We are a property and casualty insurance writer that provides a range of specialty insurance products as well as a variety of segmented commercial and personal insurance products. With roots dating back to 1831, we have been operating for more than 175 years and have many long-standing relationships with independent agencies, which constitute our primary distribution channel. We consist of a group of operating companies which are U.S.-based property and casualty insurance writers, most of which operate in a multi-company pool. Pooling arrangements permit the participating companies to rely on the capacity of the entire pool’s capital and surplus rather than just on its own capital and surplus. Under such arrangements, the members share substantially all insurance business that is written, and allocate the combined premiums, losses and expenses. In the year ended December 31, 2008, our net written premiums totaled $2.0 billion and we had total assets of $7.9 billion and total common shareholder’s equity of $1.1 billion at December 31, 2008.
Affiliate Quota Shares. During 2004 and 2005, we entered into two quota share reinsurance arrangements with other subsidiaries of White Mountains, primarily for White Mountains’ capital management purposes. These arrangements were commuted in the fourth quarter of 2006 in connection with OBIG’s initial public offering. Under the Sirius Quota Share, we ceded between 6% and 12% of business written, effective April 1, 2004, to Sirius. Under the Esurance Quota Share, effective January 1, 2005, we assumed approximately 85% of business written by Esurance, which includes business written by its wholly-owned subsidiary.
The income tax (benefit) provision related to pre-tax income or loss from continuing operations for the years ended December 31, 2008, 2007 and 2006 represented an effective tax rate of (32.6)%, 41.2% and 31.3%, respectively. 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 from operations and non-deductible dividends and accretion on the Berkshire Preferred Stock, partially offset by tax exempt interest and dividend income. Our effective tax rate for the year ended December 31, 2007 was higher than the U.S. statutory rate of 35% primarily due to non-deductible dividends and accretion on the Berkshire Preferred Stock, partially offset by tax exempt interest and dividend income. Our effective tax rate for the year ended December 31, 2006 was lower than the U.S. statutory rate of 35% primarily due to the settlement of the federal income tax audits related to tax years prior to 2003, the tax benefits recognized on the exchange of our investment in MSA and tax exempt interest and dividend income, partially offset by non-deductible dividends and accretion on the Berkshire Preferred Stock. Due to the redemption of the Berkshire Preferred Stock in May 2008, the impact of this item has been eliminated for 2009 and subsequent years.
During the third quarter of 2008, we acquired EBI, an insurance agency specializing in the entertainment, sports and leisure industries, for $8.0 million in cash. In connection with the purchase of EBI, which was accounted for as an acquisition under the purchase method of accounting in accordance with SFAS No. 141, “Business Combinations,” we recorded the identifiable assets and liabilities of EBI at their fair value at acquisition date. Significant assets and liabilities acquired include premiums and commissions receivable of $16.6 million and premiums and commissions payable of $16.1 million. After allocating the purchase price to identifiable tangible assets and liabilities, we also recorded an intangible asset of $9.5 million which represents the value of business in force at the acquisition date. The amortization associated with the intangible asset will be amortized over a 10-year period in proportion to the timing of the discounted cash flows used to value the business.
(5) Prior accident year development, including development on catastrophes, for the years ended December 31, 2008, 2007 and 2006 (decreased) increased our loss and LAE and total combined ratios by (3.3) points, (2.6) points and 1.2 points, respectively.
Our Other Operations segment consists of our holding company, OBH, which primarily consists of financing activities, purchase accounting adjustments relating to the OneBeacon Acquisition and other assets and general and administrative expenses incurred at the holding company level. This segment also includes entities that prior to OBIG’s initial public offering employed persons associated with White Mountains’ holding company operations. Accordingly, in 2006, Other Operations incentive compensation expense included $4.1 million associated with these persons transferred to White Mountains from these entities.
(3) The year ended December 31, 2006 includes the impact of the adoption of SFAS No. 155.
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.
OBH’s ability to declare or pay dividends was limited by the terms of the Series A Preferred Stock issued to Berkshire. OBH could not, in certain circumstances, declare or pay any dividend or distribution to any other class or series of stock without the consent of the holders of a majority of outstanding shares of the Berkshire Preferred Stock. Under the terms of a Keep-Well Agreement dated November 30, 2004 between White Mountains and OBH (the Keep-Well), White Mountains had agreed to return to OBH up to approximately $1.1 billion if some or all of that amount is required by OBH to meet its obligations under the terms of the Berkshire Preferred Stock. As described below, the Keep-Well has expired. Under the Keep-Well, White Mountains had to make any required contributions to OBH prior to making any distributions to its shareholders. The aggregate amount of distributions that White Mountains may make to its shareholders was limited; the limit increased or decreased by an amount equal to White Mountains’ consolidated net income or loss over the remaining life of the Keep-Well. The Keep-Well expired when all obligations of the Berkshire Preferred Stock were satisfied upon its redemption in May 2008. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Economic Defeasance” for a discussion of the creation and funding of an irrevocable grantor trust to economically defease the Berkshire Preferred Stock.
In connection with OBIG’s initial public offering, OBH established an irrevocable grantor trust. The assets of the trust were solely dedicated to the satisfaction of the payment of dividends and redemption amounts on the $300 million liquidation preference of the Berkshire Preferred Stock. OBH funded the trust with cash and purchased a portfolio of fixed maturity securities issued by the U.S. government and government-sponsored enterprises. The scheduled interest and principal payments were sufficient to pay 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 preferred stock nor create any additional rights for the holders of the Berkshire Preferred Stock in the trust or otherwise, although the assets in the trust were segregated from the Company’s other general assets and were not available to the Company for any use other than the payment of the Berkshire Preferred Stock. The assets held in trust were used to redeem the Berkshire Preferred Stock in May 2008. White Mountains Capital, Inc., a subsidiary of White Mountains, served as the trustee for the irrevocable grantor trust. The assets held in the trust as of December 31, 2008 and 2007 include $0 and $305.5 million, respectively, of fixed maturity investments and $0 and $0.1 million, respectively, of short-term investments. Pre-tax net investment income earned on these investments totaled $6.2 million, $15.4 million and $2.1 million, respectively, for the years ended December 31, 2008, 2007 and 2006, respectively.
· In 2004, we established a separate 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 been reflected in historical losses. Therefore, we have given considerable weight to the most recent loss experience for this segment.
The recorded reserves represent management’s best estimate of unpaid loss and LAE by line of business. We use the results of several different actuarial methods to develop our estimate of ultimate reserves. While we have not determined the statistical probability of actual ultimate paid losses falling within the range, management believes that it is reasonably likely that actual ultimate paid losses will fall within the ranges noted above because the ranges were developed by using several different generally accepted actuarial methods.