Tranzact is headquartered in Fort Lee, New Jersey with various call centers throughout the United States. QuoteLab’s headquarters are located in Santa Monica, California, Wobi’s headquarters are located in Tel Aviv, Israel, Star & Shield Services LLC’s and Star & Shield Claims Services LLC’s headquarters are located in Alpharetta, Georgia and Star & Shield Risk Management LLC’s headquarters are located in Orlando, Florida.
During 2014, 2013, 2012, 2011 and 2010, White Mountains repurchased 217,879, 141,535, 1,329,640, 646,502 and 687,871, respectively, of its common shares through a combination of tender offers, open market transactions and other transactions.
RESULTS OF OPERATIONS FOR THE YEARS ENDED December 31, 2014, 2013 and 2012
WM Life Re reported losses of $9 million in 2014 compared to $17 million of losses in 2013.
Additionally, in June 2014, White Mountains committed $21 million to fund a 50/50 joint venture with DavidShield for the international development, marketing and distribution of PassportCard travel insurance. The transaction with DavidShield is expected to close in the first quarter of 2015, subject to Israeli regulatory approvals.
White Mountains’s total net written premiums decreased 7% to $1,979 million in 2013, primarily related to OneBeacon’s exit from the collector car and boat and energy businesses and lower premiums in the accident and health and trade credit lines at Sirius Group, partially offset by growth in all of OneBeacon’s ongoing specialty lines and an increase in property lines at Sirius Group. OneBeacon’s net written premiums decreased 8% to $1,089 million in 2013. Excluding the $206 million of net premiums written in 2012 from the exited businesses, White Mountains’s net written premiums decreased 3% and OneBeacon’s net written premiums increased 12% in 2013. Sirius Group’s net written premiums decreased 8% to $877 million in 2013.
WM Life Re reported losses of $17 million in 2013 compared to $19 million of losses in 2012.
The following table is a summary of goodwill and intangible assets that are included in White Mountains’s adjusted book value as of December 31, 2014, 2013 and 2012:
A summary of White Mountains’s consolidated financial results for the years ended December 31, 2014, 2013 and 2012 follows:
Net (loss) gain on sale of discontinued operations, net of tax
White Mountains’s total expenses increased 12% to $2,209 million in 2014. Losses and LAE, insurance and reinsurance acquisition expenses increased 12% and 6% in 2014, while other underwriting expenses decreased 7% in 2014. The increase in loss and LAE includes the $109 million reserve charge recorded by OneBeacon related to the actuarial analysis performed in the fourth quarter of 2014, which was partially offset by a $28 million decrease in OneBeacon’s incentive compensation expense accrual, contributing to the decrease in other underwriting expenses in 2014 (see “Summary of Operations by Segment” on page 56). General and administrative expenses in 2014 included $61 million from QuoteLab and $37 million from Tranzact.
Consolidated Results-Year Ended December 31, 2013 versus Year Ended December 31, 2012
White Mountains’s total revenues decreased 5% to $2,317 million in 2013, primarily due to lower earned insurance and reinsurance premiums, net investment income and other revenues, partially offset by higher net realized and unrealized investment gains. Earned insurance and reinsurance premiums decreased 4% to $1,987 million in 2013. Net investment income was down 28% to $111 million in 2013, due to a lower fixed maturity asset base, resulting primarily from $749 million of share repurchases since January 2012, and lower investment yields. White Mountains reported net realized and unrealized investment gains of $162 million in 2013, which included $1 million of net realized and unrealized foreign currency gains, compared to $118 million of gains in 2012, which included $57 million of net realized and unrealized foreign currency losses. Most of the net realized and unrealized foreign currency gains (losses) on investments are related to GAAP foreign currency translation and are offset by amounts recognized in other comprehensive income (see “Foreign Currency Translation” on page 73). Other revenue decreased to $58 million in 2013 from $100 million in 2012. Other revenue in 2013 included transaction gains of $42 million, compared to $28 million of net transaction gains in 2012. Transaction gains in 2013 included a $23 million gain on OneBeacon’s sale of Essentia, a $7 million gain on Sirius Group’s acquisition of Empire, a $7 million gain on Sirius Group’s acquisition of Ashmere and a $4 million gain from the extension of the transition service agreement for services provided by OneBeacon on business sold to Tower in the personal lines transaction in 2010, while 2012 included a $15 million gain on Sirius Group’s sale of IMG, $14 million of gains from Sirius Group’s acquisitions that closed in 2012, a $5 million gain on OneBeacon’s sale of a shell company and a $6 million loss from OneBeacon’s repurchase of its senior notes. Other revenue in 2013 also included $1 million in foreign currency translation losses, compared to $40 million in foreign currency translation gains in 2012. In addition, 2013 included $11 million of mark-to-market gains on the Symetra warrants compared to $18 million of gains in 2012. Other revenue included $13 million of WM Life Re’s losses in 2013 compared to $25 million of WM Life Re’s losses in 2012. See Note 9 - “Derivatives” for details regarding WM Life Re’s total impact on White Mountains’s statement of operations. Other revenues also included third-party investment management fee income at WM Advisors of $11 million in both 2013 and 2012. In 2012, White Mountains reported other revenue of $24 million related to the consolidation of Hamer and Bri-Mar. Effective October 1, 2012, the results of Hamer and Bri-Mar are no longer consolidated in White Mountains’s financial statements.
The Company and its Bermuda-domiciled subsidiaries are not subject to Bermuda income tax under current Bermuda law. In the event there is a change in the current law such that taxes are imposed, the Company and its Bermuda-domiciled subsidiaries would be exempt from such tax until March 31, 2035, pursuant to the Bermuda Exempted Undertakings Tax Protection Act of 1966. The Company has subsidiaries and branches that operate in various other jurisdictions around the world that are subject to tax in the jurisdictions in which they operate. The jurisdictions in which the Company’s subsidiaries and branches are subject to tax are Australia, Belgium, Canada, Denmark, Germany, Gibraltar, Israel, Luxembourg, Malaysia, the Netherlands, Peru, Singapore, Sweden, Switzerland, the United Kingdom and the United States.
White Mountains reported income tax expense of $53 million in 2014 on pre-tax income of $302 million. White Mountains’s effective tax rate for 2014 was 18%, which was lower than the U.S. statutory rate of 35% due primarily to income generated in jurisdictions with lower tax rates than the United States.
White Mountains reported an income tax benefit of $16 million in 2012 on pre-tax income of $263 million. Effective January 1, 2013, Sweden reduced its corporate tax rate from 26.3% to 22.0% and Luxembourg increased its corporate tax rate from 28.8% to 29.2%. This resulted in a reduction in deferred tax liabilities in Sweden and an increase in deferred tax assets in Luxembourg as of December 31, 2012. As a result, Sirius Group recognized $73 million in tax benefits from these changes. During 2012, Sirius Group also had a net release of valuation allowances on deferred tax assets in Luxembourg, resulting in a tax benefit of $41 million, and White Mountains established a valuation allowance on deferred tax assets of a group of U.S. companies reported in the Other Operations segment, resulting in a tax expense of $38 million. In total, White Mountains recognized $76 million in overall net tax benefits from these changes. Excluding the impact of these changes, White Mountains’s effective tax rate for 2012 was 23%, which was lower than the U.S. statutory rate of 35% due primarily to income generated in jurisdictions with lower tax rates than the United States.
OneBeacon ended 2014 with a book value per share of $10.99, an increase of 2.2% during 2014, including dividends, compared to an increase of 17.3% during 2013, including dividends. During 2014, OneBeacon’s book value per share was significantly impacted by (1) a fourth quarter increase in loss and LAE reserves of $109 million ($71 million after-tax) resulting from an actuarial and claims analysis of its ongoing specialty loss reserves, as further described below; (2) a $21 million after-tax loss from discontinued operations, driven primarily by valuation adjustments related to the surplus notes provided in conjunction with the seller financing of the Runoff Transaction; and (3) an after-tax other comprehensive loss of $12 million, primarily due to a decrease in the weighted average discount rate (from 4.7% to 3.9%), as well as a change in the mortality assumptions, used for the annual remeasurement of OneBeacon’s legacy pension plan.
OneBeacon’s net written premiums increased 12% in 2014 to $1,217 million, primarily due to an $80 million increase from its newer businesses, particularly OneBeacon Crop Insurance, OneBeacon Program Group and OneBeacon Surety Group.
Through the first nine months of 2014, OneBeacon recorded $14.3 million of unfavorable loss and LAE reserve development, driven by greater-than-expected large losses in several underwriting units, primarily in the professional and management liability lines within Professional Insurance. This large loss activity, which occurred mostly during the second and third quarters of 2014, also impacted the current accident year loss and LAE estimates. Additionally, OneBeacon incurred higher-than-usual claim coverage determination costs, a component of LAE expenses, during the first nine months of 2014. Other underwriting units also reported increased claim activity, including Entertainment, Government Risks, and Accident.
Since the increased level of loss and LAE activity continued into the early part of the fourth quarter, the high level of activity in the second and third quarters no longer seemed to be isolated occurrences. As such, during the fourth quarter of 2014, OneBeacon enhanced its actuarial and claims review in several areas. OneBeacon isolated the recent large loss activity in each of its underwriting units and examined the emergence of large losses relative to the timing and amounts of expected large losses. OneBeacon also conducted additional analyses in the lawyers’ professional liability line within the Professional Insurance underwriting unit. These new analyses included a claim level review and the application of additional actuarial methods and loss development assumptions. The results of these analyses indicated that the assumed tail risk included in the loss development patterns used to record IBNR reserves for this line were insufficient and needed to be increased for remaining long-tail exposures. OneBeacon’s claims and actuarial staff also conducted an in-depth review of coverage determination, litigation and other claim-specific adjusting expenses as a result of an emerging trend of increased expenses in these areas over recent quarters, particularly coverage determination expenses. This review concluded that the ultimate costs of these loss adjustment expenses were larger than previously estimated, causing management to record an increase in estimated LAE expenses, primarily in Professional Insurance. Finally, OneBeacon also recorded unfavorable prior year development in other underwriting units, including Entertainment and Government Risks. The unfavorable loss development in Entertainment and Government Risks resulted from heavier than expected claim activity during the fourth quarter, predominantly in the general liability and commercial auto liability lines.
In order to fully reflect these recent trends, OneBeacon recorded a $109.2 million increase in loss and LAE reserves, which included a $75.5 million increase in prior accident year loss and LAE reserves and a $33.7 million increase in the current accident year loss and LAE reserves recorded at September 30, 2014. The components of the 2014 fourth quarter loss and LAE reserve increase and the net loss and LAE development for the full year are provided below:
OneBeacon’s net combined ratio was higher than the gross combined ratio by 2 points for both 2014 and 2013 as a result of the cost of the reinsurance programs more than offsetting the benefits from ceded losses.
Also during 2014, OneBeacon’s expectation of the treatment of a $7 million reserve charge related to the Runoff Business and recorded during 2013 changed. Previously, OneBeacon had expected that the Runoff SPA would be amended to provide for the transfer of $7 million of additional assets to support this reserve charge; the Runoff SPA was instead revised, in part, to increase the cap on seller financing. As a result, the $7 million reserve charge ($5 million after-tax) was recorded as a reduction to the estimated loss on sale of discontinued operations.
Subsequent to the closing of the Runoff Transaction, on January 22, 2015, three holders of insurance policies issued by the companies we sold to Armour in the Runoff Transaction filed a Petition for Review with the Commonwealth Court of Pennsylvania (“Commonwealth Court”) requesting that the Commonwealth Court vacate the PID’s orders approving the Runoff Transaction and denying their right to intervene in the PID’s regulatory review of the Runoff Transaction. OneBeacon believes the claims made by the petitioners are without merit and intends to intervene in the proceedings before the Commonwealth Court to vigorously defend the propriety of the PID’s orders in their entirety.
OneBeacon Results-Year Ended December 31, 2013 versus Year Ended December 31, 2012
OneBeacon’s net written premiums decreased 8% in 2013 to $1,089 million, primarily due to the exit from the collector car and boat and energy businesses, partially offset by growth in nearly all of OneBeacon’s ongoing specialty lines. In January 2013, OneBeacon terminated its relationship with Hagerty and sold Essentia, the wholly owned subsidiary that wrote OneBeacon’s Hagerty collector car and boat business, to Markel Corporation. Excluding the $206 million of net written premiums from the exited businesses in 2012, net written premiums increased 12%.
OneBeacon’s other revenue in 2013 included a $23 million gain from the sale of Essentia and a $4 million benefit from the extension of the transition service agreement.
OneBeacon’s losses and LAE expenses decreased 4%, driven by lower catastrophe losses and lower earned premiums, while insurance and reinsurance acquisition expenses decreased 16%, primarily due to changes in business mix and lower net written premiums driven by the termination of the underwriting arrangement with Hagerty Insurance Agency. Other underwriting expenses were consistent with prior year. Interest expense decreased 23% to $13 million in 2013, reflecting a lower interest rate on outstanding debt.
Sirius Group Results-Year Ended December 31, 2014 versus Year Ended December 31, 2013
Sirius Group’s GAAP combined ratio was 76% for 2014 compared to 82% for 2013. The decrease was due to lower catastrophe losses and higher favorable loss reserve development, partially offset by higher acquisition and incentive compensation expenses. The 2014 combined ratio included 7 points ($59 million) of catastrophe losses, including $18 million from flooding in the Jammu and Kashmir regions in India and $8 million from Cyclone Hudhud in eastern India and Nepal, compared to 10 points ($85 million) of catastrophe losses in 2013. Favorable loss reserve development was 11 points ($98 million) in 2014 primarily due to decreases in property loss reserves, including reductions for prior period catastrophe losses, in addition to decreases in aviation, accident and health, and casualty loss reserves. Favorable loss reserve development was 6 points ($48 million) in 2013 primarily due to reductions in property loss reserves, including $24 million of favorable loss reserve development on prior year’s catastrophe losses.
Sirius Group’s gross and net written premiums each increased 1% to $1,137 million and $883 million for 2014. Increases in the accident and health, property (excluding property catastrophe excess), and aviation lines were partially offset by decreases in the property catastrophe excess and trade credit lines. Net earned premiums also increased 1% for 2014.
In 2014, Sirius Group’s other revenue was a loss of $6 million, which was primarily due to a $7 million mark-to-market loss on the interest rate cap associated with the SIG Preference Shares, somewhat offset by a $1 million gain on the sale of Citation as a “shell company.” In 2013, Sirius Group’s other revenue primarily consisted of pre-tax transaction gains of $14 million from White Mountains Solutions’ acquisitions of Ashmere and Empire. Additionally, Sirius Group recorded $57 million of foreign currency translation losses in 2014 compared to $1 million of foreign currency translation losses in 2013. (See “Foreign Currency Translation” on page 73.)
Sirius Group’s insurance and reinsurance acquisition expenses increased $27 million in 2014, as 2013 included the benefit from $19 million of profit commissions accrued by Sirius Group on ceded European property treaties, compared to $6 million on these European treaties in 2014. In addition, in 2014, additional profit commissions of $6 million were due from Sirius Group for prior accident year assumed treaties as a result of favorable loss reserve development on these treaties. Sirius Group is also experiencing higher up front acquisition expenses on certain treaty renewals due to overall softening market conditions. Sirius Group’s other underwriting expenses were up 3% in 2014, primarily due to higher incentive compensation expenses.
Sirius Group’s GAAP combined ratio was 82% for 2013 compared to 90% for 2012. The decrease was primarily due to lower catastrophe losses, higher favorable loss reserve development and lower agricultural losses. The 2013 combined ratio included 10 points ($85 million) of catastrophe losses, net of reinsurance and reinstatement premiums, primarily comprised of $27 million of flood losses in Central Europe, $20 million of hail storm losses in Germany and France, and $8 million of losses from typhoon Fitow in China, while the 2012 combined ratio included 13 points ($117 million) of catastrophe losses, comprised mainly of $98 million of losses from hurricane Sandy. Favorable loss reserve development was 6 points ($48 million) in 2013, which included $24 million of favorable loss reserve development on prior year’s catastrophe losses. Other major reductions in loss reserve estimates recognized included property ($17 million), aviation/space ($10 million) and accident and health ($9 million), partially offset by a $12 million increase in asbestos loss reserves. Favorable loss reserve development was 4 points ($34 million) for 2012, primarily attributable to favorable development in property and casualty lines, offset by a $46 million increase in asbestos reserves. Additionally, the combined ratio for 2012 included 3 points of agricultural losses, primarily as a result of a drought in the Midwestern United States.
The following table presents the components of pre-tax income included in White Mountains’s HG Global/BAM segment related to the consolidation of HG Global, which includes HG Re and its other wholly-owned subsidiaries, and BAM for the years ended December 31, 2014, 2013 and 2012:
HG Global/BAM Results-Year Ended December 31, 2014 versus Year Ended December 31, 2013
In 2014, BAM insured $7.8 billion of municipal bonds, $7.4 billion of which were in the primary market, up 66% from 2013. As of December 31, 2014, BAM’s total claims paying resources were approximately $581 million on total insured par of $12.4 billion.
HG Global reported pre-tax income of $18 million in 2014, which was driven by $16 million of interest income on the BAM Surplus Notes, compared to $38 million in 2013, which was driven by $40 million of interest income on the BAM Surplus Notes. The decrease in interest income on the BAM Surplus Notes was due to a change in the interest rate. (See LIQUIDITY AND CAPITAL RESOURCES, HG Global/BAM, on page 77.)
HG Global/BAM Results-Year Ended December 31, 2013 versus Year Ended December 31, 2012
HG Global reported pre-tax income of $38 million in 2013, which was driven by $40 million of interest income on the BAM Surplus Notes, compared to $14 million in 2012, which was driven by $18 million of interest income on the BAM Surplus Notes, partially offset by startup and operational costs.
Under GAAP, the BAM Surplus Notes are classified as debt by the issuer. Under U.S. Statutory accounting, they are classified as Surplus.
Under GAAP, interest accrues daily on the BAM Surplus Notes. Under U.S. Statutory accounting, interest is not accrued on the BAM Surplus Notes until it has been approved for payment by insurance regulators.
The following table presents BAM’s total claims paying resources as of December 31, 2014 and 2013:
Other Operations Results-Year Ended December 31, 2014 versus Year Ended December 31, 2013
General and administrative expenses increased 100% in 2014 primarily due to expenses related to QuoteLab and Tranzact, including amortization of intangible assets, which substantially offset their revenues in pre-tax income. The increase from these new businesses was partially offset by a decrease in incentive compensation accruals in 2014. General and administrative expenses in 2013 included a $10 million reduction related to an adjustment to the fair value of variable annuity death benefit expenses at WM Life Re, which was mostly offset in other revenues by a component of the change in the fair value of WM Life Re's derivative assets and liabilities. WM Life Re reported losses of $9 million in 2014 compared to $17 million in 2013. WM Life Re’s results in 2013 included $7 million of gains associated with changes in projected surrender assumptions, partially offset by increased trading expenses. See Note 9 - “Derivatives” for details regarding WM Life Re’s total impact on White Mountains’s statement of operations.
White Mountains’s Other Operations segment reported pre-tax income of $15 million in 2013 compared to pre-tax income of $8 million in 2012. White Mountains’s Other Operations segment reported net realized and unrealized investment gains of $97 million in 2013 compared to $45 million in 2012. (See Summary of Investment Results on page 69.) The Other Operations segment reported net investment income of $15 million in 2013 compared to $33 million in 2012, primarily due to a lower average invested asset base, mainly a result of White Mountains’s investment of approximately $600 million in HG Global in July 2012 and share repurchases, and a shift in the investment portfolio from fixed maturity investments towards common equity securities. The value of White Mountains’s investment in Symetra warrants prior to their exercise during the second quarter of 2013 increased $11 million in 2013 compared to an increase of $18 million in 2012. (See Investment in Symetra Common Shares on page 72.) WM Life Re reported losses of $17 million in 2013 compared to $19 million in 2012. The improvement in WM Life Re’s results was primarily due to $7 million of gains in 2013 associated with changes in projected surrender assumptions, partially offset by increased trading expenses. See Note 9 - “Derivatives” for details regarding WM Life Re’s total impact on White Mountains’s statement of operations.
Share repurchases. White Mountains repurchased and retired 141,535 of its common shares for $80 million in 2013 at an average price per share of $563.91, or approximately 88% of White Mountains’s December 31, 2013 adjusted book value per share.
Change in foreign currency translation on investments recognized through other comprehensive income(2)
Excludes non-investment related foreign currency gains (losses) that are also recognized through other comprehensive income of $105.8, $(8.6) and $(55.9).
Total common equity securities, convertible fixed maturity and preferred investments and other long-term investments returns:
Investment Returns-Year Ended December 31, 2014 versus Year Ended December 31, 2013
White Mountains maintains a value-oriented equity portfolio that consists of common equity securities, convertibles and other long-term investments, including hedge funds and private equity funds. White Mountains’s management believes that prudent levels of investments in common equity securities, convertibles and other long-term investments are likely to enhance long-term after-tax total returns.
White Mountains’s equity investment style is generally value-oriented. The portfolio is constructed to provide an element of downside protection; management expects the portfolio to underperform indices in strong up markets but outperform those indices in down markets.
White Mountains has established separate accounts with third party registered investment advisers to manage its publicly-traded common equity securities and convertibles. The largest of these separate account relationships are with Prospector, Lateef and Silchester.
(1) Represents the inception of the Prospector separate account in the beginning of 2005, which was established in connection with an investment management agreement between Prospector and White Mountains whereby Prospector serves as a discretionary adviser with respect to specified assets, primarily equity securities.
White Mountains has an investment in the Calleva Trust, an open-ended unit trust established as an Undertaking for Collective Investment in Transferable Securities (“UCITS”) under the European Communities Regulations and is managed by Silchester. Silchester invests primarily in value-oriented non-U.S. equity securities. Silchester’s investment strategy focuses on companies with low market multiples of earnings, cash flow, asset value or dividends. In local currencies, the Silchester portfolio returned 8.6% for 2014 and 32.6% for 2013.
White Mountains’s GAAP pre-tax total return on invested assets was 4.1% for 2013 compared to 4.9% for 2012. Foreign currency translation did not meaningfully impact investment returns in 2013, while 2012 included 0.5% of foreign currency gains.
White Mountains maintains a high-quality, short-duration fixed income portfolio. As of December 31, 2013, the fixed income portfolio duration was approximately 2.1 years, including short-term investments, compared to 2.4 years as of December 31, 2012. In local currencies, the fixed income portfolio was up 0.5% for 2013, outperforming the longer duration Barclays U.S. Intermediate Aggregate Bond Index return of -1.0%. The portfolio’s short duration positioning contributed to the outperformance versus the benchmark as interest rates rose in 2013. Including foreign currency losses, the fixed income portfolio was up 0.4% for 2013. In local currencies, the fixed income portfolio was up 3.8% for 2012, compared to the Barclays U.S. Intermediate Aggregate Bond Index return of 3.6%. Including foreign currency gains, the fixed income portfolio was up 4.4% for 2012.
In local currencies, the Silchester portfolio, which invests primarily in value-oriented non-U.S. equity securities, returned 32.6% for 2013, compared to the S&P 500 return of 32.4%. In local currencies, the Silchester portfolio returned 15.9% for 2012 compared to the S&P 500 return of 16.0%.
During 2014, 2013 and 2012, White Mountains recorded $44 million, $35 million and $30 million in after-tax equity in earnings from its investment in Symetra’s common shares. The table below illustrates (1) the per-Symetra common share value used in the calculation of White Mountains’s adjusted book value per share, (2) Symetra’s quoted stock price and (3) Symetra’s book value per common share excluding unrealized gains and losses from its fixed maturity portfolio:
Total fixed maturity investments and convertible fixed maturity and preferred investments
Includes mortgage-backed securities which carry the full faith and credit guaranty of the U.S. government (i.e., GNMA) or are guaranteed by a government sponsored entity (i.e., FNMA, FHLMC).
White Mountains’s non-U.S. dollar-denominated assets and liabilities are valued using period-end exchange rates, and its non-U.S. dollar-denominated foreign revenues and expenses are valued using average exchange rates over the period. Foreign currency exchange rate risk is the risk that White Mountains will incur losses on a U.S. dollar basis due to adverse changes in foreign currency exchange rates. As of December 31, 2014, the following currencies represented the largest exposure to foreign currency risk as a percent of White Mountains’s common shareholders’ equity; the Swedish krona (6.2%), the British pound sterling (4.1%), the euro (1.2%) and the Canadian dollar (1.2%). See “Foreign Currency Exchange Risk” on page 112.
Holding company level. The primary sources of cash for the Company and certain of its intermediate holding companies are expected to be distributions and tax sharing payments received from its insurance and reinsurance operating subsidiaries, capital raising activities, net investment income, proceeds from sales and maturities of investments and, from time to time, proceeds from the sales of operating subsidiaries. The primary uses of cash are expected to be repurchases of the Company’s common shares, payments on and repurchases/retirements of its debt obligations, dividend payments to holders of the Company’s common shares, to non-controlling interest holders of OneBeacon Ltd.’s common shares and to holders of the SIG Preference Shares, purchases of investments, payments to tax authorities, contributions to operating subsidiaries, operating expenses and, from time to time, purchases of operating subsidiaries.
On December 23, 2014, OBIC distributed Atlantic Specialty Insurance Company (“ASIC”) to its immediate parent at a value of $701 million as part of the Runoff Transaction. OBIC also distributed $151 million of cash and investments to its immediate parent in accordance with the prescribed minimum capital to be included in the company at the time of its sale to Armour, as approved by the PID.
ASIC is now OneBeacon’s top-tier regulated U.S. insurance operating subsidiary and has the ability to pay dividends to its immediate parent during any twelve-month period without the prior approval of regulatory authorities in an amount set by formula based on 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 and subject to dividends paid in prior periods. Based upon the formula above, ASIC has the ability to pay $45 million of dividends during 2015 without prior approval of regulatory authorities. As of December 31, 2014, ASIC had $722 million of statutory surplus and $88 million of earned surplus. During 2014, ASIC did not pay any dividends to its immediate parent. Also in 2014, OneBeacon contributed $67 million to ASIC.
During 2014, OneBeacon Ltd. paid $80 million of regular quarterly dividends to its common shareholders. White Mountains received $60 million of these dividends.
In 2014, Sirius Group established Sirius Bermuda as a class 3A licensed Bermuda insurer. Sirius Bermuda, which owns Sirius International, has the ability to declare or pay dividends or make capital distributions during any 12-month period without the prior approval of Bermuda regulatory authorities on the condition that any such declaration or payment of dividends or capital distributions does not cause a breach of any of its regulatory solvency and liquidity requirements. During 2015, Sirius Bermuda has the ability, subject to meeting all appropriate liquidity and solvency requirements, to make dividend or capital distributions without the prior approval of regulatory authorities, subject to meeting all appropriate liquidity and solvency requirements, of $350 million, which is equal to 15% of its December 31, 2014 statutory capital, excluding earned surplus. The amount of dividends available to be paid by Sirius Bermuda in any given year is also subject to cash flow and earnings generated by Sirius International’s business, as well as to dividends received from its subsidiaries, including Sirius International.
Sirius International has the ability to pay dividends to Sirius Bermuda subject to the availability of unrestricted equity, calculated in accordance with the Swedish Act on Annual Accounts in Insurance Companies and the Swedish Supervisor Authorities (“Swedish FSA”). Unrestricted equity is calculated on a consolidated group account basis and on a parent account basis. Differences between the two include but are not limited to accounting for goodwill, subsidiaries (with parent accounts stated at original foreign exchange rates), taxes and pensions. Sirius International’s ability to pay dividends is limited to the “lower of” unrestricted equity as calculated within the group and parent accounts. As of December 31, 2014, Sirius International had $467 million (based on the December 31, 2014 SEK to USD exchange rate) of unrestricted equity on a parent account basis (the lower of the two) available to pay dividends in 2015. The amount of dividends available to be paid by Sirius International in any given year is also subject to cash flow and earnings generated by Sirius International’s business, as well as to dividends received from its subsidiaries, including Sirius America. Earnings generated by Sirius International’s business that are allocated to the Safety Reserve are not available to pay dividends (see “Safety Reserve” on the next page). During 2014, Sirius International distributed $221 million of dividends to its immediate parent.
As of December 31, 2014, Sirius Group and its intermediate holding companies had $20 million of net unrestricted cash, short-term investments and fixed maturity investments outside of its regulated and unregulated insurance and reinsurance operating subsidiaries. During 2014, Sirius Group distributed $50 million to its immediate parent.
As of December 31, 2014, the Company and its intermediate holding companies had $275 million of net unrestricted cash, short-term investments and fixed maturity investments, $173 million of common equity securities and convertibles and $106 million of other long-term investments included in its Other Operations segment. During 2014, White Mountains paid a $6 million common share dividend.
Sirius Group initially fronted the reinsurance contracts covering guaranteed living and death benefits of Japanese variable annuity contracts for, and was 100% reinsured by, WM Life Re. In October 2013, White Mountains and Tokio Marine completed a novation whereby Sirius Group’s obligations on the reinsurance contracts were transferred to WM Life Re. As a result, Sirius Group no longer has any obligation or liability relating to these agreements. In connection with this novation agreement, White Mountains and Life Re Bermuda entered into a keep-well agreement, which obligates White Mountains to make capital contributions to Life Re Bermuda in the event that Life Re Bermuda’s shareholder’s equity falls below $75 million, provided however that in no event shall the amount of all capital contributions made by White Mountains under this agreement exceed $127 million. As of December 31, 2014, Life Re Bermuda had $76 million of shareholder’s equity and White Mountains’s maximum capital commitment under the keep-well agreement was $118 million. WM Life Re is in runoff and all of its contracts will mature by June 30, 2016.
The summary balance sheet below presents Life Re Bermuda’s net assets as of December 31, 2014 reported to Tokio Marine as required under the terms of the novation agreement:
Insurance float is an important aspect of White Mountains’s insurance operations. Insurance float represents funds that an insurance or reinsurance company holds for a limited time. In an insurance or reinsurance operation, float arises because premiums are collected before losses are paid. This interval can extend over many years. During that time, the insurer or reinsurer invests the funds. When the premiums that an insurer or reinsurer collects do not cover the losses and expenses it eventually must pay, the result is an underwriting loss, which can be considered as the cost of insurance float. One manner in which White Mountains calculates its insurance float is by taking its insurance liabilities and subtracting its insurance assets. In prior periods, White Mountains had calculated its insurance float by taking its net investment assets and subtracting its total adjusted capital. With the acquisitions of Tranzact, QuoteLab and Wobi in 2014, the previous presentation had become less meaningful. The current presentation simplifies the insurance float calculation by including only insurance assets and liabilities, which is also more consistent with traditional insurance float presentations. Although insurance float can be calculated using numbers determined under GAAP, insurance float is not a GAAP concept and, therefore, there is no comparable GAAP measure.
Insurance float can increase in a number of ways, including through acquisitions of insurance and reinsurance operations, organic growth in existing insurance and reinsurance operations and recognition of losses that do not immediately cause a corresponding reduction in investment assets. Conversely, insurance float can decrease in a number of other ways, including sales of insurance and reinsurance operations, shrinking or runoff of existing insurance and reinsurance operations, the acquisition of operations that do not have substantial investment assets (e.g., an agency) and the recognition of gains that do not cause a corresponding increase in investment assets. It is White Mountains’s intention to generate low-cost float over time through a combination of acquisitions and organic growth in its existing insurance and reinsurance operations. However, White Mountains seeks to increase overall profits sometimes by reducing insurance float, such as in the Runoff Transaction.
Certain operational leverage metrics can be measured with ratios that are calculated using insurance float. There are many activities that do not change the amount of insurance float at an insurance or reinsurance company but can have a significant impact on the company’s operational leverage metrics. For example, investment gains and losses, foreign currency gains and losses, debt issuances and repurchases/repayments, common and preferred share issuances and repurchases and dividends paid to shareholders are all activities that do not change insurance float but that can meaningfully impact operational leverage metrics that are calculated using insurance float.
The following table illustrates White Mountains’s consolidated insurance float position as of December 31, 2014 and 2013:
(1) While classified as a liability for GAAP purposes, as a result of the indefinite deferral of these taxes, Swedish regulatory authorities apply no taxes to the safety reserve when calculating solvency capital under Swedish insurance regulations. Accordingly, under local statutory requirements, an amount equal to the deferred tax liability on Sirius International’s safety reserve is included in solvency capital (see “Safety Reserve” on page 77).
During 2014, insurance float increased by $83 million, primarily due to growth in OneBeacon’s specialty business, partially offset by the continued runoff of Sirius Group’s casualty business and payments of losses incurred in 2010, 2011 and 2012 related to major catastrophes, primarily from hurricane Sandy and earthquakes in Chile, Japan and New Zealand. These catastrophe losses increased White Mountains’s insurance float when they were first recorded, which is now reversing and decreasing insurance float as the catastrophe losses are paid or reserves reduced.
Equity in net unrealized (gains) losses from Symetra’s fixed maturity portfolio, net of applicable taxes
The non-controlling interests in reciprocals are not included in total capital. See Note 14 - “Common Shareholders’ Equity and Non-controlling Interests” for further breakdown of non-controlling interests.
On October 10, 2014, Tranzact entered into a secured credit facility with a syndicate of lenders administered by The PrivateBank and Trust Company (the “Tranzact Bank Facility”). The Tranzact Bank Facility consists of a $70 million term loan facility, which was fully drawn at closing and had an outstanding balance of $69 million as of December 31, 2014, and a revolving credit facility for an additional $4.5 million, which was undrawn as of December 31, 2014. The Tranzact Bank Facility is secured by intellectual property and the common stock of Tranzact and its subsidiaries. The Tranzact Bank Facility carries a variable interest rate, based on the U.S. dollar LIBOR rate. Tranzact has entered into an interest rate swap agreement to effectively fix the rate it pays on the $70 million term loan portion of the facility (see Note 9 - Derivatives for details).
The OBH Senior Notes and the SIG Senior Notes were issued under an indenture and fiscal agency agreement, respectively, that contain restrictive covenants which, among other things, limit the ability of OneBeacon Ltd., OBH, SIG and their respective subsidiaries to create liens and enter into sale and leaseback transactions and limits the ability of OneBeacon Ltd., OBH, SIG and their respective subsidiaries to consolidate, merge or transfer their properties and assets. The indenture and fiscal agency agreement do not contain any financial ratios or specified levels of net worth or liquidity to which OneBeacon Ltd., OBH or SIG must adhere. As of December 31, 2014, OneBeacon Ltd., OBH and SIG were in compliance with all of the covenants under the OBH Senior Notes and the SIG Senior Notes, and anticipate they will continue to remain in compliance with these covenants for the foreseeable future.
In addition, a failure by OneBeacon Ltd. or its subsidiaries to pay principal and interest on covered debt or to comply with obligations in covered debt agreements that results in the acceleration of at least $75 million of principal amount of covered debt, could trigger the acceleration of the OBH Senior Notes. A failure by SIG to pay principal and interest on covered debt or to comply with obligations in covered debt agreements that results in the acceleration of at least $25 million of the principal amount of covered debt, could trigger the acceleration of the SIG Senior Notes.
In May 2007, SIG issued $250 million non-cumulative perpetual preference shares, with an initial fixed annual dividend rate of 7.506%. In June 2017, the fixed rate will move to a floating rate equal to the greater of (i) 7.506% and (ii) 3-month LIBOR plus 320 basis points. In July 2013, SIG executed a 5-year forward LIBOR cap for the period from June 2017 to June 2022 to protect against a significant increase in interest rates during that 5-year period. The Interest Rate Cap economically fixes the annual dividend rate on the SIG Preference Shares from June 2017 to June 2022 at 8.30%. The cost of the Interest Rate Cap was an upfront premium of 395 basis points of the $250 million notional value, or $10 million for the full notional amount.
In December 2011, OneBeacon sold the majority of its fixed assets and capitalized software. OneBeacon entered into lease financing arrangements with US Bancorp Equipment Finance, Inc. (“US Bancorp”) and Fifth Third Equipment Finance Company (“Fifth Third”) whereby OneBeacon sold furniture and equipment and capitalized software, respectively, at a cost equal to net book value. OneBeacon then leased the fixed assets back from US Bancorp for a lease term of five years and leased the capitalized software back from Fifth Third for a lease term of four years. OneBeacon received cash proceeds of $23 million as a result of entering into the sale-leaseback transactions. At the end of the lease terms, OneBeacon will have the obligation to purchase the leased assets for a nominal fee, after which all rights, title and interest would transfer back. As of December 31, 2014, OneBeacon had a capital lease obligation of $7 million included within other liabilities and a capital lease asset of $7 million included within other assets.
The SIG Preference Shares are not included in the table above, as these perpetual preferred shares have no stated maturity date and are redeemable only at the option of SIG. See “Sirius Group’s Preference Shares and Senior Notes” on page 21 for more details.
There are no provisions within White Mountains’s operating leasing agreements that would trigger acceleration of future lease payments. The capital lease that OneBeacon entered into in conjunction with the sale-leaseback of certain of OneBeacon’s fixed assets and capitalized software contains provisions that could trigger an event of default, including a failure to make payments when due under the capital lease. If an event of default were to occur, the lessor would have a number of remedies available including the acceleration of future lease payments or the possession of the property covered under the lease agreement.
White Mountains also has future binding commitments to fund certain other long-term investments. These commitments, which total approximately $82 million, do not have fixed funding dates and are therefore excluded from the table above.
Based on current account value to guaranty value ratio in the annuities reinsured by WM Life Re as of December 31, 2014, WM Life Re expects $9 million of future cash outflows related to its reinsurance contracts, commencing in June 2015 through June 2016.
During the past several years, White Mountains’s board of directors authorized the Company to repurchase its common shares, from time to time, subject to market conditions. Shares may be repurchased on the open market or through privately negotiated transactions. The repurchase authorizations do not have a stated expiration date. As of December 31, 2014, White Mountains may repurchase an additional 338,092 shares under these board authorizations. In addition, from time to time White Mountains has repurchased its common shares through tender offers that were separately approved by its board of directors.
During 2014, the Company repurchased 217,879 common shares for $134 million at an average share price of $617, which was 93% of White Mountains’s adjusted book value per share of $665 as of December 31, 2014. These share repurchases were comprised of 207,404 common shares repurchased under the board authorization for $128 million at an average share price of $618 and 10,475 common shares repurchased pursuant to employee benefit plans. Shares repurchased pursuant to employee benefit plans do not fall under the board authorizations referred to above.
During 2012, the Company repurchased 1,329,640 common shares for $669 million at an average share price of $503, which was 86% of White Mountains’s adjusted book value per share of $588 as of December 31, 2012. These repurchases were comprised of (1) 502,801 common shares repurchased under the board authorization for $256 million at an average share price of $508; (2) 816,829 common shares repurchased through a fixed-price tender offer for $409 million at a share price of $500; and (3) 10,010 common shares repurchased pursuant to employee benefit plans.
During the first quarter of 2014, White Mountains made payments totaling $27 million on WTM Performance Shares.
During 2014, White Mountains borrowed and repaid a total of $65 million under the WTM Bank Facility and paid $1 million of interest on the WTM Bank Facility.
During 2014, Sirius Group paid $19 million of dividends on the SIG Preference Shares and $26 million of interest on the SIG Senior Notes.
During 2014, QuoteLab paid $2 million of dividends, of which $1 million was paid to White Mountains.
During 2014, White Mountains acquired 54% of the outstanding common shares of Wobi for NIS 14 million (approximately $4 million based upon the foreign exchange spot rate at the date of acquisition). In addition to the common shares, White Mountains also purchased NIS 13 million (approximately $4 million based upon the foreign exchange spot rate at the date of acquisition) of newly-issued convertible preferred shares of Wobi.
During 2014, White Mountains acquired certain assets and liabilities of Star & Shield Holdings LLC, including SSRM, the attorney-in-fact for SSIE, for a purchase price of $2 million. During the first nine months of 2014, White Mountains also purchased $17 million of surplus notes issued by SSIE.
During 2014, Sirius Group purchased all of the outstanding shares of Olympus Re for $12 million in cash.
During 2014, WM Solutions completed the shell sale of Citation and received $13 million as consideration.
During 2013, OneBeacon paid a total of $13 million of interest on the OBH Senior Notes.
During 2013, BAM received $17 million in surplus contributions from its members.
During the first quarter of 2012, White Mountains made payments totaling $58 million on WTM Performance Shares.
During 2012, OBH issued $275 million face value of senior unsecured notes through a public offering, at an issue price of 99.9%. The net proceeds from the issuance of the OBH Senior Notes were used to repurchase and retire the remaining $270 million principal outstanding on OBH’s previously issued senior notes.
During 2012, OneBeacon paid a total of $16 million of interest on OBH’s previously issued senior notes.
During 2012, Sirius Group paid $19 million of dividends on the SIG Preference Shares and $26 million of interest on the SIG Senior Notes.
This report includes three non-GAAP financial measures that have been reconciled to their most comparable GAAP financial measures. White Mountains believes these measures to be more relevant than comparable GAAP measures in evaluating White Mountains’s results of operations and financial condition.
Adjusted comprehensive income is a non-GAAP financial measure that excludes the change in equity in net unrealized gains and losses from Symetra’s fixed maturity portfolio, net of applicable taxes, from comprehensive income. In the calculation of comprehensive income under GAAP, fixed maturity investments are marked-to-market while the liabilities to which those assets are matched are not. Symetra attempts to earn a “spread” between what it earns on its investments and what it pays out on its products. In order to try to fix this spread, Symetra invests in a manner that tries to match the duration and cash flows of its investments with the required cash outflows associated with its life insurance and structured settlements products. As a result, Symetra typically earns the same spread on in-force business whether interest rates fall or rise. Further, at any given time, some of Symetra’s structured settlement obligations may extend 40 or 50 years into the future, which is further out than the longest maturing fixed maturity investments regularly available for purchase in the market (typically 30 years). For these long-dated products, Symetra is unable to fully match the obligation with assets until the remaining expected payout schedule comes within the duration of securities available in the market. If at that time, these fixed maturity investments have yields that are lower than the yields expected when the structured settlement product was originally priced, the spread for the product will shrink and Symetra will ultimately harvest lower returns for its shareholders. GAAP comprehensive income increases when rates decline, which would suggest an increase in the value of Symetra - the opposite of what is happening to the intrinsic value of the business. Therefore, White Mountains’s management and Board of Directors use adjusted comprehensive income when assessing Symetra’s quarterly financial performance. In addition, this measure is typically the predominant component of change in adjusted book value per share, which is used in calculation of White Mountains’s performance for both short-term (annual bonus) and long-term incentive plans. The reconciliation of adjusted comprehensive income to comprehensive income is included on page 53.
Adjusted book value per share is a non-GAAP measure which is derived by expanding the GAAP calculation of book value per White Mountains common share to exclude equity in net unrealized gains and losses from Symetra’s fixed maturity portfolio, net of applicable taxes. In addition, the number of common shares outstanding used in the calculation of adjusted book value per share are adjusted to exclude unearned restricted common shares, the compensation cost of which, at the date of calculation, has yet to be amortized. The reconciliation of adjusted book value per share to GAAP book value per share is included on page 52.
Total capital at White Mountains is comprised of White Mountains’s common shareholders’ equity, debt and non-controlling interests that White Mountains (i) benefits from the return on or (ii) has the ability to utilize the net assets supporting the non-controlling interest. As such, non-controlling interests attributable to reciprocals are excluded from total adjusted capital. Total adjusted capital also excludes the equity in net unrealized gains and losses from Symetra’s fixed maturity portfolio, net of applicable taxes from total capital. The reconciliation of total capital to total adjusted capital is included on page 79.
White Mountains establishes loss and LAE reserves that are estimates of amounts needed to pay claims and related expenses in the future for insured events that have already occurred. The process of estimating reserves involves a considerable degree of judgment by management and, as of any given date, is inherently uncertain. See Note 3-“Reserves for Unpaid Loss and Loss Adjustment Expenses” for a description of White Mountains’s loss and LAE reserves and actuarial methods.
For loss and allocated LAE reserves, the key assumption as of December 31, 2014 was that the impact of the various reserving factors, as described below, on future paid losses would be similar to the impact of those factors on the historical loss data with the exception of severity trends, which have been relatively stable over the relevant historical period. The actuarial methods used would project losses assuming continued stability in severity trends. Management has considered future increases in loss severity trends, including the impact of expected inflation, in making its reserve selections.
Property covers losses to a business' premises, inventory and equipment as a result of weather, fire, theft and other causes. For property coverage, it generally takes a relatively short period of time to close claims. The relatively high attachment points and insured values of the property policies underwritten in the Specialty Property underwriting operating segment present a potentially longer tail and greater uncertainty than our standard property business.
The commercial automobile product line is a mix of property and liability coverages and, therefore, includes both short and long tail coverages. The payments that are made quickly typically pertain to auto physical damage (included in the property line) claims and property damage (liability) claims. The payments that take longer to finalize and are more difficult to estimate relate to bodily injury claims. Commercial automobile reserves are typically analyzed in two components; liability and collision/comprehensive claims. This second component has minimum reserve risk and fast payouts and, accordingly, separate reserving factors are not presented. The liability component includes claims for both bodily injury and property damage. In general, claim reporting lags are minor, claim complexity is not a major issue, and the line is viewed as high frequency, low to moderate severity.
crop prices, estimated acreage covered, claim reporting or payment patterns, or claim handling philosophies (e.g., case
OneBeacon’s range of loss and LAE reserve estimates was evaluated to consider the strengths and weaknesses of the various actuarial methods applied against OneBeacon’s historical claims experience data. The following table shows the recorded loss and LAE reserves and the high and low ends of OneBeacon’s range of reasonable loss reserve estimates, net of reinsurance recoverable on unpaid losses, as of December 31, 2014 and 2013. The high and low ends of the range of reserve estimates in the table below are based on the results of various actuarial methods described above.
As a result of the loss and LAE reserve increases recorded in the fourth quarter of 2014 (see “Management's Discussion and Analysis of Financial Condition and Results of Operations-OneBeacon”), and in recognition of the various sensitivities and volatilities associated with loss and LAE reserves described below, particularly the risks and uncertainties associated with large losses and OneBeacon’s newer businesses, management has recorded its best estimate of loss and LAE reserves at a higher level with the actuarial range of reasonable outcomes as compared to the prior year.
The following discussion includes disclosure of possible variations from current estimates of loss reserves due to changes in a few of the many key assumptions. Each of the impacts described below is estimated individually, without consideration for any correlation among key assumptions. Further, there is uncertainty around other assumptions not explicitly quantified in the discussion below. Therefore, it would be inappropriate to take each of the amounts described below and add them together in an attempt to estimate volatility for OneBeacon’s reserves in total. It is important to note that the volatilities and variations discussed below are not meant to be a worst-case scenario, and therefore it is possible that future volatilities and variations may be more than amounts discussed below.
Various sources of inflation volatility impact all of OneBeacon’s reserves in different ways. Using its internal economic capital model, OneBeacon has derived a distribution of future loss payments under the range of inflation scenarios and related claim cost trends in its economic scenario set, holding all other sources of reserve volatility constant. At the 75th percentile of modeled outcomes, the estimated impact of claim cost inflation above OneBeacon’s actuarially indicated reserves is $39 million, net of reinsurance.
As OneBeacon starts up new businesses, its initial loss estimates and development patterns are often based on industry data. As actual losses develop OneBeacon will revise its initial expectations with its actual experience. However, depending on the tail for the specific business, it can be a few years before OneBeacon has sufficient internal data to rely on. As of December 31, 2014, OneBeacon has $168 million of inception-to-date premium from its newer businesses (Programs, Crop, Environmental and Surety). A 10% error in OneBeacon’s initial loss ratio estimates could result in approximately $17 million adverse net variance in loss reserves.
OneBeacon also considers variations and sensitivities for certain lines of business, such as:
Sirius Group’s expected annual loss reporting assumptions are updated at least once a year. Expected loss ratios underlying the current accident year are updated quarterly, to reflect new business that is underwritten by the company.
In 2014, Sirius Group had net favorable loss reserve development of $98 million. The major reductions in loss reserve estimates were recognized in property ($54 million), aviation and space ($13 million), accident and health ($13 million) lines and casualty ($13 million). The casualty reduction is net of a $10 million increase in asbestos and environmental loss reserves. For the property loss estimates decrease, $24 million represented reduction of loss reserves previously held above the actuarial central estimate. This amount represented an IBNR provision established between 2010-2012 in response to the large catastrophe events, including the 2010 earthquake in Chile, the 2010/2011 earthquakes in New Zealand, the 2011 earthquake in Japan, and hurricane Sandy in 2012, and the inherent uncertainty associated with deriving initial loss estimates. When examined in 2014, the loss estimates for these events had stabilized and had proven to be redundant in aggregate; as a result, the additional amount above the actuarial central estimate was reversed.
The actuarial analysis is a primary consideration for management in determining its best estimate of loss and LAE reserves. Management records reserves in the upper portion of the actuarial range of central estimates in response to potential volatility in the actuarial indications and estimates for large claims.
The following discussion includes disclosure of possible variations from current estimates of loss reserves due to changes in a few of the many key assumptions. Each of the impacts described below is estimated individually, without consideration for any correlation among key assumptions. Further, there is uncertainty around other assumptions not explicitly quantified in the discussion below. Therefore, it would be inappropriate to take each of the amounts described below and add them together in an attempt to estimate volatility for Sirius Group’s reserves in total. It is important to note that the volatilities and variations discussed below are not meant to be best-case or worst-case scenarios, and therefore it is possible that future volatilities and variations may be more than amounts discussed below.
Asbestos and Environmental (A&E). The internal actuarial and claims analysis suggests that Sirius Group’s A&E losses are covered by its previous paid activity and current reserves. However, the ongoing nature of the litigation surrounding these complex exposures can significantly affect Sirius Group’s liabilities. Sirius Group ended 2014 with $210 million in net reserves for A&E claims. Applying varying assumptions and industry benchmarks yielded a net range of A&E reserves from $160 million to $255 million. Further information is detailed below about Sirius Group’s A&E exposure.
Sirius Group recorded an increase of $2 million and an increase of $1 million of environmental losses in 2014 and 2013 on its already existing reserves.
The following tables show gross and net loss and LAE payments for A&E exposures for the years ending December 31, 2005 through December 31, 2014:
The costs associated with administering the underlying A&E claims by Sirius Group’s clients tend to be higher than non-A&E claims due to generally higher legal costs incurred by ceding companies in connection with A&E claims ceded to Sirius Group under the reinsurance contracts.
As of December 31, 2014, approximately 93% of the investment portfolio recorded at fair value was priced based upon quoted market prices or other observable inputs. Investments valued using Level 1 inputs include fixed maturity investments, primarily investments in U.S. Treasuries, common equity securities and short-term investments, which include U.S. Treasury Bills. Investments valued using Level 2 inputs comprise fixed maturity investments including corporate debt, state and other governmental debt, convertible fixed maturity investments and mortgage and asset-backed securities. Fair value estimates for investments that trade infrequently and have few or no observable market prices are classified as Level 3 measurements. Level 3 fair value estimates based upon unobservable inputs include White Mountains’s investments in hedge funds and private equity funds, as well as investments in certain fixed maturity securities where quoted market prices are unavailable. White Mountains determines when transfers between levels have occurred as of the beginning of the period. White Mountains uses brokers and outside pricing services to assist in determining fair values. For investments in active markets, White Mountains uses the quoted market prices provided by outside pricing services to determine fair value. The outside pricing services used by White Mountains have indicated that if no observable inputs are available for a security, they will not provide a price.
The following table summarizes White Mountains’s fair value measurements and the percentage of Level 3 investments as of December 31, 2014:
Excludes carrying value of $23.2 associated with other long-term investment limited partnerships accounted for using the equity method.
White Mountains uses quoted market prices where available as the inputs to estimate fair value for its investments in active markets. Such measurements are considered to be either Level 1 or Level 2 measurements, depending on whether the quoted market price inputs are for identical securities (Level 1) or similar securities (Level 2). Level 3 measurements for fixed maturity investments as of December 31, 2014 include securities for which the estimated fair value has not been determined based upon quoted market price inputs for identical or similar securities. See Note 5 for tables that summarize the changes in White Mountains’s fair value measurements by level for the years ended December 31, 2014 and 2013 and for amount of total gains (losses) included in earnings attributable to unrealized investment gains (losses) for Level 3 investments for years ended December 31, 2014, 2013 and 2012.
White Mountains has entered into agreements to reinsure death and living benefit guarantees associated with certain variable annuities in Japan. White Mountains carries the benefit guarantees at fair value. The fair value of the guarantees is estimated using actuarial and capital market assumptions related to the projected discounted cash flows over the term of the reinsurance agreement. The valuation uses assumptions about surrenders rates, market volatilities and other factors, and includes a risk margin which represents the additional compensation a market participant would require to assume the risks related to the business. The selection of surrender rates, market volatility assumptions, risk margins and other factors require the use of significant management judgment. Assumptions regarding future policyholder behavior, including surrender and lapse rates, are generally unobservable inputs and significantly impact the fair value estimate. Market conditions including, but not limited to, changes in interest rates, equity indices, market volatility and foreign currency exchange rates as well as variations in actuarial assumptions regarding policyholder behavior may result in significant fluctuations in the fair value of the liabilities associated with these guarantees that could materially affect results of operations. All of White Mountains’s variable annuity reinsurance liabilities ($0.7 million) were classified as Level 3 measurements as of December 31, 2014.
As of December 31, 2014, the value of bond funds tracking the WGBI was approximately ¥51 billion ($426 million). By country, the largest exposures, together comprising approximately 90% of the WGBI, were the United States (40%), France (10%), Italy (10%), Germany (9%), the United Kingdom (8%), Spain (6%), the Netherlands (3%), Belgium (3%) and Canada (2%). Eurozone countries together comprised approximately 43%. To reduce hedging basis risk (i.e., the risk that changes in the WGBI will cause WM Life Re's variable annuity guarantee liabilities to change in value at a different rate than the derivative hedges), in December 2009 WM Life Re entered into a series of total return swap contracts on the performance of the WGBI. As of December 31, 2010, approximately 49% of WM Life Re's WGBI-related liability was hedged with WGBI swaps. Because these swaps were denominated in US dollars, WM Life Re continued to hedge the results into Japanese yen to match the benchmark denominated in Japanese yen. In 2011, driven in large part by instability of Eurozone markets, WM Life Re significantly increased coverage of its WGBI exposure. Because the market for WGBI total return swaps was, and continues to be illiquid, WM Life Re entered into a series of total return swaps on the JP Morgan European Government Bond Index (JPM European GBI). Although the JPM European GBI is not an exact match for the European component of the WGBI, its structure and holdings are substantially similar. These swaps are denominated in Japanese yen. As of December 31, 2014, the total notional amounts of JPM European GBI swaps were ¥15 billion ($125 million). At that date, over 100% of the total exposure the European component of the WGBI was hedged with total return swaps. The JPM European GBI total return swaps have maturities laddered to approximate the maturities of the policies reinsured.
Under the terms of these swap contracts, WM Life Re receives cash flows based on a fixed return, reset at the beginning of each month based on current LIBOR and is required to pay cash flows based on the performance of the JPM European GBI during that month plus a fixed amount.
WM Life Re hedges the residual WGBI-related liability exposure with the limited types of available derivatives that most closely fit the country and term exposures of the WGBI. Since liability exposures are determined by the performance of the overall account value, including the funds that track the Nomura BPI, TOPIX, and MSCI Kokusai, periodic portfolio rebalancing may be required. At such times and within limits, exchange-traded futures may be used to maintain overall neutral exposure as opposed to entering into new, or unwinding existing, swaps.
Assumed hedge effectiveness in down and up markets of 93% and 106%, respectively, as of December 31, 2014 and 2013, adjusted for the unhedged portion of Japanese discount rate exposure. Some Japanese discount rate coverage remains primarily through WM Life Re's put option portfolio.
At the account value levels as of December 31, 2014, the average assumed surrender rate was approximately 40% per annum. The potential change in the fair value of the liability due to a change in current surrender assumptions is as follows:
The following table summarizes the changes in White Mountains’s variable annuity reinsurance liabilities and derivative instruments for the year ended December 31, 2014 and 2013:
As of December 31, 2014, White Mountains owned $503 million of surplus notes issued by BAM and has accrued $74 million in interest due thereon. Because BAM is consolidated in White Mountains’s financial statements, the BAM Surplus Notes and accrued interest are classified as intercompany notes, carried at face value and eliminated in consolidation. However, the BAM Surplus Notes and accrued interest are carried as assets at HG Global, of which White Mountains owns 97% of the equity, while the BAM Surplus Notes are carried as liabilities at BAM, which White Mountains has no ownership interest in and is completely attributed to non-controlling interests.
In the fourth quarter of 2014, in conjunction with the Runoff Transaction, OneBeacon provided financing in the form of surplus notes with a par value of $101 million, which had a fair value of $65 million at the date of closing and as of December 31, 2014. The OBIC Surplus Notes, issued by one of the transferred entities, OBIC (“Issuer”), were in the form of both seller priority and pari passu notes.
Represents the value of the OBIC Surplus Notes, at current market yields on publicly traded debt, and assuming issuer is allowed to make principal and interest payments when its financial capacity is available, as measured by statutory capital in excess of a 250% RBC score.
The following table summarizes Sirius Group’s premium estimates and related commissions and expenses:
The net amounts recorded in reinsurance balances receivable may not yet be due from the ceding company at the time of the estimate since actual reporting from the ceding company has not yet occurred. Therefore, based on the process described above, Sirius Group believes its estimated balances are collectible.
competitive forces, including the conduct of other property and casualty insurers and reinsurers;
The financial statements and supplementary data have been filed as a part of this Annual Report on Form 10-K as indicated in the Index to Consolidated Financial Statements and Financial Statement Schedules appearing on page 118 of this report.