The Company's headquarters, registered office, principal executive office and investment and corporate finance office are leased. Sirius International's home office in Sweden and substantially all of its branch offices, as well as WMU's offices in Ireland and Bermuda are leased. Folksamerica's home office, and its branch offices are leased as well. The home office of OneBeacon and most of its branch offices are leased with the exception of branch offices located in New York, which are owned by OneBeacon. Certain leased and owned OneBeacon office locations have been leased or subleased to
(c)Deferred credits added during 2001 resulted from the purchase of OneBeacon.
(d)Increase in 2001 included effects of capital raising activities undertaken in connection with the OneBeacon Acquisition. Increase in 2002 included the recognition of $660 million in net deferred credits as a result of a change in accounting principles. See Note 1.
(f)Book value per share plus unamortized deferred credits less goodwill and the equity in net unrealized gains from Symetra's fixed income portfolio per Common and equivalent Common Share. The 2002 fully converted tangible book value per share assumes outstanding convertible preference shares to be equivalent Common Shares.
(g)During 2003, 677,966 Common Shares were issued in satisfaction of Convertible Preference Shares. During 2004, 1,724,200 Common Shares were issued in satisfaction of warrants exercised.
(k)Extraordinary gains in 2004 resulted from the excess of the fair value over the cost of net assets acquired in the Sirius, Symetra, Tryg-Baltica and Sierra transactions.
The following discussion also includes two non-GAAP financial measures, adjusted comprehensive net income and fully converted tangible book value per share, that have been reconciled to their most comparable GAAP financial measures (see page 55). White Mountains believes these measures to be more relevant than comparable GAAP measures in evaluating White Mountains' financial performance.
White Mountains ended 2004 with a fully converted tangible book value per Common Share of $343, which represents an increase of 18% (including dividends) over the fully converted tangible book value per Common Share of $291 as of December 31, 2003. During 2003, fully converted tangible book value per Common Share increased by 13% (including dividends) from $259 as of December 31, 2002.
Adjusted comprehensive net income was $539 million for 2004, compared to $360 million in 2003. Net income for 2004 was $419 million, compared to $281 million in 2003.
The growth in book value was driven by strong investment results, particularly equities which returned 20%, and $180 million in transaction gains. This more than offset the impact of higher than expected losses from catastrophes and prior year reserve development. The growth in earnings was primarily driven by the transaction gains as both 2004 and 2003 had strong investment results.
All three business segments performed well. OneBeacon's combined ratio in 2004 was 99%, the second consecutive year it was below 100%, and Esurance earned a profit for the first time in 2004. White Mountains Re had a combined ratio of 104% due to 11 points from catastrophes. However, the segment contributed $140 million in transaction gains and therefore was a significant contributor to the Company's growth in book value for the year.
Total expenses decreased by 16% in 2003 as compared to 2002, as loss and LAE, as well as insurance acquisition and other underwriting expenses, decreased at OneBeacon as a result of improved underwriting performance on its on-going businesses and as the continued run-off of unprofitable business through the Liberty Agreement. In addition, interest expense on debt decreased 32% in 2003 as a result of the repayment of the $260 million of debt in November 2002 and the refinancing of $700 million of debt in May 2003. Also contributing to the decrease in expenses was a decrease in the accretion of the fair value adjustment to the reserves acquired as part of the OneBeacon Acquisition. This accretion will continue to decrease as those acquired reserves are paid over time. Partially offsetting these expense decreases was an increase in general and administrative expense of $109 million in 2003 over 2002, primarily due to an increase in incentive compensation accruals, which were driven by a 42% rise in White Mountains' stock price during 2003.
The following tables provide GAAP ratios, net written premiums and earned insurance premiums for OneBeacon's ongoing businesses and in total for the years ended December 31, 2004, 2003, and 2002:
OneBeacon's pretax income for 2004 was $391 million, compared to pre-tax income of $405 million for 2003 and its GAAP combined ratio was 99% for 2004, compared to 98% for 2003. The earnings and combined ratios for each period were relatively consistent as each period had solid performance for the current underwriting year, partially offset by some adverse development in prior year's reserves. In total, adverse development was $100 million in 2004 (relating primarily to 2002 and prior accident years) and $147 million in 2003 (relating primarily to 2000 and prior accident years). The 2004 development related primarily to personal auto liability, general liability and multiple peril reserves due in part to emerging trends in claims experienced in OneBeacon's run-off operations, as
OneBeacon's total expenses for 2004 increased 13% compared to 2003, primarily as a result of increased incentive compensation accruals driven by the 41% rise in White Mountains' share price in 2004, partially offset by the release of $20 million of the New York assigned risk liability. The release of this liability resulted from the continued effects of favorable revisions to the structure of credit programs. General and administrative expenses were higher in 2004 due mainly to the commencement of two new private equity funds managed by Tuckerman Capital, a group of private equity funds that are consolidated as a result of White Mountains' significant investment in the funds.
Specialty Lines. The specialty lines combined ratio was 90% for 2004, compared to the 2003 combined ratio of 86%. The 2004 combined ratio was higher than 2003 primarily due to losses relating to the four storms in the southeastern United States that impacted IMU and better than expected weather losses in 2003. Written premiums for specialty lines were up 16% in 2004, driven by growth in writings at OBPP and AutoOne Insurance, as well as the introduction of OBSP in 2004, a new division offering coverages to the excess and surplus property market.
Commercial Lines. The combined ratio for commercial lines for 2004 was 97%, compared to the 2003 combined ratio of 95%. The 2004 combined ratio was a bit higher as a result of transition and integration costs related to the Atlantic Specialty Transaction and adverse results from its non-Atlantic Mutual New York commercial lines book. The 2004 loss ratio includes two points relating to the four storms in the southeastern United States, which primarily related to Atlantic Specialty business in that area. Excluding these losses, the commercial lines loss ratio significantly improved. Premiums in this line grew by 89% primarily due to the Atlantic Specialty Transaction.
OneBeacon's total expenses for 2003 declined by 29% compared to 2002, primarily as a result of reduced premium writings and improved underwriting performance. Total expenses in 2003 included a net $147 million reserve increase in OneBeacon's runoff operations, primarily related to prior year construction defect claims, that was partially offset by an approximate $30 million release of the New York assigned risk liability due to the shrinking New York assigned risk pool. General and administrative expenses increased significantly in 2003 due mainly to expenses generated by New Jersey Skylands Management LLC and certain consolidated limited partnerships.
During the fourth quarter of 2003, OneBeacon sold one of its subsidiaries, National Farmers Union Standard Insurance Company ("NFU Standard"), for $22 million and recognized a $9 million gain on the sale through other revenue.
Personal Lines. The combined ratio in 2003 was 91%, a six point improvement over the 97% reported in 2002 as price increases achieved in 2002 and 2003 flowed through into underwriting results. In addition, the 2003 period reflected the reduction in OneBeacon's New York assigned risk liability, discussed above, which lowered the combined ratio by three points. OneBeacon's personal lines written premium volume for 2003 decreased 20% from 2002, primarily due to re-underwriting efforts such as actions to reduce exposure to windstorms on property located in coastal areas. Also contributing to the decrease were declines in written premiums relating to the transfer of OneBeacon's private passenger automobile business in New Jersey to New Jersey Skylands Insurance Association in 2002.
Commercial Lines. The combined ratio in 2003 was 95%, a five point improvement over the 100% reported in 2002 as the Company's efforts to re-underwrite its book took hold, partially offset by prior year reserve development of three points. OneBeacon's commercial lines written premium volume for 2003 decreased 6% from 2002, primarily due to the continued effects of actions taken to reduce the concentration of risks subject to terrorism, such as reducing total insured values in 11 major cities, and reductions in workers compensation writings.
Run-off Operations. Pursuant to the Liberty Agreement, Liberty Mutual assumed control of OneBeacon's claims offices in the regions subject to the Liberty Agreement and was responsible for servicing claims from the OneBeacon policies written prior to November 1, 2001, as well as policies
which renewed in those regions since that date. Effective July 11, 2003, the servicing agreement with Liberty Mutual was amended and OneBeacon took back substantially all remaining outstanding claims related to policies written prior to the Liberty Agreement.
Financial results and GAAP combined ratios for White Mountains Re for the years ended December 31, 2004, 2003 and 2002 follows:
White Mountains Re Results-Year Ended December 31, 2004 versus Year Ended December 31, 2003
White Mountains Re's GAAP combined ratio increased from 96% in 2003 to 104% in 2004, due primarily to $135 million of claims incurred related to significant property catastrophe events in the second half of 2004. These catastrophes, which are discussed further below, increased the combined ratio in 2004 by 11 points. In general, White Mountains Re has experienced favorable underwriting conditions for the past three underwriting years. Earnings from business segments not impacted by the property catastrophe events, and earnings from the recently completed Sirius Acquisition, have partially offset the impact of these natural disasters. Net written premiums, total revenues, and total expenses were all up substantially in 2004 due to the Sirius Acquisition.
Gross written premiums increased $518 million, or 37% from 2003 to 2004, and net written premiums increased $361 million, or 41% for the same period. This increase is due primarily to the Sirius Acquisition, which contributed $612 million of gross written premiums and $418 million of net written premiums during 2004. Included in these amounts is the U.S. program business written by Sirius America totaling $216 million of gross written premiums and $85 million of net written premiums. Additionally, in late 2003, White Mountains Re, through Folksamerica, entered into the CNA Re agreement and established a Chicago underwriting office. Annual gross written premiums for the 2004 underwriting year resulting from this transaction and the related opening of the Chicago underwriting office were approximately $177 million, of which $129 million was recorded as gross written premium and $91 million as net written premium for the year ended December 31, 2004. Partially offsetting the increases resulting from these transactions was the cancellation of several large casualty treaties at Folksamerica whose pricing or terms did not meet White Mountains Re's underwriting guidelines.
White Mountains Re's gross written premiums increased 44% from 2002 to 2003, while net written premiums increased 29% and earned premiums increased 33%. The increases in net written and earned premiums were due to increased pricing on White Mountains Re's expiring and renewed contracts, increased shares on renewed contracts and new contracts resulting from the increased demand of reinsurance buyers for placing reinsurance with responsible, well-capitalized reinsurers.
White Mountains Re's total revenues were up 27% in 2003 over 2002, primarily driven by a 33% increase in earned premiums. The increase in earned (and net written) premiums was due to increased pricing on White Mountains Re's expiring and renewed contracts, increased shares on renewed contracts and new contracts resulting from the increased demand of reinsurance buyers for placing reinsurance with responsible, well-capitalized reinsurers. Also contributing to the increase in revenues in 2003 was a $49 million increase ($98 million in 2003 vs $49 million in 2002) in advisory fees and profit commissions received by White Mountains Re on reinsurance placements referred to Olympus, due principally to an increase in the volume of business ceded to Olympus in 2003.
White Mountains Re experienced approximately $46 million of unfavorable loss reserve development during 2003, primarily due to strengthening of A&E reserves and reserves on Risk Capital casualty lines. White Mountains Re's 2003 loss development for A&E exposures was due to the completion of a detailed A&E market share study. This study compared Folksamerica's share of industry paid losses to estimated industry carried reserves and resulted in Folksamerica increasing its IBNR by approximately $25 million.
The auto program, combined with Esurance's self-service, web-enabled operating platform, allowed Esurance to increase premium volume and in-force policy count while reducing the expense ratio from 39% to 33%. As of December 31, 2004, Esurance's in-force count was 118,513 policies, a 60% increase over December 31, 2003. Increased advertising, particularly in radio and TV, drove policy count growth.
The trends described above that drove Esurance's favorable results in 2004 relative to 2003 also benefitted the 2003 results in relation to 2002. Thus, the pretax loss for Esurance decreased by $7 million in 2003 and the combined ratio fell 49 points, while net written premiums more than doubled.
White Mountains' capital raising and capital allocation activities are principally conducted through its holding companies. In this regard, the results of its Other Operations segment primarily relate to financing activities, purchase accounting adjustments relating to the OneBeacon Acquisition, gains and losses recognized from the purchase and sale of certain of the Company's subsidiaries and other assets and general and administrative expenses incurred at the holding company level.
Other Operations Results-Year Ended December 31, 2004 versus Year Ended December 31, 2003
Other Operations Results-Year Ended December 31, 2003 versus Year Ended December 31, 2002
Adjusted comprehensive net income is a non-GAAP measure that excludes the change in net unrealized gains from Symetra's fixed maturity portfolio from comprehensive net income. GAAP requires these assets to be marked-to-market, which results in gains during periods when interest rates fall and losses in periods when interest rates rise. Because the liabilities related to the life insurance and structured settlement products that these assets support are not marked-to-market, it is likely that the economic impact on Symetra would be the opposite of that shown under GAAP (i.e., in general, Symetra's intrinsic value increases when interest rates rise and decreases when interest rates fall). The reconciliation of adjusted comprehensive net income to comprehensive net income is included on page 43.
Operating subsidiary level. The primary sources of cash for White Mountains' insurance and reinsurance operating subsidiaries are premium collections, net investment income and proceeds from sales and maturities of investments. The primary uses of cash are claim payments, policy acquisition costs, operating expenses, the purchase of investments and dividend and tax sharing payments made to parent holding companies.
Generally, OneBeacon's regulated insurance operating subsidiaries have the ability to pay dividends during any 12 month period without the prior approval of regulatory authorities in an amount equal to the greater of prior year statutory net income or 10% of prior year end statutory surplus, subject to the availability of unassigned funds. As a result, based on 2004 statutory net income, OneBeacon's top tier regulated insurance operating subsidiaries have the ability to pay $325 million of dividends during 2005 without prior approval of regulatory authorities, subject to the availability of unassigned funds. As of December 31, 2004, OneBeacon's top tier regulated insurance operating subsidiaries had $1.3 billion of unassigned funds available for dividend distribution.
Folksamerica's principal regulated reinsurance operating subsidiary has the ability to pay dividends during any 12 month period without the prior approval of regulatory authorities in an amount equal to the lesser of net investment income, as defined by statute, or 10% of statutory surplus, in both cases as most recently reported to regulatory authorities, subject to the availability of earned surplus. As a result, based upon December 31, 2004 statutory surplus of $917 million, Folksamerica's principal regulated reinsurance operating subsidiary would have the ability to pay approximately $92 million of dividends during 2005 without prior approval of regulatory authorities, subject to the availability of earned surplus. As of December 31, 2004, Folksamerica's principal regulated reinsurance operating subsidiary had $17 million of earned surplus, therefore it can pay dividends of $17 million plus additional earned surplus reported during 2005, subject to the $92 million limitation discussed above.
In addition, as of December 31, 2004, White Mountains Re had approximately $97 million of cash and investments outside of its regulated insurance and reinsurance operating subsidiaries available for distribution during 2005.
International if it fails to maintain predetermined levels of premium writings in future years. As a result of the indefinite deferral of these taxes, Swedish regulatory authorities do not apply any taxes to the safety reserve when calculating solvency capital under Swedish insurance regulations.
On November 30, 2004, White Mountains completed a significant corporate reorganization, through which ownership of Folksamerica was transferred to White Mountains Re from Fund American. In order to effect the reorganization, White Mountains and Fund American entered into or amended certain agreements with respect to the Berkshire Preferred Stock. Under the terms of a Keep-Well Agreement dated November 30, 2004 between White Mountains and Fund American (the "Keep-Well"), White Mountains has agreed to return to Fund American up to approximately $1.1 billion, which equals the amount of net assets transferred out of Fund American as a result of the reorganization, if some or all of that amount is required by Fund American to meet its obligations to Berkshire under the Berkshire Preferred Stock. Additionally, the Keep-Well limits the aggregate amount of distributions that White Mountains may make to its shareholders to approximately $1.3 billion plus White Mountains' aggregate consolidated net income after September 30, 2004. The Keep-Well will expire when all obligations of the Berkshire Preferred Stock, which is redeemable in May 2008, have been satisfied, or when approximately $1.1 billion has been returned to Fund American.
(1)Excludes funds held by ceding companies from which White Mountains does not receive interest credits and excludes funds held by White Mountains under reinsurance treaties for which White Mountains does not provide interest credits. White Mountains has historically obtained its float primarily through acquisitions, as opposed to organic growth. For each of the years in the three-year period ending December 31, 2004, White Mountains has had negative cash flows from operations but has generated significant float from its insurance and reinsurance operations. This is due to the fact that White Mountains' cash flow from operations does not reflect cash and investments generated by the acquisition of insurance and
reinsurance businesses in recent years. Post-acquisition, such companies are often placed into partial or complete run-off, thereby resulting in negative cash flows from operations as the investments acquired are liquidated over time to pay claims.
The following table summarizes White Mountains' capital structure as of December 31, 2004 and 2003:
(1)See Note 6-Debt of the accompanying Consolidated Financial Statements for a discussion of operating subsidiary debt. Management believes that White Mountains' strong financial position provides it with the flexibility and capacity to obtain funds externally as needed through debt or equity financing on both a short-term and long-term basis. In May 2003, White Mountains reduced its cost of capital and significantly reduced its near-term obligations by fully prepaying its previous $740 million amortizing bank facility, principally through the net proceeds from the issuance of the Senior Notes, which were issued by Fund American through a public offering. The Senior Notes bear a fixed annual interest rate of 5.9% and mature in May 2013. In July 2003, White Mountains enhanced its access to the capital markets by having a shelf registration declared effective by the SEC for offerings of up to $2.0 billion in debt and/or equity securities.
In August 2004, Fund American restructured and re-syndicated its existing $300 million Bank Facility to increase the availability under the revolving credit facility to $400 million and to extend the maturity from September 2006 to August 2009. Under the Bank Facility, for which both Fund American and the Company are permitted borrowers, the Company guarantees all obligations of Fund American, and Fund American guarantees all borrowings of the Company, subject to certain limitations imposed by the terms of the Berkshire Preferred Stock. As of December 31, 2004, the Bank Facility was undrawn.
In connection with its acquisition of Atlantic Specialty on March 31, 2004, OneBeacon issued a $20 million ten-year note to the seller (the "Atlantic Specialty Note"). OneBeacon is required to repay $2 million of principal on the notes per year, commencing with the first payment due on January 1, 2007.
Fund American's Senior Notes are currently rated "Baa2" (Adequate, the 9th highest of 21 ratings) with a stable outlook by Moody's and "BBB-" (Adequate, the 10th highest of 24 ratings) with a positive outlook by S&P and "BBB" (Good, the 9th highest of 24 ratings) with a stable outlook by Fitch Ratings. It is possible that, in the future, one or more of the rating agencies may lower White Mountains' existing ratings. If one or more of its ratings were downgraded, White Mountains could incur higher borrowing costs and its ability to access the capital markets could be impacted. In addition, White Mountains' insurance and reinsurance operating subsidiaries could be adversely impacted by a downgrade in their financial strength ratings, including a possible reduction in demand for their products in certain markets.
The Senior Notes were issued under an indenture which contains restrictive covenants that, among other things, limit the ability of the Company, Fund American and their respective subsidiaries to create liens and enter into sale and leaseback transactions and substantially limits the ability of Fund American and its respective subsidiaries to consolidate, merge or transfer their properties and assets. The indenture does not contain any financial ratios or specified levels of net worth or liquidity to which the Company or Fund American must adhere. At December 31, 2004, White Mountains was in compliance with all of the covenants under the Senior Notes, and anticipates it will continue to remain in compliance with these covenants for the foreseeable future.
White Mountains' loss reserves do not have contractual maturity dates. However, based on historical payment patterns, the preceding table includes an estimate of when management expects White Mountains' loss reserves to be paid. The timing of claim payments is subject to significant uncertainty. White Mountains maintains a portfolio of marketable investments with varying maturities and a substantial amount of short-term investments to provide adequate cash flows for the payment of claims.
Through Sirius International, White Mountains has a long term investment as a stockholder in LUC Holdings, an entity that has entered into a head lease to rent the London Underwriting Center ("LUC") through 2016. LUC Holdings in turn subleases space in the LUC. In the LUC Holdings stockholders agreement, the stockholders have guaranteed any shortfall between the head lease and the sub-leases on a joint and several basis. As a consequence, in recent years the stockholders have funded an operating shortfall of LUC. At December 31, 2004, White Mountains has recorded a liability of $10 million for its share of the expected future shortfall between LUC Holdings' head lease payments
Detailed information concerning White Mountains' liquidity and capital resource activities during 2004, 2003 and 2002 follows:
During 2004, White Mountains declared and paid dividends of $9 million, $28 million and $2 million to holders of Common Shares, the Berkshire Preferred Stock and the Zenith Preferred Stock, respectively.
See Note 2-Significant Transactions of the accompanying Consolidated Financial Statements for further discussion of these transactions.
During the first quarter of 2004, White Mountains sold 4.5 million common shares of Montpelier to third parties for net proceeds of $155.3 million. Also during the first quarter of 2004, White Mountains purchased additional warrants to acquire 2.4 million common shares of Montpelier from an existing warrant holder for $54.1 million in cash.
In September 2003, Fund American established its $300 million revolving Bank Facility. As discussed earlier, this Bank Facility was restructured and re-syndicated in August 2004.
During 2003, OneBeacon declared and paid a total of $235 million in cash dividends to Fund American. Also during 2003, WMU paid a total of $35 million in cash dividends to its immediate parent, White Mountains Re, and WM Advisors paid a total of $10 million in cash dividends to Fund American.
During 2003, OneBeacon sold one of its subsidiaries, NFU Standard, for $22 million.
During 2002, OneBeacon declared and paid a total of $173 million in cash dividends to Fund American.
During 2002, the Company issued a total of 23,200 Common Shares to its employees in satisfaction of performance share and Option obligations under White Mountains' Long-Term Incentive Plan (the "Incentive Plan"). The Company received proceeds of $1.3 million as a result of exercises of Options to acquire 11,500 Common Shares during the period.
In December 2002, OBPP borrowed $8 million from a related third party.
In July and August of 2002, White Mountains received federal tax refunds totaling $167 million representing accelerated recoveries of carryback losses from 2001 under the Job Creation and Worker Assistance Act of 2002.
During 2002, White Mountains paid a total of 31,300 performance shares (relating to the 1999-2001 performance period) at a 200% value, amounting to $21 million, to its participants in cash, Common Shares or by deferral into certain non-qualified compensation plans of the Company or its subsidiaries.
See Note 17-"Related Party Transactions" in the accompanying Consolidated Financial Statements.
Management's Discussion and Analysis of Financial Condition and Results of Operations discusses the Company's consolidated financial statements, which have been prepared in accordance with GAAP.
Reserves are typically comprised of (1) case reserves for claims reported and (2) reserves for losses that have occurred but for which claims have not yet been reported, referred to as incurred but not reported ("IBNR") reserves, which include a provision for expected future development on case reserves. Case reserves are estimated based on the experience and knowledge of claims staff regarding the nature and potential cost of each claim and are adjusted as additional information becomes known or payments are made. IBNR reserves are derived by subtracting paid loss and LAE and case reserves from estimates of ultimate loss and LAE. Actuaries estimate ultimate loss and LAE using various generally accepted actuarial methods applied to known losses and other relevant information. Like case reserves, IBNR reserves are adjusted as additional information becomes known or payments are made.
in these circumstances in which the loss ratio is selected based upon information used in pricing policies for that line of business, as well as any publicly available industry data, such as industry pricing, experience and trends, for that line of business.
Uncertainties in estimating ultimate loss and LAE are magnified by the time lag between when a claim actually occurs and when it is reported and settled. This time lag is sometimes referred to as the "claim-tail". The claim-tail for most property coverages is typically short (usually a few days up to a few months). The claim-tail for liability/casualty coverages, such as automobile liability, general liability, products liability, multiple peril coverage, and workers compensation, can be especially long as claims are often reported and ultimately paid or settled years, even decades, after the related loss events occur. During the long claims reporting and settlement period, additional facts regarding coverages written in prior accident years, as well as about actual claims and trends may become known and, as a result, OneBeacon may adjust its reserves. If management determines that an adjustment is appropriate, the adjustment is booked in the accounting period in which such determination is made in accordance with GAAP. Accordingly, should reserves need to be increased or decreased in the future from amounts currently established, future results of operations would be negatively or positively impacted, respectively.
OneBeacon's actuaries use several generally accepted actuarial methods to evaluate its loss reserves, each of which has its own strengths and weaknesses. OneBeacon places more or less reliance on a particular method based on the facts and circumstances at the time the reserve estimates are made. These methods generally fall into one of the following categories or are hybrids of one or more of the following categories:
•Historical paid loss development methods: These methods use historical loss payments over discrete periods of time to estimate future losses. Historical paid loss development methods assume that the ratio of losses paid in one period to losses paid in an earlier period will remain constant. These methods necessarily assume that factors that have affected paid losses in the past, such as inflation or the effects of litigation, will remain constant in the future. Because historical paid loss development methods do not use case reserves to estimate ultimate losses, they can be more reliable than the other methods discussed below that look to case reserves (such as actuarial methods that use incurred losses) in situations where there are significant changes in how case reserves are established by a company's claims adjusters. However, historical paid loss development methods are more leveraged (meaning that small changes in payments have a larger impact on estimates of ultimate losses) than actuarial methods that use incurred losses because cumulative loss payments take much longer to equal the expected ultimate losses than cumulative incurred amounts. In addition, and for similar reasons, historical
A large number of construction defect claims have been identified relating to coverages that OneBeacon had written in the past through Commercial Union and General Accident and their subsidiaries in California, Colorado, Nevada, Washington and Oregon. Management has sought to mitigate future construction defect risks in all states by no longer providing insurance to certain residential general contractors and sub-contractors involved in multi-habitational projects. Mitigating actions also included initiating the withdrawal from problematic sub-segments within OneBeacon's construction book of business, such as street and road construction, water, sewer and pipeline construction, and dam, waterway, railroad and subway construction. Management has undertaken actions to mitigate future risks related to construction defect claims and believes that the number of reported construction defect claims relating to coverages written in the past peaked in 2004 and will begin to decline. In addition, in reserving for these claims, there is additional uncertainty due to the potential for further unfavorable judicial rulings and regulatory actions.
OneBeacon's liabilities for A&E losses from business underwritten in the recent past are substantially limited by the application of exclusionary clauses in the policy language that eliminated coverage of such claims. After 1987 for pollution and 1992 for asbestos, most liability policies contained industry-standard absolute exclusions of such claims. In earlier years, various exclusions were also applied, but the wording of those exclusions was less strict and subsequent court rulings have reduced their effectiveness.
and asbestos-containing products have gone into bankruptcy, plaintiffs have sought recoveries from peripheral defendants, such as installers, transporters or sellers of such products, or from owners of premises on which the plaintiffs' exposure to asbestos allegedly occurred. At December 31, 2004, 664 policyholders had asbestos-related claims against OneBeacon. In 2004, 112 new insureds with such peripheral involvement presented asbestos claims under prior OneBeacon policies.
Immediately prior to White Mountains' acquisition of OneBeacon, OneBeacon purchased a reinsurance contract with NICO under which OneBeacon is entitled to recover from NICO up to $2.5 billion in the future for asbestos claims arising from business written by OneBeacon in 1992 and prior, environmental claims arising from business written by OneBeacon in 1987 and prior, and certain other exposures. Under the terms of the NICO Cover, NICO receives the economic benefit of reinsurance recoverables from certain of OneBeacon's third party reinsurers in existence at the time the NICO Cover was executed ("Third Party Recoverables"). As a result, the Third Party Recoverables serve to protect the $2.5 billion limit of NICO coverage for the benefit of OneBeacon. Any amounts uncollectible from third party reinsurers due to dispute or the reinsurers' financial inability to pay are covered by NICO under its agreement with OneBeacon. Third Party Recoverables are typically for the amount of loss in excess of a stated level each year. Of claim payments in the past 11 years, approximately 63% of asbestos losses and 39% of environmental losses have been recovered under the historical third party reinsurance.
OneBeacon estimates that on an incurred basis it has exhausted approximately $1.7 billion of the coverage provided by NICO at December 31, 2004. At December 31, 2004, $14.3 million of the $1.7 billion of exhausted coverage from NICO related to uncollectible Third Party Recoverables. Net losses paid totaled approximately $682 million as of December 31, 2004, with $95 million paid in 2004. Asbestos payments during 2004 reflect payments resulting from intensified efforts by claimants to resolve asbestos claims prior to enactment of potential Federal asbestos legislation. To the extent that OneBeacon's estimate of ultimate A&E losses as well as the estimate and collectibility of Third Party Recoverables differs from actual experience, the remaining protection under the NICO Cover may be more or less than the approximate $757 million that OneBeacon estimates remained at December 31, 2004.
tailed lines of business such as ocean and inland marine insurance) recorded reserves remain rather high in the respective ranges, as management's selections reflect a conservative approach to recognition of recent favorable development experienced in our ongoing businesses.
White Mountains Re has a specialized unit that handles claims emanating from A&E exposures. The issues presented by these types of claims require specialization, expertise and an awareness of the various trends and jurisdictional developments.
Approximately $25.0 million of White Mountains Re's 2003 loss development for asbestos exposures was a bulk increase in IBNR resulting from the completion of a detailed A&E market share study. This study compared White Mountains Re's share of industry paid losses to estimated industry carried reserves.
White Mountains Re's A&E claim activity for the last two years is illustrated in the table below.
and payment patterns, and rate change history. This analysis is used to project expected loss ratios for each treaty during the upcoming contract period. These expected ultimate loss ratios are aggregated across all treaties and are input directly into the loss reserving process to generate the expected loss ratios that are used to estimate IBNR.
As mentioned above, there can be a considerable time lag from the time a claim is reported to a ceding company to the time it is reported to the reinsurer. The lag can be several years in some cases. This lag can be due to a number of reasons, including the time it takes to investigate a claim, delays associated with the litigation process, the deterioration in a claimant's physical condition many years after an accident occurs, etc. In its loss reserving process, White Mountains Re assumes that such lags are predictable, on average, over time and therefore the lags are contemplated in the loss reporting patterns used in its actuarial methods. This means that, as a reinsurer, White Mountains Re must rely on such actuarial estimates for a longer period of time after reserves are first estimated than does a primary insurance company.
Backlogs in the recording of assumed reinsurance can also complicate the accuracy of loss reserve estimation. As of December 31, 2004, there were no significant backlogs related to the processing of assumed reinsurance information at White Mountains Re.
White Mountains Re also obtain reinsurance whereby another reinsurer contractually agrees to indemnify White Mountains Re for all or a portion of the reinsurance risks underwritten by White Mountains Re. Such arrangements, where one reinsurer provides reinsurance to another reinsurer, are usually referred to as "retrocessional reinsurance" arrangements. White Mountains Re establishes estimates of amounts recoverable from retrocessional reinsurance in a manner consistent with the loss
and LAE liability associated with reinsurance contracts offered to its customers (the "ceding companies"), net of an allowance for uncollectible amounts, if any. Net reinsurance loss reserves represent loss and LAE reserves reduced by retrocessional reinsurance recoverable on unpaid losses.
White Mountains Re's net loss and LAE reserves by class of business at December 31, 2004 and 2003 were as follows:
White Mountains Re establishes loss reserves based on a single point estimate, which is management's best estimate of ultimate losses and loss expenses. This "best estimate" is derived from a combination of methods as described above. Once a point estimate is established, White Mountains Re's actuaries estimate loss reserve ranges to measure the sensitivity of the actuarial assumptions used to set the point estimates. These ranges are calculated using similar methods to the point estimate calculation, but with different expected loss ratio and loss reporting pattern assumptions. For the low estimate, more optimistic loss ratios and faster reporting patterns are assumed, while the high estimate uses more conservative loss ratios and slower reporting patterns. These variable assumptions are derived from historical variations in loss ratios and reporting patterns by class and type of business. Due to the inherent difficulties in estimating ultimate A&E exposures, White Mountains Re does not estimate ranges for these reserves. The growth in reserves from 2003 to 2004 was driven by acquisitions made during 2004.
The following table illustrates White Mountains Re's recorded net loss and LAE reserves and high and low estimates for those classes of business for which a range is calculated, at December 31, 2004.
There is a time lag from the point when premium and related commission and expense activity is recorded by a ceding company to the point when such information is reported by the ceding company, through its reinsurance intermediary, to White Mountains Re. This time lag can vary from one to
As a result of this time lag in reporting, White Mountains Re estimates a portion of its written premium and related commissions and expenses. Given the nature of White Mountains Re's business, estimated premium balances, net of related commissions and expenses, comprise a large portion of total premium balances receivable. The estimation process begins by identifying which major accounts have not reported activity at the most recent period end. In general, premium estimates for excess of loss business are based on minimum deposit information included in the contractual terms. For proportional business, White Mountains Re's estimates are derived based on a variety of factors and assumptions, including: prior reporting from the broker or ceding company, historical reporting patterns, expected premium volume based on contractual terms or ceding company reports and other correspondence and communication with underwriters, brokers, intermediaries and ceding companies. Once premium estimates are determined, related commission and expense estimates are derived using contractual terms.
The following table summarizes White Mountains Re's premium estimates and related commissions and expenses:
policies. Amounts related to reinsurance contracts are recorded in accordance with SFAS No. 113, "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts" ("SFAS 113").
The collectibility of reinsurance recoverables is subject to the solvency and willingness to pay of the reinsurer. The Company is selective in choosing its reinsurers, placing reinsurance principally with those reinsurers with a strong financial condition, industry ratings and underwriting ability. Management monitors the financial condition and ratings of its reinsurers on an ongoing basis. See Note 4-Third Party Reinsurance in the accompanying Consolidated Financial Statements for additional information on White Mountains' reinsurance programs.
During 2004, OneBeacon recognized pension expense of $3.3 million, which was comprised of net periodic benefit cost of $.4 million and special termination benefits of $2.9 million. Included in the net periodic benefit cost is $32.2 million of expected return on pension plan assets. OneBeacon contributed $4.2 million to the pension plan in 2004. No unrecognized losses on pension assets were recorded since the Company uses the market value method to value plan assets.
When White Mountains acquires another company, management must estimate the fair values of the assets and liabilities acquired, as prescribed by SFAS No. 141, "Business Combinations" ("SFAS 141"). Certain assets and liabilities require little judgment to estimate their fair values, particularly those that are quoted on a market exchange, such as publicly-traded investment securities. Other assets and liabilities, however, require a substantial amount of judgment to estimate their fair values. The most significant of these is the estimation required to fair value loss and LAE reserves.
White Mountains estimates the fair value of loss and LAE reserves obtained in an acquisition following the principles contained within FASB Statement of Financial Accounting Concepts No. 7: "Using Cash Flow Information and Present Value in Accounting Measurements" ("CON 7"). Under CON 7, the fair value of a particular asset or liability essentially contains five elements: (1) an estimate of the future cash flows, (2) expectations about possible variations in the amount or timing of those cash flows; (3) the time value of money, represented by the risk-free rate of interest; (4) the price for bearing the uncertainty inherent in the asset or liability; and (5) other, sometimes unidentifiable, factors including illiquidity and market imperfections.
•incurred losses and the adequacy of its loss and LAE reserves;