The Company maintains two professional offices in Hamilton, Bermuda which serve as its headquarters and its registered office. White Mountains Re’s headquarters is in Hamilton, Bermuda with an additional office in Jersey City, New Jersey, which also serves as White Mountains’ principal executive office. Folksamerica is headquartered in New York, New York with branch offices in various cities throughout the United States. Sirius International is headquartered in Stockholm, Sweden with various branch offices in Europe and Asia. WMU maintains offices in Dublin, Ireland and Hamilton, Bermuda. The home office of OneBeacon is located in Boston, Massachusetts, with branch offices in various cities throughout the United States. Esurance is headquartered in San Francisco, California with various offices throughout the United States. In addition, the Company maintains professional offices in Hanover, New Hampshire and Guilford, Connecticut, which house its investment and corporate finance functions.
The Company’s headquarters, registered office, principal executive office and investment and corporate finance offices are leased. Sirius International’s home office in Sweden and substantially all of its branch offices, as well as WMU’s offices in Ireland and Bermuda, are leased. Folksamerica’s home office and its branch offices are leased as well. The home office of OneBeacon and most of its branch offices are leased with the exception of branch offices located in New York, which are owned by OneBeacon. During 2005, OneBeacon purchased an office building in Canton, Massachusetts, which it expects to occupy as its home office in late 2006. Management considers its office facilities suitable and adequate for its current level of operations.
Selected consolidated income statement data and ending balance sheet data for each of the five years ended December 31, 2005, follows:
(a) Includes the acquisition of OneBeacon on June 1, 2001 and its results of operations from that date through December 31, 2001. In connection with the OneBeacon Acquisition, White Mountains issued $1,085 million in debt. White Mountains also issued preferred stock of subsidiaries, warrants to acquire common shares and Convertible Preference Shares for total proceeds of $758 million. For a description of the historical factors affecting OneBeacon’s loss and LAE reserves prior to the OneBeacon Acquisition, see “Non-Asbestos and Environmental Reserves” under the caption “Loss and Loss Adjustment Expense Reserves” in the “OneBeacon” section of the business description contained within the Company’s Amendment No. 6 to Form S-3 dated July 17, 2003 (the “Form S-3”). Such portion of the Form S-3 is incorporated by reference into this Form 10-K.
(b) In accordance with its adoption of Statement of Financial Accounting Standard (“SFAS”) No. 141, “Business Combinations”, the Company recognized all of its outstanding deferred credits on January 1, 2002.
(c) In accordance with its adoption of SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (“SFAS 150”), on July 1, 2003, the Company reclassified its outstanding mandatorily redeemable preferred stock from mezzanine equity to liabilities on its balance sheet and, beginning in the third quarter of 2003, White Mountains began presenting all accretion and dividends on its mandatorily redeemable preferred stock as interest expense. See Note 1.
(d) Extraordinary gains in 2004 resulted from the excess of the fair value over the cost of net assets acquired in the Sirius, Symetra, Tryg-Baltica and Sierra transactions.
(f) Book value per share plus unamortized deferred credits less goodwill and the equity in net unrealized gains from Symetra’s fixed income portfolio per common and equivalent common share. The 2002 fully converted tangible book value per share assumes outstanding convertible preference shares to be equivalent common shares.
(h) Includes outstanding Convertible Preference Shares, Options and warrants to acquire common shares, when applicable.
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2005, 2004 and 2003
White Mountains ended 2005 with a fully converted tangible book value per common share of $343, which represents an increase of 2% (including dividends) over the fully converted tangible book value per common share of $343 as of December 31, 2004. During 2004, fully converted tangible book value per common share increased by 18% (including dividends) from $291 as of December 31, 2003.
A summary of White Mountains’ consolidated financial results for the years ended December 31, 2005, 2004 and 2003 follows:
White Mountains’ total revenues increased by 2% in 2005 compared to 2004, mainly from a $131 million increase in net investment income, primarily due to a $74 million special dividend from Montpelier in 2005. Earned premiums decreased by 1% in 2005, primarily due to a decrease at OneBeacon, which was partially offset by increases at White Mountains Re and Esurance, and net realized investment gains decreased by $69 million in 2005, primarily due to losses in the value of the Company’s investment in Montpelier warrants during 2005.
White Mountains’ total expenses also increased by 1% for 2005 as a $267 million increase in loss and LAE, primarily due to the Gulf Coast hurricanes, was partially offset by a $153 million decrease in general and
Consolidated Results - Year Ended December 31, 2004 versus Year Ended December 31, 2003
White Mountains’ total expenses grew 26% for 2004 as loss and LAE, insurance acquisition and underwriting expenses were all up due to the Sirius Acquisition and Atlantic Specialty transactions. General and administrative costs were up 53% in 2004, primarily due to an increase in incentive compensation accruals, which were driven by a 41% rise in White Mountains’ share price during the year.
White Mountains’ net income in 2004 also benefitted from $181 million in transaction gains: $111 million from the Sirius Acquisition, $41 million for the Symetra investment, $20 million from the Tryg-Baltica acquisition and $9 million from the Sierra Group acquisition.
White Mountains conducts its operations through four segments: (1) OneBeacon, (2) White Mountains Re, (3) Esurance and (4) Other Operations. White Mountains manages all of its investments through its wholly-owned subsidiary, WM Advisors, therefore, a discussion of White Mountains’ consolidated investment operations is included after the discussion of operations by segment. White Mountains’ segment information is presented in Note 13-"Segment Information" to the Consolidated Financial Statements.
Financial results for OneBeacon for the years ended December 31, 2005, 2004 and 2003 follows:
OneBeacon’s pre-tax income for 2005 was $449 million, compared to pre-tax income of $391 million for 2004 and its combined ratio was 98% for 2005, compared to 99% for 2004. OneBeacon’s 2005 results included $69 million in losses related to hurricanes Katrina, Rita and Wilma, which impacted the combined ratio by 3 points, and $95 million in adverse development, primarily relating to 2002 and prior accident years, which impacted the combined ratio by 5 points. Offsetting these items was a $54 million gain from the settlement of OneBeacon’s retiree medical plan, which reduced the combined ratio by a total of 3 points. The retiree medical plan, which had been frozen in 2002, was terminated and an independent trust was established and funded to provide benefits to covered participants. These actions relieved OneBeacon of its future retiree medical obligations and triggered recognition of the gain.
OneBeacon’s total revenues decreased 9% in 2005 to $2,614 million, compared to $2,871 million in 2004, due principally to an 11% decline in earned premiums in 2005. The decrease in earned premiums was partially due to lower commercial lines premiums resulting from the sale of the renewal rights on most of OneBeacon’s non-Atlantic Mutual New York commercial lines business to Tower Insurance Group late in 2004. As a result of this transaction, approximately $110 million of premiums written in 2004 were subject to this renewal rights agreement and were not written by OneBeacon during 2005. OneBeacon’s commercial lines also had a one-time premium increase of approximately $135 million in 2004 from the assumption of unearned premium from the Atlantic Specialty transaction. In addition, personal lines premium decreased in 2005 due to lower volumes in Massachusetts and New York. New Jersey Skylands Insurance also had lower premiums in 2005 as compared to 2004.
Other revenue for 2005 included $34 million in gains recorded from the sales of two subsidiaries, NFU and Traders and Pacific Insurance Company. During 2004, OneBeacon sold two of its subsidiaries, Potomac Insurance Company of Illinois (“Potomac”) and Western States Insurance Company (“Western States”), as well as its boiler inspection service business, for a total gain of $22 million that was recognized in other revenue.
As a result of an actuarial review completed in the fourth quarter of 2005, OneBeacon reallocated some of its IBNR reserves from some of the ongoing lines of business to run-off operations. This shifted $34 million of IBNR reserves from specialty lines ($22 million) and personal lines ($12 million) to run-off operations. This adjustment had no impact on OneBeacon’s total combined ratio.
Specialty Lines. The specialty lines combined ratio for 2005 was 95%, compared to 90% for 2004. The increase in the combined ratio was mainly due to $56 million of losses related to hurricanes Katrina, Rita and Wilma, which impacted the combined ratio by 7 points. These losses were incurred at OBSP ($43 million), IMU ($9 million) and Agri ($4 million). Partially offsetting the hurricane losses was the reallocation of IBNR reserves to run-off operations and the settlement of the retiree medical plan, which reduced the combined ratio by a total of 4 points. In 2004, the combined ratio for specialty lines was adversely impacted by 1 point ($11 million) from the four hurricanes in the southeastern United States. Net written premiums for 2005 were essentially flat at $840 million, compared to $849 million in 2004, as increases at OBPP, which included $28 million of net written premium from a renewal rights agreement with Chubb Specialty Insurance that took effect during the third quarter of 2005, and OBSP were offset
Personal Lines. The personal lines combined ratio for 2005 was 85%, compared to 94% for 2004. The decrease in the combined ratio is primarily due to strong homeowners results, aided by favorable catastrophe experience resulting from a relatively mild winter and lack of northeast wind events, as well as lower frequencies in OneBeacon’s legacy auto business. The settlement of the retiree medical plan favorably impacted the 2005 combined ratio by 4 points. In addition, the personal lines combined ratio was favorably impacted by 2 points from the reallocation of IBNR reserves to run-off operations.
Other Lines. Other lines for 2005 included approximately $107 million in adverse development, mainly from 2002 and prior accident years, which was primarily due to higher than anticipated defense costs and higher damages from liability assessments in general liability and multiple peril lines. In addition, during 2005, OneBeacon reallocated $34 million of IBNR reserves from some of its ongoing lines of business to run-off lines.
During the fourth quarter of 2004, OneBeacon sold two of its subsidiaries, Potomac and Western States, as well as its boiler inspection service business, and recognized gains on the sales of $22 million through other revenues.
White Mountains Re Results - Year Ended December 31, 2005 versus Year Ended December 31, 2004
White Mountains Re recorded $51 million of net unfavorable loss reserve development in 2005, the majority of which resulted from a detailed, ground-up asbestos study completed by White Mountains Re in 2005. The study analyzed all insureds that have reported over $250,000 of asbestos claims to Folksamerica and a significant sample of all other insureds with reported asbestos claims of less than $250,000. Comparing estimates generated by the study to Folksamerica exposed limits by underwriting year led to an increase of approximately $50 million in IBNR during the third quarter of 2005. This unfavorable development was partially offset by favorable development in the Sirius International reserve portfolio of approximately $12 million, mainly from the three most recent underwriting years. Included in the net unfavorable loss development in 2005 was $23 million from workers compensation reserves acquired in 2004 as part of the Sierra acquisition. However, this amount was offset dollar-for-dollar by a decrease in the balance due under the adjustable note issued in conjunction with this acquisition.
Effective January 1, 2006, Folksamerica renewed its quota-share reinsurance arrangements with Olympus on modified terms and Sirius terminated its agreement with Olympus. The 2005 and prior underwriting year business will continue to run-off with Olympus. For a further discussion, see "Reinsurance Protection", under "WHITE MOUNTAINS RE" in Item 1.
There were significant levels of property catastrophe activity during the last half of 2004, including the four hurricanes which affected the Southeast United States and the Caribbean, where White Mountains Re has historically been a significant participant in the property reinsurance market. Additionally, Sirius International was exposed to losses from the tsunami that impacted South Asia in December 2004. White Mountains Re believes its underwriting discipline and risk management approach helped to contain these losses to manageable levels. This significant property catastrophe activity during the last half of 2004 resulted in $135 million of pre-tax losses, including $16 million related to the tsunami. There was no significant property catastrophe activity in 2003.
Direct written premium increased to $352 million in 2005, a 75% increase from the prior year. As of December 31, 2005, Esurance’s in-force policy count totaled 211,851, a 79% increase over the prior year, and it wrote business in twenty-two states. For the year ended December 31, 2005, Esurance’s largest states were Florida (with 20% of direct premium written), California (20%), Texas (9%), New York (8%) and Michigan (7%).
White Mountains’ capital raising and capital allocation activities are principally conducted through its holding companies. In this regard, the results of its Other Operations segment primarily relate to financing activities, purchase accounting adjustments relating to the OneBeacon Acquisition, gains and losses recognized from the change in fair value of the Company’s investments in Montpelier and Symetra warrants, gains and losses recognized from the purchase and sale of certain of the Company’s subsidiaries and other assets and general and administrative expenses incurred at the holding company level.
Other Operations Results - Year Ended December 31, 2004 versus Year Ended December 31, 2003
White Mountains’ Other Operations segment reported a pre-tax loss of $235 million for 2004, compared to $159 million for 2003. The increased loss for the year was primarily due to a $20 million increase in incentive compensation accruals, which were driven by a 41% rise in White Mountains’ stock price during 2004, and higher gains from the sale of real estate in 2003 ($13 million in 2004 and $43 million in 2003). In addition, interest expense on preferred stock was up $25 million in 2004 due to the inclusion of a full year of expense in pre-tax income in 2004 as opposed to six months included in 2003 as a result of the Company’s adoption of SFAS 150, effective July 1, 2003. Prior to the adoption of SFAS 150, the interest expense on preferred stock was classified below the pre-tax loss line on the income statement as preferred stock dividends.
White Mountains manages substantially all of its consolidated investments through its wholly-owned subsidiary, WM Advisors. White Mountains’ investment philosophy is to maximize its after-tax total risk-adjusted return over the long term. Under this approach, each dollar of after-tax investment income and realized and unrealized gains and losses is valued equally. White Mountains’ overall fixed maturity investment strategy is to purchase securities that are attractively priced in relation to credit risks. White Mountains generally manages the interest rate risk associated with holding fixed maturity investments by actively maintaining the average duration of the portfolio to achieve an adequate after-tax total return without subjecting the portfolio to an unreasonable level of interest rate risk. White Mountains’ investment portfolio mix as of December 31, 2005 consisted in large part of high-quality, fixed maturity investments and short-term investments, as well as some equity investments and limited partnerships. White Mountains’ management believes that prudent levels of investments in common equity securities and other investments within its investment portfolio are likely to enhance long term after-tax total returns without significantly increasing the risk profile of the portfolio.
Investment Returns -Year Ended December 31, 2005 versus Year Ended December 31, 2004
Net investment income for 2005 of $492 million was up 36% from $361 million for 2004, due mainly to the Montpelier special dividend, higher short-term interest rates and the inclusion of a full year of Sirius’ results.
Investment Returns -Year Ended December 31, 2004 versus Year Ended December 31, 2003
During 2005, White Mountains recorded $90 million in pre-tax dividends from Montpelier in net investment income. During the first quarter of 2005, Montpelier declared a special dividend of $5.50 per share, payable to holders of both its common shares and warrants to acquire its common shares. White Mountains recorded pre-tax dividend income of $74 million in 2005 for this special dividend, in addition to $16 million in dividend income from Montpelier’s normal quarterly dividends.
Holding company level. The primary sources of cash for the Company and certain of its intermediate holding companies are dividends and tax sharing payments received from its insurance and reinsurance operating subsidiaries, financing activities and net investment income and proceeds from sales and maturities of holding company investments. The primary uses of cash are interest payments on its debt obligations, dividend payments on the Company’s common shares and the Berkshire Preferred Stock and Zenith Preferred Stock, purchases of investments and holding company operating expenses.
Both internal and external forces influence White Mountains’ financial condition, results of operations and cash flows. Claim settlements, premium levels and investment returns may be impacted by changing rates of inflation and other economic conditions. In many cases, significant periods of time, ranging up to several years or more, may lapse between the occurrence of an insured loss, the reporting of the loss to White Mountains and the settlement of the liability for that loss. The exact timing of the payment of claims and benefits cannot be predicted with certainty. White Mountains’ insurance and reinsurance operating subsidiaries maintain portfolios of invested assets with varying maturities and a substantial amount of short-term investments to provide adequate liquidity for the payment of claims.
Generally, OneBeacon’s regulated insurance operating subsidiaries have the ability to pay dividends during any 12-month period without the prior approval of regulatory authorities in an amount equal to the greater of prior year statutory net income or 10% of prior year end statutory surplus, subject to the availability of unassigned funds. As a result, based on 2005 statutory net income, OneBeacon’s top tier regulated insurance operating subsidiaries have the ability to pay approximately $197 million of dividends during 2006 without prior approval of regulatory authorities, subject to the availability of unassigned funds. As of December 31, 2005, OneBeacon’s top tier regulated insurance operating subsidiaries had $1.3 billion of unassigned funds available for dividend distribution.
In addition, as of December 31, 2005, Esurance had $9 million of cash and short term investments outside of its regulated insurance operating subsidiaries available for distribution during 2006. During 2005, Esurance did not pay any cash dividends.
In accordance with provisions of Swedish law, Sirius International is permitted to transfer up to the full amount of its pre-tax income, subject to certain limitations, into an untaxed reserve referred to as a safety reserve. Under GAAP, an amount equal to the safety reserve, net of the related deferred tax liability established at the Swedish tax rate of 28%, is classified as shareholders’ equity. Generally, this deferred tax liability is only required to be paid by Sirius International if it fails to maintain predetermined levels of premium writings in future years. As a result of the indefinite deferral of these taxes, Swedish regulatory authorities do not apply any taxes to the safety reserve when calculating solvency capital under Swedish insurance regulations. Accordingly, under local statutory requirements, an amount equal to Sirius International’s safety reserve of $920 million at December 31, 2005 is classified as surplus.
On November 30, 2004, White Mountains completed a significant corporate reorganization, through which ownership of Folksamerica was transferred to White Mountains Re from Fund American. In order to effect the reorganization, White Mountains and Fund American entered into or amended certain agreements with respect to the Berkshire Preferred Stock. Under the terms of a Keep-Well Agreement dated November 30, 2004 between White Mountains and Fund American (the “Keep-Well”), White Mountains has agreed to return to Fund American up to approximately $1.1 billion, which equals the amount of net assets transferred out of Fund American as a result of the reorganization, if some or all of that amount is required by Fund American to meet its obligations to Berkshire under the Berkshire Preferred Stock. Additionally, the Keep-Well limits the aggregate amount of distributions that White Mountains may make to its shareholders to approximately $1.3 billion plus White Mountains’ aggregate consolidated net income after September 30, 2004 ($435 million at December 31, 2005). Since the inception of the Keep-Well agreement, White Mountains has distributed $86 million in cash dividends to its shareholders. The Keep-Well will expire when all obligations of the Berkshire Preferred Stock, which is redeemable in May 2008, have been satisfied, or when approximately $1.1 billion has been returned to Fund American.
Insurance float is an important dynamic of White Mountains’ operations that must be managed effectively. Float is money that an insurance company holds for a limited time. In an insurance operation, float arises because premiums are collected before losses are paid. This interval can extend over many years. During that time, the insurer invests the money. When the premiums that an insurer 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 float. The amount and cost of float for White Mountains is affected by underlying market conditions, as well as acquisitions or dispositions of insurance and reinsurance businesses. 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.
(1) Excludes funds held by ceding companies from which White Mountains does not receive interest credits.
The following table summarizes White Mountains’ capital structure as of December 31, 2005 and 2004:
In connection with its acquisition of the Sierra Group on March 31, 2004, Folksamerica entered into a $62 million purchase note (the “Sierra Note”), $58 million of which will be adjusted over its approximate six-year term to reflect favorable or adverse loss reserve development on the acquired reserve portfolio and run-off of remaining policies in force (mainly workers compensation business) as well as certain other balance sheet protections. Since inception, the principal of the Sierra Note has been reduced by $35 million, to an outstanding balance of $27 million as of December 31, 2005, as a result of adverse development on the acquired reserves and run-off of unearned premiums.
In connection with its purchase of an office building in Canton, Massachusetts, OneBeacon entered into a $40 million construction facility to fund renovations to the new space that will ultimately house its corporate offices. As of December 31, 2005, OneBeacon had drawn $18 million under the facility.
Fund American’s Senior Notes are currently rated “Baa2” (Moderate Risk, the ninth highest of twenty-one ratings) with a stable outlook by Moody’s, “BBB” (Adequate, the ninth highest of twenty-two ratings) with a stable outlook by Standard & Poor’s, “bbb” (Adequate, the ninth highest of twenty-two ratings) with a stable outlook by A.M. Best and “BBB” (Good, the ninth highest of twenty-three ratings) with a stable outlook by Fitch Ratings. It is possible that, in the future, one or more of the rating agencies may lower White Mountains’ existing ratings. If one or more of its ratings were downgraded, White Mountains could incur higher borrowing costs and its ability to access the capital markets could be impacted. In addition, White Mountains’ insurance and reinsurance operating subsidiaries could be adversely impacted by a downgrade in their financial strength ratings, including a possible reduction in demand for their products in certain markets.
The Senior Notes were issued under an indenture which contains restrictive covenants that, among other things, limit the ability of the Company, Fund American and their respective subsidiaries to create liens and enter into sale and leaseback transactions and substantially limits the ability of Fund American and its respective subsidiaries to consolidate, merge or transfer their properties and assets. The indenture does not contain any financial ratios or specified levels of net worth or liquidity to which the Company or Fund American must adhere. At
The Bank Facility contains various affirmative, negative and financial covenants which White Mountains considers to be customary for such borrowings and include maintaining certain minimum net worth and maximum debt to capitalization standards for White Mountains. Failure to meet one or more of these covenants could result in an event of default, which ultimately could eliminate availability under the facility and result in acceleration of principal repayment on any amounts outstanding. At December 31, 2005, White Mountains was in compliance with all of the covenants under the Bank Facility, 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, 2005:
(1) Represents expected future cash outflows resulting from loss and LAE payments. Accordingly, these balances add back the discount on OneBeacon’s workers compensation loss and LAE reserves of $214 million and the remaining purchase accounting fair value adjustment of $357 million related to the OneBeacon and Sirius acquisitions as they are non-cash items. Further, the amounts presented are gross of reinsurance recoverables on unpaid losses of $5,026 million as of December 31, 2005.
White Mountains’ loss reserves do not have contractual maturity dates. However, based on historical payment patterns, the preceding table includes an estimate of when management expects White Mountains’ loss reserves to be paid. The timing of claim payments is subject to significant uncertainty. White Mountains maintains a portfolio of marketable investments with varying maturities and a substantial amount of short-term investments to provide adequate cash flows for the payment of claims.
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 cannot be predicted, for performance shares, with certainty, as the ultimate amounts of these liabilities are based on future performance of the Company and the market price of the Company’s common shares at the time the payments are made. The estimated payments reflected in the table are based on current accrual factors (common share price and pay-out percentage) and assume that all outstanding balances were 100% vested as of December 31, 2005.
Through Sirius International, White Mountains has a long-term investment as a stockholder in LUC Holdings, an entity that has entered into a head lease to rent the London Underwriting Center (“LUC”) through 2016. LUC Holdings in turn subleases space in the LUC. In the LUC Holdings stockholders agreement, the stockholders have guaranteed any shortfall between the head lease and the sub-leases on a joint and several basis. As a consequence, in recent years the stockholders have funded an operating shortfall of LUC. At December 31, 2005,
White Mountains also has future binding commitments to fund certain limited partnership investments. These commitments, which total approximately $35 million, do not have fixed funding dates and are therefore excluded from the table above.
During 2005, White Mountains declared and paid cash dividends of $86 million, $28 million and $2 million to holders of White Mountains’ common shares, the Berkshire Preferred Stock and the Zenith Preferred Stock, respectively.
During 2005, OneBeacon declared and paid dividends of $340 million to Fund American and White Mountains Re declared and paid $98 million of dividends to its immediate parent.
During 2005, White Mountains paid a total of $41 million in interest under the Senior Notes.
During 2005, OneBeacon sold two of its insurance subsidiaries, NFU and Traders and Pacific Insurance Company, to third parties for a total of $162 million in cash.
During the first quarter of 2005, White Mountains received a $74 million special dividend related to its common stock and warrant investment in Montpelier. This dividend represented $5.50 per share and was in addition to Montpelier’s normal quarterly dividend of $.36 per share.
During 2004, White Mountains restructured and re-syndicated the Bank Facility to extend its maturity and to increase the availability of the revolving credit facility to $400 million.
During 2004, White Mountains paid a total of $41 million in interest under the Senior Notes.
During 2004, OneBeacon declared and paid a total of $305 million in dividends to Fund American. Also during 2004, WMU paid a total of $60 million of dividends to its immediate parent. On March 31, 2004, OneBeacon distributed Folksamerica to Fund American.
During 2004, White Mountains sold Potomac for $22 million, Western States, as well as its boiler inspection service business, for $15 million (both subsidiaries of OneBeacon) and Peninsula for $23 million.
During 2003, White Mountains paid a total of $20 million in interest under the Senior Notes.
During 2003, White Mountains filed a shelf registration statement, which was declared effective by the SEC in July 2003, for offerings of up to $2.0 billion in debt and/or equity securities.
During the first quarter of 2003, White Mountains paid a total of 45,000 performance shares (relating to the 2000-2002 performance period) at 200%, amounting to $29 million, to its participants in cash, common shares or by deferral into certain non-qualified compensation plans of the Company or its subsidiaries. In the second quarter of 2003, White Mountains made performance share payments amounting to $13 million in cash or by deferral into certain non-qualified compensation plans of the Company. The payments on these additional performance shares in the second quarter represented accelerated payments to certain non-employee directors of the Company for performance periods originally scheduled to end on December 31, 2003, 2004 and 2005.
Reserves are typically comprised of (1) case reserves for claims reported and (2) reserves for losses that have occurred but for which claims have not yet been reported, referred to as incurred but not reported (“IBNR”) reserves, which include a provision for expected future development on case reserves. Case reserves are estimated based on the experience and knowledge of claims staff regarding the nature and potential cost of each claim and are adjusted as additional information becomes known or payments are made. IBNR reserves are derived by subtracting paid loss and LAE and case reserves from estimates of ultimate loss and LAE. Actuaries estimate ultimate loss and LAE using various generally accepted actuarial methods applied to known losses and other relevant information. Like case reserves, IBNR reserves are adjusted as additional information becomes known or payments are made.
OneBeacon’s actuaries use several generally accepted actuarial methods to evaluate its loss reserves, each of which has its own strengths and weaknesses. OneBeacon places more or less reliance on a particular method based on the facts and circumstances at the time the reserve estimates are made. These methods generally fall into one of the following categories or are hybrids of one or more of the following categories:
• Historical paid loss development methods: These methods use historical loss payments over discrete periods of time to estimate future losses. Historical paid loss development methods assume that the ratio of losses paid in one period to losses paid in an earlier period will remain constant. These methods necessarily assume that factors that have affected paid losses in the past, such as inflation or the effects of litigation, will remain constant in the future. Because historical paid loss development methods do not use case reserves to estimate ultimate losses, they can be more reliable than the other methods discussed below that look to case reserves (such as actuarial methods that use incurred losses) in situations where there are significant changes in how case reserves are established by a company’s claims adjusters. However, historical paid loss development methods are more leveraged (meaning that small changes in payments have a larger impact on estimates of ultimate losses) than actuarial methods that use incurred losses because cumulative loss payments take much longer to equal the expected ultimate losses than cumulative incurred amounts. In addition, and for similar reasons, historical paid loss development methods are often slow to react to situations when new or different factors arise than those that have affected paid losses in the past.
• Historical incurred loss development methods: These methods, like historical paid loss development methods, assume that the ratio of losses in one period to losses in an earlier period will remain constant in the future. However, instead of using paid losses, these methods use incurred losses (i.e., the sum of cumulative historical loss payments plus outstanding case reserves) over discrete periods of time to estimate future losses. Historical incurred loss development methods can be preferable to historical paid loss development methods because they explicitly take into account open cases and the claims adjusters’ evaluations of the cost to settle all known claims. However, historical incurred loss development methods necessarily assume that case reserving practices are consistently applied over time. Therefore, when there have been significant changes in how case reserves are established, using incurred loss data to project ultimate losses can be less reliable than other methods.
NICO under its agreement with OneBeacon. Third Party Recoverables are typically for the amount of loss in excess of a stated level each year. Of claim payments in the past 11 years, approximately 51% of asbestos and environmental losses have been recovered under the historical third party reinsurance.
In June 2005, OneBeacon completed an internal study of its A&E exposures. This study considered, among other items, (1) facts, such as policy limits, deductibles and available third party reinsurance, related to reported claims; (2) current law; (3) past and projected claim activity and past settlement values for similar claims; (4) industry studies and events, such as recent settlements and asbestos-related bankruptcies; and (5) collectibility of third-party reinsurance. Based on the study, OneBeacon increased its best estimate of its incurred losses ceded to NICO, net of underlying reinsurance, by $353 million ($841 million gross) to $2.1 billion, which is within the $2.5 billion coverage provided by the NICO Cover. OneBeacon estimates that the range of reasonable outcomes around its best estimate is $1.7 billion to $2.4 billion, versus a range of $1.5 billion to $2.4 billion from its previous study that was conducted in 2003. Due to the NICO Cover, there was no impact to income or equity from the change in estimate.
The increase in the estimate of incurred A&E losses was principally driven by raised projections for claims related to asbestos (particularly from assumed reinsurance business), and for mass torts other than asbestos and environmental, particularly lead and sexual molestation. The increase was partially offset by reduced projections of ultimate hazardous waste losses.
As noted above, OneBeacon estimates that on an incurred basis it has used approximately $2.1 billion of the coverage provided by NICO at December 31, 2005. Since entering into the NICO Cover, $26 million of the $2.1 billion of utilized coverage relates to uncollected amounts from third party reinsurers through December 31, 2005. Net losses paid totaled approximately $701 million as of December 31, 2005, with $94 million paid in 2005. Asbestos payments during 2005 reflect payments resulting from intensified efforts by claimants to resolve asbestos claims prior to the potential enactment of Federal asbestos legislation. To the extent that OneBeacon’s estimate of ultimate A&E losses as well as the estimate and collectibility of Third Party Recoverables differs from actual experience, the remaining protection under the NICO Cover may be more or less than the approximate $404 million that OneBeacon estimates remained at December 31, 2005.
OneBeacon’s net loss and LAE reserves by line of business at December 31, 2005 and 2004 were as follows:
During 2005, White Mountains Re completed a detailed, ground up asbestos study on all reported Folksamerica insureds that had over $250,000 of asbestos claims as well as a significant sample of all other insureds with reported asbestos claims of less than $250,000. Comparing estimates generated by the study to Folksamerica exposed limits by underwriting year led to an increase of approximately $50 million in IBNR during the third quarter of 2005.
White Mountains Re’s A&E claim activity for the last two years is illustrated in the table below.
White Mountains Re establishes loss and LAE reserves that are estimates of amounts needed to pay claims and related expenses in the future for reinsured events that have already occurred. 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 being further extended because claims are first reported to the ceding company and then through one or more intermediary insurers or reinsurers, (2) the diversity of loss development patterns among different types of reinsurance treaties or facultative contracts, (3) the necessary reliance on the ceding companies for information regarding reported claims and (4) the differing reserving practices among ceding companies.
In order to reduce the potential uncertainty of loss reserve estimation, White Mountains Re obtains information from numerous sources to assist in the process. White Mountains Re’s pricing actuaries devote considerable effort to understanding and analyzing a ceding company’s operations and loss history during the underwriting of the business, using a combination of ceding company and industry statistics. Such statistics normally include historical premium and loss data by class of business, individual claim information for larger claims, distributions of insurance limits provided, loss reporting and payment patterns, and rate change history. This analysis is used to project expected loss ratios for each treaty during the upcoming contract period. These expected ultimate loss ratios are aggregated across all treaties and are input directly into the loss reserving process to generate the expected loss ratios that are used to estimate IBNR.
Upon notification of a loss from a ceding company, White Mountains Re establishes case reserves, including LAE reserves, based upon White Mountains Re’s share of the amount of reserves established by the ceding company and our independent evaluation of the loss. In cases where available information indicates that reserves established by the ceding company are inadequate, White Mountains Re establishes case reserves or IBNR in excess of its share of the reserves established by the ceding company. In addition, specific claim information reported by ceding companies or obtained through claim audits can alert us to emerging trends such as changing legal interpretations of coverage and liability, claims from unexpected sources or classes of business, and significant changes in the frequency or severity of individual claims. Such information is often used to supplement estimates of IBNR.
Backlogs in the recording of assumed reinsurance can also complicate the accuracy of loss reserve estimation. As of December 31, 2005, there were no significant backlogs related to the processing of assumed reinsurance information at White Mountains Re.
White Mountains Re relies heavily on information reported by ceding companies, as discussed above. In order to determine the accuracy and completeness of such information, White Mountains Re’s U.S. underwriters, actuaries, and claims personnel perform regular audits of Folksamerica’s ceding companies. While regular ceding company audits are not customary outside the United States, Sirius International’s staff regularly reviews information from ceding companies for unusual or unexpected results. Any material findings are discussed with the ceding companies. White Mountains Re sometimes encounters situations where we determine that a claim presentation from a ceding company is not in accordance with contract terms. In these situations, White Mountains Re attempts to resolve the dispute directly with the ceding company. Most situations are resolved amicably and without the need
Although loss and LAE reserves are initially determined based on underwriting and pricing analysis, White Mountains Re constantly tests the accuracy of reserves using a variety of generally accepted actuarial methods, including historical incurred and paid loss development methods. If actual loss activity differs substantially from expectations based on historical information, an adjustment to loss reserves may be warranted. As time passes, loss reserve estimates for a given accident year will rely more on actual loss activity and historical patterns than on initial assumptions based on pricing indications.
White Mountains Re also obtain reinsurance whereby another reinsurer contractually agrees to indemnify White Mountains Re for all or a portion of the reinsurance risks underwritten by White Mountains Re. Such arrangements, where one reinsurer provides reinsurance to another reinsurer, are usually referred to as “retrocessional reinsurance” arrangements. White Mountains Re establishes estimates of amounts recoverable from retrocessional reinsurance in a manner consistent with the loss and LAE liability associated with reinsurance contracts offered to its customers (the “ceding companies”), net of an allowance for uncollectible amounts, if any. Net reinsurance loss reserves represent loss and LAE reserves reduced by retrocessional reinsurance recoverable on unpaid losses.
White Mountains Re’s net loss and LAE reserves by class of business at December 31, 2005 and 2004 were as follows:
The following table illustrates White Mountains Re’s recorded net loss and LAE reserves and high and low estimates for those classes of business for which a range is calculated, at December 31, 2005.
There is a time lag from the point when premium and related commission and expense activity is recorded by a ceding company to the point when such information is reported by the ceding company, through its reinsurance intermediary, to White Mountains Re. This time lag can vary from one to several contractual reporting periods (i.e. quarterly/monthly). This lag is common in the broker market reinsurance business.
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, White Mountains Re believes all of its estimated balances are collectible, and as such no allowance has been recorded.
The information contained in this report may contain “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements, other than statements of historical facts, included or referenced in this report which address activities, events or developments which White Mountains expects or anticipates will or may occur in the future are forward-looking statements. The words “will”, “believe,” “intend,” “expect,” “anticipate,” “project,” “estimate,” “predict” and similar expressions are also intended to identify forward-looking statements. These forward-looking statements include, among others, statements with respect to White Mountains’:
• incurred losses and the adequacy of its losses and LAE reserves and related reinsurance;
• the risks discussed in Item 1A of this Form 10-K;
• business opportunities (or lack thereof) that may be presented to it and pursued;
• an economic downturn or other economic conditions adversely affecting its financial position;
• other factors, most of which are beyond White Mountains’ control.
The financial statements and supplementary data have been filed as a part of this Annual Report on Form 10-K as indicated in the Index to Consolidated Financial Statements and Financial Statement Schedules appearing on page 84 of this report.