasein the number of accounts with asbestos-related claims reported with a 37%decrease from the level reported in 2003; however, the number of accounts withasbestos-related claims reported in 2004 was still above levels reported in1999, 2000 and 2001. During 2005, 2006, 2007 and 2008, we experienced a 6%,13%, 15% and 32% decrease, respectively, in the number of accounts withasbestos-related claims reported when compared to the average of the priorthree-year period. During 2009, we experienced an 8% decrease in the number ofaccounts with asbestos-related claims reported when compared to the average ofthe prior three-year period. It is uncertain whether the number of new annualclaims and filings will continue to decrease, remain stable or increase whencompared to prior annual periods. Also, in addition to adding new claims,bankruptcy proceedings may have the effect of significantly accelerating andincreasing loss payments by insurers, including us.

 

Increasingly, policyholders have been asserting that their claims forasbestos-related insurance are not subject to aggregate limits on coverage andthat each individual bodily injury claim should be treated as a separateoccurrence under a policy. Some policyholders who previously sought paymentfrom us for asbestos claims under their products liability coverages, whichwere subject to aggregate limits, have increasingly sought payment from us forasbestos claims under the premises and operations coverages of their liabilitypolicies, which may not be subject to similar aggregate limits. We expect thistrend to continue. To the extent either issue is resolved in favor ofpolicyholders, our coverage obligations under the relevant policies would bematerially increased and capped only by the applicable per occurrence limitsand the number of asbestos bodily injury claims against the policyholders.Claims in these instances may vary significantly and policyholders may seeklarge amounts, although such claims frequently settle for a fraction of theinitial alleged amount. Accordingly, it is difficult to predict the ultimatesize of the claims for coverage not subject to aggregate limits.

 

From time to time in recent years, the United States Congress has givenconsideration to legislative proposals that would address various issuesconnected with asbestos liability. While it is unclear whether any suchproposals will be passed into law at any time in the near future, if at all, wecannot predict what impact, if any, such adopted legislation would have on ourultimate asbestos liability or on the NICO Cover.

 

As of December 31, 2009, we had established gross loss and LAEreserves for environmental claims of $350.7 million. Approximately 98% ofthese loss and LAE reserves are covered under reinsurance arrangements. Our netreserves for environmental claims after giving effect to third partyreinsurance other than the NICO Cover was $218.6 million at December 31,2009. Our net loss and LAE reserves for environmental claims after givingeffect to both third party reinsurance and the NICO Cover was $7.6 millionas of December 31, 2009. Future exposure from environmental claims isuncertain, in part, for reasons similar to those described above for asbestosclaims.

 

As a result of various state and federal laws and regulations relatingto environmental remediation, particularly the Comprehensive EnvironmentalResponse, Compensation, and Liability Act of 1980, which is commonly referredto as Superfund, and related damages claims, the insurance industry continuesto be involved 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 remains uncertain and could exceed thecoverage of our reinsurance arrangements.

 

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***We may not be able to successfullyalleviate risk through reinsurance arrangements. Additionally, we may be unableto collect all amounts due from our reinsurers under our existing reinsurancearrangements.***

 

We attempt to limit our risk of loss through reinsurance arrangements.The availability and cost of reinsurance protection is subject to marketconditions, which are outside of our control. In addition, the coverage underour reinsurance contracts may be inadequate to cover our future liabilities. Asa result, we may not be able to successfully alleviate risk through thesearrangements, which could have a material adverse effect on our financialcondition and results of operations.

 

We are not relieved of our obligations to our policyholders bypurchasing reinsurance. Accordingly, we are subject to credit risk with respectto our reinsurance in the event that a reinsurer is unable to pay amounts owedto us as a result of a deterioration in its financial condition. A number ofreinsurers in the industry experienced such deterioration in the aftermath ofthe 2001 terrorist attacks and the active 2005 hurricane season. To mitigatethis risk, we annually review and periodically monitor our reinsurers’financial condition and require at the time of purchase of reinsurance thateach of our reinsurers holds a rating of at least “A-” (Excellent, the fourthhighest of fifteen financial strength ratings) by A. M. Best or theequivalent.  While we believe that ourreinsurers’ financial condition is strong, it is possible that one or more ofour reinsurers will be significantly adversely affected by future significantloss events, causing them to be unable to pay amounts owed to us. We also maybe unable to recover amounts due under our reinsurance arrangements if ourreinsurers choose to withhold payment due to a dispute or other factors beyondour control.

 

***Unpredictable catastrophic events could adverselyaffect our financial condition or results of operations.***

 

We write insurance policies that cover catastrophic events. Ourpolicies cover unpredictable natural and other disasters, such as hurricanes,windstorms, earthquakes, floods, fires, explosions and severe winter weather.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.Some extremely remote modeled catastrophic events, or series of catastrophicevents, could be of sufficient size to cause us to become insolvent, whichwould adversely affect our financial condition and results of operations. Wealso have significant exposure to a major earthquake in California andwindstorm damage in the United States Atlantic Coast (i.e., Massachusetts toFlorida) and the United States Gulf Coast region (i.e., Florida to Texas). Inaddition, we are exposed to losses from terrorist attacks, such as attacks onthe United States on September 11, 2001.

 

The extent of losses from a catastrophe is a function of both the totalamount of insured exposure in the area affected by the event and the severityof the event. Increases in the value and concentrations of insured property,the effects of inflation and changes in cyclical weather patterns may increasethe severity of claims from catastrophic events in the future. Claims fromcatastrophic events could reduce our earnings and cause substantial volatilityin our results of operations for any fiscal quarter or year and adverselyaffect our financial condition. Our ability to write new insurance policiescould also be impacted as a result of corresponding reductions in our surpluslevels.

 

We manage our exposure to catastrophic losses by limiting the aggregateinsured value of policies in geographic areas with exposure to catastrophicevents, by estimating a probable maximum loss, which we refer to as PML, formany different catastrophe scenarios and by buying reinsurance. To manage andanalyze aggregate insured values and PML, we use a variety of tools, includingcatastrophe modeling software packages. Our estimates of PML are dependent onmany variables, including assumptions about the demand surge and storm surge, lossadjustment expenses, insurance-to-value and storm intensity in the aftermath ofweather-related catastrophes utilized to model the event and the relationshipof the actual event to the modeled event. Accordingly, if our assumptions aboutthese variables are incorrect, the losses we might incur from an actualcatastrophe could be materially higher than our expectation of losses generatedfrom modeled catastrophe scenarios, and our financial condition and results ofoperations could be materially adversely affected. In December 2009, wecompleted the Commercial Lines Transaction. In February 2010, we announcedthe Personal Lines Transaction. The closing of the Personal Lines Transactionis subject to regulatory approvals and is expected to close in the secondquarter of 2010. The Commercial Lines Transaction will reduce our exposure tocatastrophic events and our PML over time as policy terms expire during 2010,while the Personal Lines Transaction will reduce our exposure immediately uponclosing.

 

***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 our future insurancecontracts will cover terrorist acts. We also are unsure how terrorist acts willbe defined in our future contracts. The Terrorism Act, which has been extendedthrough the end of 2014, 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 

 

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TerrorismAct will not be extended for an additional period of time, there is noassurance that it will be extended or of the terms of any such extension. Thefollowing types of coverage are excluded from the program: commercialautomobile, burglary and theft, surety, farmowners, multi-peril and allprofessional liability coverages except directors and officers coverage. Wemanage our exposure to losses resulting from acts of terrorism by limiting ourconcentration of risk by geographic area. We estimate our PML for differentscenarios using computer models in conjunction with other data. We also manageour terrorism exposures by purchasing reinsurance. Our current property andcasualty catastrophe reinsurance programs provide coverage for us for “non-certified”events as defined under the Terrorism Act, provided such losses are not theresult of a nuclear, biological, chemical or radiological terrorist attack.Nonetheless, risks insured by us, including those covered by the Terrorism Act,remain exposed to terrorist attacks and the possibility remains that lossesresulting from future terrorist attacks could prove to be material to ourresults of operations and financial condition.

 

***Our investment portfolio may sufferreduced returns or losses which could adversely affect our results ofoperations and financial condition. Any adverse changes in interest rates orvolatility in the equity or debt markets could result in significant losses inthe fair value of our investment portfolio.***

 

Our investment portfolio consists of fixed maturity securities,convertible bonds, short-term investments, common equity securities and otherinvestments such as hedge funds and private equity funds. Our investmentselections are designed to maximize after tax, total risk-adjusted return overthe long term; however, investing entails substantial risks. We cannot assureyou that we will achieve our investment objectives, and our investmentperformance may vary substantially over time.

 

Investment returns are an important part of our strategy to grow bookvalue, and fluctuations in the fixed income or equity markets could impair ourresults of operations or financial condition. A significant period of timenormally elapses between the receipt of insurance premiums and the disbursementof insurance claims. Duringthis time, we invest our capital and funds allocated to support unpaid loss andLAE reserves. We seek to maximize our total return on these investments throughthe generation of investment income, consisting primarily of interest earned onfixed maturity investments and dividends earned on equity securities, andrealized and unrealized investment gains on the securities we hold in ourinvestment portfolio.

 

The investment income and fair market value of our investment portfolioare affected by general economic and market conditions, including fluctuationsin interest rates and volatility in the stock market. Interest rates are highlysensitive to many factors, including governmental monetary policies, domesticand international economic and political conditions and other factors beyondour control. Although we attempt to manage the risks of changes in interestrates, we may not be able to do so. In particular, a significant increase ininterest rates could result in significant losses, realized or unrealized, inthe fair value of our investment portfolio and, consequently, could have anadverse effect on our results of operations and financial condition.

 

In addition, we are exposed to changes in the level or volatility ofequity 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. During 2008, financial markets experienced an unprecedented level ofvolatility. For the year ended December 31, 2008, we recognized a totalpre-tax investment loss of $589.9 million, primarily due to the downturn in theequities markets. Although we have taken steps to reduce the level of risk inour portfolio by reducing our equity holdings, which are comprised of commonstock, convertible bonds and other investments, from 19% at December 31,2008 to 13% at December 31, 2009, there is no assurance that these stepswill fully protect us from further market downturns and volatility.

 

We are highly dependent on WM Advisors, which is owned by WhiteMountains, and Prospector, in connection with the management of our investmentportfolio. WM Advisors supervises and directs the fixed income and otherinvestments portion of our investment portfolio, and Prospector supervises anddirects the publicly-traded common equity and convertible bonds portion of ourinvestment portfolio. The investment management agreements with each of WMAdvisors and Prospector, entered into in November 2006 in connection withOBIG’s initial public offering, provided for an initial fixed term of threeyears, which was extended by us for an additional two year term. If we lose ourinvestment relationship with WM Advisors or with Prospector, we may not be ableto secure an investment advisor or advisors who will produce returns on ourinvestments similar to these produced by WM Advisors and Prospector in thepast, or any positive returns at all.

 

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***We may not maintain favorablefinancial strength or creditworthiness ratings, which could adversely affectour ability to conduct business.***

 

Third party rating agencies assess and rate the financial strength,including claims-paying ability, of insurers and reinsurers. These ratings arebased upon criteria established by the rating agencies and are subject torevision at any time at the sole discretion of the agencies. Some of thecriteria relate to general economic conditions and other circumstances outsidethe rated company’s control. These financial strength ratings are used bypolicyholders, agents and brokers as an important means of assessing thesuitability of insurers as business counterparties and have become anincreasingly important factor in establishing the competitive position ofinsurance companies. These financial strength ratings do not refer to ourability to meet non-insurance obligations and are not a recommendation topurchase or discontinue any policy or contract issued by us. Generalcreditworthiness ratings are used by existing or potential investors to assessthe likelihood of repayment on a particular debt issue. We believe that strongdebt ratings are important factors that provide better financial flexibilitywhen issuing new debt or restructuring existing debt.

 

Rating agencies periodically evaluate us to confirm that we continue tomeet the criteria of the ratings previously assigned to us. Our currentfinancial strength ratings are “A” (“Excellent,” third highest of fifteenratings) by A. M. Best, “A” (“Strong,” sixth highest of twenty-one ratings) byStandard & Poor’s, “A2” (“Good,” sixth highest of twenty-one ratings)by Moody’s and “A” (“Strong,” sixth highest of twenty-one ratings) by Fitch. Wecurrently have a “Stable” outlook from A.M. Best and as of February 2010are on “Watch Negative” with Standard & Poor’s. In 2009, Fitch changedour outlook from “Stable” to “Negative”, and in February 2010, Moody’salso changed our outlook from “Stable” to “Negative” after placing our ratingunder review for a potential downgrade on December 4, 2009. A downgrade,withdrawal or negative watch/outlook of our financial strength ratings couldseverely limit or prevent our insurance subsidiaries from writing new insurancepolicies or renewing existing insurance policies, which could have a materialadverse effect on our financial condition and results of operations. Adowngrade, withdrawal or negative watch/outlook of our creditworthiness ratingscould severely limit our ability to raise new debt or make new debt more costlyand/or have more restrictive conditions.

 

***Our debt and related service obligations couldadversely affect our business.***

 

As of December 31, 2009, we had $621.1 million face value ofindebtedness. Our ability to meet our debt and related service obligations, aswell as our ability to pay dividends, will depend on our future performance,which will be affected by financial, business, economic, regulatory and otherfactors, many of which are beyond our control. In addition, White Mountains is subject torestrictive financial covenants contained in its revolving credit facilitiesthat require White Mountains to pay the principal and interest on its debt andmaintain specified financial ratios and to satisfy financial conditiontests.  A breach of these covenants couldresult in an event of default under White Mountains’ revolving creditfacilities which would allow lenders to declare all amounts owed under therevolving credit facilities to be immediately due and payable. A failure to payprincipal and interest on White Mountains’ revolving credit facilities wouldtrigger cross acceleration provisions contained in the indentures of our SeniorNotes. We cannot be certain that our earnings will be sufficient to allow us topay the principal and interest on our debt and meet our other obligations, orto repay any accelerated indebtedness as a result of the trigger of the crossacceleration provisions in the indentures of the Senior Notes. If we do nothave enough cash, we may be required to refinance all or part of our existingdebt, sell assets, borrow more cash or sell equity. We cannot assure you thatwe will be able to accomplish any of these alternatives on terms acceptable tous, if at all. See the risk factor concerning our Senior Notes, “Management’sDiscussion and Analysis of Financial Condition and Results ofOperations—Liquidity and Capital Resources—Financing” and Note 16—“RelatedParty Disclosures” of the accompanying consolidated financial statements.

 

We could incur additional indebtedness and issue preferred stock in thefuture. To the extent new debt, preferred stock and other obligations are addedto our and our subsidiaries’ current debt levels, the risks described in theprevious 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 holding company with no direct operations, we rely on netinvestment income and dividends and other permitted payments from oursubsidiaries to pay our expenses. Our subsidiaries may not be able to generatecash flow sufficient to pay a dividend or distribute funds to us. In addition,under the insurance laws of the jurisdictions in which our insurancesubsidiaries are domiciled, an insurer is restricted with respect to the timingor the amount of dividends it may pay without prior approval by regulatoryauthorities. Generally, our regulated operating subsidiaries have the abilityto pay dividends during any 12-month period in an amount equal to the greaterof prior year statutory net income or 10% of prior year statutory surplus,subject to the availability of unassigned funds. As a result, based on 2009statutory surplus, our top tier 

 

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regulatedoperating subsidiaries have the ability to pay approximately $157 million ofdividends during 2010, subject to the availability of unassigned funds. As of December 31,2009, our top tier regulated operating subsidiaries had $1.1 billion ofunassigned funds available for dividend distribution. 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. However, if ourinsurance subsidiaries cannot pay dividends in future periods, we may havedifficulty servicing our debt and meeting our holding company expenses. Foradditional information relating to insurance regulations governing ouroperations, see “Regulatory Matters.”

 

***The property and casualty insuranceindustry is highly competitive and we may not be able to compete effectively inthe future.***

 

The property and casualty insurance industry is highly competitive andhas historically been cyclical, experiencing periods of severe pricecompetition and less selective underwriting standards (soft markets) followedby periods of relatively high prices and more selective underwriting standards(hard markets). We compete with numerous domestic and international insurancecompanies. Many of our competitors have greater financial, marketing andmanagement resources than we do and have established long-term and continuingbusiness relationships throughout the insurance industry, which can be asignificant competitive advantage for them.

 

In addition, we predominantly offer our products through a network ofindependent agents and brokers. These agents and brokers are sometimes able tooffer substantial discounts in pricing through their other markets as comparedto our insurance products. If our distribution partners experience increasedcompetition from other writers of insurance, we in turn could be adverselyaffected if they are unable to maintain our competitive position in theirrespective markets. If we are unable to maintain our competitive positionthroughout soft and hard market cycles, our financial condition and results ofoperations 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 to litigation andother legal proceedings as part of the claims process, the outcomes of whichare uncertain. We maintain reserves for these legal proceedings as part of ourloss and LAE reserves. We also maintain separate reserves for legal proceedingsthat are not related to the claims process. In the event of an unfavorableoutcome in one or more legal matters, our ultimate liability may be in excessof amounts we have currently reserved for and such additional amounts may bematerial to our results of operations and financial condition. As of December 31,2009, we had no material pending legal proceedings.

 

As industry practices and legal, judicial, social and other conditionschange, unexpected and unintended issues related to claims and coverage mayemerge. These issues may adversely affect our financial condition and resultsof operations by either extending coverage beyond our underwriting intent or byincreasing the number and size of claims. In some instances, these changes maynot become apparent until some time after we have issued insurance contractsthat are affected by the changes.

 

***Our profitability may be adverselyimpacted by inflation, legislative actions and judicial decisions.***

 

The effects of inflation could cause claim costs to rise in the future.In addition, legislative actions and judicial decisions continue to broadenliability and policy definitions and to increase the severity of claimpayments, such as described above with respect to A&E claims. To the extentinflation and these legislative actions and judicial decisions cause claimcosts to increase above reserves established for these claims, we will be requiredto increase our loss and LAE reserves with a corresponding reduction in our netincome in the period in which the deficiency is identified.

 

***Regulation may restrict our abilityto operate.***

 

The insurance industry is subject to extensive regulation under U.S.and state laws. Governmental agencies have broad administrative power toregulate many aspects of the insurance business, which include premium rates,marketing practices, advertising, policy forms and capital adequacy. Thesegovernmental agencies are concerned primarily with the protection ofpolicyholders rather than shareholders. Insurance laws and regulations imposerestrictions on the amount and type of investments, prescribe solvencystandards that must be met and maintained and require the maintenance ofreserves. Premium rate regulation is common across all of our lines of businessand may make it difficult for us to increase premiums to adequately reflect thecost of providing insurance coverage to our policyholders. In our underwriting,we rely heavily upon information gathered from third parties such as creditreport agencies and other data aggregators. The use of this information is alsohighly regulated and any changes to the current regulatory structure couldmaterially affect how we underwrite and price premiums.

 

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Changes in laws and regulations may restrict our ability to operateand/or have an adverse effect upon the profitability of our business within agiven jurisdiction. For example, there are efforts underway to federallyregulate financial services companies, which could include insurance companies,including through the establishment of a federal regulatory body or agency.This legislation, if enacted, could result in the Federal government assuming amore direct role in the regulation of the insurance industry. The current U.S.Congress could address the issue of Federal regulation of insurance companies,including issues such as Federal preemption of state insurance regulations aswell as solvency and capital requirements. We cannot predict whether anyFederal legislation will be enacted at all, or if it is enacted, what issues itwill address. Any such legislation could have an effect on our business,results of operations and financial condition.

 

***We may be unable to collect amounts utilized to capitalize reciprocals.***

 

Since 2002, we have capitalized three member-owned, not-for-profitinsurance associations, which we refer to as reciprocals, by loaning money tothem in exchange for surplus notes. As of December 31, 2009, we haveloaned an aggregate of $125.9 million, including $0.2 million loanedin the form of a security deposit, to the three reciprocals, and accrued$62.9 million in interest. These three associations are currentlyconsolidated in our financial statements. As a result, the surplus notes, thesecurity deposit and accrued interest have been eliminated in consolidation. Inthe 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. In November 2009,based upon the availability of surplus and unassigned funds, we submitted anapplication to the New York State Insurance Department to enable us to commencerepayment of the Adirondack Insurance surplus note. As of the date hereof, wehave not received approval to commence repayment. In February 2010, we announced the Personal LinesTransaction. The closing of the Personal Lines Transaction is subject toregulatory approval and is expected to close in the second quarter of 2010. Aspart of the Personal Lines Transaction, we agreed to sell the surplus notes. Asconsideration for the Personal Lines Transaction, we will receive an amountequal to the statutory surplus in the reciprocals, including the par value ofthe surplus notes issued by the reciprocals to us, the GAAP equity in theinsurance companies and attorneys-in-fact, plus $32.5 million.

 

***We depend on our key personnel to manage ourbusiness effectively and they may be difficult to replace.***

 

Our performance substantially depends on the efforts and abilities ofour management team and other executive officers and key employees.Furthermore, much of our competitive advantage is based on the expertise,experience and know-how of our key management personnel. We do not have fixedterm employment agreements with any of our key employees nor key man lifeinsurance, and the loss of one or more of these key employees could adverselyaffect our business, results of operations and financial condition. Our successalso depends on the ability to hire and retain additional key personnel.Difficulty in hiring or retaining key personnel could adversely affect ourresults of operation and financial condition.

 

***Our written premiums are heavily concentratedin the Northeastern United States.***

 

Ourrevenues and profitability for the foreseeable future will be substantiallyimpacted by prevailing regulatory, economic, demographic, competitive, weatherand other conditions 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 2009, 49.3% of ourdirect written premiums were derived from our Insurance Operations in New York,Massachusetts, New Jersey, Maine and Connecticut. In February 2010, weannounced the Personal Lines Transaction. The closing of the Personal LinesTransaction is subject to regulatory approvals and is expected to close in thesecond quarter of 2010. The Personal Lines Transaction will significantlyreduce our exposure to Northeast windstorm risks and premium concentration inthe Northeastern United States.

 

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***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 may reduce ourprofitability.***

 

We are often required to participate directly or indirectly inmandatory shared market mechanisms as a condition of our licenses to dobusiness in certain states. These markets, which are commonly referred to as “residual”or “involuntary” markets, generally consist of risks considered to beundesirable from a standard or routine underwriting perspective. In 2009,approximately 1% of our net written premiums, excluding premiums written byAutoOne, related to our participation in mandatory shared market mechanisms.Underwriting performance related to assigned risk plans, a form of mandatedmarket mechanism, is typically adverse and, as a result, we are required tounderwrite some policies with a higher risk of loss than we would normallyaccept.

 

Each state dictates the level of insurance coverage that is mandatorilyassigned to participating insurers within these markets. Our participation inmandatory shared market mechanisms is principally concentrated in the States ofMassachusetts, New Jersey and New York. In certain states, such as New York,the amount of involuntary policies we are obligated to write in a given year isbased on our historical market share of all voluntary policies written withinthat state. The share of involuntary written premium for policies assigned byNYAIP, a residual insurance plan that obtains personal automobile insurance forindividuals who cannot otherwise obtain insurance in the voluntary insurancemarket, to a particular insurer in a given year is based on the proportion ofthe total voluntary writings in New York two years earlier. We estimate thecost of discharging our obligation for our NYAIP assignments as of December 31,2009 to be $5.9 million and we have recorded this estimate as a liabilityin our consolidated financial statements. Our participation in assigned riskplans may result in greater liabilities than we anticipate and could materiallyadversely affect our financial condition and results of operations.

 

In addition, virtually all states require insurers licensed to dobusiness in their state to bear a portion of the loss suffered by some insuredsas the result of impaired or insolvent insurance companies. These guarantyfunds are funded by assessments that are expected to increase in the future asa result of recent insolvencies. Many states also have laws that establishedsecond-injury funds to provide compensation to injured employees foraggravation of a prior condition or injury which are funded by eitherassessments based on paid losses or premium surcharge mechanisms. The effect ofthese 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 historically has beencharacterized by periods of intense price competition, which could have anadverse effect on our results of operations and financial condition. Periods ofintense price competition historically have alternated with periods whenshortages of underwriting capacity have permitted attractive premium levels.Any significant decrease in the rates we can charge for property and casualty insurancewould adversely affect our results.

 

Our personal lines business is particularly affected by the cyclicalityof loss cost trends. Factors that affect loss cost trends in automobileunderwriting include inflation in the cost of automobile repairs, medical care,litigation of liability claims, improved automobile safety features,legislative changes and general economic conditions. Factors that affect losscost trends in homeowners underwriting include inflation in the cost ofbuilding 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 of this cyclicalitywhich, during down periods, could materially adversely affect our financialcondition and results of operations.

 

***The failure to close the Personal Lines Transactioncould result in a loss of premium revenue and adversely impact our business andresults of operations.***

 

We announced the Personal Lines Transaction with Tower on February 2,2010. The closing of the Personal Lines Transaction is subject to certainregulatory approvals and is expected to close in the second quarter of 2010.While we anticipate that the Personal Lines Transaction will close asscheduled, there can be no assurance that we or Tower will receive the requiredregulatory approvals or otherwise be able to close the transaction timely or atall. Because we market our personal lines business through a network ofindependent agents, we risk a loss of business from these agents if we areunable 

 

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toclose the Personal Lines Transaction for any reason. Other insurance companiescompete with us for the services and allegiance of these agents. Theseproducers may choose to direct business to our competitors, or may direct lessdesirable risks to us. The lossof one or more agents and/or business from agents could adversely impact our premiumvolume, resulting in a decrease in our revenues, and our business, results ofoperations and financial condition could be materially and adversely affected.

 

***We may need additional capital inthe future, which may not be available to us or available to us on favorableterms.***

 

We may need to raise additional funds through public or private debt orequity financings in order to:

 

·                  fund liquidity needs;

 

·                  replace capital lost in theevent of a catastrophe or adverse reserve development or investment losses;

 

·                  refinance$607.1 million aggregate principal amount of our Senior Notes;

 

·                  satisfy letter of credit orguarantee bond requirements that may be imposed by our clients or byregulators;

 

·                  acquire new businesses orinvest in existing businesses;

 

·                  expand our business into newregions and countries; or

 

·                  otherwise respond tocompetitive pressures.

 

Any additional financing we may need may not be available on termsfavorable to us, or at all.

 

***We may be unable to adequately maintain our systemsand safeguard the security of our data which may adversely impact our abilityto operate our business and cause reputational harm and financial loss.***

 

Our business and operations rely on secure and efficient processing,storage and transmission of customer and company data, including personallyidentifiable information such as a name together with a social security number,bank account number, driver’s license number, passport number or birthday(PII). Our ability to effectively operate our business depends upon our abilityand the ability of certain third parties including vendors and businesspartners to access our computer systems to perform necessary business functionssuch as providing quotes and product pricing, billing and processing premiums,administering claims, and reporting our financial results. Our business andoperations also depend upon our ability to safeguard PII and other confidentialand proprietary information belonging to us and our policyholders.  Our systems may be vulnerable to unauthorizedaccess and hackers, computer viruses, and other scenarios in which our data maybe vulnerable to a breach.  Specifically,we could be exposed to data breach risk from lost or stolen laptops, otherportable media or misdirected mailings containing PII.

 

Data incidents could result in reputational harm to us, which couldaffect our business and results of operations. Nearly every state has enacted data breach laws and regulations thatrequire, among other things, notification to affected persons and stateregulatory agencies of a data breach that involves PII. Some U.S. state andfederal laws also require us to implement measures to safeguard PII. Forexample, new Massachusetts regulations will require our employees to encryptinformation stored on laptops and other portable devices and transmittedthrough electronic media, and take reasonable steps to verify that our thirdparty vendors utilize security procedures to protect PII.

 

We have taken a number of steps to mitigate our risk. We have formed aData Privacy Committee and appointed an Information Privacy and SecurityOfficer. We have implemented policies, procedures, training and education ofemployees, as well as technology solutions to safeguard our information.Although we have taken measures to safeguard our information and that ofpolicyholder and other third parties, and we continually monitor the securityof our systems and information, we could be exposed to data loss. As a result,our ability to conduct our business may be affected, and impact our results ofoperations, financial condition and reputation.

 

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**Risks Relating to Our Relationship with White Mountains**

 

***Transitional and other arrangementswith White Mountains may not be on arm’s length terms.***

 

In connection with OBIG’s initial public offering, OBIG and certainsubsidiaries of OBIG entered into certain contractual arrangements with WhiteMountains and its affiliates. These agreements were made in the context of aparent-subsidiary relationship. For example, some of our investments aremanaged pursuant to an investment management agreement on a discretionary basisby a registered investment advisor which is owned by White Mountains. We have amulti-year investment management contract with this advisor. While we aresatisfied with the terms of such arrangement, we cannot confirm that such termsare as favorable to us as they might have been had we contracted with anindependent advisor. On the other hand, after the expiration of this agreement,we may not be able to replace these investment services in a timely manner oron terms and conditions, including cost, that are comparable to those we receivefrom White Mountains, and we may have to pay higher prices for similar servicesfrom unaffiliated third parties. For more information on these and otherarrangements with White Mountains, see Note 16—“Related Party Disclosures”of the accompanying consolidated financial statements.

 

***Refinancing of our Senior Notes may occur onunfavorable terms.***

 

In connection with OBIG’s initial public offering, OBIG has enteredinto an agreement with White Mountains pursuant to which White Mountainsguarantees the Senior Notes of OBH for a specified fee in the amount of 25basis points per annum on the outstanding principal amount of the Senior Notes.We further agreed that if White Mountains’ voting interest in OBIG’s commonshares ceases to represent more than 50% of all OBIG’s voting securities, wewill seek to redeem, exchange or otherwise modify the Senior Notes in order tofully and permanently eliminate White Mountains’ obligations under itsguarantee. White Mountains and its subsidiaries beneficially own all of OBIG’soutstanding Class B common shares, representing 96.8% of the voting powerof OBIG’s voting securities. If we have not successfully eliminated theguarantee within 180 days upon notice of the triggering of the votinginterest condition, the guarantee fee will increase by 200 basis points. Theguarantee fee will further increase by 100 basis points for each subsequent90 day period thereafter, up to a maximum guarantee fee of 425 basispoints, until White Mountains’ obligations under its guarantee have beenextinguished. This arrangement could require us to devote significant time andexpense trying to refinance the Senior Notes and we may not be able to do so oncommercially reasonable terms or at all.

 

White Mountains has two revolving credit facilities which provide forborrowing up to a maximum of $450.8 million and which contains restrictivefinancial covenants. The indenture documents governing the Senior Notes providethat if White Mountains as guarantor of the Senior Notes has a payment defaultin excess of $25 million under a credit agreement, mortgage or similar debtagreement, there is a default under the Senior Notes (commonly referred to as a“cross default”). Therefore, if White Mountains were to breach one or more ofits financial covenants in its revolving credit facilities, an event of defaultwould result, which would allow lenders to declare all amounts owed under therevolving credit facilities to be immediately due and payable. A failure to paythe amounts owed under the revolving credit facilities would result in atrigger of the cross default provisions in the indenture documents governingthe Senior Notes resulting in a required repayment of the Senior Notes. Whilewe believe that White Mountains is able to meet its obligations under itsrevolving credit facilities, there is the potential that adverse market orother conditions which cannot be controlled could adversely impact WhiteMountains’ ability to meet its obligations as well as our ability to refinancethe Senior Notes in the event of a cross default. As of December 31, 2009,the credit facilities were undrawn. See “Management’s Discussion and Analysisof Financial Condition and Results of Operations—Liquidity and CapitalResources—Financing” and Note 16—“Related Party Disclosures” of theaccompanying consolidated financial statements.

 

**ITEM1B.  UNRESOLVED STAFF COMMENTS**

 

As of the date of this report, we had no unresolved written commentsfrom the Commission staff regarding our periodic or current reports under theExchange Act.

 

**ITEM2.  PROPERTIES**

 

Our headquarters are located at 1 Beacon Lane, Canton, Massachusetts02021 and our principal executive office is located at 601 Carlson Parkway,Minnetonka, Minnesota 55305. We also maintain branch offices in various citiesthroughout the United States. Our headquarters is owned by us. Our principalexecutive office and branch offices are leased. Management considers our officefacilities suitable and adequate for our current level of operations.

 

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**ITEM3.  LEGAL PROCEEDINGS**

 

The Company from time to time is involved in various routine legalproceedings. We believe that the outcome of these proceedings, even ifdetermined adversely, would not have a material adverse effect on our business,financial condition and results of operations.

 

**PART II**

 

**ITEM 5.  MARKET FOR THE COMPANY’S COMMON EQUITY,RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES**

 

All of the Company’s outstanding shares are owned by OneBeacon U.S.Enterprises Holdings, Inc. (OBEH), formerly known as Fund AmericanEnterprises Holding, Inc., the Company’s parent and an indirect,wholly-owned subsidiary of OBIG. As of March 19, 2010, the Companyhad 505 shares of common stock, par value $1.00 per share, issued andoutstanding. There is no established public trading market for the Company’scommon stock.

 

For a discussion regarding the Company’s payment of dividends, and therestrictions related thereto, see “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations—Dividend Capacity”.

 

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**ITEM7.  MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

*The following discussion contains “forward-lookingstatements.” Statements that are not historical in nature are forward-lookingstatements. OB Holdings cannot promise that its expectations in suchforward-looking statements will turn out to be correct. OB Holdings’ actualresults could be materially different from and worse than our expectations. See“Forward-Looking Statements” on page 76 for specific important factorsthat could cause actual results to differ materially from those contained inforward-looking statements.*

 

*The following discussion also includes two non-GAAPfinancial measures, loss and loss adjustment expenses ratio prior to reservereallocation and total combined ratio prior to reserve reallocation that havebeen reconciled to the most comparable GAAP financial measures (see pages 41and 51). OB Holdings believes these measures to be useful supplements tothe comparable GAAP measures in evaluating OB Holdings’ financial performance.*

 

**Overview**

 

We provide a rangeof insurance products and services. We have historically offered a range ofspecialty, commercial and personal products and services sold primarily throughindependent agents and brokers. However, we have recently entered into twotransactions that will transform us into a specialty lines company. On December 3,2009, we sold the renewal rights to our non-specialty commercial lines businessand on February 2, 2010, we entered into a definitive agreement to sellour personal lines business. With roots dating back to 1831, we have beenoperating for more than 175 years and have relationships with manyindependent agencies and brokers. We consist of a group of operating companieswhich are U.S.-based property and casualty insurance writers, most of whichoperate in a multi-company pool. Pooling arrangements permit the participatingcompanies to rely on the capacity of the entire pool’s capital and surplusrather than just on its own capital and surplus. Under such arrangements, themembers share substantially all insurance business that is written, andallocate the combined premiums, losses and expenses. In the year ended December 31,2009, our net written premiums totaled $1.9 billion and we had totalassets of $7.5 billion and total OB Holdings’ shareholder’s equity of$1.4 billion at December 31, 2009.

 

***Our Segments***

 

Our reportablesegments are Insurance Operations and Other Operations.

 

*InsuranceOperations.*  Our Insurance Operations segment, formerlyknown as Primary Insurance Operations, includes the results of our insuranceoperations. We currently manager our Insurance Operations segment through aspecialty lines underwriting unit and a personal lines underwriting unit,nearly all of which is subject to the Personal Lines Transaction. See “Business—Specialtylines” and “Business—Personal lines”. Our Insurance Operations segment alsoincludes run-off business which consists of the non-specialty commercial linesbusiness being transferred to The Hanover effective January 1, 2010, aswell as national accounts, certain specialty programs and regional agencybusiness transferred to Liberty Mutual effective November 1, 2001. See “Business—Run-off”.

 

*OtherOperations.*  Our Other Operations segment consists of theactivities of our holding company, OBH.

 

***Revenues***

 

We account forinsurance policies that we write in accordance with Financial AccountingStandards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 60,“Accounting and Reporting by Insurance Enterprises,” subsequently codifiedwithin Accounting Standards Codification (ASC) 944. Premiums written arerecognized as revenues and are earned ratably over the term of the relatedpolicy. Unearned premiums represent the portion of premiums written that areapplicable to future insurance coverage provided by policies. AutoOne, one ofour subsidiaries, which acts as a LAD servicing carrier, enters intocontractual arrangements with insurance companies to assume private passengerand commercial automobile assigned risk exposures in 21 states and the Districtof Columbia. AutoOne receives LAD and CLAD servicing fees from these othercompanies for assuming these risks. In addition, AutoOne chooses to writecertain policies voluntarily by taking risks out of the NYAIP. These policiesgenerate takeout credits which can be sold for fees, which we refer to astake-out fees, to other carriers. These other carriers in turn can use suchcredits to reduce their obligations to write assigned risk business. AutoOne’sLAD and CLAD servicing and take-out fees are recorded as written premium whenbilled and are earned ratably over the term of the related policy to which thefee relates.

 

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***Deferred Acquisition Costs***

 

Deferred acquisition costs represent commissions, premium taxes,brokerage expenses and other costs that are directly attributable to and varywith the production of new business. These costs are deferred and amortizedover the applicable premium recognition period. Deferred acquisition costs arelimited to the amount expected to be recovered from future earned premiums andanticipated investment income. This limitation is referred to as a premiumdeficiency. A premium deficiency is recognized if the sum of expected loss andLAE, unamortized acquisition costs, and maintenance costs exceeds relatedunearned premiums. A premium deficiency is recognized by charging anyunamortized acquisition costs to expense to the extent required in order toeliminate the deficiency.

 

***Loss and Loss Adjustment Expenses***

 

Loss and LAE are charged against income as incurred. Unpaid loss andLAE reserves 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 reinsurance contracts fromtime to time to protect their businesses from losses due to concentration of riskand to limit losses arising from catastrophic events. The majority of suchreinsurance contracts are executed through excess-of-loss treaties andcatastrophe contracts under which a third party reinsurer indemnifies ourinsurance subsidiaries for a specified part or all of certain types of lossesover stipulated amounts arising from any one occurrence or event. We also haveentered into quota share treaties with reinsurers under which all risks meetingprescribed criteria are ceded to third party reinsurers on a pro rata basis.The amount of each risk ceded by us is subject to maximum limits that vary byline of business and type of coverage. Amounts related to reinsurance contractsare recorded in our consolidated financial statements in accordance with SFAS No. 113,“Accounting and Reporting for Reinsurance of Short-Duration and Long-DurationContracts” and Emerging Issues Task Force Topic No. D-54, bothsubsequently codified within ASC 944, as applicable.

 

Amounts recoverable from reinsurers are estimated in a mannerconsistent with the claim liability associated with the reinsured policies. Ourability to collect our reinsurance recoverables is subject to the solvency ofthe reinsurers with whom we have entered into reinsurance contracts. We areselective in regard to our reinsurers, principally placing reinsurance withthose reinsurers with strong financial condition, industry ratings andunderwriting ability. Management monitors the financial condition and ratingsof our reinsurers on an ongoing basis.

 

Reinsurance premiums, commissions, expense reimbursements and reservesrelated to reinsured business are accounted for on a basis consistent withthose used in accounting for the original policies issued and the terms of thereinsurance contracts. Premiums ceded to other companies are reported as areduction of premiums written. Expense allowances received in connection withreinsurance ceded have been accounted for as a reduction of the related policyacquisition costs.

 

***Mandatorily Redeemable Preferred Stock***

 

We had mandatorily redeemable preferred stock which was redeemed in theyear ended December 31, 2008. This instrument was classified as aliability and carried at its historical carrying value. All dividends andaccretion on our mandatorily redeemable preferred stock have been recorded asinterest expense. See Note 10—“Mandatorily Redeemable Preferred Stock” ofthe accompanying consolidated financial statements.

 

***Share-Based Compensation***

 

*CompensationPhilosophy*

 

Our executive compensation policies are designed with one goal in mind,namely, the maximization of shareholder value over long periods of time. Webelieve 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 

 

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shareholdervalue. Through this compensation program, we seek to maximize shareholder valueby aligning closely the financial interests of management with those of ourshareholder and ultimately OBIG’s shareholders. The cost of all incentivecompensation is fully accrued and expensed.

 

Compensation of our senior management team, including our namedexecutive officers, consists primarily of three components: base salary, annualbonus and long-term incentive awards. Base salaries have been capped at$500,000. Annual bonus targets for all senior executives are 50%, with theexception of the Chief Executive Officer at 75%, of base salary. Long-termincentives for senior executives have in the past been comprised of performanceshares and/or performance units. Under these instruments, payouts are explicitlytied to White Mountains’, OBIG’s or OneBeacon’s performance over a three-yearperiod and are highly variable (the actual number of shares/units paid out atthe end of the cycle will range from 0% to 200% of target depending onperformance against established goals). See Note 9—“Employee Share-BasedIncentive Compensation Plans” of the accompanying consolidated financialstatements. Additionally, in recognition that the 2007-2009 and 2008-2010performance share cycles, as described below, were projected to payout at orclose to zero, creating a significant retention risk over the next years, theCompensation Committee of OBIG’s Board of Directors (the CompensationCommittee) in February 2009 approved cash retention awards for theexecutive officers and certain members of senior management. The CompensationCommittee also approved a pool of money for senior management to make retentionawards to certainother key personnel.

 

*Share-Based Compensation—InsuranceOperations*

 

**2004—2006 through 2006—2008 performancecycles**

 

For these cycles,OneBeacon revised the design of its long-term incentive plans from prior plandesigns principally to use OneBeacon performance units instead of WhiteMountains performance shares, with performance targets primarily tied to OneBeacon’sadjusted combined ratio. Each unit was initially valued at $100 and compoundedin value over the performance period by the underwriting return on capitalachieved by OneBeacon. In the case of certain senior officers of our InsuranceOperations segment, a portion of their long-term incentive compensation inthese periods had been denominated in White Mountains performance shares. As aresult of the shift from White Mountains performance shares to OneBeaconperformance units, OB Holdings’ incentive compensation expense associated withthese performance cycles is no longer significantly impacted by changes in themarket price of White Mountains common shares. Prior to February 2007, thevalue of OneBeacon’s performance shares was based upon the market price of anunderlying White Mountains common share (WTM Performance Shares). In February 2007,the Compensation Committee canceled all of OneBeacon’s WTM Performance Sharesoutstanding (for the 2005-2007 and 2006-2008 performance cycles) and replacedthe awards with two performance share grants, a one-year 2007 performance cycleand a two-year 2007-2008 performance cycle, whose value was based upon themarket price of an underlying OBIG common share (OB Performance Shares). In the2007 performance cycle, a total of 117,363 performance shares were earned basedupon a performance factor of 63%. In the 2007-2008 performance cycle, a totalof 137,400 performance shares were earned based upon a performance factor of1.4%.

 

**2007—2009 performance cycle**

 

In February 2007,the Compensation Committee approved the principal performance share goal of theOneBeacon Long-Term Incentive Plan (the Incentive Plan) to be growth in itsintrinsic business value per share (GIBVPS). GIBVPS is defined by theCompensation Committee with respect to each award cycle. For the 2007-2009performance cycle, the Compensation Committee defined GIBVPS to be a weightedmeasure comprised of growth in OBIG’s adjusted book value per share,underwriting return on equity and growth in OBIG’s price per common share. Asof December 31, 2009, 682,344 performance shares were outstanding withrespect to the 2007—2009 performance cycle.

 

**2008—2010 performance cycle**

 

In February 2008,the Compensation Committee defined GIBVPS for the 2008-2010 performance to be aweighted measure comprised of growth in OBIG’s adjusted book value per shareand underwriting return on equity. As of December 31, 2009, 1,220,187performance shares were outstanding with respect to the 2008—2010 performancecycle.

 

**2009-2011performance cycle**

 

In February 2009, the Compensation Committee granted performanceshares with a goal of growth in book value per share. As of December 31,2009, 361,219 performance shares were outstanding with respect to the 2009-2011performance cycle.

 

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*Share-Based Compensation Recognition*

 

Our share-basedcompensation plans consist of performance shares which are typically settled incash. We account for these share-based compensation plans in accordance withSFAS No. 123R, “Share-Based Payment”, subsequentlycodified within ASC 718. 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.

 

***Purchase Accounting***

 

In connection with purchase accounting for the OneBeacon Acquisition,we were required to adjust to fair value our loss and LAE reserves and therelated reinsurance recoverables by $646.9 million and$346.9 million, respectively, on our balance sheet as of June 1,2001. This net change to loss and LAE reserves of $300.0 million is beingaccreted through an income statement charge ratably with and over the periodthe claims are settled. Accordingly, we recognized $5.4 million,$12.0 million and $16.0 million of such charges, recorded asaccretion of fair value adjustment to loss and LAE reserves, in the years ended December 31, 2009,2008 and 2007, respectively. As of December 31, 2009, the outstandingpre-tax unaccreted adjustment was $0.

 

***Income taxes***

 

The income taxexpense (benefit) related to pre-tax income or loss for the years ended December 31,2009, 2008 and 2007 represented effective tax rates of 33.4%, (32.7)% and40.8%, respectively. Our effective tax rate for the year ended December 31,2009 was lower than the U.S. statutory rate of 35% due to the receipt ofnontaxable interest and dividend income, tax reserve adjustments and a decreasein the valuation allowance. Our effective tax rate for the year ended December 31,2008 was lower than the U.S. statutory rate of 35% due to a pre-tax loss fromoperations and non-deductible dividends and accretion on the BerkshirePreferred Stock, partially offset by tax exempt interest and dividend income.Our effective tax rate for the year ended December 31, 2007 was higherthan the U.S. statutory rate of 35% primarily due to non-deductible dividendsand accretion on the Berkshire Preferred Stock, partially offset by tax exemptinterest and dividend income.

 

**OtherAcquisitions and Dispositions**

 

On December 3, 2009, we sold the renewal rights to approximately$490 million in premiums from our non-specialty commercial lines business toThe Hanover. The transaction includes small commercial accounts and thenon-specialty portion of the middle-market business, beginning with January 1,2010 effective dates. As consideration, we received $23.2 million and willreceive an additional 10% of premiums renewed in excess of $200 million for thefirst renewal period. We will continue to manage claims from business writtenprior to the Commercial Lines Transaction and for business written by TheHanover through June 30, 2010. The Hanover will reimburse us for ourexpenses incurred to provide the claims administration services.

 

During the fourthquarter of 2008, we sold one of our inactive licensed subsidiaries, Farmers andMerchants Insurance Company (FMIC), to Pride Holdings LLC for $7.8 million incash and recorded a pre-tax gain of $1.1 million through net other revenues.

 

During the thirdquarter of 2008, we acquired EBI, an insurance agency specializing in theentertainment, sports and leisure industries, for $8.0 million in cash. Inconnection with the purchase of EBI, which was accounted for as an acquisitionunder the purchase method of accounting in accordance with GAAP at the time ofthe acquisition, we recorded the identifiable assets and liabilities of EBI attheir fair value at acquisition date. Significant assets and liabilitiesacquired include premiums and commissions receivable of $16.6 million andpremiums and commissions payable of $16.1 million. After allocating thepurchase price to identifiable tangible assets and liabilities, we alsorecorded an adjustment to allocate the remaining acquisition cost to anintangible asset of $9.5 million which represents the value of business inforce at the acquisition date. The amortization associated with the intangibleasset will be amortized over a 10-year period in proportion to the timing ofthe discounted cash flows used to value the business. During the year ended December 31,2009, no amortization was recognized.

 

During the firstquarter of 2008, we sold one of our inactive licensed subsidiaries, MidwesternInsurance Company (MWIC), to National Guaranty Insurance Company for $4.2million in cash and recorded a pre-tax gain of $1.0 million through net otherrevenues.

 

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During the thirdquarter of 2007, we sold one of our inactive licensed subsidiaries, AmericanEmployers’ Insurance Company (AEIC) to Sparta Insurance Holdings, Inc.(Sparta) for $47.7 million in cash and recorded a pre-tax gain of$11.3 million through net other revenues.

 

*Recent Developments*

 

We have recently entered into two transactions, the Commercial LinesTransaction referenced above and the Personal Lines Transaction discussedbelow, that will transform us into a specialty lines insurance company. Thetransactions will free up significant capital, increase our financialflexibility and also substantially reduce our catastrophe exposure.

 

On February 2, 2010, we entered into a definitive agreement tosell our personal lines business to Tower. The transaction includes twoinsurance companies containing the personal lines business, and twoattorneys-in-fact managing the reciprocals that write the personal linesbusiness in New York and New Jersey. Net written premiums for the affectedbooks total approximately $420 million for the year ended December 31,2009. As consideration, we will receive an amount equal to the statutorysurplus in the reciprocals (approximately $103 million at December 31,2009, including the par value of the surplus notes issued by the reciprocals),the GAAP equity in the insurance companies and attorneys-in-fact (approximately$45 million at December 31, 2009), plus $32.5 million. AutoOne is notbeing sold as part of this transaction. The sale is subject to certain stateregulatory approvals and is expected to close in the second quarter of 2010.

 

**Results of Operations**

 

*Review of Consolidated Results*

 

A summary of our consolidated financial results for the years ended December 31,2009, 2008 and 2007 is as follows:

 
| ** **                                                                               | ** ** | **Year ended December 31,** | ** ** |
|------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                               | ** ** | **2009**                         | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                                               | ** ** | **($ in millions)**         | ** ** |
| Net written premiums                                                                     |       | $                                | 1,906.7    |   | $ | 1,963.1 |   | $ | 1,864.4 |   |
| **Revenues**                                                                             |       |                             |       |   |   |   |   |
| Earned premiums                                                                          |       | $                                | 1,959.5    |   | $ | 1,879.0 |   | $ | 1,873.6 |   |
| Net investment income                                                                    |       | 125.3                            |       | 162.1 |   | 202.4 |   |
| Net realized and unrealized investment gains  (losses)                                   |       | 248.6                            |       | (766.0 | ) | 173.1 |   |
| Net other revenues                                                                       |       | 44.7                             |       | 13.8 |   | 17.2 |   |
| Total revenues                                                                           |       | 2,378.1                          |       | 1,288.9 |   | 2,266.3 |   |
| **Expenses**                                                                             |       |                             |       |   |   |   |   |
| Loss and LAE                                                                             |       | 1,121.9                          |       | 1,126.2 |   | 1,089.8 |   |
| Policy acquisition expenses                                                              |       | 398.3                            |       | 368.3 |   | 318.9 |   |
| Other underwriting expenses                                                              |       | 330.0                            |       | 290.8 |   | 329.4 |   |
| General and administrative expenses                                                      |       | 18.0                             |       | 11.2 |   | (0.5 | ) |
| Accretion of fair value adjustment to loss and LAE  reserves                             |       | 5.4                              |       | 12.0 |   | 16.0 |   |
| Interest expense on debt                                                                 |       | 39.7                             |       | 44.9 |   | 45.2 |   |
| Interest expense—dividends on preferred stock  subject to mandatory redemption |       | —                           |       | 11.8 |   | 28.3 |   |
| Interest expense—accretion on preferred stock  subject to mandatory redemption |       | —                           |       | 21.6 |   | 36.1 |   |
| Total expenses                                                                           |       | 1,913.3                          |       | 1,886.8 |   | 1,863.2 |   |
| **Pre-tax income (loss)**                                                                |       | 464.8                            |       | (597.9 | ) | 403.1 |   |
| Income tax (expense) benefit                                                             |       | (155.3                           | )          | 195.3 |   | (164.5 | ) |
| **Net income (loss) including  noncontrolling interests**                                |       | 309.5                            |       | (402.6 | ) | 238.6 |   |
| Less: Net income attributable to noncontrolling  interests                               |       | (2.1                             | )          | (1.7 | ) | (3.7 | ) |
| **Net income (loss) attributable  to OB Holdings’ shareholder**                     |       | 307.4                            |       | (404.3 | ) | 234.9 |   |
| Other comprehensive income (loss)                                                        |       | 18.8                             |       | (25.6 | ) | (3.9 | ) |
| **Comprehensive net income (loss)  attributable to OB Holdings’ shareholder**       |       | $                                | 326.2      |   | $ | (429.9 | ) | $ | 231.0 |   |

 

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**Consolidated Results—Year ended December 31,2009 versus year ended December 31, 2008**

 

Our comprehensivenet income attributable to OB Holdings’ shareholder was $326.2 million in theyear ended December 31,2009, compared to a comprehensive net loss attributable to OneBeacon’sshareholder of $429.9 million in the year ended December 31, 2008. Othercomprehensive income (loss) in the year ended December 31, 2009 includedthe impact of a $12.1 million after tax increase in our pension plans primarilyrelated to an increase in the over-funded status of our qualified pension plandriven by investment results. Other comprehensive income (loss) in the yearended December 31, 2009 also included a $7.4 million pre-tax ($4.8 millionafter tax) increase resulting from the settlement of our interest rate swaprelating to the mortgage note. Other comprehensive income (loss) in the yearended December 31, 2008 included the impact of a $19.5 million after taxdecrease in our pension plans primarily related to a decrease in theover-funded status of our qualified pension plan driven by investment resultsand a $5.7 million after tax decrease in our interest rate swap related to themortgage note. Net income attributable to OB Holdings’ shareholder was $307.4million in the year ended December 31, 2009, compared to a net lossattributable to OB Holdings’ shareholder of $404.3 million in the year ended December 31,2008.

 

Our total revenuesincreased 84.5% to $2,378.1 million in the year ended December 31, 2009,compared to $1,288.9 million in the year ended December 31,2008. The increase was mainly due to a $1,014.6 million increase in netrealized and unrealized investment gains to $248.6 million. Net realized andunrealized investment losses for the year ended December 31, 2008reflected the impact of the significant declines and high volatility in theequity markets, the lack of liquidity in the credit markets and the widening ofcredit spreads experienced during the second half of 2008. The increase inearned premiums was due primarily to our specialty lines businesses, partiallyoffset by decreased earned premiums in personal lines and our non-specialty commerciallines. Net other revenues increased 223.9% to $44.7 million in the yearended December 31, 2009,compared to $13.8 million in the year ended December 31,2008. The increase was primarily due to pre-tax proceeds of $23.2 million fromthe renewal rights sale, increased revenues from our non-insurance operationsand a $5.4 million gain related to the purchase of a portion of our seniornotes, partially offset by a $7.4 million realized loss related to thesettlement of the interest rate swap. The year ended December 31, 2008included a $1.0 million gain from the sale of MWIC and a $1.1 milliongain from the sale of FMIC. These increases were partially offset by a $36.8million decrease in netinvestment income to $125.3 million in the year ended December 31,2009, due to a lower average invested asset base and lower investment yields.Contributing to the lower investment yields was a $(1.1) million inflation adjustment related to our inflationindexed treasury securities as compared to an $8.6 million inflationadjustment related to these securities for the year ended December 31,2008.

 

Our total expensesincreased 1.4% in the year ended December 31, 2009 to $1,913.3 million, compared to$1,886.8 million in the year ended December 31, 2008.Loss and LAE decreased by 0.4% to $1,121.9 million in the year ended December 31,2009 due to lower current accident year catastrophe losses and slightly morefavorable loss reserve development. Interest expense decreased by 11.6%,primarily due to the interest expense related to the Berkshire Preferred Stockwhich was redeemed in the second quarter of 2008. Partially offsetting these decreases wereincreased policy acquisition costs, other underwriting expenses and generaland administrative expenses. Policy acquisition expenses increased by 8.1% to$398.3 million in the year ended December 31, 2009 mainly due to higheracquisition costs associated with our newer specialty lines businesses andchanges in mix of business. Other underwriting expenses increased 13.5% to $330.0 million inthe year ended December 31, 2009. The year ended December 31,2008 included lower incentive compensation costs resulting from changes inassumptions on our long-term incentive compensation plans. General and administrative expenses increased 60.7%to $18.0 million primarily related to higher operating expenses of ournon-insurance operations.

 

Our income tax expense(benefit) related to pre-tax income or loss for the years ended December 31,2009 and 2008 represented effective tax rates of 33.4% and (32.7)%, respectively.The effective tax rate for the year ended December 31, 2009was lower than the U.S. statutory rate of 35% due to the receipt of nontaxableinterest and dividend income, tax reserve adjustments and a decrease in thevaluation allowance. Our effective tax rate for the year ended December 31,2008 was lower than the U.S. statutory rate of 35% due to a pre-tax loss fromoperations and non-deductible dividends and accretion on the BerkshirePreferred Stock, partially offset by tax exempt interest and dividend income.

 

Our GAAP combined ratiofor the year ended December 31, 2009 decreased to 94.4% from 95.0% for theyear ended December 31, 2008. The loss and LAE ratio decreased 2.6 pointsto 57.3% while the expenseratio increased 2.0 points to 37.1%. The decrease in the loss and LAE ratio wasdue to decreases in the current accident year catastrophe loss ratio and alsoslightly more favorable loss reserve development. The year ended December 31,2009 included $23.8 million or1.2 points of current accident year catastrophe losses. The yearended December 31, 2008 included $57.4 million or 3.1 points ofcurrent accident year catastrophe losses, mainly due to losses related tohurricanes Ike and Gustav, and weather in the 

 

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southeasternUnited States experienced in the first quarter. The year ended December 31, 2009 included$83.4 million or 4.3 points of favorable loss reserve development primarily due to lower thanexpected severity on non-catastrophe losses related to professional liabilitylines and commercial package business and general liability linespartially offset by adverse loss reserve development primarily related to personal injury protectionlitigation at AutoOne. The year ended December 31, 2008included $62.0 million or 3.3 points of favorable loss reserve developmentprimarily due to lower than expected severity on non-catastrophe losses andfavorable loss reserve development on a prior accident year catastrophe. Thefavorable non-catastrophe loss reserve development was primarily related toprofessional liability lines and commercial package business lines partiallyoffset by adverse loss reserve development at AutoOne and in legacy run-offbusiness. The expense ratio increased due to higher policy acquisition expenses and other underwritingexpenses, as described above.

 

**Consolidated Results—Year ended December 31,2008 versus year ended December 31, 2007**

 

Our comprehensive net loss attributable to OB Holdings’ shareholder was$429.9 million in the year ended December 31, 2008, compared tocomprehensive net income attributable to OB Holdings’ shareholder of$231.0 million in the year ended December 31, 2007. Comprehensive netloss attributable to OB Holdings’ shareholder in the year ended December 31,2008 included the impact of a $19.5 million after tax decrease in ourpension plans primarily related to a decrease in the over-funded status of ourqualified pension plan driven by investment results and a $5.7 millionafter tax decrease in our interest rate swap relating to the mortgage note. Netloss attributable to OB Holdings’ shareholder was $404.3 million in theyear ended December 31, 2008, compared to net income attributable to OBHoldings’ shareholder of $234.9 million in the year ended December 31,2007. As described below, effective January 1, 2008, we adopted the fairvalue option and elected to record the changes in net unrealized gains andlosses from our available-for-sale securities and our investments in hedgefunds and private equity funds in revenues in arriving at net income. In priorperiods, these changes have been included in other comprehensive income. Accordingly,net (loss) income and pre-tax (loss) income for the year ended December 31,2008 are not directly comparable to such measures for the year ended December 31,2007.

 

Our total revenues decreased 43.1% to $1,288.9 million in the yearended December 31, 2008, compared to $2,266.3 million in the yearended December 31, 2007. The decrease was mainly due to a$491.7 million decrease in net realized investment (losses) gains to$(318.6) million and the inclusion of a $(447.4) million change in netunrealized investment gains and losses in the year ended December 31,2008. During the year ended December 31, 2008, we recognized realizedlosses of $239.8 million for declines in fair value deemed to beother-than-temporary. The year ended December 31, 2007 included the saleof certain convertible fixed maturity and equity securities in industry sectorsthat experienced significant appreciation in the first half of 2007. Netinvestment income decreased 19.9% to $162.1 million in the year ended December 31,2008. Net other revenues decreased 19.8% to $13.8 million in the yearended December 31, 2008, compared to $17.2 million in the year ended December 31,2007. The year ended December 31, 2008 included a $1.0 million gainfrom the sale of MWIC and a $1.1 million gain from the sale of FMIC. Theyear ended December 31, 2007 included an $11.3 million gain from the sale of AEIC.

 

Our total expenses increased 1.3% in the year ended December 31,2008 to $1,886.8 million, compared to $1,863.2 million in the yearended December 31, 2007. Loss and LAE increased by 3.3% to $1,126.2 in theyear ended December 31, 2008 primarily due to $57.4 million or 3.1points of current accident year catastrophe losses, compared to$16.4 million or 0.9 points in the year ended December 31, 2007,partially offset by a $13.7 million increase in favorable loss reservedevelopment compared to the year ended December 31, 2007 as describedbelow. Policy acquisition expenses increased by 15.5% to $368.3 million inthe year ended December 31, 2008 mainly due to higher acquisition costsassociated with our newer specialty lines businesses and the change in mix ofbusiness at OBPI. In addition, in the year ended December 31, 2007,insurance acquisition expenses were lower due to an increase in the deferralrate of policy acquisition costs on commercial lines of business related to theexpansion into new states and the benefit of a $7.6 million state premiumtax refund in personal lines. These increases were slightly offset by adecrease in other underwriting expenses. General and administrative expensesincreased 234.0% to $11.2 million primarily related to operating expensesof EBI which was acquired in the third quarter of 2008.

 

During the year ended December 31, 2007, we reallocated reservesof our insurance operations from ongoing lines of business to legacy run-offclaims, particularly reserves for construction defect and workers compensationrelated to accident years 2001 and prior. The reallocation shifted$116.7 million of our reserves from specialty lines ($87.4 million)and personal lines ($23.3 million) to run-off claims (net $110.7 million). Thereallocation included reserves from commercial lines ($6.0 million) that arenow presented within run-off. This adjustment had no impact on our total combinedratio for the year ended December 31, 2007. The ratio discussions by lineof business that follow are based on the ratios as computed prior to thereallocation of reserves. We believe that a presentation excluding the effectof the reserve reallocation on specialty lines, personal lines and run-off lossand LAE ratios and GAAP combined ratios is meaningful for investors tounderstand the performance of our underwriting units during 2007.

 

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Our income tax(benefit) provision related to pre-tax income or loss for the years ended December 31,2008 and 2007 represented effective tax rates of (32.7)% and 40.8%,respectively. Our effective tax rate for the year ended December 31, 2008was lower than the U.S. statutory rate of 35% due to a pre-tax loss fromoperations and non-deductible dividends and accretion on the BerkshirePreferred Stock, partially offset by tax exempt interest and dividend income.Our effective tax rate for the year ended December 31, 2007 was higherthan the U.S. statutory rate of 35% primarily due to non-deductible dividendsand accretion on the Berkshire Preferred Stock, partially offset by tax exemptinterest and dividend income.

 

Our GAAP combined ratio for the year ended December 31, 2008increased to 95.0% from 92.8% for the year ended December 31, 2007. Theloss and LAE ratio increased 1.7 points to 59.9% while the expense ratioincreased 0.5 points to 35.1%. The increase in the loss and LAE ratio was dueto 3.1 points of current accident year catastrophe losses mainly fromhurricanes Ike and Gustav, and weather in the southeastern United Statesexperienced in the first quarter of 2008. The loss and LAE ratio was alsohigher due to large losses in specialty lines at IMU and in the non-specialtymiddle market commercial businesses. These increases were partially offset by$62.0 million or 3.3 points of favorable loss reserve development due primarilyto lower than expected severity on non-catastrophe losses as described above.The year ended December 31, 2007 included $48.3 million or 2.6 pointsof favorable loss reserve development due to lower than expected frequency forprofessional liability lines and lower than expected severity for personalautomobile liability partially offset by adverse loss reserve development formultiple peril lines and workers compensation lines primarily for accidentyears 2001 and prior. The increase in the expense ratio was from an increase inpolicy acquisition expenses, offset by a decrease in other underwritingexpenses as describedabove. The year ended December 31, 2007 included a 1.0 point benefit fromthe partial settlement of our qualified pension plan and a 0.4 point benefitfrom a state premium tax refund, partially offset by 0.7 points of officeconsolidation costs.

 

***Summary of Operations By Segment***

 

Our segments consist ofthe following: (1) Insurance Operations, formerly known as PrimaryInsurance Operations, and (2) Other Operations. Specialty lines includesOBPI, IMU, EBI, A&H, OBGR, OBEG, Dewar, collector cars and boats and, asdescribed above, Technology, Financial Services, OBSP and PIM which wereformerly reported in commercial lines. Personal lines includes our traditionalpersonal lines business and AutoOne. Run-off includes non-specialty commerciallines business subject to the Commercial Lines Transaction and other run-offbusiness. Prior periods have been reclassified to conform to the current presentation.

 

Our investments are managed by our affiliate, WM Advisors, and byProspector. A discussion of our consolidated investment operations is includedafter the discussion of operations by segment. Our segment information ispresented in Note 13—“Segment Information” of the accompanyingconsolidated financial statements.

 

*Insurance Operations*

 

Financial results for our Insurance Operations segment for the yearsended December 31, 2009, 2008 and 2007 were as follows:

 
| ** **                                             | ** ** | **Year ended December 31,** | ** ** |
|--------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                             | ** ** | **2009**                         | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                             | ** ** | **($ in millions)**         | ** ** |
| Net written premiums                                   |       | $                                | 1,906.7    |   | $ | 1,963.1 |   | $ | 1,864.4 |   |
| Earned premiums                                        |       | $                                | 1,959.5    |   | $ | 1,879.0 |   | $ | 1,873.6 |   |
| Net investment income                                  |       | 127.4                            |       | 152.8 |   | 184.5 |   |
| Net realized and unrealized investment gains  (losses) |       | 250.7                            |       | (760.5 | ) | 174.5 |   |
| Net other revenues                                     |       | 41.0                             |       | 14.0 |   | 19.2 |   |
| Total revenues                                         |       | 2,378.6                          |       | 1,285.3 |   | 2,251.8 |   |
| Loss and LAE                                           |       | 1,121.9                          |       | 1,126.2 |   | 1,089.8 |   |
| Policy acquisition expenses                            |       | 398.3                            |       | 368.3 |   | 318.9 |   |
| Other underwriting expenses                            |       | 330.0                            |       | 290.8 |   | 329.4 |   |
| General and administrative expenses                    |       | 16.9                             |       | 10.5 |   | (0.8 | ) |
| Interest expense on debt                               |       | 1.5                              |       | 3.5 |   | 3.2 |   |
| Total expenses                                         |       | 1,868.6                          |       | 1,799.3 |   | 1,740.5 |   |
| Pre-tax income (loss)(1)                               |       | $                                | 510.0      |   | $ | (514.0 | ) | $ | 511.3 |   |

 

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(1)             Includes income from noncontrolling interests.

 

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Thefollowing tables provide ratios, net written premiums and earned premiums byunderwriting unit for the years ended December 31, 2009, 2008 and 2007:

 
| ** **           | ** ** | **Year ended December 31, 2009** | ** ** |
|----------------------|------------|---------------------------------------|------------|
| ** **           | ** ** | **Specialty(1)**                      | ** ** | **Personal** | ** ** | **Run-off(2)** | ** ** | **Total** | ** ** |
| ** **           | ** ** | **($ in millions)**              | ** ** |
| *Ratios: (3)(4)(5)*  |       |                                  |       |   |   |   |   |   |   |
| Loss and LAE         |       | 43.9                                  | %          | 75.7 | % | 61.1 | % | 57.3 | % |
| Expense              |       | 39.6                                  |       | 31.2 |   | 39.6 |   | 37.1 |   |
| Total GAAP combined  |       | 83.5                                  | %          | 106.9 | % | 100.7 | % | 94.4 | % |
| Net written premiums |       | $                                     | 946.2      |   | $ | 508.7 |   | $ | 451.8 |   | $ | 1,906.7 |   |
| Earned premiums      |       | 917.9                                 |       | 567.9 |   | 473.7 |   | 1,959.5 |   |
|                      |            |                                       |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **           | ** ** | **Year ended December 31, 2008** | ** ** |
|----------------------|------------|---------------------------------------|------------|
| ** **           | ** ** | **Specialty(1)**                      | ** ** | **Personal** | ** ** | **Run-off(2)** | ** ** | **Total** | ** ** |
| ** **           | ** ** | **($ in millions)**              | ** ** |
| *Ratios: (3)(4)(5)*  |       |                                  |       |   |   |   |   |   |   |
| Loss and LAE         |       | 48.3                                  | %          | 64.0 | % | 71.7 | % | 59.9 | % |
| Expense              |       | 36.8                                  |       | 31.9 |   | 36.6 |   | 35.1 |   |
| Total GAAP combined  |       | 85.1                                  | %          | 95.9 | % | 108.3 | % | 95.0 | % |
| Net written premiums |       | $                                     | 836.9      |   | $ | 618.7 |   | $ | 507.5 |   | $ | 1,963.1 |   |
| Earned premiums      |       | 730.0                                 |       | 640.8 |   | 508.2 |   | 1,879.0 |   |
|                      |            |                                       |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                      | ** ** | **Year ended December 31, 2007** | ** ** |
|-------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                      | ** ** | **Specialty(1)**                      | ** ** | **Personal** | ** ** | **Run-off(2)** | ** ** | **Total** | ** ** |
| ** **                                      | ** ** | **($ in millions)**              | ** ** |
| *Ratios: (3)(4)(5)*                             |       |                                  |       |   |   |   |   |   |   |
| Loss and LAE prior to reserve reallocation(6)   |       | 49.2                                  | %          | 60.4 | % | 66.5 | % | 58.2 | % |
| Impact of reserve reallocation(6)               |       | (13.6                                 | )          | (3.2 | ) | 21.9 |   | — |   |
| Loss and LAE                                    |       | 35.6                                  |       | 57.2 |   | 88.4 |   | 58.2 |   |
| Expense                                         |       | 32.0                                  |       | 33.6 |   | 39.3 |   | 34.6 |   |
| Total GAAP combined                             |       | 67.6                                  | %          | 90.8 | % | 127.7 | % | 92.8 | % |
| Total combined prior to reserve reallocation(6) |       | 81.2                                  | %          | 94.0 | % | 105.8 | % | 92.8 | % |
| Net written premiums                            |       | $                                     | 654.0      |   | $ | 690.4 |   | $ | 520.0 |   | $ | 1,864.4 |   |
| Earned premiums                                 |       | 643.6                                 |       | 725.0 |   | 505.0 |   | 1,873.6 |   |
|                                                 |            |                                       |            |  |  |  |  |  |  |  |  |  |  |

 

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(1)           Specialty lines now includesTechnology, Financial Services, OBSP and PIM which were formerly reported incommercial lines. Prior periods have been reclassified to conform to thecurrent presentation.

 

(2)           Run-off includes non-specialtycommercial lines business subject to the renewal rights agreement with TheHanover and other run-off business. Prior periods have been reclassified toconform to the current presentation.

 

(3)           Includes our long-termincentive compensation expense. For the years ended December 31, 2009,2008 and 2007, long-term incentive compensation expense increased our totalGAAP combined ratio by 2.1 points, 0.7 points and 1.6 points, respectively.

 

(4)           Includes loss and LAErelating to catastrophes. For the years ended December 31, 2009, 2008 and2007, total calendar year incurred loss and LAE relating to catastrophesincreased our loss and LAE and total combined ratios by 0.7 points, 2.8 pointsand 0.8 points, respectively, including development on prior accident yearcatastrophes which decreased our loss and LAE and total combined ratios by 0.5points, 0.3 points and 0.1 point, respectively.

 

(5)           Prior accident yeardevelopment, including development on catastrophes, for the years ended December 31,2009, 2008 and 2007 decreased our loss and LAE and total combined ratios by 4.3points, 3.3 points and 2.6 points, respectively.

 

(6)           Represents a non-GAAPfinancial measure. During 2007, we reallocated reserves from our ongoing linesof business to run-off which had the effect of lowering the loss and LAE ratiosand combined ratios of our ongoing businesses. The reallocation had no impacton total Insurance Operations. For further discussion, see “ConsolidatedResults—Year ended December 31, 2008 versus year ended December 31,2007.” The table above for the year ended December 31, 2007 reflects ourloss and LAE ratios and total combined ratios prior to the reserve reallocationand reconciles these non-GAAP financial measures to their most comparable GAAPmeasures.

 

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**InsuranceOperations—Year ended December 31, 2009 versus year ended December 31, 2008**

 

*Overview. *We reported a GAAP combined ratio of 94.4% for the year ended December 31,2009, compared to 95.0% for the year ended December 31, 2008. The decreasein our combined ratio was primarily due to lower catastrophe losses andslightly higher favorable loss reserve development, somewhat offset by higherexpenses in the year ended December 31, 2009, including increasedincentive compensation costs, severance and other costs associated with theCommercial Lines Transaction.

 

*Specialty lines.*  Net written premiums for specialty linesincreased by 13.1% to $946.2 million in the year ended December 31,2009 from $836.9 million in the year ended December 31, 2008. Theincrease was primarily due to a $36.7 million increase in net written premiumscompared to the prior year period from EBI which we acquired in the thirdquarter of 2008, and a $34.8 million increase in net written premiums from ourcollector cars and boats business that we began writing in the second quarterof 2008. The increase compared to the prior year period was also due to a $27.0million increase in net written premiums from OBPI, an $18.5 million increasein net written premiums from A&H and a $14.5 million increase in netwritten premiums from OBGR, partially offset by a $21.5 million decrease in netwritten premiums from IMU.

 

The specialty lines combined ratio for the year ended December 31,2009 decreased to 83.5% from 85.1% for the year ended December 31, 2008.The loss and LAE ratio decreased 4.4 points to 43.9% while the expense ratioincreased 2.8 points to 39.6%. The decrease in the loss and LAE ratio wasmainly due to a 3.7 point decrease in current accident year non-catastrophe andcatastrophe losses in the year ended December 31, 2009, compared with theyear ended December 31, 2008 which included the impact of large losses atIMU, as well as higher catastrophe losses primarily related to hurricanes Ikeand Gustav. Further, the year ended December 31, 2009 included 9.2 pointsof favorable loss reserve development primarily related to lower than expectedseverity in professional liability, compared with 8.5 points in the year ended December 31,2008 primarily related to professional liability. The increase in the expenseratio was mainly due to changes in mix of business within the specialty linesbusinesses and the mix of products offered within those businesses and therelated costs incurred to acquire those businesses. Our collector cars andboats business and some of our other newer specialty lines businesses receivehigher compensation than the previous mix of business.

 

*Personal lines.*  Net written premiums for personal linesdecreased by 17.8% to $508.7 million in the year ended December 31,2009 from $618.7 million in the year ended December 31, 2008. Intraditional personal lines, net written premiums decreased by 16.0% to$419.9 million. In an effort to further reduce our property catastropheexposure in the Northeast, we entered into a 30% quota share agreement with agroup of reinsurers. During the year ended December 31, 2009, we ceded$59.9 million of written premiums from our Northeast homeowners businesswritten through OneBeacon Insurance Company (OBIC) and its subsidiarycompanies, along with Adirondack Insurance Exchange and New Jersey SkylandsInsurance Association in New York and New Jersey, respectively. Excluding theimpact of the homeowners quota share, traditional personal lines net writtenpremiums decreased by 4.0%. Further, net written premiums at AutoOne decreasedby 25.9% to $88.9 million primarily due to changes in New York’s assigned riskpool and lower writings of voluntary private passenger automobile risks in NewYork. With respect to the New York assigned risk pool, market trends indicatethat assigned risk volumes are expected to increase to approximately $150million in 2010, which is up from $135 million in 2009 and $143 million in2008 but down from $176 million in 2007. Market trends indicate that theassigned risk pool in New Jersey is expected to increase to approximately $67million in 2010, which is up from $52 million in 2009 and $46 millionin 2008, but down from $72 million in 2007.

 

The personal lines combined ratio for the year ended December 31,2009 increased to 106.9% from 95.9% for the year ended December 31, 2008.The loss and LAE ratio increased 11.7 points to 75.7%, while the expense ratiodecreased by 0.7 points to 31.2%. The increase in the loss and LAE ratio wasprimarily due to 7.7 points of adverse loss reserve development in the yearended December 31, 2009, primarily related to AutoOne and estimates of NewYork personal injury protection litigation costs, compared with 1.2 points ofadverse loss reserve development in the year ended December 31, 2008,mainly on personal automobile liability at AutoOne. Further, the year ended December 31,2009 included a 5.2 point increase in the current accident year loss and LAEratio as compared to the prior year period primarily related to higher currentaccident non-catastrophe loss ratios related to poor automobile results. Thedecrease in the expense ratio was mainly due to lower policy acquisitionexpenses as a result of the ceding commission related to the homeowners quotashare, as described above.

 

On February 2, 2010, we announced that we had entered into adefinitive agreement to sell our personal lines business to Tower Group, Inc.The transaction includes two insurance companies containing the personal linesbusiness, and two attorneys-in-fact managing the reciprocals which write thepersonal lines business in New York and New Jersey. Net written premiums forthe affected books total approximately $420 million for the year ended December 31,2009. As consideration, we will receive an amount equal to the statutorysurplus in the reciprocals (approximately $103 million at 

 

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December 31,2009, including the par value of the surplus notes issued by the reciprocals),the GAAP equity in the insurance companies and attorneys-in-fact (approximately$45 million at December 31, 2009), plus $32.5 million. All specialtylines, including the collector cars and boats business, and the personal linesassigned risk business written through AutoOne will remain. The sale is subjectto certain state regulatory approvals.

 

*Run-off.*  Net written premiums for run-off decreased by11.0% to $451.8 million in the year ended December 31, 2009, compared with$507.5 million in the year ended December 31, 2008. Net written premiumsfrom non-specialty commercial businesses were $451.6 million in the year ended December 31,2009, compared with $507.1 million in the year ended December 31, 2008.The decrease was primarily due to a $42.4 million decrease in thenon-specialty middle market commercial businesses and a $13.1 milliondecrease in the small business division. Net written premiums from legacyrun-off business were $0.2 million in the year ended December 31, 2009,compared with $0.4 million in the year ended December 31, 2008.

 

The run-off combined ratio for the year ended December 31, 2009decreased to 100.7% from 108.3% for the year ended December 31, 2008. Theloss and LAE ratio decreased 10.6 points to 61.1%, while the expense ratioincreased 3.0 points to 39.6%. The decrease in the loss and LAE ratio wasprimarily due to 9.0 points of favorable loss reserve development in the yearended December 31, 2009, mainly due to lower than expected severity inpackage business and commercial multi-peril, compared with 1.4 points offavorable loss reserve development related to lower than expected severity inpackage business and commercial multi-peril in the year ended December 31,2008. Further, the year ended December 31, 2009 included 1.8 points ofcurrent accident year catastrophe losses primarily related to severe wind andthunderstorm events, compared with 6.3 points of current accident yearcatastrophe losses in the year ended December 31, 2008 primarily relatedto hurricane Ike in our non-specialty middle market commercial businesses andsmall business division and losses from tornados in the southeastern UnitedStates in our non-specialty middle market commercial businesses in the firstquarter. These favorable variances were partially offset by a 1.5 pointincrease in non-catastrophe losses in the year ended December 31, 2009 ascompared to the prior year period. The increase in the expense ratio was primarily due toa 2.7 point increase in other underwriting expenses which included 3.5 pointsof higher incentive compensation costs, severance and other costs associatedwith the renewal rights transaction, partially offset by a 0.3 point decreasein policy acquisition costs.

 

Results from run-off include underwriting losses from legacy run-offoperations, including national accounts, certain specialty programs andregional agency business transferred to Liberty Mutual. Legacy run-off businessgenerated an underwriting loss of $3.2 million in the year ended December 31,2009, compared to an underwriting loss of $21.9 million in the year ended December 31,2008. The decrease was primarily due to lower incurred loss and LAE in the yearended December 31, 2009 which included $4.5 million of loss and LAE,compared with $20.5 million of loss and LAE in the year ended December 31,2008 due in part to $9.2 million of incurred unallocated loss adjustmentexpenses (ULAE) related to the Liberty Mutual settlement.

 

**InsuranceOperations—Year ended December 31, 2008 versus year ended December 31, 2007**

 

*Overview. *Our GAAPcombined ratio increased to 95.0% for the year ended December 31, 2008,compared to 92.8% for the year ended December 31, 2007. The increase inour combined ratio was primarily due to higher catastrophe losses.

 

During the year ended December 31, 2007, we reallocated reservesof our insurance operations from ongoing lines of business to legacy run-offclaims, particularly reserves for construction defect and workers compensationrelated to accident years 2001 and prior. The reallocation shifted$116.7 million of our reserves from specialty lines ($87.4 million)and personal lines ($23.3 million) to run-off claims (net $110.7 million). Thereallocation included reserves from commercial lines ($6.0 million) that arenow presented within run-off. This adjustment had no impact on our totalcombined ratio for the year ended December 31, 2007. The ratio discussionsby line of business that follow are based on the ratios as computed prior tothe reallocation of reserves. We believe that a presentation excluding theeffect of the reserve reallocation on specialty lines, personal lines andrun-off loss and LAE ratios and GAAP combined ratios is meaningful forinvestors to understand the performance of our underwriting units during 2007.

 

*Specialty lines.*  Net written premiums for specialty linesincreased by 28.0% to $836.9 million in the year ended December 31,2008 from $654.0 million in the year ended December 31, 2007. Theincrease was primarily due to $110.0 million in net written premiums fromour collector cars and boats business that we began writing in the secondquarter of 2008. The increase compared to prior year was also due to writingsfrom EBI which we acquired in the third quarter of 2008, as well as growth inA&H and OBGR. In addition, net written premiums at OBPI increased$26.0 million.

 

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The specialty lines combined ratio for the year ended December 31,2008 increased to 85.1% from 81.2% for the year ended December 31, 2007.The loss and LAE ratio decreased 0.9 point to 48.3% while the expense ratioincreased 4.8 points to 36.8%. The decrease in the loss and LAE ratio wasmainly due to 8.5 points of favorable loss reserve development in the yearended December 31, 2008 primarily related to lower than expected severityin professional liability, compared with 3.9 points in the year ended December 31,2007 primarily related to professional liability. Partially offsetting thisdecrease was a 2.0 point increase in current accident year non-catastrophelosses in the year ended December 31, 2008 mainly due to large losses atIMU, compared with the year ended December 31, 2007. Additionally, theyear ended December 31, 2008 included 2.6 points of current accident yearcatastrophe losses primarily related to hurricane Ike, compared to 0.9 pointsof current accident year catastrophe losses in the year ended December 31,2007. The increase in the expense ratio was mainly due to changes in mix ofbusiness within the specialty lines businesses and the mix of products offeredwithin those businesses and the related costs incurred to acquire thosebusinesses. Our collector cars and boats business and some of our other newerspecialty lines businesses receive higher compensation than the previous mix ofbusiness. Also, at OBPI, increased writings of our long-term care product anddecreased writings of our provider excess insurance product carry a higher andlower commission ratio, respectively, and shifted the expense ratio upward. Inaddition, during the year ended December 31, 2008, we incurred additionaltransition costs associated with the new management team at OBPI. The expenseratio for the year ended December 31, 2007 included a 0.7 point favorableimpact from the partial settlement of our qualified pension plan liabilities,partially offset by 0.5 points of office consolidation costs.

 

*Personal lines.*  Net written premiums for personal linesdecreased by 10.4% to $618.7 million in the year ended December 31,2008 from $690.4 million in the year ended December 31, 2007. Intraditional personal lines, net written premiums decreased by 10.7% to$559.3 million due to the decision to cease writing business in HoustonGeneral Insurance Exchange (Houston General) in late 2007, lower new businessassociated with coastal restrictions implemented at Adirondack Insurance andhigher reinsurance costs at Adirondack Insurance, lower premium volume from theinvoluntary market in Massachusetts, and the discontinuation of surplus lines business.In January 2008, Houston General entered into a reinsurance agreement withUniversal Holdings of North America (Universal) under which Houston Generalceded $6.6 million of unearned premiums to Universal. Further, net writtenpremiums at AutoOne decreased by 10.9% to $119.9 million due to changes inNew York’s and New Jersey’s assigned risk pools, as described above.

 

The personal lines combined ratio for the year ended December 31,2008 increased to 95.9% from 94.0% for the year ended December 31, 2007.The loss and LAE ratio increased 3.6 points to 64.0%, while the expense ratiodecreased by 1.7 points to 31.9%. The increase in the loss and LAE ratio wasprimarily due to 1.2 points of adverse loss reserve development in the yearended December 31, 2008, mainly on personal automobile liability atAutoOne compared with 3.3 points of favorable loss reserve development in theyear ended December 31, 2007, primarily related to personal automobileliability losses in traditional personal lines and at AutoOne. The decrease inthe expense ratio was primarily due to decreased other underwriting expenses asa result of the decision to cease writing business in Houston General andactions taken in 2007 to better align personal lines staffing with our businessneeds. The expense ratio for the year ended December 31, 2007 alsoincluded a 1.0 point benefit from a state premium tax refund, a 0.9 pointbenefit related to the partial settlement of our qualified pension planliabilities and 0.8 points of office consolidation costs.

 

*Run-off.*  Net written premiums for run-off decreased by2.4% to $507.5 million in the year ended December 31, 2008 from $520.0million in the year ended December 31, 2007. Net written premiums fromnon-specialty middle market commercial businesses were $507.1 million in theyear ended December 31, 2008, compared with $519.7 million in the yearended December 31, 2007. The decrease was primarily due to a$30.3 million decrease in non-specialty middle market commercialbusinesses, partially offset by an increase of $17.7 million in the smallbusiness division, principally driven by our small business package products.Net written premiums from legacy run-off business were $0.4 million in the yearended December 31, 2008, compared with $0.3 million in the year ended December 31,2007.

 

The run-off combined ratio for the year ended December 31, 2008increased to 108.3% from 105.8% for the year ended December 31, 2007. Theloss and LAE ratio increased 5.2 points to 71.7%, while the expense ratio decreased2.7 points to 36.6%. The increase in the loss and LAE ratio was primarily dueto 6.3 points of current accident year catastrophe losses in year ended December 31,2008 primarily related to hurricane Ike in our non-specialty middle marketcommercial businesses and small business division and losses from tornadoes inthe southeastern United States in our non-specialty middle market commercialbusinesses in the first quarter of 2008, compared to 1.0 point of catastrophelosses in the year ended December 31, 2007. Additionally, current accidentyear non-catastrophe losses increased 1.5 points in the year ended December 31,2008, compared with the year ended December 31, 2007. These increases werepartially offset by 1.4 points of favorable loss reserve development in theyear ended December 31, 2008, compared with 0.1 point of adverse lossreserve development in the year ended December 31, 2007 due to higherlarge losses related to winter weather in the northeastern United States. Thedecrease in the expense ratio was primarily due to a 4.4 point decrease inother underwriting expenses, partially offset by a 1.7 point increase in policyacquisition expenses. The year ended December 31, 2007 included a 1.6point 

 

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benefitfrom the partial settlement of our qualified pension plan liabilities, whichwas partially offset by 1.0 point of office consolidation costs.

 

Legacy run-off business generated an underwriting loss of$21.9 million in the year ended December 31, 2008, compared to anunderwriting loss of $155.6 million ($38.9 million excluding a$116.7 million increase to loss and LAE reserves resulting from the reservereallocation) in the year ended December 31, 2007. The year ended December 31,2008 includes incurred loss and LAE of $20.5 million ($9.2 million ofincurred ULAE, described above), compared with $33.1 million (excludingthe reserve reallocation) in the year ended December 31, 2007. The yearended December 31, 2007 also includes a $5.1 million benefit from thepartial settlement of our qualified pension plan liabilities.

 

*Other Operations*

 

Our Other Operations segment consists of our holding company, OBH,which primarily consists of financing activities, purchase accountingadjustments relating to the OneBeacon Acquisition and other assets andliabilities, and general and administrative expenses incurred at the holdingcompany level.

 

The purchase accounting adjustments relating to the OneBeaconAcquisition were made to reflect the estimated fair value of our assetsacquired and liabilities assumed on the date of the acquisition. The purchaseaccounting adjustments were primarily comprised of an adjustment to our lossand LAE reserves and related reinsurance recoverables to record them at fairvalue, an adjustment to record the cost of our investments at fair value and anallocation of the excess of acquired net assets over the purchase price to ournon-current, non-financial assets, primarily our property, plant and equipment.

 

The Other Operations segment results are affected by purchaseaccounting over time as the fair value adjustments made at our acquisitionunwind. Fair value adjustments other than those related to loss and LAEreserves and related reinsurance recoverables have been fully recognized in ourfinancial statements in periods prior to those presented below. The fair valueadjustment to net loss and LAE reserves is expensed through income as our netloss and LAE reserves at the time of the OneBeacon Acquisition are settled.

 

As described above, effective January 1, 2008, we adopted the fairvalue option. Accordingly, pre-tax loss for 2009 and 2008 is not directlycomparable to such measure for 2007. A summary of results from our OtherOperations segment for the years ended December 31, 2009, 2008 and 2007 isas follows:

 
| ** **                                                   | ** ** | **Year ended December 31,** | ** ** |
|--------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                   | ** ** | **2009**                         | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                   | ** ** | **($ in millions)**         | ** ** |
| Net investment (expense) income                              |       | $                                | (2.1       | ) | $ | 9.3 |   | $ | 17.9 |   |
| Net realized investment losses                               |       | (2.1                             | )          | (5.5 | ) | (1.4 | ) |
| Net other revenues (expenses)                                |       | 3.7                              |       | (0.2 | ) | (2.0 | ) |
| Total revenues                                               |       | (0.5                             | )          | 3.6 |   | 14.5 |   |
| General and administrative expenses                          |       | 1.1                              |       | 0.7 |   | 0.3 |   |
| Accretion of fair value adjustment to loss and LAE  reserves |       | 5.4                              |       | 12.0 |   | 16.0 |   |
| Interest expense on debt                                     |       | 38.2                             |       | 41.4 |   | 42.0 |   |
| Interest expense—dividends on preferred stock           |       | —                           |       | 11.8 |   | 28.3 |   |
| Interest expense—accretion on preferred stock           |       | —                           |       | 21.6 |   | 36.1 |   |
| Total expenses                                               |       | 44.7                             |       | 87.5 |   | 122.7 |   |
| Pre-tax loss                                                 |       | $                                | (45.2      | ) | $ | (83.9 | ) | $ | (108.2 | ) |

 

**OtherOperations Results—Year ended December 31, 2009 versus year ended December 31,2008**

 

Our Other Operations segment reported a pre-tax loss of$45.2 million in the year ended December 31, 2009, compared to apre-tax loss of $83.9 million in the year ended December 31, 2008.The decrease in loss was primarily related to a decrease in interest expenserelated to the Berkshire Preferred Stock which was redeemed in the secondquarter of 2008. Further, net other revenues increased mainly due to a $5.4million gain related to the purchase of a portion of our senior notes. Thedecrease in interest expense was partially offset by a decrease in netinvestment (expense) income to $(2.1) million in the year ended December 31,2009 compared to $9.3 million in the prior year, due to a lower averageinvested asset base and lower investment yields. Net investment income in theyear ended December 31, 2008 included $6.2 million related to assetsheld in trust for theBerkshire Preferred Stock.

 

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**OtherOperations Results—Year ended December 31, 2008 versus year ended December 31,2007**

 

OurOther Operations segment reported a pre-tax loss of $83.9 million in theyear ended December 31, 2008, compared to a pre-tax loss of $108.2 millionin the year ended December 31, 2007. The decrease in loss was primarilydue to a decrease in interest expense related to the preferred stock which wasredeemed in the second quarter of 2008. The decrease in interest expense waspartially offset by a decrease in net investment income to $9.3 million in theyear ended December 31, 2008, compared to $17.9 million in the prior year. Net investmentincome in the year ended December 31, 2008 included $6.2 million relatedto assets held in trust whereas the year ended December 31, 2007 included$15.4 million related to assets held in trust.

 

**Summaryof Investment Res****ults**

 

***Investment Returns***

 

A summary of our consolidated pre-tax investment results for the yearsended December 31, 2009, 2008 and 2007 is as follows:

 
|                                                  |   | **Year ended December 31,** |       |
|-------------------------------------------------------|--------|----------------------------------|------------|
|                                                  |   | **2009**                         | ** ** | **2008** | ** ** | **2007** |   |
|                                                  |   | **($ in millions)**         |       |
| Net investment income (1)                             |   | $                                | 125.3      |   | $ | 162.1 |   | $ | 202.4 |   |
| Net realized investment (losses) gains                |   | (20.5                            | )          | (318.6 | ) | 173.1 |   |
| Change in net unrealized investment gains and  losses |   | 269.1                            |       | (447.4 | ) | (4.9 | ) |
| Total GAAP pre-tax investment results                 |   | $                                | 373.9      |   | $ | (603.9 | ) | $ | 370.6 |   |

 

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(1)           Includes $6.2 million and$15.4 million of net investment income for assets held in trust for theyears ended December 31, 2008 and 2007, respectively.

 

Gross investment returnsversus typical benchmarks for the years ended December 31, 2009, 2008 and2007 are as follows:

 
| ** **                                                   | ** ** | **Year ended December 31,(1)** | ** ** |
|--------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                   | ** ** | **2009**                            | ** ** | **2008(2)** | ** ** | **2007(2)** | ** ** |
| Fixed maturity investments                                   |       | 12.3                                | %          | (2.8 | )% | 6.4 | % |
| Short-term investments                                       |       | 0.6                                 |       | 1.9 |   | 4.9 |   |
| Total fixed income                                           |       | 10.0                                |       | (2.1 | ) | 6.1 |   |
| Barclays U.S. Intermediate Aggregate Index                   |       | 6.5                                 |       | 5.2 |   | 7.0 |   |
| Common stock                                                 |       | (7.4                                | )          | (53.8 | ) | 12.6 |   |
| Convertible bonds                                            |       | 22.7                                |       | (9.1 | ) | 4.6 |   |
| Total common stock and convertible bonds                     |       | 10.8                                |       | (40.3 | ) | 9.9 |   |
| Other investments                                            |       | 10.8                                |       | (35.7 | ) | 14.4 |   |
| Total common stock, convertible bonds and other  investments |       | 10.8                                |       | (39.3 | ) | 10.8 |   |
| S&P 500 Index (total return)                        |       | 26.5                                |       | (37.0 | ) | 5.5 |   |
| Total consolidated portfolio                                 |       | 10.1                                | %          | (13.4 | )% | 7.6 | % |

 

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(1)           Gross investment returnsexclude investment expenses of $10.8 million, $14.0 million and $16.0 millionfor the years ended December 31, 2009, 2008 and 2007, respectively.

 

(2)           Includes $6.2 million and $15.4 million ofnet investment income for assets held in trust for the years ended December 31,2008 and 2007, respectively.

 

During the third and fourth quarters of 2008, there were significantdeclines and high volatility in the equity markets, a lack of liquidity in thecredit markets and a widening of credit spreads on debt securities. Thesefactors had a significant adverse effect on the performance of our investmentportfolio in 2008. In the second half of 2008, we shifted our investmentphilosophy from a total return focus to a capital preservation focus inresponse to the significant declines and high volatility in equity markets, thelack of liquidity in the credit markets and the widening of credit spreads onfixed income securities experienced. In particular, we significantly reducedthe size of our equity portfolio and now have a larger percentage of ourinvested assets in cash and short-term investments than we have in the pastunder a total return approach. As overall financial markets and our investment results continue tostabilize, we are gradually shifting back from a focus on capital preservationto our traditional total return investment philosophy.

 

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*Investment Returns—Year ended December 31, 2009versus year ended December 31, 2008*

 

**Overview**

** **

Our total pre-tax investment results were $373.9 million, a return of10.1% for the year ended December 31, 2009, compared to$(603.9) million, a return of (13.4)%, for the year ended December 31,2008. Net investment income in the year ended December 31, 2009 was$125.3 million, a decrease of $36.8 million, compared to $162.1 millionin the year ended December 31, 2008. The decrease was due to a loweraverage invested asset base and lower investment yields. Contributing to the lower investmentyields was a $(1.1) million inflation adjustment related to our inflation indexedtreasury securities for the year ended December 31, 2009 as compared to an$8.6 million inflation adjustment related to these securities for the yearended December 31, 2008. Net investment income in theyear ended December 31, 2008 included $6.2 million related to assetsheld in trust. Net realized investment (losses) gains were $(20.5) million inthe year ended December 31, 2009, an increase of $298.1 million,compared to $(318.6) million in the year ended December 31, 2008. Thechange in net unrealized investment gains and losses resulted in a gain of$269.1 million in the year ended December 31, 2009, compared to a loss of$447.4 million in the year ended December 31, 2008. As describedabove, net realized and unrealized investment losses experienced in 2008resulted from the crisis that occurred in the financial markets during thethird and fourth quarters of 2008.

 

**Fixed income**

 

Our fixed income portfolio, which includes fixed maturity andshort-term investments, returned 10.0% for the year ended December 31,2009, compared to (2.1)% for the year ended December 31, 2008. The fixedmaturity portfolio, in particular the corporate bond portfolio, performed wellduring the year ended December 31, 2009, driven by spread tightening.During the years ended December 31, 2009 and 2008, we maintained a highquality fixed maturity portfolio with a relatively short duration ofapproximately 3 years for both periods which performed consistently with itscharacteristics and above the Barclays U.S. Intermediate Aggregate Indexbenchmark for the year ended December 31, 2009 and worse for the yearended December 31, 2008.

 

**Common stock, convertible bonds and other investments**

** **

Our total common stock, convertible bond and other investmentsportfolio returned 10.8% for the year ended December 31, 2009 compared to(39.3)% for the year ended December 31, 2008. Our total common stock andconvertible bond portfolio returned 10.8% and (40.3)% for the years ended December 31,2009 and 2008, respectively, or 15.7 percentage points worse and3.3 percentage points worse, respectively, than the S&P 500benchmark. The S&P 500 rebounded during 2009; given the reduction in thesize of our equity portfolio discussed previously, we are more heavily weightedin convertible bonds than in common stocks, resulting in our portfoliounderperforming the S&P 500 benchmark. We recorded $(20.5) million innet realized losses in the year ended December 31, 2009, which included$(19.2) million of net realized losses on the sales of common stock and convertiblebond investments resulting from the reduction in the size of the equityportfolio discussed previously. Our other investments portfolio returned 10.8%for the year ended December 31, 2009, compared to (35.7)% for the yearended December 31, 2008.

 

*InvestmentReturns—Ye**ar ended December 31, 2008versus year ended December 31, 2007*

 

**Overview**

 

Our total pre-tax investment results were $(603.9) million, areturn of (13.4)% for the year ended December 31, 2008, compared to$370.6 million, a return of 7.6%, for the year ended December 31,2007. Net investment income in the year ended December 31, 2008 was$162.1 million, a decrease of 19.9%, compared to $202.4 million inthe year ended December 31, 2007. The decrease was principally due to alower average invested asset base and lower investment yields. Net investmentincome in the year ended December 31, 2008 included $6.2 million relatedto assets held in trust whereas the year ended December 31, 2007 included$15.4 million related to assets held in trust. Net realized investment (losses)gains were $(318.6) million in the year ended December 31, 2008, adecrease of $491.7 million, compared to $173.1 million in the year ended December 31,2007, mainly due to $239.8 million of impairment charges taken in the yearended December 31, 2008 and $96.3 million of realized losses on sales ofequity investments, compared to realized gains on sales in the year ended December 31,2007 of certain convertible fixed maturity and equity securities in industrysectors that experienced significant appreciation, principally energy andnatural resources. The change in net unrealized investment gains and losses wasa decrease of $447.4 million in the year ended December 31, 2008, comparedto a decrease of $4.9 million in the year ended December 31, 2007. Lossesreflected in the change in net unrealized investment gains and losses are aresult of the crisis that occurred in the financial markets during the thirdand fourth quarters of 2008 as described above. We recorded a pre-tax decrease in the change in net unrealizedinvestment gains and losses in our fixed income portfolio of $174.2 million, 

 

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mainlydriven by a general widening of credit spreads. We recorded a pre-tax decrease in the change in net unrealizedinvestment gains and losses in our common stock portfolio of $156.9 million;the majority of this decline was driven by investments within the financials,utilities and materials sectors.

 

**Fixedincome**

 

Our fixed income portfolio, which includes both fixed maturity andshort-term investments, returned (2.1)% for the year ended December 31,2008, compared to 6.1% for the year ended December 31, 2007. As previouslydiscussed, the performance was primarily driven by pre-tax losses reflected inthe change in net unrealized investment gains and losses of $174.2 million as aresult of a general widening of credit spreads. We recorded $40.9 million innet realized losses in the year ended December 31, 2008, which included$58.4 million of impairment charges, primarily in the financials sector. Ourfixed income portfolio had minimal exposure to adverse credit events occurringin the second half of 2008. Our short duration mortgage-backed and asset-backedsecurities have also performed relatively well in difficult times. During theyears ended December 31, 2008 and 2007, we maintained a high quality fixedmaturity portfolio with a relatively short duration of approximately 3 yearsfor both periods, which performed consistent with its characteristics and worsethan the longer-duration Barclays U.S. Intermediate Aggregate Index benchmark.

 

**Commonstock, convertible bonds and other investments**

 

Our total common stock, convertible bond and other investmentsportfolio returned (39.3)% for the year ended December 31, 2008 comparedto 10.8% for the year ended December 31, 2007. Our common stock andconvertible bond portfolios returned (40.3)% and 9.9% for the years ended December 31,2008 and 2007, respectively, or 3.3 percentage points worse and4.4 percentage points better than the S&P 500 benchmark, respectively.We recorded $258.9 million in net realized losses in the year ended December 31,2008, which included $151.5 million of impairment charges related toinvestments in the common stock and convertible bond portfolios and $107.4million of net realized losses on the sale of common stocks and convertiblebonds in 2008. Our other investment portfolio returned (35.7)% for the yearended December 31, 2008, compared to 14.4% for the year ended December 31,2007. Approximately 59.7% of our other investment portfolio is invested inhedge funds; these hedge funds experienced decreases in asset values during theyear ended December 31, 2008 as a result of the volatility in thefinancial markets.

 

***Portfolio Composition***

 

The following table presents the composition of our trading investmentportfolio as of December 31, 2009 and 2008:

 
| ** **                 | ** ** | **As of December 31,** | ** ** |
|----------------------------|------------|-----------------------------|------------|
| ** **                 | ** ** | **2009**                    | ** ** | **2008** | ** ** |
| **Type  of Investment**    | ** ** | **$ in millions**      | ** ** | **% of total** | ** ** | **$ in millions** | ** ** | **% of total** | ** ** |
| Fixed maturity investments |       | $                           | 2,994.3    |   | 75.1 | % | $ | 2,134.8 |   | 57.3 | % |
| Short-term investments     |       | 489.3                       |       | 12.3 |   | 875.4 |   | 23.5 |   |
| Common stock               |       | 187.6                       |       | 4.6 |   | 276.7 |   | 7.4 |   |
| Convertible bonds          |       | 170.2                       |       | 4.3 |   | 241.2 |   | 6.5 |   |
| Other investments(1)       |       | 146.3                       |       | 3.7 |   | 196.6 |   | 5.3 |   |
| Total                      |       | $                           | 3,987.7    |   | 100.0 | % | $ | 3,724.7 |   | 100.0 | % |

 

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(1)           Includesinvestments such as hedge funds and private equity funds.

 

The breakdown of our fixed maturity portfolio, including convertiblebonds, at December 31, 2009 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 agency obligations |       | $                           | 519.4      |           | 17.0       | % |
| AAA/Aaa                                |       | 1,007.3                     |       | 33.0           |       |
| AA/Aa                                  |       | 125.8                       |       | 4.1            |       |
| A/A                                    |       | 501.6                       |       | 16.4           |       |
| BBB/Baa                                |       | 690.0                       |       | 22.6           |       |
| Other/not rated                        |       | 210.2                       |       | 6.9            |       |
| Total                                  |       | $                           | 3,054.3    |           | 100.0      | % |

 

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The weighted average duration of our fixed maturity portfolio,including convertible bonds, at December 31, 2009 is approximately3 years. The maturity distribution for fixed maturity investments,including convertible bonds, held at December 31, 2009 is as follows:

 
| **Maturity**                     | ** ** | **Amortized Cost**       | ** ** | **Carrying Value** | ** ** |
|----------------------------------|------------|--------------------------|------------|--------------------|------------|
| ** **                       | ** ** | **($ in millions)** | ** ** |
| Due within one year              |       | $                        | 159.9      |               | $          | 162.0 |   |
| Due after one through five years |       | 1,505.3                  |       | 1,569.8            |       |
| Due after five through ten years |       | 210.0                    |       | 228.0              |       |
| Due after ten years              |       | 104.6                    |       | 118.3              |       |
| Asset-backed securities          |       | 1,003.7                  |       | 1,014.9            |       |
| Preferred stocks                 |       | 70.8                     |       | 71.5               |       |
| Total                            |       | $                        | 3,054.3    |               | $          | 3,164.5 |   |

 

***Asset-backed Securities***

 

In the past several years, many originators of residential mortgage andhome equity loans relaxed their underwriting standards and issued loans tocustomers with weak credit profiles. This practice is often referred to assub-prime mortgage lending. The slowing U.S. housing market has causedmany sub-prime mortgage customers to be unable to refinance their mortgageloans, particularly those customers who had adjustable rate mortgages thatreset at a higher rate than the rate at the origination of their mortgage. As aresult, there have been significantly higher delinquency and foreclosure ratesin the United States.

 

We purchase commercial and residential mortgage-backed securities tomaximize our fixed income portfolio’s risk adjusted returns and diversify theportfolio risk from primarily corporate credit risk to a mix of credit and cashflow risk. Our non-agency commercial mortgage-backed portfolio is generally ofshort tenor and structurally senior, with more than 30 points of creditenhancement on average. We are not an originator of residential mortgage loansand held $0.1 million of residential mortgage-backed securities categorized assub-prime as of December 31, 2009. In addition, our investments in hedgefunds and private equity funds contain negligible amounts of sub-primemortgage-backed securities as of December 31, 2009. We consider sub-primemortgage-backed securities to be those that are issued from dedicated sub-primeshelves, dedicated second-lien shelves (i.e., we consider investments backedprimarily by second-liens to be a sub-prime risk regardless of credit score orother metrics) or otherwise have underlying loan pools that exhibit weak creditcharacteristics.

 

There are also mortgage-backed securities that we categorize as “non-prime”(also called “Alt A” or “A-”) that are backed by collateral that hasoverall credit quality between prime and sub-prime, as determined based on areview of the characteristics of their underlying mortgage loan pools, such ascredit scores and financial ratios. As of December 31, 2009, we did nothold any mortgage-backed securities classified as non-prime. We did not own anycollateralized debt obligations, including residential mortgage-backedcollateralized debt obligations.

 

Our investments in asset-backed securities are generally valued usingmatrix and other pricing models. Key inputs in a typical valuation arebenchmark yields, benchmark securities, reported trades, issuer spreads, bids,offers, credit ratings and prepayment speeds. At December 31, 2009, themarket for our investments in asset-backed securities remained active and,accordingly, we did not adjust the fair value estimates for the effect ofilliquidity.

 

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The following table summarizes the carrying value of ourmortgage-backed and other asset-backed securities holdings as of December 31,2009 and 2008:

 
| ** **                           | ** ** | **December 31,**    | ** ** |
|--------------------------------------|------------|--------------------------|------------|
| ** **                           | ** ** | **2009**                 | ** ** | **2008** | ** ** |
| ** **                           | ** ** | **($ in millions)** | ** ** |
| Mortgage-backed securities:          |       |                     |       |   |   |
| Agency: (1)                          |       |                     |       |   |   |
| GNMA                                 |       | $                        | 483.0      |   | $ | 367.3 |   |
| FNMA                                 |       | 149.1                    |       | 28.5 |   |
| FHLMC                                |       | 76.3                     |       | 84.9 |   |
| Non-agency:                          |       |                     |       |   |   |
| Residential                          |       | 30.7                     |       | 111.9 |   |
| Commercial                           |       | 136.1                    |       | 126.8 |   |
| Total mortgage-backed securities (2) |       | 875.2                    |       | 719.4 |   |
| Other asset-backed securities:       |       |                     |       |   |   |
| Credit card                          |       | 27.7                     |       | 39.5 |   |
| Auto                                 |       | 111.1                    |       | — |   |
| Other                                |       | 0.9                      |       | — |   |
| Total other asset-backed securities  |       | 139.7                    |       | 39.5 |   |
| Total asset-backed securities (3)    |       | $                        | 1,014.9    |   | $ | 758.9 |   |

 

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(1)           Representspublicly traded residential mortgage-backed securities which carry the fullfaith and credit guaranty of the U.S. government.

 

(2)           Approximately 98% and 97% of ourmortgage-backed securities as of December 31, 2009 and 2008, respectively,have the highest ratings ascribed by Moody’s (“Aaa”) or Standard &Poor’s (“AAA”).

 

(3)           Of our total asset-backed securities, approximately97% as of both December 31, 2009 and 2008 have the highest ratingsascribed by Moody’s (“Aaa”) or Standard & Poor’s (“AAA”).

 

***Securities Lending***

 

We participated in asecurities lending program as a mechanism for generating additional investmentincome on our fixed maturity and common equity portfolios. Under the securitieslending arrangements, certain of our fixed maturity and common equityinvestments were loaned to other institutions for short periods of time througha lending agent. We maintained control over the securities we loaned, retainedthe earnings and cash flows associated with the loaned securities and receiveda fee from the borrower for the temporary use of the asset. Collateral, in theform of cash and United States government securities, was required at a rate of102% of the fair value of the loaned securities. An indemnification agreementwith the lending agent protected us in the event a borrower became insolvent orfailed to return any of the securities on loan. In the event of a shortfall inthe collateral amount required to be returned to the securities lendingcounterparty (e.g., as a result of investment losses), we were obligated tomake up any deficiency.

 

Prior to February 2009,the collateral was controlled by the lending agent. The lending agent managedthe investment of the cash collateral, however, other than in the event ofdefault by the borrower, this collateral was not available to us and was remittedto the borrower by the lending agent upon the return of the loaned securities.Because of these restrictions, we considered our securities lending activitiesto be non-cash transactions. The fair value of the securities lendingcollateral was recorded as both an asset and liability on the balance sheet.

 

In February 2009,we amended the terms of the securities lending program to give us more controlover the investment of borrowers’ collateral and to separate the assetssupporting that collateral into a segregated account. Pursuant to theamendment, (i) the guidelines for the investment of any new cashcollateral as well as the reinvestment of cash were narrowed to permitinvestment in only cash equivalent securities, (ii) we have the authorityto direct the lending agent to both sell specific collateral securities in thesegregated account and to not sell certain collateral securities which thelending agent proposes to sell, and (iii) we and the lending agent agreedto manage the securities lending program toward an orderly wind-down. In May 2009,we instructed the lending agent not to make any additional loans of securitiesand to recall all of the securities on loan and fund the return of collateralto the borrower. As of December 31, 2009, $1.7 million in collateral hadnot been returned to the borrower. As a result of the actions described above,the securities lending assets are no longer segregated and are included withinour investment securities.

 

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At December 31,2008, prior to the amendment of the terms of the securities lending program,the total market value of our securities on loan was $107.7 million withcorresponding collateral of $100.7 million, resulting in an unrealizedloss of $7.0 million recorded in change in net unrealized investment gains andlosses, a component of net realized and unrealized investment gains (losses).In 2009 prior to exiting the securities lending program, we recorded $3.9million of net realized and unrealized gains. Subsequent to exiting theprogram, we recorded $0.8 million of net realized and unrealized gains on thesecurities returned to us, resulting in a total of $2.3 million of net realizedand unrealized losses in connection with our exiting from the program. Thesecurities lending program has generated $18.1 million of additional investmentincome for us since inception in 2001.

 

**Non-GAAP Financial Measures**

 

This reportincludes two non-GAAP financial measures that have been reconciled to the mostcomparable GAAP financial measures. OB Holdings believes these measures to be auseful supplement to the comparable GAAP measures in evaluating OB Holdings’financial performance.

 

**Loss and loss adjustment expense ratio prior toreserve reallocation and total combined ratio prior to reserve reallocation** are non-GAAPfinancial measures which are derived by excluding the impact of thereallocation of loss and loss adjustment expense reserves from the loss andloss adjustment expense ratio and the GAAP combined ratio. During 2007, OBHoldings reallocated loss and loss adjustment expense reserves from ongoinglines of business to run-off which reduced the loss and loss adjustment expenseratios and the GAAP combined ratios for OB Holdings’ specialty and personallines of business but had no impact on the ratios for OB Holdings’ totalinsurance operations. OB Holdings believes that a presentation excluding theeffect of the reserve reallocation on the loss and loss adjustment expenseratios and combined ratios is a meaningful supplement for investors tounderstand the performance of its underwriting units. The reconciliation ofthese non-GAAP financial measures to the loss and loss adjustment expense ratioand GAAP combined ratio, the most closely comparable GAAP measures, is includedon page 41.

 

**Liquidityand Capital Resources**

 

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

 

Our sources and uses of cash are as follows:

 

*Holding company level.*  The primary sources of cash for OBH areexpected to be dividends and tax sharing payments received from our insuranceoperating subsidiaries, financing activities and net investment income andproceeds from sales and maturities of holding company investments. The primaryuses of cash are expected to be interest payments on our debt obligations,repurchases of debt, purchases of investments, tax payments and holding companyoperating expenses.

 

*Operating subsidiary level.*  The primary sources of cash for our operatingsubsidiaries are expected to be premium collections, financing activities, netinvestment income and proceeds from sales and maturities of investments. Theprimary uses of cash are expected to be claim payments, policy acquisition costs,debt obligations, operating expenses, purchases of investments and dividendsand tax sharing payments made to parent holding companies.

 

Insurance companies typically collect premiums on policies that theywrite prior to paying claims made under those policies. During periods ofpremium growth, insurance companies typically experience positive cash flowfrom operations, as premium receipts typically exceed claim payments. When thishappens, positive cash flow from operations is usually offset by negative cashflow from investing activities, as the positive operating cash flow is used topurchase investments. Conversely, during periods of premium decline, insurancecompanies typically experience negative cash flow from operations, even duringperiods in which they report GAAP net income, as the claims that they payexceed the premiums that they collect. When this happens, negative cash flowfrom operations is typically offset by positive cash flow from investingactivities, as invested assets are sold to fund current claim payments.

 

Both internal and external forces influence our financial condition,results of operations and cash flows. Claim settlements, premium levels andinvestment returns may be impacted by changing rates of inflation and othereconomic conditions. In many cases, significant periods of time, ranging up toseveral years or more, may lapse between the occurrence of an insured loss, thereporting of the loss to us and the settlement of the liability for that loss.The exact timing of the payment of claims and benefits cannot be predicted withcertainty. Our operating subsidiaries maintain portfolios of invested assetswith varying maturities and a substantial amount of short-term investments toprovide adequate liquidity for the payment of claims.

 

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Management believes that our cash balances, cash flows from operationsand cash flows from investments are adequate to meet expected cash requirementsfor the foreseeable future on both a holding company and operating subsidiarylevel.

 

***Dividend Capacity***

 

Under the insurance laws of the states and jurisdictions under whichour operating subsidiaries are domiciled, an insurer is restricted with respectto the timing or the amount of dividends it may pay without prior approval byregulatory authorities. Accordingly, there can be no assurance regarding theamount of such dividends that may be paid by such subsidiaries in the future.

 

Generally, our regulated insurance operating subsidiaries have theability to pay dividends during any 12-month period in an amount equal to thegreater of prior year statutory net income or 10% of prior year endstatutory surplus, subject to the availability of unassigned funds. Based on2009 statutory surplus of $1.6 billion, our top tier regulated insuranceoperating subsidiaries have the ability to pay approximately $157 millionof dividends during 2010, subject to the availability of unassigned funds. Asof December 31, 2009, OB Holdings’ top tier regulated insurance operatingsubsidiaries had $1.1 billion of unassigned funds. As of December 31,2009, we had approximately $64 million of unrestricted net cash and fixedmaturity investments outside of our regulated insurance operating subsidiaries.

 

During the years ended December 31, 2009, 2008 and 2007, ourregulated operating subsidiaries paid $80.0 million, $197.0 million and$393.9 million, respectively, of dividends to OneBeacon LLC. During theyears ended December 31, 2009, 2008 and 2007, our unregulated insuranceoperating subsidiaries paid $11.9 million, $6.0 million, and $3.6 million,respectively, of dividends to their immediate parent.

 

OBH’s ability to declare or pay dividends was limited by the terms ofthe Series A Preferred Stock issued to Berkshire. OBH could not, incertain circumstances, declare or pay any dividend or distribution to any otherclass or 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 andOBH (the Keep-Well), White Mountains had agreed to return to OBH up toapproximately $1.1 billion if some or all of that amount was required byOBH to meet its obligations under the terms of the Berkshire Preferred Stock.As described below, the Keep-Well has expired. Under the Keep-Well, WhiteMountains had to make any required contributions to OBH prior to making anydistributions to its shareholders. The aggregate amount of distributions thatWhite Mountains could make to its shareholders was limited; the limit increasedor decreased by an amount equal to White Mountains’ consolidated net income orloss over the remaining life of the Keep-Well. The Keep-Well expired when allobligations of the Berkshire Preferred Stock were satisfied upon its redemptionin May 2008. See “Management’s Discussion and Analysis of FinancialCondition and Results of Operations—Economic Defeasance” for a discussion ofthe creation and funding of an irrevocable grantor trust to economicallydefease the Berkshire Preferred Stock.

 

**Economic Defeasance**

 

In connection with OBIG’s initial public offering, OBH established anirrevocable grantor trust. The assets of the trust were solely dedicated to thesatisfaction of the payment of dividends and redemption amounts on the$300 million liquidation preference of the Berkshire Preferred Stock. OBHfunded the trust with cash and purchased a portfolio of fixed maturitysecurities issued by the U.S. government and government-sponsoredenterprises. The scheduled interest and principal payments were sufficient topay when due all amounts required under the terms of the Berkshire Preferred Stock.The creation and funding of the trust did not legally defease the preferredstock nor create any additional rights for the holders of the BerkshirePreferred Stock in the trust or otherwise, although the assets in the trustwere segregated from the Company’s other general assets and were not availableto the Company for any use other than the payment of the Berkshire PreferredStock. The assets held in trust were used to redeem the Berkshire PreferredStock in May 2008. White Mountains Capital, Inc., a subsidiary ofWhite Mountains, served as the trustee for the irrevocable grantor trust.Pre-tax net investment income earned on these investments totaled $6.2 millionand $15.4 million, respectively, for the years ended December 31,2008 and 2007.

 

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**Insurance Float**

 

Insurancefloat is an important aspect of our insurance operations. Insurance floatrepresents funds that an insurance company holds for a limited time. In aninsurance operation, float arises because premiums are collected before lossesare paid. This interval can extend over many years. During that time, theinsurer invests the funds. When the premiums that an insurer collects do notcover the losses and expenses it eventually must pay, the result is anunderwriting loss, which is considered to be the cost of insurance float. Theamount and cost of insurance float for us is affected by underlying marketconditions, as well as acquisitions or dispositions of insurance business.

 

Although insurance float can be calculated using numbers determinedunder GAAP, insurance float is not a GAAP concept and, therefore, there is nocomparable GAAP measure.

 

We calculate our insurance float by taking our net invested assets andsubtracting our total capital. The following table illustrates our consolidatedinsurance float position as of the years ended December 31, 2009and 2008.

 
| ** **                                                                        | ** ** | **December 31,**    | ** ** |
|-----------------------------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                                        | ** ** | **2009**                 | ** ** | **2008** | ** ** |
| ** **                                                                        | ** ** | **($ in millions)** | ** ** |
| Total investments                                                                 |       | $                        | 3,987.7    |   | $ | 3,724.7 |   |
| Cash                                                                              |       | 43.6                     |       | 51.6 |   |
| Accounts receivable on unsettled investment sales                                 |       | 24.2                     |       | 49.0 |   |
| Accounts payable on unsettled investment purchases                                |       | (7.6                     | )          | (6.8 | ) |
| Net invested assets                                                               |       | $                        | 4,047.9    |   | $ | 3,818.5 |   |
| OB Holdings’ shareholder’s equity                                       |       | $                        | 1,391.5    |   | $ | 1,133.4 |   |
| Debt                                                                              |       | 620.5                    |       | 731.9 |   |
| Total capital                                                                     |       | $                        | 2,012.0    |   | $ | 1,865.3 |   |
| Insurance float                                                                   |       | $                        | 2,035.9    |   | $ | 1,953.2 |   |
| Insurance float as a multiple of total capital                                    |       | 1.0                      | x          | 1.0 | x |
| Net invested assets as a multiple of total capital                                |       | 2.0                      | x          | 2.0 | x |
| Insurance float as a multiple of OB Holdings’  shareholder’s equity     |       | 1.5                      | x          | 1.7 | x |
| Net invested assets as a multiple of OB Holdings’  shareholder’s equity |       | 2.9                      | x          | 3.4 | x |

 

**Financing**

 

The following table summarizes our capital structure as of December 31,2009 and 2008:

 
| ** **                             | ** ** | **December 31,**    | ** ** |
|----------------------------------------|------------|--------------------------|------------|
| ** **                             | ** ** | **2009**                 | ** ** | **2008** | ** ** |
| ** **                             | ** ** | **($ in millions)** | ** ** |
| Senior Notes, carrying value           |       | $                        | 606.5      |   | $ | 675.1 |   |
| Other debt(1)                          |       | 14.0                     |       | 56.8 |   |
| Total debt                             |       | 620.5                    |       | 731.9 |   |
| Total common shareholder’s equity |       | 1,391.5                  |       | 1,133.4 |   |
| Total capital                          |       | $                        | 2,012.0    |   | $ | 1,865.3 |   |
| Ratio of debt to total capital         |       | 30.8                     | %          | 39.2 | % |

 

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(1)           See Note 6—“Debt” ofthe accompanying consolidated financial statements.

 

We believe that we have the flexibility and capacity to obtain fundsexternally as needed through debt or equity financing on both a short-term and long-termbasis. However, given the recent disruptions in the capital markets, we canprovide no assurance that, if needed, we would be able to obtain additionaldebt or equity financing on satisfactory terms or at all.

 

The 5.875% Senior Notes due 2013 of OBH are currently rated arecurrently rated “Baa2” (“Medium Grade”, the ninth highest of twenty-onecreditworthiness ratings) with a negative outlook by Moody’s, “BBB” (“Adequate”,the ninth highest of twenty-two creditworthiness ratings) on watch negative byStandard & Poor’s, “bbb” (“Good”, the ninth highest of twenty-twocreditworthiness ratings) with a stable outlook by A.M. Best and “BBB” (“Good”,the ninth highest of twenty-three creditworthiness ratings) with a negativeoutlook by Fitch. During2009, OBH repurchased $10.6 million of outstanding Senior Notes for $8.1million, which resulted in a $2.5 million gain. During 2009, OBIC purchased$58.3 million of 

 

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outstanding Senior Notesfor $55.0 million, which resulted in a $2.9 million gain. During 2008,OBH repurchased $24.0 million of the outstanding Senior Notes for$22.3 million, which resulted in a $1.6 million gain.

 

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 (the Guarantee Elimination). White Mountainshas agreed to provide written notice to us when its voting interest in us hasbeen reduced below 50%. We will have 180 days from the receipt of suchnotification to complete the Guarantee Elimination. If the GuaranteeElimination is not completed within the initial 180-day period, the Guaranteefee shall increase by 200 basis points. The Guarantee fee shall furtherincrease by 100 basis points for each subsequent 90-day period thereafter, upto a maximum Guarantee fee of 425 basis points, until the Guarantee Eliminationhas been completed.

 

The Senior Notes were issued under an indenture which containsrestrictive covenants that, among other things, limit the ability of WhiteMountains, OBH and their respective subsidiaries, which includes us, as asubsidiary of White Mountains, to create liens and enter into sale and leasebacktransactions and substantially limits the ability of OBH and its respectivesubsidiaries to consolidate, merge or transfer their properties and assets. Theindenture does not contain any financial ratios or specified levels of networth or liquidity to which White Mountains or OBH must adhere. At December 31,2009, OBH was in compliance with all of the covenants under the Senior Notes.

 

The indenture also contains a cross default provision which providesthat if White Mountains as guarantor has a payment default in excess of $25million under a credit agreement, mortgage or similar debt agreement, thedefault provisions under the indenture to the Senior Notes will be triggered.White Mountains has two revolving credit facilities which provide for borrowingup to a maximum of $450.8 million and which contains restrictive financialcovenants. As of December 31, 2009, the facilities were undrawn.  See Note 16—“Related Party Disclosures” ofthe accompanying consolidated financial statements.

 

In connection with our December 2005 purchase of land and anoffice building in Canton, Massachusetts, which is now our headquarters, weentered into a $40.8 million, 18-year mortgage note to fund renovations.As of December 31, 2009, we had fully drawn on the facility. Repayment onthe mortgage note commenced in January 2009. During the three months endedMarch 31, 2009, we repaid $0.2 million of principal in accordance with theterms of the mortgage note. On May 7, 2009, we repaid $40.6 million,representing the outstanding principal on the mortgage note.

 

**Contractual Obligations and Commitments**

 

Below is a schedule of our material contractual obligations andcommitments as of December 31, 2009:

 
| ** **                                    | ** ** | **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        |                            | $          | 4.0                             |       | $                          | 615.1      |      | $          | — |   | $ | 621.1 |   |
| Loss and LAE reserves(1)                      |       | 907.6                         |       | 1,072.6                         |       | 577.5                           |       | 1,567.6                    |       | 4,125.3   |       |
| Interest on debt                              |       | 36.3                          |       | 72.2                            |       | 18.2                            |       | —                     |       | 126.7     |       |
| Long-term incentive compensation              |       | 23.0                          |       | 37.5                            |       | 4.9                             |       | 10.8                       |       | 76.2      |       |
| Pension and other benefit plan obligations(2) |       | 25.8                          |       | 8.9                             |       | 8.1                             |       | 36.4                       |       | 79.2      |       |
| Operating leases                              |       | 13.3                          |       | 20.8                            |       | 10.3                            |       | 7.6                        |       | 52.0      |       |
| Total contractual obligations                 |       | $                             | 1,008.0    |                            | $          | 1,216.0                         |       | $                          | 1,234.1    |      | $          | 1,622.4 |   | $ | 5,080.5 |   |

 

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(1)           Represents expected futurecash outflows resulting from loss and LAE payments. The amounts presented aregross of reinsurance recoverables on unpaid losses of $2,383.4 million andinclude the discount on our workers compensation loss and LAE reserves of$127.0 million as of December 31, 2009. These balances add back theremaining purchase accounting fair value adjustment of $190.5 millionrelated to the OneBeacon Acquisition as it is a non-cash item.

 

(2)           Includes expected futurecash outflows under our non-qualified, non-contributory, defined benefitpension plan and our 401 (k) savings andemployee stock ownership plan. Our pension plans were curtailed during thefourth 

 

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quarter of 2002. As a result, new participants are no longer added andbenefits for existing participants are not increased. Non-vested participantscontinue to vest during their employment. (See Note 8—“Retirement Plans”of the accompanying consolidated financial statements.)

 

Our loss and LAE reserves do not have contractual maturity dates.However, based on historical payment patterns, the preceding table includes anestimate of when management expects our loss and LAE reserves to be paid. Thetiming of claim payments is subject to significant uncertainty. We maintain aportfolio of marketable investments with varying maturities and a substantialamount of short-term investments to provide adequate cash flows for the paymentof claims.

 

The balances included in the table above regarding our long-termincentive compensation plans include amounts payable for performance shares andunits, as well as deferred compensation balances. Exact amounts to be paidcannot be predicted with certainty, as the ultimate amounts of theseliabilities are based on future performance. The estimated payments reflectedin the table are based on current accrual factors (common share price andpay-out percentage) and assume that all outstanding balances were 100% vestedas of December 31, 2009.

 

There are no provisions within our lease agreements that would triggeracceleration of future lease payments. We have accrued $1.7 million, $1.3million and $5.4 million, respectively, for the years ended December 31,2009, 2008 and 2007 net of anticipated sub-lease income for leased space whichwe have ceased using. We do not finance our operations through thesecuritization of trade receivables, special purpose entities or syntheticleases. Further, we have not entered into any material arrangement requiring usto guarantee payment of third party debt, lease payments or to fund losses ofan unconsolidated special purpose entity.

 

We also have future binding commitments to fund certain hedge funds andprivate equity funds. These commitments, which total $46.5 million as of December 31,2009, do not have fixed funding dates and are therefore excluded from the tableabove.

 

**CashFlows**

 

Detailed informationconcerning our cash flows during the years ended December 31, 2009, 2008and 2007 follows:

 

***For the year ended December 31,2009***

 

*Financingand Other Capital Activities*

 

During 2009, wedeclared and paid $68.1 million in cash dividends to OBEH.

 

During 2009, wepaid a total of $38.9 million in interest, including $37.4 million ininterest on the Senior Notes, and repaid a total of $2.2 million in principalon our debt obligations.

 

During 2009, OBICpurchased a portion of the Senior Notes for $55.0 million.

 

During the first quarterof 2009, we repurchased a portion of the Senior Notes for $8.1 million.

 

During the second quarterof 2009, we repaid the $40.6 million outstanding balance on our mortgage note.

 

*Acquisitionsand Dispositions*

 

During the fourthquarter of 2009, we sold the renewal rights to our non-specialty commerciallines business for $23.2 million to a third party.

 

*OtherLiquidity and Capital Resource Activities*

 

During 2009, wereported net decreases in our loss and LAE reserves and reinsurancerecoverables on paid and unpaid losses, primarily due to the decline of ourbusiness exposures related to legacy run-off.

 

During the firstquarter of 2009, we made payments with respect to our long-term incentivecompensation plans totaling $27.3 million, in cash or by deferral intocertain of our non-qualified compensation plans. These payments were madeprimarily with respect to 137,400 performance shares and 148,422 performanceunits for various performance cycles.

 

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***For the year ended December 31,2008***

 

*Financingand Other Capital Activities*

 

During 2008, wedeclared and paid $219.9 million in cash dividends to OBEH.

 

During 2008, wedeclared and paid $11.8 million in cash dividends to holders of theBerkshire Preferred Stock.

 

During 2008, wepaid a total of $43.7 million in interest, including $40.4 million ininterest on the Senior Notes, and repaid $2.0 million in principal on our debtobligations.

 

During 2008, werepurchased a portion of the Senior Notes for $22.3 million.

 

During the secondquarter of 2008, we redeemed the Berkshire Preferred Stock for $300.0 million,its redemption value, using funds that had been held in trust.

 

*Acquisitionsand Dispositions*

 

During the fourthquarter of 2008, we sold one of our inactive licensed subsidiaries, FMIC, for$7.8 million in cash, to a third party.

 

During the thirdquarter of 2008, we acquired EBI for $8.0 million in cash to a third party.

 

During the firstquarter of 2008, we sold one of our inactive licensed subsidiaries, MWIC, for$4.2 million in cash to a third party.

 

*OtherLiquidity and Capital Resource Activities*

 

During 2008, wereported net decreases in our loss and LAE reserves and reinsurancerecoverables on paid and unpaid losses, primarily due to the decline of ourbusiness exposures related to legacy run-off.

 

During the firstquarter of 2008, we made payments with respect to our long-term incentivecompensation plans totaling $47.2 million, in cash or by deferral into certainof our non-qualified compensation plans. These payments were made primarilywith respect to 117,363 performance shares and 178,006 performance units forvarious performance cycles.

 

***For the year ended December 31,2007***

 

*Financingand Other Capital Activities*

 

During 2007, wedeclared and paid $93.4 million in cash dividends to OBEH.

 

During 2007, wedeclared and paid $28.3 million in cash dividends  to holders of the Berkshire Preferred Stock.

 

During 2007, wepaid a total of $44.3 million in interest, including $41.1 million ininterest on the Senior Notes, and repaid $2.0 million in principal on our debtobligations.

 

*Acquisitionsand Dispositions*

 

During the thirdquarter of 2007, we sold one of our inactive licensed subsidiaries, AEIC, for$47.7 million in cash to a third party.

 

*OtherLiquidity and Capital Resource Activities*

 

During 2007, wereported net decreases in our loss and LAE reserves and reinsurancerecoverables on paid and unpaid losses, primarily due to the decline of ourbusiness exposures related to legacy run-off.

 

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During the firstquarter of 2007, we made payments primarily with respect to our long-termincentive compensation plans totaling $39.8 million, in cash or bydeferral into certain of our non-qualified compensation plans. These paymentswere made with respect to 4,400 performance shares and 160,470 performanceunits.

 

**RelatedParty Disclosures**

 

See Note 16—“RelatedParty Disclosures” of the accompanying consolidated financial statements.

 

**Critical Accounting Estimates**

 

Management’sDiscussion and Analysis of Financial Condition and Results of Operationsdiscusses our consolidated financial statements, which have been prepared inaccordance with GAAP. The consolidated financial statements presented hereininclude all adjustments considered necessary by management to fairly presentour financial position, results of operations and cash flows.

 

The preparation offinancial statements in conformity with GAAP requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities as of the date of the historical consolidated financial statementsand the reported amounts of revenues and expenses during the reporting period.

 

On an ongoingbasis, management evaluates its estimates, including those related to fairvalue measurements of investments, 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.

 

Managementbelieves that certain of these estimates are considered critical in that theyinvolve a higher degree of judgment and are subject to a significant degree ofvariability. The descriptions below summarize the more significant estimatesused in the preparation of our historical consolidated financial statements.

 

***1.******            ******Fair Value Considerations***

 

On January 1,2008, we adopted SFAS No. 157, “Fair Value Measurements”, subsequentlycodified as ASC 820. ASC 820 provides a revised definition of fair value,establishes a framework for measuring fair value and expands financialstatement disclosure requirements for fair value information. Under ASC 820,fair value is defined as the price that would be received to sell an asset orpaid to transfer a liability in an orderly transaction between marketparticipants (an “exit price”). ASC 820 establishes a fair value hierarchy thatdistinguishes between inputs based on market data from independent sources (“observableinputs”) and a reporting entity’s internal assumptions based upon the bestinformation available when external market data is limited or unavailable (“unobservableinputs”). The fair value hierarchy in ASC 820 prioritizes fair valuemeasurements into three levels based on the nature of the inputs. Quoted pricesin active markets for identical assets or liabilities have the highest priority(“Level 1”), followed by observable inputs other than quoted prices,including prices for similar but not identical assets or liabilities (“Level 2”)and unobservable inputs, including the reporting entity’s estimates of theassumptions that market participants would use, having the lowest priority (“Level 3”).

 

Effective January 1,2008, we adopted ASC 825 for our available-for-sale securities and ourinvestments in hedge funds and private equity funds. Consistent with theguidance in ASC 825, in conjunction with the adoption, these securities are nowreported as trading securities. Upon adoption, we recorded an adjustment of$182.4 million to reclassify net unrealized gains, after tax, and netunrealized foreign currency translation gains, after tax, related toinvestments from accumulated other comprehensive income to opening retainedearnings. Subsequent to adoption, we report changes in fair value in revenuesbefore the effect of tax.

 

We use brokers andoutside pricing services to assist in determining fair values. For investmentsin active markets, we use the quoted market prices provided by the outsidepricing services to determine fair value. The outside pricing services we usehave indicated that they will only provide prices where observable inputs areavailable. In circumstances where quoted market prices are unavailable, weutilize fair value estimates based upon other observable inputs includingmatrix pricing, benchmark interest rates, market comparables and other relevantinputs. In circumstances where observable inputs are adjusted to reflectmanagement’s best estimate of fair value, such fair value measurements areconsidered a lower level measurement in the fair value hierarchy.

 

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Ourprocess to validate the market prices obtained from the outside pricing sourcesincludes, but is not limited to, periodic evaluation of model pricingmethodologies and analytical reviews of certain prices. We also periodicallyperform back-testing of selected sales activity to determine whether there areany significant differences between the market price used to value the securityprior to sale and the actual sale price.

 

Other investments, which are comprised of hedge funds and privateequity funds for which the fair value option has been elected, are carried atfair value based upon our proportionate interest in the underlying fund’s netasset value, which is deemed to approximate fair value. The fair value of our investments inhedge funds and private equity funds has been estimated using net asset valuebecause it reflects the fair value of the funds’ underlying investments inaccordance with ASC 820. We employ a number of procedures to assess thereasonableness of the fair value measurements, including obtaining andreviewing each fund’s audited financial statements and discussing each fund’spricing with the fund’s manager. However, since the fund managers do notprovide sufficient information to independently evaluate the pricing inputs andmethods for each underlying investment, the inputs are considered to beunobservable. Accordingly, the fair values of our investment in hedge funds andprivate equity funds have been classified as Level 3 under the fair valuehierarchy.

 

In circumstanceswhere the underlying investments are publicly traded, such as the investmentsmade by hedge funds, the fair value of the underlying investments is determinedusing current market prices. In circumstances where the underlying investmentsare not publicly traded, such as the investments made by private equity funds,the private equity fund managers have considered the need for a liquiditydiscount on each of the underlying investments when determining the fund’s netasset value in accordance with ASC 820. In circumstances where our portion of afund’s net asset value is deemed to differ from fair value due to illiquidityor other factors associated with our investment in the fund, includingcounterparty credit risk, the net asset value is adjusted accordingly. At December 31,2009 and December 31, 2008, we did not record an adjustment to the netasset value related to our investments in hedge funds or private equity funds.

 

As of December 31,2009 and 2008, other investments represented approximately 4% and 5%,respectively, of the investment portfolio recorded at fair value. Otherinvestments accounted for at fair value as of December 31, 2009 and 2008were comprised of $74.2 million and $117.3 million, respectively, in hedgefunds, $58.0 million and $65.2 million, respectively, in private equity fundsand $14.1 million for both periods of an investment in a community reinvestmentvehicle. At December 31, 2009 and 2008, we held investments in 15 and 20hedge funds, respectively, and 15 and 16 private equity funds, respectively.The largest investment in a single fund was $10.8 million and $26.1 million at December 31,2009 and 2008, respectively.

 

Asof December 31, 2009 and 2008, approximately 93% and 92%, respectively, ofthe investment portfolio recorded at fair value was priced based uponobservable inputs.

 

Thefair value measurements at December 31, 2009 and 2008 for assets for whichwe adopted ASC 825 and any related Level 3 inputs are as follows:

 
| ** **                                        | ** ** | **Fair value at  December 31,**** ****2009** | ** ** | **Level 3 Inputs** | ** ** | **Level 3  Percentage** | ** ** |
|---------------------------------------------------|------------|------------------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                        | ** ** | **($ in millions)**                                    | ** ** | ** **                   | ** ** |
| Fixed maturity investments:                       |       |                                                             |       |                         |       |                         |       |
| U.S. Government and agency obligations            |       | $                                                                | 531.6      |                         | $          | —                       |       | — | % |
| Debt securities issued by industrial corporations |       | 1,347.0                                                          |       | 0.2                          |       | —                       |       |
| Municipal obligations                             |       | 2.6                                                              |       | —                       |       | —                       |       |
| Asset-backed securities                           |       | 1,014.9                                                          |       | 15.7                         |       | 1.5                          |       |
| Foreign government obligations                    |       | 26.7                                                             |       | —                       |       | —                       |       |
| Preferred stocks                                  |       | 71.5                                                             |       | 70.0                         |       | 97.9                         |       |
| Fixed maturity investments                        |       | 2,994.3                                                          |       | 85.9                         |       | 2.9                          |       |
| Short-term investments                            |       | 489.3                                                            |       | —                       |       | —                       |       |
| Common equity securities                          |       | 187.6                                                            |       | 33.8                         |       | 18.1                         |       |
| Convertible bonds                                 |       | 170.2                                                            |       | —                       |       | —                       |       |
| Other investments                                 |       | 146.3                                                            |       | 146.3                        |       | 100.0                        |       |
| Total                                             |       | $                                                                | 3,987.7    |                         | $          | 266.0                        |       | 6.7 | % |

 

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|                                              |   | **Fair value at  December 31, 2008** |    | **Level 3 Inputs** |   | **Level 3  Percentage** |   |
|---------------------------------------------------|--------|----------------------------------------------------------|---------|------------------------------|--------|------------------------------|--------|
|                                              |   | **($ in millions)**                            |    |                         |   |
| Fixed maturity investments:                       |   |                                                     |    |                         |   |                         |   |
| U.S. Government and agency obligations            |   | $                                                        | 409.6   |                         | $      | —                       |   | — | % |
| Debt securities issued by industrial corporations |   | 870.2                                                    |    | —                       |   | —                       |   |
| Municipal obligations                             |   | 5.0                                                      |    | —                       |   | —                       |   |
| Asset-backed securities                           |   | 758.9                                                    |    | 28.0                         |   | 3.7                          |   |
| Foreign government obligations                    |   | 38.6                                                     |    | —                       |   | —                       |   |
| Preferred stocks                                  |   | 52.5                                                     |    | 51.3                         |   | 97.7                         |   |
| Fixed maturity investments                        |   | 2,134.8                                                  |    | 79.3                         |   | 3.7                          |   |
| Short-term investments                            |   | 875.4                                                    |    | —                       |   | —                       |   |
| Common equity securities                          |   | 276.7                                                    |    | 26.2                         |   | 9.5                          |   |
| Convertible bonds                                 |   | 241.2                                                    |    | —                       |   | —                       |   |
| Other investments                                 |   | 196.6                                                    |    | 196.6                        |   | 100.0                        |   |
| Total                                             |   | $                                                        | 3,724.7 |                         | $      | 302.1                        |   | 7.9 | % |

 

At December 31, 2009 and 2008, we held oneprivate preferred stock that represented approximately 98% and 97%,respectively, of our preferred stock portfolio. We used quoted market pricesfor similar securities that were adjusted to reflect management’s best estimateof fair value; this security is classified as a Level 3 measurement.

 

In addition to theinvestment portfolio described above, we had $27.2 million and $20.2 million,respectively, of liabilities recorded at fair value and included in otherliabilities as of December 31, 2009 and 2008. These liabilities relate tosecurities that have been sold short by a limited partnership that we invest inand are required to consolidate in accordance with GAAP. All of the liabilitiesincluded in the $27.2 million and $20.2 million, respectively, have been deemedto have a Level 1 designation as of December 31, 2009 and 2008. As of December 31,2008, other liabilities also included $10.4 million related to the fair valueof the interest rate swap on the mortgage note. The interest rate swap wasdeemed to have a Level 2 designation at December 31, 2008. During thesecond quarter of 2009, we repaid the outstanding balance on the mortgage noteand settled the interest rate swap. See Note 6 — “Debt” of the accompanyingconsolidated financial statements.

 

The changes in Level 3 fair value measurements for the year ended December 31,2009 are as follows:

 
| ** **                                       | ** ** | **Fixed  maturity  investments** | ** ** | **Common  equity  securities** | ** ** | **Convertible  bonds** | ** ** | **Other  investments** | ** ** | **Total** | ** ** |
|--------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|------------------------|------------|------------------------|------------|-----------|------------|
| ** **                                       | ** ** | **($ in  millions)**        | ** ** |
| Balance at January 1, 2009                  |       | $                                | 79.3       |                           | $          | 26.2                   |       | $                      | —     |      | $          | 196.6 |   | $ | 302.1 |   |
| Total net realized and unrealized gains (losses) |       | 22.6                             |       | 7.2                            |       | 0.1                    |       | 10.6                   |       | 40.5      |       |
| Purchases                                        |       | 29.1                             |       | 0.4                            |       | 2.9                    |       | 7.6                    |       | 40.0      |       |
| Sales                                            |       | (13.6                            | )          | —                         |       | (0.2                   | )          | (68.5                  | )          | (82.3     | )          |
| Transfers in                                     |       | 28.0                             |       | —                         |       | —                 |       | —                 |       | 28.0      |       |
| Transfers out                                    |       | (59.5                            | )          | —                         |       | (2.8                   | )          | —                 |       | (62.3     | )          |
| Balance at December 31, 2009                |       | $                                | 85.9       |                           | $          | 33.8                   |       | $                      | —     |      | $          | 146.3 |   | $ | 266.0 |   |

 

“Transfersin” for the year ended December 31, 2009 comprise securities for whichobservable inputs became unavailable as well as securities for which quotedmarket prices were deemed to be unreliable. Observable inputs in the form ofquoted market prices for similar securities became unavailable for 2 securitieswith a fair value of $11.2 million. Quoted market prices for these securitieshad been used at December 31, 2008 to estimate fair value, and as such,these securities were categorized as a Level 2 measurement at December 31,2008. In addition, the estimated fair values for 4 securities of $16.8 millionfor which the quoted prices provided by a third party source were deemedunreliable and could not be validated against an alternative source arereflected in “Transfers in”. The fair values of these securities were estimatedusing industry standard pricing models, in which management selected inputsusing its best judgment. These inputs principally included benchmarkyields, benchmark securities, reported trades, issuer spreads, bids, offers,credit ratings and prepayment speeds. We use pricing models which use the samevaluation methodology for all Level 3 measurements for fixed maturities. Thesesecurities are considered to be Level 3 because the measurements are notdirectly observable. At December 31, 2009, the estimated fair values forthese securities determined using the industry standard pricing models were$1.8 million less than the estimated fair values based upon quoted pricesprovided by a third party. “Transfers out” of $62.3 million for the year 

 

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endedDecember 31, 2009 comprise 18 securities which had been previouslyclassified as Level 3 measurements and were recategorized as Level 2measurements when quoted market prices for similar securities that wereconsidered reliable and could be validated against an alternative source becameavailable during the year ended December 31, 2009.

 

***2.******             ******Loss and LAE***

 

*Reserves other than Asbestos and EnvironmentalReserves and Construction Defect Claim Reserves*

 

We establish loss and LAE reserves that are estimates of amounts neededto pay claims and related expenses in the future for insured events that havealready occurred. The process of estimating reserves involves a considerabledegree of judgment by management and, as of any given date, is inherentlyuncertain.

 

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 IBNR reserves, whichinclude a provision for expected future development on case reserves. Casereserves are estimated based on the experience and knowledge of claims staffregarding 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 by extrapolation ofclaim emergence and settlement patterns observed in the past that canreasonably be expected to persist into the future. In forecasting ultimate lossand LAE with respect to any line of business, past experience with respect tothat line of business is the primary resource, but cannot be relied upon inisolation. Our own experience, particularly claims development experience, suchas trends in case reserves, payments on and closings of claims, as well aschanges in business mix and coverage limits, is the most important informationfor estimating our reserves. External data, available from organizations suchas statistical bureaus, consulting firms and reinsurance companies, issometimes used to supplement or corroborate our own experience, and can beespecially useful for estimating costs of new business. For some lines ofbusiness, such as “long-tail” coverages discussed below, claims data reportedin the most recent accident year is often too limited to provide a meaningfulbasis for analysis due to the typical delay in reporting of claims. For thistype of business, we use a selected loss ratio method for the initial accidentyear or years. This is a standard and accepted actuarial reserve estimationmethod in these circumstances in which the loss ratio is selected based uponinformation used in pricing policies for that line of business, as well as anypublicly available industry data, such as industry pricing, experience andtrends, for that line of business.

 

Uncertainties in estimating ultimate loss and LAE are magnified by thetime lag between when a claim actually occurs and when it is reported andsettled. This time lag is sometimes referred to as the “claim-tail”. Theclaim-tail for most property coverages is typically short (usually a few daysup to a few months). The claim-tail for liability/casualty coverages, such asautomobile 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 indemnify claimants,provide needed legal defense and other services for insureds and administer theinvestigation and adjustment of claims are considered. These claim costs areinfluenced by many factors that change over time, such as expanded coveragedefinitions as a result of new court decisions, inflation in costs to repair orreplace damaged property, inflation in the cost of medical services andlegislated changes in statutory benefits, as well as by the particular, uniquefacts that pertain to each claim. As a result, the rate at which claims arose inthe past and the costs to settle them may not always be representative of whatwill occur in the future. The factors influencing changes in claim costs areoften difficult to isolate or quantify and developments in paid and incurredlosses from historical trends are frequently subject to multiple andconflicting interpretations. Changes in coverage terms or claims handlingpractices may also cause future experience and/or development patterns to varyfrom the past. A key objective of actuaries in developing estimates of ultimateloss and LAE, and resulting IBNR reserves, is to identify aberrations andsystemic changes occurring within historical experience and accurately adjustfor them so that the future can be projected 

 

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reliably.Because of the factors previously discussed, this process requires the use ofinformed judgment and is inherently uncertain.

 

Our actuaries use several generally accepted actuarial methods toevaluate our loss and LAE reserves, each of which has its own strengths andweaknesses. We place more or less reliance on a particular method based on thefacts and circumstances at the time the reserve estimates are made. Thesemethods generally fall into one of the following categories or are hybrids ofone or more of the following categories:

 

·                  *Historicalpaid loss development methods: *These methodsuse historical loss payments over discrete periods of time to estimate futurelosses. Historical paid loss development methods assume that the ratio oflosses paid in one period to losses paid in an earlier period will remainconstant. These methods necessarily assume that factors that have affected paidlosses in the past, such as inflation or the effects of litigation, will remainconstant in the future. Because historical paid loss development methods do notuse case reserves to estimate ultimate losses, they can be more reliable thanthe other methods discussed below that look to case reserves (such as actuarialmethods that use incurred losses) in situations where there are significantchanges in how case reserves are established by a company’s claims adjusters.However, historical paid loss development methods are more leveraged, meaningthat small changes in payments have a larger impact on estimates of ultimatelosses, than actuarial methods that use incurred losses because cumulative losspayments take much longer to equal the expected ultimate losses than cumulativeincurred amounts. In addition, and for similar reasons, historical paid lossdevelopment methods are often slow to react to situations when new or differentfactors arise than those that have affected paid losses in the past.

 

·                  *Historicalincurred loss development methods: *These methods,like historical paid loss development methods, assume that the ratio of lossesin one period to losses in an earlier period will remain constant in thefuture. However, instead of using paid losses, these methods use incurredlosses (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 to historicalpaid loss development methods because they explicitly take into account opencases and the claims adjusters’ evaluations of the cost to settle all knownclaims. However, historical incurred loss development methods necessarilyassume that case reserving practices are consistently applied over time.Therefore, when there have been significant changes in how case reserves areestablished, using incurred loss data to project ultimate losses can be lessreliable than other methods.

 

·                  *Expectedloss 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.

 

·                  *Adjustedhistorical paid and incurred loss development methods: *These methods taketraditional historical paid and incurred loss development methods and adjustthem for the estimated impact of changes from the past in factors such asinflation, the speed of claim payments or the adequacy of case reserves.Adjusted historical paid and incurred loss development methods are often morereliable methods of predicting ultimate losses in periods of significantchange, provided the actuaries can develop methods to reasonably quantify theimpact of changes.

 

We perform an actuarial review of our recorded reserves each quarter.Our actuaries compare the previous quarter’s estimates of paid loss and LAE,case reserves and IBNR to amounts indicated by actual experience. Differencesbetween previous estimates and actual experience are evaluated to determinewhether a given actuarial method for estimating loss and LAE should be reliedupon to a greater or lesser extent than it had been in the past. While somevariance is expected each quarter due to the inherent uncertainty in loss andLAE, persistent or large variances would indicate that prior assumptions and/orreliance on certain reserving methods may need to be revised going forward.

 

In its selection of recorded reserves, our management historically gavegreater weight to adjusted paid loss development methods, which are notdependent on the consistency of case reserving practices, over methods thatrely on incurred losses. In recent years, the amount of weight given to methodsbased on incurred losses has increased with management’s confidence that ourcase reserving practices have been more consistently applied.

 

Upon completion of each quarterly review, our actuaries selectindicated reserve levels based on the results of the actuarial methodsdescribed previously, which are the primary consideration in determiningmanagement’s best estimate of required reserves. However, in making its bestestimate, management also considers other qualitative factors that may lead toa difference between held reserves and actuarially recommended levels in thefuture. 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, among 

 

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others,recent entry into new markets or new products, improvements in the claimsdepartment that are expected to lessen future ultimate loss costs and legal andregulatory developments. At December 31, 2009 and 2008, total carriedreserves were 10.2% and 7.3% above the actuarial point estimate, respectively.

 

*Construction Defect Claims Reserves*

 

Construction defect claims are a non-A&E exposure that has provento have a greater degree of uncertainty when estimating loss and LAE usinggenerally accepted actuarial methods. Our general liability and multiple perillines of business have been significantly impacted by a large number ofconstruction defect claims. Construction defect is a liability allegationrelating to defective work performed in the construction of structures such asapartments, condominiums, single family dwellings or other housing, as well asthe sale of defective building materials. Such claims seek recovery due todamage caused by alleged deficient construction techniques or workmanship. Muchof the recent claims activity has been generated by plaintiffs’ lawyers whoapproach new homeowners, and in many cases homeowner associations with largenumbers of homeowners in multi-residential complexes, about defects or otherflaws in their homes. Claims for construction defects began with claimsrelating to exposures in California. Then, as plaintiffs’ lawyers organizedsuits in other states with high levels of multi-residential construction,construction defect claims were reported in nearby western states, such asColorado and Nevada, and eventually throughout the country. The reporting ofsuch claims can be quite delayed as the statute of limitations can be up to tenyears. Court decisions have expanded insurers’ exposure to construction defect claimsas well. For example, in 1995 California courts adopted a “continuous trigger”theory in which all companies that had ever insured a property that was allegedto have been damaged must respond to the claimant, even if evidence of thealleged damage did not appear until after the insurance period had expired. Asa result, construction defect claims may be reported more than ten years aftera project has been completed as litigation can proceed for several years beforean insurance company is identified as a potential contributor. Claims have alsoemerged from parties claiming additional insured status on policies issued toother parties (e.g., such as contractors seeking coverage on asub-contractor’s policy). Further, in reserving for these claims, there isadditional uncertainty due to the potential for further unfavorable judicialrulings and regulatory actions. The primary actuarial methods that are used toestimate loss and LAE reserves for construction defect claims are frequency andseverity methods. These methods separately project the frequency of futurereported claims and the average cost or severity of individual claims. Thereserve is the product of the projected number of reported claims and theseverity.

 

A large number of construction defect claims have been identifiedrelating to coverages that we had written in the past through Commercial UnionCorporation and General Accident Corporation of America, which we refer to asour legacy companies, and their subsidiaries in California, Colorado, Nevada,Washington and Oregon. Management has sought to mitigate future constructiondefect risks in all states by no longer providing insurance to certainresidential general contractors and sub-contractors involved inmulti-habitational projects. Mitigating actions also included initiating thewithdrawal from problematic sub-segments within our construction book ofbusiness, such as street and road construction, water, sewer and pipelineconstruction. As a result of these actions, management believes that the numberof reported construction defect claims relating to coverages written in thepast peaked in 2004 and will continue to decline.

 

*Asbestos and Environmental Reserves*

 

Our reserves include provisions made for claims that assert damagesfrom asbestos and environmental, or A&E, related exposures. Asbestos claimsrelate primarily to injuries asserted by those who allegedly came in contactwith asbestos or products containing asbestos. Environmental claims relateprimarily to pollution and related clean-up cost obligations, particularly asmandated by Federal and state environmental protection agencies. In addition tothe factors described above under “Non-Asbestos and Environmental Reserves”regarding the reserving process, we estimate our A&E reserves based upon,among other factors, facts surrounding reported cases and exposures to claims,such as policy limits and deductibles, current law, past and projected claimactivity and past settlement values for similar claims, as well as analysis ofindustry studies and events, such as recent settlements and asbestos-relatedbankruptcies. The cost of administering A&E claims, which is an importantfactor in estimating loss and LAE reserves, tends to be higher than in the caseof non-A&E claims due to the higher legal costs typically associated withA&E claims.

 

A large portion of our A&E losses resulted from the operations ofthe Employers Group, an entity acquired by one of the legacy companies in 1971.These operations, including business of Employers Surplus Lines InsuranceCompany and Employers Liability Assurance Corporation, provided primary andexcess liability insurance for commercial insureds, including Fortune 500-sizedaccounts, some of whom subsequently experienced claims for A&E losses. We stoppedwriting such coverage in 1984.

 

Our liabilities for A&E losses from business underwritten in therecent past are substantially limited by the application of exclusionaryclauses in the policy language that eliminated coverage for such claims. After1987 for pollution and 1992 for asbestos, most liability policies containedindustry-standard absolute exclusions of such claims. In earlier years, 

 

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variousexclusions were also applied, but the wording of those exclusions was lessstrict and subsequent court rulings have reduced their effectiveness.

 

We also incurred A&E losses via our participation in industry poolsand associations. The most significant of these pools was Excess CasualtyReinsurance Association, or ECRA, which provided excess liability reinsuranceto U.S. insurers from 1950 until the early 1980s. ECRA incurred significantliabilities for A&E, of which we bear approximately a 4.7% share at both December 31,2009 and 2008, or $35.8 million and $40.0 million at December 31,2009 and 2008, respectively, which is fully reflected in our loss and LAEreserves.

 

More recently, since the 1990s, we have experienced an influx of claimsfrom commercial insureds, including many non-Fortune 500-sized accounts writtenduring the 1970s and 1980s, who are named as defendants in asbestos lawsuits.As a number of large well-known manufacturers of asbestos and asbestos-containingproducts have gone into bankruptcy, plaintiffs have sought recoveries fromperipheral defendants, such as installers, transporters or sellers of suchproducts, or from owners of premises on which the plaintiffs’ exposure toasbestos allegedly occurred. At December 31, 2009, 482 policyholders hadasbestos-related claims against us. In 2009, 93 new insureds with suchperipheral involvement presented asbestos claims under prior policies we hadwritten.

 

Historically, most asbestos claims have been asserted as productliability claims. Recently, insureds who have exhausted the available productsliability limits of their insurance policies have sought from insurers such asus payment for asbestos claims under the premises and operations coverage of theirliability policies, which may not be subject to similar aggregate limits. Weexpect this trend to continue. However, to date there have been fewer of thesepremises and operations coverage claims than product liability coverage claims.This may be due to a variety of factors, including that it may be moredifficult for underlying plaintiffs to establish losses as stemming frompremises and operations exposures, which requires proof of the defendant’snegligence, rather than products liability under which strict legal liabilityapplies. Premises and operations claims may vary significantly andpolicyholders may seek large amounts, although such claims frequently settlefor a fraction of the initial alleged amount. Accordingly, there is a greatdeal of variation in damages awarded for the actual injuries. As of December 31,2009, there were approximately 240 active claims by insureds against us withoutproduct liability coverage asserting operations or premises coverage, which maynot be subject to aggregate limits under the policies.

 

Immediately preceding the OneBeacon Acquisition, we purchased areinsurance contract with NICO under which we are entitled to recover from NICOup to $2.5 billion in the future for asbestos claims arising from businesswritten by us in 1992 and prior, environmental claims arising from businesswritten by us in 1987 and prior, and certain other exposures. Under the termsof the NICO Cover, NICO receives the economic benefit of reinsurancerecoverables from certain of our third party reinsurers in existence at thetime the NICO Cover was executed, or Third Party Recoverables. As a result, theThird Party Recoverables serve to protect the $2.5 billion limit of NICOcoverage for the benefit of us. Any amounts uncollectible from third partyreinsurers due to dispute or the reinsurers’ financial inability to pay arecovered by NICO under its agreement with us. Third Party Recoverables aretypically for the amount of loss in excess of a stated level each year. Ofclaim payments from 1999 through 2009, approximately 46% of A&E losses havebeen recovered under the historical third party reinsurance.

 

In September 2008, we completed a study of our A&E exposures.This study considered, among other items, (1) facts, such as policylimits, deductibles and available third party reinsurance, related to reportedclaims; (2) current law; (3) past and projected claim activity andpast settlement values for similar claims; (4) industry studies andevents, such as recent settlements and asbestos-related bankruptcies; and (5) collectibilityof third party reinsurance. Based on the study, we increased our best estimateof our incurred losses ceded to NICO, net of underlying reinsurance, by$83.4 million to $2.2 billion, which is within the $2.5 billioncoverage provided by the NICO Cover. The increase in the estimate of incurredA&E losses was principally driven by raised projections for claims relatedto asbestos. Based on the results of the study, we believe that, under allreasonable scenarios, ultimate incurred losses will not exceed the NICO Cover.Due to the NICO Cover, there was no impact to income or equity from the changein estimate.

 

As part of our previously described actuarial review process, we reviewA&E activity each quarter and compare that activity to what was assumed inthe most recently completed study. As of December 31, 2009, we noted nochange in the range of reasonable outcomes around our best estimate describedabove.

 

As noted above, we have ceded estimated incurred losses of approximately$2.2 billion to the NICO Cover at December 31, 2009. Since enteringinto the NICO Cover, approximately 4% of the $2.2 billion of utilizedcoverage relates to uncollectible Third Party Recoverables and settlements onThird Party Recoverables through December 31, 2009. Net losses paidtotaled $1.2 billion as of December 31, 2009, with$118.0 million paid in 2009. Asbestos payments during 2009 reflectpayments resulting from intensified efforts by claimants to resolve asbestosclaims prior to the potential enactment of U.S. 

 

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federalasbestos legislation. To the extent that actual experience differs from our estimateof incurred A&E losses and Third Party Recoverables, future losses couldexceed the $320.2 million of protection remaining under the NICO Cover.

 

Our reserves for A&E losses, net of Third Party Recoverables butprior to NICO recoveries, were $0.9 billion at December 31, 2009. Anindustry benchmark of reserve adequacy is the “survival ratio”, computed as acompany’s reserves divided by its historical average yearly loss payments. Thisratio indicates approximately how many more years of payments the reserves cansupport, assuming future yearly payments are equal to historical levels. Oursurvival ratio was 11.6 at December 31, 2009. This was computed as theratio of A&E reserves, net of Third Party Recoverables prior to the NICOCover of $0.9 billion plus the remaining unused portion of the NICO Coverof $320.2 million, to the average A&E loss payments over thethree-year period ended December 31, 2009, net of Third PartyRecoverables. Our survival ratio was 12.7 at December 31, 2008. We believethat as a result of the NICO Cover and our historical third party reinsuranceprograms, we should not experience material financial loss from A&Eexposures under current coverage interpretations and that our survival ratiocompares favorably to industry survival ratios. However, the survival ratio isa simplistic measure estimating the number of years it would be before thecurrent ending loss reserves for these claims would be paid using recent annualaverage payments. Many factors, such as aggressive settlement procedures, mixof business and coverage provided, have a significant effect on the amount ofA&E reserves and payments and the resultant survival ratio. Thus, cautionshould be exercised in attempting to determine reserve adequacy for theseclaims based simply on this survival ratio.

 

Our reserves for A&E losses at December 31, 2009 representmanagement’s best estimate of its ultimate liability based on informationcurrently available. However, significant uncertainties, including but notlimited to case law developments, medical and clean-up cost increases andindustry settlement practices, limit our ability to accurately estimateultimate liability and we may be subject to A&E losses beyond currentlyestimated amounts. In addition, we remain liable for risks reinsured in theevent that a reinsurer does not honor its obligations under reinsurancecontracts. See Note 3—“Reserves for Unpaid Loss and LAE—Asbestos andenvironmental loss and LAE reserve activity” of the accompanying consolidatedfinancial statements for more information regarding our A&E reserves.

 

*Insurance Operations A&E Claims Activity*

 

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

 
| ** **                                                          | ** ** | **Year ended December 31,** | ** ** |
|---------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                          | ** ** | **2009**                         | ** ** | **2008** | ** ** |
| **Asbestos**                                                        |       |                             |       |   |   |
| Accounts with asbestos claims at the beginning of  the year         |       | 474                              |       | 491 |   |
| Accounts reporting asbestos claims during the year                  |       | 93                               |       | 80 |   |
| Accounts on which asbestos claims were closed  during the year      |       | (85                              | )          | (97 | ) |
| Accounts with asbestos claims at the end of the  year               |       | 482                              |       | 474 |   |
| **Environmental**                                                   |       |                             |       |   |   |
| Accounts with environmental claims at the  beginning of the year    |       | 378                              |       | 382 |   |
| Accounts reporting environmental claims during the  year            |       | 131                              |       | 109 |   |
| Accounts on which environmental claims were closed  during the year |       | (125                             | )          | (113 | ) |
| Accounts with environmental claims at the end of  the year          |       | 384                              |       | 378 |   |
| **Total**                                                           |       |                             |       |   |   |
| Total accounts with A&E claims at the  beginning of the year    |       | 852                              |       | 873 |   |
| Accounts reporting A&E claims during the year                   |       | 224                              |       | 189 |   |
| Accounts on which A&E claims were closed  during the year       |       | (210                             | )          | (210 | ) |
| Total accounts with A&E claims at the end of  the year          |       | 866                              |       | 852 |   |

 

*Insurance Operations Reserve Estimation by Line ofBusiness*

 

The process of establishing loss reserves is complex and imprecise asit must consider many variables that are subject to the outcome of futureevents. As a result, informed subjective estimates and judgments as to ourultimate exposure to losses are an integral component of our loss reservingprocess. We, like other insurance companies, categorize and track our insurancereserves by “line of business”, such as automobile liability, multiple perilpackage business, and workers compensation. Furthermore, we regularly reviewthe appropriateness of reserve levels at the line of business level, 

 

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consideringthe variety of trends that impact the ultimate settlement of claims for thesubsets of claims in each particular line of business.

 

For loss and allocated loss adjustment expense reserves, excludingA&E, the key assumption as of December 31, 2009 was that the impact ofthe various reserving factors, as described below, on future paid losses wouldbe similar to the impact of those factors on the historical loss data with thefollowing exceptions:

 

·                  Recent increases in paidloss trends were inflated due to changes in claim handling procedure thatdecreased the settlement time for claims. This resulted in some increases inpaid loss activity that we believe will not continue into the future.

 

·                  Increases in case reserveadequacy over the 2001-2004 calendar periods have resulted in trends in caseincurred activity that we believe will not continue into the future. Caseincurred activity can be the result of underlying changes in expected claimcosts or changes in the adequacy of the case reserves relative to theunderlying expected claim cost. If the activity is the result of underlyingchanges in expected costs, it is more likely to repeat in the future, and wouldlikely result in prior year reserve development, as the change in ultimateclaim costs would not have been considered when making the previous selectionof IBNR reserves. If the activity is the result of changes in case reserveadequacy, it would not indicate any change in the ultimate claim costs andwould not be expected to repeat in the future. In these cases, it is unlikelythat prior year reserve development would occur, as the change in case reserveswould be offset by a corresponding change in IBNR reserves(i.e., deficiency or redundancy in case reserves was implicitly capturedwhen making the previous selection of IBNR reserves).

 

·                  In 2004, we established aseparate claim group to manage run-off claims. Due to the nature of this event,we do not believe that the impacts of this group on future losses have beenreflected in historical losses. Therefore, we have given considerable weight tothe most recent loss experience for this segment.

 

The major causes of material uncertainty (“reserving factors”)generally will vary for each product line, as well as for each separatelyanalyzed component of the product line. The following section details reservingfactors by product line. There could be other reserving factors that may impactultimate claim costs. Each reserving factor presented will have a differentimpact on estimated reserves. Also, reserving factors can have offsetting orcompounding effects on estimated reserves. For example, in workerscompensation, the use of expensive medical procedures that result in medicalcost inflation may enable workers to return to work faster, thereby loweringindemnity costs. Thus, in almost all cases, it is impossible to discretelymeasure the effect of a single reserving factor and construct a meaningfulsensitivity expectation. Actual results will likely vary from expectations foreach of these assumptions, resulting in an ultimate claim liability that isdifferent from that being estimated currently.

 

*Workers compensation*

 

Workers compensation covers an employer’s liability for injuries,disability or death of employees, without regard to fault, as prescribed bystate workers compensation law and other statutes. Workers compensation isgenerally considered a long-tail coverage, as it takes a relatively long periodof time to finalize claims from a given accident year. While certain paymentssuch as initial medical treatment or temporary wage replacement for the injuredworker are made quickly, some other payments are made over the course ofseveral years, such as awards for permanent partial injuries. In addition, somepayments can run as long as the injured worker’s life, such as permanentdisability benefits and ongoing medical care. Despite the possibility of longpayment tails, the reporting lags are generally short, settlements aregenerally not complex, and most of the liability can be considered highfrequency with moderate severity. The largest reserve risk generally comes fromthe low frequency, high severity claims providing lifetime coverage for medicalexpense arising from a worker’s injury.

 

Examplesof common reserving factors that can change and, thus, affect the estimatedworkers compensation reserves include:

 

*General workers compensation reserving factors*

 

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

 

·                  Degree of cost shiftingbetween workers compensation and health insurance

 

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

 

*Indemnity reserving factors*

 

·*     *Time required to recoverfrom the injury

 

·      Degree of availabletransitional jobs

 

·      Degree of legal involvement

 

·      Changes in theinterpretations and processes of various workers compensation bureaus’oversight of claims

 

·      Future wage inflation forstates that index benefits

 

·      Changes in theadministrative policies of second injury funds

 

·      Re-marriage rate for spousein instances of death

 

*Medical reserving factors*

 

·*     *Changes in the cost ofmedical treatments, including prescription drugs, and underlying fee schedules

 

·      Frequency of visits tohealth providers

 

·      Number of medical proceduresgiven during visits to health providers

 

·      Types of health providersused

 

·      Type of medical treatmentsreceived

 

·      Use of preferred providernetworks and other medical cost containment practices

 

·      Availability of new medicalprocesses and equipment

 

·      Changes in the use ofpharmaceutical drugs

 

·      Degree of patientresponsiveness to treatment

 

*Workers compensation book of business reservingfactors*

 

·*     *Product mix

 

·      Injury type mix

 

·      Changes in underwritingstandards

 

*Personal automobile liability*

 

Automobile covers both physical damage and liability coverage.Automobile physical damage insurance covers loss or damage to vehicles fromcollision, vandalism, fire, theft or other causes. Automobile liabilityinsurance covers bodily injury of others, damage to their property and costs oflegal defense resulting from a collision caused by the insured. The personalautomobile product line is a mix of property and liability coverages and,therefore, includes both short- and long-tail coverages. The payments that aremade quickly typically pertain to automobile physical damage (property) claimsand property damage (liability) claims. The payments that take longer tofinalize and are more difficult to estimate relate to bodily injury claims.Personal automobile reserves are typically analyzed in three components: bodilyinjury liability, property damage liability, and collision/comprehensiveclaims. This last component has minimum reserve risk and fast payouts and,accordingly, separate factors are not presented. Reporting lags are relativelyshort and the claim settlement process for 

 

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personalautomobile liability generally is the least complex of the liability products.It is generally viewed as a high frequency, low to moderate severity productline.

 

Examples of common reserving factors that can change and, thus, affectthe estimated personal automobile liability reserves include:

 

*Personal automobile liability reserving factors*

 

·*     *Trends in jury awards

 

·      Changes in the underlyingcourt system and its philosophy

 

·      Changes in case law

 

·      Litigation trends

 

·      Frequency of claims with paymentcapped by policy limits

 

·      Change in average severityof accidents, or proportion of severe accidents

 

·      Subrogation opportunities

 

·      Degree of patientresponsiveness to treatment

 

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

 

*Personal automobile liability book of businessreserving factors*

 

·*     *Changes in policy provisions(e.g., deductibles, policy limits, or endorsements)

 

·      Changes in underwritingstandards

 

*Multiple peril*

 

Multiple peril represents a package policy sold to insureds or tomembers of trade associations or other groups that include general liabilityand property insurance. General liability covers businesses for any liabilityresulting from bodily injury and property damage arising from general business operations,accidents on a premises and the products manufactured or sold. Property coverslosses to a business’ premises, inventory and equipment as a result of weather,fire, theft and other causes. Because commercial multiple peril provides acombination of property and liability coverage typically for small businesses,it 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 generally analyzed as twocomponents: bodily injury and property damage. Bodily injury payments reimbursethe claimant for damages pertaining to physical injury as a result of thepolicyholder’s legal obligation arising from non-intentional acts such asnegligence, subject to the insurance policy provisions. In some cases thedamages can include future wage loss (which is a function of future earningspower and wage inflation) and future medical treatment costs. Property damagepayments result from damages to the claimant’s private property arising fromthe policyholder’s legal obligation for non-intentional acts. In most cases,property damage losses are a function of costs as of the loss date, or soonthereafter. 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 theamount of policy limit available to pay the claim.

 

Multiple peril liability is generally considered a long-tail line, asit takes a relatively long period of time to finalize and settle claims from agiven accident year. The speed of claim reporting and claim settlement is afunction of the specific coverage provided and the jurisdiction, among otherfactors. There are numerous components underlying the multiple peril liabilityproduct line. Some of these have relatively moderate payment patterns (withmost of the claims for a given accident 

 

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yearclosed within 5 to 7 years), while others can have extreme lags in bothreporting and payment of claims (e.g., a reporting lag of a decade for “constructiondefect” claims).

 

Examples of common reserving factors that can change and, thus, affectthe estimated multiple peril liability reserves include:

 

*Multiple peril liability reserving factors*

 

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

 

·      Changes in policy provisionsor court interpretations of such provisions

 

·      New theories of liability

 

·      Trends in jury awards

 

·      Changes in the propensity tosue, in general with specificity to particular issues

 

·      Changes in statutes oflimitations

 

·      Changes in the underlyingcourt system

 

·      Distortions from lossesresulting from large single accounts or single issues

 

·      Changes in tort law

 

·      Shifts in law suit mixbetween federal and state courts

 

·      Changes in settlementpatterns

 

*Multiple peril liability book of business reservingfactors*

 

·*     *Changes in policy provisions(e.g., deductibles, policy limits, or endorsements)

 

·      Changes in underwritingstandards

 

·      Product mix (e.g., sizeof account, industries insured, or jurisdiction mix)

 

*Commercial automobile liability*

 

The commercial automobile product line is a mix of property andliability coverages and, therefore, includes both short- and long-tailcoverages. The payments that are made quickly typically pertain to automobilephysical 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 common reserving factors that can change and, thus, affectthe estimated commercial automobile liability reserves include:

 

*Bodily injury and property damage liability reservingfactors*

 

·*     *Trends in jury awards

 

·      Changes in the underlyingcourt system

 

·      Changes in case law

 

·      Litigation trends

 

·      Frequency of claims withpayment capped by policy limits

 

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·      Change in average severityof accidents, or proportion of severe accidents

 

·      Subrogation opportunities

 

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

 

·      Frequency of visits tohealth providers

 

·      Number of medical proceduresgiven during visits to health providers

 

·      Types of health providersused

 

·      Types of medical treatmentsreceived

 

·      Changes in cost of medicaltreatments

 

·      Degree of patientresponsiveness to treatment

 

*Commercial automobile liability book of businessreserving factors*

 

·*     *Changes in policy provisions(e.g., deductibles, policy limits, or endorsements)

 

·      Changes in mix of insuredvehicles (e.g., long-haul trucks versus local and smaller vehicles, orfleet risks versus non-fleet risks)

 

·      Changes in underwritingstandards

 

*General liability*

 

See the above discussions under the liability product lines with regardto reserving factors for multiple peril.

 

*Homeowners/Farmowners*

 

Homeowners/Farmowners is generally considered a short-tail coverage.Most payments are related to the property portion of the policy, where theclaim reporting and settlement process is generally restricted to the insuredand the insurer. Claims on property coverage are typically reported soon afterthe actual damage occurs, although delays of several months are not unusual.The resulting settlement process is typically fairly short term, althoughexceptions do exist. The liability portion of the homeowners/farmowners policygenerates claims which take longer to pay due to the involvement of litigationand negotiation, but with generally small reporting lags. Overall, the line isgenerally high frequency, low to moderate severity (except for catastrophes),with simple to moderate claim complexity.

 

Examples of common reserving factors that can change and, thus, affectthe estimated homeowners/farmowners reserves include:

 

*Non-catastrophe reserving factors*

 

·*     *Salvage opportunities

 

·      Amount of time to returnproperty to residential use

 

·      Changes in weather patterns

 

·      Local building codes

 

·      Litigation trends

 

·      Trends in jury awards

 

*Catastrophe reserving factors*

 

·*     *Physical concentration ofpolicyholders

 

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·      Availability and cost oflocal contractors

 

·      Local building codes

 

·      Quality of construction ofdamaged homes

 

·      Amount of time to returnproperty 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/Farmowners book of business reservingfactors*

 

·*     *Policy provisions mix(e.g., deductibles, policy limits, or endorsements)

 

·      Degree of concentration ofpolicyholders

 

·      Changes in underwritingstandards

 

*Insurance Operations Loss and LAE Development*

 

*Loss andLAE development—2009*

 

In 2009, weexperienced $83.4 million of favorable loss and LAE reserve development onprior accident year loss reserves. The favorable loss reserve development was primarilyrelated to lower than expected severity on non-catastrophe losses. Thefavorable non-catastrophe loss reserve development was primarily related toprofessional liability lines, commercial package business and other generalliability lines partially offset by adverse loss reserve development atAutoOne.

 

Specifically, at December 31,2008, management had revised its expectations downward with respect to futureloss emergence in the professional liability business, which is included in thegeneral liability line of business, which had initially been based on marketanalysis when this business was initiated in 2002 and 2003. However, during2009, losses continued to be significantly lower than these revisedexpectations. As a result, management lowered its selected reserves on theearliest years which affected more recent years as total loss expectations forthose years are based in part on prior years’ results. The impact of thisrevised estimate was a decrease to professional liability reserves of $60.0 million.

 

At December 31,2008, management had estimated that future payments from personal injuryprotection (PIP) litigation from our AutoOne business would be approximately$7.8 million. During 2009, the legal expenses related to this litigationwere higher than expected. As a result, management increased estimates of allaccident years for AutoOne. The total increase in estimate was$33.3 million.

 

At December 31,2008, based on actuarial techniques described above, management estimated thatIBNR related to multiple peril liability was $173.9 million, orapproximately 85% of case reserves of $204.9 million for 2002 andsubsequent accident years. During 2009, case incurred loss and allocated LAE(ALAE) was $36.8 million, which was less than expected for this line ofbusiness. As a result of the lower than expected case incurred loss and ALAEduring 2009, the actuarial methods based on case incurred losses produced lowerestimated ultimate losses for these accident years. As a result, at December 31,2009, the IBNR was determined to be $95.4 million, or approximately 73% ofthe remaining case reserves. The impact of this revised estimate was a decreaseto multiple peril liability reserves of $42.6 million.

 

At December 31,2008, based on actuarial techniques described above, management estimated thatIBNR related to general liability occurrence was $93.9 million, orapproximately 275% of case reserves of $34.2 million for 2002 andsubsequent accident years. During 2009, case incurred loss and ALAE was $15.6 million,which was less than expected for this line of business. As a result of thelower than expected case incurred loss and ALAE during 2009, the actuarialmethods based on case incurred losses produced lower estimated ultimate lossesfor these accident years. As a result, at December 31, 2009, the IBNR wasdetermined to be $61.6 million, or approximately 214% of the remainingcase reserves. The impact of this revised estimate was a decrease to generalliability occurrence reserves of $14.1 million.

 

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In addition to thedevelopment described for the lines of business above, management also recordedchanges in IBNR in other lines of business as a result of its review of lossreserves at December 31, 2009 that essentially offset. The change in IBNRfor each other line of business was not individually significant.

 

*Loss andLAE development—2008*

 

In 2008, we experienced $62.0 million of favorable loss reservedevelopment primarily related to lower than expected severity onnon-catastrophe losses. The favorable non-catastrophe loss reserve developmentwas primarily related to professional liability lines and commercial packagebusiness lines partially offset by adverse loss reserve development at AutoOneand in legacy run-off.

 

Specifically, at December 31, 2007, management had revised itsexpectations downward with respect to future loss emergence in the professionalliability business, which is included in the general liability line ofbusiness, which had initially been based on market analysis when this businesswas initiated in 2002 and 2003. However, during 2008, losses continued to besignificantly lower than these revised expectations. As a result, managementlowered its selected reserves on the earliest years which affected more recentyears as total loss expectations for those years are based in part on prioryears’ results. The impact of this revised estimate was a decrease toprofessional liability reserves of $50.5 million.

 

At December 31, 2007, management had estimated that futurepayments from PIP litigation from our NYAIP business would be approximately$14.0 million. During 2008, the legal expenses related to this litigationwere higher than expected as the 2002 accident year neared conclusion. As aresult, management increased estimates of all accident years for NYAIP andother similar business in New York. The total increase in estimate was$10.8 million.

 

At December 31, 2007, based on actuarial techniques describedabove, management estimated that IBNR related to multiple peril liability was$137.0 million, or approximately 64% of case reserves of$212.8 million for 2002 and subsequent accident years. During 2008, caseincurred loss and ALAE was $16.2 million, which was less than expected forthis line of business. As a result of the lower than expected case incurredloss and ALAE during 2008, the actuarial methods based on case incurred lossesproduced lower estimated ultimate losses for these accident years. As a result,at December 31, 2008, the IBNR was determined to be $86.9 million, orapproximately 64% of the remaining case reserves. The impact of this revisedestimate was a decrease to multiple peril liability reserves of$33.8 million.

 

At December 31, 2007, based on actuarial techniques describedabove, management estimated that IBNR related to workers compensation was$41.1 million, or approximately 96% of case reserves of $43.0 millionfor 2005 and subsequent accident years. During 2008, case incurred loss andALAE was $20.2 million, which was greater than expected for this line ofbusiness. As a result of the higher than expected case incurred loss and ALAEduring 2008, the actuarial methods based on case incurred losses producedhigher estimated ultimate losses for these accident years. As a result, at December 31,2008, the IBNR was determined to be $34.8 million, or approximately 81% ofthe remaining case reserves. The impact of this revised estimate was anincrease to workers compensation reserves of $13.9 million.

 

In addition to the development described for the lines of businessabove, management also recorded a $2.4 million net decrease in IBNR inother lines of business as a result of its review of loss reserves at December 31,2008. The change in IBNR for each other line of business was not individuallysignificant.

 

*Loss andLAE development—2007*

 

In 2007, we experienced $48.3 million of favorable loss reservedevelopment primarily related to lower than expected frequency for professionalliability lines and lower than expected severity for personal automobileliability, partially offset by adverse loss reserve development for multipleperil and workers compensation, primarily for accident years 2001 and prior.

 

Specifically, at December 31, 2006, management continued to expectlosses to emerge in the professional liability business, which is included inour general liability line of business, in line with initial expectations basedon market analysis when this business was initiated in 2002 and 2003. During2007, losses continued to be significantly lower than initial expectations. Asa result, management lowered its selected reserves on the earliest years whichaffected more recent years as total loss expectations for those years are basedin part on prior years’ results. The impact of this revised estimate was adecrease to professional liability reserves of $79.6 million.

 

At December 31, 2006, based on actuarial techniques described above,management estimated that IBNR related to personal automobile liability was$137.6 million, or approximately 49% of case reserves of$278.7 million for 2002 and 

 

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subsequentaccident years. During 2007, case incurred loss and ALAE was$38.4 million, which was less than expected for this relatively short-tailline of business. At December 31, 2007, based on actuarial techniquesdescribed above, management estimated that IBNR was $66.1 million, orapproximately 49% of the remaining case reserves. The actuarial methods thatmanagement relied upon to estimate IBNR at December 31, 2007 were similarto those used at December 31, 2006. The impact of this revised estimatewas a decrease to personal automobile liability reserves of $33.0 million.

 

At December 31, 2006, based on actuarial techniques describedabove, management estimated that IBNR related to workers compensation andmultiple peril liability was $95.6 million, or approximately 15% of casereserves of $621.5 million for 2001 and prior accident years. During 2007,case incurred loss and ALAE was $44.7 million, which was greater thanexpected for these long-tail lines of business. As a result of the higher thanexpected case incurred loss and ALAE during 2007, management gave greaterweight to actuarial techniques that are based on historical incurred lossdevelopment during its review of loss reserves at December 31, 2007. As aresult, at December 31, 2007, the IBNR was determined to be$149.4 million, or approximately 28% relative to the remaining casereserves. The impact of this revised estimate was an increase to workerscompensation and multiple peril liability reserves of $98.5 million.

 

In addition to the development described for the lines of businessabove, management also recorded a $34.2 million net decrease in IBNR inother lines of business as a result of its review of loss reserves at December 31,2007. The change in IBNR for each other line of business was not individuallysignificant.

 

*Insurance Operations Case and IBNR Reserves by Lineof Business*

 

Loss and LAE reserves, net of reinsurance recoverables on unpaidlosses, by line of business at December 31, 2009 and 2008 for ourInsurance Operations were as follows:

 
| ** **                      | ** ** | **December 31, 2009** | ** ** | **December 31, 2008** | ** ** |
|---------------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                      | ** ** | **Case**                   | ** ** | **IBNR**                   | ** ** | **Total** | ** ** | **Case** | ** ** | **IBNR** | ** ** | **Total** | ** ** |
| ** **                      | ** ** | **($ in millions)**   | ** ** |
| Workers compensation(1)         |       | $                          | 134.7      |                       | $          | 126.7 |   | $ | 261.4 |   | $ | 160.2 |   | $ | 132.7 |   | $ | 292.9 |   |
| Personal automobile liability   |       | 254.4                      |       | 117.6                      |       | 372.0 |   | 271.3 |   | 110.3 |   | 381.6 |   |
| Multiple peril(1)(2)            |       | (30.7                      | )          | 222.4                      |       | 191.7 |   | (4.9 | ) | 238.5 |   | 233.6 |   |
| Commercial automobile liability |       | 90.5                       |       | 68.9                       |       | 159.4 |   | 90.9 |   | 66.2 |   | 157.1 |   |
| General liability(2)(3)         |       | 129.3                      |       | 382.6                      |       | 511.9 |   | 112.1 |   | 362.7 |   | 474.8 |   |
| Homeowners/Farmowners           |       | 41.8                       |       | 22.9                       |       | 64.7 |   | 55.1 |   | 23.0 |   | 78.1 |   |
| Other(1)(4)                     |       | 114.7                      |       | 66.1                       |       | 180.8 |   | 116.5 |   | 61.5 |   | 178.0 |   |
| Total                           |       | $                          | 734.7      |                       | $          | 1,007.2 |   | $ | 1,741.9 |   | $ | 801.2 |   | $ | 994.9 |   | $ | 1,796.1 |   |

 

----

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

 

(2)           Includes loss and LAEreserves related to construction defect claims.

 

(3)           Includes loss and LAEreserves related to professional liability.

 

(4)           Includes loss and LAEreserves related to marine liability.

 

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*InsuranceOperations Range of Reserves by Line of Business*

 

Our range of reserve estimates at December 31, 2009 was evaluatedto consider the strengths and weaknesses of the actuarial methods appliedagainst our historical claims experience data. The following table shows therecorded reserves and the high and low ends of our range of reasonable loss andLAE reserve estimates at December 31, 2009. The high and low ends of ourrange of reserve estimates in the table below are based on the results ofvarious actuarial methods described above.

 
| ** **                      | ** ** | **December 31, 2009** | ** ** |
|---------------------------------|------------|----------------------------|------------|
| ** **                      | ** ** | **Low**                    | ** ** | **Recorded** | ** ** | **High** | ** ** |
| ** **                      | ** ** | **($ in millions)**   | ** ** |
| Workers compensation            |       | $                          | 200.5      |   | $ | 261.4 |   | $ | 304.7 |   |
| Personal automobile liability   |       | 345.9                      |       | 372.0 |   | 398.3 |   |
| Multiple peril                  |       | 108.9                      |       | 191.7 |   | 201.9 |   |
| Commercial automobile liability |       | 143.5                      |       | 159.4 |   | 165.1 |   |
| General liability               |       | 370.7                      |       | 511.9 |   | 520.3 |   |
| Homeowners/Farmowners           |       | 60.2                       |       | 64.7 |   | 66.1 |   |
| Other                           |       | 165.8                      |       | 180.8 |   | 181.2 |   |
| Total                           |       | $                          | 1,395.5    |   | $ | 1,741.9 |   | $ | 1,837.6 |   |

 

The recorded reserves represent management’s best estimate of unpaidloss and LAE by line of business. We use the results of several differentactuarial methods to develop our estimate of ultimate reserves. While we havenot determined the statistical probability of actual ultimate paid lossesfalling within the range, management believes that it is reasonably likely thatactual ultimate paid losses will fall within the ranges noted above because theranges were developed by using several different generally accepted actuarialmethods.

 

The probability that ultimate losses will fall outside of the ranges ofestimates by line of business is higher for each line of business individuallythan it is for the sum of the estimates for all lines taken 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 represent the linearinterpolation of where our recorded loss and LAE reserves are within the rangeof reserves estimates by line of business at December 31, 2009 and 2008,where the low end of the range equals zero, the middle of the range equals 50%and the high end of the range equals 100%.

 
| ** **                      | ** ** | **December 31,**                        | ** ** |
|---------------------------------|------------|----------------------------------------------|------------|
| ** **                      | ** ** | **2009**                                     | ** ** | **2008** | ** ** |
| ** **                      | ** ** | **(expressed as a percentage of the range)** | ** ** |
| Workers compensation            |       | 58                                           | %          | 45 | % |
| Personal automobile liability   |       | 50                                           |       | 26 |   |
| Multiple peril                  |       | 89                                           |       | 69 |   |
| Commercial automobile liability |       | 74                                           |       | 88 |   |
| General liability               |       | 94                                           |       | 97 |   |
| Homeowners/Farmowners           |       | 76                                           |       | 37 |   |
| Other                           |       | 97                                           |       | 80 |   |
| Total                           |       | 78                                           | %          | 67 | % |

 

During 2009, management continued to see actuarial methods based oncase incurred data produce lower estimated losses for the longer tailed linesof business. However, due to the nature of these lines and the inherent risksin estimating the longer tailed lines of business, management chose to recordlosses higher in the range for workers compensation and multiple peril.

 

In 2008, management began to see higher than anticipated paid loss andLAE for personal automobile liability which had resulted in increases in themethods used to develop the ranges. However, at year end 2008, managementbelieved that the ultimate losses would not increase as much as the models hadsuggested resulting in a recorded reserve lower in the range. During 2009, theincreased estimates persisted and management adjusted the held reserves higherin the range.

 

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Overall, management is concerned about the impact of future increasesin inflation, including adverse changes in tort liability. These types ofchanges would result in deterioration in the loss reserves, therefore,management has selected loss reserves somewhat higher relative to actuarialindications than in previous years.

 

*Sensitivity Analysis*

 

The following discussion includes disclosure of possible variationsfrom current estimates of loss reserves due to a change in certain keyassumptions. Each of the impacts described below is estimated individually,without consideration for any correlation among key assumptions or among linesof business. Therefore, it would be inappropriate to take each of the amountsdescribed below and add them together in an attempt to estimate volatility forour reserves in total. It is important to note that the variations discussedare not meant to be a worst-case scenario, and therefore, it is possible thatfuture variations may be more than amounts discussed below.

 

·      *Workerscompensation: *Recordedreserves for workers compensation were $261.4 million at December 31,2009. The two most important assumptions for workers compensation reserves areloss development factors and loss cost trends, particularly medical cost inflation.Loss development patterns are dependent on medical cost inflation.Approximately half of the workers compensation net reserves are related tofuture medical costs. Across the entire reserve base, a 0.5 point change incalendar year medical inflation would have changed the estimated net reserve byapproximately $48 million at December 31, 2009, in either direction.

 

·      *Professionalliability: *Recordedreserves for professional liability were $314.0 million at December 31,2009. A key assumption for professional liability is the implicit loss costtrend, particularly the severity inflation trend component of loss costs.Across the entire reserve base, a 5.0 point change in assumed annual severitywould have changed the estimated net reserve by approximately $52 million at December 31,2009, in either direction.

 

·      *Multipleperil liability: *Recordedreserves for multiple peril were $191.7 million at December 31, 2009.Reported loss development patterns are a key assumption for these lines ofbusiness, particularly for more mature accident years. Historically,assumptions on reported loss development patterns have been impacted by, amongother things, emergence of new types of claims (e.g. construction defectclaims) or a shift in the mixture between smaller, more routine claims andlarger, more complex claims. If case reserve adequacy for non-construction defect claims changed by10.0 points this would have changed the estimated net reserve by approximately$19 million at December 31, 2009, in either direction.

 

***3.******    ******ReinsuranceTransactions***

 

Our insurancesubsidiaries purchase reinsurance from time to time to protect their businessesfrom losses due to exposure aggregation, to manage their operatingleverage ratios and to limit ultimate losses arising from catastrophic events.Amounts recoverable from reinsurers are estimated in a manner consistent withthe claim liability associated with the reinsured policies. Amounts related toreinsurance contracts are recorded in accordance with ASC 944.

 

In connection with the OneBeacon Acquisition, Aviva caused us topurchase reinsurance contracts with two reinsurance companies rated “AA+” (“VeryStrong”, the second highest of twenty-one financial strength ratings) byStandard & Poor’s and “A++” (“Superior”, the highest of fifteenfinancial strength 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 to asbestos claims arising from business written by ourpredecessor prior to 1992, environmental claims arising from business writtenby our predecessor prior to 1987 and certain other latent exposures. As of December 31,2009, we have ceded estimated incurred losses of approximately$2.2 billion to NICO under the NICO Cover. The other contract is areinsurance cover with GRC for up to $570 million of additional losses onall claims arising from accident years 2000 and prior. As of December 31,2009, 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 a seller guarantee under GAAP. NICO and GRC are wholly-ownedsubsidiaries of Berkshire Hathaway.

 

The collectibility of reinsurance recoverables is subject to thesolvency and willingness to pay of the reinsurer. We are selective in choosingour reinsurers, placing reinsurance principally with those reinsurers with astrong financial condition, industry ratings and underwriting ability.Management monitors the financial condition and ratings of our reinsurers on anongoing basis. See Note 4—“Reinsurance” of the accompanying consolidatedfinancial statements for additional information on our reinsurance programs.

 

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***4.******             ******PurchaseAccounting***

 

When we acquire another company, our management must estimate the fairvalues of the assets and liabilities acquired, in accordance with GAAP at thetime of the acquisition. See Note 1—“Nature of Operations and Summary ofSignificant Accounting Policies—Recent Accounting Pronouncements” of theaccompanying consolidated financial statements. Certain assets and liabilitiesrequire little judgment to estimate their fair values, particularly those thatare quoted on a market exchange, such as publicly-traded investment securities.Other assets and liabilities, however, require a substantial amount of judgmentto estimate their fair values. The most significant of these is the estimationrequired to fair value loss and LAE reserves. We estimate the fair value ofloss and LAE reserves obtained in an acquisition following the principlescontained within FASB Statement of Financial Accounting Concepts No. 7: “UsingCash Flow Information and Present Value in Accounting Measurements” (CON 7).Under CON 7, the fair value of a particular asset or liability essentiallycontains five elements: (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 LAE reserves obtainedin an acquisition by taking the acquired company’s recorded reserves anddiscounting them based on expected reserve payout patterns using the currentrisk-free rate of interest. Then, our actuaries develop additional cash flowscenarios that use different payout and ultimate reserve assumptions deemed tobe reasonably possible based upon the inherent uncertainties present in determiningthe amount and timing of payment of such reserves. In each scenario, therisk-free rate of interest is used to discount future cash flows. Thesescenarios are put in a statistical model that assigns a probability to eachcash flow scenario. Our actuaries then choose the scenario that best representsthe price for bearing the uncertainty inherent within the acquired company’srecorded reserves. The “price” for bearing the uncertainty inherent within theacquired company’s reserves is measured as the difference between the selectedcash flow scenario and the expected cash flow scenario. The scenario selectedhas typically been between 1.5 and 2 standard deviations from the expected cashflow outcome. The fair value of the acquired company’s loss and LAE reserves isdetermined to be the sum of the expected cash flow scenario (i.e., theacquired company’s discounted loss and LAE reserves) and the uncertainty “price.”

 

The difference between an acquired company’s loss and LAE reserves andour best estimate of the fair value of such reserves at the acquisition date isamortized ratably over the payout period of the acquired loss and LAE reserves.Historically, the fair value of an acquired company’s loss and LAE reserves hasbeen less than its nominal reserves at acquisition. Accordingly, theamortization has been and will continue to be recorded as an expense on ourincome statement until fully amortized.

 

In connection with purchase accounting for the OneBeacon Acquisition,we were required to adjust to fair value our loss and LAE reserves and therelated reinsurance recoverables by $646.9 million and$346.9 million, respectively, on OneBeacon’s acquired balance sheet as of June 1,2001. This net reduction to loss and LAE reserves of $300.0 million is beingaccreted through an income statement charge ratably with and over the periodthe claims are settled. The outstanding pre-tax unaccreted adjustment as of December 31,2009 was $0.

 

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**FORWARD-LOOKING STATEMENTS**

 

The information contained in this report may contain “forward-lookingstatements” within the meaning of Section 27A of the Securities Act of1933 and Section 21E of the Securities Exchange Act of 1934. Allstatements, other than statements of historical facts, included or referencedin this report that address activities, events or developments which we expector anticipate will or may occur in the future are forward-looking statements.The words “will,” “believe,” “intend,” “expect,” “anticipate,” “project,” “estimate,”“predict” and similar expressions are also intended to identify forward-lookingstatements. These forward-looking statements include, among others, statementswith respect to our:

 

·                  change in book value pershare or return on equity;

 

·                  business strategy;

 

·                  financial and operatingtargets or plans;

 

·                  incurred loss and lossadjustment expenses and the adequacy of our loss and loss adjustment expensereserves and related reinsurance;

 

·                  projections of revenues,income (or loss), earnings (or loss) per share, dividends, market share orother financial forecasts;

 

·                  expansion and growth of ourbusiness and operations; and

 

·                  future capital expenditures.

 

These statements are based on certain assumptions and analyses made byus in light of our experience and perception of historical trends, currentconditions and expected future developments, as well as other factors believedto be appropriate in the circumstances. However, whether actual results anddevelopments will conform with our expectations and predictions is subject to anumber of risks and uncertainties that could cause actual results to differmaterially from expectations, including:

 

·                  the risks discussedbeginning on page 21 of this Form 10-K;

 

·                  recorded loss and lossadjustment expense reserves subsequently proving to have been inadequate;

 

·                  claims arising fromcatastrophic events, such as hurricanes, windstorms, earthquakes, floods,fires, explosions,  terrorist attacks orsevere winter weather;

 

·                  the continued availabilityand cost of reinsurance;

 

·                  competitive forces,including the conduct of other property and casualty insurers and agents;

 

·                  changes in domestic orforeign laws or regulations, or their interpretation, applicable to us, ourcompetitors, our agents or our customers;

 

·                  the continued availabilityof capital and financing;

 

·                  general economic, market orbusiness conditions;

 

·                  an economic downturn orother economic conditions adversely affecting our financial position, includingstock market volatility;

 

·                  business opportunities (orlack thereof) that may be presented to us and pursued;

 

·                  actions taken by ratingagencies from time to time, such as financial strength or credit ratingdowngrades or placing ratings on negative watch; and

 

·                  other factors, most of whichare beyond our control.

 

Consequently, all of the forward-looking statements made in this reportare qualified by these cautionary statements, and there can be no assurancethat the actual results or developments anticipated by us will be realized or,even if substantially realized, that they will have the expected consequencesto, or effects on, us or our business or operations. We assume no obligation toupdate publicly any such forward-looking statements, whether as a result of newinformation, future events or otherwise.

 

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**ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

Our consolidated balance sheet includes a substantial amount of assetsand liabilities whose fair values are subject to market risk. The term marketrisk refers to the risk of loss arising from adverse changes in interest ratesand other relevant market rates and prices. Due to our sizable balances ofinterest rate sensitive instruments, market risk can have a significant effecton our consolidated financial position.

 

***Interest Rate Risk***

 

*Fixed Maturity and Convertible Bond Portfolios.*  In connection with our consolidated insurancesubsidiaries, we invest in interest rate sensitive securities, primarily debtsecurities. Our strategy is to purchase fixed maturity investments andconvertible bonds that are attractively priced in relation to perceived creditrisks. Upon adoption of ASC 825 on January 1, 2008, our portfolio of fixedmaturity investments held for general investment purposes were reclassified astrading securities which are reported at fair value as of the balance sheetdate as determined by quoted market prices when available. Realized andunrealized investment gains and losses on trading securities are reportedpre-tax in revenues. Prior to adoption of ASC 825, our fixed maturityinvestments were held as available-for-sale in accordance with SFAS No. 115,“Accounting for Certain Investments in Debt and Equity Securities,”subsequently codified within ASC 320, whereby these investments were carried atfair value on the balance sheet with net unrealized gains or losses reportednet of tax as a separate component of shareholder’s equity.

 

Upon adoption of ASC 825, our convertible bonds are carried at fairvalue with changes therein recorded in revenues as unrealized investment gainsor losses. Prior to adoption, our convertible bonds were held asavailable-for-sale and were carried at fair value with changes in fair valuerecorded through income as realized investment gains or losses in accordancewith SFAS No. 155, “Accounting for Certain Hybrid Instruments,”subsequently codified within ASC 815.

 

We generally manage our interest rate risk associated with ourportfolio of fixed maturity investments and convertible bonds by monitoring theaverage duration of the portfolio, which allows us to achieve an adequate yieldwithout subjecting the portfolio to an unreasonable level of interest raterisk. Our fixed maturity and convertible bond portfolios are comprised ofprimarily investment grade corporate securities, U.S. government and agencysecurities, municipal obligations and mortgage-backed securities(e.g., those receiving an investment grade rating from Standard &Poor’s or Moody’s).

 

Increases and decreases in prevailing interest rates generallytranslate into decreases and increases in fair values of fixed maturity andconvertible bond investments, respectively. Additionally, fair values ofinterest rate sensitive instruments may be affected by the creditworthiness ofthe issuer, prepayment options, relative values of alternative investments, theliquidity of 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 and convertible bondinvestments and pension fixed maturity and convertible bond investments:

 
| ** **                                        | ** ** | **Fair value at  December 31,  2009** | ** ** | **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 and convertible bond investments   |       | $                                          | 3,164.5    |                                           | 100 bp decrease |                                                     | $          | 3,240.8                                               |       | $ | 49.6 |   |
|                                              |       |                                       |       | 50 bp decrease                                 |            | 3,203.6                                                  |       | 25.4                                                  |       |
|                                              |       |                                       |       | 50 bp increase                                 |            | 3,122.8                                                  |       | (27.1                                                 | )          |
|                                              |       |                                       |       | 100 bp increase                                |            | 3,079.2                                                  |       | (55.4                                                 | )          |
| Qualified pension plan fixed maturity investments |       | $                                          | 44.7       |                                           | 100 bp decrease |                                                     | $          | 45.8                                                  |       | $ | 0.7 |   |
|                                              |       |                                       |       | 50 bp decrease                                 |            | 45.3                                                     |       | 0.4                                                   |       |
|                                              |       |                                       |       | 50 bp increase                                 |            | 44.2                                                     |       | (0.3                                                  | )          |
|                                              |       |                                       |       | 100  bp increase                               |            | 43.7                                                     |       | (0.7                                                  | )          |

 

*Long-term obligations.*  As of December 31, 2009, our interestand dividend bearing long-term obligations consisted primarily of the SeniorNotes which have a fixed interest rate. 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, 2009, the fair value of the Senior Notes was$605.8 million, which compared to a carrying value of $606.5 million.The fair value of this obligation was estimated by discounting future cashflows using current market rates for similar obligations or using quoted marketprices.

 

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***Credit Spread Risk***

 

*Sensitivity analysis of spreadrisk*

 

Our overall fixedmaturity investment strategy is to purchase securities that are attractivelypriced in relation to credit risks. Widening and tightening of spreadsgenerally translate into decreases and increases in fair values of fixedmaturity investments. The table below summarizes the estimated effects ofhypothetical widening and tightening of spreads for different classes of ourfixed maturity and convertible bond portfolios. In estimating the impact ofhypothetical tightening of spreads, for fixed maturity investments yieldingmore than the 5 year Constant Maturity Treasury Index (CMT Index) as of December 31,2009, to the extent their yields would have decreased to levels lower than the5 year CMT Index as of December 31, 2009, we limited their price appreciationto a level equal to the yield of the 5 year CMT Index.  For fixed maturityinvestments yielding less than the 5 year CMT Index as of December 31,2009, we assumed no price appreciation.

 
| ** **                            | ** ** | **December 31,  2009  Fair Value** | ** ** | **Tighten 50** | ** ** | **Tighten 25** | ** ** | **Widen 25** | ** ** | **Widen 50** | ** ** |
|---------------------------------------|------------|-----------------------------------------|------------|----------------|------------|----------------|------------|--------------|------------|--------------|------------|
| ** **                            | ** ** | **($ in millions)**           | ** ** |
| U.S Government and agency obligations |       | $                                       | 531.6      |           | $          | —         |       | $            | —     |         | $          | — |   | $ | — |   |
| Foreign government obligations        |       | 26.7                                    |       | 0.1            |       | 0.1            |       | (0.1         | )          | (0.2         | )          |
|                                       |            |                                         |            |                |            |                |            |              |            |              |            |  |  |  |  |  |

 
| ** **                        | ** ** | ** ** | ** ** | **Tighten 100** | ** ** | **Tighten 50** | ** ** | **Widen 50** | ** ** | **Widen 100** | ** ** |
|-----------------------------------|------------|------------|------------|----------------------|------------|---------------------|------------|-------------------|------------|--------------------|------------|
| Agency mortgage-backed securities |       | $          | 708.4      |                 | $          | 10.2                |       | $                 | 6.3        |               | $          | (8.3 | ) | $ | (16.3 | ) |
| Other asset-backed securities     |       | 139.7      |       | —               |       | —              |       | (0.3              | )          | (0.6               | )          |
|                                   |            |            |            |                      |            |                     |            |                   |            |                    |            |  |  |  |  |  |

 
| ** **                                        | ** ** | ** ** | ** ** | **Tighten 200** | ** ** | **Tighten 100** | ** ** | **Widen 100** | ** ** | **Widen 200** | ** ** |
|---------------------------------------------------|------------|------------|------------|----------------------|------------|----------------------|------------|--------------------|------------|--------------------|------------|
| Debt securities issued by industrial corporations |       | $          | 1,347.0    |                 | $          | 56.8                 |       | $                  | 35.4       |               | $          | (45.0 | ) | $ | (87.4 | ) |
| Municipal obligations                             |       | 2.6        |       | —               |       | —               |       | (0.1               | )          | (0.1               | )          |
| Convertible bonds                                 |       | 170.2      |       | 0.9                  |       | 0.5                  |       | (3.4               | )          | (6.9               | )          |
|                                                   |            |            |            |                      |            |                      |            |                    |            |                    |            |  |  |  |  |  |

 
| ** **                                       | ** ** | ** ** | ** ** | **Tighten 400** | ** ** | **Tighten 200** | ** ** | **Widen 200** | ** ** | **Widen 400** | ** ** |
|--------------------------------------------------|------------|------------|------------|----------------------|------------|----------------------|------------|--------------------|------------|--------------------|------------|
| Non-agency commercial mortgage-backed securities |       | $          | 136.1      |                 | $          | 4.6                  |       | $                  | 3.0        |               | $          | (4.3 | ) | $ | (8.3 | ) |
|                                                  |            |            |            |                      |            |                      |            |                    |            |                    |            |  |  |  |  |  |

 
| ** **                                        | ** ** | ** ** | ** ** | **Tighten 600** | ** ** | **Tighten 300** | ** ** | **Widen 300** | ** ** | **Widen 600** | ** ** |
|---------------------------------------------------|------------|------------|------------|----------------------|------------|----------------------|------------|--------------------|------------|--------------------|------------|
| Preferred stocks                                  |       | $          | 71.5       |                 | $          | 6.8                  |       | $                  | 6.4        |               | $          | (10.5 | ) | $ | (22.4 | ) |
| Non-agency residential mortgage-backed securities |       | 30.7       |       | 4.9                  |       | 2.5                  |       | (2.1               | )          | (3.9               | )          |
|                                                   |            |            |            |                      |            |                      |            |                    |            |                    |            |  |  |  |  |  |

 

Thetable below summarizes the estimated effects of hypothetical widening andtightening of spreads on our qualified pension plan fixed maturity investments.

 
| ** **                                        | ** ** | **December 31,  2009  Fair Value** | ** ** | **Tighten 200** | ** ** | **Tighten 100** | ** ** | **Widen 100** | ** ** | **Widen 200** | ** ** |
|---------------------------------------------------|------------|-----------------------------------------|------------|----------------------|------------|----------------------|------------|--------------------|------------|--------------------|------------|
| ** **                                        | ** ** | **($ in  millions)**               | ** ** |
| Debt securities issued by industrial corporations |       | $                                       | 4.5        |                 | $          | 0.4                  |       | $                  | 0.2        |               | $          | (0.2 | ) | $ | (0.4 | ) |
| Convertible bonds                                 |       | 39.8                                    |       | 0.2                  |       | 0.1                  |       | (0.8               | )          | (1.7               | )          |
|                                                   |            |                                         |            |                      |            |                      |            |                    |            |                    |            |  |  |  |  |  |

 
| ** **       | ** ** | ** ** | ** ** | **Tighten 600** | ** ** | **Tighten 300** | ** ** | **Widen 300** | ** ** | **Widen 600** | ** ** |
|------------------|------------|------------|------------|----------------------|------------|----------------------|------------|--------------------|------------|--------------------|------------|
| Preferred stocks |       | $          | 0.4        |                 | $          | 0.2                  |       | $                  | 0.1        |               | $          | (0.1 | ) | $ | (0.2 | ) |
|                  |            |            |            |                      |            |                      |            |                    |            |                    |            |  |  |  |  |  |

 

***Equity Price Risk***

 

The carrying values of our common equity securities and our otherinvestments are based on quoted market prices or management’s estimates of fairvalue (which is based, in part, on quoted market prices) as of the balancesheet date. Market prices of common equity securities, in general, are subjectto fluctuations which could cause the amount to be realized upon sale orexercise of the instruments to differ significantly from the current reportedvalue. The fluctuations may result from perceived changes in the underlyingeconomic characteristics of the investee, the relative price of alternativeinvestments, general market conditions and supply and demand imbalances for aparticular security.

 

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*Sensitivityanalysis of likely changes in fair values of common equity securities, hedgefund and private equity fund investments*

 

Our investment portfolioincludes investments in common equity securities, hedge funds and privateequity funds. The underlying investments of the hedge funds and private equityfunds are typically publicly traded and private common equity investments, and,as such, are subject to market risks that are similar to those in our commonequity portfolio.

 

The following illustratesthe estimated effect on December 31, 2009 fair values resulting fromhypothetical changes in market value:

 
| ** **                | ** ** | **Change in fair value** | ** ** |
|---------------------------|------------|-----------------------------------------|------------|
| ** **                | ** ** | **10%  decline**                        | ** ** | **10%  increase** | ** ** | **30%  decline** | ** ** | **30%  increase** | ** ** |
| ** **                | ** ** | **($ in  millions)**               | ** ** |
| Common  equity securities |       | $                                       | (18.8      | ) | $ | 18.8 |   | $ | (56.3 | ) | $ | 56.3 |   |
| Hedge  funds              |       | (7.4                                    | )          | 7.4 |   | (22.3 | ) | 22.3 |   |
| Private  equity funds     |       | (5.8                                    | )          | 5.8 |   | (17.4 | ) | 17.4 |   |
|                           |            |                                         |            |  |  |  |  |  |  |  |  |  |  |

 

Returns on common equitysecurities are measured against the S&P 500 Index. Hedge funds and privateequity funds returns are commonly measured against the benchmark returns ofhedge fund indices and/or the S&P 500 Index. The Hedge Fund Research, Inc.(HFRX) Equal Weighted Strategies Index is representative of the overallcomposition of the hedge fund market and is comprised of typical hedge fundstrategies, including convertible arbitrage, distressed securities, equityhedge, equity market neutral, event driven, macro, merger arbitrage andrelative value arbitrage. The HFRX Equal Weighted Strategies Index applies anequal weight to all constituent strategy indices. The historical returns foreach index in the past 5 full years are listed below:

 
| ** **                            | ** ** | **Year  ended December 31,** | ** ** |
|---------------------------------------|------------|-----------------------------------|------------|
| ** **                            | ** ** | **2009**                          | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
| HFRX  Equal Weighted Strategies Index |       | 11.4                              | %          | (21.9 | )% | 4.0 | % | 8.8 | % | 1.3 | % |
| S&P  500 Index                    |       | 26.5                              |       | (37.0 | ) | 5.5 |   | 15.8 |   | 4.9 |   |

 

***Foreign Currency Exchange Rates***

 

Our investments denominated in foreign currencies are valued usingperiod-end exchange rates and our net investment income on foreign-denominatedsecurities are valued using average exchange rates. Foreign currency exchangerate risk is the risk that we will incur losses on a U.S. dollar basis due toadverse changes in foreign currency exchange rates.

 

At December 31, 2009, we held $66.4 million in bondsdenominated in foreign currencies, mostly in British pounds and Australiandollars. Assuming a hypothetical 10% increase or decrease in the rate ofexchange from the British pound and Australian dollar to the U.S. dollar as of December 31,2009, the carrying value of our foreign currency-denominated bond portfoliowould have respectively decreased or increased by $6.6 million.

 

**ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**

 

The financialstatements and supplementary data have been filed as a part of this AnnualReport on Form 10-K as indicated in the Index to Consolidated FinancialStatements and Financial Statement Schedules appearing on page F-1 of thisreport.

 

**ITEM9.  CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

None.

 

**ITEM 9A.  CONTROLS AND PROCEDURES**

 

We maintain disclosure controls and procedures that are designed toensure that information required to be disclosed in the reports that we file orsubmit under the Securities Exchange Act of 1934 is recorded, processed, summarizedand reported within the time periods specified in the SEC’s rules andforms, and that such information is accumulated and communicated to ourmanagement, including our Chief Executive Officer (CEO) and Chief FinancialOfficer (CFO), as appropriate, to allow timely decisions regarding requiredfinancial disclosure.

 

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Our CEO and the CFO (the principal executive officer and principalfinancial officer, respectively) have evaluated the effectiveness of ourdisclosure controls and procedures (as defined in Rule 13a-1 5(e) ofthe Securities Exchange Act of 1934, as amended) as of December 31, 2009.Based on this evaluation, the CEO and CFO have concluded that as of December 31,2009, our disclosure controls and procedures are adequate and effective toprovide reasonable assurance that material information required to be includedin our periodic SEC reports is recorded, processed, summarized and reportedwithin the time periods specified in rules and forms.

 

The CEO and the CFO have evaluated the effectiveness of our internalcontrol over financial reporting as of December 31, 2009. Based on thatevaluation, the CEO and CFO have concluded that our internal control overfinancial reporting is effective. Management’s annual report on internalcontrol over financial reporting is included on page F-56 of this report.This annual report does not include an attestation report of our registeredpublic accounting firm regarding internal control over financial reporting.Management’s report was not subject to attestation by our registered publicaccounting firm pursuant to the rules of the Securities and ExchangeCommission that permit us to provide only management’s report in this annualreport.

 

There were no significant changes with respect to our internal controlover financial reporting or in other factors that materially affected, or arereasonably likely to materially affect, internal control over financialreporting during the quarter ended December 31, 2009.

 

**ITEM9B.  OTHER INFORMATION**

 

None.

 

**PART III**

 

**ITEM14.  PRINCIPAL ACCOUNTANT FEES ANDSERVICES**

 

The following table presents fees for professional services rendered byPricewaterhouseCoopers LLP for the audit of the Company’s annual financialstatements, audit-related services, tax services and all other services for theyears ended December 31, 2009 and 2008.

 
| ** **            | ** ** | **Year ended December 31,** | ** ** |
|-----------------------|------------|----------------------------------|------------|
| ** **            | ** ** | **2009**                         | ** ** | **2008** | ** ** |
| ** **            | ** ** | **($ in millions)**         | ** ** |
| Audit fees(1)         |       | $                                | 1.3        |   | $ | 1.7 |   |
| Audit-related fees(2) |       | 0.2                              |       | 0.2 |   |
| Tax fees(3)           |       | —                           |       | — |   |
| Total(4)              |       | $                                | 1.5        |   | $ | 1.9 |   |

 

----

(1)                                  The fees inthis category were for professional services rendered in connection with (i) theaudits of the Company’s annual financial statements set forth in the Company’sAnnual Report on Form 10-K, (ii) the review of the Company’squarterly financial statements as set forth in its Quarterly Reports on Form 10-Q,(iii) audits of the Company’s subsidiaries that are required by statute orregulation, and (iv) services that generally only the Company’sindependent registered public accounting firm reasonably can provide.

 

(2)                                  The fees inthis category were for professional services rendered in connection with (i) employeebenefit plans, (ii) agreed upon procedures, (iii) a consent inconnection with the filing of the Company’s shelf registration statement on Form S-3in 2008, and (iv) other regulatory requirements.

 

(3)                                  The fees inthis category were for professional services rendered in connection with taxstrategy assistance and tax compliance services.

 

(4)                                  These fees area component of the total accountant fees incurred by OBIG during 2009 and 2008.

 

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**PART IV**

 

**ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES**

 

**a.****                                      ****Documents Filed as Part of the Report**

 

The financial statements and financial statement schedules and reportof independent auditors 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 page 81 of this report.

 

**b.****                                      ****Exhibits**

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                         |
|----------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 23.1*                |       | Consent  of PricewaterhouseCoopers LLP.                                                                                                                            |
| 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. |

 

----

*                                         Filed Herewith

 

**                                  FurnishedHerewith

 

**c.****                                      ****Financial Statement Schedules**

 

The financial statement schedules and report of independent registeredpublic accounting firm 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.

 

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**SIGNATURES**

 

Pursuant to the requirements of the Securities Act of 1934, theregistrant has duly caused this report to be signed on its behalf by theundersigned, thereto duly authorized.

 
| ** **                 | **ONEBEACON U.S. HOLDINGS, INC.** |
|----------------------------|-----------------------------------|
|                       |                              |
|                       |                              |
|                       | By:                               | /s/  T. MICHAEL MILLER |
|                       |                              | T.  Michael Miller |
| Date:  March 19, 2010 |                              | *President and Chief Executive Officer* |

 

Pursuant to the requirements of the Securities Act of 1934, this reporthas been signed by the following persons in the capacities and on the dateindicated.

 

| **Signature**         | ** ** | **Title**                                                               | ** ** | **Date**            |
|-----------------------|------------|-------------------------------------------------------------------------|------------|---------------------|
| ** **            | ** ** | ** **                                                              | ** ** | ** **          |
| /s/ T. MICHAEL MILLER |       | Director,  Chairman of the Board, President and Chief Executive Officer |       | March 19, 2010 |
| T. Michael Miller     |       |                                                                    |       |                |
|                  |       |                                                                    |       |                |
|                  |       |                                                                    |       |                |
| /s/ PAUL H. MCDONOUGH |       | Director  and Chief Financial Officer                                   |       | March 19, 2010 |
| Paul H. McDonough     |       |                                                                    |       |                |
|                  |       |                                                                    |       |                |
|                  |       |                                                                    |       |                |
| /s/ ANN MARIE ANDREWS |       | Chief  Accounting Officer                                               |       | March 19, 2010 |
| Ann Marie Andrews     |       |                                                                    |       |                |

 

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**ONEBEACONU.S. HOLDINGS, INC.**

 

**INDEX TOCONSOLIDATED FINANCIAL STATEMENTS**

 
| ** **                                                                                                                         | ** **                                                                 | **Form 10-K  Pages** |
|------------------------------------------------------------------------------------------------------------------------------------|----------------------------------------------------------------------------|---------------------------|
| **Audited Consolidated Financial Statements**                                                                                      |                                                                       |                      |
| Consolidated Balance Sheets:  As of December 31, 2009 and 2008                                                                |                                                                       | F-2                       |
| Consolidated Statements of Operations and Comprehensive  Income (Loss):  For the years ended December 31, 2009, 2008 and 2007 |                                                                       | F-3                       |
| Consolidated Statements of Common Shareholder’s  Equity:  For the years ended December 31, 2009, 2008 and 2007           |                                                                       | F-4                       |
| Consolidated Statements of Cash Flows:  For the years ended December 31, 2009, 2008 and 2007                                  |                                                                       | F-5                       |
| Notes to Consolidated Financial Statements                                                                                         |                                                                       | F-6                       |
|                                                                                                                               |                                                                       |                      |
| **Other Financial Information:**                                                                                                   |                                                                       |                      |
| Management’s Annual Report on Internal Control Over  Financial Reporting                                                      |                                                                       | F-56                      |
| Report of Independent Registered Public Accounting  Firm                                                                           |                                                                       | F-57                      |
| Selected Quarterly Financial Data (Unaudited)                                                                                      |                                                                       | F-58                      |
|                                                                                                                               |                                                                       |                      |
| **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-4 |
| IV.                                                                                                                                | Reinsurance                                                                |                      | S-5 |
| V.                                                                                                                                 | Valuation and  qualifying accounts                                         |                      | S-6 |
| VI.                                                                                                                                | Supplemental  information for property and casualty insurance underwriters |                      | S-7 |

 

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**ONEBEACONU.S. HOLDINGS, INC.**

 

**CONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                   | ** ** | **December 31,**                                                            | ** ** |
|----------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|
| ** **                                                                                   | ** ** | **2009**                                                                         | ** ** | **2008** | ** ** |
| ** **                                                                                   | ** ** | **(in millions, except  share and per share  amounts)** | ** ** |
| **Assets**                                                                                   | ** ** | ** **                                                                       | ** ** | ** ** | ** ** |
| Investment securities:                                                                       |       |                                                                             |       |   |   |
| Fixed maturity investments, at fair value  (amortized cost $2,900.6 and $2,246.4)            |       | $                                                                                | 2,994.3    |   | $ | 2,134.8 |   |
| Short-term investments, at amortized cost (which  approximates fair value)                   |       | 489.3                                                                            |       | 875.4 |   |
| Common equity securities, at fair value (cost  $176.3 and $284.6)                            |       | 187.6                                                                            |       | 276.7 |   |
| Convertible bonds, at fair value (amortized cost  $153.7 and $255.0)                         |       | 170.2                                                                            |       | 241.2 |   |
| Other investments, at fair value (cost $122.8 and  $178.6)                                   |       | 146.3                                                                            |       | 196.6 |   |
| Total investments                                                                            |       | 3,987.7                                                                          |       | 3,724.7 |   |
| Cash                                                                                         |       | 43.6                                                                             |       | 51.6 |   |
| Reinsurance recoverable on unpaid losses                                                     |       | 664.1                                                                            |       | 859.4 |   |
| Reinsurance recoverable on unpaid losses—Berkshire  Hathaway, Inc.                 |       | 1,528.8                                                                          |       | 1,643.9 |   |
| Reinsurance recoverable on paid losses                                                       |       | 15.9                                                                             |       | 21.7 |   |
| Premiums receivable                                                                          |       | 469.1                                                                            |       | 527.6 |   |
| Securities lending collateral                                                                |       | —                                                                           |       | 100.7 |   |
| Deferred acquisition costs                                                                   |       | 215.0                                                                            |       | 225.5 |   |
| Net deferred tax asset                                                                       |       | 184.6                                                                            |       | 269.4 |   |
| Investment income accrued                                                                    |       | 29.4                                                                             |       | 25.7 |   |
| Ceded unearned premiums                                                                      |       | 49.9                                                                             |       | 66.5 |   |
| Accounts receivable on unsettled investment sales                                            |       | 24.2                                                                             |       | 49.0 |   |
| Other assets                                                                                 |       | 279.7                                                                            |       | 296.3 |   |
| Total assets                                                                                 |       | $                                                                                | 7,492.0    |   | $ | 7,862.0 |   |
| **Liabilities**                                                                              | ** ** | ** **                                                                       | ** ** | ** ** | ** ** |
| Loss and LAE reserves                                                                        |       | $                                                                                | 3,934.8    |   | $ | 4,294.0 |   |
| Unearned premiums                                                                            |       | 1,018.3                                                                          |       | 1,088.2 |   |
| Debt                                                                                         |       | 620.5                                                                            |       | 731.9 |   |
| Securities lending payable                                                                   |       | 1.7                                                                              |       | 107.7 |   |
| Ceded reinsurance payable                                                                    |       | 24.7                                                                             |       | 70.5 |   |
| Accounts payable on unsettled investment purchases                                           |       | 7.6                                                                              |       | 6.8 |   |
| Other liabilities                                                                            |       | 473.8                                                                            |       | 412.3 |   |
| Total liabilities                                                                            |       | 6,081.4                                                                          |       | 6,711.4 |   |
| **Shareholder’s equity and  noncontrolling interests**                                  | ** ** | ** **                                                                       | ** ** | ** ** | ** ** |
| OB Holdings’ shareholder’s equity:                                                 |       |                                                                             |       |   |   |
| Common shares and paid-in surplus (par value $1,  issued and outstanding, 505 shares)        |       | 970.5                                                                            |       | 970.5 |   |
| Retained earnings                                                                            |       | 427.2                                                                            |       | 187.9 |   |
| Accumulated other comprehensive loss, after tax:                                             |       |                                                                             |       |   |   |
| Net unrealized foreign currency translation losses                                           |       | (0.7                                                                             | )          | (0.6 | ) |
| Other comprehensive income and loss items                                                    |       | (5.5                                                                             | )          | (24.4 | ) |
| Total OB Holdings’ shareholder’s equity                                            |       | 1,391.5                                                                          |       | 1,133.4 |   |
| Total noncontrolling interests                                                               |       | 19.1                                                                             |       | 17.2 |   |
| Total OB Holdings’ shareholder’s equity and  noncontrolling interests              |       | 1,410.6                                                                          |       | 1,150.6 |   |
| Total liabilities, OB Holdings’ shareholder’s  equity and noncontrolling interests |       | $                                                                                | 7,492.0    |   | $ | 7,862.0 |   |

 

See Notes to ConsolidatedFinancial Statements including Note 17—“Commitments and Contingencies.”

 

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**ONEBEACONU.S. HOLDINGS, INC.**

 

**CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVEINCOME (LOSS)**

 
| ** **                                                                          | ** ** | **Year ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                          | ** ** | **2009**                         | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                                          | ** ** | **($ in millions)**         | ** ** |
| **Revenues**                                                                        |       |                             |       |   |   |   |   |
| Earned premiums                                                                     |       | $                                | 1,959.5    |   | $ | 1,879.0 |   | $ | 1,873.6 |   |
| Net investment income                                                               |       | 125.3                            |       | 162.1 |   | 202.4 |   |
| Net realized and unrealized investment gains  (losses)                              |       | 248.6                            |       | (766.0 | ) | 173.1 |   |
| Net other revenues                                                                  |       | 44.7                             |       | 13.8 |   | 17.2 |   |
| Total revenues                                                                      |       | 2,378.1                          |       | 1,288.9 |   | 2,266.3 |   |
| **Expenses**                                                                        |       |                             |       |   |   |   |   |
| Loss and LAE                                                                        |       | 1,121.9                          |       | 1,126.2 |   | 1,089.8 |   |
| Policy acquisition expenses                                                         |       | 398.3                            |       | 368.3 |   | 318.9 |   |
| Other underwriting expenses                                                         |       | 330.0                            |       | 290.8 |   | 329.4 |   |
| General and administrative expenses                                                 |       | 18.0                             |       | 11.2 |   | (0.5 | ) |
| Accretion of fair value adjustment to loss and LAE  reserves                        |       | 5.4                              |       | 12.0 |   | 16.0 |   |
| Interest expense on debt                                                            |       | 39.7                             |       | 44.9 |   | 45.2 |   |
| Interest expense—dividends on preferred stock  subject to mandatory redemption |       | —                           |       | 11.8 |   | 28.3 |   |
| Interest expense—accretion on preferred stock  subject to mandatory redemption |       | —                           |       | 21.6 |   | 36.1 |   |
| Total expenses                                                                      |       | 1,913.3                          |       | 1,886.8 |   | 1,863.2 |   |
| **Pre-tax income (loss)**                                                           |       | 464.8                            |       | (597.9 | ) | 403.1 |   |
| Income tax (expense) benefit                                                        |       | (155.3                           | )          | 195.3 |   | (164.5 | ) |
| **Net income (loss) including  noncontrolling interests**                           |       | 309.5                            |       | (402.6 | ) | 238.6 |   |
| Less: Net income attributable to noncontrolling  interests                          |       | (2.1                             | )          | (1.7 | ) | (3.7 | ) |
| **Net income (loss) attributable  to OB Holdings’ shareholder**                |       | 307.4                            |       | (404.3 | ) | 234.9 |   |
| Change in net unrealized gains and losses for  investments held                     |       | —                           |       | — |   | 105.1 |   |
| Recognition of net unrealized gains and losses for  investments sold                |       | —                           |       | — |   | (108.3 | ) |
| Change in foreign currency translation                                              |       | (0.1                             | )          | (0.4 | ) | 0.5 |   |
| Change in other comprehensive income and loss  items                                |       | 18.9                             |       | (25.2 | ) | (1.2 | ) |
| **Comprehensive net income (loss)  attributable to OB Holdings’ shareholder**  |       | $                                | 326.2      |   | $ | (429.9 | ) | $ | 231.0 |   |

 

See Notes to ConsolidatedFinancial Statements.

 

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**ONEBEACONU.S. HOLDINGS, INC.**

 

**CONSOLIDATED STATEMENTS OF COMMON SHAREHOLDER’S EQUITY**

 
| ** **                                               | ** ** | **OB Holdings’ Shareholder’s Equity** | ** **  | ** **                               | ** ** |
|----------------------------------------------------------|------------|-------------------------------------------------|-------------|------------------------------------------|------------|
| ** **                                               | ** ** | **Common  shareholder’s  equity**          | ** **  | **Common  shares and  paid-in  surplus** | ** ** | **Retained  earnings** | ** ** | **Accum. other  comprehensive  income (loss),  after tax** | ** ** | **Noncontrolling interests,********after tax** | ** ** |
| ** **                                               | ** ** | **($ in  millions)**                       | ** **  |
| Balances at January 1, 2007                         |       | $                                               | 1,747.5     |                                     | $          | 970.5 |   | $ | 590.1 |   | $ | 186.9 |   | $ | 17.8 |   |
| Adjustment to adopt ASC 740                              |       | (0.3                                            | )           | —                                   |       | (0.3 | ) | — |   | — |   |
| Net income                                               |       | 234.9                                           |        | —                                   |       | 234.9 |   | — |   | 3.7 |   |
| Issuance of common shares                                |       | —                                          |        | —                                   |       | — |   | — |   | 0.3 |   |
| Dividends                                                |       | (195.0                                          | )           | —                                   |       | (195.0 | ) | — |   | (0.5 | ) |
| Other comprehensive income and loss items, after  tax:   |       |                                            |        |                                     |       |   |   |   |   |   |   |
| Change in net unrealized gains and losses on investments |       | (3.2                                            | )           | —                                   |       | — |   | (3.2 | ) | — |   |
| Change in foreign currency translation                   |       | 0.5                                             |        | —                                   |       | — |   | 0.5 |   | — |   |
| Change in interest rate swap                             |       | (1.1                                            | )           | —                                   |       | — |   | (1.1 | ) | — |   |
| Change in additional pension liability                   |       | (0.1                                            | )           | —                                   |       | — |   | (0.1 | ) | — |   |
| Other comprehensive loss, after tax                      |       | (3.9                                            | )           | —                                   |       | — |   | (3.9 | ) | — |   |
| Balances at December 31, 2007                       |       | $                                               | 1,783.2     |                                     | $          | 970.5 |   | $ | 629.7 |   | $ | 183.0 |   | $ | 21.3 |   |
| Adjustment to adopt ASC 825, after tax                   |       | —                                          |        | —                                   |       | 182.4 |   | (182.4 | ) | — |   |
| Net (loss) income                                        |       | (404.3                                          | )           | —                                   |       | (404.3 | ) | — |   | 1.7 |   |
| Issuance of common shares                                |       | —                                          |        | —                                   |       | — |   | — |   | 0.3 |   |
| Dividends                                                |       | (219.9                                          | )           | —                                   |       | (219.9 | ) | — |   | (0.6 | ) |
| Contributions                                            |       | —                                          |        | —                                   |       | — |   | — |   | 1.0 |   |
| Distributions                                            |       | —                                          |        | —                                   |       | — |   | — |   | (6.5 | ) |
| Other comprehensive income and loss items, after  tax:   |       |                                            |        |                                     |       |   |   |   |   |   |   |
| Change in foreign currency translation                   |       | (0.4                                            | )           | —                                   |       | — |   | (0.4 | ) | — |   |
| Change in interest rate swap                             |       | (5.7                                            | )           | —                                   |       | — |   | (5.7 | ) | — |   |
| Change in additional pension liability                   |       | (19.5                                           | )           | —                                   |       | — |   | (19.5 | ) | — |   |
| Other comprehensive loss, after tax                      |       | (25.6                                           | )           | —                                   |       | — |   | (25.6 | ) | — |   |
| Balances at  December 31, 2008                      |       | $                                               | 1,133.4     |                                     | $          | 970.5 |   | $ | 187.9 |   | $ | (25.0 | ) | $ | 17.2 |   |
| Net income                                               |       | 307.4                                           |        | —                                   |       | 307.4 |   | — |   | 2.1 |   |
| Issuance of common shares                           |       | —                                          |        | —                                   |       | — |   | — |   | 0.3 |   |
| Dividends                                                |       | (68.1                                           | )           | —                                   |       | (68.1 | ) | — |   | (0.6 | ) |
| Contributions                                            |       | —                                          |        | —                                   |       | — |   | — |   | 5.1 |   |
| Distributions                                            |       | —                                          |        | —                                   |       | — |   | — |   | (5.0 | ) |
| Other comprehensive income and loss items, after  tax:   |       |                                            |        |                                     |       |   |   |   |   |   |   |
| Change in foreign currency translation                   |       | (0.1                                            | )           | —                                   |       | — |   | (0.1 | ) | — |   |
| Change in interest rate swap                             |       | 6.8                                             |        | —                                   |       | — |   | 6.8 |   | — |   |
| Change in additional pension liability                   |       | 12.1                                            |        | —                                   |       | — |   | 12.1 |   | — |   |
| Other comprehensive income, after tax                    |       | 18.8                                            |        | —                                   |       | — |   | 18.8 |   | — |   |
| **Balances at December 31,  2009**                  | ** ** | **$**                                           | **1,391.5** | ** **                               | **$**      | **970.5** | ** ** | **$** | **427.2** | ** ** | **$** | **(6.2** | **)** | **$** | **19.1** | ** ** |

 

See Notes to ConsolidatedFinancial Statements.

 

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**ONEBEACON U.S.HOLDINGS, INC.**

 

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

 
| ** **                                                                                           | ** ** | **Year ended December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                           | ** ** | **2009**                         | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                                                           | ** ** | **($ in millions)**         | ** ** |
| Cash flows from operations:                                                                          |       |                             |       |   |   |   |   |
| Net income (loss)                                                                                    |       | $                                | 309.5      |   | $ | (402.6 | ) | $ | 238.6 |   |
| Charges (credits) to reconcile net income (loss) to  cash flows provided from (used for) operations: |       |                             |       |   |   |   |   |
| Net realized and unrealized investment (gains)  losses                                               |       | (248.6                           | )          | 766.0 |   | (173.1 | ) |
| Net realized gains from sale of common stock of  subsidiaries                                        |       | —                           |       | (2.1 | ) | (11.3 | ) |
| Net realized loss on settlement of interest rate  swap                                               |       | 7.4                              |       | — |   | — |   |
| Net other realized gains                                                                             |       | (5.4                             | )          | — |   | — |   |
| Dividends paid on mandatorily redeemable preferred  stock                                            |       | —                           |       | 11.8 |   | 28.3 |   |
| Deferred income tax expense (benefit)                                                                |       | 74.7                             |       | (207.3 | ) | 29.8 |   |
| Other operating items:                                                                               |       |                             |       |   |   |   |   |
| Net change in loss and LAE reserves                                                                  |       | (359.2                           | )          | (186.3 | ) | (357.4 | ) |
| Net change in unearned premiums                                                                      |       | (69.9                            | )          | 82.3 |   | 20.7 |   |
| Net change in ceded reinsurance payable                                                              |       | (45.8                            | )          | (9.3 | ) | 30.9 |   |
| Net change in ceded unearned premium                                                                 |       | 16.6                             |       | 1.6 |   | (29.9 | ) |
| Net change in premiums receivable                                                                    |       | 58.5                             |       | (21.4 | ) | (12.1 | ) |
| Net change in reinsurance recoverable on paid and  unpaid losses                                     |       | 316.2                            |       | 126.4 |   | 223.6 |   |
| Net change in other assets and liabilities                                                           |       | 123.2                            |       | (143.4 | ) | (11.3 | ) |
| Net cash provided from (used for) operations                                                         |       | 177.2                            |       | 15.7 |   | (23.2 | ) |
| Cash flows from investing activities:                                                                |       |                             |       |   |   |   |   |
| Net maturities, purchases and sales of short-term  investments                                       |       | 388.2                            |       | (597.4 | ) | (25.0 | ) |
| (Purchases) maturities of short-term  held-to-maturity investments                                   |       | —                           |       | (7.1 | ) | 13.4 |   |
| Maturities of fixed maturity investments                                                             |       | 498.1                            |       | 644.3 |   | 137.9 |   |
| Maturities of fixed maturity investments  held-to-maturity                                           |       | —                           |       | 312.6 |   | 13.4 |   |
| Sales of fixed maturity investments                                                                  |       | 715.1                            |       | 893.4 |   | 1,889.7 |   |
| Sales of common equity securities                                                                    |       | 214.4                            |       | 446.5 |   | 327.6 |   |
| Sales of convertible bonds                                                                           |       | 195.3                            |       | 225.3 |   | 241.3 |   |
| Distributions and redemptions from other  investments                                                |       | 68.7                             |       | 76.6 |   | 50.5 |   |
| Purchases of fixed maturity investments                                                              |       | (1,871.1                         | )          | (992.6 | ) | (1,853.0 | ) |
| Purchases of common equity securities                                                                |       | (137.4                           | )          | (338.6 | ) | (291.9 | ) |
| Purchases of convertible bonds                                                                       |       | (91.0                            | )          | (101.0 | ) | (251.9 | ) |
| Contributions for other investments                                                                  |       | (7.6                             | )          | (30.1 | ) | (78.9 | ) |
| Sales of common stock of subsidiaries, net of sales  costs                                           |       | —                           |       | 12.0 |   | 47.2 |   |
| Purchase of subsidiary                                                                               |       | —                           |       | (7.3 | ) | — |   |
| Net change in unsettled investment purchases and  sales                                              |       | 25.6                             |       | 8.9 |   | (55.6 | ) |
| Net acquisitions of property and equipment                                                           |       | (2.0                             | )          | (0.8 | ) | (12.0 | ) |
| Net cash used for investing activities                                                               |       | (3.7                             | )          | 544.7 |   | 152.7 |   |
| Cash flows from financing activities:                                                                |       |                             |       |   |   |   |   |
| Repayment of debt                                                                                    |       | (42.8                            | )          | (2.0 | ) | (2.0 | ) |
| Settlement of interest rate swap                                                                     |       | (7.4                             | )          | — |   | — |   |
| Repurchases of debt                                                                                  |       | (63.2                            | )          | (22.3 | ) | — |   |
| Cash dividends paid to OneBeacon U.S. Enterprises  Holdings, Inc.                               |       | (68.1                            | )          | (219.9 | ) | (93.4 | ) |
| Redemption of mandatorily redeemable preferred  stock                                                |       | —                           |       | (300.0 | ) | — |   |
| Dividends paid on mandatorily redeemable preferred  stock                                            |       | —                           |       | (11.8 | ) | (28.3 | ) |
| Net cash used for financing activities                                                               |       | (181.5                           | )          | (556.0 | ) | (123.7 | ) |
| Net (decrease) increase in cash during year                                                          |       | (8.0                             | )          | 4.4 |   | 5.8 |   |
| Cash balance at beginning of year                                                                    |       | 51.6                             |       | 47.2 |   | 41.4 |   |
| Cash balance at end of year                                                                          |       | $                                | 43.6       |   | $ | 51.6 |   | $ | 47.2 |   |

 

See Notes to ConsolidatedFinancial Statements.

 

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE1.  Nature of Operations and Summary ofSignificant Accounting Policies**

 

The accompanyingconsolidated financial statements include the accounts of OneBeacon U.S.Holdings, Inc. (the “Company” or “OBH”), formerly known as Fund AmericanCompanies, Inc., and its subsidiaries (collectively, “OB Holdings”) andhave been prepared in accordance with generally accepted accounting principlesin the United States of America (“GAAP”). The OB Holdings operating companiesare U.S.-based property and casualty insurance writers, most of which operatein a multi-company pool. OB Holdings offers a wide range of insurance productsand services sold through independent agencies, brokers and managing generalagencies. OB Holdings has historically offered a range of specialty, commercialand personal products and services, however, OB Holdings has recently enteredinto two transactions that will transform it into a specialty lines company. OnDecember 3, 2009, OB Holdings sold the renewal rights to its non-specialtycommercial lines business and on February 2, 2010, OB Holdings’ ultimateparent, OneBeacon Insurance Group, Ltd., and certain of its subsidiariesentered into a definitive agreement to sell the personal lines business. SeeNote 18 for further discussion.

 

OBH was created in2000 by White Mountains Insurance Group, Ltd. (“White Mountains”) toacquire and subsequently be the holding company for OneBeacon InsuranceGroup LLC (together with its subsidiaries, “OneBeacon”). On June 1,2001, OBH acquired OneBeacon from Aviva plc (“Aviva”, formerly CGNU), (the“OneBeacon Acquisition”). During 2006, White Mountains undertook an internal reorganizationand formed OneBeacon Insurance Group, Ltd. (“OBIG”) for the purpose ofholding certain of its property and casualty insurance businesses. As part ofthis reorganization, certain of White Mountains’ businesses that werehistorically indirect wholly-owned subsidiaries of White Mountains, includingOBH, became indirect wholly-owned subsidiaries of OBIG. During the fourthquarter of 2006, White Mountains sold 27.6 million or 27.6% of OBIG’scommon shares in an initial public offering. As of December 31, 2009,White Mountains owned 75.4% of OBIG’s common shares. Within this report, theterm “OB Holdings” is used to refer to one or more entities within theconsolidated organization, as the context requires. The Company is a U.S.-basedcompany with its principal executive office located at 601 Carlson Parkway,Minnetonka, Minnesota 55305 and its headquarters located at 1 Beacon Lane,Canton, Massachusetts 02021.

 

OB Holdings’reportable segments are Insurance Operations and Other Operations. OB Holdings’Insurance Operations segment, formerly known as Primary Insurance Operations,includes the results of its insurance operations. OB Holdings currently managesits Insurance Operations segment through a specialty lines underwriting unitand a personal lines underwriting unit, nearly all of which is subject to thepersonal lines transaction described in Note 18. The Insurance Operationssegment also includes run-off business, which primarily consists ofnon-specialty commercial lines business which is being transferred to TheHanover Insurance Group, as described below, and other run-off business. OBHoldings’ Other Operations segment consists of the activities of the Company.

 

All significantintercompany transactions have been eliminated in consolidation. Thepreparation of financial statements in conformity with GAAP requires managementto make estimates and assumptions that affect the reported amounts of assetsand liabilities as of the date of the financial statements and the reportedamounts of revenues and expenses during the reporting period. Actual resultscould differ from those estimates. Certain amounts in the prior periodfinancial statements have been reclassified to conform to the currentpresentation.

 

***Basis of presentation***

 

*InvestmentSecurities*

 

On January 1,2008, OB Holdings adopted Financial Accounting Standards Board (“FASB”)Statement of Financial Accounting Standards (“SFAS”) No. 159, “The FairValue Option for Financial Assets and Financial Liabilities”, subsequentlycodified within Accounting Standards Codification (the “Codification” or “ASC”)825, which allows companies to make an election, on an individual instrumentbasis, to report financial assets and liabilities at fair value. The electionmust be made at the inception of a transaction and may not be reversed. Theelection may also be made for existing financial assets and liabilities at thetime of adoption. Unrealized gains and losses on assets or liabilities forwhich the fair value option has been elected are reported in revenues. Uponadoption, OB Holdings recorded an adjustment of $182.4 million to reclassifynet unrealized gains, after tax, and net unrealized foreign currencytranslation gains, after tax, related to investments from accumulated othercomprehensive income to opening retained earnings. The Company believes thatmaking the election results in reporting its investment results on a basisconsistent with one of its operating principles, namely to manage investmentsfor total return.

 

In accordance withthe adoption of the fair value option, OB Holdings classifies its portfolio offixed maturity investments and common equity securities, including convertiblebonds, held for general investment purposes as trading 

 

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securities. Tradingsecurities are reported at fair value as of the balance sheet date asdetermined by quoted market prices when available. Realized and unrealizedinvestment gains and losses on trading securities are reported pre-tax inrevenues. Prior to adoption of ASC 825, OB Holdings’ fixed maturity investmentsand common equity securities, excluding convertible bonds which are describedbelow, held for general investment purposes, were classified asavailable-for-sale and reported at fair value. Net unrealized investment gainsand losses on available-for-sale securities were reported net, after tax, as aseparate component of shareholder’s equity. Changes in net unrealizedinvestment gains and losses, after tax, were reported as a component of othercomprehensive income.

 

OB Holdings ownsconvertible bonds with embedded derivatives. Prior to adoption of ASC 825, OBHoldings recorded its convertible bonds in accordance with SFAS No. 155, “Accountingfor Certain Hybrid Instruments, an amendment to Statements No. 133 and 140”,subsequently codified within ASC 815. Under ASC 815, OB Holdings had accountedfor the convertible bonds on a fair value basis with changes in fair valuerecorded through revenues as realized investment gains or losses. ASC 815eliminated the requirement to bifurcate financial instruments with embeddedderivatives if the holder of the instrument elected to account for the entireinstrument on a fair value basis with changes in fair value of the entireinstrument recorded through income as realized investment gains or losses. At December 31,2009 and 2008, OB Holdings had $170.2 million and $241.2 million,respectively, of convertible bonds.

 

Short-terminvestments consist of money market funds, certificates of deposit and othersecurities which, at the time of purchase, mature or become available for usewithin one year. Short-term investments are carried at amortized cost, whichapproximated fair value as of December 31, 2009 and 2008.

 

Other investmentsinclude hedge funds and private equity funds. Prior to January 1, 2008,changes in OB Holdings’ interest in other investments accounted for using theequity method were included in net realized investment gains (losses). Changesin OB Holdings’ interest in other investments not accounted for under theequity method were reported, net of tax, as a component of shareholder’s equitywith changes therein reported, after tax, as a component of other comprehensiveincome or loss. Upon adoption of ASC 825 on January 1, 2008, OB Holdingsmeasures its investments in hedge funds and private equity funds at fair valuewith changes therein reported in revenues on a pre-tax basis.

 

On January 1,2008, OB Holdings adopted SFAS No. 157, “Fair Value Measurements”,subsequently codified as ASC 820. ASC 820 provides a revised definition of fairvalue, establishes a framework for measuring fair value and expands financialstatement disclosure requirements for fair value information. Under ASC 820,fair value is defined as the price that would be received to sell an asset orpaid to transfer a liability in an orderly transaction between marketparticipants (an “exit price”). ASC 820 establishes a fair value hierarchy thatdistinguishes between inputs based on market data from independent sources (“observableinputs”) and a reporting entity’s internal assumptions based upon the bestinformation available when external market data is limited or unavailable (“unobservableinputs”). The fair value hierarchy prioritizes fair value measurements intothree levels based on the nature of the inputs. Quoted prices in active marketsfor identical assets or liabilities have the highest priority (“Level 1”),followed by observable inputs other than quoted prices, including prices forsimilar but not identical assets or liabilities (“Level 2”) andunobservable inputs, including the reporting entity’s estimates of theassumptions that market participants would use, having the lowest priority (“Level 3”).

 

OB Holdings uses brokersand outside pricing services to assist in determining fair values. Forinvestments in active markets, OB Holdings uses the quoted market pricesprovided by the outside pricing services to determine fair value. The outsidepricing services OB Holdings uses have indicated that they will only provideprices where observable inputs are available. In circumstances where quotedmarket prices are unavailable, OB Holdings utilizes fair value estimates basedupon other observable inputs including matrix pricing, benchmark interestrates, market comparables and other relevant inputs. In circumstances whereobservable inputs are adjusted to reflect management’s best estimate of fairvalue, such fair value measurements are considered a lower level measurement inthe fair value hierarchy.

 

OB Holdings’process to validate the market prices obtained from the outside pricing sourcesinclude, but is not limited to, periodic evaluation of model pricingmethodologies and analytical reviews of certain prices. OB Holdings alsoperiodically performs back-testing of selected sales activity to determinewhether there are any significant differences between the market price used tovalue the security prior to sale and the actual sale price.

 

Other investments,which are comprised of hedge funds and private equity funds for which the fairvalue option has been elected, are carried at fair value based upon OB Holdings’proportionate interest in the underlying fund’s net asset value, which isdeemed to approximate fair value. The fair value of OB Holdings’ investments inhedge funds and private equity funds has been estimated using net asset valuebecause it reflects the fair value of the funds’ underlying investments inaccordance with ASC 820. See Note 5.

 

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*SecuritiesLending*

 

OB Holdings participatedin a securities lending program as a mechanism for generating additionalinvestment income on its fixed maturity and common equity portfolios. Under thesecurities lending arrangements, certain of its fixed maturity and commonequity investments were loaned to other institutions for short periods of timethrough a lending agent. OB Holdings maintained control over the securities itloaned, retained the earnings and cash flows associated with the loanedsecurities and received a fee from the borrower for the temporary use of theasset. Collateral, in the form of cash and United States government securities,was required at a rate of 102% of the fair value of the loaned securities. Anindemnification agreement with the lending agent protected OB Holdings in theevent a borrower became insolvent or failed to return any of the securities onloan. In the event of a shortfall in the collateral amount required to bereturned to the securities lending counterparty (e.g., as a result ofinvestment losses), OB Holdings was obligated to make up any deficiency.

 

Prior to February 2009,the collateral was controlled by the lending agent. The lending agent managedthe investment of the cash collateral, however, other than in the event ofdefault by the borrower, this collateral was not available to OB Holdings andwas remitted to the borrower by the lending agent upon the return of the loanedsecurities. Because of these restrictions, OB Holdings considered itssecurities lending activities to be non-cash transactions. The fair value ofthe securities lending collateral was recorded as both an asset and liabilityon the balance sheet.

 

In February 2009, OBHoldings amended the terms of the securities lending program to give it morecontrol over the investment of borrowers’ collateral and to separate the assetssupporting that collateral into a segregated account. In May 2009, OBHoldings instructed the lending agent not to make any additional loans ofsecurities and to recall all of the securities on loan and fund the return ofcollateral to the borrower. Pursuant to the amendment, (i) the guidelinesfor the investment of any new cash collateral as well as the reinvestment ofcash were narrowed to permit investment in only cash equivalent securities, (ii) OBHoldings has the authority to direct the lending agent to both sell specificcollateral securities in the segregated account and to not sell certaincollateral securities which the lending agent proposes to sell, and (iii) OBHoldings and the lending agent agreed to manage the securities lending programtoward an orderly wind-down. In May 2009, OB Holdings instructed thelending agent not to make any additional loans of securities and to recall allof the securities on loan and fund the return of collateral to the borrower. Asof December 31, 2009, $1.7 million in collateral had not been returned tothe borrower. As a result of the actions described above, the securitieslending assets are no longer segregated and are included within OB Holdings’investment securities.

 

*Cash*

 

Cash includesamounts on hand and demand deposits with banks and other financialinstitutions. Amounts presented in the statements of cash flows are shown netof balances acquired and sold in the purchase or sale of the Company’sconsolidated subsidiaries.

 

*InsuranceOperations*

 

OB Holdingsaccounts for insurance policies that it writes in accordance with SFAS No. 60,“Accounting and Reporting by Insurance Enterprises”, subsequently codifiedwithin ASC 944. Premiums written are recognized as revenues and are earnedratably over the term of the related policy. Unearned premiums represent theportion of premiums written that are applicable to future insurance coverageprovided by policies. AutoOne Insurance (“AutoOne”), which acts as a limitedassignment distribution (“LAD”) servicing carrier, enters into contractualarrangements with insurance companies to assume private passenger andcommercial automobile assigned risk exposures in 21 states and the District ofColumbia. AutoOne receives LAD and commercial limited assignment distribution (“CLAD”)servicing fees from these other companies for assuming these risks. LAD andCLAD servicing fees are typically a percentage of the total premiums thatAutoOne must write to fulfill the obligation of the transferor company. Inaddition, LAD servicing carriers may choose to write certain policiesvoluntarily by taking risks out of the New York Automobile Insurance Plan (“NYAIP”).These policies generate takeout credits which can be “sold” for fees (“takeoutfees”) to other carriers. These other carriers in turn can use such credits toreduce their obligations to write assigned risk business. AutoOne’s LAD andCLAD servicing and takeout fees are recorded as written premium when billed andare earned ratably over the term of the related policy to which the feerelates. Fees charged on installment premiums are recorded as a reduction toother underwriting expenses.

 

Deferredacquisition costs represent commissions, premium taxes, brokerage expenses andother costs which are directly attributable to and vary with the production ofbusiness. These costs are deferred and amortized over the applicable premiumrecognition period as policy acquisition expenses. Deferred acquisition costsare limited to the amount expected to be recovered from future earned premiumsand anticipated investment income. This limitation is referred to as a premiumdeficiency. A premium deficiency is recognized if the sum of expected loss andloss adjustment expenses (“LAE”), unamortized acquisition costs, andmaintenance costs exceeds related unearned premiums. A premium deficiency is 

 

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recognized by chargingany unamortized 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. Duringthe year ended December 31, 2009, OB Holdings recorded a deficiency of$0.8 million related to AutoOne as a reduction to its unamortized deferredacquisition costs asset. For the years ended December 31, 2008 and 2007,no deferred acquisition costs were charged to expense based on thedetermination of a premium deficiency.

 

Loss and LAE arecharged against income as incurred. Unpaid insurance loss and LAE are based onestimates (generally determined by claims adjusters, legal counsel andactuarial staff) of the ultimate costs of settling claims, including theeffects of inflation and other societal and economic factors. Unpaidreinsurance loss and LAE are based primarily on reports received from cedingcompanies and actuarial projections. Unpaid loss and LAE reserves representmanagement’s best estimate of ultimate loss and LAE, net of estimated salvageand subrogation recoveries, if applicable. Such estimates are regularlyreviewed and updated and any adjustments resulting therefrom are reflected incurrent operations. The process of estimating loss and LAE involves aconsiderable degree of judgment by management and the ultimate amount ofexpense to be incurred could be considerably greater than or less than theamounts currently reflected in the financial statements.

 

OB Holdingsdiscounts certain of its long-term workers compensation loss and LAE reserveswhen such liabilities constitute unpaid but settled claims under which thepayment pattern and ultimate costs are fixed and determinable on an individualclaim basis. OB Holdings discounts these reserves using an average discountrate which is determined based on various assumptions including considerationof when the claims will be settled (5.3% and 5.5% at December 31, 2009 and2008, respectively). As of December 31, 2009 and 2008, the discount on OBHoldings’ workers compensation loss and LAE reserves amounted to $127.0 millionand $142.1 million, respectively.

 

In connection withpurchase accounting for the OneBeacon Acquisition, OB Holdings was required toadjust to fair value its loss and LAE reserves and the related reinsurancerecoverables by $646.9 million and $346.9 million, respectively, onthe acquired balance sheet as of June 1, 2001. This net reduction to lossand LAE reserves of $300.0 million is being accreted through an incomestatement charge ratably with and over the period the claims are settled. SeeNote 3.

 

OB Holdings’insurance subsidiaries enter into ceded reinsurance contracts from time to timeto protect their businesses from losses due to concentration of risk, to managetheir operating leverage ratios and to limit losses arising from catastrophicevents. The majority of such reinsurance contracts are executed through excessof loss treaties and catastrophe contracts under which the reinsurerindemnifies for a specified part or all of certain types of losses overstipulated amounts arising from any one occurrence or event. OB Holdings hasalso entered into quota share treaties with reinsurers under which all risksmeeting prescribed criteria are covered on a pro rata basis. The amount of eachrisk ceded by OB Holdings is subject to maximum limits which vary by line ofbusiness and type of coverage. Amounts related to reinsurance contracts arerecorded in accordance with SFAS No. 113, “Accounting and Reporting forReinsurance of Short-Duration and Long-Duration Contracts” and Emerging IssuesTask Force (“EITF”) Topic No. D-54, both subsequently codified within ASC944, as applicable.

 

Amountsrecoverable from reinsurers are estimated in a manner consistent with the claimliability associated with the reinsured policies. The collectibility ofreinsurance recoverables is subject to the solvency of the reinsurers. OBHoldings is selective in regard to its reinsurers, principally placingreinsurance with those reinsurers with strong financial condition, industry ratingsand underwriting ability. Management monitors the financial condition andratings of its reinsurers on an ongoing basis.

 

Reinsurancepremiums, commissions, expense reimbursements and reserves related to reinsuredbusiness are accounted for on a basis consistent with those used in accountingfor the original policies issued and the terms of the reinsurance contracts.Premiums ceded to other companies are reported as a reduction of premiumswritten. Expense allowances received in connection with reinsurance ceded havebeen accounted for as a reduction of the related policy acquisition costs andare deferred and amortized accordingly. Funds held by ceding companiesrepresent amounts due to OB Holdings in connection with certain assumedreinsurance agreements in which the ceding company retains a portion of thepremium to provide security against future loss payments. The funds held byceding companies are generally invested by the ceding company and interest iscredited to OB Holdings and recognized as investment income. Funds held underreinsurance treaties represent contractual payments due to the reinsurer thatOB Holdings has retained to secure obligations of the reinsurer. Such amountsare recorded as liabilities in the consolidated financial statements.

 

*Accountingfor Mandatory Shared Market Mechanisms*

 

As a condition toits licenses to do business in certain states, OB Holdings’ insuranceoperations must participate in various mandatory shared market mechanismscommonly referred to as “residual” or “involuntary” markets. These marketsgenerally consist of risks considered to be undesirable from a standard orroutine underwriting perspective. Each state 

 

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dictates the levels ofinsurance coverage that are mandatorily assigned to participating insurerswithin these markets. The total amount of such business an insurer must acceptin a particular state is generally based on that insurer’s market share ofvoluntary business written within that state. In certain cases, OB Holdings isobligated to write business from shared market mechanisms at a future datebased on its historical market share of all voluntary policies written withinthat state. Involuntary business generated from mandatory shared marketmechanisms, which may be treated as assumed reinsurance depending on thestructure of the mechanism, is accounted for in accordance with ASC 944.

 

OB Holdings’ marketassignments are typically required to be written in the current period,although, in certain cases OB Holdings is required to accept policy assignmentsat a future date. OB Holdings’ residual market assignments to be written in thefuture primarily relate to private passenger automobile assigned risk exposureswithin the State of New York where certain of OB Holdings’ insurancesubsidiaries write voluntary automobile insurance. The share of involuntarywritten premium for policies assigned by the NYAIP to a particular insurer in agiven year is based on the proportion of the total voluntary writings in NewYork two years prior. Anticipated losses associated with future marketassignments are recognized in accordance with SFAS No. 5, “Accounting forContingencies”, subsequently codified within ASC 450, when the amount of suchanticipated losses is determined to be probable and can be reasonablyestimated.

 

*Accountingfor Insurance Related Assessments*

 

Under existingguaranty fund laws in all states, insurers licensed to do business in thosestates can be assessed for certain obligations of insolvent insurance companiesto policyholders and claimants. In accordance with Statement of Position (“SOP”)97-3, “Accounting by Insurance and Other Enterprises for Insurance RelatedAssessments”, subsequently codified within ASC 405, OB Holdings’ insurancesubsidiaries record guaranty fund assessments when such assessments are billedby the respective guaranty funds. In addition, each insurance subsidiary’spolicy is to accrue for any significant insolvencies when the loss is probableand the assessment amount can be reasonably estimated.

 

*DeferredSoftware Costs*

 

OB Holdingscapitalizes costs related to computer software developed for internal useduring the application development stage of software development projects inaccordance with SOP 98-1, “Accounting for the Costs of Computer SoftwareDeveloped or Obtained for Internal Use”, subsequently codified within ASC 350.These costs generally consist of certain external, payroll and payroll relatedcosts. OB Holdings begins amortization of these costs once the project iscompleted and ready for its intended use. Amortization is on a straight linebasis and over a useful life of three to five years. At December 31, 2009and 2008, OB Holdings had deferred software costs of $18.6 million and$22.1 million, respectively.

 

*Federaland State Income Taxes*

 

The Company andits subsidiaries join in the filing of a federal consolidated tax return. Theconsolidated parent, which is not included in these financial statements, isOneBeacon U.S. Financial Services, Inc. (“OBFS”), formerly known as FundAmerican Financial Services, Inc. OBFS is an indirect, wholly-ownedsubsidiary of OBIG.

 

Deferred taxassets and liabilities are recorded when a difference between the carryingamounts of assets and liabilities for financial reporting purposes and theamounts for tax purposes exists, and for other temporary differences as definedby SFAS No. 109, “Accounting for Income Taxes”, subsequently codified asASC 740. The deferred tax asset or liability is recorded based on tax ratesexpected to be in effect when the difference reverses. The deferred tax assetis recognized when it is more likely than not that it will be realized.

 

*ForeignCurrency Exchange*

 

The U.S. dollar isthe functional currency for all of OB Holdings’ businesses. OB Holdings issubject to foreign currency fluctuations primarily associated with its foreigninvestment securities. Assets recorded in foreign currencies are translatedinto U.S. dollars at exchange rates in effect at the balance sheet date. Priorto the adoption of ASC 825, net foreign exchange gains and losses arising fromthe translation were generally reported in shareholder’s equity, in accumulatedother comprehensive income or loss, net of tax. Upon adoption of ASC 825, netforeign exchange gains and losses arising from the translation are generallyreported in revenues in change in net unrealized investment gains and losses, acomponent of net realized and unrealized investment gains (losses).

 

*CashFlow Hedge*

 

Contemporaneouslywith entering into a variable rate mortgage note during 2005, as furtherdescribed in Note 6, OB Holdings entered into an interest rate swapagreement under which it paid a fixed rate and received a variable rate tohedge its 

 

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exposure to interest ratefluctuations. The notional amount of the swap was equal to the outstandingprincipal of the mortgage note it hedged and was adjusted at the same time asthe mortgage note principal changed for drawdowns and repayments. Theunderlying index used to determine the variable interest paid under the swapwas the same as that used for OB Holdings’ variable rate mortgage note. Inaccordance with SFAS No. 133, “Accounting for Derivative Instruments andHedging Activities”, subsequently codified as ASC 815, OB Holdings accountedfor the swap as a cash flow hedge and recorded the interest rate swap at fairvalue on the balance sheet in other assets or other liabilities depending onthe value as of the balance sheet date. Changes in the fair value of theinterest rate swap were reported as a component of other comprehensive incomeor loss. For the years ended December 31, 2009, 2008 and 2007, no gains orlosses were charged through the statement of operations due to hedgeineffectiveness or hedge components excluded from the assessment ofeffectiveness. OB Holdings settled the interest rate swap at the time that itrepaid the outstanding balance on the mortgage note. See Note 6.

 

*VariableInterest Entities*

 

OB Holdingsrecords the reciprocal insurance exchanges (“reciprocals”), as defined inNote 14, in accordance with FASB Interpretation (“FIN”) No. 46(R), “Consolidationof Variable Interest Entities” (“FIN 46R”), subsequently codified as ASC810. ASC 810 addresses consolidation issues surrounding special purposeentities and certain other entities, collectively termed variable interestentities (“VIE”), to which previous accounting guidance on consolidation doesnot apply. A VIE is an entity in which the equity investors do not have thecharacteristics of a controlling interest or do not have sufficient equity atrisk for the entity to finance its activities without additional subordinatedfinancial support from other parties. Under ASC 810, the primary beneficiary ofa VIE is required to consolidate the VIE in its financial statements. Theprimary beneficiary is an entity that has a variable interest that will absorbthe majority of the VIE’s expected losses if they occur, receive a majority ofthe entity’s expected residual returns if they occur, or both. SeeNote 14.

 

*MandatorilyRedeemable Preferred Stock*

 

OB Holdings hadmandatorily redeemable preferred stock which was considered a noncontrollinginterest and had been recorded as a liability at its historical carrying valuein accordance with SFAS No. 150, “Accounting for Certain FinancialInstruments With Characteristics of Both Liability and Equity”, subsequentlycodified within ASC 480. Dividends and accretion on OB Holdings’ mandatorilyredeemable preferred stock were recorded as interest expense. See Note 10.

 

*DefinedBenefit Plans*

 

In September 2006,the FASB issued SFAS No. 158, “Employers’ Accounting for Defined BenefitPension and Other Postretirement Plans, an amendment to Statements No. 87,88, 106 and 132R”, subsequently codified within ASC 715. An employer thatsponsors a defined benefit plan is required to recognize the funded status of abenefit plan, measured as the difference between plan assets at fair value andthe projected benefit obligation (for defined benefit pension plans) or theaccumulated benefit obligation (for other postretirement benefit plans) in itsstatement of financial position. The Statement also requires recognition ofamounts previously deferred and amortized under SFAS No. 87, “Employers’Accounting for Pensions” and SFAS No. 106, “Employers’ Accounting forPostretirement Benefits Other Than Pensions”, both subsequently codified withinASC 715, in other comprehensive income in the period in which they occur. UnderASC 715, plan assets and obligations must be measured as of the fiscal yearend. See Note 8.

 

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

 

*Accounting Standards Codification*

 

In June 2009, the FASB issued SFAS No. 168, “The FASBAccounting Standards Codification and the Hierarchy of Generally AcceptedAccounting Principles” which establishes the FASB Codification as the source ofauthoritative accounting principles to be applied in the preparation offinancial statements in conformity with GAAP. Subsequently codified as ASC 105,the Codification is effective for interim and annual periods ending after September 15,2009. All existing non-Securities and Exchange Commission (“SEC”) accountingand reporting were superseded by the Codification. OB Holdings adopted theCodification for the interim period ending September 30, 2009. Adoptionhad no effect on OB Holdings’ accounting policies or financial statementpresentation. The Codification did change the basis for reference toauthoritative GAAP guidance, and, accordingly, OB Holdings’ note disclosuresreflect the references under Codification. New accounting guidance is issued bythe FASB in the form of Accounting Standard Updates (“ASUs”). Accountingguidance that became effective prior to the adoption of Codification has beendescribed herein using the original FASB reference with a reference to theprincipal Codification topic into which the guidance has been incorporated.

 

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*BusinessCombinations and Noncontrolling Interests*

 

On January 1, 2009,OB Holdings adopted SFAS No. 141 (Revised 2007), “Business Combinations —A Replacement of FASB Statement No. 141”, subsequently codified as ASC805, and SFAS No. 160, “Noncontrolling Interests — an amendment to ARB 51”,subsequently codified within ASC 810.

 

ASC 805 requires theacquiring company to recognize the fair value of all assets acquired andliabilities assumed at their fair values at the acquisition date, with certainexceptions including income taxes which will continue to be accounted for underASC 740. This represents a basic change in approach from the old costallocation method used prior to the revision. In addition, ASC 805 changes theaccounting for step acquisitions since it requires recognition of all assetsacquired and liabilities assumed, regardless of the acquirer’s percentage ofownership in the acquiree. This means that the acquirer will measure andrecognize all of the assets, liabilities and goodwill, not just the acquirer’sshare. Assets and liabilities arising from contractual contingencies are to berecognized at the acquisition date, at fair value. Non-contractualcontingencies are to be recognized when it is more likely than not that theymeet the Statement of Financial Accounting Concepts No. 6, “Elements ofFinancial Statements (A Replacement of FASB Concepts Statement No. 3—Incorporatingan Amendment of FASB Concepts Statement No. 2)”criteria for an asset or liability. Previously, recognition of preacquisitioncontingencies was deferred until the criteria in ASC 450 had been met. Changesin the amount of deferred taxes arising from a business combination are to berecognized in either income or through a change in contributed capital,depending on the circumstances. Previously under ASC 740, such changes wererecognized through goodwill. Acquisition related costs, such as legal fees anddue diligence costs would be expensed and would not be recognized as part ofgoodwill. The classification of insurance and reinsurance contracts isre-evaluated at the acquisition date only if their terms were changed inconnection with the acquisition. ASC 805 applies prospectively to businesscombinations effective January 1, 2009. ASC 805 didnot impact OB Holdings’ previous transactions involving purchase accounting.

 

ASC 810 requires allcompanies to account for noncontrolling interests (formerly referred to as “minorityinterests”) in subsidiaries as equity, clearly identified and presentedseparately from parent company equity. Once a controlling interest has been acquired,any subsequent acquisitions or dispositions of noncontrolling interests that donot result in a change of control are to be accounted for as equitytransactions. Assets and liabilities acquired are measured at fair value onlyonce; at the original acquisition date, i.e., the date at which theacquirer gained control. When a subsidiary is deconsolidated, any retainednoncontrolling equity investment is to be measured at fair value with the gainor loss on the deconsolidation being measured using fair value rather than thecarrying amount of the retained ownership interest. The recognition andmeasurement requirements of ASC 810 apply prospectively upon adoption; thepresentation and disclosure requirements must be retrospectively applied.Accordingly, upon adoption of ASC 810, OB Holdings has changed the presentationof its financial statements for prior periods to conform to the requiredpresentation as follows: noncontrolling interests are presented on the balancesheets within equity, separate from OB Holdings’ shareholder’s equity; theportion of net income (loss) and comprehensive income (loss) attributable to OBHoldings’ common shareholder and the noncontrolling interests are presentedseparately on the consolidated statements of operations and comprehensiveincome (loss); and the consolidated statements of shareholder’s equity includea reconciliation of the noncontrolling interests from the beginning to the endof each reporting period.

 

*Derivativesand Hedging Activities*

 

On January 1, 2009,OB Holdings adopted SFAS No. 161, “Disclosures about DerivativeInstruments and Hedging Activities — an Amendment of FASB Statement No. 133”,subsequently codified within ASC 815. Under ASC 815, companies that usederivatives must disclose the following: objectives and strategies for using derivative instruments in terms ofunderlying risk and accounting designation; the fair values of derivativeinstruments and their gains and losses in a tabular format; and informationabout credit-risk-related contingent features. The adoption had no impact on OBHoldings’ financial position or results of operations. See Note 6 fordisclosures related to OB Holdings’ interest rate swap.

 

*ParticipatingSecurities Granted in Share-Based Payment Transactions*

 

On January 1, 2009,OB Holdings adopted FASB Staff Position (“FSP”) EITF 03-6-1, “DeterminingWhether Instruments Granted in Share-Based Transactions are ParticipatingSecurities”, subsequently codified within ASC 260, which addresses whetherinstruments granted in share-based payment transactions should be consideredparticipating securities prior to vesting. Under ASC 260, instruments that holdunforfeitable rights to dividends or dividend equivalents, regardless ofwhether paid or unpaid, should be considered participating securities andaccordingly should be included in the calculation of earnings per share underthe two-class method instead of the treasury stock method. Unvested restrictedstock issued under employee incentive compensation plans containing such dividendparticipation features would be considered participating securities. None of OBHoldings’ share-based payment transactions include participating securities.The adoption did not impact OB Holdings.

 

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*Fair Value Measurements*

 

On January 1, 2009, OB Holdings adopted FSP FAS157-2, “Effective Date of FASB Statement No. 157”, subsequently codifiedwithin ASC 820. Fair value measurement under ASC 820 was delayed fornonfinancial assets and nonfinancial liabilities to fiscal years beginning after November 15, 2008. OB Holdingsadopted ASC 820 for items that are recognized or disclosed at fair valuein the financial statements on a recurring basis (at least annually) as of January 1,2008 with respect to its investments securities. Refer to Note 5 for therequired disclosures related to investment securities. The adoption of ASC 820with regard to nonfinancial assets and nonfinancial liabilities had no impacton OB Holdings’ financial position or results of operations.

 

*Other-Than-Temporary Impairments*

 

On June 30, 2009, OBHoldings adopted FSP FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments”,subsequently codified within ASC 320, which amends the guidance forother-than temporary impairments for debt securities classified asheld-to-maturity or available-for-sale. ASC 320 requires that in evaluating ifan impairment of a debt security is other-than-temporary, the entity is toassess whether it has the intent to sell the security or if it is more likelythan not that it will be required to sell the security before the recovery ofits amortized cost basis. If the present value of cash flows expected to becollected is less than the amortized cost of the security, a credit loss isdeemed to exist and the security is considered to be impaired. The portion ofthe impairment loss related to a credit loss is to be recognized in earnings.The portion of the impairment loss related to factors other than credit loss isrecognized in other comprehensive income. Upon adoption, a cumulative effectadjustment to the opening balance of retained earnings shall be recorded with acorresponding adjustment to accumulated other comprehensive income.

 

OB Holdings accounts forits investments in debt securities under ASC 825, and accordingly, all changesin the fair value of its debt securities are recognized in revenues regardlessof whether or not such changes in fair value represent a temporary orother-than-temporary decline in value. Accordingly, the adoption of ASC 320 hadno effect on OB Holdings’ method of accounting for its portfolio of investmentsecurities.

 

*DeterminingFair Values in an Inactive Market and Distressed Transactions*

 

On June 30, 2009, OBHoldings adopted FSP FAS 157-4, “Determining Fair Value When the Volume andLevel of Activity for the Asset or Liability Have Significantly Decreased andIdentifying Transactions That Are Not Orderly”, subsequently codified withinASC 820. ASC 820 provides guidance for estimating fair value when the volumeand level of activity for the asset or liability have significantly decreasedand on identifying circumstances that indicate a transaction is not orderly.Factors to consider include few recent transactions, price quotations that arenot based on current information or which vary substantially over time or amongmarket makers, a significant increase in implied liquidity risk premiums,yields, or performance indicators, a wide bid-ask spread, a significant declineor absence of a market for new issuances or limited information releasedpublicly. A reporting entity should evaluate whether there has been asignificant decrease in the volume and level of activity for the asset orliability when compared with normal activity for the asset or liability orsimilar assets or liabilities. If the reporting entity concludes that there hasbeen a significant decrease in the volume and level of activity, transactionsor quoted prices may not be determinative of fair value. Further analysis ofthe transactions or quoted prices is needed, and a significant adjustment tothe transactions or quoted prices may be necessary to estimate fair value whichis the price that would be received to sell an asset or paid to transfer aliability in an orderly transaction. In addition, ASC 820 expands interimdisclosures to require a description of the inputs and valuation techniquesused to estimate fair value and a discussion of changes during the period. Theadoption of ASC 820 had no material impact on OB Holdings’ financial positionor results of operations.

 

*InterimFair Value Disclosures*

 

On June 30, 2009,OB Holdings adopted FSP FAS 107-1 and APB 28-1, “Interim Disclosures about FairValue of Financial Instruments” (“FSP FAS 107-1 and APB 28-1”), subsequentlycodified within ASC 825, which amends SFAS No. 107, “Disclosures aboutFair Value of Financial Instruments”, subsequently codified within ASC 820, andAccounting Principles Board Opinion (“APB”) No. 28, “Interim FinancialReporting”, subsequently codified as ASC 270. Under ASC 825, a publicly tradedcompany shall disclose in the body or the accompanying notes of its summarizedfinancial information for interim reporting periods and in its financialstatements for its annual reporting periods the fair value of all financialinstruments for which it is practicable to estimate that value. An entity shallalso disclose the method(s) and significant assumptions used to estimatethe fair value of the financial instruments and any changes in the method(s) andsignificant assumptions, if any, during the period. OB Holdings carries itsfinancial instruments on its balance sheet at fair value with the exception ofits fixed-rated, long-term indebtedness. See Note 15 for required disclosures.

 

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*SubsequentEvents*

 

On June 30,2009, OB Holdings adopted SFAS No. 165, “Subsequent Events”, subsequentlycodified within ASC 855, which establishes principles and requirements forsubsequent events. ASC 855 establishes the period after the balance sheet dateduring which management shall evaluate events or transactions that may occurfor potential recognition or disclosure in the financial statements; thecircumstances under which an entity shall recognize events or transactionsoccurring after the balance sheet date in its financial statements; and thedisclosures that an entity shall make about events or transactions thatoccurred after the balance sheet date. Subsequent events that provideadditional evidence about conditions that existed at the balance sheet date areto be recognized in the financial statements. Subsequent events that areconditions that arose after the balance sheet date but prior to the issuance ofthe financial statements are not recognized in the financial statements, butshould be disclosed if failure to do so would render the financial statementsmisleading. ASC 855 requires disclosure of the date through which subsequentevents have been evaluated. For subsequent events not recognized, disclosuresshould include a description of the nature of the event and either an estimateof its financial effect or a statement that such an estimate cannot be made.The adoption of ASC 855 had no impact on the recognition or disclosure ofsubsequent events. OB Holdings evaluates subsequent events up to the date itfiles its Annual Report on Form 10-K with the SEC. See Note 18 foradditional disclosures.

 

*Disclosuresabout Postretirement Benefit Plan Assets*

 

On December 31,2009, OB Holdings adopted FSP FAS 132(R)-1, “Employers’ Disclosures aboutPostretirement Benefit Plan Assets”, subsequently codified within ASC 715,which requires additional disclosures regarding plan assets of a definedbenefit pension or other postretirement plan. The disclosures are to provideusers of financial statements with an understanding of how investmentallocation decisions are made, the major categories of plan assets, the inputsand valuation techniques used to measure the fair value of plan assets, theeffect of fair value measurements using significant unobservable inputs onchanges in plan assets for the period and significant concentrations of riskwithin plan assets. The adoption of ASC 715 had no impact on OB Holdings’financial position or results of operations. See Note 8 for requireddisclosures.

 

*Measuring Liabilities at Fair Value*

 

On December 31, 2009, OB Holdings adopted ASU 2009-05, “MeasuringLiabilities at Fair Value”, which amends the guidance for measuring the fairvalue for liabilities. The ASU provides additional guidance for circumstanceswhere a quoted price in an active market for an identical liability is notavailable. The ASU permits use of the quoted price for an identical liabilitywhen traded as an asset or quoted prices for similar liabilities when traded asan asset. The ASU also notes that valuation techniques consistent with the fairvalue principles of ASC 820 may be used, including a present value technique ormarket approach based on the amount that the reporting entity would pay totransfer the identical liability or would receive to enter into an identicalliability at the measurement date. OB Holdings has liabilities recorded at fair value in accordance withASC 820 and included in other liabilities. These liabilities relate tosecurities that have been sold short by a limited partnership that OB Holdingsinvests in and is required to consolidate in accordance with GAAP. The adoptionof ASU 2009-05 had no material impact on OB Holdings’ financial position orresults of operations.

 

*Alternative Investments*

 

On December 31, 2009, OB Holdings adopted ASU 2009-12, “Investmentsin Certain Entities that Calculate Net Asset Value per Share (or ItsEquivalent).” Alternative investments include ownership interests in hedgefunds and private equity funds, which OB Holdings includes in otherinvestments. Under the ASU, the fair value of an alternative investment may beestimated based on net asset value per share (“NAV”) as reported by theinvestee, subject to certain requirements. The investee must calculate its NAVin accordance with the measurement principles of ASC 946 (U.S. GAAP for InvestmentCompanies), meaning that the investee’s underlying investments have beenmeasured at fair value. In addition, in circumstances where the investorintends to sell the investment for an amount that differs from the NAV, NAV maynot be used to estimate fair value. The ASU also expands required disclosures,including requiring the amount of unfunded commitments, a description of theterms and conditions upon which the investor may redeem investments, thecircumstances in which an otherwise redeemable investment might not beredeemable (for instance, investment that is subject to a lockup period) aswell as an estimate of when the restriction will lapse and, in circumstanceswhere the investment cannot be redeemed but the investor receives distributionsthrough the liquidation of the underlying assets, an estimate of the period oftime over which the underlying assets are expected to be liquidated. Theadoption of ASU 2009-12 had no material impact on OB Holdings’ financialposition or results of operations. See Note 5 for required disclosures.

 

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***Recent Accounting Pronouncements***

 

*Transfers of Financial Assets and Amendments to FIN 46R*

 

In June 2009, the FASB issued SFAS No. 166, “Accounting forTransfers of Financial Assets” and SFAS No. 167, “Amendments to FIN46(R)”,subsequently codified within ASC 860 and ASC 810, respectively. ASC 860eliminates the concept of a qualifying special-purpose entity (“QSPE”) andaccordingly, any existing QSPE must be evaluated for consolidation uponadoption. Under ASC 860, the appropriateness of derecognition is evaluatedbased on whether or not the transferor has surrendered control of thetransferred assets. The evaluation must consider any continuing involvement bythe transferor. OB Holdings does not have any entities that were considered aQSPE under guidance prior to ASC 860. ASC 810 amends FIN 46R to clarify theapplication of consolidation accounting for entities for which the controllingfinancial interest might not be solely identified through voting rights. Theguidance under ASC 810 still requires a reporting entity to perform an analysisto determine if its variable interests give it a controlling financial interestin a VIE. The analysis required identifies the primary beneficiary of a VIE asthe entity having both of the following:

 

·                  The power todirect the activities of a variable interest entity that most significantly impactthe entity’s economic performance; and

·                  The obligationto absorb losses of the entity that could potentially be significant to the VIEor the right to receive benefits from the entity that could potentially besignificant to the VIE.

 

In addition, a reporting entity must assess whether it has an implicitfinancial responsibility to ensure that a VIE operates as designed whendetermining if it has the power to direct the activities of the VIE that mostsignificantly affect the entity’s economic performance. The concept of areconsideration event is retained and an ongoing reassessment of whether areporting entity is the primary beneficiary of a VIE is required. Specifically,the list of reconsideration events includes a change in facts and circumstanceswhere the holders of an equity investment at risk as a group lose the powerfrom voting or similar rights to direct the activities of the entity that mostsignificantly affect the entity’s economic performance. In addition, a troubleddebt-restructuring is now defined as a reconsideration event. Both statementsexpand required disclosures and are effective as of the beginning of the firstannual reporting period that begins after November 15, 2009. OB Holdings iscurrently evaluating the potential impact of adopting ASC 860 and ASC 810.

 

**NOTE2.  Acquisitions and Dispositions**

 

On December 3,2009, OB Holdings sold the renewal rights to approximately $490 million inpremiums from its non-specialty commercial lines business to The HanoverInsurance Group (“The Hanover”). The transaction includes small commercialaccounts and the non-specialty portion of the middle-market business, beginningwith January 1, 2010 effective dates (the “Commercial Lines Transaction”).As consideration for the Commercial Lines Transaction, OB Holdings received$23.2 million, reflected in net other revenues.

 

During the yearended December 31, 2009, there were no acquisitions.

 

During the fourthquarter of 2008, OB Holdings sold one of its inactive licensed subsidiaries,Farmers and Merchants Insurance Company, to Pride Holdings LLC for $7.8 millionin cash and recorded a pre-tax gain of $1.1 million through net other revenues.

 

During the third quarterof 2008, OB Holdings acquired Entertainment Brokers International InsuranceServices (“EBI”), an insurance agency specializing in the entertainment, sportsand leisure industries, for $8.0 million. In connection with the purchase ofEBI, which was accounted for as an acquisition under the purchase method ofaccounting in accordance with GAAP at the time of the acquisition, OB Holdingsrecorded the identifiable assets and liabilities of EBI at their fair value atacquisition date.  Significant assets andliabilities acquired include premiums and commissions receivable of $16.6million and premiums and commissions payable of $16.1 million. After allocatingthe purchase price to identifiable tangible assets and liabilities, OB Holdingsalso recorded an adjustment to allocate the remaining acquisition cost to anintangible asset of $9.5 million which represents the value of business inforce at the acquisition date.  The amortizationassociated with the intangible asset will be amortized over a 10-year period inproportion to the timing of the discounted cash flows used to value thebusiness. During the year ended December 31, 2009, no amortization wasrecognized.

 

During the first quarterof 2008, OB Holdings sold one of its inactive licensed subsidiaries, MidwesternInsurance Company, to National Guaranty Insurance Company for $4.2 million incash and recorded a pre-tax gain of $1.0 million through net other revenues.

 

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During the third quarterof 2007, OB Holdings sold one of its inactive licensed subsidiaries, AmericanEmployers’ Insurance Company to Sparta Insurance Holdings, Inc. for$47.7 million in cash and recorded a pre-tax gain of $11.3 millionthrough net other revenues.

 

**NOTE3.  Reserves for Unpaid Loss and LAE**

 

OB Holdings’insurance subsidiaries establish loss and LAE reserves that are estimates ofamounts needed to pay claims and related expenses in the future for insuredevents that have already occurred. The process of estimating reserves involvesa considerable degree of judgment by management and, as of any given date, isinherently uncertain.

 

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. OB Holdings’ 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 OB Holdings’ 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 recent accidentyear is often too limited to provide a meaningful basis for analysis due to thetypical delay in reporting of claims. For this type of business, OB Holdingsuses a selected loss ratio method for the initial accident year or years. Thisis a standard and accepted actuarial reserve estimation method in thesecircumstances in which the loss ratio is selected based upon information usedin 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 a claimactually occurs and when it is reported and settled. This time lag is sometimesreferred to as the “claim-tail”. The claim-tail for most property coverages istypically short (usually a few days up to a few months). The claim-tail forliability/casualty coverages, such as automobile liability, general liability,products liability, multiple peril coverage, and workers compensation, can beespecially long as claims are often reported and ultimately paid or settledyears, even decades, after the related loss events occur. During the longclaims reporting and settlement period, additional facts regarding coverageswritten in prior accident years, as well as about actual claims and trends maybecome known and, as a result, OB Holdings may adjust its reserves. Ifmanagement determines that an adjustment is appropriate, the adjustment isbooked in the accounting period in which such determination is made inaccordance with GAAP. Accordingly, should reserves need to be increased ordecreased in the future from amounts currently established, future results ofoperations would be negatively or positively impacted, respectively.

 

In determiningultimate loss and LAE, the cost to indemnify claimants, provide needed legaldefense and other services for insureds and administer the investigation andadjustment of claims are considered. These claim costs are influenced by manyfactors that change over time, such as expanded coverage definitions as aresult of new court decisions, inflation in costs to repair or replace damagedproperty, inflation in the cost of medical services and legislated changes instatutory benefits, as well as by the particular, unique facts that pertain toeach claim. As a result, the rate at which claims arose in the past and thecosts to settle them may not always be representative of what will occur in thefuture. The factors influencing changes in claim costs are often difficult toisolate or quantify and developments in paid and incurred losses fromhistorical trends are frequently subject to multiple and conflictinginterpretations. Changes in coverage terms or claims handling practices mayalso cause future experience and/or development patterns to vary from the past.A key objective of actuaries in developing estimates of ultimate loss and LAE,and resulting IBNR reserves, is to identify aberrations and systemic changesoccurring within historical experience and accurately adjust for them so thatthe future can be projected reliably. Because of the factors previouslydiscussed, this process requires the use of informed judgment and is inherentlyuncertain.

 

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OB Holdings’actuaries use several generally accepted actuarial methods to evaluate its lossreserves, each of which has its own strengths and weaknesses. OB Holdingsplaces more or less reliance on a particular method based on the facts andcircumstances at the time the reserve estimates are made. These methodsgenerally fall into one of the following categories or are hybrids of one ormore of the following categories:

 

·                  *Historical paid loss developmentmethods: *These methods use historical loss payments overdiscrete periods of time to estimate future losses. Historical paid lossdevelopment methods assume that the ratio of losses paid in one period tolosses paid in an earlier period will remain constant. These methodsnecessarily assume that factors that have affected paid losses in the past,such as inflation or the effects of litigation, will remain constant in thefuture. Because historical paid loss development methods do not use casereserves to estimate ultimate losses, they can be more reliable than the othermethods discussed below that look to case reserves (such as actuarial methodsthat use incurred losses) in situations where there are significant changes inhow case reserves are established by a company’s claims adjusters. However,historical paid loss development methods are more leveraged, meaning that smallchanges in payments have a larger impact on estimates of ultimate losses, thanactuarial methods that use incurred losses because cumulative loss paymentstake much longer to equal the expected ultimate losses than cumulative incurredamounts. In addition, and for similar reasons, historical paid loss developmentmethods are often slow to react to situations when new or different factorsarise than those that have affected paid losses in the past.

 

·                  *Historical incurred loss developmentmethods: *These methods, like historical paid loss developmentmethods, assume that the ratio of losses in one period to losses in an earlierperiod will remain constant in the future. However, instead of using paidlosses, these methods use incurred losses (i.e., the sum of cumulativehistorical loss payments plus outstanding case reserves) over discrete periodsof time to estimate future losses. Historical incurred loss development methodscan be preferable to historical paid loss development methods because theyexplicitly take into account open cases and the claims adjusters’ evaluationsof the cost to settle all known claims. However, historical incurred lossdevelopment methods necessarily assume that case reserving practices areconsistently applied over time. Therefore, when there have been significantchanges in how case reserves are established, using incurred loss data toproject ultimate losses can be less reliable than other methods.

 

·                  *Expected loss ratio methods: *These methods are based on the assumption thatultimate losses vary proportionately with premiums. Expected loss ratios aretypically developed based upon the information used in pricing, and aremultiplied by the total amount of premiums written to calculate ultimate losses.Expected loss ratio methods are useful for estimating ultimate losses in theearly years of long-tailed lines of business, when little or no paid orincurred loss information is available.

 

·                  *Adjusted historical paid andincurred loss development methods: *These methods take traditional historicalpaid and incurred loss development methods and adjust them for the estimatedimpact of changes from the past in factors such as inflation, the speed ofclaim payments 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.

 

OB Holdings performsan actuarial review of its recorded reserves each quarter. OB Holdings’actuaries compare the previous quarter’s estimates of paid loss and LAE, casereserves and IBNR to amounts indicated by actual experience. Differencesbetween previous estimates and actual experience are evaluated to determinewhether a given actuarial method for estimating loss and LAE should be reliedupon to a greater or lesser extent than it had been in the past. While somevariance is expected each quarter due to the inherent uncertainty in loss andLAE, persistent or large variances would indicate that prior assumptions and/orreliance on certain reserving methods may need to be revised going forward.

 

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***Loss and LAE reserve summary***

 

The followingtable summarizes the loss and LAE reserve activities of OB Holdings’ insurancesubsidiaries for the years ended December 31, 2009, 2008 and 2007:

 
| ** **                                                       | ** ** | **Year ended December 31,** | ** ** |
|------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                       | ** ** | **2009**                         | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                       | ** ** | **($ in millions)**         | ** ** |
| Gross beginning balance                                          |       | $                                | 4,294.0    |   | $ | 4,480.3 |   | $ | 4,837.7 |   |
| Less beginning reinsurance recoverable on unpaid  losses         |       | (2,503.3                         | )          | (2,629.5 | ) | (2,842.6 | ) |
| Net loss and LAE reserves                                        |       | 1,790.7                          |       | 1,850.8 |   | 1,995.1 |   |
| Loss and LAE incurred relating to:                               |       |                             |       |   |   |   |   |
| Current year losses                                              |       | 1,205.3                          |       | 1,188.2 |   | 1,138.1 |   |
| Prior year losses                                                |       | (83.4                            | )          | (62.0 | ) | (48.3 | ) |
| Total incurred loss and LAE                                      |       | 1,121.9                          |       | 1,126.2 |   | 1,089.8 |   |
| Accretion of fair value adjustment to net loss and  LAE reserves |       | 5.4                              |       | 12.0 |   | 16.0 |   |
| Loss and LAE paid relating to:                                   |       |                             |       |   |   |   |   |
| Current year losses                                              |       | (499.3                           | )          | (495.1 | ) | (527.1 | ) |
| Prior year losses                                                |       | (676.8                           | )          | (703.2 | ) | (723.0 | ) |
| Total loss and LAE payments                                      |       | (1,176.1                         | )          | (1,198.3 | ) | (1,250.1 | ) |
| Net ending balance                                               |       | 1,741.9                          |       | 1,790.7 |   | 1,850.8 |   |
| Plus ending reinsurance recoverable on unpaid  losses            |       | 2,192.9                          |       | 2,503.3 |   | 2,629.5 |   |
| Gross ending balance                                             |       | $                                | 3,934.8    |   | $ | 4,294.0 |   | $ | 4,480.3 |   |

 

*Lossand LAE development—2009*

 

In 2009, OBHoldings experienced $83.4 million of favorable loss and LAE reservedevelopment on prior accident year loss reserves. The favorable loss reservedevelopment was primarily related to lower than expected severity onnon-catastrophe losses. The favorable non-catastrophe loss reserve developmentwas primarily related to professional liability lines, commercial packagebusiness and other general liability lines partially offset by adverse lossreserve development at AutoOne.

 

Specifically, at December 31,2008, management had revised its expectations downward with respect to futureloss emergence in the professional liability business, which is included in thegeneral liability line of business, which had initially been based on marketanalysis when this business was initiated in 2002 and 2003. However, during2009, losses continued to be significantly lower than these revisedexpectations. As a result, management lowered its selected reserves on theearliest years which affected more recent years as total loss expectations forthose years are based in part on prior years’ results. The impact of thisrevised estimate was a decrease to professional liability reserves of$60.0 million.

 

At December 31,2008, management had estimated that future payments from personal injuryprotection (“PIP”) litigation from OB Holdings’ AutoOne business would beapproximately $7.8 million. During 2009, the legal expenses related tothis litigation were higher than expected. As a result, management increasedestimates of all accident years for AutoOne. The total increase in estimate was$33.3 million.

 

At December 31,2008, based on actuarial techniques described above, management estimated thatIBNR related to multiple peril liability was $173.9 million, orapproximately 85% of case reserves of $204.9 million for 2002 andsubsequent accident years. During 2009, case incurred loss and allocated LAE (“ALAE”)was $36.8 million, which was less than expected for this line of business.As a result of the lower than expected case incurred loss and ALAE during 2009,the actuarial methods based on case incurred losses produced lower estimatedultimate losses for these accident years. As a result, at December 31,2009, the IBNR was determined to be $95.4 million, or approximately 73% ofthe remaining case reserves. The impact of this revised estimate was a decreaseto multiple peril liability reserves of $42.6 million.

 

At December 31,2008, based on actuarial techniques described above, management estimated thatIBNR related to general liability occurrence was $93.9 million, or approximately275% of case reserves of $34.2 million for 2002 and subsequent accidentyears. During 2009, case incurred loss and ALAE was $15.6 million, whichwas less than expected for this line of business. As a result of the lower thanexpected case incurred loss and ALAE during 2009, the actuarial methods basedon case incurred losses produced lower estimated ultimate losses for theseaccident years. As a result, at December 31, 

 

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2009, the IBNR wasdetermined to be $61.6 million, or approximately 214% of the remainingcase reserves. The impact of this revised estimate was a decrease to generalliability occurrence reserves of $14.1 million.

 

In addition to thedevelopment described for the lines of business above, management also recordedchanges in IBNR in other lines of business as a result of its review of lossreserves at December 31, 2009 that essentially offset. The change in IBNRfor each other line of business was not individually significant.

 

*Lossand LAE development—2008*

 

In 2008, OBHoldings experienced $62.0 million of favorable loss and LAE reservedevelopment on prior accident year loss reserves. The favorable loss reservedevelopment was primarily related to lower than expected severity onnon-catastrophe losses.  The favorablenon-catastrophe loss reserve development was primarily related to professionalliability lines and commercial package business lines partially offset byadverse loss reserve development at AutoOne and in legacy run-off.

 

Specifically, at December 31,2007, management had revised its expectations downward with respect to futureloss emergence in the professional liability business, which is included in thegeneral liability line of business, which had initially been based on marketanalysis when this business was initiated in 2002 and 2003. However, during2008, losses continued to be significantly lower than these revised expectations.As a result, management lowered its selected reserves on the earliest yearswhich affected more recent years as total loss expectations for those years arebased in part on prior years’ results. The impact of this revised estimate wasa decrease to professional liability reserves of $50.5 million.

 

At December 31,2007, management had estimated that future payments from PIP litigation from OBHoldings’ NYAIP business would be approximately $14.0 million.  During 2008, the legal expenses related tothis litigation were higher than expected as the 2002 accident year nearedconclusion.  As a result, managementincreased estimates of all accident years for NYAIP and other similar businessin New York.  The total increase inestimate was $10.8 million.

 

At December 31,2007, based on actuarial techniques described above, management estimated thatIBNR related to multiple peril liability was $137.0 million, or approximately64% of case reserves of $212.8 million for 2002 and subsequent accident years.During 2008, case incurred loss and ALAE was $16.2 million, which was less thanexpected for this line of business. As a result of the lower than expected caseincurred loss and ALAE during 2008, the actuarial methods based on caseincurred losses produced lower estimated ultimate losses for these accidentyears. As a result, at December 31, 2008, the IBNR was determined to be$86.9 million, or approximately 64% of the remaining case reserves. The impactof this revised estimate was a decrease to multiple peril liability reserves of$33.8 million.

 

At December 31,2007, based on actuarial techniques described above, management estimated thatIBNR related to workers compensation was $41.1 million, or approximately 96% ofcase reserves of $43.0 million for 2005 and subsequent accident years. During2008, case incurred loss and ALAE was $20.2 million, which was greater thanexpected for this line of business. As a result of the higher than expectedcase incurred loss and ALAE during 2008, the actuarial methods based on caseincurred losses produced higher estimated ultimate losses for these accidentyears. As a result, at December 31, 2008, the IBNR was determined to be$34.8 million, or approximately 81% of the remaining case reserves. The impactof this revised estimate was an increase to workers compensation reserves of$13.9 million.

 

In addition to thedevelopment described for the lines of business above, management also recordeda $2.4 million net decrease in IBNR in other lines of business as a result ofits review of loss reserves at December 31, 2008. The change in IBNR foreach other line of business was not individually significant.

 

*Lossand LAE development—2007*

 

In 2007, OBHoldings experienced $48.3 million of favorable loss reserve developmenton prior accident year loss reserves. The favorable loss reserve developmentwas primarily related to lower than expected frequency for professionalliability lines and lower than expected severity for personal automobileliability, partially offset by adverse loss reserve development for multipleperil and workers compensation, primarily for accident years 2001 and prior.

 

Specifically, at December 31,2006, management continued to expect losses to emerge in the professionalliability business, which is included in the general liability line ofbusiness, in line with initial expectations based on market analysis when thisbusiness was initiated in 2002 and 2003. During 2007, losses continued to besignificantly lower than initial expectations. As a result, management loweredits selected reserves on the earliest years which affected more recent years astotal loss expectations for those years are based in part on prior years’results. The impact of this revised estimate was a decrease to professionalliability reserves of $79.6 million.

 

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At December 31,2006, based on actuarial techniques described above, management estimated thatIBNR related to personal automobile liability was $137.6 million, orapproximately 49% of case reserves of $278.7 million for 2002 and subsequentaccident years. During 2007, case incurred loss and ALAE was $38.4 million,which was less than expected for this relatively short-tail line ofbusiness.  At December 31, 2007,based on actuarial techniques described above, management estimated that IBNRwas $66.1 million, or approximately 49% of the remaining case reserves. Theactuarial methods that management relied upon to estimate IBNR at December 31,2007 were similar to those used at December 31, 2006. The impact of thisrevised estimate was a decrease to personal automobile liability reserves of$33.0 million.

 

At December 31,2006, based on actuarial techniques described above, management estimated thatIBNR related to workers compensation and multiple peril liability was $95.6million, or approximately 15% of case reserves of $621.5 million for 2001 andprior accident years. During 2007, case incurred loss and ALAE was $44.7million, which was greater than expected for these long-tail lines of business.As a result of the higher than expected case incurred loss and ALAE during2007, management gave greater weight to actuarial techniques that are based onhistorical incurred loss development during its review of loss reserves at December 31,2007. As a result, at December 31, 2007, the IBNR was determined to be$149.4 million, or approximately 28% of the remaining case reserves. The impactof this revised estimate was an increase to workers compensation and multipleperil liability reserves of $98.5 million.

 

In addition to thedevelopment described for the lines of business above, management also recordeda $34.2 million net decrease in IBNR in other lines of business as a result ofits review of loss reserves at December 31, 2007. The change in IBNR foreach other line of business was not individually significant.

 

*Fairvalue adjustment*

 

In connection withpurchase accounting for the OneBeacon Acquisition, OB Holdings was required toadjust to fair value OB Holdings’ loss and LAE reserves and the relatedreinsurance recoverables by $646.9 million and $346.9 million,respectively, on OB Holdings’ acquired balance sheet as of June 1, 2001.This net reduction to loss and LAE reserves of $300.0 million is beingaccreted through an income statement charge ratably with and over the periodthe claims are settled. Accordingly, OB Holdings recognized $5.4 million, $12.0million and $16.0 million of such charges, recorded as accretion of fairvalue adjustment to loss and LAE reserves in the years ended December 31,2009, 2008 and 2007, respectively. As of December 31, 2009, theoutstanding pre-tax unaccreted adjustment was $0.

 

The fair values ofOB Holdings’ loss and LAE reserves and related reinsurance recoverablesacquired on June 1, 2001 were based on the present value of their expectedcash flows with consideration for the uncertainty inherent in both the timingof, and the ultimate amount of, future payments for losses and receipts ofamounts recoverable from reinsurers. In estimating fair value, managementadjusted the nominal loss reserves of OB Holdings (net of the effects ofreinsurance obtained from the NICO Cover, as defined below, and the GRC Cover, asdefined in Note 4) and discounted them to their present value using anapplicable risk-free discount rate. The series of future cash flows related tosuch loss payments and reinsurance recoveries were developed using OB Holdings’historical loss data. The resulting discount was reduced by the “price” forbearing the uncertainty inherent in OB Holdings’ net loss reserves in order toestimate fair value. This was approximately 11% of the present value of theexpected underlying cash flows of the loss reserves and reinsurancerecoverables of OB Holdings, which is believed to be reflective of the cost OBHoldings would incur if they had attempted to reinsure the full amount of itsnet loss and LAE reserves with a third party reinsurer.

 

***Asbestos and environmental loss and LAE reserve activity***

 

OB Holdings’reserves include provisions made for claims that assert damages from asbestosand environmental (“A&E”) related exposures. Asbestos claims relateprimarily to injuries asserted by those who came in contact with asbestos orproducts containing asbestos. Environmental claims relate primarily topollution and related clean-up costs obligations, particularly as mandated byfederal and state environmental protection agencies. In addition to the factorsdescribed above regarding the reserving process, OB Holdings estimates itsA&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 reserves, tendsto be higher than in the case of non-A&E claims due to the higher legalcosts typically associated with A&E claims.

 

In connection withthe OneBeacon Acquisition, Aviva caused OneBeacon to purchase a reinsurancecontract with National Indemnity Company (“NICO”) under which OB Holdings isentitled to recover from NICO up to $2.5 billion in the future forasbestos claims arising from business written by OB Holdings in 1992 and prior,environmental claims arising 

 

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from business written byOB Holdings in 1987 and prior, and certain other exposures (the “NICO Cover”).Under the terms of the NICO Cover, NICO receives the economic benefit ofreinsurance recoverables from certain of OB Holdings’ third party reinsurers inexistence at the time the NICO Cover was executed (“Third Party Recoverables”).As a result, the Third Party Recoverables serve to protect the $2.5 billionlimit of NICO coverage for the benefit of OB Holdings. Any amountsuncollectible from third party reinsurers due to dispute or the reinsurers’financial inability to pay are covered by NICO under its agreement with OBHoldings. Third Party Recoverables are typically for the amount of loss inexcess of a stated level each year. Of claim payments in the past11 years, approximately 46% of A&E losses have been recovered underthe historical third party reinsurance.

 

In September 2008,OB Holdings completed a study of its A&E exposures. This study considered,among other items, (i) facts, such as policy limits, deductibles andavailable third party reinsurance, related to reported claims; (ii) currentlaw; (iii) past and projected claim activity and past settlement valuesfor similar claims; (iv) industry studies and events, such as recentsettlements and asbestos-related bankruptcies; and (v) collectibility ofthird party reinsurance. Based on the study, OB Holdings increased its bestestimate of its incurred losses ceded to NICO, net of underlying reinsurance,by $83.4 million to $2.2 billion, which is within the $2.5 billion coverageprovided by the NICO Cover. The increase in the estimate of incurred A&Elosses was principally driven by raised projections for claims related toasbestos. Due to the NICO Cover, there was no impact to income or equity fromthe change in estimate.

 

As noted above, OBHoldings estimates that on an incurred basis it has used approximately$2.2 billion of the coverage provided by NICO at December 31, 2009.Since entering into the NICO Cover, approximately 4% of the $2.2 billionof utilized coverage relates to uncollectible Third Party Recoverables andsettlements on Third Party Recoverables through December 31, 2009. Netlosses paid totaled approximately $1.2 billion as of December 31, 2009,with $118.0 million paid in 2009. Asbestos payments during 2009 reflectpayments resulting from intensified efforts by claimants to resolve asbestosclaims prior to enactment of potential federal asbestos legislation. To theextent that actual experience differs from OB Holdings’ estimate of ultimateA&E losses and Third Party Recoverables, future losses could exceed the$320.2 million of protection remaining under the NICO Cover at December 31,2009.

 

OB Holdings’reserves for A&E losses at December 31, 2009 represent management’sbest estimate of its ultimate liability based on information currentlyavailable. However, significant uncertainties, including but not limited tocase law developments, medical and clean up cost increases and industrysettlement practices, limit OB Holdings’ ability to accurately estimateultimate liability and OB Holdings may be subject to A&E losses beyondcurrently estimated amounts. In addition, OB Holdings remains liable for risksreinsured in the event that a reinsurer does not honor its obligations underreinsurance contracts. OB Holdings cannot reasonably estimate at the presenttime loss reserve additions arising from any such future adverse loss reservedevelopments and cannot be sure that allocated loss reserves, plus theremaining capacity under the NICO Cover and other reinsurance contracts, willbe sufficient to cover additional liability arising from any such adverse lossreserve developments.

 

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The followingtables summarize reported A&E loss and LAE reserve activities (gross andnet of reinsurance) for OB Holdings for the years ended December 31, 2009,2008 and 2007, respectively.

 
| ** **                            |   | **Year  ended December 31,** |       |
|---------------------------------------|--------|-----------------------------------|------------|
| ** **                            |   | **2009**                          |       | **2008** |   | **2007** |   |
| ** **                            |   | **Gross**                         | ** ** | **Pre-NICO  Net(1)** | ** ** | **Net** | ** ** | **Gross** | ** ** | **Pre-NICO  Net(1)** | ** ** | **Net** | ** ** | **Gross** | ** ** | **Pre-NICO  Net(1)** | ** ** | **Net** |   |
| ** **                            |   | **($ in  millions)**         |       |
| **Asbestos:**                         |   |                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Beginning  balance                    |   | $                                 | 1,098.4    |   | $ | 741.5 |   | $ | 6.5 |   | $ | 1,155.9 |   | $ | 699.7 |   | $ | 7.2 |   | $ | 1,227.6 |   | $ | 766.6 |   | $ | 6.8 |   |
| Incurred  loss and LAE                |   | 1.0                               |       | — |   | — |   | 37.8 |   | 114.5 |   | — |   | 14.7 |   | — |   | — |   |
| Paid  loss and LAE                    |   | (113.8                            | )          | (52.7 | ) | — |   | (95.3 | ) | (72.7 | ) | (0.7 | ) | (86.4 | ) | (66.9 | ) | 0.4 |   |
| Ending  balance                       |   | $                                 | 985.6      |   | $ | 688.8 |   | $ | 6.5 |   | $ | 1,098.4 |   | $ | 741.5 |   | $ | 6.5 |   | $ | 1,155.9 |   | $ | 699.7 |   | $ | 7.2 |   |
| **Environmental:**                    |   |                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Beginning  balance                    |   | $                                 | 470.3      |   | $ | 261.2 |   | $ | 5.5 |   | $ | 577.1 |   | $ | 342.5 |   | $ | 6.0 |   | $ | 678.0 |   | $ | 394.6 |   | $ | 10.6 |   |
| Incurred  loss and LAE                |   | 4.9                               |       | 5.0 |   | 5.0 |   | (74.3 | ) | (56.2 | ) | 2.6 |   | (18.3 | ) | — |   | — |   |
| Paid  loss and LAE                    |   | (124.5                            | )          | (47.6 | ) | (2.9 | ) | (32.5 | ) | (25.1 | ) | (3.1 | ) | (82.6 | ) | (52.1 | ) | (4.6 | ) |
| Ending  balance                       |   | $                                 | 350.7      |   | $ | 218.6 |   | $ | 7.6 |   | $ | 470.3 |   | $ | 261.2 |   | $ | 5.5 |   | $ | 577.1 |   | $ | 342.5 |   | $ | 6.0 |   |
| **Total asbestos and environmental:** |   |                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Beginning  balance                    |   | $                                 | 1,568.7    |   | $ | 1,002.7 |   | $ | 12.0 |   | $ | 1,733.0 |   | $ | 1,042.2 |   | $ | 13.2 |   | $ | 1,905.6 |   | $ | 1,161.2 |   | $ | 17.4 |   |
| Incurred  loss and LAE                |   | 5.9                               |       | 5.0 |   | 5.0 |   | (36.5 | ) | 58.3 |   | 2.6 |   | (3.6 | ) | — |   | — |   |
| Paid  loss and LAE                    |   | (238.3                            | )          | (100.3 | ) | (2.9 | ) | (127.8 | ) | (97.8 | ) | (3.8 | ) | (169.0 | ) | (119.0 | ) | (4.2 | ) |
| Ending  balance                       |   | $                                 | 1,336.3    |   | $ | 907.4 |   | $ | 14.1 |   | $ | 1,568.7 |   | $ | 1,002.7 |   | $ | 12.0 |   | $ | 1,733.0 |   | $ | 1,042.2 |   | $ | 13.2 |   |

 

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(1)                                  Represents A&E reserve activity, netof third party reinsurance, but prior to the NICO Cover.

 

**NOTE4.  Reinsurance**

 

In the normalcourse of business, OB Holdings’ insurance subsidiaries seek to limit lossesthat may arise from catastrophes or other events by reinsuring with third partyreinsurers. OB Holdings remains liable for risks reinsured even if thereinsurer does not honor its obligations under reinsurance contracts. Theeffects of reinsurance on OB Holdings’ insurance subsidiaries’ written andearned premiums and on loss and LAE were as follows:

 
| ** **            | ** ** | **Year ended December 31,** | ** ** |
|-----------------------|------------|----------------------------------|------------|
| ** **            | ** ** | **2009**                         | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **            | ** ** | **($ in millions)**         | ** ** |
| **Written premiums:** |       |                             |       |   |   |   |   |
| Direct(1)(2)          |       | $                                | 2,061.3    |   | $ | 2,154.0 |   | $ | 2,041.3 |   |
| Assumed               |       | 58.6                             |       | 60.0 |   | 50.6 |   |
| Ceded(1)(2)           |       | (213.2                           | )          | (250.9 | ) | (227.5 | ) |
| Net written premiums  |       | $                                | 1,906.7    |   | $ | 1,963.1 |   | $ | 1,864.4 |   |
| **Earned premiums:**  |       |                             |       |   |   |   |   |
| Direct                |       | $                                | 2,122.4    |   | $ | 2,078.0 |   | $ | 2,017.3 |   |
| Assumed               |       | 66.8                             |       | 53.6 |   | 54.7 |   |
| Ceded                 |       | (229.7                           | )          | (252.6 | ) | (198.4 | ) |
| Net earned premiums   |       | $                                | 1,959.5    |   | $ | 1,879.0 |   | $ | 1,873.6 |   |
| **Loss and LAE:**     |       |                             |       |   |   |   |   |
| Direct                |       | $                                | 1,137.3    |   | $ | 1,262.1 |   | $ | 1,172.0 |   |
| Assumed               |       | 40.8                             |       | 34.2 |   | (11.1 | ) |
| Ceded                 |       | (56.2                            | )          | (170.1 | ) | (71.1 | ) |
| Net loss and LAE      |       | $                                | 1,121.9    |   | $ | 1,126.2 |   | $ | 1,089.8 |   |

 

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(1)                                  Includes policies written for Agri, adivision of OB Holdings that provided commercial farm and ranch and commercialagricultural insurance products, on a direct basis which were then ceded 100%to QBE Insurance Group, Ltd. as a result of the sale of the renewal rights ofthe Agri business to QBE on September 29, 2006.

 

(2)                                  Includes policies written under a quotashare agreement with a group of reinsurers to cede 30% of written premiums fromOB Holdings’ Northeast homeowners business effective January 1, 2009, asdescribed below.

 

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In the normalcourse of its business, OB Holdings purchases reinsurance from high-quality,highly rated third party reinsurers in order to minimize loss from large risksor catastrophic events.

 

The timing andsize of catastrophe losses are unpredictable and the level of lossesexperienced in any year could be material to OB Holdings’ operating results andfinancial position. Examples of catastrophes include losses caused byearthquakes, wildfires, hurricanes and other types of storms and terroristacts. The extent of losses caused by catastrophes is a function of the amountand type of insured exposure in an area affected by the event and the severityof the event. OB Holdings continually assesses and implements programs tomanage its exposure to catastrophe losses through individual risk selection andby limiting its concentration of insurance written in catastrophe-prone areas,such as coastal regions. In addition, OB Holdings imposes wind deductibles onexisting coastal windstorm exposures. OB Holdings’ largest single event naturalcatastrophe exposures are Northeastern United States windstorms and Californiaearthquakes. OB Holdings uses probable maximum loss (“PML”) forecasting toquantify its exposure to catastrophic losses. PML is a statistical modelingtechnique that measures a company’s catastrophic exposure as the maximumprobable loss in a given time period.

 

Since theterrorist attacks of September 11, 2001, OB Holdings has sought tomitigate the risk associated with any future terrorist attacks by limiting theaggregate insured value of policies in geographic areas with exposure to lossesfrom terrorist attacks. This is accomplished by either limiting the totalinsured values exposed, or, where applicable, through the use of terrorismexclusions.

 

In December 2007,the United States government extended the Terrorism Risk Insurance Act (the “TerrorismAct” or “TRIA”) for seven more years until December 31, 2014. TheTerrorism Act, originally enacted in 2002, established a federal “backstop” forcommercial property and casualty losses, including workers compensation,resulting from acts of terrorism by or on behalf of any foreign person orforeign interest. As extended, the law now also covers domestic acts ofterrorism. The law limits the industry’s aggregate liability by requiring thefederal government to share 85% of certified losses once a company meets aspecific retention or deductible as determined by its prior year’s directwritten premiums and limits the aggregate liability to be paid by thegovernment and industry without further action by Congress at$100 billion. In exchange for this “back-stop,” primary insurers arerequired to make coverage available to commercial insureds for losses from actsof terrorism 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 coverage exceptdirectors and officers coverage.

 

OB Holdingsestimates its individual retention level for commercial policies subject to theTerrorism Act to be approximately $177 million in 2010. The federalgovernment will pay 85% of covered terrorism losses that exceed OB Holdings’ orthe industry’s retention levels in 2010, up to a total of $100 billion.

 

OB Holdings seeksto further reduce its potential loss from catastrophe exposures through thepurchase of catastrophe reinsurance. Effective July 1, 2009, OB Holdingsrenewed its property catastrophe reinsurance program through June 30,2010. The program provides coverage for OB Holdings’ personal and commercialproperty business as well as certain acts of terrorism. Under the program, thefirst $100 million of losses resulting from any single catastrophe areretained and the next $750 million of losses resulting from thecatastrophe are reinsured. Any loss above $850 million would be retained.In the event of a catastrophe, OB Holdings’ property catastrophe reinsuranceprogram is reinstated for the remainder of the original contract term by payinga reinstatement premium that is based on the percentage of coverage reinstatedand the original property catastrophe coverage premium.

 

Effective January 1,2009, OB Holdings entered into a quota share agreement with agroup of reinsurers to cede 30% of written premiums fromOB Holdings’ Northeast homeowners business written through OneBeacon InsuranceCompany (“OBIC”) and its subsidiary companies, along with Adirondack InsuranceExchange (“Adirondack Insurance”) and New Jersey Skylands Insurance Associationin New York and New Jersey, respectively. The program provides supplementalprotection to previously established reinsurance. During the year ended December 31,2009, OB Holdings ceded $59.9 million of written premiums under this quotashare agreement. Effective January 1, 2010, OB Holdings renewed the quotashare agreement.

 

OB Holdings’property catastrophe reinsurance program does not cover personal or commercialproperty losses resulting from nuclear events or biological, chemical orradiological terrorist attacks or losses resulting from acts of terrorism asdefined under the Terrorism Act, as amended, committed by an individual orindividuals acting on behalf of any foreign person or foreign interest.

 

OB Holdings alsopurchases individual property reinsurance coverage for certain risks to reducelarge loss volatility. The property-per-risk reinsurance program reinsureslosses in excess of $10 million up to $100 million. Individual riskfacultative reinsurance may be purchased above $100 million where OBHoldings deems it appropriate. The property-per-risk 

 

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treaty also provides onelimit of reinsurance protection for losses in excess of $10 million up to$100 million on an individual risk basis for terrorism losses. However,nuclear, biological, chemical and radiological terrorist attacks are notcovered.

 

OB Holdings alsomaintains a casualty reinsurance program that provides protection forindividual risk or catastrophe losses involving workers compensation, generalliability, automobile liability, professional liability or umbrella liabilityin excess of $6 million up to $81 million. Corporate accident lossesare covered up to $95 million excess of $35 million. This program providescoverage for terrorism losses but does not provide coverage for lossesresulting from nuclear, biological, chemical or radiological terrorist attacks.

 

In connection withthe OneBeacon Acquisition, Aviva caused OneBeacon to purchase two reinsurancecontracts: the NICO Cover, a reinsurance contract from NICO for up to $2.5 billionin old A&E claims and certain other exposures and an adverse loss reservedevelopment cover from General Reinsurance Corporation (“GRC”) for up to$570.0 million, comprised of $400.0 million of adverse loss reservedevelopment occurring in years 2000 and prior (the “GRC Cover”) in addition to$170.0 million of reserves ceded as of the date of the OneBeaconAcquisition. 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 under GAAP as a seller guarantee. NICO and GRC are wholly-ownedsubsidiaries of Berkshire Hathaway, Inc (“Berkshire”).

 

Pursuant to theGRC Cover, OB Holdings is not entitled to recover losses to the full contractlimit if such losses are reimbursed by GRC more quickly than anticipated at thetime the contract was signed. OB Holdings intends to seek reimbursement fromGRC only for claims which result in payment patterns similar to thosesupporting its recoverables recorded pursuant to the GRC Cover. The economiccost of not submitting certain other eligible claims to GRC is primarily theinvestment spread between the rate credited by GRC and the rate achieved by OneBeaconon its own investments. This cost, if any, is expected to be nominal.

 

Reinsurancecontracts do not relieve OB Holdings of its obligation. Therefore,collectibility of balances due from reinsurers is critical to OB Holdings’financial strength. The following table provides a listing of OB Holdings’ topreinsurers for its insurance operations, excluding industry pools andassociations and affiliates of OB Holdings, based upon recoverable amounts, thepercentage of total reinsurance recoverables and the reinsurer’s A.M. BestCompany, Inc. (“A.M. Best”) rating.

 
| **($ in  millions)**                                          | ** ** | **Balance at  December 31, 2009** | ** ** | **% of total** | ** ** | **A.M. Best Rating(1)** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------------|------------|----------------|------------|-------------------------|------------|
| National Indemnity Company and General Reinsurance  Corporation(2) |       | $                                      | 1,849.0    |           | 77         | %                       | A++        |   |
| Tokio Marine and Nichido Fire (3)                                  |       | 75.8                                   |       | 3              | %          | A++                     |       |
| Munich Reinsurance America                                         |       | 41.1                                   |       | 2              | %          | A+                      |       |
| QBE Insurance Corporation                                          |       | 36.0                                   |       | 2              | %          | A                       |       |
| Swiss Re Group                                                     |       | 19.0                                   |       | 1              | %          | A                       |       |
|                                                                    |            |                                        |            |                |            |                         |            |  |

 

----

(1)                                  A.M. Best ratings as detailed above are: “A++”(Superior, which is the highest of fifteen financial strength ratings), “A+”(Superior, which is the second highest of fifteen financial strength ratings)and “A” (Excellent, which is the third highest of fifteen financial strengthratings).

 

(2)                                  Includes $320.2 million of ThirdParty Recoverables, which NICO would pay under the terms of the NICO Cover ifthey are unable to collect from third party reinsurers. OB Holdings also has anadditional $133.9 million of Third Party Recoverables from variousreinsurers, the majority of which are rated “A” or better by A.M. Best.

 

(3)                                  Includes $39.1 million ofreinsurance recoverables from various reinsurers that are guaranteed by TokioMarine and Nichido Fire under the terms of a 100% quota share reinsuranceagreement between Houston General Insurance Company and Tokio Marine andNichido Fire.

 

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**NOTE5.  Investment Securities**

 

OB Holdings’ netinvestment income is comprised primarily of interest income associated with OBHoldings’ fixed maturity investments, dividend income from its equityinvestments and interest income from its short-term investments. Net investmentincome for the years ended December 31, 2009, 2008 and 2007 consisted ofthe following:

 
| ** **                     | ** ** | **Year ended December 31,** | ** ** |
|--------------------------------|------------|----------------------------------|------------|
| ** **                     | ** ** | **2009**                         | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                     | ** ** | **($ in millions)**         | ** ** |
| **Investment income:**         |       |                             |       |   |   |   |   |
| Fixed maturity investments     |       | $                                | 124.2      |   | $ | 143.2 |   | $ | 179.9 |   |
| Short-term investments         |       | 2.1                              |       | 8.6 |   | 14.1 |   |
| Common equity securities       |       | 1.9                              |       | 15.3 |   | 14.8 |   |
| Convertible bonds              |       | 6.7                              |       | 6.3 |   | 6.7 |   |
| Other investments              |       | 1.2                              |       | 2.7 |   | 2.9 |   |
| Total investment income        |       | 136.1                            |       | 176.1 |   | 218.4 |   |
| Less investment expenses       |       | (10.8                            | )          | (14.0 | ) | (16.0 | ) |
| Net investment income, pre-tax |       | $                                | 125.3      |   | $ | 162.1 |   | $ | 202.4 |   |

 

The composition ofnet realized investment (losses) gains, a component of net realized andunrealized investment gains (losses) consisted of the following:

 
| ** **                                        | ** ** | **Year ended December 31,** | ** ** |
|---------------------------------------------------|------------|----------------------------------|------------|
| ** **                                        | ** ** | **2009**                         | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                        | ** ** | **($ in millions)**         | ** ** |
| Fixed maturity investments                        |       | $                                |  (6.8 | ) | $ |  (41.0 | ) | $ |  17.5 |   |
| Short-term investments                            |       | 0.2                              |       | — |   | — |   |
| Common equity securities                          |       | (31.5                            | )          | (246.5 | ) | 108.5 |   |
| Convertible bonds                                 |       | 12.3                             |       | (12.4 | ) | 12.2 |   |
| Other investments                                 |       | 5.3                              |       | (18.7 | ) | 34.9 |   |
| Net realized investment (losses) gains, pre-tax   |       | (20.5                            | )          | (318.6 | ) | 173.1 |   |
| Income taxes                                      |       | 7.2                              |       | 111.5 |   | (60.6 | ) |
| Net realized investment (losses) gains, after tax |       | $                                | (13.3      | ) | $ |  (207.1 | ) | $ | 112.5 |   |

 

OB Holdingsrecognized gross realized investment gains of $85.4 million, $104.3 million and$208.8 million and gross realized investment losses of $105.9 million,$422.9 million and $35.7 million on sales and other-than-temporaryimpairment charges on investment securities during the years ended December 31,2009, 2008 and 2007, respectively.

 

As of December 31,2009 and 2008, OB Holdings reported $7.6 million and $6.8 million,respectively, in accounts payable on unsettled investment purchases and $24.2million and $49.0 million, respectively, in accounts receivable on unsettledinvestment sales.

 

The net changes in fairvalue for the years ended December 31, 2009 and 2008 are as follows:

 
| ** **                 | ** ** | **Year ended December 31, 2009**                     | ** ** |
|----------------------------|------------|--------------------------------------------------------------------------|------------|
| ** **                 | ** ** | **Changes in net  unrealized gains  and losses (1)** | ** ** | **Changes in net  foreign currency  translation gains  and losses (1)** | ** ** | **Total net changes  in fair value  reflected in  revenues (1)** | ** ** |
| ** **                 | ** ** | ** **                                                               | ** ** | **($ in millions)** | ** ** | ** ** | ** ** |
| Fixed maturity investments |       | $                                                                        | 185.7      |   | $ | 20.0 |   | $ | 205.7 |   |
| Short-term investments     |       | (0.2                                                                     | )          | 1.5 |   | 1.3 |   |
| Common equity securities   |       | 19.1                                                                     |       | 0.1 |   | 19.2 |   |
| Convertible bonds          |       | 30.3                                                                     |       | — |   | 30.3 |   |
| Other investments (2)      |       | 12.6                                                                     |       | — |   | 12.6 |   |
| Total                      |       | $                                                                        | 247.5      |   | $ | 21.6 |   | $ | 269.1 |   |

 

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Table of Contents

 
| ** **                 | ** ** | **Changes in net  unrealized gains  and losses (1)** | ** ** | **Changes in net  foreign currency  translation gains  and losses (1)** | ** ** | **Total net changes  in fair value  reflected in  revenues (1)** | ** ** |
|----------------------------|------------|-----------------------------------------------------------|------------|------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                 | ** ** | ** **                                                | ** ** | **($ in millions)**                                                     | ** ** | ** **                                                                 | ** ** |
| Fixed maturity investments |       | $                                                         | (139.4     | )                                                                            | $          | (35.3                                                                      | )          | $ | (174.7 | ) |
| Short-term investments     |       | 0.2                                                       |       | 0.3                                                                          |       | 0.5                                                                        |       |
| Common equity securities   |       | (154.3                                                    | )          | (2.6                                                                         | )          | (156.9                                                                     | )          |
| Convertible bonds          |       | (22.5                                                     | )          | —                                                                       |       | (22.5                                                                      | )          |
| Other investments(3)       |       | (93.8                                                     | )          | —                                                                       |       | (93.8                                                                      | )          |
| Total                      |       | $                                                         | (409.8     | )                                                                            | $          | (37.6                                                                      | )          | $ | (447.4 | ) |

 

----

| (1)    |   | Includes  changes in net deferred gains and losses on sales of investments between OB  Holdings and entities under White Mountains’ common control of $0.4 million  and $(11.0) million, pre-tax, for the years ended December 31, 2009 and  2008, respectively. |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                       |
| (2)    |   | Includes  net unrealized gains related  to OB Holdings’ securities lending program of $7.0 million, pre-tax, for the  year ended December 31, 2009.                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                       |
| (3)    |   | Includes  net unrealized losses related to OB Holdings’ securities lending program of  $7.0 million, pre-tax, for the year ended December 31, 2008.                                                                                                              |

 

The components ofOB Holdings’ change in net unrealized investment gains and losses, after tax,and change in net unrealized foreign currency gains and losses, after tax, onits available-for-sale portfolio, as recorded in the statements of operationsand comprehensive income (loss) prior to adopting ASC 825 were as follows:

 
| ** **                                                                       | ** ** | **Year ended December 31,** | ** ** |
|----------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                       | ** ** | **2007**                         | ** ** |
| ** **                                                                       | ** ** | **($ in  millions)**        | ** ** |
| Net change in pre-tax unrealized investment gains  and losses for investments(1) |       | $                                | 160.7      |   |
| Income taxes                                                                     |       | (55.6                            | )          |
| Net change in unrealized gains and losses for  investments, after tax            |       | 105.1                            |       |
| Recognition of pre-tax net unrealized gains and  losses for investments sold (1) |       | (166.5                           | )          |
| Income taxes                                                                     |       | 58.2                             |       |
| Recognition of net unrealized gains and losses for  investments sold, after tax  |       | (108.3                           | )          |
| Change in net unrealized investment gains and  losses, after tax                 |       | $                                | (3.2       | ) |

 

----

| (1) |   | Includes the change in  deferred gains and losses on sales of investments between OB Holdings and  entities under White Mountains’ common control. |
|-----|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------|

 
| ** **                                                                     | ** ** | **Year ended December 31,** | ** ** |
|--------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                     | ** ** | **2007**                         | ** ** |
| ** **                                                                     | ** ** | **($ in  millions)**        | ** ** |
| Net change in unrealized foreign currency gains  and losses for investments(1) |       | $                                | 1.0        |   |
| Income taxes                                                                   |       | (0.3                             | )          |
| Change in net unrealized foreign currency gains  and losses, after tax(1)      |       | $                                | 0.7        |   |

 

----

| (1) |   | Includes the change in  deferred foreign currency gains and losses on sales of investments between OB  Holdings and entities under White Mountains’ common control. Excludes changes  in net unrealized foreign currency gains and losses on funds held under  reinsurance agreements in foreign banks for the year ended December 31,  2007 of $(0.2) million, after tax. |
|-----|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

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The components ofOB Holdings’ ending net unrealized investment gains and losses, excluding theimpact of net unrealized foreign currency translation gains and losses, on itstrading investment portfolio as of December 31, 2009 and 2008 were asfollows:

 
| ** **                                                 | ** ** | **Year ended December 31,** | ** ** |
|------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                 | ** ** | **2009**                         | ** ** | **2008** | ** ** |
| ** **                                                 | ** ** | **($ in millions)**         | ** ** |
| **Investment securities:**                                 |       |                             |       |   |   |
| Gross unrealized investment gains                          |       | $                                | 167.2      |   | $ | 74.1 |   |
| Gross unrealized investment losses                         |       | (23.5                            | )          | (170.6 | ) |
| Net unrealized gains (losses) from investment  securities  |       | 143.7                            |       | (96.5 | ) |
| Income taxes                                               |       | (50.3                            | )          | 33.7 |   |
| Total net unrealized investment gains (losses),  after tax |       | $                                | 93.4       |   | $ | (62.8 | ) |

 

The cost oramortized cost, gross unrealized investment gains and losses, and carryingvalues of OB Holdings’ fixed maturity investments as of December 31, 2009and 2008 were as follows:

 
|                                                    |   | **December 31,  2009** |       |
|---------------------------------------------------------|--------|-----------------------------|------------|
|                                                    |   | **Cost or  amortized cost** | ** ** | **Gross  unrealized  gains** | ** ** | **Gross  unrealized  losses** | ** ** | **Net  foreign  currency gains** | ** ** | **Carrying  value** |   |
|                                                    |   | **($ in  millions)**   |       |
| U.S. Government and agency obligations                  |   | $                           | 519.4      |   | $ | 12.4 |   | $ | (0.2 | ) | $ | — |   | $ | 531.6 |   |
| Debt securities issued by  industrial corporations |   | 1,278.6                     |       | 73.5 |   | (6.4 | ) | 1.3 |   | 1,347.0 |   |
| Municipal obligations                                   |   | 2.5                         |       | 0.1 |   | — |   | — |   | 2.6 |   |
| Asset-backed securities                                 |   | 1,003.7                     |       | 18.4 |   | (7.2 | ) | — |   | 1,014.9 |   |
| Foreign government obligations                          |   | 25.6                        |       | 1.1 |   | — |   | — |   | 26.7 |   |
| Preferred stocks                                        |   | 70.8                        |       | 0.7 |   | — |   | — |   | 71.5 |   |
| Total fixed maturity investments                        |   | $                           | 2,900.6    |   | $ | 106.2 |   | $ | (13.8 | ) | $ | 1.3 |   | $ | 2,994.3 |   |

 
|                                                    |   | **December 31,  2008** |       |
|---------------------------------------------------------|--------|-----------------------------|------------|
|                                                    |   | **Cost or  amortized cost** | ** ** | **Gross  unrealized  gains** | ** ** | **Gross  unrealized  losses** | ** ** | **Net  foreign  currency losses** | ** ** | **Carrying  value** |   |
|                                                    |   | **($ in  millions)**   |       |
| U.S. Government and agency obligations                  |   | $                           | 417.3      |   | $ | 5.3 |   | $ | (13.0 | ) | $ | — |   | $ | 409.6 |   |
| Debt securities issued by  industrial corporations |   | 914.9                       |       | 13.2 |   | (39.2 | ) | (18.7 | ) | 870.2 |   |
| Municipal obligations                                   |   | 4.8                         |       | 0.2 |   | — |   | — |   | 5.0 |   |
| Asset-backed securities                                 |   | 791.9                       |       | 9.3 |   | (42.3 | ) | — |   | 758.9 |   |
| Foreign government obligations                          |   | 46.0                        |       | 0.4 |   | (7.8 | ) | — |   | 38.6 |   |
| Preferred stocks                                        |   | 71.5                        |       | 0.2 |   | (19.2 | ) | — |   | 52.5 |   |
| Total fixed maturity investments                        |   | $                           | 2,246.4    |   | $ | 28.6 |   | $ | (121.5 | ) | $ | (18.7 | ) | $ | 2,134.8 |   |

 

The cost oramortized cost and carrying value of OB Holdings’ fixed maturity investmentsand convertible bonds at December 31, 2009 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, 2009**  | ** ** |
|----------------------------------------|------------|-----------------------------|------------|
| ** **                             | ** ** | **Cost or amortized  cost** | ** ** | **Carrying value** | ** ** |
| ** **                             | ** ** | **($ in millions)**    | ** ** |
| Due in one year or less                |       | $                           | 159.9      |   | $ | 162.0 |   |
| Due after one year through five years  |       | 1,505.3                     |       | 1,569.8 |   |
| Due after five years through ten years |       | 210.0                       |       | 228.0 |   |
| Due after ten years                    |       | 104.6                       |       | 118.3 |   |
| Asset-backed securities                |       | 1,003.7                     |       | 1,014.9 |   |
| Preferred stocks                       |       | 70.8                        |       | 71.5 |   |
| Total                                  |       | $                           | 3,054.3    |   | $ | 3,164.5 |   |

 

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The cost oramortized cost, gross unrealized investment gains and losses, and carryingvalues of OB Holdings’ common equity securities, convertible bonds and otherinvestments as of December 31, 2009 and 2008 were as follows:

 
| ** **               | ** ** | **December 31, 2009**   | ** ** |
|--------------------------|------------|------------------------------|------------|
| ** **               | ** ** | **Cost or  amortized  cost** | ** ** | **Gross  unrealized  gains** | ** ** | **Gross  unrealized  losses** | ** ** | **Net foreign  currency  gains** | ** ** | **Carrying  value** | ** ** |
| ** **               | ** ** | **($ in millions)**     | ** ** |
| Common equity securities |       | $                            | 176.3      |   | $ | 12.3 |   | $ | (1.0 | ) | $ | — |   | $ | 187.6 |   |
| Convertible bonds        |       | 153.7                        |       | 16.6 |   | (0.1 | ) | — |   | 170.2 |   |
| Other investments        |       | 122.8                        |       | 32.1 |   | (8.6 | ) | — |   | 146.3 |   |
|                          |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **               | ** ** | **December 31, 2008**   | ** ** |
|--------------------------|------------|------------------------------|------------|
| ** **               | ** ** | **Cost or  amortized  cost** | ** ** | **Gross  unrealized  gains** | ** ** | **Gross  unrealized  losses** | ** ** | **Net  foreign  currency  losses** | ** ** | **Carrying  value** | ** ** |
| ** **               | ** ** | **($ in  millions)**    | ** ** |
| Common equity securities |       | $                            | 284.6      |   | $ | 6.4 |   | $ | (14.2 | ) | $ | (0.1 | ) | $ | 276.7 |   |
| Convertible bonds        |       | 255.0                        |       | 2.4 |   | (16.2 | ) | — |   | 241.2 |   |
| Other investments        |       | 178.6                        |       | $ | 36.7 |   | (18.7 | ) | $ | — |   | 196.6 |   |
|                          |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Sales andmaturities of investments, excluding short-term investments and other investments,totaled $1,622.9 million, $2,522.1 million and $2,609.9 million for theyears ended December 31, 2009, 2008 and 2007, respectively. There were nonon-cash exchanges or involuntary sales of investment securities during theyears ended December 31, 2009, 2008 or 2007.

 

OB Holdings’consolidated insurance operations are required to maintain deposits withcertain insurance regulatory agencies in order to maintain their insurancelicenses. The fair value of such deposits totaled $232.6 million and $281.3million as of December 31, 2009 and 2008, respectively.

 

*Fair value measurements at December 31,2009*

 

On January 1, 2008,OB Holdings adopted ASC 820 which provides a revised definition of fair value,establishes a framework for measuring fair value and expands financialstatement disclosure requirements for fair value information. Under ASC 820,fair value is defined as the price that would be received to sell an asset orpaid to transfer a liability in an orderly transaction between marketparticipants (an “exit price”). ASC 820 establishes a fair value hierarchy thatdistinguishes between inputs based on market data from independent sources (“observableinputs”) and a reporting entity’s internal assumptions based upon the bestinformation available when external market data is limited or unavailable (“unobservableinputs”). The fair value hierarchy in ASC 820 prioritizes fair valuemeasurements into three levels based on the nature of the inputs as follows:

 

Level 1 — Valuationsbased on quoted prices in active markets for identical assets;

 

Level 2 — Valuationsbased on observable inputs that do not meet the criteria for Level 1, includingquoted prices in inactive markets and quoted prices in active markets forsimilar, but not identical instruments; and

 

Level 3 — Valuationsbased on unobservable inputs.

 

As of December 31,2009 and 2008, approximately 93% and 92%, respectively, of the investmentportfolio recorded at fair value was priced based upon observable inputs.

 

Fair values forsecurities for which quoted prices are unavailable are estimated based uponreference to observable inputs other than quoted prices, such as benchmarkinterest rates, market comparables, broker quotes and other relevant observableinputs. In circumstances where observable inputs are adjusted to reflectmanagement’s best estimate of fair value, such fair value measurements areconsidered a lower level measurement in the fair value hierarchy.

 

Other investments, whichare comprised of hedge funds and private equity funds for which the fair valueoption has been elected, are carried at fair value based upon OB Holdings’proportionate interest in the underlying fund’s net asset value, which isdeemed to approximate fair value. The fair value of OB Holdings’ investments inhedge funds and private equity funds has been estimated using net asset valuebecause it reflects the fair value of the funds’ underlying investments inaccordance with ASC 820. OB Holdings employs a number of procedures to assessthe reasonableness of the fair value 

 

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measurements, includingobtaining and reviewing each fund’s audited financial statements and discussingeach fund’s pricing with the fund’s manager. However, since the fund managersdo not provide sufficient information to independently evaluate the pricinginputs and methods for each underlying investment, the inputs are considered tobe unobservable. Accordingly, the fair values of OB Holdings’ investment inhedge funds and private equity funds have been classified as Level 3 under thefair value hierarchy.

 

In circumstances wherethe underlying investments are publicly traded, such as the investments made byhedge funds, the fair value of the underlying investments is determined usingcurrent market prices. In circumstances where the underlying investments arenot publicly traded, such as the investments made by private equity funds, theprivate equity fund managers have considered the need for a liquidity discounton each of the underlying investments when determining the fund’s net assetvalue in accordance with ASC 820. In circumstances where OB Holdings’ portionof a fund’s net asset value is deemed to differ from fair value due toilliquidity or other factors associated with OB Holdings’ investment in thefund, including counterparty credit risk, the net asset value is adjustedaccordingly. At December 31, 2009 and 2008, OB Holdings did not record anadjustment to the net asset value related to its investments in hedge funds orprivate equity funds.

 

As of December 31,2009 and 2008, other investments represented approximately 4% and 5%,respectively, of the investment portfolio recorded at fair value. Otherinvestments accounted for at fair value as of December 31, 2009 and 2008were comprised of $74.2 million and $117.3 million, respectively, in hedgefunds, $58.0 million and $65.2 million, respectively, in private equity fundsand $14.1 million for both periods of an investment in a community reinvestmentvehicle. At December 31, 2009 and 2008, OneBeacon held investments in 15and 20 hedge funds, respectively, and 15 and 16 private equity funds,respectively. The largest investment in a single fund was $10.8 million and$26.1 million, respectively, at December 31, 2009 and 2008.

 

The fair valuemeasurements at December 31, 2009 and 2008 and their related inputs are asfollows:

 
| ** **                                        | ** ** | **Fair value at  December 31, 2009** | ** ** | **Level 1 Inputs** | ** ** | **Level 2 Inputs** | ** ** | **Level 3 Inputs** | ** ** |
|---------------------------------------------------|------------|----------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                        | ** ** | **($ in millions)**                            | ** ** |
| Fixed maturity investments:                       |       |                                                     |       |                         |       |                         |       |                         |       |
| U.S. Government and agency obligations            |       | $                                                        | 531.6      |                         | $          | 529.0                        |       | $                            | 2.6        |   | $ | — |   |
| Debt securities issued by industrial corporations |       | 1,347.0                                                  |       | —                       |       | 1,346.8                      |       | 0.2                          |       |
| Municipal obligations                             |       | 2.6                                                      |       | —                       |       | 2.6                          |       | —                       |       |
| Asset-backed securities                           |       | 1,014.9                                                  |       | —                       |       | 999.2                        |       | 15.7                         |       |
| Foreign government obligations                    |       | 26.7                                                     |       | 21.4                         |       | 5.3                          |       | —                       |       |
| Preferred stocks                                  |       | 71.5                                                     |       | —                       |       | 1.5                          |       | 70.0                         |       |
| Fixed maturity investments                        |       | 2,994.3                                                  |       | 550.4                        |       | 2,358.0                      |       | 85.9                         |       |
| Short-term investments                            |       | 489.3                                                    |       | 489.3                        |       | —                       |       | —                       |       |
| Common equity securities                          |       | 187.6                                                    |       | 153.8                        |       | —                       |       | 33.8                         |       |
| Convertible bonds                                 |       | 170.2                                                    |       | —                       |       | 170.2                        |       | —                       |       |
| Other investments                                 |       | 146.3                                                    |       | —                       |       | —                       |       | 146.3                        |       |
| Total                                             |       | $                                                        | 3,987.7    |                         | $          | 1,193.5                      |       | $                            | 2,528.2    |   | $ | 266.0 |   |

 
| ** **                                        | ** ** | **Fair value at  December 31, 2008** | ** ** | **Level 1 Inputs** | ** ** | **Level 2 Inputs** | ** ** | **Level 3 Inputs** | ** ** |
|---------------------------------------------------|------------|----------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                        | ** ** | **($ in millions)**                            | ** ** |
| Fixed maturity investments:                       |       |                                                     |       |                         |       |                         |       |                         |       |
| U.S. Government and agency obligations            |       | $                                                        | 409.6      |                         | $          | 409.6                        |       | $                            | —     |   | $ | — |   |
| Debt securities issued by industrial corporations |       | 870.2                                                    |       | —                       |       | 870.2                        |       | —                       |       |
| Municipal obligations                             |       | 5.0                                                      |       | —                       |       | 5.0                          |       | —                       |       |
| Asset-backed securities                           |       | 758.9                                                    |       | —                       |       | 730.9                        |       | 28.0                         |       |
| Foreign government obligations                    |       | 38.6                                                     |       | 20.2                         |       | 18.4                         |       | —                       |       |
| Preferred stocks                                  |       | 52.5                                                     |       | —                       |       | 1.2                          |       | 51.3                         |       |
| Fixed maturity investments                        |       | 2,134.8                                                  |       | 429.8                        |       | 1,625.7                      |       | 79.3                         |       |
| Short-term investments                            |       | 875.4                                                    |       | 875.4                        |       | —                       |       | —                       |       |
| Common equity securities                          |       | 276.7                                                    |       | 249.2                        |       | 1.3                          |       | 26.2                         |       |
| Convertible bonds                                 |       | 241.2                                                    |       | —                       |       | 241.2                        |       | —                       |       |
| Other investments                                 |       | 196.6                                                    |       | —                       |       | —                       |       | 196.6                        |       |
| Total                                             |       | $                                                        | 3,724.7    |                         | $          | 1,554.4                      |       | $                            | 1,868.2    |   | $ | 302.1 |   |

 

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At December 31, 2009 and 2008, OB Holdings heldone private preferred stock that represented approximately 98% and 97%,respectively, of its preferred stock portfolio. OB Holdings used quoted marketprices for similar securities that were adjusted to reflect management’s bestestimate of fair value; this security is classified as a Level 3 measurement.

 

In addition to the investment portfolio describedabove, OB Holdings had $27.2 million and $20.2 million, respectively, ofliabilities recorded at fair value and included in other liabilities as of December 31,2009 and 2008. These liabilities relate to securities that have been sold shortby a limited partnership that OB Holdings invests in and is required toconsolidate in accordance with GAAP. All of the liabilities included in the$27.2 million and $20.2 million, respectively, have been deemed to have a Level1 designation as of December 31, 2009 and 2008. As of December 31,2008, other liabilities also included $10.4 million related to the fair valueof the interest rate swap on the mortgage note. The interest rate swap wasdeemed to have a Level 2 designation at December 31, 2008. During thesecond quarter of 2009, OB Holdings repaid the outstanding balance on themortgage note and settled the interest rate swap. See Note 6.

 

The changes inLevel 3 fair value measurements for the year ended December 31, 2009are as follows:

 
| ** **                                       | ** ** | **Fixed  maturity  investments** | ** ** | **Common  equity  securities** | ** ** | **Convertible  bonds** | ** ** | **Other  investments** | ** ** | **Total** | ** ** |
|--------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|------------------------|------------|------------------------|------------|-----------|------------|
| ** **                                       | ** ** | **($ in  millions)**        | ** ** |
| Balance at January 1, 2009                  |       | $                                | 79.3       |                           | $          | 26.2                   |       | $                      | —     |      | $          | 196.6 |   | $ | 302.1 |   |
| Total net realized and unrealized gains (losses) |       | 22.6                             |       | 7.2                            |       | 0.1                    |       | 10.6                   |       | 40.5      |       |
| Purchases                                        |       | 29.1                             |       | 0.4                            |       | 2.9                    |       | 7.6                    |       | 40.0      |       |
| Sales                                            |       | (13.6                            | )          | —                         |       | (0.2                   | )          | (68.5                  | )          | (82.3     | )          |
| Transfers in                                     |       | 28.0                             |       | —                         |       | —                 |       | —                 |       | 28.0      |       |
| Transfers out                                    |       | (59.5                            | )          | —                         |       | (2.8                   | )          | —                 |       | (62.3     | )          |
| Balance at December 31, 2009                |       | $                                | 85.9       |                           | $          | 33.8                   |       | $                      | —     |      | $          | 146.3 |   | $ | 266.0 |   |

 

“Transfers in” for theyear ended December 31, 2009 comprise securities for which observableinputs became unavailable as well as securities for which quoted market priceswere deemed to be unreliable. Observable inputs in the form of quoted marketprices for similar securities became unavailable for 2 securities with a fairvalue of $11.2 million. Quoted market prices for these securities had been usedat December 31, 2008 to estimate fair value, and as such, these securitieswere categorized as a Level 2 measurement at December 31, 2008. Inaddition, the estimated fair values for 4 securities of $16.8 million for whichthe quoted prices provided by a third party source were deemed unreliable andcould not be validated against an alternative source are reflected in “Transfersin”. The fair values of these securities were estimated using industry standardpricing models, in which management selected inputs using its bestjudgment. These inputs principally included benchmark yields, benchmarksecurities, reported trades, issuer spreads, bids, offers, credit ratings andprepayment speeds. The pricing models used by OB Holdings use the samevaluation methodology for all Level 3 measurements for fixed maturities. Thesesecurities are considered to be Level 3 because the measurements are notdirectly observable. At December 31, 2009 the estimated fair values forthese securities determined using the industry standard pricing models were$1.8 million less than the estimated fair values based upon quoted pricesprovided by a third party. “Transfers out” of $62.3 million for the year ended December 31,2009 comprise 18 securities which had been previously classified as Level 3measurements and were recategorized as Level 2 measurements when quoted marketprices for similar securities that were considered reliable and could bevalidated against an alternative source became available during the year ended December 31,2009.

 

The following tablesummarizes the change in net unrealized gains and losses for assets designatedas Level 3 for the year ended December 31, 2009 and 2008:

 
| ** **                 | ** ** | **Year ended  December 31,** | ** ** |
|----------------------------|------------|-----------------------------------|------------|
| ** **                 | ** ** | **2009**                          | ** ** | **2008** | ** ** |
| ** **                 | ** ** | **($ in millions)**          | ** ** |
| Fixed maturity investments |       | $                                 | 20.8       |   | $ | (26.3 | ) |
| Short-term investments     |       | —                            |       | — |   |
| Common equity securities   |       | 4.8                               |       | (3.9 | ) |
| Convertible bonds          |       | —                            |       | — |   |
| Other investments          |       | 5.5                               |       | (93.7 | ) |
| Total                      |       | $                                 | 31.1       |   | $ | (123.9 | ) |

 

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OB Holdings holdsinvestments in hedge funds and private equity funds which are included in otherinvestments. The fair value of these investments has been estimated using thenet asset value of the funds. The following table summarizes investments inhedge funds and private equity funds at December 31, 2009:

 
| ** **                                     | ** ** | **Fair  Value**           | ** ** | **Unfunded  Commitments** | ** ** |
|------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                                     | ** ** | **($ in  millions)** | ** ** |
| **Hedge funds**                                |       |                      |       |                      |       |
| Long/short  credit and distressed              |       | $                         | 21.7       |                      | None       |   |
| Long bank loan                                 |       | 3.4                       |       | None                      |       |
| Long/short  equity                             |       | 47.8                      |       | None                      |       |
| Long/short  equity activist                    |       | 1.3                       |       | None                      |       |
| Total  hedge funds                             |       | $                         | 74.2       |                      |       |   |
|                                           |       |                      |       |                      |       |
| **Private equity funds**                       |       |                      |       |                      |       |
| Insurance                                      |       | $                         | 5.8        |                      | $          | 0.1 |   |
| Banking                                        |       | 4.2                       |       | 0.1                       |       |
| Distressed  residential real estate            |       | 4.6                       |       | 20.5                      |       |
| Energy  infrastructure and services            |       | 17.2                      |       | 8.8                       |       |
| Healthcare                                     |       | —                    |       | 4.8                       |       |
| Multi-sector                                   |       | 16.7                      |       | 7.7                       |       |
| Private  equity secondaries                    |       | 4.6                       |       | 3.4                       |       |
| Real  estate                                   |       | 4.9                       |       | 1.1                       |       |
| Total  private equity funds                    |       | $                         | 58.0       |                      | $          | 46.5 |   |
|                                           |       |                      |       |                      |       |
| Total  hedge funds and private equity funds(1) |       | $                         | 132.2      |                      | $          | 46.5 |   |

 

----

(1)                                 Other investments also includes $14.1million of an investment in a community reinvestment vehicle.

 

Redemptions ofinvestments in certain funds are subject to restrictions including lock-upperiods where no redemptions or withdrawals are allowed, restrictions onredemption frequency and advance notice periods for redemptions. Amountsrequested for redemptions remain subject to market fluctuations until theredemption effective date, which generally falls at the end of the definedredemption period.  The followingsummarizes the December 31, 2009 fair value of hedge funds subject torestrictions on redemption frequency and advance notice period requirements forinvestments in active hedge funds:

 
| ** **               | ** ** | **Hedge  Funds – Active Funds** | ** ** |
|--------------------------|------------|--------------------------------------|------------|
| ** **               | ** ** | **30 – 59  days  notice**       | ** ** | **60 – 89  days  notice** | ** ** | **90 – 119  days  notice** | ** ** | **120+  days  notice** | ** ** | **Total** | ** ** |
| ** **               | ** ** | **($ in  millions)**            | ** ** |
| **Redemption frequency** |       |                                 |       |   |   |   |   |   |   |   |   |
| Quarterly                |       | $                                    | 17.9       |   | $ | 20.7 |   | $ | 10.4 |   | $ | — |   | $ | 49.0 |   |
| Semi-annual              |       | 10.8                                 |       | 1.3 |   | — |   | — |   | 12.1 |   |
| Annual                   |       | 0.7                                  |       | — |   | 9.1 |   | 3.3 |   | 13.1 |   |
| Total                    |       | $                                    | 29.4       |   | $ | 22.0 |   | $ | 19.5 |   | $ | 3.3 |   | $ | 74.2 |   |

 

Certain of thehedge fund investments are no longer active and are in the process of disposingof their underlying investments. Distributions from such funds are remitted toinvestors as the fund’s underlying investments are liquidated. At December 31,2009, $16.2 million of hedge funds were in liquidation. The actual amount ofthe final distribution is subject to market fluctuations. The date at whichsuch distributions will be received is not determinable at December 31,2009. OB Holdings has submitted redemption requests for certain of itsinvestments in active hedge funds. Redemptions are recorded as receivables whenapproved by the hedge funds and when no longer subject to market fluctuations.

 

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Investments inprivate equity funds are generally subject to “lock-up” periods during whichinvestors may not request a redemption. Distributions prior to the expectedtermination date of the fund may be limited to dividends or proceeds arisingfrom the liquidation of the fund’s underlying investment. In addition, certainprivate equity funds provide an option to extend the lock-up period at eitherthe sole discretion of the fund manager or upon agreement between the fund andthe investors. At December 31, 2009, investments in private equity fundswere subject to lock-up periods as follows:

 
| ** **                                                    | ** ** | **1-3  years**            | ** ** | **3 – 5  years** | ** ** | **5 – 10  years** | ** ** | **>10  years** | ** ** | **Total** | ** ** |
|---------------------------------------------------------------|------------|---------------------------|------------|-----------------------|------------|------------------------|------------|-------------------|------------|-----------|------------|
| ** **                                                    | ** ** | **($ in  millions)** | ** ** |
| Private  Equity Funds — expected lock-upperiod remaining |       | $                         | 5.8        |                  | $          | 4.6                    |       | $                 | 47.6       |      | $          | — |   | $ | 58.0 |   |
|                                                               |            |                           |            |                       |            |                        |            |                   |            |           |            |  |  |  |  |  |

 

*Securities Lending*

 

As described in Note 1, during the year ended December 31, 2009,OB Holdings exited its securities lending program. As of December 31,2009, $1.7 million in collateral had not been returned to the borrower.

 

At December 31, 2008, prior to the amendment of the terms of thesecurities lending program, the total market value of OB Holdings’ securitieson loan was $107.7 million with corresponding collateral of$100.7 million, resulting in an unrealized loss of $7.0 million recordedin change in net unrealized investment gains and losses, a component of netrealized and unrealized investment gains (losses). In 2009 prior to exiting thesecurities lending program, OB Holdings recorded $3.9 million of net realizedand unrealized gains. Subsequent to exiting the program, OB Holdings recorded$0.8 million of net realized and unrealized gains on the securities returned tous, resulting in a total of $2.3 million of net realized and unrealized lossesin connection with OB Holdings’ exiting from the program. The securitieslending program has generated $18.1 million of additional investment income forOB Holdings since inception in 2001.

 

**NOTE6.  Debt**

 

OB Holdings’ debtoutstanding as of December 31, 2009 and 2008 consisted of the following:

 
| ** **                             | ** ** | **December 31,**    | ** ** |
|----------------------------------------|------------|--------------------------|------------|
| ** **                             | ** ** | **2009**                 | ** ** | **2008** | ** ** |
| ** **                             | ** ** | **($ in millions)** | ** ** |
| Senior unsecured notes, at face value  |       | $                        | 607.1      |   | $ | 676.0 |   |
| Unamortized original issue discount    |       | (0.6                     | )          | (0.9 | ) |
| Senior unsecured notes, carrying value |       | 606.5                    |       | 675.1 |   |
| Mortgage note on real estate owned     |       | —                   |       | 40.8 |   |
| Atlantic Specialty Note                |       | 14.0                     |       | 16.0 |   |
| Total debt                             |       | $                        | 620.5      |   | $ | 731.9 |   |

 

A schedule of contractualrepayments of OB Holdings’ debt as of December 31, 2009 follows:

 
| ** **                | ** ** | **December 31,  2009** | ** ** |
|---------------------------|------------|-----------------------------|------------|
| ** **                | ** ** | **($ in millions)**    | ** ** |
| Due in one year or less   |       | $                           | 2.0        |   |
| Due in two to three years |       | 4.0                         |       |
| Due in four to five years |       | 615.1                       |       |
| Due after five years      |       | —                      |       |
| Total                     |       | $                           | 621.1      |   |

 

***Senior Notes***

 

In May 2003,the Company issued $700.0 million face value of senior unsecured debtthrough a public offering, at an issue price of 99.7% (the “Senior Notes”). TheSenior Notes bear an annual interest rate of 5.875%, payable semi-annually inarrears on May 15 and November 15, until maturity on May 15,2013, and are fully and unconditionally guaranteed as to the payment ofprincipal and interest by White Mountains. The Company incurred$7.3 million in expenses related to the issuance of the Senior Notes(including the $4.5 million underwriting discount), which have beendeferred and are being recognized into interest expense over the life of theSenior Notes. Taking into effect the amortization of the original issuediscount and all underwriting and issuance expenses, the Senior Notes have aneffective yield to maturity of approximately 6.0% per annum. During 2009, theCompany repurchased $10.6 million of outstanding Senior Notes for $8.1 million,which resulted in a $2.5 million gain. During 2009, OBICpurchased $58.3 million of outstanding Senior Notes for $55.0 million, 

 

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which resulted in a $2.9million gain. During 2008, the Company repurchased $24.0 million of theoutstanding Senior Notes for $22.3 million, which resulted in a $1.6 milliongain. At December 31, 2009, the Company was in compliance with all of thecovenants under the Senior Notes.

 

White Mountainshas provided and, pursuant to a separation agreement, continues to provide anirrevocable and unconditional guarantee as to the payment of principal andinterest on the Senior Notes. See Note 16.

 

***Mortgage Note on Real Estate Owned***

 

In connection withits December 2005 purchase of land and an office building that is now itsheadquarters, OB Holdings entered into a $40.8 million, 18-year mortgagenote which has a variable interest rate based upon the lender’s 30-day LIBORrate. As of December 31, 2008, OB Holdings had drawn the full amount of$40.8 million on the mortgage note. Repayment on the mortgage notecommenced in January 2009. During the three months ended March 31,2009, OB Holdings repaid $0.2 million of principal in accordance with the termsof the mortgage note. On May 7, 2009, OB Holdings repaid $40.6 million,representing the outstanding principal on the mortgage note.

 

Concurrent withentering into the mortgage note, OB Holdings also entered into an interest rateswap to hedge its exposure to the variability in the interest rate on themortgage note. The notional amount of the swap was equal to the debtoutstanding on the mortgage note and was adjusted to match the drawdowns andrepayments on the mortgage note so that the principal amount of the mortgagenote and the notional amount of the swap were equal at all times. Under theterms of the swap, OB Holdings paid a fixed interest rate of approximately 6.0%and receives a variable interest rate based on the same LIBOR index used forthe mortgage note. Interest paid or received on the swap was reported ininterest expense. In accordance with GAAP, OB Holdings accounted for the swapas a cash flow hedge and recorded the interest rate swap at fair value on thebalance sheet in other assets or liabilities depending on the value as of thebalance sheet date. The swap was recorded at its fair value of $(10.4) millionas of December 31, 2008. Changes in the fair value of the interest rateswap were reported as a component of other comprehensive income or loss. Anygains and losses on the derivatives representing either hedge ineffectivenessor hedge components excluded from the assessment of effectiveness were recordedin revenues. At the time of repayment of the outstanding balance on themortgage note, OB Holdings paid $7.4 million to settle the interest rate swap.The $7.4 million settlement amount is recorded as an expense in net otherrevenues on a pre-tax basis and in other comprehensive income and loss items asan increase of $4.8 million on an after tax basis ($7.4 million pre-tax). Theafter tax change in the fair value of the interest rate swap included in othercomprehensive income and loss items was a gain (loss) of $2.0 million, $(5.7)million and $(1.1) million, respectively, for the years ended December 31,2009, 2008 and 2007.

 

***Other Debt of Operating Subsidiaries***

 

In connection withthe acquisition of Atlantic Specialty Insurance Company on March 31, 2004,OB Holdings issued a $20.0 million ten-year note to the seller (the “AtlanticSpecialty Note”). OB Holdings is required to repay $2.0 million ofprincipal on the Atlantic Specialty Note each year, commencing in January 2007.The Atlantic Specialty Note accrues interest at a rate of 5.2% except that theoutstanding principal amount in excess of $15.0 million accrues interestat a rate of 3.6%. During each of the years ended December 31, 2009, 2008and 2007, OB Holdings repaid $2.0 million on the Atlantic Specialty Note.

 

***Interest***

 

Total interest expenseincurred by OB Holdings for its indebtedness was $39.7 million, $44.9 millionand $45.2 million in 2009, 2008 and 2007, respectively. Total cashinterest paid by OB Holdings for its indebtedness was $38.9 million, $43.7million and $44.3 million in 2009, 2008 and 2007, respectively.

 

**NOTE7.  Income Taxes**

 

OBH and itssubsidiaries are domiciled in the United States. The majority of OB Holdings’operations are taxed in the United States.

 

OBH and its subsidiariesjoin in the filing of a federal consolidated tax return. The consolidatedparent, which is not included in these financial statements, is OBFS. For allyears, the companies included within the U.S. consolidated tax return areparties to a tax sharing agreement which provides that each company pays theamount of income taxes or estimated tax or receives refunds that it would haveto make or be entitled to if it filed its own separate tax return. As a result,certain companies have made payments, and received refunds from theconsolidated parent that are different than amounts payable to the InternalRevenue Service (“IRS”). In addition, OB Holdings has a separate agreement withthe consolidated parent which 

 

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provides that OB Holdingswill be paid for their tax benefits (losses and credits) the earlier of whenthey would be able to utilize such benefits on a stand-alone basis or when theparent utilizes such losses on a consolidated basis.

 

The total incometax (expense) benefit for the years ended December 31, 2009, 2008 and 2007consisted of the following:

 
| ** **                           | ** ** | **Year ended December 31,** | ** ** |
|--------------------------------------|------------|----------------------------------|------------|
| ** **                           | ** ** | **2009**                         | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                           | ** ** | **($ in millions)**         | ** ** |
| **Current tax expense:**             |       |                             |       |   |   |   |   |
| Federal                              |       | $                                | (79.4      | ) | $ | (10.6 | ) | $ | (134.0 | ) |
| State                                |       | (1.1                             | )          | (1.2 | ) | (0.6 | ) |
| Non-U.S.                             |       | (0.1                             | )          | (0.2 | ) | (0.1 | ) |
| Total current tax expense            |       | (80.6                            | )          | (12.0 | ) | (134.7 | ) |
| **Deferred tax (expense) benefit:**  |       |                             |       |   |   |   |   |
| Federal                              |       | (74.7                            | )          | 207.3 |   | (29.8 | ) |
| State                                |       | —                           |       | — |   | — |   |
| Non-U.S.                             |       | —                           |       | — |   | — |   |
| Total deferred tax (expense) benefit |       | (74.7                            | )          | 207.3 |   | (29.8 | ) |
| Total income tax (expense) benefit   |       | $                                | (155.3     | ) | $ | 195.3 |   | $ | (164.5 | ) |

 

Deferred incometaxes reflect the net tax effects of temporary differences between the carryingamounts of assets and liabilities for financial reporting purposes and theamounts for tax purposes. An outline of the significant components of OBHoldings’ deferred tax assets and liabilities follows:

 
| ** **                                            | ** ** | **December 31,**    | ** ** |
|-------------------------------------------------------|------------|--------------------------|------------|
| ** **                                            | ** ** | **2009**                 | ** ** | **2008** | ** ** |
| ** **                                            | ** ** | **($ in millions)** | ** ** |
| **Deferred income tax assets  related to:**           |       |                     |       |   |   |
| Discounting of loss and LAE reserves                  |       | $                        | 96.9       |   | $ | 38.8 |   |
| U.S. net operating loss and tax credit  carryforwards |       | 70.6                     |       | 61.0 |   |
| Unearned premiums                                     |       | 66.8                     |       | 70.6 |   |
| Compensation and bonus accruals                       |       | 28.4                     |       | 22.5 |   |
| Investment basis differences                          |       | 23.9                     |       | 92.9 |   |
| Deferred compensation plans                           |       | 15.3                     |       | 15.2 |   |
| Fixed assets                                          |       | 5.4                      |       | 6.3 |   |
| Pension and benefit accruals                          |       | 4.1                      |       | 9.9 |   |
| Allowance for doubtful accounts                       |       | 2.2                      |       | 2.5 |   |
| Involuntary pool and guaranty fund accruals           |       | 2.0                      |       | 1.6 |   |
| Other accrued compensation                            |       | 1.6                      |       | 1.9 |   |
| Net unrealized investment losses                      |       | —                   |       | 33.7 |   |
| Foreign currency translation on investments           |       | —                   |       | 6.8 |   |
| Other items                                           |       | 6.5                      |       | 9.8 |   |
| Total gross deferred income tax assets                |       | 323.7                    |       | 373.5 |   |
| Less valuation allowance                              |       | (12.1                    | )          | (17.1 | ) |
| Total net deferred income tax assets                  |       | 311.6                    |       | 356.4 |   |
| **Deferred income tax liabilities  related to:**      |       |                     |       |   |   |
| Deferred acquisition costs                            |       | 75.1                     |       | 78.7 |   |
| Net unrealized investment gains                       |       | 50.3                     |       | — |   |
| Foreign currency translation on investments           |       | 0.8                      |       | — |   |
| Investment basis differences                          |       | —                   |       | — |   |
| Purchase accounting                                   |       | —                   |       | 1.9 |   |
| Other items                                           |       | 0.8                      |       | 6.4 |   |
| Total deferred income tax liabilities                 |       | 127.0                    |       | 87.0 |   |
| Net deferred tax asset                                |       | $                        | 184.6      |   | $ | 269.4 |   |

 

The total netdeferred tax asset relates solely to the U.S. consolidated return group.

 

At December 31,2009 and 2008, a valuation allowance of $12.1 million and$17.1 million, respectively, was established for the net deferred taxassets of the consolidated insurance reciprocals, which each file their own taxreturn.

 

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OB Holdingsbelieves that, based upon its prior earnings history, expected future earningsand capacity for carry-back of losses, it is more likely than not that thedeferred tax asset balances (net of valuation allowance) carried at December 31,2009 and 2008 will be realized.

 

A reconciliationof taxes calculated using the 35% U.S. statutory rate (the tax rate at whichthe majority of OB Holdings’ operations are taxed) to the income tax (expense)benefit on pre-tax earnings follows:

 
| ** **                                              | ** ** | **Year ended December 31,** | ** ** |
|---------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                              | ** ** | **2009**                         | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                              | ** ** | **($ in millions)**         | ** ** |
| Tax (expense) benefit at the U.S. statutory rate        |       | $                                | (162.7     | ) | $ | 209.3 |   | $ | (141.1 | ) |
| **Differences in taxes resulting  from:**               |       |                             |       |   |   |   |   |
| Non-deductible preferred stock dividends and  accretion |       | —                           |       | (11.7 | ) | (22.5 | ) |
| Tax reserve adjustments                                 |       | 2.0                              |       | (1.0 | ) | (1.2 | ) |
| Tax exempt interest and dividends                       |       | 1.6                              |       | 3.6 |   | 3.6 |   |
| Change in valuation allowance                           |       | 5.0                              |       | (3.3 | ) | (2.5 | ) |
| Other, net                                              |       | (1.2                             | )          | (1.6 | ) | (0.8 | ) |
| Total income tax (expense) benefit on pre-tax  earnings |       | $                                | (155.3     | ) | $ | 195.3 |   | $ | (164.5 | ) |

 

At December 31,2009, there were net operating losses of $17.7 million and capital losscarryforwards of $0.4 million, which will begin to expire in 2011, related tothe insurance reciprocals, which each file their own tax return. Under the taxsharing agreement, the Company and its subsidiaries have net operating losscarryforwards of $182.5 million, which begin to expire in 2021.

 

On January 1,2007, OB Holdings adopted FASB Interpretation No. 48, “Accounting forUncertainty in Income Taxes”, subsequently codified within ASC 740, whichprescribes when the benefit of a given tax position should be recognized andhow it should be measured. Under the guidance, recognition is based uponwhether or not a company determines that it is more likely than not that a taxposition will be sustained upon examination based upon the technical merits ofthe position. In evaluating the more-likely-than not recognition threshold, OBHoldings must presume that the tax position will be subject to examination by ataxing authority with full knowledge of all relevant information. If therecognition threshold is met, then the tax position is measured at the largestamount of benefit that is more than 50% likely of being realized upon ultimatesettlement.

 

In connection withthe adoption of ASC 740, OB Holdings recognized a $0.3 million increase inthe liability for unrecognized tax benefits, primarily as a result of increasesin its estimates of accrued interest. The effect of adoption was recorded as anadjustment to opening retained earnings on January 1, 2007. Areconciliation of the beginning and ending amount of unrecognized tax benefitsis as follows:

 
| ** **                                                       | ** ** | **Year ended December 31,** | ** ** |
|------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                       | ** ** | **2009**                         | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                       | ** ** | **($ in millions)**         | ** ** |
| Beginning of period                                              |       | $                                | 15.2       |   | $ | 12.9 |   | $ | 15.2 |   |
| Additions based on tax positions related to the  current year    |       | 12.7                             |       | — |   | — |   |
| Additions (reductions) for tax positions of prior  years         |       | 49.7                             |       | 2.3 |   | (2.3 | ) |
| Reductions as a result of a lapse in the statute  of limitations |       | (1.0                             | )          | — |   | — |   |
| Reductions for settlements with taxing authority                 |       | (1.2                             | )          | — |   | — |   |
| End of period                                                    |       | $                                | 75.4       |   | $ | 15.2 |   | $ | 12.9 |   |

 

Included in thebalance at December 31, 2009 are $67.1 million of tax positions forwhich ultimate deductibility is highly certain but the timing of deductibilityis uncertain. Because of the impact of deferred tax accounting, other thaninterest and penalties, the disallowance of the shorter deductibility periodwould not affect the effective tax rate but would accelerate the payment ofcash to the taxing authority to an earlier period. On November 18, 2009,the IRS released a coordinated issue paper outlining their position withrespect to loss reserves. The vast majority of the increase during 2009 inadditional liability for the current and prior years relates to deductions forloss reserves in which the timing of the deductions is uncertain. The remainingbalance of $8.3 million, if recognized, would be recorded as a reductionto income tax expense.

 

OB Holdingsclassifies all interest and penalties on unrecognized tax benefits as part ofincome tax expense. During the years ended December 31, 2009, 2008 and2007, OB Holdings recognized $1.6 million, $1.0 million and $(0.3) million,respectively, in interest expense (income), net of federal benefit. The balanceof accrued interest at December 31, 2009 and 

 

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2008 is $3.2 million and$1.6 million, respectively, net of federal benefit. OB Holdings has notaccrued any amount for penalties.

 

With fewexceptions, OB Holdings is no longer subject to U.S. federal, state or non-U.S.income tax examinations by tax authorities for years before 2005. On October 14,2009, a settlement was reached with the IRS on the 2003 and 2004 federal taxexamination, which resulted in an assessment of $24.9 million of additionaltax, or a total assessment of $51.7 million including interest, withholding taxand utilization of tax credits. The portion of the assessment that relates toOB Holdings is $5.9 million of tax. The total assessment relating to OBHoldings, including interest, is $6.4 million. OBIG and its subsidiaries’overall liability for tax assessments for 2003 and 2004 was limited due to theTax Make Whole Arrangements with White Mountains, which fixed the liability forthese items at the amount recorded on OBIG’s consolidated books. OBIGand its subsidiaries recorded a tax benefit in the consolidated statement ofoperations of $15.5 million offset by a capital distribution of approximately$8.4 million, reflected in shareholders’ equity, which resulted in a net increaseto book value of $7.1 million in the fourth quarter of 2009 from the settlementof the 2003 and 2004 tax examination.

 

InOctober 2008,the IRS commenced examination of OBFS’ U.S. income tax returns for 2005 and2006. As of December 31, 2009, the IRS has not proposed any significantadjustments to taxable income as a result of the 2005 and 2006tax examination. It is possible that the 2005 and 2006 examination willconclude within the next 12 months. However, an estimate of the range of potential outcomes can not be madeat this time. OB Holdings does not expect to receive any adjustments that wouldresult in a material change to its financial position.

 

Net cash (refunds)payments for federal, state and non-U.S. income taxes, including tax sharing paymentsto related companies, totaled $(1.0) million, $101.8 million and$174.2 million, respectively, for the years ended December 31, 2009,2008 and 2007.

 

For the years ended December 31, 2009 and 2008, OB Holdings hadnet tax sharing amounts receivable of $29.3 million and $49.8 million,respectively.

 

**NOTE 8. Retirement Plans**

 

OneBeacon sponsors qualified and non-qualified, non-contributory,defined benefit pension plans covering substantially all employees who wereemployed as of December 31, 2001 and remain actively employed withOneBeacon. Current plans include a OneBeacon qualified pension plan (the “QualifiedPlan”) and a OneBeacon non-qualified pension plan (the “Non-qualified Plan”)(collectively the “Plans”). OneBeacon’s Plans were frozen and curtailed in thefourth quarter of 2002. The Plans no longer add new participants or increasebenefits for existing participants, which effectively causes the projectedbenefit obligation to equal the accumulated benefit obligation. Non-vested planparticipants continue to vest during their employment with OneBeacon.

 

The benefits for the Plans are based primarily on years of service andemployees’ compensation through December 31, 2002. Participants generallyvest after five years of continuous service. OneBeacon’s funding policy isconsistent with the funding requirements of U.S. federal laws and regulations.

 

On July 11, 2007, OneBeacon settled approximately 80% of theQualified Plan liabilities through the purchase of two group annuity contractsfor $398.5 million from Transamerica Life Insurance Company (“Transamerica”)and Hartford Life Insurance Company (“Hartford Life”). In accordance with SFAS No. 88“Employers’ Accounting for Settlements and Curtailments of Defined BenefitPension Plans and for Termination Benefits”, subsequently codified within ASC715, the Qualified Plan’s obligations were re-measured in connection with thissettlement. As a result of the partial settlement and re-measurement, OneBeaconrecognized a gain of $25.6 million through pre-tax income($6.3 million as a reduction to loss and LAE, allocated to claimsdepartment employees, and $19.3 million as a reduction to otherunderwriting expenses) and a pre-tax loss of $2.5 million through othercomprehensive income and loss items in the third quarter of 2007. At the timeof settlement, the remaining Qualified Plan liabilities were primarilyattributable to Qualified Plan participants who were actively employed byOneBeacon.

 

During the third quarter of 2008, the Qualified Plan received reimbursementsfrom Transamerica and Hartford Life in the amounts of $0.8 million and $0.6million, respectively, due to the final reconciliation of the partial pensionsettlement. These amounts represented changes in participants and benefitsbetween the time of purchase of the annuity contracts and the settlement plusany related interest and resulted in a pre-tax gain of $1.4 million recognizedin other comprehensive income and loss items.

 

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Thefollowing tables set forth the obligations and funded status, assumptions, planassets and cash flows associated with the Plans at December 31, 2009 and2008:

 
| ** **                                                                     | ** ** | **December 31,**    | ** ** |
|--------------------------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                                     | ** ** | **2009**                 | ** ** | **2008** | ** ** |
| ** **                                                                     | ** ** | **($ in millions)** | ** ** |
| **Change in projected benefit  obligation:**                                   |       |                     |       |   |   |
| Projected benefit obligation at beginning of year                              |       | $                        | 115.9      |   | $ | 121.6 |   |
| Service cost                                                                   |       | 0.5                      |       | 1.0 |   |
| Interest cost                                                                  |       | 6.5                      |       | 6.7 |   |
| Special termination benefit expense                                            |       | 1.2                      |       | 1.8 |   |
| Assumption changes                                                             |       | 2.0                      |       | 1.8 |   |
| Actuarial loss (gain)                                                          |       | 1.8                      |       | (2.8 | ) |
| Benefits and expenses paid with plan assets, net  of participant contributions |       | (7.9                     | )          | (11.3 | ) |
| Benefits paid directly by OneBeacon                                            |       | (2.9                     | )          | (2.9 | ) |
| **Projected benefit obligation at  end of year**                               |       | $                        | 117.1      |   | $ | 115.9 |   |
| **Change in plan assets:**                                                     |       |                     |       |   |   |
| Fair value of plan assets at beginning of year                                 |       | $                        | 111.0      |   | $ | 145.5 |   |
| Actual return on plan assets                                                   |       | 27.1                     |       | (23.2 | ) |
| Employer contributions                                                         |       | —                   |       | — |   |
| Benefits and expenses paid, net of participant  contributions                  |       | (7.9                     | )          | (11.3 | ) |
| **Fair value of plan assets at  end of year**                                  |       | $                        | 130.2      |   | $ | 111.0 |   |
| **Funded status at end of year**                                               |       | $                        | 13.1       |   | $ | (4.9 | ) |

 

The funded status of the consolidated pension plans at December 31,2009 was $13.1 million, which represents an over-funding of $40.2 millionrelated to the Qualified Plan and an under-funding of $27.1 millionrelated to the Non-qualified Plan. The Non-qualified Plan, which is unfunded,does not hold any assets. OneBeacon has set aside $14.5 million in anirrevocable rabbi trust for the benefit of Non-qualified Plan participants. Inaccordance with GAAP, the assets held in the rabbi trust are not reflected inthe funded status of the consolidated pension plans as presented.

 

Amounts recognized in the financial statements as of December 31,2009 and 2008 consist of:

 
| ** **                                             | ** ** | **December 31,**    | ** ** |
|--------------------------------------------------------|------------|--------------------------|------------|
| ** **                                             | ** ** | **2009**                 | ** ** | **2008** | ** ** |
| ** **                                             | ** ** | **($ in millions)** | ** ** |
| Prepaid benefit cost recorded in other assets          |       | $                        | 40.2       |   | $ | 20.8 |   |
| Accrued benefit cost recorded in other liabilities     |       | (27.1                    | )          | (25.7 | ) |
| **Net amount recognized in the  financial statements** |       | $                        | 13.1       |   | $ | (4.9 | ) |

 

Information for the Non-qualified Plan, which had accumulated benefitobligations in excess of plan assets, was as follows:

 
| ** **                     | ** ** | **December 31,**    | ** ** |
|--------------------------------|------------|--------------------------|------------|
| ** **                     | ** ** | **2009**                 | ** ** | **2008** | ** ** |
| ** **                     | ** ** | **($ in millions)** | ** ** |
| Projected benefit obligation   |       | $                        | 27.1       |   | $ | 25.7 |   |
| Accumulated benefit obligation |       | $                        | 27.1       |   | $ | 25.7 |   |
| Fair value of plan assets      |       | $                        | —     |   | $ | — |   |

 

Information for the Qualified Plan, which had accumulated benefitobligations less than plan assets, was as follows:

 
| ** **                     | ** ** | **December 31,**    | ** ** |
|--------------------------------|------------|--------------------------|------------|
| ** **                     | ** ** | **2009**                 | ** ** | **2008** | ** ** |
| ** **                     | ** ** | **($ in millions)** | ** ** |
| Projected benefit obligation   |       | $                        | 90.0       |   | $ | 90.2 |   |
| Accumulated benefit obligation |       | $                        | 90.0       |   | $ | 90.2 |   |
| Fair value of plan assets(1)   |       | $                        | 130.2      |   | $ | 111.0 |   |

 

----

(1)                                  Includesreceivables related to securities sold, interest and dividends as well aspayables related to securities purchased.

 

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The amountsrecognized in accumulated other comprehensive (loss) income on a before taxbasis for the years ended December 31, 2009 and 2008 were as follows:

 
| ** **                                                             | ** ** | **December 31,**     | ** ** |
|------------------------------------------------------------------------|------------|---------------------------|------------|
| ** **                                                             | ** ** | **2009**                  | ** ** | **2008** | ** ** |
| ** **                                                             | ** ** | **($ in  millions)** | ** ** |
| Accumulated other comprehensive (loss) income  beginning balance       |       | $                         | (27.1      | ) | $ | 3.0 |   |
| Increase (decrease) in accumulated other  comprehensive (loss) income: |       |                      |       |   |   |
| Amortization of net actuarial losses recognized during  the year       |       | 1.6                       |       | 0.3 |   |
| Net actuarial gains (losses) occurring during the  year                |       | 17.0                      |       | (30.4 | ) |
| Accumulated other comprehensive loss ending  balance                   |       | $                         | (8.5       | ) | $ | (27.1 | ) |

 

The amount inaccumulated other comprehensive loss, on a before tax basis, that has not yetbeen recognized as a component of net periodic benefit cost for the year ended December 31,2009 is attributable to net losses. During 2010, OneBeacon expects$0.6 million will be amortized from accumulated other comprehensive lossinto net periodic benefit cost.

 

The components ofnet periodic benefit cost (income) for the years ended December 31, 2009,2008 and 2007 were as follows:

 
| ** **                                                                                                 | ** ** | **December 31,**         | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                                                                 | ** ** | **2009**                 | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                                                                 | ** ** | **($ in millions)** | ** ** |
| Service cost                                                                                               |       | $                        | 0.5        |   | $ | 1.0 |   | $ | 2.1 |   |
| Interest cost                                                                                              |       | 6.5                      |       | 6.7 |   | 16.7 |   |
| Expected return on plan assets                                                                             |       | (6.3                     | )          | (8.2 | ) | (17.7 | ) |
| Amortization of prior service benefit                                                                      |       | —                   |       | — |   | — |   |
| Amortization of unrecognized loss                                                                          |       | 1.6                      |       | 0.3 |   | 0.3 |   |
| Net periodic pension cost (income) before  settlements, curtailments and special termination benefits |       | 2.3                      |       | (0.2 | ) | 1.4 |   |
| Settlement gain                                                                                            |       | —                   |       | — |   | (25.6 | ) |
| Special termination benefits expense(1)                                                                    |       | 1.2                      |       | 1.8 |   | 1.8 |   |
| **Total net periodic benefit cost  (income)**                                                              |       | $                        | 3.5        |   | $ | 1.6 |   | $ | (22.4 | ) |

 

----

(1)                                 Specialtermination benefits represent additional payments made from the Qualified Planto certain vested participants when their employment was terminated due to areduction in force.

 

**Assumptions**

 

The weightedaverage assumptions used to determine benefit obligations at December 31,2009 and 2008 were:

 
| ** **    | ** ** | **December 31,** | ** ** |
|---------------|------------|-----------------------|------------|
| ** **    | ** ** | **2009**              | ** ** | **2008** | ** ** |
| Discount rate |       | 5.44                  | %          | 5.67 | % |

 

The weightedaverage assumptions used to determine net periodic benefit cost for the yearsended December 31, 2009 and 2008 were:

 
| ** **                                       | ** ** | **December 31,** | ** ** |
|--------------------------------------------------|------------|-----------------------|------------|
| ** **                                       | ** ** | **2009**              | ** ** | **2008** | ** ** |
| Discount rate                                    |       | 5.67                  | %          | 5.75 | % |
| Expected long-term rate of return on plan assets |       | 5.75                  | %          | 5.75 | % |

 

OneBeacon’sdiscount rate assumptions used to account for the Plans reflect the rates atwhich the benefit obligations could be effectively settled. For 2009 and 2008,in addition to consideration of published yields for high quality long-termcorporate bonds, U.S. Treasuries and insurance company annuity contractpricings, consideration was given to a cash flow matching analysis utilizingthe Citigroup Pension Discount Curve and Liability Index.

 

OneBeaconperformed an analysis of expected long-term rates of return based on theallocation of its Qualified Plan assets at December 31, 2008 and 2007 todevelop expected rates of return for 2009 and 2008 for each significant assetclass or economic indicator. A range of returns was developed based both onforecasts and on broad-market historical benchmarks for expected return,correlation, and volatility for each asset class.

 

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***Plan Assets***

 

The majority of the Qualified Plan’s assets are managed by ProspectorPartners, LLC (“Prospector”), a related party (see Note 16). Theinvestment policy places an emphasis on preserving invested assets through adiversified portfolio of high-quality income producing investments and equityinvestments.

 

The investment management process integrates the risks and returnsavailable in the investment arena with the risks and returns available to theQualified Plan in establishing the proper allocation of invested assets. Theasset classes include fixed maturity, equity, convertible bonds, and cash andshort-term investments. Fixed maturity and convertible bonds include bonds,convertible bonds and convertible preferred stocks of companies fromdiversified industries. Equity securities primarily include investments inlarge-cap and mid-cap companies primarily located in the United States. Cashand short-term investments include registered investment companies andcommon/collective trust funds.

 

The factors examined in establishing the appropriate investment mixinclude the outlook for risk and return in the various investment markets andsectors, and the long-term need for capital growth. As of December 31,2009, the Qualified Plan assets were comprised of 3.7% fixed maturityinvestments, 51.2% of common equity securities, 30.5% of convertible bonds and14.6% cash and short-term investments.

 

The Qualified Plan’sinvestments are stated at fair value. Many factors are considered in arrivingat fair market value. In general, fixed maturity investments such as corporatebonds and government securities are valued based on yields currently availableon comparable securities of issuers with similar credit ratings. Shares ofcommon and preferred stock are valued at quoted market prices when available.Convertible bonds are valued based on quoted market prices, analysis of listedmarkets and use of sensitivity analyses. Registered investment companies arevalued at the net asset value as reported by the fund at year-end. Units ofcommon/collective trust funds are valued at the net asset value of the fund asof the balance sheet date.

 

The fair value of the Qualified Plan’s assets and their related inputsat December 31, 2009 by asset category were as follows:

 
| ** **                      | ** ** | **Fair value at  December 31, 2009** | ** ** | **Level 1 Inputs** | ** ** | **Level 2 Inputs** | ** ** |
|---------------------------------|------------|----------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                      | ** ** | **($ in  millions)**                                | ** ** |
| Fixed maturity investments      |       | $                                                        | 4.9        |                         | $          | —                       |       | $ | 4.9 |   |
| Common equity securities        |       | 66.8                                                     |       | 66.8                         |       | —                       |       |
| Convertible bonds               |       | 39.8                                                     |       | —                       |       | 39.8                         |       |
| Cash and short-term investments |       | 19.0                                                     |       | 19.0                         |       | —                       |       |
| Total                           |       | $                                                        | 130.5      |                         | $          | 85.8                         |       | $ | 44.7 |   |

 

There were no fair value measurements valued using Level 3 inputs as ofDecember 31, 2009 and 2008.

 

The Qualified Plan’sasset allocations at December 31, 2009 and 2008 by asset category were asfollows:

 
| ** **                      | ** ** | **Plan Assets at  December 31,** | ** ** |
|---------------------------------|------------|---------------------------------------|------------|
| **Asset Category**         | ** ** | ** **                            | **2009**   | ** ** | **2008** | ** ** |
| Fixed maturity investments      |       | 3.7                                   | %          | 7.5 | % |
| Common equity securities        |       | 51.2                                  |       | 38.1 |   |
| Convertible bonds               |       | 30.5                                  |       | 42.1 |   |
| Cash and short-term investments |       | 14.6                                  |       | 12.3 |   |
| Total                           |       | 100.0                                 | %          | 100.0 | % |
|                                 |            |                                       |            |  |  |  |

 

As describedabove, the Qualified Plan’s investment securities are exposed to various riskssuch as interest rate, market, and credit risks. Market prices of common equitysecurities, in general, are subject to fluctuations which would cause theamount to be realized upon sale or exercise of the instruments to differsignificantly from the current reported value. The fluctuations may result fromperceived changes in the underlying economic characteristics of the investee,the relative price of alternative investments, general market conditions andsupply and demand imbalances for a particular security. Increases and decreasesin prevailing interest rates generally translate into decreases and increasesin fair values of fixed maturity and convertible bond investments,respectively. Additionally, fair values of interest rate sensitive instrumentsmay be affected by 

 

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the creditworthiness ofthe issuer, prepayment options, relative values of alternative investments, theliquidity of the instrument and other general market conditions.

 

***Cash Flows***

 

OneBeacon does not expect to make a contribution to its Qualified Planin 2010. OneBeacon anticipates contributing $2.8 million to the Non-qualifiedPlan, for which OneBeacon has assets held in a rabbi trust.

 

The following benefit payments, which reflect expected future service,as appropriate, are expected to be paid:

 
| ** ** | ** ** | **Expected Benefit  Payments** | ** ** |
|------------|------------|--------------------------------|------------|
| ** ** | ** ** | **($ in millions)**       | ** ** |
| 2010       |       | $                              | 5.3        |   |
| 2011       |       | 5.7                            |       |
| 2012       |       | 6.2                            |       |
| 2013       |       | 6.5                            |       |
| 2014       |       | 6.9                            |       |
| 2015-2019  |       | 38.7                           |       |
|            |            |                                |            |  |

 

***Other Benefit Plans***

 

OneBeacon sponsors an employee savings plan (defined contribution plan)covering the majority of employees. The contributory plan provides qualifyingemployees with matching contributions of 50% of the first 6% of salary (subjectto federal limits on allowable contributions in a given year). Total expensefor the plan was $4.6 million, $4.7 million and $3.7 million,respectively, in the years ended December 31, 2009, 2008 and 2007,respectively. The employee savings plan includes an employee stock ownershipcomponent. See Note 9.

 

OneBeacon had a post-employment benefit liability of $7.8 million and$8.0 million related to its long-term disability plan at December 31,2009 and 2008, respectively.

 

**NOTE 9. Employee Share-Based Incentive Compensation Plans**

 

OB Holdings’ share-based compensation plans consist of performance shares.OB Holdings’ share-based compensation plans are designed to maximizeshareholder value over long periods of time by aligning the financial interestsof its management with those of its owners. Performance shares are payable onlyupon achievement of pre-defined business goals and are valued based on themarket value of OBIG’s common shares at the time awards are earned. See “PerformanceShares” below. Performance shares are typically paid in cash, though, in someinstances, they may be paid in common shares or may be deferred in accordancewith the terms of one of the deferred compensation plans of the Company’ssubsidiaries. OB Holdings expenses the full cost of all its share-basedcompensation.

 

OB Holdings records it share-based compensation in accordance with SFASNo. 123(R), “Share-Based Payment”, subsequently codified within ASC 718.ASC 718 applies to new grants of share-based awards, award modifications andthe remaining portion of the fair value of the unvested awards. The unvestedportion of OB Holdings performance share awards, as well as new awards, aresubject to the fair value measurement and recognition requirements of ASC 718.

 

***OneBeacon Long-Term Incentive Plan(the “Incentive Plan”)***

 

The Incentive Plan provides for granting various types of share-basedincentive awards including performance shares, performance units, options,share appreciation rights and restricted shares to certain key employees of OBHoldings. The Incentive Plan was adopted by OBIG’s board of directors (the “Board”)in October 2006. Prior to adoption of the Incentive Plan, share-basedawards were granted under the OneBeacon Phantom WTM Share Plan. In 2007, theBoard and shareholders approved the 2007 OneBeacon Long-Term Incentive Plan(the “2007 Incentive Plan”). The 2007 Incentive Plan provides for all of theawards referenced above as well as restricted stock units.  Awards are granted under the 2007 IncentivePlan.

 

***Performance Shares &Phantom Performance Shares***

 

Performance shares are conditional grants of a specified maximum numberof common shares or an equivalent amount of cash. Phantom shares are much likeperformance shares but settle only in cash. In general, grants are earned, 

 

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subjectto the attainment of pre-specified performance goals, at the end of athree-year period or as otherwise determined by the Compensation Committee ofthe Board (the “Compensation Committee”) and are valued based on the marketvalue of common shares at the time awards are paid. Results that significantlyexceed pre-specified targets can result in a performance share payout of up to200% of granted shares whereas results significantly below target result in nopayout.

 

Through 2006, the principal performance share goal had been WhiteMountains’ after tax corporate return on equity as measured by growth in itsintrinsic value per share. In determining intrinsic value per share, WhiteMountains’ Compensation Committee of its Board of Directors had considered theWhite Mountains’ growth in economic value per share with some attention togrowth in tangible book value per share and growth in market value per share.This proprietary measure was viewed by White Mountains’ and OB Holdings’management as being an objective and conservative measure of the value of WhiteMountains’ stock and included the cost of all outstanding compensation awards.

 

Prior to February 2007, the value of OB Holdings’ performanceshares was based upon the market price of an underlying White Mountains commonshare (“WTM Performance Shares”). In February 2007, all of OB Holdings’WTM Performance Shares outstanding were replaced with performance shares whosevalue is based upon the market price of an underlying OBIG common share (“OBPerformance Shares”).

 

For awards granted in February 2007, the Compensation Committeedefined growth in intrinsic business value per share (“GIBVPS”) to be aweighted measure comprised of growth in OBIG’s adjusted book value per share,underwriting return on equity and growth in OBIG’s common price per share. Thetargeted performance goal for full payment of the outstanding performanceshares granted during the year ended December 31, 2007 is the attainmentof a GIBVPS of 13%. At a GIBVPS of 6% or less, no performance shares would beearned and at a GIBVPS of 20% or more, 200% of performance shares would beearned.

 

For awards granted in February 2008, the Compensation Committeedefined GIBVPS to be a weighted measure comprised of growth in OBIG’s adjustedbook value per share and underwriting return on equity. The targetedperformance goal for full payment of the outstanding performance shares grantedduring the year ended December 31, 2008 is the attainment of a GIBVPS of11%. At a GIBVPS of 4% or less, no performance shares would be earned and at aGIBVPS of 18% or more, 200% of performance shares would be earned.

 

For awards granted in February 2009, the Compensation Committeegranted performance shares with a goal of growth in OBIG’s book value per share(“GBVPS”). The targeted performance goal for full payment of the outstandingperformance shares granted during the year ended December 31, 2009 is theattainment of a GBVPS of 12%. At a GBVPS of 5% or less, no performance shareswould be earned and at a GBVPS of 19% or more, 200% of performance shares wouldbe earned.

 

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Thefollowing summarizes performance share activity for OB Performance Shares forthe years ended December 31, 2009, 2008 and 2007:

 
| ** **                                        | ** ** | **Year ended December 31,**               | ** ** |
|---------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                        | ** ** | **2009**                                       | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                        | ** ** | **Target OB Performance  Shares  outstanding** | ** ** | **Accrued  expense** | ** ** | **Target OB Performance  Shares  outstanding** | ** ** | **Accrued  expense** | ** ** | **Target OB Performance  Shares  outstanding** | ** ** | **Accrued  expense** | ** ** |
| ** **                                        | ** ** | **($ in millions)**                       | ** ** |
| Beginning of period                               |       | 2,212,313                                      |       | $ | 4.6 |   | 1,058,194 |   | $ | 9.2 |   | — |   | $ | — |   |
| Payments and deferrals(1)(2)                      |       | (137,400                                       | )          | — |   | (117,363 | ) | (1.6 | ) | — |   | — |   |
| New awards                                        |       | 379,085                                        |       | — |   | 1,430,258 |   | — |   | 934,131 |   | — |   |
| Forfeitures and net change in assumed forfeitures |       | (229,783                                       | )          | (0.5 | ) | (158,776 | ) | (0.6 | ) | (158,638 | ) | (0.2 | ) |
| Transfers in(3)                                   |       | —                                         |       | — |   | — |   | — |   | 282,701 |   | 4.1 |   |
| Expense (income) recognized                       |       | —                                         |       | 11.0 |   | — |   | (2.4 | ) | — |   | 5.3 |   |
| End of period                                     |       | 2,224,215                                      |       | $ | 15.1 |   | 2,212,313 |   | $ | 4.6 |   | 1,058,194 |   | $ | 9.2 |   |

 

----

(1)                                  Performanceshare payments in 2009 for the 2007-2008 performance cycle were based upon aperformance factor of 1.4%.

 

(2)                                  Performance share payments in 2008 forthe 2007 performance cycle were based upon a performance factor of 63%.

 

(3)                                  In February 2007,OB Holdings’ WTM Performance Shares were replaced with OB Performance Shares ofan equivalent value.

 

The following summarizes performance share activity for WTM PerformanceShares for the year ended December 31, 2007:

 
| ** **                                        | ** ** | **Year ended December 31,**                  | ** ** |
|---------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                        | ** ** | **2007**                                          | ** ** |
| ** **                                        | ** ** | **Target  WTM  Performance  Shares  outstanding** | ** ** | **Accrued  expense** | ** ** |
| ** **                                        | ** ** | **($ in millions)**                          | ** ** |
| Beginning of period                               |       | 16,470                                            |       | $ | 7.8 |   |
| Payments and deferrals(1)                         |       | (4,400                                            | )          | (3.7 | ) |
| New awards                                        |       | —                                            |       | — |   |
| Forfeitures and net change in assumed forfeitures |       | —                                            |       | — |   |
| Transfers out(2)                                  |       | (12,070                                           | )          | (4.1 | ) |
| Expense recognized                                |       | —                                            |       | — |   |
| End of period                                     |       | —                                            |       | $ | — |   |

 

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(1)                                  Performanceshare payments in 2007 for the 2004-2006 performance cycle were based upon aperformance factor of 145%.

 

(2)                                  In February 2007,OB Holdings’ WTM Performance Shares were replaced with OB Performance Shares ofan equivalent value.

 

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Thefollowing summarizes performance shares outstanding and accrued performanceshare expense at December 31, 2009 for each performance cycle:

 
| ** **                      | ** ** | **Target OB  Performance  Shares  outstanding** | ** ** | **Accrued  expense** | ** ** |
|---------------------------------|------------|-------------------------------------------------|------------|----------------------|------------|
| ** **                      | ** ** | **($ in millions)**                        | ** ** |
| Performance cycle:              |       |                                            |       |                 |       |
| 2007—2009                  |       | 682,344                                         |       | $                    | 2.1        |   |
| 2008—2010                  |       | 1,220,187                                       |       | 9.8                  |       |
| 2009—2011                  |       | 361,219                                         |       | 3.5                  |       |
| Sub-total                       |       | 2,263,750                                       |       | 15.4                 |       |
| Assumed forfeitures             |       | (39,535                                         | )          | (0.3                 | )          |
| Total at December 31, 2009 |       | 2,224,215                                       |       | $                    | 15.1       |   |

 

If 100% of theoutstanding performance shares had been vested on December 31, 2009, thetotal additional compensation cost to be recognized would have been$11.7 million, based on current accrual factors (OBIG’s common share priceand payout assumptions).

 

All performanceshares earned for the 2007-2008 and 2007 performance cycles were settled incash or by deferral into certain non-qualified deferred compensation plans ofthe Company’s subsidiaries.

 

At December 31, 2009, 361,219, 1,220,187 and 682,344 performanceshares had been granted at target and remained outstanding under the IncentivePlan for the performance periods 2009-2011, 2008-2010 and 2007-2009, respectively.

 

***Other Share-Based Compensation***

 

OBIC, an indirectwholly-owned subsidiary of the Company, sponsors a defined contribution plan,the OneBeacon 401(k) Savings and Employee Stock Ownership Plan (“KSOP”),formerly known separately as the OneBeacon 401(k) Savings Plan and theOneBeacon Employee Stock Ownership Plan (“ESOP”). In April 2007, the twoplans were merged to form the KSOP. Under the KSOP, participants have theability to invest their balances in several different investment options,including the common shares of White Mountains and the common shares of OBIG.

 

The employee stockownership component of the KSOP provides all participants with an annual basecontribution in common shares of OBIG equal to 3% of their salary, up to theapplicable Social Security wage base (or $106,800 with respect to 2009).Additionally, those participants not otherwise eligible to receive certainother OneBeacon benefits can earn a variable contribution up to an additional6% of their salary, capped at the annual covered compensation limits ($245,000for 2009), contingent upon OneBeacon’s performance. The variable contributionamounts earned by eligible participants constituted approximately 4%, 4% and 6%of salary for the years ended December 31, 2009, 2008 and 2007,respectively. OneBeacon has recorded $10.7 million, $11.5 million and$15.4 million in compensation expense to pay benefits and allocate commonshares to participants’ accounts for the years ended December 31, 2009,2008 and 2007, respectively.

 

As of December 31,2009 and 2008, the KSOP owned 2% or less of either of the total White Mountainscommon shares outstanding or the total OBIG shares outstanding.

 

As of December 31,2009, there were no outstanding share appreciation rights or restricted shareawards.

 

**NOTE10.  Mandatorily Redeemable PreferredStock**

 

***Mandatorily Redeemable Preferred Stock***

 

OBH heldmandatorily redeemable preferred stock prior to its redemption in May 2008.This instrument was classified as a liability and carried at its historicalcarrying value. Dividends and accretion on OBH’s mandatorily redeemablepreferred stock were recorded as interest expense. During the years ended December 31,2008 and 2007, OBH recorded $33.4 million and $64.4 million, respectively,as interest expense on preferred stock (of which $21.6 million and$36.1 million, respectively, represented accretion of discount).

 

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*BerkshirePreferred Stock*

 

As part of thefinancing for the OneBeacon Acquisition, Berkshire invested a total of$300 million in cash, of which (1) $225 million was for thepurchase of cumulative non-voting preferred stock of OBH (the “BerkshirePreferred Stock”), which had 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 was entitled to a dividend of no lessthan 2.35% per quarter until it was redeemed on May 31, 2008 for $300million, its redemption value. The Berkshire Preferred Stock was initiallyrecorded at $145.2 million, as the aggregate proceeds received fromBerkshire of $300 million were allocated between the Berkshire PreferredStock and the warrants, based on their relative fair values in accordance withAPB No. 14, “Accounting for Convertible Debt and Debt Issued with StockPurchase Warrants”, subsequently codified within ASC 470. During the yearsended December 31, 2008 and 2007, OBH declared and paid dividends of $11.8million and $28.3 million, respectively, on the Berkshire Preferred Stockand recorded $21.6 million and $36.1 million, respectively, of relatedaccretion charges on the Berkshire Preferred Stock.

 

In connection withOBIG’s initial public offering and as part of the reorganization, the Companycreated an irrevocable grantor trust and funded it with assets sufficient tomake the remaining dividend and redemption payments for the $300 millionBerkshire Preferred Stock. The creation and funding of the trust did notlegally defease the preferred stock nor create any additional rights for theholders of the preferred stock either in the trust or otherwise, although theassets in the trust were segregated from the Company’s other general assets andwere not available for any use other than the payment of the BerkshirePreferred Stock. The assets held in trust were used to redeem the BerkshirePreferred Stock in May 2008 for $300 million, its redemption value.

 

**NOTE11.  Common Shareholder’s Equity**

 

*Adjustmentsto Adopt Accounting Pronouncements*

 

On January 1,2008, OB Holdings adopted ASC 825. See Note 5 for further discussion. Uponadoption, OB Holdings recorded an adjustment of $182.4 million to reclassifynet unrealized gains, after tax, and net unrealized foreign currencytranslation gains, after tax, related to investments from accumulated othercomprehensive income to opening retained earnings.

 

On January 1,2007, OB Holdings adopted ASC 740.  SeeNote 7 for further discussion.  Uponadoption, OB Holdings recognized a $0.3 million increase in the liabilityfor unrecognized tax benefits, primarily as a result of increases in itsestimates of accrued interest. The effect of adoption was recorded as anadjustment to opening retained earnings.

 

*Dividends*

 

During 2009, OBHdeclared and paid dividends to its immediate parent, OneBeacon U.S. EnterprisesHoldings, Inc. (“OBEH”), formerly known as Fund American EnterprisesHoldings, Inc., totaling $68.1 million, all of which was paid in cash.During 2008, OBH declared and paid dividends to OBEH totaling $219.9 million,all of which was paid in cash. During 2007, OBH declared and paid dividends toOBEH totaling $195.0 million, of which $93.4 million was paid incash.

 

*Accumulated Other ComprehensiveIncome (Loss)*

 

For the yearsended December 31, 2009, 2008 and 2007, OB Holdings recorded the after taxchange in the fair value of the interest rate swap related to the mortgage loanof $6.8 million, $(5.7) million and $(1.1) million, respectively, as achange to accumulated other comprehensive (loss) income.  See Note 6 for further information.

 

For the yearsended December 31, 2009, 2008 and 2007, OB Holdings recorded the after taxchange in its additional pension liability of $12.1 million, $(19.5) millionand $(0.1), respectively, as a change to accumulated other comprehensive income(loss).  See Note 8 for furtherinformation.

 

Prior to theadoption of ASC 825, OB Holdings recorded the change in net unrealized gainsand losses on investments and the change in foreign currency translation on itsforeign investment securities as a component of accumulated other comprehensiveincome (loss). For the year ended December 31, 2007, OB Holdings recordedthe after tax change in net unrealized gains and losses on investments of$(3.2) million and the change in foreign currency translation on its foreigninvestment securities of $0.5 million. See Note 5.

 

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**NOTE12.  Statutory Capital and Surplus**

 

OB Holdings’insurance operations are subject to regulation and supervision in each of thejurisdictions where they are domiciled and licensed to conduct business.Generally, regulatory authorities have broad supervisory and administrativepowers over such matters as licenses, standards of solvency, premium rates,policy forms, investments, security deposits, methods of accounting, form andcontent of financial statements, reserves for unpaid loss and LAE, reinsurance,minimum capital and surplus requirements, dividends and other distributions toshareholders, periodic examinations and annual and other report filings. In general,such regulation is for the protection of policyholders rather thanshareholders. Over the last several years most states have implemented lawsthat establish standards for current, as well as continued, stateaccreditation. In addition, the National Association of Insurance Commissionersuses risk-based capital (“RBC”) standards for property and casualty insurers asa means of monitoring certain aspects affecting the overall financial conditionof insurance companies. At December 31, 2009, OB Holdings’ activeinsurance operating subsidiaries met their respective RBC requirements.

 

OB Holdings’combined insurance subsidiaries’ policyholders’ surplus as reported to variousregulatory authorities as of December 31, 2009 and 2008, was $1.6 billionand $1.4 billion, respectively. OB Holdings’ consolidated combinedstatutory net income (loss) for the years ended December 31, 2009, 2008and 2007 was $210.5 million, $(156.5) million and $335.2 million,respectively. The principal differences between OB Holdings’ combined statutoryamounts and the amounts reported in accordance with GAAP include deferredacquisition costs, deferred taxes, gains recognized under retroactivereinsurance contracts, market value adjustments for debt securities andrecognition of pension plans. OB Holdings’ combined insurance subsidiaries’statutory policyholders’ surplus at December 31, 2009 was in excess of theminimum requirements of relevant state insurance regulations.

 

In December 2008,OneBeacon Insurance Group LLC (“OneBeacon LLC”) contributed$25.0 million to OBIC.

 

***Dividend Capacity***

 

Under theinsurance laws of the states and jurisdictions under which OB Holdings’insurance operating subsidiaries are domiciled, an insurer is restricted withrespect to the timing or the amount of dividends it may pay without priorapproval by regulatory authorities. Accordingly, there can be no assuranceregarding the amount of such dividends that may be paid by such subsidiaries inthe future.

 

Generally, OBHoldings’ regulated insurance operating subsidiaries have the ability to paydividends during any twelve month period in an amount equal to the greater ofprior year statutory net income or 10% of prior year end statutory surplus,subject to the availability of unassigned funds. Based upon 2009 statutorysurplus of $1.6 billion, OB Holdings’ top tier regulated insurance operatingsubsidiaries have the ability to pay approximately $157 million ofdividends during 2010, subject to the availability of unassigned funds. As of December 31,2009, OB Holdings’ top tier regulated insurance operating subsidiaries hadapproximately $1.1 billion of unassigned funds. As of December 31,2009, OB Holdings had approximately $64 million of unrestricted net cashand fixed maturity investments outside of its regulated insurance operatingsubsidiaries.

 

During the yearsended December 31, 2009, 2008 and 2007, OB Holdings’ regulated operatingsubsidiaries paid $80.0 million, $197.0 million and $393.9 million,respectively, of dividends to OneBeacon LLC. During the years ended December 31,2009, 2008 and 2007, OB Holdings’ unregulated insurance operating subsidiariespaid $11.9 million, $6.0 million and $3.6 million, respectively, ofdividends to their immediate parent.

 

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**NOTE13.  Segment Information**

 

OB Holdings’segments consist of the following: (1) Insurance Operations, formerlyknown as Primary Insurance Operations; and (2) Other Operations. OBHoldings has made its segment determination based on consideration of thefollowing criteria: (i) the nature of the business activities of each ofthe Company’s subsidiaries and affiliates; (ii) the manner in which theCompany’s subsidiaries and affiliates are organized; (iii) the existenceof primary managers responsible for specific subsidiaries and affiliates; and (iv) theorganization of information provided to the chief operating decision makers andthe Board. Significant intercompany transactions among OB Holdings’ segmentshave been eliminated herein. Financial information for OB Holdings’ segmentsfollows:

 
| ** **                                                                          | ** ** | **Insurance  Operations** | ** ** | **Other  Operations** | ** ** | **Total** | ** ** |
|-------------------------------------------------------------------------------------|------------|---------------------------|------------|-----------------------|------------|-----------|------------|
| ** **                                                                          | ** ** | **($ in  millions)** | ** ** |
| **Year ended December 31, 2009**                                               |       |                      |       |                  |       |      |       |
| Earned premiums                                                                     |       | $                         | 1,959.5    |                  | $          | —    |       | $ | 1,959.5 |   |
| Net investment income (expense)                                                     |       | 127.4                     |       | (2.1                  | )          | 125.3     |       |
| Net realized and unrealized investment gains  (losses)                              |       | 250.7                     |       | (2.1                  | )          | 248.6     |       |
| Net other revenues                                                                  |       | 41.0                      |       | 3.7                   |       | 44.7      |       |
| Total revenues                                                                      |       | 2,378.6                   |       | (0.5                  | )          | 2,378.1   |       |
| Loss and LAE                                                                        |       | 1,121.9                   |       | —                |       | 1,121.9   |       |
| Policy acquisition expenses                                                         |       | 398.3                     |       | —                |       | 398.3     |       |
| Other underwriting expenses                                                         |       | 330.0                     |       | —                |       | 330.0     |       |
| General and administrative expenses                                                 |       | 16.9                      |       | 1.1                   |       | 18.0      |       |
| Accretion of fair value adjustment to loss and  LAE reserves                   |       | —                    |       | 5.4                   |       | 5.4       |       |
| Interest expense on debt                                                            |       | 1.5                       |       | 38.2                  |       | 39.7      |       |
| Total expenses                                                                      |       | 1,868.6                   |       | 44.7                  |       | 1,913.3   |       |
| Pre-tax income (loss)(1)                                                            |       | $                         | 510.0      |                  | $          | (45.2     | )          | $ | 464.8 |   |
| **Year ended December 31, 2008**                                               |       |                      |       |                  |       |      |       |
| Earned premiums                                                                     |       | $                         | 1,879.0    |                  | $          | —    |       | $ | 1,879.0 |   |
| Net investment income                                                               |       | 152.8                     |       | 9.3                   |       | 162.1     |       |
| Net realized and unrealized investment losses                                       |       | (760.5                    | )          | (5.5                  | )          | (766.0    | )          |
| Net other revenues (expenses)                                                       |       | 14.0                      |       | (0.2                  | )          | 13.8      |       |
| Total revenues                                                                      |       | 1,285.3                   |       | 3.6                   |       | 1,288.9   |       |
| Loss and LAE                                                                        |       | 1,126.2                   |       | —                |       | 1,126.2   |       |
| Policy acquisition expenses                                                         |       | 368.3                     |       | —                |       | 368.3     |       |
| Other underwriting expenses                                                         |       | 290.8                     |       | —                |       | 290.8     |       |
| General and administrative expenses                                                 |       | 10.5                      |       | 0.7                   |       | 11.2      |       |
| Accretion of fair value adjustment to loss and  LAE reserves                   |       | —                    |       | 12.0                  |       | 12.0      |       |
| Interest expense on debt                                                            |       | 3.5                       |       | 41.4                  |       | 44.9      |       |
| Interest expense—dividends on preferred stock  subject to mandatory redemption |       | —                    |       | 11.8                  |       | 11.8      |       |
| Interest expense—accretion on preferred stock  subject to mandatory redemption |       | —                    |       | 21.6                  |       | 21.6      |       |
| Total expenses                                                                      |       | 1,799.3                   |       | 87.5                  |       | 1,886.8   |       |
| Pre-tax loss (1)                                                                    |       | $                         | (514.0     | )                     | $          | (83.9     | )          | $ | (597.9 | ) |
| **Year ended December 31, 2007**                                               |       |                      |       |                  |       |      |       |
| Earned premiums                                                                     |       | $                         | 1,873.6    |                  | $          | —    |       | $ | 1,873.6 |   |
| Net investment income                                                               |       | 184.5                     |       | 17.9                  |       | 202.4     |       |
| Net realized and unrealized investment gains  (losses)                              |       | 174.5                     |       | (1.4                  | )          | 173.1     |       |
| Net other revenues (expenses)                                                       |       | 19.2                      |       | (2.0                  | )          | 17.2      |       |
| Total revenues                                                                      |       | 2,251.8                   |       | 14.5                  |       | 2,266.3   |       |
| Loss and LAE                                                                        |       | 1,089.8                   |       | —                |       | 1,089.8   |       |
| Policy acquisition expenses                                                         |       | 318.9                     |       | —                |       | 318.9     |       |
| Other underwriting expenses                                                         |       | 329.4                     |       | —                |       | 329.4     |       |
| General and administrative expenses                                                 |       | (0.8                      | )          | 0.3                   |       | (0.5      | )          |
| Accretion of fair value adjustment to loss and  LAE reserves                   |       | —                    |       | 16.0                  |       | 16.0      |       |
| Interest expense on debt                                                            |       | 3.2                       |       | 42.0                  |       | 45.2      |       |
| Interest expense—dividends on preferred stock  subject to mandatory redemption |       | —                    |       | 28.3                  |       | 28.3      |       |
| Interest expense—accretion on preferred stock  subject to mandatory redemption |       | —                    |       | 36.1                  |       | 36.1      |       |
| Total expenses                                                                      |       | 1,740.5                   |       | 122.7                 |       | 1,863.2   |       |
| Pre-tax income (loss) (1)                                                           |       | $                         | 511.3      |                  | $          | (108.2    | )          | $ | 403.1 |   |

 

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| ** **                                                                      | ** ** | **Insurance  Operations** | ** ** | **Other  Operations** | ** ** | **Total** | ** ** |
|---------------------------------------------------------------------------------|------------|---------------------------|------------|-----------------------|------------|-----------|------------|
| ** **                                                                      | ** ** | **($ in  millions)** | ** ** |
| **December 31, 2009**                                                      |       |                      |       |                  |       |      |       |
| Total investments                                                               |       | $                         | 3,989.9    |                  | $          | (2.2      | )          | $ | 3,987.7 |   |
| Reinsurance recoverable on paid and unpaid losses                               |       | 2,399.3                   |       | (190.5                | )          | 2,208.8   |       |
| Total assets                                                                    |       | 7,690.6                   |       | (198.6                | )          | 7,492.0   |       |
| Loss and LAE reserves                                                           |       | 4,125.3                   |       | (190.5                | )          | 3,934.8   |       |
| Total liabilities                                                               |       | 5,660.0                   |       | 421.4                 |       | 6,081.4   |       |
| Total OB Holdings’ shareholder’s equity                               |       | 2,011.5                   |       | (620.0                | )          | 1,391.5   |       |
| Total OB Holdings’ shareholder’s equity and  noncontrolling interests |       | 2,030.6                   |       | (620.0                | )          | 1,410.6   |       |
| **December 31, 2008**                                                      |       |                      |       |                  |       |      |       |
| Total investments                                                               |       | $                         | 3,653.3    |                  | $          | 71.4      |       | $ | 3,724.7 |   |
| Reinsurance recoverable on paid and unpaid losses                               |       | 2,730.1                   |       | (205.1                | )          | 2,525.0   |       |
| Total assets                                                                    |       | 7,962.7                   |       | (100.7                | )          | 7,862.0   |       |
| Loss and LAE reserves                                                           |       | 4,504.5                   |       | (210.5                | )          | 4,294.0   |       |
| Total liabilities                                                               |       | 6,241.8                   |       | 469.6                 |       | 6,711.4   |       |
| Total OB Holdings’ shareholder’s equity                               |       | 1,703.7                   |       | (570.3                | )          | 1,133.4   |       |
| Total OB Holdings’ shareholder’s equity and  noncontrolling interests |       | 1,720.9                   |       | (570.3                | )          | 1,150.6   |       |

 

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(1)                                  Includes incomefrom noncontrolling interests.

 

OB Holdings currentlymanages its Insurance Operations segment through a specialty lines underwritingunit and a personal lines underwriting unit, nearly all of which is subject tothe personal lines transaction described below. See Note 18. The InsuranceOperations segment also includes run-off business, which primarily consists ofnon-specialty commercial lines business which is being transferred to TheHanover, as described in Note 2, and other run-off business.

 

OB Holdings’ specialtylines underwriting unit is a collection of niche insurance businesses,including professional liability products, marine insurance, collectors carsand boats, property and inland marine, tuition reimbursement, excess propertyand accident & health products, as well as property and casualtyinsurance coverages tailored to industry groups such as technology, financialservices, entertainment, sports and leisure industries and government entities.OB Holdings’ personal lines underwriting unit provides homeowners, automobileand combination insurance policies. The personal lines underwriting unit alsoincludes AutoOne, a subsidiary within OB Holdings that offers products andservices to assigned risk markets. OB Holdings’ Insurance Operations segment alsoincludes run-off which consists of non-specialty commercial lines businessincluded in the Commercial Lines Transaction, as well as national accounts,certain specialty programs and regional agency business transferred to LibertyMutual Insurance Group (“Liberty Mutual”) effective November 1, 2001.

 

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The following tables provide ratios, net written premiums and earnedpremiums for OB Holdings’ Insurance Operations by major underwriting unit andin total for the years ended December 31, 2009, 2008 and 2007:

 
| ** **                            | ** ** | **Specialty(1)**         | ** ** | **Personal** | ** ** | **Run-off(2)** | ** ** | **Total** | ** ** |
|---------------------------------------|------------|--------------------------|------------|--------------|------------|----------------|------------|-----------|------------|
| ** **                            | ** ** | **($ in millions)** | ** ** |
| **Year ended December 31, 2009** |       |                     |       |         |       |           |       |      |       |
| Ratios:                               |       |                     |       |         |       |           |       |      |       |
| Loss and LAE                          |       | 43.9                     | %          | 75.7         | %          | 61.1           | %          | 57.3      | %          |
| Expense                               |       | 39.6                     |       | 31.2         |       | 39.6           |       | 37.1      |       |
| Total GAAP combined                   |       | 83.5                     | %          | 106.9        | %          | 100.7          | %          | 94.4      | %          |
| Net written premiums                  |       | $                        | 946.2      |         | $          | 508.7          |       | $         | 451.8      |   | $ | 1,906.7 |   |
| Earned premiums                       |       | 917.9                    |       | 567.9        |       | 473.7          |       | 1,959.5   |       |
| **Year ended December 31, 2008** |       |                     |       |         |       |           |       |      |       |
| Ratios:                               |       |                     |       |         |       |           |       |      |       |
| Loss and LAE                          |       | 48.3                     | %          | 64.0         | %          | 71.7           | %          | 59.9      | %          |
| Expense                               |       | 36.8                     |       | 31.9         |       | 36.6           |       | 35.1      |       |
| Total GAAP combined                   |       | 85.1                     | %          | 95.9         | %          | 108.3          | %          | 95.0      | %          |
| Net written premiums                  |       | $                        | 836.9      |         | $          | 618.7          |       | $         | 507.5      |   | $ | 1,963.1 |   |
| Earned premiums                       |       | 730.0                    |       | 640.8        |       | 508.2          |       | 1,879.0   |       |
| **Year ended December 31, 2007** |       |                     |       |         |       |           |       |      |       |
| Ratios:                               |       |                     |       |         |       |           |       |      |       |
| Loss and LAE(3)                       |       | 35.6                     | %          | 57.2         | %          | 88.4           | %          | 58.2      | %          |
| Expense                               |       | 32.0                     |       | 33.6         |       | 39.3           |       | 34.6      |       |
| Total GAAP combined(3)                |       | 67.6                     | %          | 90.8         | %          | 127.7          | %          | 92.8      | %          |
| Net written premiums                  |       | $                        | 654.0      |         | $          | 690.4          |       | $         | 520.0      |   | $ | 1,864.4 |   |
| Earned premiums                       |       | 643.6                    |       | 725.0        |       | 505.0          |       | 1,873.6   |       |

 

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| (1)    | Specialty  lines now includes Technology, Financial Services, OneBeacon Specialty  Property and Property and Inland Marine which were formerly reported in  commercial lines. Prior periods have been reclassified to conform to the  current presentation.             |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                    |
| (2)    | Run-off  includes non-specialty commercial lines business subject to the Commercial  Lines Transaction and other run-off business. Prior periods have been  reclassified to conform to the current presentation.                                                        |
|   |                                                                                                                                                                                                                                                                    |
| (3)    | During  the fourth quarter of 2007, OB Holdings reallocated reserves from ongoing  lines of business to run-off. This had the effect of lowering the loss and  LAE and GAAP combined ratios for specialty and personal lines but had no net  impact on overall results. |

 

**NOTE 14. Variable Interest Entities**

 

***Reciprocals***

 

Reciprocals are not-for-profit, policyholder-owned insurance carriersorganized as unincorporated associations. Each policyholder insured by thereciprocal shares risk with the other policyholders. Policyholders shareprofits and losses in the same proportion as the amount of insurance purchasedbut are not subject to assessment for net losses of the reciprocal.

 

OB Holdings has capitalized three reciprocals by loaning funds to themin exchange for surplus notes. In 2002, OB Holdings formed New Jersey SkylandsManagement LLC (“NJSM”) to provide management services for a fee to NewJersey Skylands Insurance Association, a reciprocal, and its wholly-owned subsidiaryNew Jersey Skylands Insurance Company (together, “New Jersey Skylands Insurance”).New Jersey Skylands Insurance was capitalized with a $31.3 million surplusnote issued to OB Holdings in 2002. OB Holdings also loaned $0.2 million to NewJersey Skylands Insurance in the form of a security deposit. New JerseySkylands Insurance began writing personal automobile coverage for new customersin August 2002. In 2004, OB Holdings formed Houston General ManagementCompany to provide management services for a fee to another reciprocal, HoustonGeneral Insurance Exchange. During 2004, OB Holdings contributed$2.0 million of capital to Houston General Insurance Exchange. In 2005, OBHoldings contributed one of its subsidiaries, Houston General Insurance Companywith assets of $149.4 million and liabilities of $127.6 million, toHouston General Insurance Exchange (together “Houston General Insurance”).Subsequent to the contribution of Houston General Insurance Company, HoustonGeneral Insurance Exchange issued a surplus note of $23.7 million to OBHoldings. In November 2005, Houston General Insurance commenced writingpersonal automobile business in Arizona. In September 2007, OB Holdingsnotified agents that it planned to seek regulatory approval of a withdrawalplan to cease writing business in all states where Houston General 

 

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Insurance Exchange, a reciprocal, wrotebusiness. In 2006, Adirondack AIF, LLC, a wholly-owned subsidiary of OBHoldings, entered into an agreement to provide management services for a fee toAdirondack Insurance, a reciprocal. Adirondack Insurance was capitalized with a$70.7 million surplus note issued to OB Holdings in May 2006.Adirondack Insurance began writing personal automobile and homeowners businessin August 2006. Principal and interest on the surplus notes are repayableto OB Holdings 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. OB Holdingshas no ownership interest in New Jersey Skylands Insurance, Houston General Insuranceor Adirondack Insurance.

 

Under the provisions of ASC 810, OB Holdings has determined that eachof the reciprocals qualifies as a VIE. Further, OB Holdings has determined thatit is the primary beneficiary and accordingly, consolidates all three reciprocals.New Jersey Skylands Insurance was consolidated on March 31, 2004 uponadoption of ASC 810 and Houston General Insurance Exchange and AdirondackInsurance were consolidated upon inception.

 

At December 31, 2009 and 2008, consolidated amounts related to NewJersey Skylands Insurance included total assets of $134.9 million and$119.0 million, respectively, and total liabilities of $154.8 million and$140.3 million, respectively. At December 31, 2009, the net amount ofcapital at risk is equal to the surplus note of $31.3 million less theaccumulated losses as of December 31, 2009 of $19.9 million whichincludes accrued interest on the surplus note of $22.9 million whicheliminates in consolidation.

 

At December 31, 2009 and 2008, consolidated amounts related toHouston General Insurance included total assets of $111.4 million and$142.4 million, respectively, and total liabilities of $127.2 millionand $157.5 million, respectively. At December 31, 2009, the netamount of capital at risk is equal to the surplus note of $23.7 millionless the accumulated losses as of December 31, 2009 of $15.8 millionwhich includes accrued interest on the surplus note of $12.0 million whicheliminates in consolidation.

 

At December 31, 2009 and 2008, amounts related to AdirondackInsurance included total assets of $281.0 million and $250.3 million,respectively, and total liabilities of $280.9 million and$264.3 million, respectively. At December 31, 2009, the net amount ofcapital at risk is equal to the surplus note of $70.7 million plus theaccumulated earnings as of December 31, 2009 of $0.1 million whichincludes accrued interest on the surplus note of $28.0 million whicheliminates in consolidation.

 

**NOTE15.  Fair Value of Financial Instruments**

 

SFAS No. 107,“Disclosure about Fair Value of Financial Instruments”, subsequently codifiedwithin ASC 825, requires disclosure of fair value information of financialinstruments. For certain financial instruments where quoted market prices arenot available, other independent valuation techniques and assumptions are used.Because considerable judgment is used, these estimates are not necessarilyindicative of amounts that could be realized in a current market exchange.Certain financial instruments are excluded from disclosure, including insurancecontracts, other than financial guarantees and investment contracts. OBHoldings carries its financial instruments on its balance sheet at fair valuewith the exception of its fixed-rate, long-term indebtedness.

 

The fair values ofthe fixed-rate, long-term indebtedness were estimated by discounting futurecash flows using current market rates for similar obligations or using quotedmarket prices. Considerable judgment is required to develop such estimates offair value. Therefore, the estimate provided herein is not necessarilyindicative of the amounts that could be realized in a current market exchange.

 

At December 31,2009 and 2008, the fair value of OBH’s Senior Notes (its fixed-rate, long-termindebtedness) was $605.8 million and $483.3 million, respectively,which compared to a carrying value of $606.5 million and$675.1 million, respectively.

 

In December 2005,OB Holdings entered into a mortgage note with a variable interest rate based on30-day LIBOR. At December 31, 2008, the carrying value of the note of$40.8 million was considered to approximate its fair value. OB Holdingsrepaid the mortgage note in its entirety in May 2009. Refer to Note 6.

 

In March 2004,OB Holdings issued the Atlantic Specialty Note. At December 31, 2009 and2008, the carrying value of the note of $14.0 million and$16.0 million, respectively, was considered to approximate its fair value.

 

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**NOTE16.  Related Party Disclosures**

 

***White Mountains***

 

During the fourthquarter of 2006, White Mountains sold 27.6 million or 27.6% of OBIG’scommon shares in an initial public offering. OBIG is the ultimate parent of OBH.Prior to OBIG’s initial public offering, OBH was a wholly-owned subsidiary ofWhite Mountains. As of December 31, 2009, White Mountains owned 75.4% ofOBIG’s outstanding common shares.

 

*SeparationAgreement*

 

In connection withOBIG’s initial public offering, OBIG entered into a separation agreement dated November 14,2006 with White Mountains (the “Separation Agreement”) to address a number ofoperational, administrative and financial matters relating to the fact thatOBIG would no longer be a wholly-owned subsidiary of White Mountains. Thesematters included, among others, the administration of payroll, employeebenefits programs, deferred compensation and 401(k) plans, OB Holdings’travel and logistics office, certain information technology assets and functionsand certain agreements with respect to finance and tax arrangements. Pursuantto the Separation Agreement, White Mountains has agreed to indemnify OBIG andits subsidiaries, including OB Holdings, as well as their current and formerofficers, directors and employees to the extent permitted by law, for any andall claims or actions resulting in losses, expenses or damages relating to orarising out of the business, operation or ownership of any subsidiary companyor business owned by OBIG or its subsidiaries that, subsequent to OBIG’sownership, was a subsidiary or business of White Mountains (but no longer asubsidiary or business of OBIG).

 

Included withinthe Separation Agreement is a provision which indemnifies OBIG from an increasein income taxes which result from certain transactions that took place prior tothe initial public offering (“Tax Make Whole Arrangements”). This provisionalso states that any excess taxes and interest recorded in the contingencyreserve will be payable to White Mountains if a final determination results inless cash payment to the government for taxes and interest. On December 9,2009, OBIG made a payment of $8.4 million to White Mountains due to the finaldetermination of the 2003 and 2004 federal income tax examination.

 

Prior to enteringinto the Separation Agreement, a number of these matters were governed byinformal arrangements between OBIG and White Mountains. For the years ended December 31,2009, 2008 and 2007, OB Holdings recorded expenses of $0.6 million, $0.7 millionand $1.0 million, respectively, and recorded revenues of $2.6 million,$2.1 million and $3.3 million, respectively, for services under theSeparation Agreement that OB Holdings received from or provided to WhiteMountains and its subsidiaries.

 

*InvestmentManagement Agreement with WM Advisors*

 

Prior to OBIG’sinitial public offering, White Mountains Advisors LLC (“WM Advisors”)managed the majority of OB Holdings’ investments, including the investments ofthe employee benefit plan portfolios. Prospector served as a discretionaryadvisor with respect to certain assets, specifically publicly-traded commonequity and convertible securities, through a sub-advisory agreement withWM Advisors.

 

Subsequent to OBIG’sinitial public offering, under agreements dated as of November 2006 and November 2007,WM Advisors supervises and directs the fixed income and other investmentsportions of OB Holdings’ investment portfolio in accordance with the investmentobjectives, policies and restrictions described in OB Holdings’ investmentguidelines (the “Investment Guidelines”), as well as the majority of theinvestments of the employee benefit plan portfolios.

 

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Under theagreements, WM Advisors has full discretion and authority to make allinvestment decisions in respect of the fixed income and other investmentsportions of OB Holdings’ investment portfolio, and, until the fourth quarter of2009, the portfolios of the employee benefit plans on OB Holdings’ behalf andat OB Holdings’ sole risk, and to do anything which WM Advisors deems isrequired, appropriate or advisable in connection with the foregoing, subject toand in accordance with Investment Guidelines. The assets of OB Holdings’portfolio, as well as the portfolios of the employee benefit plans, are held inone or more separately identifiable accounts in the custody of a bank orsimilar entity designated by OB Holdings and acceptable to WM Advisors. OBHoldings is responsible for custodial arrangements and the payment of allcustodial charges and fees. OB Holdings has agreed to pay annual investmentmanagement fees generally based on the quarter-end market values held undercustody 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  Equity Funds |       | 100.0 basis points                 |       |

 

OB Holdingsincurred $6.8 million, $7.9 million and $8.6 million, respectively, intotal fees for investment management services provided by WM Advisorsunder these investment management agreements during the years ended December 31,2009, 2008 and 2007. 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 on an annual basis. OB Holdings incurred$0.7 million, $0.6 million and $0.8 million, respectively, in treasurymanagement fees during the years ended December 31, 2009, 2008 and 2007.

 

The agreementsprovided for an initial fixed term of three years, which was extended by OBHoldings for an additional two year term. During such term, theWM Advisors Agreement is terminable by OB Holdings only (i) for cause(including material non-performance by WM Advisors), (ii) if there isa change in control of WM Advisors (for this purpose, a change in controlrepresents 50% or greater change in voting interest of WM Advisors), or (iii) ifWhite Mountains’ voting interest in OBIG falls below 50%. Following the end ofthe initial term and any extensions, the agreements may be terminated by eitherparty on 60 days written notice.

 

In July 2009,WM Advisors notified OB Holdings that it intended to terminate the investment managementagreements with respect to the management of the employee benefit planportfolios. As described above, Prospector served as discretionary advisor withrespect to the publicly-traded common equity and convertible securities portionof the employee benefit plan portfolios through a sub-advisory agreement withWM Advisors. WM Advisors was also the investment manager for three proprietaryfunds offered in the KSOP and had appointed Prospector through a sub-advisoryagreement to manage two of those funds. Effective November 1, 2009 and December 1,2009, the investment management agreements between OB Holdings and WM Advisorsrelated to the defined benefit plan portfolios and the KSOP, respectively, wereterminated. Concurrent with those terminations, the sub-advisory agreementswith Prospector were terminated and new investment management agreements wereentered into with Prospector to manage the portfolios of the Qualified Plan andthe KSOP. See “Related Party Disclosures—Prospector”.

 

*OBHGuarantee*

 

White Mountainshas provided and, pursuant to the Separation Agreement, continues to provide anirrevocable and unconditional guarantee as to the payment of principal andinterest (the “Guarantee”) on the OBH 5.875% Senior Notes due 2013. SeeNote 6.

 

In considerationof this Guarantee, OBH 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.OBH has further agreed that if White Mountains’ voting interest in OBIG ceasesto represent more than 50% of all of OBIG’s voting securities, OBH will redeem,exchange or 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 OBH whenits voting interest in OBIG has been reduced below 50%. OBH shall 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 basis points. TheGuarantee fee shall further increase by 100 basis points for each subsequent90-day period thereafter, up to a maximum Guarantee fee of 425 basis points,until the Guarantee Elimination has been completed. All expenses associatedwith the elimination of the 

 

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Guarantee will be borne by OBH. OBH incurred$1.7 million, $1.7 million and $1.8 million, respectively, in fees for theprovision of the Guarantee during the years ended December 31, 2009, 2008and 2007.

 

White Mountainshas two revolving credit facilities which provide for borrowing up to a maximumof $450.8 million and which contain restrictive financial covenants. Theindenture documents governing the Senior Notes provide that if White Mountainsas guarantor of the Senior Notes has a payment default in excess of$25 million under a credit agreement, mortgage or similar debt agreement,there is a default under the Senior Notes (commonly referred to as a “crossdefault”). Therefore, if White Mountains were to breach its financial covenantsin its revolving credit facilities, an event of default would result, whichwould allow lenders to declare all amounts owed under the revolving creditfacilities to be immediately due and payable. A failure to pay the amounts owedunder the revolving credit facilities would result in a trigger of the crossdefault provisions in the indenture documents governing the Senior Notesresulting in a required repayment of the Senior Notes. As of December 31,2009, the facilities were undrawn.

 

*IrrevocableGrantor Trust*

 

In connection withOBIG’s initial public offering, OBH created an irrevocable grantor trust andfunded it with assets sufficient to make the remaining dividend and redemptionpayments for $300 million of preferred stock that was redeemed in May 2008.White Mountains Capital, Inc. served as the trustee for the irrevocablegrantor trust and received no fee for the provision of trustee services.

 

*EsuranceClaims Administrations Services*

 

Esurance InsuranceServices, Inc., a subsidiary of White Mountains (“Esurance Insurance”),and NJSM, an indirect subsidiary of the Company, entered into a TransitionServices Agreement (the “Transition Services Agreement”) dated as of June 28,2007 and a related Termination Agreement (the “Termination Agreement”) dated asof the same date. The Termination Agreement terminated a Claims AdministrationAgreement (the “Claims Administration Agreement”) dated as of February 1,2005 between Esurance Insurance and NJSM pursuant to which NJSM had beenproviding claims administration services to Esurance Insurance in the State ofNew Jersey. Pursuant to the Transition Services Agreement, NJSM providedcertain transition services to Esurance Insurance during the period from July 2,2007 through May 2009. NJSM provided the following services to EsuranceInsurance pursuant to the Transition Services Agreement: facilities andbuilding services (cubicles, office furniture, common space, conference rooms,telecommunications equipment and services, building management services andmailroom services) and IT services (network connections and voice andtelecommunications services). For the years ended December 31, 2009, 2008and 2007, Esurance Insurance paid NJSM $0.1 million, $0.3 million and$0.1 million, respectively, under the Transition Services Agreement. Forthe year ended December 31, 2007, Esurance Insurance paid NJSM$1.2 million under the Claims Administration Agreement.

 

*EsuranceInsurance Claims Counsel Services*

 

From time to time,OneBeacon provides staff counsel services to Esurance Insurance. OneBeacon’sstaff counsel defends Esurance Insurance policyholders when the policyholdersare sued by third party tort plaintiffs arising from automobile accidents. Thehourly cost of the staff counsels’ time is charged to Esurance Insurance. Foreach of the years ended December 31, 2009, 2008 and 2007, OBIC had billedEsurance Insurance $0.1 million for counsel services.

 

*EsuranceSublease*

 

OBIC subleases toEsurance Insurance approximately 4,200 square feet of an approximately 14,000square foot office facility in Brooklyn, NY. The sublease term commenced August 15,2008 and terminates on November 29, 2014. Esurance Insurance has theoption to sublease an additional 3,000 square feet of the office space ifavailable on the same terms and conditions as the original sublease except thatthe monthly rental payment would increase. In addition, Esurance Insurance hasthe right of first refusal on the remainder of the office space on terms and conditionsto be agreed upon by the parties. During the years ended December 31, 2009and 2008, Esurance Insurance paid OBIC approximately $0.2 million and $0.1million, respectively, for the office space. During the year ended December 31,2008, Esurance Insurance also purchased office equipment and furniture fromOBIC for approximately $22,000.

 

*Esurance Brokerage Commission*

 

During the year ended December 31,2009, AutoOne assisted Esurance Insurance with the sale of approximately $5million of excess 2009 New York take-out credits and received a fee of $15,000.During the year ended December 31, 2008, AutoOne assisted EsuranceInsurance with the sale of $6.1 million of excess 2008 New York take-outcredits and received a fee of $195,200. Various states have assigned riskspools which provide automobile insurance for individuals unable to 

 

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secure coverage in the voluntarymarket. Insurers are obligated to accept future assignments from stateassigned risk pools as a condition of maintaining a license to write automobilebusiness in the state. However, insurers may satisfy their assigned riskobligations by utilizing various credits (including take-out credits).

 

*Sale ofHCIC to Esurance Holdings, Inc.*

 

During the thirdquarter of 2006, OB Holdings sold one of its inactive licensed subsidiaries,Homeland Central Insurance Company (“HCIC”), to Esurance Holdings, Inc. (“EsuranceHoldings”), a subsidiary of White Mountains. HCIC was renamed EsuranceInsurance Company of New Jersey (“Esurance Insurance NJ”). In connection withthe sale, Esurance Holdings agreed to pay $2.9 million of the total purchaseprice in periodic annual installments based upon a percentage of an annuallyrecognized tax benefit with respect to premium tax in the state of New Jersey.Because of the license held by HCIC in New Jersey, Esurance Insurance NJ isentitled to a tax benefit that results in a reduction in the amount of annualstate premium tax due on premiums written in New Jersey. In March 2009,after the filing of its New Jersey premium tax return, Esurance Insurance NJpaid OB Holdings approximately $0.4 million. In April 2008, after the filingof its New Jersey premium tax return, Esurance Insurance NJ paid OB Holdingsapproximately $0.1 million.

 

*OFACCompliance Services Agreement between OneBeacon Insurance Company and EsuranceInsurance Company*

 

TheU.S. Department of the Treasury Office of Foreign Assets Control (“OFAC”) rules prohibitU.S. businesses from providing services to terrorists, drug traffickers, andothers engaged in activities related to the proliferation of weapons of massdestruction and threats to the national security, foreign policy or economy ofthe United States in order to enforce U.S. foreign policy including economicand trade sanctions. In November 2009, OBIC entered into an OFACCompliance Services Agreement with Esurance pursuant to which OBIC willcontinue to assist Esurance with its compliance with OFAC rules andregulations. Prior to entry into the OFAC Compliance Services Agreement, OBICprovided OFAC compliance services to Esurance pursuant to the SeparationAgreement. The fees paid by Esurance to OBIC pursuant to the SeparationAgreement are included under “Related Party Disclosures—Separation Agreement”above.

 

*Purchase of State Premium Tax Credits*

 

InMay and June 2008, respectively, OneBeacon Midwest Insurance Companyand the Employers’ Fire Insurance Company purchased $1.1 million of Connecticutpremium tax credits from White Mountains Capital, Inc. and FolksamericaHolding Company, Inc. for approximately $0.9 million.

 

*FederalInsurance Indemnity*

 

In December 2003,White Mountains and Fund American Companies, Inc., now OBH, entered into aGeneral Agreement of Indemnity with Federal Insurance Company (“Federal”),under which Federal agreed to execute judicial and similar bonds on behalf ofWhite Mountains and OBH and their respective subsidiaries. Under the GeneralAgreement of Indemnity, White Mountains and OBH agreed to jointly and severallyindemnify Federal for any losses under the bonds. Included within theSeparation Agreement is a provision under which each of White Mountains and theCompany will indemnify the other for losses arising out of or in connectionwith bonds to the extent for the benefit of White Mountains or the Company,respectively. As of November 2006, the Company entered into a newagreement with Federal providing a similar bonding capacity to which WhiteMountains is not a party. At December 31, 2009, total exposure under theGeneral Agreement of Indemnity for outstanding bonds was $1.6 million, of which$1.3 million related to bonds issued on behalf of OBH or its subsidiaries.

 

At December 31,2008, total exposure under the General Agreement of Indemnity for outstandingbonds was $0.4 million, of which $0.1 million related to bonds issued on behalfof OBH or its subsidiaries.

 

***Prospector***

 

*InvestmentManagement Agreement with Prospector*

 

Prior to OBIG’sinitial public offering, Prospector managed most of the publicly-traded commonequity and convertible securities in OB Holdings’ portfolio, as well as certainassets of the employee benefit plan portfolios, through a sub-advisoryagreement with WM Advisors.

 

In connection withOBIG’s initial public offering, OB Holdings entered into an investmentmanagement agreement with Prospector in November 2006, as amended in November 2007,pursuant to which Prospector supervises and directs the publicly-traded commonequity and convertible securities portion of OB Holdings’ investment portfolioin accordance with 

 

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the investment objectives, policies andrestrictions described in OB Holdings’ investment guidelines. Under theagreement, Prospector has discretion and authority with respect to theportfolio it manages for OB Holdings that is substantially similar toWM Advisors’ discretion and authority under its agreements. The assets ofOB Holdings’ portfolio are held in one or more separately identifiable accountsin the custody of a bank or similar entity designated by OB Holdings andacceptable to Prospector. OB Holdings is responsible for custodial arrangementsand the payment of all custodial charges and fees. For the years ended December 31,2009, 2008 and 2007, OneBeacon incurred $3.6 million, $4.2 million and$4.3 million, respectively, in fees for investment management servicesprovided by Prospector.

 

Under theProspector investment management agreement, OB Holdings 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 agreementhad an initial fixed term of three years, which was extended by OB Holdings foran additional two year term. The agreement is terminable by OB Holdings only (i) forcause (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 inOBIG falls below 50%. Following the end of the initial term and any extensions,the Prospector agreement may be terminated by either party on 60 dayswritten notice. OB Holdings reviews periodically the performance of and thefees paid to Prospector under the agreement.

 

Prospector servedas a discretionary advisor to WM Advisors under sub-advisory agreementswith respect to specified assets in OneBeacon’s employee benefit planportfolios until the fourth quarter of 2009. As described above under “RelatedParty Disclosures—WM Advisors”, in July 2009, WM Advisors notified OBHoldings that it intended to terminate the investment management agreementspursuant to which WM Advisors provided services with respect to the employeebenefit plan portfolios. Effective as of November 1, 2009, the QualifiedPlan entered into a new investment management agreement with Prospector withrespect to the management of the plan assets. Effective as of December 1,2009, OBIC, the sponsor of the KSOP, entered into a new investment managementagreement with Prospector with respect to the management of two proprietaryfunds under the KSOP.

 

Richard P. Howard,a portfolio manager of Prospector, is a director of OBIG.

 

*ProspectorManaged Limited Partnerships*

 

At December 31,2009 and 2008, OB Holdings had $41.6 million and $38.9 million,respectively, invested in limited partnerships managed by Prospector. Under thelimited partnership agreements, Prospector serves as general partner andgeneral manager of the funds and is paid a management fee by OB Holdings. Inaddition, OB Holdings allocates a portion of its earnings from OB Holdings’limited partnership interests to Prospector as an incentive fee. For the yearsended December 31, 2009, 2008 and 2007, OB Holdings incurred $0.4 million,$0.4 million and $0.4 million, respectively, in management fees and$0.3 million, $0.1 million and $0.9 million, respectively, in incentivefees.

 

**NOTE17.  Commitments and Contingencies**

 

OB Holdings leases certain office space under noncancellable operatingleases expiring at various dates through 2020. Rental expense for all of OBHoldings’ locations was approximately $20.3 million, $21.0 million and$28.0 million, respectively, for the years ended December 31, 2009,2008 and 2007. In addition, OB Holdings has accrued $1.7 million, $1.3 millionand $5.4 million, respectively, for the years ended December 31, 2009,2008 and 2007 net of anticipated sub-lease income for leased space which OBHoldings has ceased using. OB Holdings also has various other lease obligationswhich are immaterial in the aggregate.

 

OB Holdings future annual minimum rental payments required undernoncancellable leases primarily for office space are $13.3 million,$11.4 million, $9.4 million, $6.4 million and $11.5 millionfor 2010, 2011, 2012, 2013 and 2014 and thereafter, respectively.

 

OB Holdings hasfuture binding commitments to fund certain limited partnership and hedge fundinvestments. These commitments, which do not have fixed funding dates, totaled$46.5 million as of December 31, 2009.

 

***Assigned Risks***

 

As a condition ofOB Holdings’ license to do business in certain states, OB Holdings’ 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 

 

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share of voluntary business in the state. Incertain cases, OB Holdings is obligated to write business from mandatory sharedmarket mechanisms at some time in the future based on the market share ofvoluntary policies it is currently writing. Underwriting results related toassigned risk plans are typically adverse and are not subject to thepredictability associated with OB Holdings’ voluntarily written business.

 

Under existingguaranty fund laws in all states, insurers licensed to do business in thosestates can be assessed for certain obligations of insolvent insurance companiesto policyholders and claimants. In accordance with ASC 405, OB Holdings’insurance 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, 2009, thereserve for such assessments at OB Holdings’ insurance subsidiaries totaled$17.2 million.

 

***Legal Contingencies***

 

OB Holdings, andthe insurance industry in general, is subject to litigation and arbitration inthe normal course of business. OB Holdings is not a party to any materiallitigation or arbitration other than as routinely encountered in claimsactivity, none of which is expected by management to have a material adverseeffect on OB Holdings’ financial condition and/or cash flows.

 

On July 24, 2008,OneBeacon and Liberty Mutual entered into a Confidential Settlement Agreementand Release (the “Settlement Agreement”) that resolved nearly four years ofarbitration and litigation.  The disputesconcerned amounts which Liberty Mutual asserted were due to it under agreementswith OneBeacon (the “Liberty Agreements”) for unallocated loss adjustmentexpenses and amounts which OneBeacon asserted were due to it related to claimsadministration and reinsurance.  TheSettlement Agreement represents a full and final resolution of the disputesrelated to the Liberty Agreements.

 

In connection withthe Settlement Agreement, OneBeacon took a pre-tax charge in the amount of $9.2million in the second quarter of 2008, representing a part of the cost of thesettlement. OneBeacon made a cash payment to Liberty Mutual in the amount of$16.0 million on July 30, 2008. No further charges or payments will bemade with respect to the disputed matters.

 

**NOTE18. Subsequent Events**

 

On February 2,2010, OBIG and certain of its subsidiaries entered into a definitive agreementto sell the personal lines business to Tower Group, Inc. The transactionincludes two insurance companies containing the personal lines business, andtwo attorneys-in-fact managing the reciprocals that write the personal linesbusiness in New York and New Jersey. Net written premiums for the affectedbooks total approximately $420 million for the year ended December 31,2009. As consideration, OneBeacon will receive an amount equal to the statutorysurplus in the reciprocals, including the par value of the surplus notes issuedby the reciprocals to OB Holdings, the GAAP equity in the insurance companiesand attorneys-in-fact, plus $32.5 million. All specialty lines, including thecollector cars and boats business, and the personal lines assigned riskbusiness written through AutoOne, will remain with OB Holdings. The sale issubject to certain state regulatory approvals.

 

In February 2010, OBIC purchased $1.1 million of outstanding SeniorNotes for $1.1 million. In March 2010, OBH repurchased $11.0 million ofoutstanding Senior Notes for $11.5 million, which resulted in a $0.3 millionloss.

 

In January 2010,OB Holdings repaid $2.0 million of principal in accordance with the terms ofthe Atlantic Specialty Note. In March 2010, OB Holdings repaid $12.0million, representing the outstanding principal on the Atlantic Specialty Note.

 

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**MANAGEMENT’S RESPONSIBILITY FOR FINANCIAL STATEMENTS**

 

Management is responsible for the preparation and fair presentation ofthe financial statements included in this report. The financial statements havebeen prepared in conformity with GAAP in the United States. The preparation offinancial statements in conformity with GAAP requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities as of the date of the financial statements and the reported amountsof revenues and expenses during the reporting period. Actual results coulddiffer from those estimates.

 

**MANAGEMENT’S ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIALREPORTING**

 

Management is responsible for establishing and maintaining adequateinternal control over financial reporting as defined in Rules 13a-15(f) and15d-15(f) under the Securities Exchange Act of 1934. There are inherentlimitations in the effectiveness of any internal control over financialreporting, including the possibility of human error and the circumvention oroverriding of internal control. Accordingly, even effective internal controlover financial reporting can provide only reasonable assurance with respect tofinancial statement preparation. Further, an effective internal control environmentas of a point in time may become inadequate in the future because of changes inconditions, or deterioration in the degree of compliance with the policies andprocedures.

 

We assessed the effectiveness of OB Holdings’ internal control overfinancial reporting as of December 31, 2009. In making our assessment, weused the criteria set forth by the Committee of Sponsoring Organizations of theTreadway Commission (COSO) in *InternalControl-Integrated Framework.* Based on this assessment, we have concludedthat OB Holdings maintained effective internal control over financial reportingas of December 31, 2009.

 

This annual report does not include an attestation report of theCompany’s registered public accounting firm regarding internal control over financialreporting. Management’s report was not subject to attestation by the Company’sregistered public accounting firm pursuant to rules of the Securities andExchange Commission that permit the Company to provide only management’s reportin this annual report.

 

March 19,2010

 
| /s/  T. MICHAEL MILLER                 |   | /s/  PAUL H. MCDONOUGH         |
|----------------------------------------|--------|--------------------------------|
| T.  Michael Miller                     |   | Paul  H. McDonough             |
| President  and Chief Executive Officer |   | Chief  Financial Officer       |
| (Principal  Executive Officer)         |   | (Principal  Financial Officer) |

 

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**Report of Independent Registered Public Accounting Firm**

 

Tothe Board of Directors and Shareholder of OneBeacon U.S. Holdings, Inc.:

 

Inour opinion, the accompanying consolidated financial statements listed in theaccompanying index appearing on page F-1 present fairly, in all materialrespects, the financial position of OneBeacon U.S. Holdings, Inc. and itssubsidiaries (the “Company”), a indirect wholly-owned subsidiary of OneBeaconInsurance Group, Ltd. at December 31, 2009 and 2008, and the resultsof their operations and their cash flows for each of the three years in theperiod ended December 31, 2009 in conformity with accounting principlesgenerally accepted in the United States of America. In addition, in ouropinion, the financial statement schedules listed in the accompanying indexpresent fairly, in all material respects, the information set forth thereinwhen read in conjunction with the related consolidated financial statements.These financial statements and financial statement schedules are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these financial statements and financial statement schedules basedon our audits. We conducted our audits of these statements in accordance withthe standards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements, assessing theaccounting principles used and significant estimates made by management, andevaluating the overall financial statement presentation. We believe that ouraudits provide a reasonable basis for our opinion.

 

Asdiscussed in Note 1 to the consolidated financial statements, the Companychanged its method of accounting for certain invested assets in 2008.

 

/s/PricewaterhouseCoopers LLP

 

PricewaterhouseCoopersLLP

New York, New York

March 19, 2010

 

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**SELECTED QUARTERLY FINANCIAL DATA**

 

**(Unaudited)**

 

Selected quarterlyfinancial data for 2009 and 2008 is shown in the following table. The quarterlyfinancial data includes, in the opinion of management, all recurringadjustments necessary for a fair presentation of the results of operations forthe interim periods.

 
| ** **                                                        | ** ** | **2009  Three months ended** | ** ** | **2008  Three months ended** | ** ** |
|-------------------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| **Millions**                                                      | ** ** | **Mar. 31**             | ** ** | **June 30**             | ** ** | **Sept. 30** | ** ** | **Dec. 31** | ** ** | **Mar. 31** | ** ** | **June 30** | ** ** | **Sept. 30** | ** ** | **Dec. 31** | ** ** |
| Revenues                                                          |       | $                            | 513.0      |                         | $          | 654.8 |   | $ | 650.5 |   | $ | 559.8 |   | $ | 450.0 |   | $ | 507.7 |   | $ | 162.5 |   | $ | 168.7 |   |
| Expenses                                                          |       | 472.9                        |       | 473.1                        |       | 493.9 |   | 473.4 |   | 488.4 |   | 470.5 |   | 489.4 |   | 438.5 |   |
| Pre-tax  income (loss)                                            |       | 40.1                         |       | 181.7                        |       | 156.6 |   | 86.4 |   | (38.4 | ) | 37.2 |   | (326.9 | ) | (269.8 | ) |
| Tax  (expense) benefit                                            |       | (12.4                        | )          | (61.4                        | )          | (52.3 | ) | (29.2 | ) | 12.2 |   | (17.8 | ) | 110.8 |   | 90.1 |   |
| Net  income (loss) including noncontrolling interests             |       | 27.7                         |       | 120.3                        |       | 104.3 |   | 57.2 |   | (26.2 | ) | 19.4 |   | (216.1 | ) | (179.7 | ) |
| Less:  Net (income) loss attributable to noncontrolling interests |       | (0.5                         | )          | (0.7                         | )          | (0.7 | ) | (0.2 | ) | (1.1 | ) | (1.0 | ) | 0.6 |   | (0.2 | ) |
| Net  income (loss) attributable to OB Holdings’ shareholder  |       | $                            | 27.2       |                         | $          | 119.6 |   | $ | 103.6 |   | $ | 57.0 |   | $ | (27.3 | ) | $ | 18.4 |   | $ | (215.5 | ) | $ | (179.9 | ) |

 

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**SCHEDULE I**

 

**ONEBEACON U.S. HOLDINGS, INC.**

 

**SUMMARY OF INVESTMENTS—OTHER THAN****INVESTMENTS IN RELATED PARTIES**

 

**At December 31,2009**

 
| ** **                                               | ** ** | **Cost**                 | ** ** | **Fair  Value** | ** ** | **Carrying  Value** | ** ** |
|----------------------------------------------------------|------------|--------------------------|------------|-----------------|------------|---------------------|------------|
| ** **                                               | ** ** | **($ in millions)** | ** ** |
| **Investments:**                                         |       |                     |       |            |       |                |       |
| Fixed maturities:                                        |       |                     |       |            |       |                |       |
| Bonds:                                                   |       |                     |       |            |       |                |       |
| U.S. Government and government agencies and  authorities |       | $                        | 519.4      |            | $          | 531.6               |       | $ | 531.6 |   |
| Corporate bonds and asset-backed securities              |       | 2,282.3                  |       | 2,361.9         |       | 2,361.9             |       |
| States, municipalities and political subdivisions        |       | 2.5                      |       | 2.6             |       | 2.6                 |       |
| Convertibles and bonds with warrants attached            |       | 153.7                    |       | 170.2           |       | 170.2               |       |
| Foreign governments                                      |       | 25.6                     |       | 26.7            |       | 26.7                |       |
| Redeemable preferred stocks                              |       | 70.8                     |       | 71.5            |       | 71.5                |       |
| Total fixed maturities                                   |       | 3,054.3                  |       | 3,164.5         |       | 3,164.5             |       |
| Short-term investments                                   |       | 487.5                    |       | 489.3           |       | 489.3               |       |
| Common equity securities:                                |       |                     |       |            |       |                |       |
| Banks, trust and insurance companies                     |       | 73.9                     |       | 82.3            |       | 82.3                |       |
| Public utilities                                         |       | 10.8                     |       | 10.6            |       | 10.6                |       |
| Industrial, miscellaneous and other                      |       | 91.6                     |       | 94.7            |       | 94.7                |       |
| Total common equity securities                           |       | 176.3                    |       | 187.6           |       | 187.6               |       |
| Other investments                                        |       | 122.8                    |       | 146.3           |       | 146.3               |       |
| Total investments                                        |       | $                        | 3,840.9    |            | $          | 3,987.7             |       | $ | 3,987.7 |   |

 

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Table of Contents

 

**SCHEDULE II**

 

**ONEBEACON U.S. HOLDINGS, INC.**

**(RegistrantOnly)**

 

**CONDENSEDBALANCE SHEETS**

 
| ** **                                                                                   | ** ** | **December 31,**     | ** ** |
|----------------------------------------------------------------------------------------------|------------|---------------------------|------------|
| ** **                                                                                   | ** ** | **2009**                  | ** ** | **2008** | ** ** |
| ** **                                                                                   | ** ** | **($ in  millions)** | ** ** |
| Assets:                                                                                      |       |                      |       |   |   |
| Investments                                                                                  |       | $                         | 33.3       |   | $ | 71.3 |   |
| Investments in consolidated subsidiaries                                                     |       | 2,032.3                   |       | 1,730.5 |   |
| Other assets                                                                                 |       | 7.3                       |       | 28.9 |   |
| Total assets                                                                                 |       | $                         | 2,072.9    |   | $ | 1,830.7 |   |
| Liabilities:                                                                                 |       |                      |       |   |   |
| Long-term debt                                                                               |       | 654.7                     |       | 675.1 |   |
| Other liabilities                                                                            |       | 7.6                       |       | 5.0 |   |
| Total liabilities                                                                            |       | 662.3                     |       | 680.1 |   |
| OB Holdings’ shareholder’s equity                                                  |       | 1,391.5                   |       | 1,133.4 |   |
| Noncontrolling interests                                                                     |       | 19.1                      |       | 17.2 |   |
| Total OB Holdings’ shareholder’s equity and  noncontrolling interests              |       | 1,410.6                   |       | 1,150.6 |   |
| Total liabilities, OB Holdings’ shareholder’s  equity and noncontrolling interests |       | $                         | 2,072.9    |   | $ | 1,830.7 |   |

 

**CONDENSED STATEMENTS OF OPERATIONS AND COMPREHENSIVEINCOME (LOSS)**

 
| ** **                                                                                   | ** ** | **Year ended December 31,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                   | ** ** | **2009**                                   | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                                                   | ** ** | **($ in millions)**              | ** ** |
| Revenues                                                                                     |       | $                                          | 1.0        |   | $ | 3.6 |   | $ | 14.5 |   |
| Expenses                                                                                     |       | 40.6                                       |       | 75.5 |   | 106.7 |   |
| Pre-tax loss                                                                                 |       | (39.6                                      | )          | (71.9 | ) | (92.2 | ) |
| Income tax benefit                                                                           |       | 11.5                                       |       | 14.9 |   | 10.5 |   |
| Net loss                                                                                     |       | (28.1                                      | )          | (57.0 | ) | (81.7 | ) |
| Equity in earnings (loss) from consolidated  subsidiaries including noncontrolling interests |       | 337.6                                      |       | (345.6 | ) | 320.3 |   |
| Consolidated net income (loss) including  noncontrolling interests                           |       | 309.5                                      |       | (402.6 | ) | 238.6 |   |
| Less: Net income attributable to noncontrolling  interests                                   |       | (2.1                                       | )          | (1.7 | ) | (3.7 | ) |
| Consolidated net income (loss) attributable to OB  Holdings’ shareholder                |       | 307.4                                      |       | (404.3 | ) | 234.9 |   |
| Other comprehensive income and loss items, after  tax                                        |       | 18.8                                       |       | (25.6 | ) | (3.9 | ) |
| Consolidated comprehensive net income (loss)  attributable to OB Holdings’ shareholder  |       | $                                          | 326.2      |   | $ | (429.9 | ) | $ | 231.0 |   |

 

The condensedfinancial statements should be read in conjunction with the accompanyingconsolidated financial statements and notes thereto. Certain amounts in theprior periods have been reclassified to conform with the current presentation.

 

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**ONEBEACON U.S. HOLDINGS, INC.**

**(RegistrantOnly)**

 

**CONDENSED STATEMENTS OF CASH FLOWS**

 
| ** **                                                                                       | ** ** | **Year ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                       | ** ** | **2009**                         | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                                                       | ** ** | **($ in millions)**         | ** ** |
| Consolidated net income (loss) including  noncontrolling interests                               |       | $                                | 309.5      |   | $ | (402.6 | ) | $ | 238.6 |   |
| Charges (credits) to reconcile net income (loss)  to net cash from operations:                   |       |                             |       |   |   |   |   |
| Net realized and unrealized losses from investment  securities                                   |       | —                           |       | 5.5 |   | 1.4 |   |
| Undistributed (earnings) loss from consolidated  subsidiaries including noncontrolling interests |       | (337.6                           | )          | 345.6 |   | (320.3 | ) |
| Dividends paid on mandatorily redeemable preferred  stock                                        |       | —                           |       | 11.8 |   | 28.3 |   |
| Dividends received from subsidiaries                                                             |       | 40.2                             |       | 203.0 |   | 99.4 |   |
| Other operating items:                                                                           |       |                             |       |   |   |   |   |
| Net change in other assets and liabilities                                                       |       | 26.1                             |       | (22.0 | ) | 21.7 |   |
| Net cash provided from operations                                                                |       | 38.2                             |       | 141.3 |   | 69.1 |   |
| Cash flows from investing activities:                                                            |       |                             |       |   |   |   |   |
| Net change in short-term investments  held-to-maturity                                           |       | —                           |       | 0.1 |   | 13.4 |   |
| Net change in short-term investments                                                             |       | 38.0                             |       | (68.2 | ) | 1.9 |   |
| Purchases of fixed maturity investments                                                          |       | —                           |       | (33.2 | ) | (10.2 | ) |
| Maturities of held-to-maturity investments                                                       |       | —                           |       | 311.4 |   | 13.4 |   |
| Proceeds from the sales of fixed maturity  investments                                           |       | —                           |       | 202.5 |   | 34.1 |   |
| Net cash provided from investing activities                                                      |       | 38.0                             |       | 412.6 |   | 52.6 |   |
| Cash flows from financing activities:                                                            |       |                             |       |   |   |   |   |
| Repurchases of debt                                                                              |       | (8.1                             | )          | (22.3 | ) | — |   |
| Dividends to OBEH                                                                                |       | (68.1                            | )          | (219.9 | ) | (93.4 | ) |
| Redemption of mandatorily redeemable preferred  stock                                            |       | —                           |       | (300.0 | ) | — |   |
| Dividends paid on mandatorily redeemable preferred  stock                                        |       | —                           |       | (11.8 | ) | (28.3 | ) |
| Net cash used for financing activities                                                           |       | (76.2                            | )          | (554.0 | ) | (121.7 | ) |
| Net change in cash during the year                                                               |       | —                           |       | (0.1 | ) | — |   |
| Cash balance at beginning of year                                                                |       | —                           |       | 0.1 |   | 0.1 |   |
| Cash balance at end of year                                                                      |       | $                                | —     |   | $ | — |   | $ | 0.1 |   |

 

The condensedfinancial statements should be read in conjunction with the accompanyingconsolidated financial statements and notes thereto. Certain amounts in theprior periods have been reclassified to conform with the current presentation.

 

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Table ofContents

 

**SCHEDULE III**

 

**ONEBEACONU.S. HOLDINGS, INC.**

 

**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, 2009:** |       |                             |       |                                                                            |       |                   |       |                                                  |       |                 |       |                           |       |                                                           |       |                                                    |       |                           |       |                  |       |
| Insurance Operations        |       | $                                | 215.0      |                                                                            | $          | 4,125.3                |       | $                                                     | 1,018.3    |                 | $          | —                         |       | $                                                              | 1,959.5    |                                                    | $          | 127.4                          |       | $                     | 1,121.9    |   | $ | 398.3 |   | $ | 330.0 |   | $ | 1,906.7 |   |
| Other Operations            |       | —                           |       | (190.5                                                                          | )          | —                 |       | —                                                |       | —               |       | —                         |       | —                                                         |       | —                                                  |       | —                         |       | —                |       |
| **December 31, 2008:** |       |                             |       |                                                                            |       |                   |       |                                                  |       |                 |       |                           |       |                                                           |       |                                                    |       |                           |       |                  |       |
| Insurance Operations        |       | $                                | 225.5      |                                                                            | $          | 4,504.5                |       | $                                                     | 1,088.2    |                 | $          | —                         |       | $                                                              | 1,879.0    |                                                    | $          | 152.8                          |       | $                     | 1,126.2    |   | $ | 368.3 |   | $ | 290.8 |   | $ | 1,963.1 |   |
| Other Operations            |       | —                           |       | (210.5                                                                          | )          | —                 |       | —                                                |       | —               |       | —                         |       | —                                                         |       | —                                                  |       | —                         |       | —                |       |
| **December 31, 2007:** |       |                             |       |                                                                            |       |                   |       |                                                  |       |                 |       |                           |       |                                                           |       |                                                    |       |                           |       |                  |       |
| Insurance Operations        |       | $                                | 200.0      |                                                                            | $          | 4,718.8                |       | $                                                     | 1,005.9    |                 | $          | —                         |       | $                                                              | 1,873.6    |                                                    | $          | 184.5                          |       | $                     | 1,089.8    |   | $ | 318.9 |   | $ | 329.4 |   | $ | 1,864.4 |   |
| Other Operations            |       | —                           |       | (238.5                                                                          | )          | —                 |       | —                                                |       | —               |       | —                         |       | —                                                         |       | —                                                  |       | —                         |       | —                |       |

 

----

(1)                                The amountsshown exclude net investment (expense) income relating to non-insuranceoperations of $(2.1) million, $9.3 million and $17.9 million for theyears ended December 31, 2009, 2008 and 2007, respectively.

 

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Table ofContents

 

**SCHEDULE IV**

 

**ONEBEACONU.S. HOLDINGS, INC.**

 

**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, 2009:** |       |                            |       |                           |       |                                |       |              |       |                                       |       |
| Insurance Operations        |       | $                               | 2,122.4    |                           | $          | (229.7                              | )          | $                 | 66.8       |                                       | $          | 1,959.5 |   | 3.4 | % |
| Other Operations            |       | —                          |       | —                         |       | —                              |       | —            |       | —                                     |       |
| **December 31, 2008:** |       |                            |       |                           |       |                                |       |              |       |                                       |       |
| Insurance Operations        |       | $                               | 2,078.0    |                           | $          | (252.6                              | )          | $                 | 53.6       |                                       | $          | 1,879.0 |   | 2.9 | % |
| Other Operations            |       | —                          |       | —                         |       | —                              |       | —            |       | —                                     |       |
| **December 31, 2007:** |       |                            |       |                           |       |                                |       |              |       |                                       |       |
| Insurance Operations        |       | $                               | 2,017.3    |                           | $          | (198.4                              | )          | $                 | 54.7       |                                       | $          | 1,873.6 |   | 2.9 | % |
| Other Operations            |       | —                          |       | —                         |       | —                              |       | —            |       | —                                     |       |

 

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Table of Contents

 

**SCHEDULE V**

 

**ONEBEACONU.S. HOLDINGS, INC.**

 

**VALUATION AND QUALIFYING ACCOUNTS**

 
| ** **                                               | ** ** | **Column A**                         | ** ** | **Column B**                                    | ** ** | **Column C**                                | ** ** | **Column D**                                     | ** ** | **Column E**                   | ** ** |
|----------------------------------------------------------|------------|--------------------------------------|------------|-------------------------------------------------|------------|---------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------|------------|
| ** **                                               | ** ** | **Additions (subtractions)**         | ** ** |
| **Description**                                          | ** ** | **Balance at  beginning  of period** | ** ** | **Charged  (credited)  to costs and  expenses** | ** ** | **Charged  (credited)  to other  accounts** | ** ** | **Other  additions  (deductions)  described(1)** | ** ** | **Balance at  end of  period** | ** ** |
| ** **                                               | ** ** | **($ in millions)**             | ** ** |
| **Years ended:**                                         |       |                                 |       |                                            |       |                                        |       |                                             |       |                           |       |
| **December 31, 2009:**                              |       |                                 |       |                                            |       |                                        |       |                                             |       |                           |       |
| Reinsurance recoverable on paid and  unpaid losses: |       |                                 |       |                                            |       |                                        |       |                                             |       |                           |       |
| Allowance for reinsurance balances                       |       | $                                    | 16.6       |                                            | $          | —                                      |       | $                                                | —     |                           | $          | (0.8 | ) | $ | 15.8 |   |
| Premiums receivable:                                     |       |                                 |       |                                            |       |                                        |       |                                             |       |                           |       |
| Allowance for uncollectible accounts                     |       | 7.1                                  |       | 1.5                                             |       | (1.8                                        | )          | (0.5                                             | )          | 6.3                            |       |
| **December 31, 2008:**                              |       |                                 |       |                                            |       |                                        |       |                                             |       |                           |       |
| Reinsurance recoverable on paid and  unpaid losses: |       |                                 |       |                                            |       |                                        |       |                                             |       |                           |       |
| Allowance for reinsurance balances(2)                    |       | $                                    | 12.7       |                                            | $          | —                                      |       | $                                                | 5.2        |                           | $          | (1.3 | ) | $ | 16.6 |   |
| Premiums receivable:                                     |       |                                 |       |                                            |       |                                        |       |                                             |       |                           |       |
| Allowance for uncollectible accounts(3)                  |       | 18.5                                 |       | 2.0                                             |       | (13.1                                       | )          | (0.3                                             | )          | 7.1                            |       |
| **December 31, 2007:**                              |       |                                 |       |                                            |       |                                        |       |                                             |       |                           |       |
| Reinsurance recoverable on paid and unpaid losses:       |       |                                 |       |                                            |       |                                        |       |                                             |       |                           |       |
| Allowance for reinsurance balances                       |       | $                                    | 13.4       |                                            | $          | —                                      |       | $                                                | —     |                           | $          | (0.7 | ) | $ | 12.7 |   |
| Premiums receivable:                                     |       |                                 |       |                                            |       |                                        |       |                                             |       |                           |       |
| Allowance for uncollectible accounts                     |       | 16.8                                 |       | (1.0                                            | )          | —                                      |       | 2.7                                              |       | 18.5                           |       |

 

----

(1)                                  Represents netcollections (charge-offs) of balances receivable.

 

(2)                                  Amount chargedto other accounts represents an increase in the Allowance for uncollectiblereinsurance which was offset by a corresponding increase in Ceded reinsurance,a component of Reinsurance recoverable on unpaid losses. There was no impact toReinsurance recoverable on unpaid losses as presented in the consolidated balancesheets.

 

(3)                                  Amount creditedto other accounts represents a reduction in the Allowance for uncollectiblepremiums receivable which was offset by a corresponding reduction in Grosspremiums receivable. There was no impact to Premiums receivable as presented inthe consolidated balance sheets.

 

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Table ofContents

 

**SCHEDULE VI**

 

**ONEBEACONU.S. HOLDINGS, INC.**

 

**SUPPLEMENTAL INFORMATION FOR PROPERTY AND CASUALTY INSURANCEUNDERWRITERS**

 
| **Column A**                    | ** ** | **Column B**                     | ** ** | **Column C**                                                       | ** **             | **Column D**                                   | ** **           | **Column E** | ** ** | **Column F**          | ** ** | **Column G**                   | ** ** | **Column H**                                                     | ** ** | **Column I**                                              | ** ** | **Column J**                                        | ** ** | **Column K** | ** ** |
|---------------------------------|------------|----------------------------------|------------|--------------------------------------------------------------------|------------------------|------------------------------------------------|----------------------|--------------|------------|-----------------------|------------|--------------------------------|------------|------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|-----------------------------------------------------|------------|--------------|------------|
| ** **                      | ** ** | **Deferred  acquisition  costs** | ** ** | **Reserves  for Unpaid  Claims and  Claims  Adjustment  Expenses** | ** **             | **Discount,  if any,  deducted  in  Column C** | ** **           | ** **   | ** ** | ** **            | ** ** | **Net  investment  income(3)** | ** ** | **Claims and Claims  Adjustment  Expenses Incurred  Related to** | ** ** | **Amortization  of deferred  policy  acquisition  costs** | ** ** | **Paid  Claims  and  Claims  Adjustment  Expenses** | ** ** | ** **   | ** ** |
| **Affiliation with registrant** | ** ** | ** **                       | ** ** | ** **                                                         | **Unearned  Premiums** | ** **                                     | **Earned  Premiums** | ** **   | ** ** | **(1)  Current Year** | ** ** | **(2)  Prior Year**            | ** ** | ** **                                                       | ** ** | **Premiums  written**                                     | ** ** |
| ** **                      | ** ** | **($ in millions)**         | ** ** |
| **Insurance Operations:**       |       |                             |       |                                                               |                   |                                           |                 |         |       |                  |       |                           |       |                                                             |       |                                                      |       |                                                |       |         |       |   |   |
| 2009                            |       | $                                | 215.0      |                                                               | $                      | 4,125.3                                        |                 | $            | 127.0      | (1)                   | $          | 1,018.3                        |       | $                                                                | 1,959.5    |                                                      | $          | 127.4                                               |       | $            | 1,205.3    |   | $ | (83.4 | ) | $ | 398.3 |   | $ | 1,176.1 |   | $ | 1,906.7 |   |
| 2008                            |       | 225.5                            |       | 4,504.5                                                            |                   | 142.1                                          | (1)                  | 1,088.2      |       | 1,879.0               |       | 152.8                          |       | 1,188.2                                                          |       | (62.0                                                     | )          | 368.3                                               |       | 1,198.3      |       | 1,963.1 |   |
| 2007                            |       | 200.0                            |       | 4,718.8                                                            |                   | 156.9                                          | (1)                  | 1,005.9      |       | 1,873.6               |       | 184.5                          |       | 1,138.1                                                          |       | (48.3                                                     | )          | 318.9                                               |       | 1,250.1      |       | 1,864.4 |   |
| **Other Operations:**           |       |                             |       |                                                               |                   |                                           |                 |         |       |                  |       |                           |       |                                                             |       |                                                      |       |                                                |       |         |       |   |   |
| 2009                            |       | $                                | —     |                                                               | $                      | (190.5                                         | )                    | $            | 190.5      | (2)                   | $          | —                         |       | $                                                                | —     |                                                      | $          | —                                              |       | $            | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| 2008                            |       | —                           |       | (210.5                                                             | )                      | 210.5                                          | (2)                  | —       |       | —                |       | —                         |       | —                                                           |       | —                                                    |       | —                                              |       | —       |       | — |   |
| 2007                            |       | —                           |       | (238.5                                                             | )                      | 238.5                                          | (2)                  | —       |       | —                |       | —                         |       | —                                                           |       | —                                                    |       | —                                              |       | —       |       | — |   |

 

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(1)                                  The amountsshown represent OB Holdings’ discount on its long-term workers compensationloss and LAE reserves, as such liabilities constitute unpaid but settled claimsunder which the payment pattern and ultimate costs are fixed and determinableon an individual basis. OB Holdings discounts these reserves using an averagediscount rate which is determined based on various assumptions including considerationof when the claims will be settled (5.3%, 5.5% and 5.5% at December 31,2009, 2008 and 2007).

 

(2)                                  The amountsshown exclude unamortized fair value adjustments to reserves for unpaid claimsand claims adjustment expenses made in purchase accounting as a result of OBH’spurchase of OneBeacon for the years ended December 31, 2009, 2008 and2007, respectively.

 

(3)                                  The amountsshown exclude net investment (expense) income relating to non-insuranceoperations of $(2.1) million, $9.3 million and $17.9 million for the yearsended December 31, 2009, 2008 and 2007, respectively.

 

S-7

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