In 2015, White Mountains changed the accounting for its investment in Symetra from the equity method to fair value and recognized $259 of unrealized investment gains through net income. See Note 17 - “Investments in Unconsolidated Affiliates”.
As of December 31, 2012, White Mountains had $75 outstanding under its credit facility, which was repaid in January 2013. During 2011 and 2010, OneBeacon repurchased $150 and $187 face value of the OBH Senior Notes.
Includes the dilutive effects of outstanding incentive options to acquire common shares, the last of which were exercised in 2010. Non-qualified options were not included in the diluted earnings per share denominator as their inclusion would be anti-dilutive for the periods presented.
Adjusted book value per share is a non-GAAP measure which is derived by expanding the GAAP book value per share calculation to include the effects of assumed conversion of all in-the-money convertible securities and to exclude the net unrealized gains (losses) from Symetra’s fixed maturity portfolio and unearned restricted common shares. See the reconciliation of adjusted book value per share to book value per share on page 43.
OneBeacon’s book value per share increased 3.8% during 2015, including dividends, compared to an increase of 2.1% during 2014, including dividends. OneBeacon’s GAAP combined ratio was 96% for 2015 compared to 102% for 2014. The lower combined ratio is primarily the result of the $109 million loss reserve charge in the fourth quarter of 2014, partially offset by higher expense ratios driven by higher incentive compensation expense, changes in business mix and the impact of exiting the crop business. OneBeacon’s net written premiums decreased 7% to $1.1 billion in 2015, primarily due to the exit from crop and lawyers liability businesses, a decrease in the Healthcare business and the termination of an affiliated reinsurance treaty, partially offset by increases in OneBeacon’s newer Programs and Surety businesses.
As a result of the agreement to sell Sirius Group, its results are reported as discontinued operations within White Mountains’s GAAP financial statements. Sirius Group’s results continue to inure to White Mountains through the closing date of the sale. Sirius Group’s GAAP combined ratio was 85% for 2015 compared to 76% for 2014. The increase was primarily due to lower favorable net loss reserve development and a significantly higher frequency of non-catastrophe per risk and pro rata loss events, including $18 million in losses from the Tianjin port explosions, partially offset by lower catastrophe losses. Additionally, the combined ratio for the year ended December 31, 2015 included 1 point from the cost of ILW covers purchased to mitigate the potential impact of major events on Sirius Group’s balance sheet pending the close of the sale to CMI.
In 2015, White Mountains deployed approximately $400 million of capital, including $284 million through share repurchases and approximately $120 million through the purchase of insurance service businesses, both in new investments and additional financings in existing investments to support growth in acquisitions.
White Mountains ended 2014 with an adjusted book value per share of $665, an increase of 3.6% during the year, including dividends, compared to an increase of 9.5% during 2013, including dividends. White Mountains reported adjusted comprehensive income of $136 million in 2014 compared to adjusted comprehensive income of $340 million in 2013. The decrease was driven by $87 million of after-tax foreign currency exchange losses, $58 million of after-tax adverse prior year loss reserve development at OneBeacon and lower investment returns.
OneBeacon’s book value per share increased 2.1% during 2014, including dividends, compared to an increase of 17.2% during 2013, including dividends. OneBeacon’s GAAP combined ratio was 102% for 2014 compared to 92% for 2013. OneBeacon’s 2014 results reflect a $109 million pre-tax increase to loss reserves in the fourth quarter of 2014, of which $75 million is related to prior accident years and $34 million related to the current accident year. Full year 2014 results reflect a $90 million pre-tax increase to prior accident year reserves. The reserve increases were driven primarily by professional liability (including lawyers’ professional liability) and management liability within Professional Insurance, and to a lesser extent the Entertainment and Government Risks businesses. In 2015, Professional Insurance was reorganized into Other Professional Lines, Management Liability, Financial Services and Healthcare. OneBeacon’s net written premiums increased 12% to $1.2 billion in 2014, primarily related to OneBeacon’s newer businesses, particularly Crop, Programs and Surety.
During 2014, White Mountains completed the acquisitions of four insurance service businesses: (i) Tranzact, a provider of end-to-end direct-to-consumer customer acquisition solutions to leading insurance carriers, (ii) MediaAlpha, an advertising technology company that develops platforms for the buying and selling of insurance and other vertical-specific performance media, (iii) Wobi, the only price comparison/aggregation business in Israel, and (iv) Star & Shield, which includes the attorney-in-fact for SSIE, a Florida-domiciled reciprocal insurance exchange providing private passenger auto insurance to members of the public safety community and their families. In 2014, White Mountains deployed almost $400 million of capital, including approximately $235 million through the purchase of insurance service businesses and $134 million through share repurchases.
Estimated compensation expense, transaction costs and other, net of applicable tax
White Mountains’s total revenues increased 24% to $1.8 billion in 2015, which was driven by the $259 million unrealized investment gain from Symetra and increases in other revenues from the recently-acquired insurance service businesses. Earned insurance premiums in 2015 were in line with 2014. Net investment income increased 2% to $61 million, as lower investment expenses were mostly offset by lower common stock dividends. White Mountains reported net realized and unrealized investment gains of $225 million in 2015, which included $259 million from Symetra, compared to $79 million of gains in 2014. See “Summary of Investment Results” on page 58 for a discussion and analysis of White Mountains’s investment returns. Other revenue increased to $334 million in 2015 from $131 million in 2014. Other revenue in 2015 included $187 million from Tranzact and $106 million from MediaAlpha compared to $43 million from Tranzact and $65 million from MediaAlpha in 2014. Other revenues also included third-party investment management fee income at WM Advisors of $13 million in 2015, compared to $17 million in 2014. Other revenue included $1 million of WM Life Re’s losses in 2015 compared to $4 million of WM Life Re’s losses in 2014. See Note 9 - “Derivatives” for details regarding WM Life Re’s total impact on White Mountains’s statement of operations. Other revenue also included a $20 million pre-tax gain in 2015 from the sale of Hamer LLC, a small manufacturing company that White Mountains received in 2012 in connection with the liquidation of a limited partnership fund.
White Mountains’s total expenses increased 11% to $1.7 billion in 2015, which was driven by increases in other expenses from the recently-acquired insurance services businesses, partially offset by lower expenses in OneBeacon’s insurance business. Losses and LAE decreased 14%, primarily due to the $109 million reserve charge recorded by OneBeacon related to the actuarial analysis performed in the fourth quarter of 2014, while insurance acquisition expenses and other underwriting expenses increased 7% and 22% in 2015 due to changes in business mix and higher incentive compensation expense (see “Summary of Operations by Segment” on page 47). General and administrative expenses in 2015 included $167 million from Tranzact and $99 million from MediaAlpha compared to $37 million from Tranzact and $61 million from MediaAlpha in 2014.
White Mountains conducts its operations through three segments: (1) OneBeacon, (2) HG Global/BAM and (3) Other Operations. While investment results are included in these segments, because White Mountains manages the majority of its investments through its wholly-owned subsidiary, WM Advisors, a discussion of White Mountains’s consolidated investment operations is included after the discussion of operations by segment. White Mountains’s segment information is presented in Note 16 -“Segment Information” to the Consolidated Financial Statements.
OneBeacon Results-Year Ended December 31, 2015 versus Year Ended December 31, 2014
OneBeacon’s net written premiums decreased 7% in 2015 to $1.1 billion, primarily due to the exit from crop ($44 million) and lawyers liability ($28 million) businesses, a decrease in the Healthcare business ($33 million) and the termination of an affiliated reinsurance treaty ($20 million), partially offset by increases in OneBeacon’s newer Programs and Surety businesses ($67 million). Excluding the impact of OneBeacon’s exit from the Crop and lawyers liability businesses and the affiliated reinsurance treaty termination, consolidated net written premiums increased $13 million, or 1.1%.
For 2015 and 2014, OneBeacon’s net combined ratio was higher than the gross combined ratio by 1 point and 2 points as a result of the cost of the reinsurance programs more than offsetting the benefits from ceded losses.
OneBeacon’s net written premiums increased 12% in 2014 to $1.2 billion, primarily due to an $80 million increase from its newer businesses, particularly OneBeacon Crop Insurance, OneBeacon Program Group and OneBeacon Surety Group.
As noted above, OneBeacon increased its provision for current accident year losses and LAE by $33.7 million in the fourth quarter of 2014. In making its loss and LAE reserve picks for the 2014 accident year, OneBeacon considered the results of the enhanced actuarial and claim review and the fact that reported large claims were approaching estimated ultimate held reserves for large losses sooner than originally expected. $3.8 million of the increase is related to higher-than-expected reports of crop losses that emerged in the fourth quarter. The remaining $29.9 million of the increase reflects an increase in management’s best estimate of current losses and LAE as of December 31, 2014 from those recorded in the first nine months of 2014. This increase primarily affected the Professional Insurance underwriting unit, which represented $22.9 million of the total provision.
As part of closing the Runoff Transaction on December 23, 2014, OneBeacon provided financing in the form of surplus notes with a par value of $101 million issued by OneBeacon Insurance Company (“OBIC”), one of the entities that were transferred from OneBeacon to Armour as part of the transaction (the “OneBeacon Surplus Notes”). As of December 31, 2014, the OneBeacon Surplus Notes had a fair value of $65 million, based on a discounted cash flow model, resulting in a total valuation adjustment of $36 million pre-tax ($23 million after tax) included in loss from sale of discontinued operations. Subsequent to closing, the OneBeacon Surplus Notes are included in OneBeacon’s investment portfolio, categorized within other long-term investments, and subsequent changes in value thereon will be reflected in continuing operations. See “Critical Accounting Estimates” on page 76 for a sensitivity analysis of potential changes in these key variables that can impact the estimated fair value of the OneBeacon Surplus Notes.
These changes, along with certain other adjustments, resulted in a net increase in the estimated loss on the sale of the Runoff Business of $29 million ($19 million after tax) for the full year 2014, resulting in a pre-tax loss on sale at closing of $98 million ($64 million after tax) recognized since the third quarter of 2012.
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, 2015, 2014 and 2013:
BAM is a mutual insurance company whose affairs are managed on a statutory accounting basis, and it does not report stand-alone GAAP financial results. BAM is owned by its members. Each municipal issuer insured by BAM becomes a “member” of BAM. The cost of policies issued by BAM is comprised of a risk premium and a contribution to BAM’s qualified statutory capital (a “Member Surplus Contribution”).
In 2015, BAM insured $10.6 billion of municipal bonds, $10.0 billion of which were in the primary market, up 36% from 2014. The average total premium (including both risk premiums and Member Surplus Contributions), weighted by insured par, of insurance provided by BAM in the primary markets in 2015 was 48 basis points, up from 36 basis points in 2014.
In 2014, BAM insured $7.8 billion of municipal bonds, $7.4 billion of which were in the primary market, up 66% from 2013. The average total premium (including both risk premium and Member Surplus Contributions), weighted by insured par, of insurance provided by BAM in the primary markets in 2014 was 36 basis points, down from 59 basis points in 2013.
A summary of White Mountains’s financial results from its Other Operations segment for the years ended December 31, 2015, 2014 and 2013 follows:
White Mountains’s Other Operations segment reported pre-tax income of $159 million in 2015 compared to a pre-tax loss of $49 million in 2014. White Mountains’s Other Operations segment reported net realized and unrealized investment gains of $260 million in 2015 compared to $30 million in 2014, primarily related to the $259 million unrealized gain from the investment in Symetra common shares. (See “Summary of Investment Results” on page 58.) The Other Operations segment reported net investment income of $9 million in both 2015 and 2014. Other revenues in 2015 includes $187 million from Tranzact and $106 million from MediaAlpha compared to $43 million from Tranzact and $65 million from MediaAlpha in 2014. White Mountains acquired its stake in Tranzact in October 2014 and acquired its stake in MediaAlpha in March 2014. Other revenue also includes a $20 million pre-tax gain in 2015 from the sale of Hamer LLC, a small manufacturing company that White Mountains received in 2012 in connection with the liquidation of a limited partnership fund. In addition, other revenues in 2015 included third-party investment management fee income at WM Advisors of $13 million, compared to $17 million in 2014.
General and administrative expenses in 2015 included $167 million from Tranzact and $99 million from MediaAlpha compared to $37 million from Tranzact and $61 million from MediaAlpha in 2014. General and administrative expenses also included $36 million of increased incentive compensation expense recorded in connection with the agreements to sell Sirius Group and Symetra.
WM Life Re reported losses of $6 million in 2015 compared to $9 million in 2014. 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 a $4 million GAAP pre-tax loss relating to SSIE in 2015 compared to $12 million in 2014. As a reciprocal insurance exchange that is owned by its policyholders, SSIE’s results are attributed to non-controlling interests and do not affect White Mountains’s adjusted book value per share.
Share repurchases. White Mountains repurchased and retired 387,495 of its common shares for $284 million in 2015 at an average price per share of $733.37, or approximately 105% of White Mountains’s December 31, 2015 adjusted book value per share. The average share price paid was approximately 94% of White Mountains’s December 31, 2015 adjusted book value per share including the estimated gain from the Sirius Group transaction.
General and administrative expenses increased in 2014 primarily due to expenses related to MediaAlpha 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.
During 2014, OneBeacon recorded a $19 million net loss on sale of discontinued operations on the Runoff Transaction, which included a $24 million after-tax loss from the change in the estimated value of the surplus notes issued with the Runoff Transaction, partially offset by a reduction in the loss on sale from the Runoff Transaction related to the change in the treatment of the $7 million pre-tax ($5 million after-tax) reserve charge recorded during the second quarter of 2013 (as described below). Previously, OneBeacon expected that the Runoff Business Stock Purchase Agreement (“Runoff SPA”) would be amended to provide for the transfer of $7 million of additional assets to support the reserve charge. The Runoff SPA was instead revised to increase the cap on seller financing.
During 2015 and 2014, White Mountains recognized $18 million and $3 million of net income from discontinued operations related to the final settlement with Allstate for favorable development on loss reserves transferred in the sale of Esurance and Answer Financial. Since the closing of the transaction through September 30, 2015, White Mountains has received a net amount of $28 million from Allstate, primarily related to the favorable development on loss reserves.
For purposes of discussing rates of return, all percentages are presented gross of management fees and trading expenses in order to produce a better comparison to benchmark returns, while all dollar amounts are presented net of any management fees and trading expenses. A summary of White Mountains’s consolidated pre-tax investment results, including the returns from discontinued operations, for the years ended December 31, 2015, 2014 and 2013 follows:
In local currencies, the fixed income portfolio returned 1.1% for 2015, a decent absolute result for the year and essentially in-line with the longer duration Barclays U.S. Intermediate Aggregate Index return of 1.2%. Including foreign currency losses, the fixed income portfolio returned 0.2% for 2015. In local currencies, the fixed income portfolio returned 2.7% for 2014, a decent absolute result for the year but behind the longer duration Barclays U.S. Intermediate Aggregate Index return of 4.1%. The portfolio’s short duration positioning contributed to the underperformance versus the benchmark as interest rates fell in 2014. Including foreign currency losses, the fixed income portfolio returned 0.5% for 2014.
In local currencies, the equity portfolio returned 8.1% for 2014, a strong absolute result but mixed against benchmarks, underperforming the S&P 500 Index return of 13.7% and outperforming the small-cap Russell 2000 return of 4.9%. Including foreign currency losses, the equity portfolio returned 7.2% for 2014.
In 2015, the ETFs earned the effective market return, before expenses, over the period in which White Mountains was invested in each respective fund.
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 that 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 investment returned 6.5% for 2015, outperforming the MCSI EAFE Index return of 5.3%. Including currency losses, the Silchester investment returned 1.2% for 2015, underperforming the S&P 500 Index return of 1.4%. In 2014, the Silchester investment returned 8.6% in local currencies, outperforming the MCSI EAFE Index return of 5.9%. Including currency losses, the Silchester investment returned -1.7% in U.S. dollars, underperforming the S&P 500 Index return of 13.7%.
The Prospector portfolio accounted for approximately 30% of White Mountains’s common equity securities and other long-term investments as of December 31, 2014. In local currencies, the Prospector portfolio returned 6.6% for 2014, underperforming the S&P 500 Index return of 13.7%. Prospector’s underperformance relative to the S&P 500 Index in 2014 reflected an underweight position and underperformance in the technology and healthcare sectors. Like many managers, Prospector’s underweight position in large cap stocks also negatively impacted its performance relative to the S&P 500 Index in 2014. As of December 31, 2013, the Prospector portfolio accounted for approximately 50% of White Mountains’s common equity securities and other long-term investments. In local currencies, the Prospector portfolio returned 23.2% for 2013, underperforming the S&P 500 Index return of 32.4%. Prospector’s underperformance relative to the S&P 500 Index return in 2013 reflected an overweight position in gold mining, an underweight position in the consumer discretionary, technology and industrial sectors and the impact of convertible fixed maturity positions (as opposed to common equity securities), which tend to lag the index in strong up markets.
In local currencies and U.S. dollars, the Lateef separate account returned 6.5% for 2014, underperforming the S&P 500 Index return of 13.7%. In local currencies and U.S. dollars, the Lateef separate account returned 30.5% for 2013, slightly underperforming the S&P 500 Index return of 32.4%.
In local currencies, the Silchester investment returned 8.6% for 2014, outperforming the MCSI EAFE Index return of 5.9%. Including currency losses, the Silchester investment returned -1.7% for 2014, underperforming the S&P 500 Index return of 13.7%. In 2013, the Silchester investment returned 32.6 % in local currencies, outperforming the MCSI EAFE index of 26.9%. Including currency losses, the Silchester investment returned 28.4%, underperforming the S&P 500 Index return of of 32.4%.
White Mountains's continuing operations pre-tax investment results, as presented in the consolidated statement of operations for 2015, 2014, and 2013 are presented below.
The breakdown of White Mountains’s fixed maturity investment as of December 31, 2015 by credit class, based upon issue credit ratings provided by Standard & Poor’s, or if unrated by Standard & Poor’s, long term obligation ratings provided by Moody’s, is as follows:
White Mountains’s holds non-U.S. dollar-denominated assets and liabilities, primarily within discontinued operations, which are valued using period-end exchange rates. White Mountains has non-U.S. dollar-denominated foreign revenues and expenses, primarily within discontinued operations, which 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 (see “Foreign Currency Exchange Risk” on page 98).
During the third quarter of 2015, Symetra announced that it entered into a definitive merger agreement with Sumitomo Life Insurance Company (“Sumitomo Life”) pursuant to which Sumitomo Life will acquire all of the outstanding shares of Symetra. Following the announcement and Symetra shareholders' November 5, 2015 meeting to approve the transaction, White Mountains relinquished its representation on Symetra’s board of directors. As a result, White Mountains changed its accounting for Symetra common shares from the equity method to fair value. The carrying value per Symetra share used in the calculation of White Mountains’s adjusted book value per share rose to $31.77 at December 31, 2015 from $18.65 at December 31, 2014. Including dividends, Symetra produced $264 million of adjusted comprehensive income for White Mountains in 2015, of which $241 million was recognized as an after-tax unrealized investment gain in the fourth quarter. On February 1, 2016, Symetra closed its definitive merger agreement with Sumitomo Life and White Mountains received proceeds of $658 million, or $32 per common share.
Symetra’s total revenues and net income through September 30, 2015 were $1.6 billion and $90 million. As of September 30, 2015, Symetra had total assets of $35.0 billion and shareholders’ equity of $3.1 billion. Symetra’s total revenues and net income for the years ended December 31, 2014 and 2013 were $2.2 billion, $254 million and $2.1 billion and $221 million. As of December 31, 2014, Symetra had total assets of $33.0 billion and shareholders’ equity of $3.4 billion. Symetra’s shareholders’ equity excluding unrealized gains (losses) from its fixed maturity investments was $2.4 billion as of December 31, 2014. Since inception, White Mountains received a total of $149.0 million in cash dividends recorded as a reduction of White Mountains investment in Symetra under the equity method. White Mountains received a cash dividend of $2.3 million in the fourth quarter of 2015 recorded within net investment income.
OneBeacon’s top-tier regulated U.S. insurance operating subsidiary, Atlantic Specialty Insurance Company (“ASIC”), has the ability to pay dividends to its immediate parent during any 12-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, most recently calculated as of December 31, 2015, ASIC has the ability to pay $27 million of dividends during 2016 without prior approval of regulatory authorities. As of December 31, 2015, ASIC had $622 million of statutory surplus and $68 million of earned surplus. During 2015, ASIC paid $45 million of dividends to its immediate parent and redeemed and retired common shares held by its immediate parent at an aggregate price of $66 million.
OneBeacon is in the process of seeking regulatory approval of the redomestication of ASIC from New York to Pennsylvania. Under the exiting dividend capacity formula for the Commonwealth of Pennsylvania, which is the greater of 10% of policyholder surplus or net income of the previous year, ASIC would have the ability to pay $62 million in dividends in 2016. OneBeacon expects that any distributions paid by ASIC prior to its redomestication to Pennsylvania would reduce the $62 million allowed under the dividend capacity formula.
Effective January 1, 2014, HG Global and BAM agreed to change the interest rate on the BAM Surplus Notes for the five years ending December 31, 2018 from a fixed rate of 8% to a variable rate equal to the one-year U.S. treasury rate plus 300 basis points, set annually, which was 3.15% for 2015 and is 3.54% for 2016. Prior to the end of 2018, BAM has the option to extend the variable rate period for an additional three years. At the end of the variable rate period, the interest rate will be fixed at the higher of the then current variable rate or 8%. BAM is required to seek regulatory approval to pay interest and principal on its surplus notes only when adequate capital resources have accumulated beyond BAM’s initial capitalization and a level that continues to support its outstanding obligations, business plan and ratings. BAM did not pay any interest on the BAM Surplus Notes in 2015, 2014 or 2013.
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. At December 31, 2015, Life Re Bermuda had $77 million of shareholder’s equity and White Mountains’s maximum capital commitment under the keep-well agreement was $111 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, 2015 reported to Tokio Marine as required under the terms of the novation agreement:
Sirius Bermuda a class 3A licensed Bermuda insurer which owns Sirius International, has the ability to declare or pay dividends or make capital distributions to its immediate parent 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 2016, Sirius Bermuda has the ability to pay dividends or make capital distributions without the prior approval of regulatory authorities, subject to meeting all appropriate liquidity and solvency requirements, of $635 million, which is equal to 25% of its December 31, 2015 regulatory capital available for distribution. 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 Bermuda's business, as well as to dividends received from its subsidiaries, including Sirius International. During 2015, Sirius Bermuda paid $123 million of dividends to its immediate parent.
Sirius International has the ability to pay dividends up 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, 2015, Sirius International had $334 million (based on the December 31, 2015 SEK to USD exchange rate) of unrestricted equity on a parent account basis (the lower of the two approaches) available to pay dividends in 2016. 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. 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 2015, Sirius International paid $195 million of dividends to its immediate parent.
Subject to certain limitations under Swedish law, Sirius International is permitted to transfer certain portions of its pre-tax income to its Swedish parent companies to minimize taxes (referred to as a group contribution). On January 1, 2013, new tax legislation became effective in Sweden that limits the deductibility of interest paid on certain intra-group debt instruments. Uncertainty exists with respect to the interpretation of the legislation on existing intra-group debt instruments within the Sirius Group structure. During 2015, Sirius International did not transfer any of its 2014 pre-tax income via group contributions to its Swedish parent companies.
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 to calculate insurance float is to take insurance liabilities and subtract insurance assets. 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 profitability, which sometimes reduces insurance float, such as in the Sirius Group transaction.
The following table illustrates White Mountains’s consolidated insurance float position as of December 31, 2015 and 2014:
(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 67).
During 2015, insurance float from continuing operations increased by $91 million, primarily from an increase at OneBeacon of unrestricted collateral held relating to the growth of its Surety business. During 2015, insurance float from discontinued operations decreased by $206 million, primarily due to reduced loss and LAE reserve balances at Sirius Group resulting from payments.
On July 23, 2015, MediaAlpha entered into a credit facility with Opus Bank, which has a total commitment of $20 million and has a maturity date of July 23, 2019 (the “MediaAlpha Bank Facility”). The MediaAlpha Bank Facility consists of a $15 million term loan facility, which was fully drawn as of December 31, 2015, and a revolving credit facility for an additional $5 million, which was undrawn as of December 31, 2015.
The MediaAlpha Bank Facility is secured by the intellectual property and the common stock of MediaAlpha's subsidiaries and contains various affirmative, negative and financial covenants which White Mountains considers to be customary for such borrowings, including a maximum leverage ratio. The MediaAlpha Bank Facility carries a variable interest rate, based on the U.S. dollar LIBOR rate.
The OBH Senior Notes were issued under indentures that contain restrictive covenants which, among other things, limit the ability of OneBeacon Ltd., OBH and their respective subsidiaries to create liens and enter into sale and leaseback transactions and limits the ability of OneBeacon Ltd., OBH and their respective subsidiaries to consolidate, merge or transfer their properties and assets. The indentures do not contain any financial ratios or specified levels of net worth or liquidity to which OneBeacon Ltd. or OBH must adhere. 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.
In December 2015 the lease agreement with Fifth Third expired and OneBeacon purchased the leased assets under the agreement with a remaining book value of $1 million for a nominal amount. At the end of the lease term with US Bancorp on December 31, 2016, OneBeacon will purchase the leased furniture and equipment assets for a nominal amount, and all rights, title and interest will transfer back to it. As of December 31, 2015, OneBeacon had a capital lease obligation of $2 million included within other liabilities and a capital lease asset of $2 million included within other assets.
WM Life Re reinsures death and living benefit guarantees associated with certain variable annuities issued in Japan. WM Life Re has assumed the risk related to a shortfall between the account value and the guaranteed value that must be paid by the ceding company to an annuitant or to an annuitant’s beneficiary in accordance with the underlying annuity contracts. WM Life Re uses derivative instruments, including put options, interest rate swaps, total return swaps and futures contracts on major equity indices, currency pairs and government bonds, to mitigate the risks associated with changes in the fair value of the reinsured variable annuity guarantees. As of December 31, 2015, the total guarantee value was approximately ¥50.7 billion (approximately $0.4 billion) and the related account values were approximately 109% of this amount.
Based on current account value to guaranty value ratio in the annuities reinsured by WM Life Re as of December 31, 2015, WM Life Re expects $3 million of future cash outflows related to its reinsurance contracts through June 2016.
White Mountains purchases derivative instruments, including futures and over-the-counter option contracts on interest rates, major equity indices, and foreign currencies, to mitigate the risks associated with changes in the fair value of the reinsured variable annuity guarantees. As of December 31, 2015, the fair value of these derivative instruments was $20 million. In addition, WM Life Re held approximately $6 million of cash and fixed maturity investments as of December 31, 2015 posted as collateral to its reinsurance and derivatives counterparties.
The following table presents common shares repurchased by the Company, as well as the average price per share as a percent of the adjusted book value per share. For 2016 and 2015, the average price per share as a percent of adjusted book value per share including the estimated gain from the Sirius Group transaction is presented. See page 44 for the estimated gain on Sirius Group transaction.
Detailed information concerning White Mountains’s cash flows during 2015, 2014 and 2013 follows:
Net cash flows provided from (used for) continuing operations was $161 million, $59 million and $(40) million in 2015, 2014 and 2013, respectively. Cash flows from continuing operations increased $102 million in 2015 compared to 2014 primarily due to increased cash collateral received from OneBeacon’s Surety business and from higher amounts of cash provided by WTM Life Re from the sale and settlement of derivative instruments as its business runs off. Cash flows from continuing operations increased $99 million in 2014 compared to 2013 primarily due to lower amounts of cash used for the settlement and purchase of derivative instruments at WM Life Re in 2014 compared to 2013. White Mountains does not believe that these trends will have a meaningful impact on its future liquidity or its ability to meet its future cash requirements.
During 2015, 2014 and 2013 White Mountains made long-term incentive payments totaling $57 million, $27 million and $11 million.
During 2015, WM Life Re repaid $23 million under an internal revolving credit facility with an intermediate holding company of White Mountains.
During 2015, BAM received $29 million in surplus contributions from its members.
On April 2, 2015, White Mountains closed on PassportCard, a 50/50 joint venture with DavidShield and contributed $21 million of assets to a newly formed entity, PassportCard Limited (formerly PPCI Global Limited).
During 2015, White Mountains purchased $4 million of surplus notes issued by SSIE, which increased its investment in surplus notes issued by SSIE to $21 million as of December 31, 2015.
During 2014, White Mountains borrowed and repaid a total of $65 million under the WTM Bank Facility.
During 2014, MediaAlpha paid $2 million of dividends, of which $1 million was paid to White Mountains.
During 2014, White Mountains acquired 60% of the outstanding Class A common units of MediaAlpha for an initial purchase price of $28 million.
During 2014, OneBeacon transferred $51 million of cash in connection with the sale of the Runoff Business.
During the first quarter of 2013, the Company declared and paid a $6 million cash dividend to its common shareholders.
During 2013, WTM Life Re borrowed a total of $145 million and repaid a total of $115 million under an internal revolving credit facility with an intermediate holding company of White Mountains.
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 45.
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 mutuals and 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 69.
Total consolidated portfolio returns excluding Symetra and total common equity securities and long-term investments returns excluding Symetra are non-GAAP financial measures that remove the $259 million pre-tax unrealized gain recognized in the fourth quarter of 2015 that was the result of the change in accounting for Symetra common shares from the equity method to fair value. White Mountains believes these measures to be more relevant by making the returns in the current year comparable to the prior periods which did not contain any investment returns from Symetra.
White Mountains performs an actuarial review of its recorded reserves each quarter. White Mountains’s actuaries compare the previous quarter’s estimates of paid loss and LAE, case reserves and IBNR to amounts indicated by actual experience. Differences between previous estimates and actual experience are evaluated to determine whether a given actuarial method for estimating loss and LAE should be relied upon to a greater or lesser extent than it had been in the past. While some variance is expected each quarter due to the inherent uncertainty in loss and LAE, persistent or large variances would indicate that prior assumptions and/or reliance on certain reserving methods may need to be revised going forward.
The process of establishing loss reserves is complex and imprecise as it must consider many variables that are subject to the outcome of future events. As a result, informed subjective estimates and judgments as to OneBeacon’s ultimate exposure to losses are an integral component of the loss reserving process. OneBeacon, like other insurance companies, categorize and track its insurance reserves by "line of business", such as general liability, automobile liability and workers compensation. Furthermore, OneBeacon regularly reviews the appropriateness of reserve levels at the line of business level, considering the variety of trends that impact the ultimate settlement of claims for the subsets of claims in each particular line of business.
OneBeacon’s loss and LAE reserves, net of reinsurance recoverables, as of December 31, 2015 and 2014 were as follows:
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 unit present a potentially longer tail and greater uncertainty than our standard property business.
Changes in the type, frequency of utilization or cost of medical treatments (e.g., changes in the use of pharmaceutical drugs, types of health providers used, use of preferred provider networks and other medical cost containment practices)
In addition to the examples of common reserving factors related to general liability described above, other examples of common reserving factors that can change and, thus, also affect estimated commercial automobile liability reserves include:
(severity) which is impacted by the bond limit, or amount and collectability of assets or other collateral available to mitigate
Net favorable loss reserve development was $2 million during the year ended December 31, 2015. The net favorable loss reserve development was primarily attributable to favorable loss reserve development from the Technology, Collector Cars and Boats, Specialty Property and Financial Services lines of business, offset by unfavorable net loss reserve development from the Entertainment and Ocean Marine lines of business. See “RESULTS OF OPERATIONS - OneBeacon” on page 47.
During 2014, OneBeacon experienced $90 million of net unfavorable loss and LAE reserve development on prior accident year reserves, of which $75 million related to the 2014 fourth quarter reserving increase and the remaining amount primarily driven by unfavorable development in the professional liability and management liability businesses included within Professional Insurance. In 2015, Professional Insurance was reorganized into Other Professional Lines, Management Liability, Financial Services and Healthcare.
During 2013, OneBeacon experienced no net loss and LAE reserve development on prior accident year reserves. OneBeacon experienced unfavorable development primarily related to its property, general liability and accident and health lines, which was offset by favorable development in its other liability and ocean marine lines.
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, 2015 and 2014. 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.
The recorded reserves represent management’s best estimate of unpaid loss and LAE reserves. OneBeacon uses the results of several different actuarial methods to develop its estimate of ultimate reserves. While it has not determined the statistical probability of actual ultimate paid losses falling within the range, OneBeacon believes that it is reasonably likely that actual ultimate paid losses will fall within the ranges noted above because the ranges were developed by using several different generally accepted actuarial methods.
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 scenarios or an all-inclusive list, and therefore it is possible that future volatilities and variations may be more than amounts discussed below.
Multiple peril liability: Recorded loss and LAE reserves, net of reinsurance recoverable for multiple peril were $66 million as of December 31, 2015. Reported loss development patterns are a key assumption for this line of business, particularly for more mature accident years. Historically, assumptions on reported loss development patterns have been impacted by, among other things, emergence of new types of claims (e.g. construction defect claims) or a shift in the mixture between smaller, more routine claims and larger, more complex claims. If case reserve adequacy for multiple peril claims changed by 10 points this would have changed the estimated net reserve by approximately $2 million as of December 31, 2015, in either direction.
The estimation of net reinsurance loss and LAE reserves is subject to the same risk as the estimation of insurance loss and LAE reserves. In addition to those risk factors which give rise to inherent uncertainties in establishing insurance loss and LAE reserves, the inherent uncertainties of estimating such reserves are even greater for the reinsurer, due primarily to: (1) the claim-tail for reinsurers and insurers working through MGUs being further extended because claims are first reported to either the original primary insurance company or the MGU and then through one or more intermediaries or reinsurers, (2) the diversity of loss development patterns among different types of direct insurance contracts, reinsurance treaties or facultative contracts, (3) the necessary reliance on the ceding companies, intermediaries and MGUs for information regarding reported claims and (4) the differing reserving practices among ceding companies and MGUs.
Sirius Group’s expected annual loss reporting assumptions are updated at least once a year. Expected loss ratios underlying the recent underwriting years are updated quarterly.
In 2015, Sirius Group had net favorable loss reserve development of $51 million. The major reductions in loss reserve estimates were recognized in the property ($26 million), casualty and other runoff lines ($14 million). The remaining reductions were recognized across accident & health, aviation, credit, and marine lines of business. The decrease in property was driven primarily by reductions in the ultimate loss estimates for natural catastrophes that occurred between 2010 and 2014 due to less than expected claims activity.
The actuarial methods described above are used to calculate a point estimate of loss and LAE reserves for each company within Sirius Group. These point estimates are then aggregated to produce an actuarial point estimate for the entire segment. Once a point estimate is established, Sirius Group’s actuaries estimate loss reserve ranges to measure the sensitivity of the actuarial assumptions used to set the point estimates. These ranges are calculated from historical variations in loss ratios, payment and reporting patterns by class and type of business.
The following table illustrates Sirius Group’s recorded net loss and LAE reserves and high and low estimates as of December 31, 2015 and 2014.
Sustained Economic and Tort Inflation. Future inflation beyond the recent historical levels could impact the required reserves. For example, Sirius America has loss reserves of roughly $725 million including asbestos and environmental at the end of fourth quarter 2015. The estimated additional claim payments for Sirius America due to hypothetical increases in the inflation rate of 200 to 800 basis points beginning in 2019 and continuing through 2023 is estimated to be $31 to $160 million.
Included in Sirius Group’s liabilities held for sale are A&E loss reserves. Sirius Group's A&E exposure is primarily from reinsurance contracts written between 1974 through 1985. The exposures are mostly higher layer excess of loss treaty and facultative coverages with relatively low limits exposed for each claim. In 2014, Sirius Group increased its net A&E exposure through incoming runoff portfolios acquired by Sirius Global Solutions. These acquisitions added $23 million in net asbestos reserves and $2 million in net environmental reserves in 2014. The acquisition of companies having modest portfolios of A&E exposure has been typical of several prior Sirius Global Solutions transactions and is likely to be an element of at least some future acquisitions. However, the acquisition of new A&E liabilities is undertaken only after careful due diligence and utilizing conservative reserving assumptions in relation to industry benchmarks. In the case of the portfolios acquired during 2014, the exposures arise almost entirely from old assumed reinsurance contracts having small limits of liability.
Sirius Group recorded $8 million of asbestos-related net incurred losses and LAE on its already existing asbestos reserves in 2014 that was primarily the result of management’s monitoring of a variety of metrics including actual paid and reported claims activity. No amount was recorded in 2015.
Sirius Group’s net reserves for A&E losses were $190 million and $210 million as of December 31, 2015 and 2014, respectively. Sirius Group’s A&E three-year net paid survival ratio was approximately 8.9 years and 8.8 years as of December 31, 2015 and 2014, which is fairly consistent with industry survival ratios.
The following tables show gross and net loss and LAE payments for A&E exposures for the years ending December 31, 2006 through December 31, 2015:
Sirius Group utilizes specialized claims handling processes on A&E exposures. The issues presented by these types of claims require expertise and an awareness of the various trends and developments in relevant jurisdictions. Generally, Sirius Group sets up claim files for each reported claim by each cedant for each individual insured. In many instances, a single claim notification from a cedant could involve several years and layers of coverage resulting in a file being set up for each involvement. Precautionary claim notices are submitted by the ceding companies in order to preserve their right to pursue coverage under the reinsurance contract. Such notices do not contain an incurred loss amount. Accordingly, an open claim file is not established. As of December 31, 2015, Sirius Group had 2,348 open claim files for asbestos and 462 open claim files for environmental exposures.
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 White Mountains uses have indicated that they will only provide prices where observable inputs are available. In circumstances where quoted market prices are unavailable or are not considered reasonable, White Mountains estimates the fair value using industry standard pricing models and observable inputs such as benchmark yields, reported trades, broker-dealer quotes, issuer spreads, benchmark securities, bids, offers, prepayment speeds, reference data including research publications and other relevant inputs. Given that many fixed maturity investments do not trade on a daily basis, the outside pricing services evaluate a wide range of fixed maturity investments by regularly drawing parallels from recent trades and quotes of comparable securities with similar features. The characteristics used to identify comparable fixed maturity investments vary by asset type and take into account market convention.
White Mountains's process to assess the reasonableness of the market prices obtained from the outside pricing sources covers substantially all of its fixed maturity investments and includes, but is not limited to, evaluation of model pricing methodologies, review of the pricing services' quality control processes and procedures on at least an annual basis, comparison of market prices to prices obtained from different independent pricing vendors on at least a semi-annual basis, monthly analytical reviews of certain prices and review of assumptions utilized by the pricing service for selected measurements on an ad hoc basis throughout the year. White Mountains also performs back-testing of selected sales activity to determine whether there are any significant differences between the market price used to value the security prior to sale and the actual sale price on an ad-hoc basis throughout the year. Prices provided by the pricing services that vary by more than 5% and $1.0 million from the expected price based on these procedures are considered outliers. Also considered outliers are prices that haven’t changed from period to period and prices that have trended unusually compared to market conditions. In circumstances where the results of White Mountains's review process does not appear to support the market price provided by the pricing services, White Mountains challenges the price. During the past year, 8 securities fell outside White Mountains’s expected results, thereby triggering the challenge with the pricing service. If White Mountains cannot gain satisfactory evidence to support the challenged price, it relies upon its own pricing methodologies to estimate the fair value of the security in question.
Debt securities issued by corporations: The fair value of debt securities issued by corporations is determined from an evaluated pricing model that uses information from market sources and integrates relative credit information, observed market movements, and sector news. Key inputs include benchmark yields, reported trades, broker-dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data including sector, coupon, credit quality ratings, duration, credit enhancements, early redemption features and market research publications.
Municipal obligations: The fair value of municipal obligations is determined from an evaluated pricing model that uses information from market makers, brokers-dealers, buy-side firms, and analysts along with general market information. Key inputs include benchmark yields, reported trades, issuer financial statements, material event notices and new issue data, as well as broker-dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data including type, coupon, credit quality ratings, duration, credit enhancements, geographic location and market research publications.
Preferred stocks: The fair value of preferred stocks is determined from an evaluated pricing model that calculates the appropriate spread over a comparable security for each issue. Key inputs include exchange prices (underlying and common stock of same issuer), benchmark yields, reported trades, broker-dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data including sector, coupon, credit quality ratings, duration, credit enhancements, early redemption features and market research publications.
Level 3 valuations are generated from techniques that use assumptions not observable in the market. These unobservable assumptions reflect White Mountains’s assumptions that market participants would use in valuing the investment. Generally, certain securities may start out as Level 3 when they are originally issued but as observable inputs become available in the market, they may be reclassified to Level 2.
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, 2015 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 - “Investment Securities” for tables that summarize the changes in White Mountains’s fair value measurements by level for the years ended December 31, 2015 and 2014 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, 2015, 2014 and 2013.
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 of $(.3) million were classified as Level 3 measurements as of December 31, 2015.
As of December 31, 2015, the value of bond funds tracking the WGBI was approximately ¥18.6 billion ($154.3 million). By country, the largest exposures, together comprising approximately 92% of the WGBI, were the United States (43%), France (10%), Italy (10%), Germany (8%), the United Kingdom (8%), Spain (5%), the Netherlands (3%), Belgium (3%) and Canada (2%). Eurozone countries together comprised approximately 41%. 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, 2015, the total notional amounts of JPM European GBI swaps were ¥4.1 billion ($34 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.
As of December 31, 2015, the value of bond funds tracking the Nomura BPI was approximately ¥20.2 billion ($168 million). In January 2010, because the types and tenors of liquid Japanese bond futures are extremely limited, to more closely track the performance of bond funds tracking the Nomura BPI, WM Life Re entered into its first total return swap contract on the performance of that index and subsequently hedged the majority of its Japan bond exposure with total return swaps. As of December 31, 2015, all of these contracts had matured and were not renewed due to what is deemed to be minimal remaining risk. Nomura BPI exposure is hedged with liquid Japanese bond futures and is subject to basis risk relating to the difference between the tenor of the bond futures and the tenor of the assets in the annuity funds covered by WM Life Re’s variable annuity guarantees.
The table below summarizes as of December 31, 2015 and 2014, the estimated financial impact of simultaneous market events. Unlike the individual sensitivity analysis illustrated above, the analysis in the table below reflects the inter-dependencies between individual variables.
Assumed hedge effectiveness in down and up markets of 93% and 106%, respectively, as of December 31, 2015 and 2014, 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.
During 2013, improved markets led to significantly higher ratios of annuitants’ account values to guarantee values and, as a result, annuitants surrendered their policies at higher rates than WM Life Re has observed in the past. In response to this trend, WM Life Re adjusted the projected surrender assumptions used in the valuation of its variable annuity reinsurance liability upward in the second quarter of 2013, which resulted in a gain of $2 million and again in the fourth quarter of 2013, which resulted in a gain of $5 million. In 2014 surrender rates continued to outpace assumptions and another adjustment was made in the fourth quarter of 2014. This adjustment resulted in a loss of $0.2 million because the policies most impacted had account values that were significantly higher than their guaranty values.
As of December 31, 2011, WM Life Re increased the variable annuity guaranty liability by $6 million to partially reflect a “basis swap” implied by foreign exchange rates which results in lower projected returns (in Japanese yen) for the portion of funds invested in countries outside of Japan. Since the financial crisis in 2008, there has been a break in expected arbitrage free relationships between swap interest rates and foreign exchange rates (in particular, between the U.S. and Japan). This adjustment recognizes that this anomaly of trading values may be more than temporary. The balance of this reserve was $0 million as of December 31, 2015.
The following table summarizes the changes in White Mountains’s variable annuity reinsurance liabilities and derivative instruments for the year ended December 31, 2015 and 2014:
Includes interest rate swaps, total return swaps and foreign currency forward contracts. Fair value measurement based upon bid/ask pricing quotes for similar instruments that are actively traded, where available. Swaps for which an active market does not exist have been priced using observable inputs including the swap curve and the underlying bond index.
In addition to derivative instruments, WM Life Re held cash, short-term and fixed maturity investments of $5.8 and $33.2 as of December 31, 2015 and 2014 posted as collateral to its counterparties.
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. As of December 31, 2015 and 2014 the surplus notes has a fair value of $52 million and $65 million. The OneBeacon surplus notes, issued by one of the transferred entities, OBIC, since renamed Bedivere (“Issuer”), were in the form of both seller priority and pari passu notes.
Under the contractual terms of both the seller priority and pari passu notes, scheduled interest payments accrue at 6.0% until the scheduled maturity date of March 15, 2020 and at a floating interest rate thereafter, should any principal remain outstanding. As required by the PID, interest on the notes does not compound. The notes restrict the Issuer’s ability to make distributions to holders of its equity interest. All such distributions are prohibited while the seller priority note is outstanding, and while the pari passu note is outstanding, distributions are permitted only if the Issuer concurrently repays a pro rata amount of any outstanding principal on the pari passu note.
Below is a table illustrating the valuation adjustments taken to arrive at the estimated fair value of the OneBeacon Surplus Notes as of December 31, 2015 and December 31, 2014:
(4) The decrease in the fair value of the surplus notes during the twelve months ended December 31, 2015 was primarily due to widening of non-investment grade credit spreads.
(1) Represents the sensitivity to changes in the estimate of the liquidity spread added to account for OneBeacon’s sole ownership of the OneBeacon Surplus Notes, lack of a liquid trading market, and ongoing regulatory approval risk.
(2) Represents the sensitivity to changes in the estimate of the underlying equivalent credit quality of the OneBeacon Surplus Notes. Such credit quality is approximated by comparing the expected percentage of discounted payments missed, as calculated in a proprietary Stochastic simulation, to a series of benchmarks derived from data published by Standard & Poor’s. Note that “notch” is defined as the difference between, for example. a “B” and “B+” rated instrument.
incurred loss and loss adjustment expenses and the adequacy of its loss and loss adjustment expense reserves and related reinsurance;
The financial statements of Symetra for the years ended December 31, 2014 and 2013 and the interim period ended September 30, 2015 have been filed as a part of this Annual Report on Form 10-K (see Exhibits 99.1 and 99.2 on page 103 of this report).