The Company maintains two professional offices in Hamilton, Bermuda which serve as its headquarters and its registered office. The Company’s principal executive office is in Hanover, New Hampshire. In addition, White Mountains maintains professional offices in Guilford, Connecticut, which house its investment and corporate finance functions, and Boston, Massachusetts, which house its corporate accounting, reporting and internal audit functions.
Selected consolidated income statement data and ending balance sheet data for each of the five years ended through December 31, 2012, follows:
Earnings (loss) before extraordinary items attributable to White Mountains’ common shareholders per share:
As a result of the Esurance Sale, the AutoOne Sale, and the Runoff Transaction, White Mountains has reclassified the results from these businesses for the past five years in the table above to discontinued operations, net of tax. In 2012, discontinued operations, net of tax, includes a $91 loss related to the sale of the Runoff Business and a net loss of $24 related to the operations of the Runoff Business. In 2011, discontinued operations, net of tax, includes a $678 gain related to the Esurance Sale, a $19 loss related to the AutoOne Sale, and a $37 net loss related to the Runoff Business.
During 2012, White Mountains capitalized HG Global with approximately $600 to fund the start-up of BAM. At December 31, 2012, White Mountains owned 97.3% of HG Global’s preferred equity and 88.7% of its common equity. White Mountains does not have an ownership interest in BAM, which is a mutual insurance company owned by its members. Accordingly, all of BAM’s results are attributed to non-controlling interest.
Includes the dilutive effects of outstanding incentive options to acquire common shares. 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 47.
During 2012, 2011 and 2010, White Mountains repurchased 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.
The following discussion contains “forward-looking statements”. White Mountains intends statements that are not historical in nature, which are hereby identified as forward-looking statements, to be covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. White Mountains cannot promise that its expectations in such forward-looking statements will turn out to be correct. White Mountains’ actual results could be materially different from and worse than its expectations. See “FORWARD-LOOKING STATEMENTS” on page 102 for specific important factors that could cause actual results to differ materially from those contained in forward-looking statements.
The following discussion also includes three non-GAAP financial measures, adjusted comprehensive income, adjusted book value per share and adjusted capital, that have been reconciled to their most comparable GAAP financial measures (see page 73). White Mountains believes these measures to be more relevant than comparable GAAP measures in evaluating White Mountains’ financial performance and condition.
Overview-Year Ended December 31, 2012 versus Year Ended December 31, 2011
White Mountains ended 2011 with an adjusted book value per share of $542, an increase of 23%, including dividends, from December 31, 2010. White Mountains reported adjusted comprehensive income of $745 million in 2011 compared to adjusted comprehensive income of $141 million in 2010. The increase in adjusted book value per share in 2011 was driven by an $89 increase from the gain from the Esurance Sale, net of transaction related expenses.
OneBeacon’s book value per share increased 3% during 2011, including dividends. OneBeacon's GAAP combined ratio was 92% for 2011 compared to 96% for 2010. The decrease was primarily driven by improved current accident year results, partially offset by higher catastrophe losses. Sirius Group’s GAAP combined ratio was 100% for 2011 compared to 94% for 2010. Both years were impacted by significant catastrophe losses as 2011 included 24 points of catastrophe losses compared to 23 points in 2010.
The following table presents White Mountains’ adjusted book value per share, a non-GAAP financial measure, for the years ended December 31, 2012, 2011 and 2010 and reconciles this non-GAAP measure to the most comparable GAAP measure (See NON-GAAP FINANCIAL MEASURES on page 73):
A summary of White Mountains’ consolidated financial results for the years ended December 31, 2012, 2011 and 2010 follows:
Change in equity in net unrealized (losses) gains from investments in unconsolidated affiliates
(1) On December 31, 2011, Tuckerman Fund I was dissolved and all of the net assets of the fund, which consisted of the LLC units of Hamer and Bri-Mar, two small manufacturing companies, were distributed. As of October 1, 2012, Hamer and Bri-Mar are no longer consolidated and are accounted for as investments in unconsolidated affiliates.
Consolidated Results-Year Ended December 31, 2012 versus Year Ended December 31, 2011
White Mountains’ total revenues increased 12% to $2,436 million in 2012 compared to $2,173 million in 2011, primarily due to higher earned insurance and reinsurance premiums, foreign currency translation gains, higher net realized and unrealized investment gains and an improvement of the mark-to-market performance of the Symetra warrants, partially offset by lower net investment income. Earned premiums increased 7% to $2,064 million in 2012, with an 11% increase at OneBeacon and a 3% increase at Sirius Group. Net investment income was down 17% to $154 million in 2012, principally due to a lower invested asset base driven by share repurchases and lower fixed maturity yields. White Mountains reported net realized and unrealized investment gains of $118 million in 2012 compared to $74 million in 2011. Net realized and unrealized investment gains for both periods were impacted by foreign currency translation on U.S. dollar-denominated investments at Sirius International, the effects of which are offset in other comprehensive income (see “Impact of Foreign Currency on Investment Returns” on page 59). Other revenues increased to a gain of $100 million in 2012 from a loss of $10 million in 2011, due primarily to $40 million in foreign currency translation gains and $18 million in mark-to-market gains on the Symetra warrants in 2012, compared to $6 million in foreign currency translation losses and $25 million in mark-to-market losses on the Symetra warrants in 2011. Other revenues included a $25 million loss from WM Life Re in 2012 compared to a $16 million loss in 2011. See Note 8 - Variable Annuity Reinsurance for details regarding WM Life Re’s total impact on White Mountains’ statement of operations. Other revenues in 2012 also included a $15 million pre-tax gain on Sirius Group’s sale of IMG, $14 million in pre-tax transaction gains from White Mountains Solutions’ acquisitions that closed in 2012, a $5 million pre-tax gain on OneBeacon’s sale of a shell company and a $6 million pre-tax loss from OneBeacon’s repurchase of its remaining 2003 OBH Senior Notes. Other revenues in 2011 included a $7 million pre-tax gain from Sirius Group’s acquisition of Old Lyme.
Consolidated Results-Year Ended December 31, 2011 versus Year Ended December 31, 2010
White Mountains’ total expenses decreased 3% to $2,075 million in 2011 compared to $2,144 million in 2010. Excluding the $218 million of expenses reported in 2010 related to OneBeacon’s personal lines business, White Mountains’ total expenses increased 8% in 2011, as losses and LAE expenses, insurance and reinsurance acquisition expenses and other underwriting expenses increased 10%, 6% and 2%, driven by increased business volume. The increase in loss and LAE expenses was also due to higher catastrophe losses. General and administrative expenses increased 14% to $167 million in 2011 compared to $147 million in 2010, due primarily to increased compensation expenses as a result of the gain from the Esurance Sale and to the 35% increase in White Mountains’ stock price during 2011. Interest expense on debt decreased 4% to $55 million in 2011 compared to $57 million in 2010, primarily due to reductions of outstanding debt resulting from repurchases of the 2003 OBH Senior Notes.
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 at December 31, 2012. As a result, Sirius Group recognized $73 million in tax benefits from these changes. In addition, during the quarter Sirius Group 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 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 other than the United States.
On October 17, 2012, OneBeacon entered into an agreement to sell its runoff business to Armour and recorded $101 million in after-tax losses related to the Runoff Transaction in 2012. These losses are composed of a $92 million after-tax loss on sale and a $9 million after-tax loss related to a reduction in the workers compensation loss reserve discount rate on reserves being transferred as part of the sale. The transaction is expected to close in the second half of 2013. On October 7, 2011, White Mountains completed the sale of Esurance to Allstate for cash equal to $700 million plus the tangible book value at closing of the entities being sold and recorded a gain of $678 million. In 2011, OneBeacon agreed to sell its AutoOne business to Interboro and recorded a charge of $19 million after tax for the estimated loss on the sale. The AutoOne transaction closed in February 2012.
OneBeacon ended 2012 with a book value per share of $10.63, a decrease of 0.8%, including dividends (a quarterly dividend of $0.21 per share) from December 31, 2011. The decrease in book value was driven by a $92 million estimated after-tax loss on the Runoff Transaction and $24 million of net after-tax operating losses from discontinued operations, which included a $9 million after-tax charge related to the Runoff Transaction from a reduction in the workers compensation loss reserve discount rate. This negative impact to book value was partially offset by a $14 million increase from the sale of OneBeacon Holdings (Luxembourg) S.à r.l. to Sirius Group. The transaction was recorded as an increase in OneBeacon’s equity and was eliminated in White Mountains’ consolidated financial statements. OneBeacon’s GAAP return of investments was 4.4% for 2012.
OneBeacon’s GAAP combined ratio for 2011 decreased to 92% from 96% for 2010, primarily due to better current accident year results, partially offset by higher catastrophe losses. OneBeacon experienced a number of large losses in its property and inland marine business during 2010. The GAAP combined ratio for 2011 included 4 points of catastrophe losses compared to 2 points in 2010. The GAAP combined ratio included 3 points of favorable loss reserve development for both years.
OneBeacon’s net written premiums decreased 8% in 2011 to $1,063 million from $1,168 million in 2010. Excluding $171 million of net written premiums in 2010 related to OneBeacon’s personal lines business, which was sold in July of 2010, OneBeacon’s net written premiums increased 8% in 2011, primarily due to new business and improved retention in several lines, particularly within the collector cars and boats, accident, government risk, energy and technology businesses.
OneBeacon’s policy acquisition expenses decreased 12% to $221 million and other underwriting expenses decreased 17% to $162 million in 2011. Excluding the personal lines business that OneBeacon sold in 2010, OneBeacon’s policy acquisition expenses increased 4% and other underwriting expenses were essentially flat in 2011. Interest expense decreased 31% to $21 million in 2011, reflective of lower outstanding debt.
Financial results and GAAP combined ratios for Sirius Group for the years ended December 31, 2012, 2011 and 2010 follows:
Sirius Group's gross written premiums increased 4% (6% in local currencies) to $1,179 million in 2012 from $1,128 million for 2011, while net written premiums increased 3% (5% in local currencies) to $948 million for 2012 from $916 million in 2011. These increases were primarily from the property and accident and health lines of business, partially offset by decreases in the casualty and trade credit lines. Net written premiums for 2012 increased less than gross written premiums due to increased retrocessions on the property and accident and health lines of business. Net earned premiums increased 2% (4% in local currencies) to $932 million for 2012 from $912 million in 2011.
Sirius Group's gross combined ratio was lower than the net combined ratio by 6 points for 2012 and 7 points for 2011. The higher net combined ratio for 2012 was primarily due to the cost of property retrocessions with limited ceded property loss recoveries. The higher net combined ratio for 2011 was due to the Japan and New Zealand earthquake losses, very little of which were ceded under Sirius Group's retrocessional reinsurance coverage, in addition to the cost of the property retrocessions.
Sirius Group's gross written premiums increased 5% (2% in local currencies) to $1,128 million in 2011 from $1,079 million in 2010, while net written premiums increased 6% (3% in local currencies) to $916 million in 2011 from $866 million in 2010. These increases were primarily due to increases in the accident and health and trade credit lines of business and foreign exchange translation. Earned premiums increased 8% (5% in local currencies) to $912 million in 2011 from $848 million in 2010. In addition to the changes noted above for written premiums, earned premiums increased due to a change in business mix. Trade credit and accident and health premiums, which have a longer earnings recognition period than Sirius Group's other writings, have been an increasingly higher percentage of Sirius Group's total written premiums in recent years.
Sirius Group's other revenues consisted primarily of $6 million of foreign currency translation losses recorded in 2011 compared to $28 million of foreign currency translation gains in 2010. Additionally, Sirius Group acquired the loss reserve portfolio of Old Lyme and recorded a pre-tax gain of approximately $7 million in other revenues in 2011, which reflects the excess of the fair value of the net assets acquired over the consideration paid. In 2010, Sirius Group acquired Central National and recorded a pre-tax gain of approximately $13 million in other revenues.
Sirius Group's other underwriting expenses increased $6 million in 2011, primarily due to foreign exchange, higher professional fees mainly from systems initiatives, somewhat offset by lower incentive compensation costs.
Reinsurance protection. Sirius Group's net combined ratio for 2011 was higher than its gross combined ratio by 7 points and the net combined ratio was lower than the gross combined ratio by 6 points for 2010. The higher net combined ratio for 2011 was due to the Japan and New Zealand earthquake losses, very little of which were ceded under Sirius Group's retrocessional reinsurance coverage, in addition to the cost of the property retrocessions. The lower net combined ratio for 2010 was primarily due to significant retrocessional recoveries, including recovery of the full $65 million limit under Sirius Group's non-U.S./non-Japan earthquake cover triggered by losses from the Chile earthquake.
HG Global and BAM. The following table presents the components of pre-tax income included in White Mountains' 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 year ended December 31, 2012:
HG Global reported pre-tax income of $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. BAM reported $36 million in pre-tax losses in 2012 that were driven by $18 million of interest expense on the BAM Surplus Notes and startup and operational costs. Since BAM is a mutual insurance company owned by its members, BAM's results do not affect White Mountains' adjusted book value per share as they are attributed to non-controlling interests.
The following table presents amounts from HG Global, which includes HG Re and its other wholly-owned subsidiaries, and BAM that are contained within White Mountains’ consolidated balance sheet as of December 31, 2012:
(2) Under GAAP, interest accrues daily on the BAM Surplus Notes. Under Statutory accounting, interest is not accrued on the BAM
(1) On December 31, 2011, Tuckerman Fund I was dissolved and all of the net assets of the fund, which consisted of the LLC units of
Hamer and Bri-Mar, two small manufacturing companies, were distributed. As of October 1, 2012, Hamer and Bri-Mar are no longer
Share repurchases. White Mountains repurchased and retired 646,502 of its common shares for $253 million in 2011 at an average share price of $390, which was approximately 72% of White Mountains' December 31, 2011 adjusted book value per share.
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’ consolidated pre-tax investment results for the years ended December 31, 2012, 2011 and 2010 follows:
(2)Excludes non-investment related foreign currency (losses) gains of $(55.9), $26.5 and $(58.1).
Net investment income was down 17% to $154 million in 2012, due primarily to a lower invested asset base driven by share repurchases and lower fixed maturity yields.
WM Advisors has a sub-advisory agreement with Prospector, a registered investment adviser, under which Prospector manages most of White Mountains’ publicly-traded common equity securities and convertible fixed maturity securities. Total annualized returns for White Mountains’ equity portfolio managed by Prospector compared to the annualized total returns of the S&P 500 Index are as follows:
Investment Returns-Year Ended December 31, 2011 versus Year Ended December 31, 2010
White Mountains’ GAAP pre-tax total return on invested assets was 2.9% for 2011, which includes 0.2% of foreign currency losses, compared to 5.0% for 2010, which includes 0.5% of foreign currency gains. White Mountains’ fixed income portfolio returned 3.1% for 2011, lagging the Barclays U.S. Intermediate Aggregate Index return of 6.0%. White Mountains’ high-quality, short-duration fixed income portfolio trailed the longer-duration benchmark as rates declined during 2011. White Mountains’ equity portfolio, approximately 14% of GAAP invested assets at December 31, 2011, returned 1.4% for 2011, compared to the S&P 500 Index return of 2.1%, while the equity portfolio returned 12.6% in 2010, compared to the S&P 500 Index return of 15.1%. White Mountains’ equity portfolio included convertible fixed maturity investments whose returns were hurt by rising credit spreads on the fixed maturity component of the instruments.
Total foreign currency translation (losses) gains recognized through other comprehensive income
At December 31, 2012, White Mountains’ investment portfolio included approximately $1.2 billion in non-U.S. dollar-denominated investments, most of which are held at Sirius International and denominated in Swedish kronor or euros. The value of the investments in this portfolio is impacted by changes in the exchange rate between the U.S. dollar and the kronor and between the U.S. dollar and the euro. During 2012, the U.S. dollar weakened 6% against the kronor and 2% against the euro. These currency movements resulted in approximately $38 million of pre-tax foreign currency investment gains for the year ended December 31, 2012, which are recorded as components of net realized and unrealized investment gains and unrealized foreign currency gains and losses on investments. During 2011, the U.S. dollar strengthened 3% against the kronor and 3% against the euro, which resulted in $21 million of pre-tax foreign currency losses for the year. During 2010, the U.S. dollar weakened 6% against the kronor and strengthened 7% against the euro, which resulted in $32 million of pre-tax foreign currency gains for the year.
The following table presents the composition of White Mountains’ investment portfolio as of December 31, 2012 and 2011:
White Mountains’ investment portfolio consists of debt and equity securities issued in over 30 countries worldwide. The United States represents the country of issue for 76% of White Mountains’ fixed maturity, common equity and convertible fixed maturity investment portfolio. White Mountains has minimal sovereign risk exposure to European peripheral countries such as Ireland, Greece, Portugal, Spain and Italy (“peripheral countries”). White Mountains’ portfolio includes 0.6% of total fixed maturity, convertible fixed maturity and common equity investments issued from these peripheral countries at December 31, 2012. However, White Mountains may have indirect exposure to peripheral countries through securities issued from non-peripheral countries as the issuers of those securities could have exposure to peripheral countries.
Generally, OneBeacon's top tier regulated insurance operating subsidiaries have the ability to pay dividends during any 12-month period without the prior approval of regulatory authorities in an amount set by formula based on the greater of prior year statutory net income or 10% of prior year end statutory surplus, subject to the availability of unassigned funds. OneBeacon Insurance Company (“OBIC”), OneBeacon's primary top tier regulated insurance operating subsidiary, has the ability to pay $330 million of dividends during 2013 (based on its 2012 statutory net income of $330 million) without prior approval of regulatory authorities, subject to the availability of unassigned funds. The amount of dividends available to be paid by OBIC in any given year is also subject to cash flow and earnings generated by OBIC's business, which now just comprises the Runoff Business, as well as to dividends received from its subsidiaries, including Atlantic Specialty Insurance Company (“ASIC”). At December 31, 2012, OBIC had $0.7 billion of unassigned funds and $0.9 billion of statutory surplus.
As disclosed in Note 2 - “Significant Transactions” of the accompanying consolidated financial statements, during the fourth quarter of 2012, OneBeacon executed various intercompany reinsurance agreements which, along with other internal capital transactions among our insurance operating subsidiaries, resulted in ASIC becoming the lead insurance company for the ongoing specialty business and OBIC becoming the lead insurance company for the Runoff Business. Notwithstanding these restructuring transactions, OneBeacon continues to manage its statutory capital on a combined basis. Although OBIC remains a top tier regulated insurance operating subsidiary and maintains sufficient statutory capital to support the Runoff Business, the majority of the group's statutory capital is now included in ASIC to support the ongoing specialty business.
ASIC has the ability to pay dividends 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. Given the changes in structure noted above, ASIC will likely require prior approval by regulatory authorities in order to pay dividends until it builds up a historical net investment income stream and earned surplus balance under its new structure. At December 31, 2012, ASIC had negative earned surplus and $0.7 billion of statutory surplus.
During 2012, OneBeacon's unregulated insurance operating subsidiaries paid $5 million of dividends to their immediate parent. At December 31, 2012, OneBeacon's unregulated insurance operating subsidiaries had $29 million of net unrestricted cash, short-term investments and fixed maturity investments.
Subject to certain limitations under Swedish law, Sirius International is permitted to transfer a portion of its pre-tax income to its Swedish parent companies to minimize taxes (referred to as a group contribution). In 2012, Sirius International transferred $82 million of its 2011 pre-tax income to its Swedish parent companies as a group contribution. In 2013, Sirius International currently intends to transfer approximately $110 million (based on the December 31, 2012 SEK to USD exchange rate) of its 2012 pre-tax income to its Swedish parent companies as a group contribution.
Sirius International has the ability to pay dividends subject to the availability of unrestricted statutory surplus. Historically, Sirius International has allocated the majority of its pre-tax income, after group contributions to its Swedish parent companies, to the Safety Reserve (see “Safety Reserve” below). At December 31, 2012, Sirius International had $852 million (based on the December 31, 2012 SEK to USD exchange rate) of unrestricted statutory surplus, which is available for distribution in 2013. 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. During 2012, Sirius International distributed $24 million of dividends to its immediate parent and declared an additional $75 million of dividends at December 31, 2012 (for a total of $99 million). The $75 million was paid in January 2013. In 2013, Sirius International currently intends to distribute an additional $50 million of dividends to its immediate parent.
During 2012, Sirius Group distributed $40 million to its immediate parent and declared an additional $75 million at December 31, 2012 (for a total of $115 million). The $75 million was paid in January 2013.
At December 31, 2012, Sirius Group and its intermediate holding companies had $72 million of net unrestricted cash, short-term investments and fixed maturity investments and $18 million of other long-term investments outside of its regulated and unregulated insurance and reinsurance operating subsidiaries.
During the fourth quarter of 2011, White Mountains completed a rebranding and reorganization (the “Reorganization”) of its reinsurance business. As part of the Reorganization, White Mountains' reinsurance businesses adopted the Sirius name globally and Sirius America (formerly WMRe America) became a wholly owned subsidiary of Sirius International (formerly WMRe Sirius). In connection with the Reorganization, A.M. Best upgraded the financial strength rating of Sirius America from “A-” (Excellent, the fourth highest of sixteen ratings) to a group “A” (Excellent, the third highest of sixteen ratings), consistent with Sirius International's rating, and all financial strength ratings from the four major ratings agencies were affirmed with stable outlook. Additionally, A.M. Best upgraded the creditworthiness ratings from “bbb-” (Adequate, the tenth highest of twenty-two ratings) on the SIG Senior Notes to “bbb” (Adequate, the ninth highest of twenty-two ratings) and from “bb” (Speculative, the twelfth highest of twenty-two ratings) on the SIG Preference Shares to “bb+” (Speculative, the eleventh highest of twenty-two ratings). S&P upgraded the creditworthiness ratings from “BBB-” (Adequate, the tenth highest of twenty-two ratings) on the SIG Senior Notes to “BBB” (Adequate, the ninth highest of twenty-two ratings) and from “BB” (Speculative, the twelfth highest of twenty-two ratings) on the SIG Preference Shares to “BB+” (Speculative, the eleventh highest of twenty-two ratings).
· Sirius International paid $169 million to an intermediate holding company of Sirius Group for a portion of Sirius America.
· White Mountains contributed a portion of its common share investment in Symetra to an intermediate holding company of Sirius Group. At December 31, 2011, White Mountains' entire common share investment in Symetra, which had a carrying value of $261 million, was held by Sirius Group.
Subject to certain limitations under Swedish law, Sirius International is permitted to transfer pre-tax income amounts into an untaxed reserve referred to as a safety reserve. At December 31, 2012, Sirius International's safety reserve amounted to SEK 9.6 billion, or $1.5 billion (based on the December 31, 2012 SEK to USD exchange rate). Under GAAP, an amount equal to the safety reserve, net of a related deferred tax liability established at the Swedish tax rate, is classified as shareholder’s equity. The tax rate in effect on December 31, 2011 was 26.3%. The tax rate utilized on December 31, 2012 was the new Swedish tax rate of 22.0%. Generally, this deferred tax liability is only required to be paid by Sirius International if it fails to maintain prescribed levels of premium writings and loss reserves in future years. As a result of the indefinite deferral of these taxes, Swedish regulatory authorities do not apply any taxes to the safety reserve when calculating solvency capital under Swedish insurance regulations. Accordingly, under local statutory requirements, an amount equal to the deferred tax liability on Sirius International's safety reserve ($327 million at December 31, 2012) is included in solvency capital. Access to the safety reserve is restricted to coverage of reinsurance losses. Access for any other purpose requires the approval of Swedish regulatory authorities. Similar to the approach taken by Swedish regulatory authorities, most major rating agencies generally include the $1.5 billion balance of the safety reserve, without any provision for deferred taxes, in Sirius International's capital when assessing Sirius International's financial strength.
HG Global has $613 million face value of preferred shares outstanding, of which White Mountains owns 97.3%. Holders of the HG Global preferred shares receive cumulative dividends at a fixed annual rate of 6.0% on a quarterly basis, when and if declared by HG Global. HG Global did not declare or pay any preferred dividends in 2012. As of December 31, 2012, HG Global has accrued $16.8 million of dividends payable to holders of its preferred shares, $16.3 million of which is payable to White Mountains and eliminated in consolidation.
HG Re is a Special Purpose Insurer subject to regulation and supervision by the BMA, but does not require regulatory approval to pay dividends. However, HG Re’s dividend capacity is limited by amounts held in the collateral trusts pursuant to the FLRT with BAM. As of December 31, 2012, HG Re had statutory capital of $412 million, of which $12 million (which partially relates to accrued interest on the BAM Surplus Notes held by HG Re) was available for dividends to HG Global and $400 million was held as collateral in the Supplemental Trust pursuant to the FLRT with BAM.
Interest on the BAM Surplus Notes is payable quarterly at a fixed annual rate of 8.0%. Interest and principal payments are subject to approval of the New York State Department of Financial Services. BAM did not pay any interest on the BAM Surplus Notes in 2012. As of December 31, 2012, HG Global has accrued $18.4 million of interest receivable on the BAM Surplus Notes.
During 2012, WM Advisors did not pay any dividends to its immediate parent. At December 31, 2012, WM Advisors had approximately $18 million of net unrestricted cash and short-term investments.
At December 31, 2012, the Company and its intermediate holding companies had $132 million of net unrestricted cash, short-term investments and fixed maturity investments, $540 million of common equity securities and $78 million of other long-term investments included in its Other Operations segment. During 2012, White Mountains paid a $7 million common share dividend.
Insurance float is an important aspect of White Mountains’ 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 is considered to be the cost of insurance float. One manner in which White Mountains calculates its insurance float is by taking its net investment assets and subtracting its total adjusted capital. 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.
The following table illustrates White Mountains’ consolidated insurance float position as of December 31, 2012 and 2011:
Equity in net unrealized (gains) losses from Symetra’s fixed maturity portfolio
Cash and investments posted as collateral by WM Life Re (2)
(2) Consists of cash, fixed maturity and short-term investments held by WM Life Re and posted as collateral to its variable annuity reinsurance counterparties.
During 2012, insurance float decreased by $480 million, primarily due to the AutoOne Sale and the continued runoff of reserves at OneBeacon and Sirius America, the final settlement and commutation of Scandinavian Re’s multi-year retrocessional Casualty Aggregate Stop Loss Agreement with St. Paul, as well as commutations and runoff of Sirius Group's casualty business and payments of losses incurred in 2010 and 2011 related to major catastrophes, primarily from earthquakes in Chile, Japan and New Zealand. These catastrophe losses increased White Mountains’ insurance float when they were first recorded, which is now reversing and decreasing insurance float as the catastrophe losses are paid. These decreases in insurance float were partially offset by an increase in float resulting from the $101 million in after tax losses recognized at OneBeacon related to the Runoff Transaction and $113 million of after tax catastrophe losses recognized by White Mountains in 2012, primarily due to hurricane Sandy. Based on December 31, 2012 balances, the closing of the Runoff Transaction is expected to decrease insurance float by approximately $340 million.
The following table summarizes White Mountains’ capital structure at December 31, 2012 and 2011:
Total debt to total adjusted capital and the deferred tax liability on the safety reserve at Sirius International (2)
Total debt and Preference Shares to total adjusted capital and the deferred tax liability on the safety reserve at Sirius International (2)
Includes the regulatory capital represented by the deferred tax liability on the safety reserve at Sirius International (See “Safety
It is possible that, in the future, one or more of the rating agencies may lower White Mountains’ existing ratings. If one or more of its ratings were lowered, White Mountains could incur higher borrowing costs on future borrowings and its ability to access the capital markets could be impacted. In addition, White Mountains’ insurance and reinsurance operating subsidiaries could be adversely impacted by a lowering of their financial strength ratings, including a possible reduction in demand for their products in certain markets.
In November 2012, OBH issued $275 million face value of senior unsecured debt through a public offering, at an issue price of 99.9%. The net proceeds from the issuance of the 2012 OBH Senior Notes were used to repurchase the remaining 2003 OBH Senior Notes. The 2012 OBH Senior Notes, which are fully and unconditionally guaranteed as to the payment of principal and interest by OneBeacon Ltd., bear an annual interest rate of 4.60%, payable semi-annually in arrears on May 9 and November 9, until maturity on November 9, 2022.
The 2012 OBH Senior Notes and the SIG Senior Notes were issued under indentures 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 indentures do not contain any financial ratios or specified levels of net worth or liquidity to which OneBeacon, Ltd., OBH or SIG must adhere. At December 31, 2012, OneBeacon, Ltd., OBH and SIG were in compliance with all of the covenants under the 2012 OBH Senior Notes and the SIG Senior Notes, and anticipates it will continue to remain in compliance with these covenants for the foreseeable future.
Below is a schedule of White Mountains’ material contractual obligations and commitments as of December 31, 2012:
Represents expected future cash outflows resulting from loss and LAE payments. The amounts presented are gross of reinsurance
recoverables on unpaid losses of $429 and include the discount on OneBeacon’s workers compensation loss and LAE reserves of $5 as of
The balances included in the table above regarding White Mountains’ long-term incentive compensation plans include amounts payable for performance shares and units, as well as deferred compensation balances. Exact amounts to be paid for performance shares cannot be predicted with certainty, as the ultimate amounts of these liabilities are based on the future performance of White Mountains and in some cases the market price of the Company’s and OneBeacon Ltd.’s common shares at the time the payments are made.
There are no provisions within White Mountains’ 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.
Through Sirius International, White Mountains has a long-term investment as a stockholder in LUC Holdings, an entity that has entered into a lease to rent the London Underwriting Center (“LUC”) through 2016. LUC Holdings in turn subleases space in the LUC. In the LUC Holdings stockholders agreement, the stockholders have guaranteed any shortfall between the lease and the sub-leases on a joint and several basis. As a consequence, in recent years the stockholders have funded an operating shortfall of LUC. At December 31, 2012, White Mountains has recorded a liability of $4 million for its share of the expected future shortfall between LUC Holdings’ head lease payments and sub-lease receipts. White Mountains does not believe that future shortfalls, if any, will have a material impact on its results of operations.
White Mountains also has future binding commitments to fund certain other long-term investments. These commitments, which total approximately $125 million, do not have fixed funding dates and are therefore excluded from the table above.
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, 2012, the total guarantee value was approximately ¥230 billion (approximately $2.7 billion) and the related account values were approximately 87% of this amount.
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. At December 31, 2012, the fair value of these derivative instruments was $98 million. In addition, WM Life Re held approximately $394 million of cash and fixed maturity investments at December 31, 2012 posted as collateral to its reinsurance counterparties.
During 2012, White Mountains repurchased a total of 1,329,640 of its common shares for $669 million at an average share price of $503, which was 86% of White Mountains' adjusted book value per share of $588 at 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 to satisfy employee income tax withholdings, pursuant to employee benefit plans. Shares repurchased pursuant to employee benefit plans do not fall under the board authorization referred to above.
Net cash flows (used for) provided from continuing operations was $(30) million, $94 million and $29 million in 2012, 2011 and 2010, respectively. Cash flows from continuing operations decreased $124 million from 2011 to 2012 due to declining net investment income, primarily due to a decrease in the overall average invested asset base, the final settlement and commutation of Scandinavian Re’s multi-year retrocessional Casualty Aggregate Stop Loss Agreement with St. Paul, as well as commutations and runoff of Sirius Group's casualty business and payments of losses incurred in 2010 and 2011 related to major catastrophes, primarily from earthquakes in Chile, Japan and New Zealand. Net cash flows (used for) provided from discontinued operations was $(196) million, $(209) million and $27 million in 2012, 2011 and 2010, respectively. The cash outflows from discontinued operations in 2012 and 2011 were primarily due to the runoff of reserves related to non-specialty commercial lines businesses that OneBeacon has exited since 2010.
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 the first quarter of 2012, the Company declared and paid a $7 million cash dividend to its common shareholders and paid $2 million of interest on the WTM Credit Facility.
In December 2012, White Mountains borrowed $150 million under the WTM Bank Facility. White Mountains repaid $75 million of this advance in December 2012 and the remaining $75 million was repaid in January 2013.
During 2012, Sirius Group declared $115 million and paid $40 million of capital distributions to its immediate parent. In January 2013, Sirius Group paid the remaining $75 million capital distribution to its immediate parent.
During 2012, White Mountains contributed $25 million to WM Life Re.
During 2011, the Company repurchased and retired 646,502 of its common shares for $253 million.
During 2011, OneBeacon paid a total of $20 million of interest on the 2003 OBH Senior Notes.
During 2011, Sirius Group declared and paid $594 million of capital distributions to its immediate parent, which included $300 million received in connection with the Reorganization.
During 2010, the Company repurchased and retired 687,871 of its common shares for $226 million.
During 2010, Sirius Group paid Sierra $43 million on the Sierra Note, which consisted of $33 million for the principal repayment and $10 million for accrued interest. In accordance with an indemnification agreement, Berkshire reimbursed White Mountains $37 million related to the Sierra Note payments.
During the first quarter of 2010, Sirius Group acquired Central National for $5 million in cash.
During 2010, OneBeacon received $10 million of additional consideration from the the sale of the renewal rights to its non-specialty commercial lines business.
See Note 18-“Transactions with Related Persons” in the accompanying Consolidated Financial Statements.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Certain of these estimates are considered critical in that they involve a higher degree of judgment and are subject to a significant degree of variability. On an ongoing basis, management evaluates its estimates, including those related to fair value measurements of investments and other financial instruments, valuation of liabilities associated with an assumed reinsurance agreement covering benefit guarantees on variable annuities in Japan, its property-casualty loss and LAE reserves and its property-casualty reinsurance contracts. Management bases it estimates on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.
Expected loss ratio methods: These methods are based on the assumption that ultimate losses vary proportionately with premiums. Expected loss ratios are typically developed based upon the information used in pricing, and are multiplied by the total amount of premiums written to calculate ultimate losses. Expected loss ratio methods are useful for estimating ultimate losses in the early years of long-tailed lines of business, when little or no paid or reported loss information is available.
In its selection of recorded reserves, OneBeacon historically gave greater weight to adjusted paid loss development methods, which are not dependent on the consistency of case reserving practices, over methods that rely on reported losses. In recent years, the amount of weight given to methods based on reported losses has increased with OneBeacon’s confidence that its case reserving practices have been more consistently applied.
Upon completion of each quarterly review, OneBeacon’s actuaries select indicated reserve levels based on the results of the actuarial methods described previously, which are the primary consideration in determining management’s best estimate of required reserves. However, in making its best estimate, management also considers other qualitative factors that may lead to a difference between held reserves and actuarially recommended levels in the future. Typically, these factors exist when management and OneBeacon’s actuaries conclude that there is insufficient historical reported and paid loss information or that trends included in the historical reported and paid loss information are unlikely to repeat in the future. Such factors include, among others, recent entry into new markets or new products, improvements in the claims department that are expected to lessen future ultimate loss costs and legal and regulatory developments. At December 31, 2012 and 2011, total carried reserves, including reserves that are presented as liabilities held for sale in the December 31, 2012 balance sheet related to the Runoff Business, were 6% and 10%, respectively, above the actuarial point estimate.
(1) Amounts included in Runoff Business as of December 31, 2012 consist of case and IBNR reserves that have been reclassified to liabilities held for
For loss and allocated LAE reserves, excluding A&E, the key assumption as of December 31, 2012 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 inflation, in making its reserve selections.
During 2010, management began separately reviewing loss reserves for some business which had been previously managed as a part of OneBeacon’s former commercial lines underwriting unit. As of December 31, 2010, the reserves for these businesses had been selected based on expected emergence that was based on the historic loss development of former commercial lines underwriting unit. However, during 2011 the actual emerged experience for these businesses was significantly lower than the expected emergence. As a result of this favorable emergence, management lowered the loss reserves for these businesses by $14 million during 2011.
Specifically, at December 31, 2009, management had revised its expectations downward with respect to future loss emergence in the professional liability business, which had initially been based on market analysis when this business was initiated in 2002 and 2003. However, during 2010, losses continued to be significantly lower than these revised expectations. As a result, management lowered its selected reserves on the earliest years which affected more recent years as total loss expectations for those years are based in part on prior years’ results. The impact of this revised estimate was a decrease to professional liability reserves of $19 million.
At December 31, 2009, management had recorded $8 million of reserves for certain claims related to catastrophes from accident years 2004 and 2005 related to OneBeacon’s excess property business. During 2010, these claims were resolved for amounts below OneBeacon’s policy coverage therefore the reserves were no longer necessary. In addition to the development described for the lines of business above, management also recorded a $9 million net decrease in IBNR in other lines of business, primarily personal lines, as a result of its review of loss reserves at December 31, 2010.
The percentages shown in the following table represent the linear interpolation of where OneBeacon’s recorded loss and LAE reserves, net of reinsurance recoverable on unpaid losses, are within the range of reserve estimates at December 31, 2012 and 2011, where the low end of the range equals zero, the middle of the range equals 50% and the high end of the range equals 100%. The middle of the range (50%) does not necessarily represent the actuarial indication within the range of possible outcomes, provided above. During 2012, OneBeacon modeled the range of reserves for its Ongoing Business at a more refined line of business level than it had previously used; the prior period has been restated to reflect the more refined range.
The percentages shown in the following table represent the linear interpolation of where OneBeacon’s recorded loss and LAE reserves on its Ongoing Business, net of reinsurance recoverable on unpaid losses, are within the range of reserves estimates by line of business at December 31, 2012 and 2011. Similar to the preceding table, the low end of the range equals zero, the middle of the range equals 50% and the high end of the range equals 100%.
It is important to note that the variations discussed are not meant to be a worst-case scenario, and therefore, it is possible that future variations may be more than amounts discussed below.
Workers compensation: Recorded loss and LAE reserves, net of reinsurance recoverable, for Ongoing and Runoff Business workers compensation were $254 million at December 31, 2012. The two most important assumptions for workers compensation reserves are loss development factors and loss cost trends, particularly medical cost inflation. Loss development patterns are dependent on medical cost inflation. Approximately half of the workers compensation net reserves are related to future medical costs. Across the entire reserve base, a 0.5 point change in calendar year medical inflation would have changed the estimated net reserve by approximately $46 million at December 31, 2012, in either direction.
Professional liability: Recorded loss and LAE reserves, net of reinsurance recoverable, for professional liability were $410 million across all lines at December 31, 2012. A key assumption for professional liability is the implicit loss cost trend, particularly the severity inflation trend component of loss costs. Across the entire reserve base, a 5.0 point change in assumed annual severity would have changed the estimated net reserve by approximately $68 million at December 31, 2012, in either direction.
OneBeacon’s liabilities for A&E losses from business underwritten in the recent past are substantially limited by the application of exclusionary clauses in the policy language that eliminated coverage for such claims. After 1987 for pollution and 1992 for asbestos, most liability policies contained industry- standard absolute exclusions of such claims. In earlier years, various exclusions were also applied, but the wording of those exclusions was less strict and subsequent court rulings have reduced their effectiveness.
Historically, most asbestos claims have been asserted as product liability claims. Recently, insureds who have exhausted the available products liability limits of their insurance policies have sought from insurers such as OneBeacon payment for asbestos claims under the premises and operations coverage of their liability policies, which may not be subject to similar aggregate limits. OneBeacon expects this trend to continue. However, to date there have been fewer of these premises and operations coverage claims than product liability coverage claims. This may be due to a variety of factors, including that it may be more difficult for underlying plaintiffs to establish losses as stemming from premises and operations exposures, which requires proof of the defendant’s negligence, rather than products liability under which strict legal liability applies. Premises and operations claims may vary significantly and policyholders may seek large amounts, although such claims frequently settle for a fraction of the initial alleged amount. Accordingly, there is a great deal of variation in damages awarded for the actual injuries. As of December 31, 2012, there were approximately 379 active claims by insureds against OneBeacon without product liability coverage asserting operations or premises coverage, which may not be subject to aggregate limits under the policies.
During 2011, OneBeacon completed a study of its legacy A&E exposures. Reasonable estimates of potential adverse scenarios continue to be within the $2.5 billion reinsurance cover issued by NICO. Based on the results of the study, OneBeacon increased the point estimate of incurred losses ceded to NICO from $2.2 billion to $2.3 billion, an increase of $122 million for asbestos, environmental and other mass tort exposures, net of underlying reinsurance. Due to the NICO Cover, there was no impact to income or equity from the change in the estimate.
As part of its previously described actuarial review process, OneBeacon reviews A&E activity each quarter and compares that activity to what was assumed in the most recently completed study. As of December 31, 2012, OneBeacon noted no change in the range of reasonable outcomes around its best estimate described above.
OneBeacon’s reserves for A&E losses, net of Third-Party Recoverables but prior to NICO recoveries, were $0.7 billion at December 31, 2012. An industry benchmark of reserve adequacy is the “survival ratio”, computed as a company’s reserves divided by its historical average yearly loss payments. This ratio indicates approximately how many more years of payments the reserves can support, assuming future yearly payments are equal to historical levels. OneBeacon’s survival ratio was 10.4 years at December 31, 2012. This was computed as the ratio of A&E reserves, net of Third-Party Recoverables prior to the NICO Cover of $0.7 billion plus the remaining unused portion of the NICO Cover of $198 million, to the average A&E loss payments over the three-year period ended December 31, 2012, net of Third-Party Recoverables. OneBeacon’s survival ratio was 13.3 years at December 31, 2011. OneBeacon believes that as a result of the NICO Cover and its historical third-party reinsurance programs, OneBeacon should not experience material financial loss from A&E exposures under current coverage interpretations and that its survival ratio compares favorably to industry survival ratios. However, the survival ratio is a simplistic measure estimating the number of years it would be before the current ending loss reserves for these claims would be paid using recent annual average payments subject to adjustments for unusual items. Many factors, such as aggressive settlement procedures, mix of business and coverage provided, have a significant effect on the amount of A&E reserves and payments and the resultant survival ratio. Thus, caution should be exercised in attempting to determine reserve adequacy for these claims based simply on this survival ratio.
OneBeacon’s reserves for A&E losses at December 31, 2012 represent management’s best estimate of its ultimate liability based on information currently available. However, significant uncertainties, including but not limited to case law developments, medical and clean-up cost increases and industry settlement practices, limit management’s ability to accurately estimate ultimate liability and OneBeacon may be subject to A&E losses beyond currently estimated amounts. In addition, OneBeacon remains liable for risks reinsured in the event that a reinsurer does not honor its obligations under reinsurance contracts. See Note 3-“Reserves for Unpaid Loss and LAE-Asbestos and environmental loss and LAE reserve activity” of the accompanying historical consolidated financial statements for more information regarding its A&E reserves.
Sirius Group’s net loss and LAE reserves by class of business at December 31, 2012 and 2011 were as follows:
Sirius Group’s A&E exposures are principally the result of runoff of businesses acquired in the 1990s.
In 2012, Sirius Group had net favorable loss reserve development of $34 million. The major reductions in loss reserve estimates were recognized in casualty runoff ($32 million), property ($28 million), marine/energy ($12 million), trade credit ($7 million) and aviation/space ($5 million) lines, partially offset by a $46 million increase in asbestos loss reserves and a $4 million increase in accident and health. In 2011, Sirius Group had net favorable loss reserve development of $47 million, primarily attributable to $41 million of favorable development on property lines, including $13 million of loss reserve reductions for the 2010 Chile earthquake, partially offset by asbestos and environmental increases of $12 million. In 2010, Sirius Group had net favorable loss reserve development of $57 million, primarily related to short-tailed lines, such as property, accident and health, and marine, from recent underwriting years. Included in the $57 million favorable loss reserve development was the recognition of $16 million in deferred gains from a retrocessional reinsurance contract that incepted in 2000 and was fully collected in 2010.
The actuarial analysis is a primary consideration for management in determining its best estimate of loss and LAE reserves. In making its best estimate, management also considers other qualitative factors that may lead to a difference between its best estimate of loss and LAE reserves and the actuarial point estimate. Typically, these factors exist when management and the company’s actuaries conclude that there is insufficient historical incurred and paid loss information or that trends included in the historical incurred and paid loss information are unlikely to repeat in the future. These factors may include, among others, changes in the techniques used to assess underwriting risk, more accurate and detailed levels of data submitted with reinsurance applications, the uncertainty of the current reinsurance pricing environment, the level of inflation in loss costs, changes in ceding company reserving practices, and legal and regulatory developments. At December 31, 2012 and 2011, total carried net reserves were 2.4% and 2.7% above the actuarial point estimate, respectively.
Net incurred loss activity for asbestos and environmental in the last two years was as follows:
Sirius Group’s A&E claim activity for the last two years is illustrated in the table below.
The following table summarizes White Mountains’ fair value measurements and the percentage of Level 3 investments at December 31, 2012:
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 maturities at December 31, 2012 comprise securities for which the estimated fair value has not been determined based upon quoted market price inputs for identical or similar securities.
At December 31, 2011, ten fixed maturity securities which had been classified as Level 3 measurements at January 1, 2011 were recategorized as Level 2 measurements because quoted market prices for similar securities that were considered reliable and could be validated against an alternative source were available at December 31, 2011. These measurements comprise “Transfers out” of Level 3 and “Transfers in” to Level 2 of $269.2 million for the period ended December 31, 2011. One security that was classified as a Level 2 investment at January 1, 2011 was priced with unobservable inputs and represents “Transfers in” of $18.2 million in Level 3 investments. The fair value of this security was estimated using industry standard pricing models, in which management selected inputs using its best judgment. The pricing models used by White Mountains use the same valuation methodology for all Level 3 measurements for fixed maturities. The security is considered to be Level 3 because the measurements are not directly observable. At December 31, 2011, the estimated fair value for this security determined using the industry standard pricing models was $1.6 million less than the estimated fair value based upon quoted prices provided by a third party pricing vendor.
The following table summarizes the amount of total gains (losses) included in earnings attributable to unrealized investment gains (losses) for Level 3 investments for years ended December 31, 2012, 2011, and 2010:
Other long-term investments accounted for at fair value at December 31, 2012 consist of $115 million in hedge funds and $125 million in private equity funds. At December 31, 2012, White Mountains held investments in 16 hedge funds and 38 private equity funds. The largest investment in a single fund was $16.0 million and $27.4 million at December 31, 2012 and 2011.
In circumstances where the underlying investments are publicly traded, such as the investments made by hedge funds, the fund manager uses current market prices to determine fair value. In circumstances where the underlying investments are not publicly traded, such as the investments made by private equity funds, the private equity fund managers generally consider the need for a liquidity discount on each of the underlying investments when determining the fund’s net asset value. In circumstances where White Mountains’ portion of a fund’s net asset value is deemed to differ from fair value due to illiquidity or other factors associated with White Mountains’ investment in the fund, the net asset value is adjusted accordingly. At December 31, 2012, there were no circumstances where illiquidity or other factors required an adjustment to the net asset value related to any of its investments in hedge funds or private equity funds.
Generally, the liabilities associated with these guarantees increase with declines in the equity markets, interest rates and currencies against the Japanese yen, as well as with increases in market volatilities. In 2008, particularly in the fourth quarter, as a result of worldwide declines in equity markets, interest rates and the strengthening of the Japanese yen, the underlying investment accounts declined substantially and have stayed low. The collective account values were approximately 87% and 78% of the guarantee value at December 31, 2012 and December 31, 2011. The liability is also affected by annuitant related behavioral and actuarial assumptions, including surrender and mortality rates. WM Life Re lowered its projected surrender rates in 2011 and 2010 to reflect the behavior observed during the turbulent markets experienced throughout those years.
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 WGBI or JPM European GBI during that month plus a fixed amount.
WM Life Re hedges the remaining 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.
During 2009, WM Life Re entered into long term Japanese interest rate swaps, largely replacing its use of short term Japanese Government Bond (“JGB”) futures to hedge its discount rate exposure. By doing so, WM Life Re better matched the term structure of its discount rate exposure, substantially reduced its exposure to changes in Japanese interest rate swap spreads and significantly reduced the potential costs associated with rolling JGB futures contracts during times of relative market illiquidity. During December 2012, after the relevant Japanese interest rate swap rates fell to their lowest level in many years, the resulting potential benefit, net of cost, to WM Life Re of maintaining its Japanese interest rate swap hedge portfolio was deemed to be limited. Therefore, the decision was made to unwind or offset these Japanese interest rate swaps. During December 2012, approximately 24% of the notional amount of Japanese interest rate swap contracts was unwound and during January 2013 the remaining 76% was unwound or offset. As of December 31, 2012 and 2011, the notional amount of Japanese interest rate swaps was ¥153 billion ($1.8 billion) and ¥183 billion ($2.4 billion), respectively.
The table below summarizes as of December 31, 2012 and 2011, the estimated financial impact of simultaneous market events, as well as December 31, 2012 on a proforma basis, adjusted for the unwinding or offsetting of the remaining Japanese interest rate swaps during January 2013. 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, 2012 and 93% and 107%, respectively, as of December 31, 2011. Hedge effectiveness as of December 31, 2012 has been adjusted for 24% reduction in Japan interest rate swap coverage due to the unwinding of Japanese interest rate swaps at the end of December. Proforma hedge effectiveness as of December 31, 2012 has been adjusted for the unwinding or offsetting of the remaining Japanese interest rate swaps during January 2013. Some Japanese interest rate swap coverage remains primarily through WM Life Re's put option portfolio.
WM Life Re projects future surrender rates by year for policies based on a combination of actual experience and expected policyholder behavior. Actual policyholder behavior, either individually or collectively, may differ from projected behavior as a result of a number of factors such as the level of the account value versus guarantee value and applicable surrender charge, views of the primary insurance company's financial strength and ability to pay the guarantee at maturity, annuitants' need for money in a prolonged recession and time remaining to receive the guarantee at maturity. Policyholder behavior is especially difficult to predict given that WM Life Re's reinsurance contracts are relatively new and the recent financial turmoil is unprecedented for this type of product in the Japanese market. Actual policyholder behavior may differ materially from WM Life Re's projections.
During the third quarter of 2010, WM Life Re lowered the surrender assumptions that it uses to calculate its variable annuity guarantee liability. WM Life Re’s previous assumptions reflected its expectation that surrenders would rise as the surrender charges in the underlying annuities decline. However, the persistent instability in financial and foreign exchange markets has kept surrenders low. The lower surrender assumptions resulted in a $48 million increase in WM Life Re’s variable annuity guarantee liability, but reduced its exposure to adverse changes in surrender rates in the future. During the fourth quarter of 2011, WM Life Re lowered the surrender assumptions again to reflect the somewhat lower surrenders that emerged versus expected in the policy cohort that rolled into policy year seven, resulting in a $7.2 million increase in the variable annuity guaranty liability. No surrender assumption adjustments were required during 2012.
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 $2.2 million as of December 31, 2012.
There is a time lag from the point when premium and related commission and expense activity is recorded by a ceding company to the point when such information is reported by the ceding company to Sirius Group. This time lag can vary from one to several contractual reporting periods (i.e. quarterly/monthly). This lag is common in the reinsurance business, but slightly longer when a reinsurance intermediary is involved.
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 all of its estimated balances are collectible, and as such no allowance has been recorded.
White Mountains accounts for its investment in Symetra common shares using the equity method of accounting. Under the equity method, the GAAP carrying value of White Mountains’ investment in Symetra common shares is normally equal to the percentage of Symetra’s GAAP book value represented by White Mountains’ common share ownership, which was 15% at December 31, 2012 and 2011. Under GAAP, a decline in the fair value of an investment is considered to be other-than-temporary when the fair value of the investment is not expected to recover to its GAAP carrying value in the near term. Declines in the fair value of an investment that are considered to be other-than-temporary are recognized as a write-down to the GAAP carrying value of the investment. Having observed the divergence between the quoted market price for Symetra’s common shares and its GAAP carrying value, management evaluated White Mountains’ investment in Symetra common shares to determine whether an other-than-temporary impairment under GAAP existed at December 31, 2011. As a result of this evaluation, management concluded that White Mountains’ investment in Symetra common shares was other-than-temporarily impaired and wrote down the GAAP book value of the investment to its estimated fair value of $261 million at December 31, 2011, or approximately $15 per Symetra common share.
When determining the value of life insurance holding companies that are acquisition targets, market participants commonly utilize an approach that values the company as the sum of (A) adjusted statutory net worth of any regulated life insurance companies (i.e. statutory surplus plus asset valuation reserve) plus the GAAP net assets of any non-life businesses, less holding company debt and (B) the present value of future earnings related to business in force as of the valuation date plus the present value of future earnings related to business written after the valuation date. White Mountains used this approach when it acquired its initial investment in Symetra in 2004. Part A of the calculation can be performed using observable inputs from the statutory and GAAP financial statements. Part B of the calculation requires a large number of actuarial calculations including assumptions such as discount rates, mortality, persistency and future investment results that, while based on historical data and are supportable, are nonetheless judgmental and largely unobservable. For Symetra, part A is approximately $15 per share as of December 31, 2011. Symetra management provided White Mountains with an actuarial appraisal that demonstrates that part B would be a meaningful positive value in most reasonable scenarios. When determining the GAAP fair value of White Mountains’ investment in Symetra common shares at December 31, 2011, management ascribed the greatest weight to part A, as it is observable and less subjective.
An other-than-temporary impairment for GAAP does not equate to a permanent impairment in value. The reasons why management concluded that an other-than-temporary impairment for GAAP existed at December 31, 2011 related to the environment in which life insurance companies operated and not from reasons specific to Symetra itself. Symetra has recorded solid growth in adjusted book value per share since the financial crisis at the end of 2008, continues to pay quarterly dividends to its shareholders and has maintained strong financial strength and creditworthiness ratings and capital ratios. Management does not believe that the write-down in 2011 is an indication of impairment in Symetra’s long-term intrinsic business value. At December 31, 2012 the GAAP carrying value of White Mountains’ investment in the Symetra common shares was $351 million, which reflects White Mountains’ equity in Symetra’s earnings and unrealized investment gains as well as the amortization of the basis difference that arose upon recognition of the impairment in 2011 (see Note 15). Management does not believe that the investment in Symetra’s common shares is other-than-temporarily impaired at December 31, 2012.
changes in adjusted book value per share or return on equity;
claims arising from catastrophic events, such as hurricanes, earthquakes, floods or terrorist attacks;
changes in domestic or foreign laws or regulations, or their interpretation, applicable to White Mountains, its competitors or its clients;