The United States headquarters of OneBeacon is located in Canton, Massachusetts, while its principal executive office is located in Minnetonka, Minnesota. OneBeacon also maintains offices in various cities throughout the United States.
(b)The extraordinary gain in 2006 resulted from the excess of the fair value over the cost of net assets acquired in the Mutual Services acquisition. 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.
(d)Fully diluted tangible 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 any unamortized goodwill and net unrealized gains from Symetra's fixed maturity portfolio. See the reconciliation of fully diluted tangible book value per share to book value per share on page 47.
(e)During 2007, the Company repurchased and retired 290,841 common shares in two transactions with institutional investors. During 2004, 1,724,200 common shares were issued in satisfaction of warrants exercised.
(f)Includes outstanding Options and warrants to acquire common shares, when applicable. In addition, for periods subsequent to December 31, 2006, the number of common shares outstanding used in the calculation of fully diluted tangible book value per share is adjusted to exclude unearned shares of restricted stock representative of the proportion of unamortized compensation cost at the date of the calculation to the value of the restricted stock on the date of issuance.
(g)In connection with the OneBeacon Offering, White Mountains recognized a $171 million gain in other revenues and recorded a $491 million minority interest liability.
(i)In May 2007, WMRe Group, an intermediate holding company of White Mountains Re, issued $250 million non-cumulative perpetual preference shares.
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" for specific important factors that could cause actual results to differ materially from those contained in forward-looking statements.
White Mountains ended 2007 with a fully diluted tangible book value per common share of $444, which represented an increase of 11.4% (including dividends) over the fully diluted tangible book value per common share of $406 as of December 31, 2006. This increase reflects favorable weather conditions and strong investment results in 2007. Fully diluted tangible book value per share at December 31, 2007 was reduced by $2 from the impact of share repurchases during the fourth quarter of 2007.
White Mountains ended 2006 with a fully diluted tangible book value per common share of $406, which represented an increase of 21% (including dividends) over the fully diluted tangible book value per common share of $343 as of December 31, 2005. This increase reflected favorable weather conditions and strong investment results when compared to 2005. Additionally, during the fourth quarter of 2006, White Mountains recognized an after-tax gain of $171 million, or $16 per common share, from the OneBeacon Offering.
(1)Remaining adjustment of subsidiary preferred stock to face value, which is based on White Mountains' ownership interest in OneBeacon Ltd. of 72.9%, 72.4% and 100% as of December 31, 2007, 2006 and 2005.
Consolidated Results-Year Ended December 31, 2007 versus Year Ended December 31, 2006
White Mountains' total expenses were relatively flat at $4,052 million for 2007 when compared to 2006. Interest expense on debt increased 46% in 2007, primarily due to interest on the WMRe Senior Notes that were issued in March of 2007. This was partially offset by an 8% decrease in general and administrative expenses, due primarily to lower incentive compensation expense in 2007.
White Mountains' total revenues increased by 4% to $4,794 million in 2006 compared to $4,632 million in 2005, mainly due to the $171 million gain on the sale of OneBeacon shares and a $160 million increase in net realized investment gains, primarily due to $165 million of pre-tax losses in the value of the Company's investment in Montpelier Re realized during 2005, compared to a $5 million pre-tax gain realized in 2006. These increases were partially offset by a $56 million decrease in net investment income, primarily due to the receipt in 2005 of a $74 million special dividend from Montpelier Re, and a 2% decrease in earned premiums, primarily due to decreases at OneBeacon and White Mountains Re, which were partially offset by an increase at Esurance.
White Mountains' total expenses decreased by 6% to $4,064 million for 2006, primarily due to a $406 million decrease in losses and LAE, partially offset by a $70 million increase in general and administrative expenses. The decrease in losses and LAE was due mainly to lower catastrophe losses in 2006 compared to 2005. In 2005, White Mountains reported $422 million in pre-tax loss and LAE on hurricanes Katrina, Rita and Wilma, compared to $106 million in loss and LAE from adverse development on those storms, as well as a $137 million loss and $9 million in forgone override commissions from the Olympus reimbursement in 2006. The increase in general and administrative expenses in 2006 when compared to 2005 was primarily due to increased incentive compensation expenses.
The income tax provision related to pretax earnings for 2007, 2006 and 2005 represents an effective tax rate of 30.9%, 13.6% and 12.0%, respectively. White Mountains' effective tax rates for 2007, 2006 and 2005 were lower than the U.S. statutory rate of 35% due primarily to income generated in jurisdictions other than the United States. In addition, White Mountains' effective tax rate for 2006 reflected tax benefits related to settlements of U.S. Federal income tax audits for years 2001 and 2002.
The following table presents OneBeacon's adjusted book value per common share and reconciles this non-GAAP measure to book value per common share, the most comparable GAAP measure.
The following tables provide GAAP ratios, net written premiums and earned insurance premiums for OneBeacon's ongoing businesses and in total for the years ended December 31, 2007, 2006, and 2005:
The decrease in OneBeacon's 2007 GAAP combined ratio was primarily due to a 3 point decrease in its loss and LAE ratio. The 2007 results included 3 points of favorable development on prior accident year losses due to lower than expected frequency for professional liability in specialty lines and lower than expected severity for automobile liability in personal lines, partially offset by unfavorable development for multiple peril and workers compensation, primarily for accident years 2001 and prior. The 2006 results included 1 point of adverse development on prior
accident year losses, mainly due to adverse development on catastrophe losses, primarily related to hurricanes Katrina and Wilma and two 2004 catastrophes, partially offset by favorable development on prior accident year non-catastrophe losses in specialty lines and commercial lines.
Specialty lines. Net written premiums for specialty lines increased by 2% to $446 million in 2007 from $438 million in 2006. Excluding the business transferred in the Agri Sale, net written premiums increased by 20% in 2007 due to a $35 million increase in net written premiums in specialty liability products at OBPP, a $19 million increase in net written premiums at IMU and $15 million in net written premiums in the Accident & Health business, which commenced operations in 2007.
The specialty lines combined ratio for 2007 was 89%, consistent with the 2006 combined ratio. The loss and LAE ratio increased 3 points to 58%, primarily due to unfavorable large non-catastrophe current accident year losses in the Agri run-off business, while the expense ratio for 2007 decreased 3 points to 31%, primarily due to a 3 point reduction of commission expense from fees received in 2007 from QBE for fronting services performed on renewals of Agri business.
The personal lines combined ratio for 2007 decreased to 94% from 96% for 2006. The loss and LAE ratio decreased 4 points to 60%, primarily due to 3 points of favorable development on prior accident years in automobile liability in traditional personal lines and at AutoOne, compared to 1 point of adverse development on prior accident years in 2006. Partially offsetting this decrease was higher large loss activity experienced in the first half of 2007. The expense ratio increased by 2 points to 34% from 32% in 2006. The increase was primarily due to the adverse effect of a lower earned premium base compared to 2006. The expense ratio in 2007 included the impact of non-recurring favorable items in 2007, including 1 point from a state premium tax refund and 1 point from the partial pension settlement. The 2006 expense ratio also included the benefit of non-recurring favorable items, including 1 point from a reduction of contingent commission accruals and 1 point related to the favorable settlement of a state franchise tax audit. Both periods included 1 point of office consolidation costs. In addition, the expense ratio for 2007 included 1 point of expense incurred in connection with the decision to cease writing business in Houston General Insurance Exchange and actions taken to reduce the personal lines workforce.
Run-off. For 2007, run-off business generated an underwriting loss of $39 million (excluding $117 million from the reserve reallocation), compared to an underwriting loss of $44 million in 2006. The results for both 2007 (excluding the reserve reallocation) and 2006 included $9 million in adverse development.
Lower adverse development on prior accident year losses caused OneBeacon's 2006 combined ratio to decrease four points from 2005. OneBeacon's 2006 results included $23 million of adverse development on prior accident years compared to $95 million in 2005, which primarily related to 2002 and prior accident years. Lower current accident year catastrophe losses also caused OneBeacon's 2006 combined ratio to decrease two points from 2005. OneBeacon's 2006 results included $29 million in current accident year catastrophe losses compared to $81 million in 2005, which included $69 million from hurricanes Katrina, Rita and Wilma. Offsetting these decreases was a one point increase from higher incentive compensation expenses in 2006 and a one point increase from $20 million of expenses associated with actions taken to reduce long-term occupancy costs, including OneBeacon's move to its new U.S. headquarters in Canton, Massachusetts. In addition, OneBeacon's 2005 results included a $54 million gain from the settlement of its retiree medical plan, which reduced the 2005 combined ratio by three 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. The majority of the gain was recorded as a reduction of other underwriting expenses with a portion of the gain reflected as a reduction in loss and LAE because a portion of the expense of the retiree medical program was allocated to the claims department.
Personal Lines. Net written premiums for personal lines decreased by 12% to $801 million in 2006 compared to $910 million in 2005. The decrease was primarily attributable to reduced writings at AutoOne due to the size of New York's assigned risk pool significantly decreasing and reduced writings in traditional personal lines due to an increasingly competitive automobile market and state-mandated rate decreases in Massachusetts. With respect to the New York assigned risk pool, assigned risk volumes declined to $253 million in 2006, down from $383 million in 2005 and $629 million in 2004. Assigned risk volumes in New Jersey are also expected to decline. The assigned risk pool in New Jersey declined to $141 million in 2006, down from $247 million in 2005 and $375 million in 2004. OneBeacon expects a continued reduction in AutoOne's premium volume in 2007 reflective of these trends.
The personal lines combined ratio for 2006 increased to 96% from 92% for 2005. The loss and LAE ratio increased 1 point to 64% in 2006 from 63% in 2005, primarily due to favorable items in 2005. The personal lines 2005 loss and LAE ratio included the benefit of the settlement of the retiree medical plan and the favorable impact of the reallocation of IBNR reserves to run-off, which each reduced the loss and LAE ratio by approximately one point. The expense ratio increased to 32% in 2006, compared to 29% in the prior year, mainly due to increased incentive compensation expenses of approximately one point in 2006 and the benefit of the settlement of the retiree medical plan in 2005, which decreased the 2005 expense ratio by approximately two points. In addition, the 2006 expense ratio was higher than the 2005 expense ratio by approximately one point as expense reductions were not proportional to reductions in earned premiums.
Financial results and GAAP combined ratios for White Mountains Re for the years ended December 31, 2007, 2006 and 2005 follows:
White Mountains Re Results-Year Ended December 31, 2007 versus Year Ended December 31, 2006
White Mountains Re's pre-tax income for 2007 was $297 million compared to a $237 million for 2006, and its GAAP combined ratio was 94% for 2007 compared to 102% for 2006. The loss and LAE ratio for 2007 included $76 million, or 7 points, of pre-tax catastrophe losses, net of reinsurance and reinstatement premiums, primarily from European windstorms Kyrill and Hanno in the first quarter of 2007, floods that impacted the United Kingdom during the second and third quarters, the Peru earthquake, hurricanes Dean and Felix, and floods in Jakarta, Slovenia, and Mexico. In addition to these catastrophes, White Mountains Re recorded $9 million of net unfavorable development in 2007, which consisted of $63 million related to A&E exposures, $28 million in strengthening of certain of its U.S. casualty reserves and $7 million related to surety business. These losses were largely offset by favorable development of $91 million, primarily on property lines from prior accident years. The loss and LAE ratio for 2006 included net adverse development of $218 million, or 18 points, which included a charge of $137 million arising from the Olympus reimbursement described below, $92 million ($86 million net of reinstatement premiums) in adverse development on hurricanes Katrina, Rita and Wilma, and $55 million of adverse development from casualty losses associated with the Risk Capital acquisition in 2000. These losses were partially offset by favorable development on various lines, including $46 million and $19 million of favorable development on the property and agriculture lines of business, respectively.
Net investment income in 2007 increased by 15% to $211 million compared to the prior year mainly due to an increase in invested assets from the transfer of White Mountains Re's investment in Symetra to White Mountains for cash in December 2006, proceeds from the issuance of the preference shares in May 2007, as well as capital contributions of $100 million from White Mountains in June 2006.
General and administrative expenses in 2007 increased by $2 million to $26 million compared to 2006. This increase is mainly due to costs expensed in connection with the issuance of $250 million of non-cumulative perpetual preference shares during the second quarter of 2007 and $400 million face value of senior unsecured notes during the first quarter of 2007, as further discussed below.
In March 2007, White Mountains Re issued $400 million face value of senior unsecured notes that have an annual effective yield of 6.5% for net proceeds of $392 million. In anticipation of the issuance of the WMRe Senior Notes, White Mountains Re entered into an interest rate lock agreement to hedge its interest rate exposure and recorded a $2 million loss in accumulated other comprehensive income related to this agreement, which is being amortized into interest expense over the life of the WMRe Senior Notes. White Mountains Re deferred $4 million in expenses related to the issuance of the WMRe Senior Notes (including a $3 million underwriting discount), which are also being recognized into interest expense over the life of the WMRe Senior Notes.
White Mountains Re's interest expense in 2007 increased by $22 million, primarily due to the interest on the aforementioned WMRe Senior Notes.
Excluding the unfavorable development from Katrina, Rita and Wilma and the Olympus reimbursement, White Mountains Re's underwriting units performed well in 2006, reflecting generally more favorable weather conditions and continued favorable prices, terms and conditions within the reinsurance marketplace. Excluding the additional losses from hurricanes Katrina, Rita and Wilma and the Olympus reimbursement, favorable development on prior year reserves of $11 million resulted primarily from continued favorable run off of recent underwriting years at Sirius International of $46 million and favorable development of $19 million arising from Folksamerica's agriculture line of business, offset by unfavorable development of $55 million from casualty losses associated with the Risk Capital acquisition.
White Mountains Re's 2006 gross written premiums decreased by 18% to $1,625 million and net written premiums decreased by 1% to $1,290 million from $1,304 million in 2005. White Mountains Re reduced its overall property exposure and Folksamerica non-renewed its excess offshore energy and marine business in the Gulf of Mexico starting on January 1, 2006, which caused gross written premiums to decline substantially in 2006 versus 2005. All of the non-renewed excess offshore energy and marine business was subject to Folksamerica's reinsurance treaty with Olympus, under which Folksamerica ceded up to 75% of this business in 2005. As a result, the impact on the change in White Mountains Re's net written premiums from 2005 to 2006 was significantly less than the impact on the change in its gross written premiums over the same period. Gross and net written premiums were also lower during 2006 due to lower reinstatement premiums on property catastrophe reinsurance, which had primarily resulted from reinstated coverage after hurricanes Katrina and Rita in 2005, and lower premiums from Sirius America, which was sold in August 2006. Sirius America contributed $71 million and $39 million of gross and net written premiums, respectively, in 2006, compared to $248 million and $87 million, respectively, in 2005. Additionally, gross and net written premiums on casualty lines were lower in 2006, due mainly to pricing, terms and conditions that did not meet White Mountains Re's pricing guidelines and due to higher ceding company retentions. These decreases were partially offset by increases in certain non-catastrophe exposed classes, particularly in specialty lines.
Accretion of the fair value adjustment to loss and LAE reserves decreased in 2006 by $9 million, or 86%, from $11 million in 2005 as a result of a change in the rate of accretion of the fair value adjustment to loss and LAE reserves that was established in the purchase accounting for the Sirius Acquisition. The change in accretion resulted from the aforementioned evaluation of the remaining run-off contracts at Scandinavian Re and will be made prospectively over the remaining amortization period.
White Mountains Re recognized fee income of $12 million from Olympus and Helicon in 2006, $9 million of which was recorded as other revenues, compared to $61 million of fee income from Olympus in 2005, $28 million of which was recorded as other revenues. The decrease in fee income was primarily the result of a reduction in amounts ceded to Olympus and Helicon in 2006 compared to 2005 and due to Folksamerica Holdings Company ("Folksamerica Holdings") waiving $9 million of override commission due from Olympus in accordance with the
Olympus reimbursement. Other revenues in 2006 also included a $14 million gain from the sale of Sirius America and $21 million of realized foreign exchange gains. In 2005, other revenue also included a $5 million gain from the sale of California Indemnity Insurance Company, a wholly-owned subsidiary of White Mountains Re acquired in 2004 as part of the Sierra acquisition.
Olympus reimbursement. In June 2006, following the receipt of new claims information reported from several ceding companies and subsequent reassessment of the ultimate loss exposures, White Mountains Re increased its gross loss estimates for hurricanes Katrina, Rita and Wilma by $201 million. This was mostly on Folksamerica's off-shore energy and marine exposures attributable to retrocessional arrangements and business interruption coverage. As a result, Folksamerica set its gross loss and LAE reserves as of June 30, 2006 on offshore energy and marine exposures for hurricanes Katrina and Rita at full contract limits. Starting January 1, 2006, Folksamerica non-renewed its excess offshore energy and marine business in the Gulf of Mexico.
Esurance Results-Year Ended December 31, 2007 versus Year Ended December 31, 2006
Esurance's pre-tax loss for 2007 was $73 million compared to a pre-tax loss of $8 million for 2006. Esurance's GAAP combined ratio was 116% for 2007 compared to 108% for 2006. Esurance's loss ratio increased to 82% in 2007 from 73% in 2006 due to a higher current year loss ratio and $30 million, or 4 points, of prior period adverse loss development. During the second quarter of 2007, Esurance began to experience higher than expected paid loss severity for injury claims. A review of all open liability claim files was completed third quarter. As a result, case reserves were increased to reflect the higher loss severity for injury claims. Esurance is seeing higher injury claim severities reported by its peer group and in industry data, indicating that the trend is not unique to Esurance's business. In response to higher claim costs, Esurance has increased prices for injury coverages. Due to these rate increases and effects of competition in the personal auto market, Esurance expects to grow more slowly in 2008 than in previous years. Esurance's expense ratio decreased to 34% in 2007 from the prior period expense ratio of 35% as lower operating expenses offset higher acquisition costs that resulted from increased competition in the personal auto market.
During 2007, Esurance wrote business in 28 states, the largest of which were California (with 22% of direct premium written), Florida (16%), New York (7%), Texas (6%) and Michigan (5%).
Net written premium increased to $596 million, a 71% increase from 2005. As of December 31, 2006, Esurance's in-force policy count totaled 372,688, a 76% increase over 2005. During 2006, Esurance continued to expand through national and local television advertising, online marketing, direct mail, and online agency channels. More site traffic and improved conversion rates lowered the costs of acquiring new customers during 2006.
Other Operations Results-Year Ended December 31, 2007 versus Year Ended December 31, 2006
Other Operations Results-Year Ended December 31, 2006 versus Year Ended December 31, 2005
White Mountains' Other Operations segment reported pre-tax income of $189 million for 2006, compared to $3 million for 2005. The increase was primarily attributable to the $171 million gain on the sale of OneBeacon shares. In addition, the Montpelier Re investment accounted for $13 million in pre-tax income during 2006, compared to $63 million of pre-tax losses during 2005, which included $39 million of net investment income from the special dividend. These increased gains were partially offset by a $58 million increase in incentive compensation expense in 2006 compared to 2005. In addition, White Mountains' weather risk management and variable annuity reinsurance businesses contributed $(3) million and $2 million, respectively, to pre-tax income for the Other Operations segment in their first year of operation.
Gross investment returns versus typical benchmarks for the years ended December 31, 2007, 2006 and 2005 are as follows. For purposes of discussing rates of return, all percentages are presented gross of management fees and trading expenses in order to produce a more relevant comparison to benchmark returns, while all dollar amounts are presented net of any management fees and trading expenses.
Investment Returns-Year Ended December 31, 2007 versus Year Ended December 31, 2006
Net investment income of $533 million in 2007 increased by 22% from $436 million in 2006, principally due to a higher average invested asset base in 2007, resulting from the sale of OneBeacon shares late in 2006 and the issuance of the WMRe Senior Notes and Preference Shares early in 2007. Net realized investment gains in 2007 of $263 million were relatively consistent with the $273 million reported in 2006. Pre-tax net unrealized gains decreased to $63 million in 2007, from $114 million in 2006, mainly due to a higher foreign currency exchange unrealized gains in 2006 than in 2007.
White Mountains' total pre-tax investment result was a gain of $822 million, a return of 8.4% for 2006 compared to a gain of $318 million, a return of 3.3% for 2005. White Mountains' total fixed maturity portfolio returned 6.0% during 2006 versus 3.0% during 2005. The higher return in 2006 was primarily due to a more favorable interest rate environment, where the rate of increase in interest rates during 2006 was lower than during 2005. In addition, the weakening of the U.S. dollar during 2006 reversed a trend from 2005 and produced unrealized currency exchange
Net investment income of $436 million during 2006 decreased 11% from $492 million during 2005, principally due to the receipt of a $74 million special dividend on the Montpelier Re common share and warrant investments during 2005. Net realized investment gains of $273 million during 2006 increased by 142% from $113 million during 2005, primarily due to a $170 million increase in realized gains from the Montpelier Re common share and warrant investment (a $5 million realized gain in 2006 period versus a $165 million realized loss in 2005, which included a $55 million other-than-temporary impairment charge). Net unrealized gains on investments of $114 million during 2006 improved from net unrealized losses of $286 million during 2005, primarily due to the effect of interest rate movements and foreign currency fluctuations, as described above. In addition, 2005 included a $65 million pre-tax unrealized loss from the Montpelier Re common share investment.
The following table presents the composition of White Mountains' investment portfolio as of December 31, 2007 and 2006:
The following table summarizes White Mountains' mortgage-backed and asset-backed securities holdings as of December 31, 2007 and 2006:
This report includes five non-GAAP financial measures that have been reconciled to their most comparable GAAP financial measures. White Mountains believes these measures to be more relevant than comparable GAAP measures in evaluating White Mountains' results of operations and financial condition.
Adjusted book value per common share at OneBeacon is a non-GAAP financial measure which is derived by excluding the impact of economically defeasing OneBeacon's mandatorily redeemable preferred stock from book value per common share, the most closely comparable GAAP measure. Management believes that adjusted book value per common share is a useful supplement to understanding the OneBeacon's earnings and profitability. A reconciliation of OneBeacon's book value per common share to OneBeacon's adjusted book value per common share is included on page 50.
During 2005 and 2007, OneBeacon reallocated loss and LAE reserves from specialty, commercial and personal lines to run-off, which reduced specialty, commercial and personal lines' GAAP loss and LAE ratios and GAAP combined ratios, but had no impact on OneBeacon's total GAAP combined ratio. OneBeacon's specialty, commercial and personal lines' loss and LAE ratios and combined ratios prior to reserve reallocation are non-GAAP financial measures that are derived by excluding the impact of the reserve reallocation from specialty, commercial and personal lines' loss and LAE ratios and combined ratios. OneBeacon believes that a presentation excluding the effect of the reserve reallocation on specialty, commercial and personal lines' loss and LAE ratios and GAAP combined ratios is meaningful for investors to understand the performance of its underwriting units during 2005 and 2007. The reconciliation of these non-GAAP financial measures to the GAAP loss and LAE ratios and GAAP combined ratios is included on page 51.
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, capital raising activities, net investment income and proceeds from sales and maturities of holding company investments. The primary uses of cash are repurchases of the Company's common shares, payments on its debt obligations, dividend payments on the Company's common shares, minority interest holders of OneBeacon Ltd.'s common shares, the Berkshire Preferred Stock and to holders of the WMRe Preference Shares, purchases of investments, payments made to tax authorities and holding company operating expenses.
Management believes that White Mountains' cash balances, cash flows from operations, routine sales of investments and the liquidity provided by the WTM Bank Facility and the Fund American Bank Facility are adequate to meet expected cash requirements for the foreseeable future on both a holding company and insurance and reinsurance operating subsidiary level.
In addition, as of December 31, 2007, OneBeacon had approximately $380 million of net unrestricted cash, fixed maturity and equity investments outside of its regulated insurance operating subsidiaries. During 2007, OneBeacon paid $394 million of dividends to Fund American and OneBeacon Ltd. paid $84 million of dividends to its common shareholders, $60 million of which was paid to an intermediate holding company of White Mountains.
Fund American's ability to declare or pay dividends is limited by the terms of the Berkshire Preferred Stock. Fund American may not, under certain circumstances, declare or pay any dividend or distribution without the consent of the holders of the Berkshire Preferred Stock. In addition, White Mountains and Fund American entered into or amended certain agreements with respect to the Berkshire Preferred Stock to effect a corporate reorganization in 2004 (see Keep-Well below).
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 earnings to the Safety Reserve (see "Safety Reserve" below). As of December 31, 2007, Sirius International had $52 million of unrestricted statutory surplus, which is available for distribution in 2008. Based on its 2007 results, Sirius International would have the ability to declare and pay additional dividends (on top of the $52 million noted above) of up to $60 million in 2008 without regulatory approval, if it elects not to allocate its related pre-tax earnings to the Safety Reserve.
In accordance with the provisions of Swedish law, Sirius International can voluntarily transfer its pre-tax income, or a portion thereof, subject to certain limitations, to its parent company to minimize taxes. In early 2008, Sirius International intends to transfer aproximately $33 million of its 2007 pre-tax income to its Swedish parent company as a group contribution.
WMRe (Bermuda) has the ability to declare and pay dividends of up to $103 million in 2008 without regulatory approval, subject to meeting all appropriate liquidity and solvency requirements.
WMRUS has the ability to distribute its 2008 earnings without restriction. At December 31, 2007, WMRUS had $2 million of unrestricted cash. During 2007, WMRUS paid $8 million of dividends to its immediate parent.
In addition, as of December 31, 2007, White Mountains Re and its intermediate holding companies had an additional $58 million of net unrestricted cash and fixed maturity investments outside of Folksamerica, Sirius International, WMRe (Bermuda) and WMRUS.
In addition, as of December 31, 2007, Esurance had $.4 million of net unrestricted cash and fixed maturity investments outside of its regulated insurance operating subsidiaries. During 2007, Esurance did not pay any cash dividends to its immediate parent.
Insurance float is an important aspect of White Mountains' insurance operations. Insurance 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 funds. 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 insurance float. The amount and cost of insurance float for White Mountains is affected by underlying market conditions, as well as acquisitions or dispositions of insurance and reinsurance businesses.
One of the means by which White Mountains calculates its insurance float is by taking its net investment assets and subtracting its total tangible capital. The following table illustrates White Mountains' consolidated insurance float position as of the past five year-ends:
(1)The minority interest portion of investments of consolidated limited partnerships have not been included in insurance float because White Mountains does not have the ability to utilize these assets.
(2)Excludes funds held by ceding companies from which White Mountains does not receive interest credits.
(3)Excludes funds held by White Mountains under reinsurance treaties for which White Mountains does not provide interest credits.
(4)Excludes preferred stock subject to mandatory redemption, having an aggregate accreted liquidation preference at December 31, 2007 and 2006 of $278 million and $269 million, respectively (and $306 million and $339 million of investments held in irrevocable grantor trusts for the purpose of economically defeasing the preferred stock subject to mandatory redemption). The creation and funding of these trusts did not legally defease the preferred stock and therefore the preferred stock will continue to appear on White Mountains' balance sheet until it is redeemed. White Mountains has historically obtained its insurance float primarily through acquisitions, as opposed to organic growth. It is White Mountains' intention to generate low-cost float over time through a combination of acquisitions and/or by organic growth in its existing insurance and reinsurance operations. However, White Mountains will seek to increase its insurance float organically only when market conditions allow for an expectation of generating underwriting profits.
The following table summarizes White Mountains' capital structure as of December 31, 2007 and 2006:
(1)The $320.0 million outstanding on December 31, 2006 was under White Mountains' previous credit facility, which was refinanced in June 2007 (See below).
(2)See Note 6-"Debt" of the accompanying Consolidated Financial Statements for a discussion of operating subsidiary debt.
In May 2007, WMRe Group issued $250 million non-cumulative perpetual preference shares and received $246 million of proceeds, net of $4 million of issuance costs and commissions. Holders of the WMRe Preference Shares receive dividends on a non-cumulative basis only when, and if declared by WMRe Group at a fixed dividend rate of 7.506% for the period from issuance until June 30, 2017 and a variable dividend rate thereafter. The WMRe Preference Shares are redeemable only at the option of WMRe Group.
In March 2007, WMRe Group issued $400 million face value of senior unsecured debt at an issue price of 99.715%, wihich resulted in net proceeds of $392 million. The WMRe Senior Notes bear an annual interest rate of 6.375%, payable semi-annually in arrears on March 20 and September 20, until maturity in March 2017. Taking into effect the amortization of the orginal issue discount and all underwriting and issuance expenses, including an interest rate lock agreement, the WMRe Senior Notes yield an effective rate of 6.49% per annum.
During the first quarter of 2007, White Mountains repaid the $320 million outstanding under its revolving credit facility using a portion of the net proceeds from the issuance of the WMRe Senior Notes. During the second quarter of 2007, White Mountains replaced its existing credit facility with a new $475 million revolving credit facility that matures in June 2012. This new facility removed WMRe Group as co-borrower and co-guarantor, added certain intermediate holding companies of White Mountains as co-guarantors and amended and/or removed certain financial and other covenants. As of December 31, 2007, the WTM Bank Facility was undrawn.
In November 2006, Fund American, a subsidiary of OneBeacon Ltd., established a $75 million revolving credit facility that matures in November 2011. All borrowings under this facility are guaranteed by OneBeacon Ltd. As of December 31, 2007, this facility was undrawn.
downgrade in their financial strength ratings, including a possible reduction in demand for their products in certain markets.
The WTM Bank Facility and the Fund American Bank Facility contain 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. Failure to meet one or more of these covenants could result in an event of default, which ultimately could eliminate availability under these facilities and result in acceleration of principal repayment on any amounts outstanding. At December 31, 2007, White Mountains was in compliance with all of the covenants under the WTM Bank Facility and the Fund American 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, 2007:
White Mountains also has future binding commitments to fund certain limited partnership investments. These commitments, which total approximately $144 million, do not have fixed funding dates and are therefore excluded from the table above.
In March 2007, White Mountains Re received net proceeds of $392 million through the issuance of the WMRe Senior Notes and subsequently paid a cash dividend of $392 million to its immediate parent. White Mountains used a portion of these proceeds to repay its $320 million outstanding balance on its existing bank facility.
During 2007, the Company repurchased and retired 290,841 of its common shares for $145 million as part of its previously announced share repurchase plan.
During 2007, OneBeacon Ltd. declared and paid cash dividends of $84 million to its common shareholders, $60 million of which was received by an intermediate holding company of White Mountains. On June 30, 2007, OneBeacon repaid $20 million of its mandatorily redeemable preferred stock using funds that were held in trust for the purpose of economically defeasing the preferred stock. OneBeacon also paid $29 million in dividends on its mandatorily redeemable preferred stock during 2007, also using funds that were held in trust.
During 2007, OneBeacon Ltd. repurchased and retired 1.6 million of its common shares for $33 million as part of its previously announced share repurchase plan.
During 2007, White Mountains paid $41 million in interest under the Fund American Senior Notes and $20 million under the WMRe Senior Notes.
During 2007, White Mountains made payments totaling $56 million, in cash or by deferral into certain non-qualified compensation plans of the Company or its subsidiaries, to participants in its long-term incentive compensation plans. These payments were made with respect to 63,300 target performance shares at payout levels ranging from 145% to 186% of target.
During 2006, OneBeacon Ltd. declared and paid a $12 million cash dividend to its immediate parent and OneBeacon paid $90 million of dividends to Fund American. Also during 2006, White Mountains Re paid $46 million of dividends to its immediate parent.
During 2006, the Company, through various intermediate holding companies, contributed $100 million in cash and investments to White Mountains Re and $125 million in cash to Esurance.
During 2006, OneBeacon and Folksamerica Holdings repaid $8 million and $7 million, respectively, of loans to Dowling and Partners Connecticut Fund III LP.
On December 22, 2006, White Mountains Re acquired Mutual Service for $34 million in cash.
On September 29, 2006, OneBeacon transferred certain assets and the right to renew existing policies of its Agri division to QBE Insurance Group for $32 million in cash.
During the third quarter of 2006, White Mountains sold 5.4 million common shares of Montpelier Re for proceeds of $104 million in cash.
During 2006, the Company issued a total of 3,530 common shares to its employees through the exercise of Options during the period and received cash proceeds of $.6 million in connection with these Option exercises.
During 2005, OneBeacon drew down $18 million on an 18-year mortgage note that it entered into in connection with its purchase of land and a home office building.
During 2005, White Mountains received a total of $60 million in tax refunds and interest from the Internal Revenue Service related to the completion of an audit of White Mountains' 1997-2000 tax years, the period during which the Company redomesticated to Bermuda.
During 2005, the Company issued a total of 7,750 common shares to its employees through the exercise of Options during the period and received cash proceeds of $1 million in connection with these Option exercises.
See Note 20-"Transactions with Related Persons" in the accompanying Consolidated Financial Statements.
Ultimate loss and LAE are generally determined by extrapolation of claim emergence and settlement patterns observed in the past that can reasonably be expected to persist into the future. In forecasting ultimate loss and LAE with respect to any line of business, past experience with respect to that line of business is the primary resource, but cannot be relied upon in isolation. OneBeacon's own experience, particularly claims development experience, such as trends in case reserves, payments on and closings of claims, as well as changes in business mix and coverage limits, is the most important information for estimating its reserves. External data, available from organizations such as statistical bureaus, consulting firms and reinsurance companies, is sometimes used to supplement or corroborate OneBeacon's own experience, and can be especially useful for estimating costs of new business. For some lines of business, such as "long-tail" coverages discussed below, claims data reported in the most recent accident year is often too limited to provide a meaningful basis for analysis due to the typical delay in reporting of claims. For this type of business, OneBeacon uses a selected loss ratio method for the initial accident year or years. This is a standard and accepted actuarial reserve estimation method in these circumstances in which the loss ratio is selected based upon information used in pricing policies for that line of business, as well as any publicly available industry data, such as industry pricing, experience and trends, for that line of business.
OneBeacon performs an actuarial review of its recorded reserves each quarter. OneBeacon's actuaries compare the previous quarter's estimates of paid loss and LAE, case reserves and IBNR to amounts indicated by actual experience. Differences between previous estimates and actual experience are evaluated to determine whether a given actuarial method for estimating loss and LAE should be relied upon to a greater or lesser extent than it had been in the past. While some variance is expected each quarter due to the inherent uncertainty in loss and LAE, persistent or large variances would indicate that prior assumptions and/or reliance on certain reserving methods may need to be revised going forward.
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 incurred and paid loss information or that trends included in the historical incurred 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, 2007 and 2006, total carried reserves were 2.7% and 1.8% above the actuarial point estimate, respectively.
Construction defect claims are a non-A&E exposure that has proven to have a greater degree of uncertainty when estimating loss and LAE using generally accepted actuarial methods. OneBeacon's general liability and multiple peril lines of business have been significantly impacted by a large number of construction defect claims. Construction defect is a liability allegation relating to defective work performed in the construction of structures such as apartments, condominiums, single family dwellings or other housing, as well as the sale of defective building materials. Such claims seek recovery due to damage caused by alleged deficient construction techniques or workmanship. Much of the recent claims activity has been generated by plaintiffs' lawyers who approach new homeowners, and in many cases homeowner associations with large numbers of homeowners in multi-residential complexes, about defects or other flaws in their homes. Claims for construction defects began with claims relating to exposures in California. Then, as plaintiffs' lawyers organized suits in other states with high levels of multi-residential construction, construction defect claims were reported in nearby western states, such as Colorado and Nevada, and eventually throughout the country. The reporting of such claims can be quite delayed as the statute of limitations can be up to ten years. Court decisions have expanded insurers' exposure to construction defect claims as well. For example, in 1995 California courts adopted a "continuous trigger" theory in which all companies that had ever insured a property that was alleged to have been damaged must respond to the claimant, even if evidence of the alleged damage did not appear until after the insurance period had expired. As a result, construction defect claims may be reported more than ten years after a project has been completed as litigation can proceed for several years before an insurance company is identified as a potential contributor. Claims have also emerged from parties claiming additional insured status on policies issued to other parties (e.g., such as contractors seeking coverage on a sub-contractor's policy). Further, in reserving for these claims, there is additional uncertainty due to the potential for further unfavorable judicial rulings and regulatory actions. The primary actuarial methods that are used to estimate loss and LAE reserves for construction defect claims are frequency and severity methods. These methods separately project the frequency of future reported claims and the average cost, or severity, of individual claims. The reserve is the product of the projected number of reported claims and the severity.
A large number of construction defect claims have been identified relating to coverages that OneBeacon had written in the past through Commercial Union Corporation and General Accident Corporation of America, which OneBeacon refers to as their legacy companies, and their subsidiaries in California, Colorado, Nevada, Washington and Oregon. OneBeacon's management has sought to mitigate future construction defect risks in all states by no longer providing insurance to certain residential general contractors and sub-contractors involved in multi-habitational projects. Mitigating actions also included initiating the withdrawal from problematic sub-segments within OneBeacon's construction book of business, such as street and road construction, water, sewer and pipeline construction. As a result of these actions, OneBeacon's management believes that the number of reported construction defect claims relating to coverages written in the past peaked in 2004 and will continue to decline.
OneBeacon's reserves include provisions made for claims that assert damages from A&E related exposures. Asbestos claims relate primarily to injuries asserted by those who allegedly came in contact with asbestos or products containing asbestos. Environmental claims relate primarily to pollution and related clean-up cost obligations, particularly as mandated by federal and state environmental protection agencies. In addition to the factors described above under "Non-Asbestos and Environmental Reserves" regarding the reserving process, OneBeacon estimates its A&E reserves based upon, among other factors, facts surrounding reported cases and exposures to claims, such as policy limits and deductibles, current law, past and projected claim activity and past settlement values for similar claims, as well as analysis of industry studies and events, such as recent settlements and asbestos-related bankruptcies. The cost of administering A&E claims, which is an important factor in estimating loss and LAE reserves, tends to be higher than in the case of non-A&E claims due to the higher legal costs typically associated with A&E claims.
OneBeacon also incurred A&E losses via its participation in industry pools and associations. The most significant of these pools was Excess Casualty Reinsurance Association ("ECRA"), which provided excess liability reinsurance to U.S. insurers from 1950 until the early 1980s. ECRA incurred significant liabilities for A&E, of which OneBeacon bears approximately a 4.7% share, or $60 million and $65 million at December 31, 2007 and 2006, respectively, which is fully reflected in OneBeacon's loss and LAE reserves.
More recently, since the 1990s, OneBeacon has experienced an increase in claims from commercial insureds, including many non-Fortune 500-sized accounts written during the 1970s and 1980s, who are named as defendants in asbestos lawsuits. As a number of large well-known manufacturers of asbestos and asbestos-containing products have gone into bankruptcy, plaintiffs have sought recoveries from peripheral defendants, such as installers, transporters or sellers of such products, or from owners of premises on which the plaintiffs' exposure to asbestos allegedly occurred. At December 31, 2007, 491 policyholders had asbestos-related claims against OneBeacon. In 2007, 102 new insureds with such peripheral involvement presented asbestos claims under prior OneBeacon policies.
As noted above, OneBeacon estimates that on an incurred basis it has ceded estimated incurred losses of approximately $2.1 billion of the coverage provided by NICO at December 31, 2007. Since entering into the NICO Cover, $40 million of the $2.1 billion of utilized coverage relates to uncollected amounts from third party reinsurers through December 31, 2007. Net losses paid totaled approximately $986 million as of December 31, 2007, with $139 million paid in 2007. Asbestos payments during 2007 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, 2007.
OneBeacon's reserves for A&E losses, net of Third Party Recoverables but prior to NICO recoveries, were $1.0 billion at December 31, 2007. 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 14.2 at December 31, 2007. This was computed as the ratio of A&E reserves, net of Third Party Recoverables prior to the NICO Cover of $1.2 billion plus the remaining unused portion of the NICO Cover of $404 million, to the average A&E loss payments over the three-year period ended December 31, 2007, net of Third Party Recoverables. OneBeacon's survival ratio was 16.6 at December 31, 2006. 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. 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, 2007 represent management's best estimate of its ultimate liability based on information currently available. Based on this estimate, OneBeacon believes the NICO Cover will be adequate to cover all of its A&E obligations. However, as case law expands, medical and clean-up costs increase and industry settlement practices change, OneBeacon may be subject to A&E losses beyond currently estimated amounts. Therefore, OneBeacon cannot guarantee that its A&E loss and LAE reserves, plus the remaining coverage under the NICO Cover, will be sufficient to cover additional liability arising from any such unfavorable developments. 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.
The process of establishing loss reserves is complex and imprecise as it must take into consideration many variables that are subject to the outcome of future events. As a result, informed subjective estimates and judgments as to OneBeacon's ultimate exposure to losses are an integral component of its loss reserving process. OneBeacon, like other insurance companies, categorizes and tracks its insurance reserves by "line of business", such as automobile liability, multiple peril package business, and workers compensation. Furthermore, OneBeacon regularly reviews the appropriateness of reserve levels at the line of business level, taking into consideration the variety of trends that impact the ultimate settlement of claims for the subsets of claims in each particular line of business.
•Recent increases in paid loss trends were inflated due to changes in claim handling procedures that decreased the settlement time for claims. This resulted in some increases in paid loss activity that OneBeacon believes will not continue into the future.
•Increases in case reserve adequacy over the 2001-2004 calendar periods have resulted in trends in case incurred activity that OneBeacon believes will not continue into the future. Case incurred activity can be the result of underlying changes in expected claim costs or changes in the adequacy of the case reserves relative to the underlying expected claim cost. If the activity is the result of underlying changes in expected costs, it is more likely to repeat in the future, and would likely result in prior year reserve development, as the change in ultimate claim costs would not have been considered when making the previous selection of IBNR reserves. If the activity is the result of changes in case reserve adequacy, it would not indicate any change in the ultimate claim costs and would not be expected to repeat in the future. In these cases, it is unlikely that prior year reserve development would occur, as the change in case reserves would be offset by a corresponding change in IBNR reserves (i.e., deficiency or redundancy in case reserves was implicitly captured when making the previous selection of IBNR reserves).
•In 2004, OneBeacon established a separate claim group to manage run-off claims. Due to the recent nature of this event, OneBeacon does not believe that the impacts of this group on future losses have been reflected in historical losses. Therefore, OneBeacon has given considerable weight to the most recent loss experience for this segment.
•Changes in claim handling philosophies (e.g., case reserving standards) Personal automobile liability book of business reserving factors
Multiple peril liability is generally considered a long tail line, as it takes a relatively long period of time to finalize and settle claims from a given accident year. The speed of claim reporting and claim settlement is a function of the specific coverage provided and the jurisdiction, among other factors. There are numerous components underlying the multiple peril liability product line. Some of these have relatively moderate payment patterns (with most of the claims for a given accident year closed within 5 to 7 years), while others can have extreme lags in both reporting and payment of claims (e.g., a reporting lag of a decade for "construction defect" claims).
Specifically, at December 31, 2006, management continued to expect losses to emerge in the professional liability business (which is included in OneBeacon's general liability line of business) in line with initial expectations based on market analysis when this business was initiated in 2002 and 2003. During 2007, emerged losses continued to be significantly lower than those initial expectations. As a result, management lowered its selected reserves on the earliest years of this business which had some effect on the more recent years as total loss expectations for those years are partially based on results from earlier years.
Specifically, OneBeacon's management had assumed at December 31, 2004 that the IBNR and known case development would be approximately 26% of actual case reserves for the 2001 and prior accident years for multiple peril and general liability. During 2005, case incurred loss and ALAE was 72% of the entire future expected development which was unusually large for these long tail lines of business. As a result, OneBeacon's management increased IBNR reserves for these lines so that as of year end 2005 the IBNR was approximately 40% relative to the remaining case reserves.
OneBeacon's range of reserve estimates at December 31, 2007 was evaluated to consider the strengths and weaknesses of the actuarial methods applied against OneBeacon's historical claims experience data. The following table shows the recorded reserves and the high and low ends of OneBeacon's range of reasonable loss reserve estimates at December 31, 2007. The high and low ends of OneBeacon's range of reserve estimates in the table below are based on the results of various actuarial methods described above.
The percentages shown in the following table represent the linear interpolation of where OneBeacon's recorded loss and LAE reserves are within the range of reserves estimates by line of business at December 31, 2007 and 2006, 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%.
During 2007, management saw increasing consistency in the actuarial methods which were used to develop the range of reserves for certain long tailed lines of business. As a result, management selected point estimates higher in the range and closer to the middle of the range for workers compensation, commercial automobile liability and multiple peril. Additionally in 2007, management continued to see favorable trends in some newer and/or growing segments relative to initial expectations. For personal automobile this resulted in selecting a reserve lower in the range and closer to the middle of the range. For homeowners and "other" (principally shorter tailed lines of business such as ocean and inland marine insurance) recorded reserves remain at the high end of their respective ranges, as management's selections reflect a conservative approach to recognition of recent favorable incurred loss development patterns. In general management continues to select somewhat higher in the range for newer and/or growing segments and as those reserves become an increasing proportion of its total reserves, OneBeacon's overall selected reserves have moved up in the range.
During the fourth quarter of 2007, White Mountains Re completed another detailed, ground-up asbestos exposure study. This study was an update to the analysis first performed in 2005. The study analyzed potential exposure to loss of all insureds that had reported at least $250,000 in losses to Folksamerica through reinsurance contracts as of June 30, 2007. This analysis entailed examining total expected asbestos losses and LAE from a variety of information sources, including asbestos studies, data reported to Folksamerica and a review of historical public filings. The results of this analysis were compared to Folksamerica's reinsurance contract layers to derive an estimated expected loss. White Mountains Re also analyzed a significant sample of all other insureds that had reported losses of less than $250,000 and extrapolated the sample findings to the entire population.
In addition, Folksamerica has received notices of claims from a number of other insureds with reported loss amounts that have not exceeded the attachment points in the reinsurance contracts written by Folksamerica. Based on the claims activity related to those insureds since the 2005 study, White Mountains Re estimated its exposure to these insureds as well as to insureds that have not reported any claims to date.
In the study, White Mountains Re sought to include adequate provision for future reported claims, premises/operations coverage (in addition to products liability coverage), and future adverse court decisions. To estimate this provision, White Mountains Re measured the changes in individual insured estimates from the 2005 study to the 2007 study to estimate future reported losses. The combined effect of all these estimates resulted in an increase of $52 million in IBNR asbestos losses and LAE.
In the fourth quarter of 2007, White Mountains Re also reviewed Folksamerica's exposure to environmental losses using industry benchmarks known as "survival ratios". The survival ratio, computed as a company's reserves divided by the average of its last three years' net loss payments, indicates approximately how many more years of payments the current reserves can support, assuming future yearly payments are consistent with the average three-year historical levels. This analysis led to an increase of $11 million in IBNR for environmental losses and LAE in the fourth quarter of 2007.
White Mountains Re's net reserves for A&E losses were $163 million and $112 million at December 31, 2007 and 2006, respectively. White Mountains Re's A&E three-year survival ratio was approximately 13 years and 8 years at December 31, 2007 and 2006, respectively.
The following tables show gross and net loss and LAE payments for A&E exposures for the years ending December 31, 2000 through December 31, 2007:
Generally, White Mountains Re sets up claim files for each reported claim by each cedent for each individual insured. In many instances, a single claim notification from a cedent could involve several years and layers of coverage resulting in a file being set up for each involvement. Precautionary claim notices are submitted by the ceding companies in order to preserve their right to pursue coverage under the reinsurance contract. Such notices do not contain an incurred loss amount. Accordingly, an open claim file is not established. As of December 31, 2007, White Mountains Re had approximately 1,198 open claim files for asbestos and 290 open claim files for environmental exposures.
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.
White Mountains Re also obtains 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 expected annual loss reporting assumptions are updated at least once a year. These assumptions are applied to year-end IBNR to generate expected reported losses for the subsequent year. Interpolation methods are applied to estimate quarterly reported losses, which are then compared to actual reported losses each quarter. Significant differences may result in a change in estimates or a revision in the loss reporting pattern. Expected loss ratios underlying the current accident year are updated quarterly, to reflect new business that is underwritten by the company.
In 2007, White Mountains Re recorded $9 million of net unfavorable development, which consisted of $63 million related to A&E exposures, $28 million of strengthening of certain of its U.S. casualty reserves and $7 million related to surety business. This adverse development was largely offset by favorable development of $91 million, primarily on property lines from prior accident years.
In 2005 and 2007, White Mountains Re changed its assumptions relating to asbestos reserves, as discussed above in the A&E section. During 2006, White Mountains Re increased its estimate for net losses from hurricanes Katrina, Rita, and Wilma by $86 million following the receipt of new claims information from several ceding companies and subsequent reassessment of ultimate loss exposures. The company also entered into an indemnity agreement with Olympus, which resulted in an additional $137 million in losses and LAE. Also in 2006, White Mountains Re increased prior year loss and LAE reserves by $55 million for casualty losses associated with the Risk Capital acquisition, primarily as a result of a detailed study of loss exposure by individual contract. Reserves for 2004 and prior years were decreased by $46 million at Sirius in 2006, as White Mountains Re has seen lower than expected loss emergence across all lines of business and have reduced IBNR accordingly.
As a result of this time lag in reporting, White Mountains Re estimates a portion of its written premium and related commissions and expenses. Given the nature of White Mountains Re's business, estimated premium balances, net of related commissions and expenses, comprise a large portion of total premium balances receivable. The estimation process begins by identifying which major accounts have not reported activity at the most recent period end. In general, premium estimates for excess of loss business are based on minimum deposit and premium information included in the contractual terms. For proportional business, White Mountains Re's estimates are derived from expected premium volume based on contractual terms or ceding company reports and other correspondence and communication with underwriters, intermediaries and ceding companies. Once premium estimates are determined, related commission and expense estimates are derived using contractual terms.
White Mountains Re closely monitors its estimation process on a quarterly basis and adjusts its estimates as more information and actual amounts become known. There is no assurance that the amounts estimated by White Mountains Re will not deviate from the amounts reported by the ceding company or reinsurance intermediary. Any such deviations are reflected in the results of operations when they become known.
In connection with the OneBeacon Acquisition, Aviva caused OneBeacon to purchase reinsurance contracts with two reinsurance companies rated "AAA" ("Extremely Strong", the highest of twenty-one ratings) by Standard & Poor's and "A++" ("Superior", the highest of fifteen ratings) by A.M. Best. One is a reinsurance cover with NICO which entitles OneBeacon to recover up to $2.5 billion in ultimate loss and LAE incurred related to A&E claims arising from business written by its predecessor prior to 1992 and 1987, respectively and certain other latent exposures. As of December 31, 2007, OneBeacon has ceded estimated incurred losses of approximately $2.1 billion to NICO under the NICO Cover. The other contract is a reinsurance cover with GRC for up to $570 million of additional losses on all claims arising from accident years 2000 and prior. As of December 31, 2007, OneBeacon has ceded estimated incurred losses of $550 million to GRC under the GRC Cover. The NICO Cover and GRC Cover, which were contingent on and occurred contemporaneously with the OneBeacon Acquisition, were put in place in lieu of a seller guarantee of loss and LAE reserves and are therefore accounted for as a seller guarantee under GAAP in accordance with Emerging Issues Task Force Topic No. D 54. NICO and GRC are wholly-owned subsidiaries of Berkshire.
The collectibility of reinsurance recoverables is subject to the solvency and willingness to pay of the reinsurer. The Company is selective in choosing its reinsurers, placing reinsurance principally with those reinsurers with a strong financial condition, industry ratings and underwriting ability. Management monitors the financial condition and ratings of its reinsurers on an ongoing basis. See Note 4-"Third Party Reinsurance" in the accompanying Consolidated Financial Statements for additional information on White Mountains' reinsurance programs.
The difference between an acquired company's loss and LAE reserves and White Mountains' best estimate of the fair value of such reserves at the acquisition date is amortized ratably over the payout period of the acquired loss and LAE reserves. Historically, the fair value of an acquired company's loss and LAE reserves has been less than its nominal reserves at acquisition. Accordingly, the amortization has been and will continue to be recorded as an expense on White Mountains' income statement until fully amortized.
•the risks associated with Item 1A of this Report on Form 10-K;
•changes in domestic or foreign laws or regulations, or their interpretation, applicable to White Mountains, its competitors or its clients;
•an economic downturn or other economic conditions adversely affecting its financial position;