The Company’s headquarters, registered office, principal executive office, and corporate accounting, reporting and internal audit offices are leased. White Mountains owns its investment and corporate finance office in Connecticut. Sirius Group’s home offices and substantially all of its branch offices are leased. OneBeacon owns a building in Canton, Massachusetts that houses certain of its shared services functions, while its principal executive office and branch offices are leased. Management considers its office facilities suitable and adequate for its current level of operations.
As a result of the Esurance Sale, the AutoOne Sale, and the Runoff Transaction, White Mountains has reclassified the results from these businesses for the past five years in the table above to discontinued operations, net of tax. In 2013, discontinued operations, net of tax, includes a $47 gain related to the sale of the Runoff Business and a net loss of $42 related to the operations of the Runoff Business. In 2012, discontinued operations, net of tax, includes a $91 loss related to the sale of the Runoff Business and a net loss of $24 related to the operations of the Runoff Business. In 2011, discontinued operations, net of tax, includes a $678 gain related to the Esurance Sale, a $19 loss related to the AutoOne Sale, and a $37 net loss related to the Runoff Business.
During 2012, White Mountains capitalized HG Global to fund the start-up of BAM. At December 31, 2013 and 2012, White Mountains owned 97.3% of HG Global’s preferred equity and 88.7% of its common equity. White Mountains does not have an ownership interest in BAM, which is a mutual insurance company owned by its members. Accordingly, all of BAM’s results are attributed to non-controlling interest.
The following discussion contains “forward-looking statements”. White Mountains intends statements that are not historical in nature, which are hereby identified as forward-looking statements, to be covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. White Mountains cannot promise that its expectations in such forward-looking statements will turn out to be correct. White Mountains’ actual results could be materially different from and worse than its expectations. See “FORWARD-LOOKING STATEMENTS” on page 108 for specific important factors that could cause actual results to differ materially from those contained in forward-looking statements.
Overview-Year Ended December 31, 2013 versus Year Ended December 31, 2012
White Mountains' GAAP total return on invested assets was 4.1% in 2013, compared to 4.9% in 2012. Currency translation did not meaningfully impact investment returns in 2013, while 2012 included 0.5% of foreign currency gains. White Mountains' fixed income portfolio was up 0.4% in U.S. dollars (0.5% in local currencies) in 2013, outperforming the longer duration Barclay's Intermediate Aggregate Bond Index of (1.0)% as interest rates rose during 2013. White Mountains' fixed income portfolio returned 4.4% in U.S. dollars (3.8% in local currencies) in 2012, compared to the Barclays U.S. Intermediate Aggregate return of 3.6%.
White Mountains’ value-oriented equity portfolio returned 18.9% in 2013, which includes the effect of a 23.2% return on its common stock portfolio, compared to the S&P 500 Index return of 32.4%. White Mountains’ equity portfolio underperformed the S&P 500 Index due to an overweight position in gold mining, an underweight position in the consumer discretionary and industrial sectors and the impact of convertible fixed maturity positions (as opposed to common equity securities), which tend to lag the index in strong up markets.
OneBeacon's book value per share decreased 0.8% during 2012, including dividends, compared to an increase of 3% during 2011, including dividends. OneBeacon's 2012 results included $101 million of after-tax GAAP losses related to the sale of the Runoff Business, which resulted in a decrease of $12 to White Mountains’ adjusted book value per share (net of non-controlling interest). OneBeacon's GAAP combined ratio was 98% for 2012 compared to 92% for 2011. The increase was primarily driven by higher catastrophe losses, mainly from hurricane Sandy, lower favorable loss reserve development and higher expenses. Sirius Group's GAAP combined ratio was 90% for 2012 compared to 100% for 2011. Sirius Group’s combined ratio for 2012 included 13 points of catastrophe losses, 11 points of which were from hurricane Sandy, compared to 24 points of catastrophe losses for 2011. Additionally, Sirius Group’s combined ratio for 2012 included 3 points of losses from its agricultural line of business, primarily as a result of the drought in the midwestern United States.
Total net written premiums increased 8% to $2,127 million in 2012, due to higher net written premiums at both OneBeacon and Sirius Group. OneBeacon’s net written premiums increased 11% to $1,179 million in 2012, primarily due to new business and improved retention in several lines, particularly within the accident, government risk, energy and technology businesses. Sirius Group’s net written premiums increased 3% to $948 million in 2012, primarily due to increases in the accident and health and property lines of business, partially offset by a decrease in the trade credit line of business.
A summary of White Mountains’ consolidated financial results for the years ended December 31, 2013, 2012 and 2011 follows:
Net gain (loss) on sale of discontinued operations, net of tax
Adjusted comprehensive income is a non-GAAP measure. For a reconciliation to the most comparable GAAP measure (see NON-GAAP FINANCIAL MEASURES on page 78).
White Mountains’ total revenues decreased 5% to $2,317 million in 2013, primarily due to lower earned insurance and reinsurance premiums, net investment income and other revenues, partially offset by higher net realized and unrealized investment gains. Earned insurance and reinsurance premiums decreased 4% to $1,987 million in 2013. Net investment income was down 28% to $111 million in 2013, primarily from a lower invested asset base, resulting from $749 million of share repurchases since January 2012, and lower investment yields. White Mountains reported net realized and unrealized investment gains of $162 million in 2013, which included $1 million of net realized and unrealized foreign currency gains, compared to $118 million of gains in 2012, which included $57 million of net realized and unrealized foreign currency losses. Most of the net realized and unrealized foreign currency gains (losses) on investments are related to GAAP foreign currency translation and are offset by amounts recognized in other comprehensive income (see “Foreign Currency Translation” on page 63). Other revenue decreased to $58 million in 2013 from $100 million in 2012. Other revenue in 2013 included transaction gains of $42 million, compared to $28 million of net transaction gains in 2012. Transaction gains in 2013 included a $23 million gain on OneBeacon’s sale of Essentia, a $7 million gain on Sirius Group’s acquisition of Empire, a $7 million gain on Sirius Group’s acquisition of Ashmere and a $4 million gain from the extension of the transition service agreement for services provided by OneBeacon on business sold to Tower in the personal lines transaction in 2010, while 2012 included a $15 million gain on Sirius Group’s sale of IMG, $14 million of gains from Sirius Group’s acquisitions that closed in 2012, a $5 million gain on OneBeacon’s sale of a shell company and a $6 million loss from OneBeacon’s repurchase of its remaining 2003 OBH Senior Notes. Other revenue in 2013 also included $1 million in foreign currency translation losses, compared to $40 million in foreign currency translation gains in 2012. In addition, 2013 included $11 million of mark-to-market gains on the Symetra warrants compared to $18 million of gains in 2012. Other revenue included a $17 million loss from WM Life Re in 2013 compared to a $25 million loss in 2012. See Note 8 - “Derivatives” for details regarding WM Life Re’s total impact on White Mountains’ statement of operations. In 2012, White Mountains reported other revenue of $24 million related to the consolidation of Hamer and Bri-Mar. Effective October 1, 2012, the results of Hamer and Bri-Mar are no longer consolidated in White Mountains' financial statements.
White Mountains' total expenses decreased 9% to $1,973 million in 2013. Losses and LAE decreased 13% in 2013, exceeding the 4% decrease in earned insurance and reinsurance premiums primarily as a result of lower catastrophe losses and higher favorable loss reserve development in 2013. Insurance and reinsurance acquisition expenses decreased 12% in 2013, exceeding the 9% decrease in net written premiums primarily due to changes in business mix at OneBeacon driven by the termination of the underwriting arrangement with Hagerty Insurance Agency and higher profit commissions accrued at Sirius Group on ceded European property business, while other underwriting expenses increased 3%, primarily due to higher incentive compensation expenses at Sirius Group.
White Mountains’ total revenues increased 12% to $2,436 million in 2012, primarily due to higher earned insurance and reinsurance premiums, foreign currency translation gains, higher net realized and unrealized investment gains and an improvement of the mark-to-market performance of the Symetra warrants, partially offset by lower net investment income. Earned premiums increased 7% to $2,064 million in 2012, with an 11% increase at OneBeacon and a 3% increase at Sirius Group. Net investment income was down 17% to $154 million in 2012, principally due to a lower invested asset base driven by share repurchases and lower fixed maturity yields. White Mountains reported net realized and unrealized investment gains of $118 million in 2012 compared to $74 million in 2011. Net realized and unrealized investment gains for both periods were impacted by foreign currency translation on U.S. dollar-denominated investments at Sirius International, the effects of which are offset in other comprehensive income (see “Foreign Currency Translation” on page 63). Other revenue increased to a gain of $100 million in 2012 from a loss of $10 million in 2011, due primarily to $40 million in foreign currency translation gains and $18 million in mark-to-market gains on the Symetra warrants in 2012, compared to $6 million in foreign currency translation losses and $25 million in mark-to-market losses on the Symetra warrants in 2011. Other revenue included a $25 million loss from WM Life Re in 2012 compared to a $16 million loss in 2011. Other revenue in 2012 also included a $15 million pre-tax gain on Sirius Group’s sale of IMG, $14 million in pre-tax transaction gains from White Mountains Solutions’ acquisitions that closed in 2012, a $5 million pre-tax gain on OneBeacon’s sale of a shell company and a $6 million pre-tax loss from OneBeacon’s repurchase of its remaining 2003 OBH Senior Notes. Other revenue in 2011 included a $7 million pre-tax gain from Sirius Group’s acquisition of Old Lyme.
White Mountains reported an income tax benefit of $16 million in 2012 on pre-tax income of $263 million. Effective January 1, 2013, Sweden reduced its corporate tax rate from 26.3% to 22.0% and Luxembourg increased its corporate tax rate from 28.8% to 29.2%. This resulted in a reduction in deferred tax liabilities in Sweden and an increase in deferred tax assets in Luxembourg at December 31, 2012. As a result, Sirius Group recognized $73 million in tax benefits from these changes. During 2012, Sirius Group also had a net release of valuation allowances on deferred tax assets in Luxembourg, resulting in a tax benefit of $41 million, and White Mountains established a valuation allowance on deferred tax assets of a group of U.S. companies reported in the Other Operations segment, resulting in a tax expense of $38 million. In total, White Mountains recognized $76 million in overall net tax benefits from these changes. Excluding the impact of these changes, White Mountains effective tax rate for 2012 was 23%, which was lower than the U.S. statutory rate of 35% due primarily to income generated in jurisdictions other than the United States.
White Mountains reported an income tax benefit of $110 million in 2011 on pre-tax income of $98 million, due primarily to a $130 million tax benefit from the release of a valuation allowance against certain deferred tax assets as a result of the reorganization of Sirius Group. In connection with the reorganization, which included Sirius Group’s acquisition of a Luxembourg holding company from OneBeacon in January 2012, internal debt was contributed to holding companies that had large deferred tax assets offset by full valuation allowances. Because the reorganization created a future stream of income for these holding companies, White Mountains was required to reduce the valuation allowances by $130 million in the fourth quarter of 2011. White Mountains also recorded a reclassification of $3 million of equity from White Mountains’ common shareholders’ equity to non-controlling interest, which represents OneBeacon’s minority shareholders’ portion of the excess of the purchase price over the net assets of the Luxembourg holding company. Excluding the valuation allowance reduction, White Mountains effective tax rate for 2011 was 20%, which was lower than the U.S. statutory rate of 35% due primarily to income generated in jurisdictions other than the United States.
In October 2012, OneBeacon entered into an agreement to sell the Runoff Business to Armour and recorded $101 million in after-tax losses related to the Runoff Transaction in 2012. These losses are composed of a $92 million after-tax loss on sale and a $9 million after-tax loss related to a reduction in the workers compensation loss reserve discount rate on reserves being transferred as part of the sale. During the fourth quarter of 2013, OneBeacon completed additional analysis of its runoff loss reserves. As a result of its analysis, OneBeacon increased its runoff loss reserves by $72 million ($47 million after tax), which was offset by an equal reduction of the estimated loss on sale, both reported within discontinued operations. The sale of the Runoff Business is pending the completion of regulatory review and is anticipated to close in mid-2014 (See Runoff Transaction on page 53). On October 7, 2011, White Mountains completed the sale of Esurance to Allstate for cash equal to $700 million plus the tangible book value at closing of the entities being sold and recorded a gain of $678 million. In 2011, OneBeacon agreed to sell its AutoOne business to Interboro and recorded a charge of $19 million after tax for the estimated loss on the sale. The AutoOne transaction closed in February 2012.
Financial results and GAAP combined ratios for OneBeacon for the years ended December 31, 2013, 2012 and 2011 follow:
OneBeacon's GAAP combined ratio decreased to 92% for 2013 from 98% for 2012, which reflects both lower loss and expense ratios as compared to 2012. The decrease in the loss ratio was driven by a decrease in catastrophe losses which were negligible in 2013 compared to 5 points of net catastrophe losses ($56 million, including $8 million of ceded reinstatement premiums) for 2012, due primarily to the impact of hurricane Sandy. Favorable loss reserve development for 2013 was negligible, compared to 1 point ($7 million) for 2012. The decrease in the expense ratio for 2013 was primarily from lower insurance acquisition expenses due to changes in business mix driven by the termination of the underwriting arrangement with Hagerty Insurance Agency, partially offset by higher non-claims litigation expenses.
OneBeacon's net written premiums decreased 8% in 2013 to $1,089 million, primarily due to the exit from the collector car and boat and energy businesses, partially offset by growth in nearly all of OneBeacon’s ongoing specialty lines. In January 2013, OneBeacon terminated its relationship with Hagerty and sold Essentia, the wholly owned subsidiary that wrote OneBeacon’s Hagerty collector car and boat business, to Markel Corporation. Excluding the $206 million of net written premiums from the exited businesses in 2012, net written premiums increased 12%.
OneBeacon’s GAAP combined ratio increased to 98% for 2012 from 92% for 2011, primarily driven by lower favorable loss reserve development, higher catastrophe losses and higher expenses. Favorable loss reserve development for 2012 was $7 million, or 1 point, compared to $30 million, or 3 points, for 2011. The favorable reserve development for 2012 was primarily in the workers' compensation, multiple peril liability and general liability lines, mostly offset by adverse loss reserve development on excess property claims. The combined ratio for 2012 included 5 points of net catastrophe losses ($56 million, including $8 million of ceded reinstatement premiums), due primarily to the impact of hurricane Sandy, compared to 4 points ($37 million) of catastrophe losses for 2011, primarily related to hurricane Irene, tornados in the southeastern and midwestern United States as well as storms and freezing weather in the northeastern and southwestern United States. The increase in the expense ratio is primarily the result of startup costs for new specialty businesses and costs associated with actions taken to migrate certain corporate functions to Minnesota in 2012.
OneBeacon’s net written premiums increased 11% in 2012 to $1,179 million, compared to $1,063 million in 2011, primarily due to the growth in several underwriting units, particularly within the Professional Insurance, Technology and Accident units.
Reinsurance protection. OneBeacon’s net combined ratio for 2012 was lower than its gross combined ratio by 1 point, primarily due to the significant amount of reinsurance cessions related to hurricane Sandy, which were partially off-set by the impact of the cost of facultative reinsurance and property reinsurance, and also the cost of catastrophe reinsurance and marine reinsurance. OneBeacon’s net combined ratio for 2011 was higher than its gross combined ratio by 4 points, primarily due to the impact of the cost of facultative reinsurance and property reinsurance, and also the cost of catastrophe reinsurance and marine reinsurance.
During the fourth quarter of 2013, and as part of its annual actuarial certification process, OneBeacon completed a comprehensive actuarial analysis of the non-A&E loss and LAE reserves associated with the Runoff Business. In addition to OneBeacon’s internal actuaries taking into account the differing assumptions, methods, and analyses produced by the independent actuarial review and other factors, management considered other sources of information, including runoff claims staffing models and related costs. For A&E reserve estimates associated with the Runoff Business, OneBeacon primarily relies on the internal study of its legacy A&E exposures completed in 2011 and on subsequent monitoring of quarterly A&E activity, including the comparison of that activity against what was assumed in that most recent study.
As a result of the comprehensive actuarial analysis conducted by OneBeacon during the fourth quarter of 2013, OneBeacon recorded $72 million of unfavorable prior year non-A&E loss and LAE development related to the Runoff Business. The increase in loss reserves was concentrated in the workers compensation, personal auto liability and excess liability lines of business. In addition, OneBeacon increased its estimate of adjusting and other expenses, a component of LAE reserves. OneBeacon has not revised its estimate of net ultimate A&E payments.
In October 2013, OneBeacon and Armour amended the Runoff SPA to extend the date at which either party may terminate the Runoff SPA to July 31, 2014. If the required regulatory approval to close the Runoff Transaction has not been obtained on or prior to July 31, 2014, either OneBeacon or Armour may unilaterally extend the termination date of the Runoff SPA by up to 90 days. OneBeacon expects the Runoff Transaction to close in mid-2014.
Sirius Group's GAAP combined ratio was 82% for 2013 compared to 90% for 2012. The decrease was primarily due to lower catastrophe losses, higher favorable loss reserve development and lower agricultural losses. The 2013 combined ratio included 10 points ($85 million) of catastrophe losses, net of reinsurance and reinstatement premiums, primarily comprised of $27 million of flood losses in Central Europe, $20 million of hail storm losses in Germany and France, and $8 million of losses from typhoon Fitow in China, while the 2012 combined ratio included 13 points ($117 million) of catastrophe losses, comprised mainly of $98 million of losses from hurricane Sandy. Favorable loss reserve development was 6 points ($48 million) in 2013, which included $24 million of favorable loss reserve development on prior year’s catastrophe losses. Other major reductions in loss reserve estimates recognized included property ($17 million), aviation/space ($10 million) and accident and health ($9 million), partially offset by a $12 million increase in asbestos loss reserves. Favorable loss reserve development was 4 points ($34 million) for 2012, primarily attributable to favorable development in property and casualty lines, offset by a $46 million increase in asbestos reserves. Additionally, the combined ratio for 2012 included 3 points of agricultural losses, primarily as a result of a drought in the Midwestern United States.
Sirius Group's gross written premiums decreased 5% for 2013 to $1,120 million, while net written premiums decreased 8% for 2013 to $877 million. These decreases were primarily from the accident and health and trade credit lines of business, partially offset by increases in the property lines. Net earned premiums decreased 7% for 2013 to $866 million due to lower accident and health and trade credit premiums. The effects of foreign currency translation on premiums were not material in 2013.
Sirius Group's insurance and reinsurance acquisition expenses decreased $14 million in 2013, primarily due to lower business volume and higher profit commissions earned on ceded European property treaties. Sirius Group's other underwriting expenses increased $10 million in 2013, primarily due to increased incentive compensation expenses and higher professional fees, primarily related to Lloyd's Syndicate 1945. General and administrative expenses decreased by $5 million, primarily due to lower severance and separation costs in 2013 as a result of reductions in staff in 2012. Accretion of fair value adjustment to losses and LAE reserves decreased by $9 million due to the acceleration of the amortization of the purchase accounting established for the acquisition of Scandinavian Reinsurance Company Ltd. (“Scandinavian Re”) due to a treaty commutation in the first quarter of 2012.
Sirius Group Results-Year Ended December 31, 2012 versus Year Ended December 31, 2011
Sirius Group's other revenues primarily consisted of $40 million of foreign currency translation gains recorded in 2012 compared to foreign currency translation losses of $6 million in 2011. (See “Foreign Currency Translation” on page 63.) Additionally, Sirius Group recorded pre-tax transaction gains of $14 million from White Mountains Solutions’ acquisitions of PICO, Citation, Woodridge and Oakwood and $15 million on the sale of its interest in IMG. In 2011, Sirius Group recorded a $7 million pre-tax gain from White Mountains Solutions’ acquisition of the loss reserve portfolio of Old Lyme.
Sirius Group's other underwriting expenses increased $11 million in 2012, primarily due to higher incentive compensation costs and professional fees. General and administrative expenses increased $10 million in 2012, primarily due to higher incentive compensation costs in addition to severance and separation costs as a result of a reduction in staff.
Reinsurance protection. Sirius Group's gross combined ratio was lower than the net combined ratio by 6 points for 2012 and 7 points for 2011. The higher net combined ratio for 2012 was primarily due to the cost of property retrocessions with limited ceded property loss recoveries. The higher net combined ratio for 2011 was due to the Japan and New Zealand earthquake losses, very little of which were ceded under Sirius Group's retrocessional reinsurance coverage, in addition to the cost of the property retrocessions.
The following table presents the components of pre-tax income included in White Mountains' HG Global/BAM segment related to the consolidation of HG Global, which includes HG Re and its other wholly-owned subsidiaries, and BAM for the years ended December 31, 2013 and 2012:
The following table presents amounts from HG Global, which includes HG Re and its other wholly-owned subsidiaries, and BAM that are contained within White Mountains’ consolidated balance sheet as of December 31, 2013:
The following table presents the gross par value of policies priced and closed by BAM for the year ended December 31, 2013:
White Mountains’ Other Operations segment reported pre-tax income of $15 million in 2013 compared to pre-tax income of $8 million in 2012. White Mountains’ Other Operations segment reported net realized and unrealized investment gains of $97 million in 2013 compared to $45 million in 2012. (See Summary of Investment Results on page 60.) The Other Operations segment reported net investment income of $15 million in 2013 compared to $33 million in 2012, primarily due to a lower average invested asset base, mainly a result of White Mountains’ investment of approximately $600 million in HG Global in July 2012 and share repurchases, and a shift in the investment portfolio from fixed maturities towards common equity securities. The value of White Mountains’ investment in Symetra warrants prior to their exercise during the second quarter of 2013 increased $11 million in 2013 compared to an increase of $18 million in 2012. (See Investment in Symetra Common Shares on page 62.) WM Life Re reported losses of $17 million in 2013 compared to $19 million in 2012. The improvement in WM Life Re’s results was primarily due to $7 million of gains in 2013 associated with changes in projected surrender assumptions, partially offset by increased trading expenses. See Note 8 - “Derivatives” for details regarding WM Life Re’s total impact on White Mountains’ statement of operations.
White Mountains’ Other Operations segment reported pre-tax income of $8 million in 2012 compared to a pre-tax loss of $103 million in 2011. The improvement in the 2012 results was driven by an improvement in the mark-to-market performance of the Symetra warrants, higher pre-tax income from investments, lower incentive compensation expenses and lower losses from WM Life Re. 2011 included a higher level of incentive compensation expenses as a result of the gain from the Esurance Sale and a 35% increase in White Mountains’ stock price during 2011 compared to a 14% increase in 2012. The value of White Mountains' investment in Symetra warrants increased $18 million in 2012 compared to a decrease of $25 million in 2011. WM Life Re reported pre-tax loss of $19 million in 2012 compared to pre-tax loss of $27 million in 2011. See Note 8 - “Derivatives” for details regarding WM Life Re’s total impact on White Mountains’ statement of operations.
Share repurchases. White Mountains repurchased and retired 1,329,640 of its common shares for $669 million in 2012 at an average price per share of $503.09, or approximately 86% of White Mountains' December 31, 2012 adjusted book value per share.
For purposes of discussing rates of return, all percentages are presented gross of management fees and trading expenses in order to produce a better comparison to benchmark returns, while all dollar amounts are presented net of any management fees and trading expenses. A summary of White Mountains’ consolidated pre-tax investment results for the years ended December 31, 2013, 2012 and 2011 follows:
Excludes non-investment related foreign currency (losses) gains that are also recognized through other comprehensive income of $(8.7), $(55.9) and $26.5.
White Mountains maintains a high-quality, short-duration fixed income portfolio. At December 31, 2013, the fixed income portfolio duration was approximately 2.1 years, including short term investments, compared to 2.4 years at December 31, 2012. White Mountains’ fixed income portfolio returned 0.4% in U.S. dollars (0.5% in local currencies) in 2013, outperforming the longer duration Barclay's Intermediate Aggregate Bond Index of (1.0)%, as interest rates rose during the year. White Mountains' fixed income portfolio returned 4.4% in U.S. dollars (3.8% in local currencies) in 2012, compared to the Barclays U.S. Intermediate Aggregate Bond Index return of 3.6%.
White Mountains maintains an equity portfolio that consists of common equity securities, convertible fixed maturity investments and other long-term investments and represents approximately 20% of GAAP invested assets at December 31, 2013. White Mountains' total equity portfolio returned 18.9% for 2013, lagging the S&P 500 Index return of 32.4%. White Mountains' total equity portfolio, which represented approximately 20% of GAAP invested assets at December 31, 2012, returned 7.7% for 2012, lagging the S&P 500 Index return of 16.0%.
Relative to the 2013 and 2012 S&P 500 Index returns, Prospector’s performance for both periods reflects an overweight position in gold mining, an underweight position in the consumer discretionary, technology and industrial sectors and the impact of convertible fixed maturity investments (as opposed to common equity securities), which tend to lag the index in strong up markets.
Total annualized returns for White Mountains’ separate accounts managed by Prospector compared to the annualized total returns of the S&P 500 Index are as follows:
(1) Annualized total returns since the inception of the Prospector separate account in the beginning of 2005, which was established in connection with an investment management agreement between Prospector and White Mountains whereby Prospector serves as a discretionary adviser with respect to specified assets, primarily equity securities.
White Mountains’ GAAP pre-tax total return on invested assets was 4.9% for 2012, which includes 0.5% of foreign currency gains, compared to 2.9% for 2011, which includes 0.2% of foreign currency losses.
At December 31, 2012, the fixed income portfolio duration was approximately 2.4 years, including short term investments, compared to 2.2 years at December 31, 2011. White Mountains fixed income portfolio returned 4.4% (3.8% in local currencies) for 2012, outperforming the longer duration Barclays U.S. Intermediate Aggregate Index return of 3.6%. White Mountains’ fixed income portfolio returned 3.1% for 2011 (3.3% in local currencies), trailing the benchmark return of 6.0%, as interest rates declined during 2011.
During 2013, 2012 and 2011, White Mountains recorded $35 million, $30 million and $26 million in after-tax equity in earnings from its investment in Symetra’s common shares. The table below illustrates (1) the per-Symetra common share value of the investment in Symetra's common shares used in the calculation of White Mountains' adjusted book value per share (2) Symetra's quoted stock price and (3) Symetra's book value per common share excluding unrealized gains and losses from its fixed maturity investment portfolio:
Value of the investment in Symetra’s common shares used in the calculation of White Mountains’ adjusted book value per share
Symetra’s book value per common share excluding unrealized gains and losses from its fixed maturity investment portfolio
At December 31, 2013, White Mountains’ investment portfolio included approximately $1.1 billion in non-U.S. dollar-denominated investments, most of which are held at Sirius International and are denominated in Swedish kronor or euros. The value of the investments in this portfolio is impacted by changes in the exchange rate between the U.S. dollar and the kronor and between the U.S. dollar and the euro. During 2013, the U.S. dollar weakened 1% against the kronor and 4% against the euro. These currency movements resulted in approximately $12 million of pre-tax foreign currency investment gains for the year ended December 31, 2013, which are recorded as components of net realized and unrealized investment gains (recognized in pre-tax income) and change in foreign currency translation on investments (recognized in other comprehensive income). During 2012, the U.S. dollar weakened 6% against the kronor and 2% against the euro, which resulted in $38 million of pre-tax foreign currency gains for the year. During 2011, the U.S. dollar strengthened 3% against the kronor and 3% against the euro, which resulted in $21 million of pre-tax foreign currency losses for the year.
Sirius International holds a large portfolio of investments that are denominated in U.S. dollars, but its functional currency is the Swedish kronor. When Sirius International prepares its stand-alone GAAP financial statements, it translates its U.S. dollar-denominated investments to Swedish kronor and recognizes the related foreign currency translation gains or losses through pre-tax income. When White Mountains consolidates Sirius International, it translates Sirius International’s stand-alone GAAP financial statements to U.S. dollars and recognizes the foreign currency gains or losses arising from this translation, including those associated with Sirius International’s U.S. dollar-denominated investments, through other comprehensive income. Since White Mountains reports its financial statements in U.S. dollars, there is no net effect to adjusted book value per share or to investment returns from foreign currency translation on its U.S. dollar-denominated investments at Sirius International. However, net realized and unrealized investment gains, other revenues and other comprehensive income can be significantly affected during periods of high volatility in the foreign exchange rate between the U.S. dollar and other currencies, especially the Swedish kronor.
The amount of foreign currency translation on Sirius International’s U.S. dollar denominated investments recognized as an increase of other comprehensive income and a decrease of net income was $10 million in 2013. The amount of foreign currency translation on Sirius International’s U.S. dollar denominated investments recognized as an increase of other comprehensive income and a decrease of net income was $40 million in 2012. The amount of foreign currency translation on Sirius International’s U.S. dollar denominated investments recognized as a decrease of other comprehensive income and an increase of net income was $25 million in 2011.
The breakdown of White Mountains’ fixed maturity and convertible fixed maturity investments at December 31, 2013 by credit class, based upon issue credit ratings provided by Standard & Poor’s, or if unrated by Standard & Poor’s, long term obligation ratings provided by Moody’s, is as follows:
White Mountains’ investment portfolio consists of debt and equity securities issued in over 30 countries worldwide. The United States represents the country of issue for 79% of White Mountains’ fixed maturity, common equity security and convertible fixed maturity investment portfolios. White Mountains has minimal sovereign risk exposure to European peripheral countries such as Ireland, Greece, Portugal, Spain and Italy (“peripheral countries”). White Mountains’ portfolio includes 0.7% of total fixed maturity, convertible fixed maturity and common equity security investments issued from these peripheral countries at December 31, 2013. However, White Mountains may have indirect exposure to peripheral countries through securities issued from non-peripheral countries as the issuers of those securities could have exposure to peripheral countries.
The following tables list White Mountains’ investments in fixed maturity investments, common equity securities and convertible fixed maturity investments at December 31, 2013 categorized as financial or non-financial investments and by country of issue:
Operating subsidiary level. The primary sources of cash for White Mountains’ insurance and reinsurance operating subsidiaries are expected to be premium collections, net investment income, proceeds from sales and maturities of investments, contributions from holding companies, capital raising activities and, from time to time, proceeds from the sales of operating subsidiaries. The primary uses of cash are expected to be claim payments, policy acquisition costs, purchases of investments, payments on and repurchases/retirements of its debt obligations, distributions and tax sharing payments made to holding companies and operating expenses and, from time to time, purchases of operating subsidiaries.
OneBeacon’s combined statutory surplus (including U.S. statutory surplus and Bermuda statutory capital and surplus for Split Rock) was $1.0 billion and $0.9 billion as of December 31, 2013 and 2012. OneBeacon’s combined U.S. statutory surplus as of both December 31, 2013 and 2012 was $0.9 billion. Split Rock’s statutory capital and surplus was $96.4 million as of December 31, 2013.
OneBeacon Insurance Company (“OBIC”), OneBeacon's primary top tier regulated U.S. insurance operating subsidiary, has the ability to pay dividends during any 12-month period without the prior approval of regulatory authorities in an amount set by formula based on the greater of prior year statutory net income or 10% of prior year end statutory surplus, subject to the availability of unassigned funds. OBIC has the ability to pay $87 million of dividends during 2014 without prior approval of regulatory authorities, subject to the availability of unassigned funds. The amount of dividends available to be paid by OBIC in any given year is also subject to cash flow and earnings generated by OBIC’s business, which now just comprises the Runoff Business, as well as to dividends received from its subsidiaries, including Atlantic Specialty Insurance Company (“ASIC”), the lead U.S. insurance operating subsidiary for the Ongoing Business. At December 31, 2013, OBIC had $0.6 billion of unassigned funds and $0.9 billion of statutory surplus.
As disclosed in Note 21 - “Discontinued Operations” of the accompanying consolidated financial statements, during the fourth quarter of 2012, OneBeacon executed various intercompany reinsurance agreements which, along with other internal capital transactions among its regulated U.S. insurance operating subsidiaries, resulted in ASIC becoming the lead insurance company for the ongoing specialty business and OBIC becoming the lead insurance company for the Runoff Business. Notwithstanding these restructuring transactions, OneBeacon continues to manage its statutory capital on a combined basis. Although OBIC remains the primary top tier regulated U.S. insurance operating subsidiary and maintains sufficient statutory capital to support the Runoff Business, the majority of the group's statutory capital is now included in ASIC, which is currently a subsidiary of OBIC, to support the ongoing specialty business. Prior to the closing of the Runoff Transaction and subject to regulatory approval, OBIC will distribute ASIC to its immediate parent, OneBeacon LLC.
ASIC has the ability to pay dividends during any 12-month period without the prior approval of regulatory authorities in an amount set by formula based on the lesser of net investment income, as defined by statute, or 10% of statutory surplus, in both cases as most recently reported to regulatory authorities, subject to the availability of earned surplus and subject to dividends paid in prior periods. ASIC has the ability to pay $24 million of dividends during 2014 without prior approval of regulatory authorities, subject to the availability of earned surplus. Given the changes in structure noted above, and in order for ASIC to pay dividends consistent with being the lead insurance company for the Ongoing Business, ASIC may require prior approval by regulatory authorities in order to make additional distributions until it builds up a historical net investment income stream and earned surplus balance under its new structure. At December 31, 2013, ASIC had $95 million of earned surplus and $0.7 billion of statutory surplus. During 2013, ASIC paid a $190 million extraordinary return of capital to OBIC, which, in turn, distributed the $190 million to its immediate parent. During 2013, OneBeacon also contributed $35.0 million to OBIC.
In addition, under the Companies Act, Split Rock is prohibited from declaring or paying a dividend or making a distribution out of contributed surplus if there are reasonable grounds for believing that after such payment is made, Split Rock would be unable to pay its liabilities as they become due or the realizable value of the its assets would be less than its liabilities.
During 2014, Split Rock has the ability to make capital distributions without the prior approval of regulatory authorities, subject to meeting all appropriate liquidity and solvency requirements, of up to $20 million, which is equal to 15% of its December 31, 2013 statutory capital, excluding earned surplus. During 2013, OneBeacon contributed $135 million to Split Rock. Split Rock did not pay any dividends in 2013.
During 2013, OneBeacon's unregulated insurance operating subsidiaries paid $17 million of dividends to their immediate parent. At December 31, 2013, OneBeacon’s unregulated insurance operating subsidiaries had $58 million of net unrestricted cash, short-term investments and fixed maturity investments.
At December 31, 2013, OneBeacon Ltd. and its intermediate holding companies held $218 million of net unrestricted cash, short-term investments and fixed maturity investments and $90 million of common equity securities and convertible fixed maturity investments outside of its regulated and unregulated insurance operating subsidiaries.
There is a capital maintenance agreement between Sirius International and Sirius America which obligates Sirius International to make contributions to Sirius America's surplus in order for Sirius America to maintain surplus equal to at least 125% of the company action level risk based capital as defined in the NAIC Property/Casualty Risk-Based Capital Report. The agreement provides for a maximum contribution to Sirius America of $200 million. Sirius International also provides Sirius America with accident year stop loss reinsurance, which protects Sirius America's accident year loss and allocated loss adjustment expense ratio in excess of 70%, with a limit of $90 million. This stop loss contract was in effect for all of 2013 and has been renewed for all of 2014 with the same terms.
Interest on the BAM Surplus Notes is payable quarterly at a fixed annual rate of 8.0%. BAM manages its affairs on a statutory accounting basis. BAM’s statutory surplus includes surplus notes and is not reduced by accruals of interest expense on the surplus notes. Interest and principal payments are subject to approval of the NYDFS. Interest expense on the BAM Surplus Notes does not reduce BAM’s statutory surplus until the payment of the interest is approved by the NYDFS. BAM did not pay any interest on the BAM Surplus Notes in 2013. BAM’s members’ surplus, as reported to regulatory authorities as of December 31, 2013 was $469 million.
Insurance float can increase in a number of ways, including through acquisitions of insurance and reinsurance operations, organic growth in existing insurance and reinsurance operations and recognition of losses that do not cause a corresponding reduction in investment assets. Conversely, insurance float can decrease in a number of other ways, including sales of insurance and reinsurance operations, shrinking or runoff of existing insurance and reinsurance operations, the acquisition of operations that do not have substantial investment assets (e.g., an agency) and the recognition of gains that do not cause a corresponding increase in investment assets. 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 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.
Excludes funds held by ceding companies from which White Mountains does not receive interest credits.
Equity in net unrealized gains from Symetra’s fixed maturity portfolio, net of
In addition, a failure by certain of White Mountains’ subsidiaries to pay principal and interest on a credit facility, mortgage or similar debt agreement (“covered debt”), where such a default results in the acceleration of at least $75 million of the principal amount of covered debt, could trigger a cross acceleration provision contained in the WTM Bank Facility.
It is possible that, in the future, one or more of the rating agencies may lower White Mountains’ credit existing ratings. If one or more of its ratings were lowered, White Mountains could incur higher borrowing costs on future borrowings and its ability to access the capital markets could be impacted. In addition, White Mountains’ insurance and reinsurance operating subsidiaries could be adversely impacted by a lowering of their financial strength ratings, including a possible reduction in demand for their products in certain markets.
In November 2012, OBH issued $275 million face value of senior unsecured notes through a public offering, at an issue price of 99.9%. The net proceeds from the issuance of the 2012 OBH Senior Notes were used to repurchase the remaining 2003 OBH Senior Notes. The 2012 OBH Senior Notes, which are fully and unconditionally guaranteed as to the payment of principal and interest by OneBeacon Ltd., bear an annual interest rate of 4.60%, payable semi-annually in arrears on May 9 and November 9, until maturity on November 9, 2022.
In addition, a failure by OneBeacon Ltd. subsidiaries to pay principal and interest on covered debt, where such failure results in the acceleration of at least $75 million of the principal amount of covered debt, could trigger the acceleration of the 2012 OBH Senior Notes. A failure by SIG subsidiaries to pay principal and interest on covered debt, where such failure results in the acceleration of at least $25 million principal amount of covered debt, could trigger the acceleration of the SIG Senior Notes.
In May 2007, SIG issued $250 million non-cumulative perpetual preference shares, with an initial fixed annual dividend rate of 7.506%. In June 2017, the fixed rate will move to a floating rate equal to the greater of (i) 7.506% and (ii) 3-month LIBOR plus 320 bps. In July 2013, SIG executed a 5-year forward LIBOR cap for the period from June 2017 to June 2022 to protect against a significant increase in interest rates during that 5-year period. The Interest Rate Cap economically fixes the annual dividend rate on the SIG Preference Shares from June 2017 to June 2022 at 8.30%. The cost of the Interest Rate Cap was an upfront premium of 395 bps of the $250 million notional value, or $10 million for the full notional amount.
In December 2011, OBIC, an indirect wholly-owned subsidiary of OneBeacon Ltd., sold the majority of its fixed assets and capitalized software to OneBeacon Services LLC (“OB Services”), another indirect wholly-owned subsidiary of OneBeacon Ltd. The fixed assets and capitalized software were sold at a cost equal to book value with no gain or loss recorded on the sale. Subsequent to purchasing the fixed assets and capitalized software from OBIC, OB Services entered into lease financing arrangements with US Bancorp Equipment Finance, Inc. (“US Bancorp”) and Fifth Third Equipment Finance Company (“Fifth Third”) whereby OB Services sold its fixed assets to US Bancorp and its capitalized software to Fifth Third. The assets were sold at a cost equal to net book value. OB Services then leased the fixed assets back from US Bancorp for a lease term of five years and leased the capitalized software back from Fifth Third for a lease term of four years. OB Services received cash proceeds of $23 million as a result of entering into the sale-leaseback transactions. At the end of the lease terms, OB Services will be obligated to purchase the leased assets for a nominal fee, after which all rights, title and interest would transfer to OB Services. At December 31, 2013, OB Services has recorded a capital lease obligation of $13 million included within other liabilities and a capital lease asset of $11 million included within other assets.
Below is a schedule of White Mountains’ material contractual obligations and commitments as of December 31, 2013:
The SIG Preference Shares are not included in the table above as these perpetual preferred shares have no stated maturity date and are redeemable only at the option of SIG. See “Sirius Group’s Preference Shares and Senior Notes” on page 21 for more details.
WM Life Re reinsures death and living benefit guarantees associated with certain variable annuities issued in Japan. WM Life Re has assumed the risk related to a shortfall between the account value and the guaranteed value that must be paid by the ceding company to an annuitant or to an annuitant’s beneficiary in accordance with the underlying annuity contracts. WM Life Re uses derivative instruments, including put options, interest rate swaps, total return swaps and futures contracts on major equity indices, currency pairs and government bonds, to mitigate the risks associated with changes in the fair value of the reinsured variable annuity guarantees. As of December 31, 2013, the total guarantee value was approximately ¥203.6 billion (approximately $1.9 billion) and the related account values were approximately 104% of this amount.
White Mountains purchases derivative instruments, including futures and over-the-counter option contracts on interest rates, major equity indices, and foreign currencies, to mitigate the risks associated with changes in the fair value of the reinsured variable annuity guarantees. At December 31, 2013, the fair value of these derivative instruments was $69 million. In addition, WM Life Re held approximately $81 million of cash and fixed maturity investments at December 31, 2013 posted as collateral to its reinsurance and derivatives counterparties.
In 2006, White Mountains' Board of Directors authorized the Company to repurchase up to 1,000,000 of its common shares, from time to time, subject to market conditions. In 2010 and 2012, White Mountains' Board of Directors authorized the Company to repurchase an additional 600,000 and 1,000,000, respectively, of its common shares, for a total authorization of 2.6 million shares. Shares may be repurchased on the open market or through privately negotiated transactions. The repurchase authorizations do not have a stated expiration date. At December 31, 2013, White Mountains may repurchase an additional 545,496 shares under these board authorizations. In addition, from time to time White Mountains has also repurchased its common shares through tender offers that were separately approved by its Board of Directors.
During 2012, White Mountains repurchased a total of 1,329,640 of its common shares for $669 million at an average share price of $503, which was 86% of White Mountains' adjusted book value per share of $588 at December 31, 2012. These repurchases were comprised of (1) 502,801 common shares repurchased under the board authorization for $256 million at an average share price of $508; (2) 816,829 common shares repurchased through a fixed-price tender offer for $409 million at a share price of $500; and (3) 10,010 common shares repurchased pursuant to employee benefit plans.
Cash flows from operations for the years ended 2013, 2012 and 2011
Net cash flows (used for) provided from continuing operations was $(29) million, $(30) million and $94 million in 2013, 2012 and 2011, respectively. An increase in cash provided by continuing operations during 2013, primarily due to an increase at OneBeacon due to inflows from premiums exceeding loss and LAE payments and an increase in unrestricted cash collateral held in respect of its surety business, was partially offset by cash used for the settlements and purchases of derivative instruments at WM Life Re and payments made on losses related to hurricane Sandy. Cash flows from continuing operations decreased $124 million from 2011 to 2012 due to declining net investment income, primarily due to a decrease in the overall average invested asset base, the final settlement and commutation of Scandinavian Re’s multi-year retrocessional Casualty Aggregate Stop Loss Agreement with St. Paul, as well as commutations and runoff of Sirius Group's casualty business and payments of losses incurred in 2010 and 2011 related to major catastrophes, primarily from earthquakes in Chile, Japan and New Zealand. Net cash flows used for discontinued operations was $72 million, $196 million and $209 million in 2013, 2012 and 2011, respectively. The cash outflows from discontinued operations in 2013 were primarily due to the runoff of reserves related to businesses that OneBeacon has agreed to sell to Armour. The cash outflows from discontinued operations in 2012 and 2011 were primarily due to the runoff of reserves related to the Runoff Business.
Cash flows from investing and financing activities for the year ended December 31, 2013
During 2013, OneBeacon paid a total of $13 million of interest on the 2012 OBH Senior Notes.
During 2013, OneBeacon contributed $135 million to Split Rock and $35 million to OBIC.
During 2013, OneBeacon completed the sale of Essentia and received $31 million as consideration.
During the first quarter of 2012, the Company declared and paid a $7 million cash dividend to its common shareholders.
During 2012, White Mountains Solutions acquired PICO and Citation for a purchase price of $15 million and Woodridge and Oakwood for a purchase price of $35 million.
During 2011, the Company repurchased and retired 646,502 of its common shares for $253 million, which included 189 common shares repurchased under employee benefit plans.
During 2011, White Mountains completed the sale of Esurance and received $1.01 billion in cash proceeds from Allstate.
During 2011, Sirius Group acquired Old Lyme for $6 million in cash and a note of $2 million.
Adjusted comprehensive income is a non-GAAP financial measure that excludes the change in equity in net unrealized gains and losses from Symetra’s fixed maturity portfolio, net of applicable taxes, from comprehensive income. In the calculation of comprehensive income under GAAP, fixed maturity investments are marked-to-market while the liabilities to which those assets are matched are not. Symetra attempts to earn a “spread” between what it earns on its investments and what it pays out on its products. In order to try to fix this spread, Symetra invests in a manner that tries to match the duration and cash flows of its investments with the required cash outflows associated with its life insurance and structured settlements products. As a result, Symetra typically earns the same spread on in-force business whether interest rates fall or rise. Further, at any given time, some of Symetra’s structured settlement obligations may extend 40 or 50 years into the future, which is further out than the longest maturing fixed maturity investments regularly available for purchase in the market (typically 30 years). For these long-dated products, Symetra is unable to fully match the obligation with assets until the remaining expected payout schedule comes within the duration of securities available in the market. If at that time, these fixed maturity investments have yields that are lower than the yields expected when the structured settlement product was originally priced, the spread for the product will shrink and Symetra will ultimately harvest lower returns for its shareholders. GAAP comprehensive income increases when rates decline, which would suggest an increase in the value of Symetra - the opposite of what is happening to the intrinsic value of the business. Therefore, White Mountains’ management and Board of Directors use adjusted comprehensive income when assessing Symetra’s quarterly financial performance. In addition, this measure is typically the predominant component of change in adjusted book value per share, which is used in calculation of White Mountains’ performance for both short-term (annual bonus) and long-term incentive plans. The reconciliation of adjusted comprehensive income to comprehensive income is included on page 48.
Total capital at White Mountains is comprised of White Mountains’ common shareholders’ equity, debt and non-controlling interest in OneBeacon Ltd., HG Global and the SIG Preference Shares. Total adjusted capital excludes the equity in net unrealized gains and losses from Symetra’s fixed maturity portfolio, net of applicable taxes from total capital. The reconciliation of total capital to total adjusted capital is included on page 72.
Upon completion of each quarterly review, OneBeacon’s actuaries select indicated reserve levels based on the results of the actuarial methods described previously, which are the primary consideration in determining management’s best estimate of required reserves. However, in making its best estimate, management also considers other qualitative factors that may lead to a difference between held reserves and actuarially recommended levels in the future. Typically, these factors exist when management and OneBeacon’s actuaries conclude that there is insufficient historical reported and paid loss information or that trends included in the historical reported and paid loss information are unlikely to repeat in the future. Such factors include, among others, recent entry into new markets or new products, improvements in the claims department that are expected to lessen future ultimate loss costs and legal and regulatory developments. At December 31, 2013 and 2012, carried reserves that are related to the Ongoing Business were 5% and 6% above the actuarial central estimate. Loss and LAE reserves related to the Runoff Business that are presented in liabilities held for sale in the December 31, 2013 and 2012 balance sheets were at the actuarial central indications and 4% above the actuarial central estimate, respectively.
For loss and allocated LAE reserves, excluding A&E, the key assumption as of December 31, 2013 was that the impact of the various reserving factors, as described below, on future paid losses would be similar to the impact of those factors on the historical loss data with the exception of severity trends, which have been relatively stable over the relevant historical period. The actuarial methods used would project losses assuming continued stability in severity trends. Management has considered future increases in loss severity trends, including the impact of inflation, in making its reserve selections.
Workers compensation covers an employer’s liability for injuries, disability or death of employees, without regard to fault, as prescribed by state workers compensation law and other statutes. Workers compensation is generally considered a long tail coverage, as it takes a relatively long period of time to finalize claims from a given accident year. While certain payments such as initial medical treatment or temporary wage replacement for the injured worker are made quickly, some other payments are made over the course of several years, such as awards for permanent partial injuries. In addition, some payments can run as long as the injured worker’s life, such as permanent disability benefits and ongoing medical care. Despite the possibility of long payment tails, the reporting lags are generally short, settlements are generally not complex, and most of the liability can be considered high frequency with moderate severity. The largest reserve risk generally comes from the low frequency, high severity claims providing lifetime coverage for medical expense arising from a worker’s injury.
Changes in the cost of medical treatments, including prescription drugs, and underlying fee schedules
During 2011, OneBeacon experienced $30 million of net favorable loss and LAE reserve development on prior accident year loss reserves. The favorable loss reserve development was primarily due to lower than expected severity on non-catastrophe losses related to professional liability lines, multiple peril liability lines and other general liability lines.
As a result of the comprehensive actuarial analysis conducted by OneBeacon during the fourth quarter of 2013, OneBeacon recorded $72 million of unfavorable prior year non A&E loss and LAE development related to the Runoff Business. The increase in loss reserves was concentrated in the workers compensation, personal auto liability, and excess liability lines of business. In addition, OneBeacon increased its estimate of adjusting and other expenses, a component of LAE reserves. OneBeacon has not revised its estimate of net ultimate A&E payments.
During 2013, OneBeacon recorded $79 million loss and LAE provision for the Runoff Business, which includes a $7 million of increase in loss and LAE reserves recorded in the second quarter of 2013. The $79 million loss and LAE adverse development recorded in 2013 was partially offset by other revenue of $8 million associated with a settlement award in the second quarter of 2013 in the Safeco v. AIG class action related to AIG’s alleged underreporting of workers' compensation premiums to the National Workers' Compensation Reinsurance Pool.
During 2012, OneBeacon experienced $40 million of net unfavorable loss and LAE development related to the Runoff Business primarily driven by case incurred development on claims related to multiple peril liability lines and general liability lines and also the impact of an adverse court ruling in Mississippi regarding a disputed assessment from an involuntary pool for hurricane Katrina claims. In addition, there was a change in the workers' compensation tabular discount rate from 4.5% to 3.5% that resulted in unfavorable loss reserve development of $15 million.
OneBeacon’s range of reserve estimates at December 31, 2013 was evaluated to consider the strengths and weaknesses of the various actuarial methods applied against OneBeacon’s historical claims experience data. The following table shows the recorded unpaid loss and LAE reserves, net of reinsurance recoverables on unpaid losses, and the high and low ends of OneBeacon’s range of reasonable loss reserve estimates at December 31, 2013 and 2012. For the Runoff Business, the range of reasonable reserve estimates provided below reflects A&E reserves at a net zero across the entire range. 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 following table shows the recorded loss and LAE reserves and the high and low ends of OneBeacon’s range of reasonable loss reserve estimates, net of reinsurance recoverable on unpaid losses, for OneBeacon’s Ongoing Business by line of business at December 31, 2013 and 2012.
The percentages shown in the following table represent the linear interpolation of where OneBeacon’s recorded loss and LAE reserves, net of reinsurance recoverable on unpaid losses, are within the range of reserve estimates at December 31, 2013 and 2012, where the low end of the range equals zero, the middle of the range equals 50% and the high end of the range equals 100%. The middle of the range (50%) does not necessarily represent the actuarial central estimate within the range of possible outcomes, provided above. During 2013, OneBeacon modeled the range of reserves for its Ongoing Business at a more refined line of business level than it had previously used; the prior period has been revised to reflect the more refined range.
For OneBeacon’s A&E reserves, which have a net zero balance after the NICO Cover (defined below) and Third-Party Recoverables, OneBeacon reviews A&E activity each quarter and compares that activity to what was assumed in the most recent A&E study, which was completed in 2011. Through December 31, 2013, that activity has been in line with expectations, generally, so OneBeacon has not revised its estimate of ultimate A&E payments. Accordingly, the net amount of A&E reserves included in the Runoff Business are zero across the entire range of reasonable reserve estimates.
The following discussion includes disclosure of possible variations from current estimates of loss reserves in OneBeacon’s Ongoing Business due to a change in certain key assumptions. Each of the impacts described below is estimated individually, without consideration for any correlation among key assumptions or among lines of business. Therefore, it would be inappropriate to take each of the amounts described below and add them together in an attempt to estimate volatility for OneBeacon’s reserves in total.
OneBeacon’s reserves include provisions made for claims that assert damages from A&E related exposures. Substantially all of these reserves have been reclassified to liabilities held for sale as of December 31, 2013 and 2012, as they relate to the Runoff Business. 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 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.
More recently, since the 1990s, OneBeacon has experienced an influx of 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, 2013, 547 policyholders had asbestos-related claims against OneBeacon. In 2013, 94 new insureds with such peripheral involvement presented asbestos claims under prior OneBeacon policies.
During 2011, OneBeacon completed a study of its legacy A&E exposures. Based on the results of the study, OneBeacon increased the central estimate of incurred losses ceded to NICO from $2.2 billion to $2.3 billion, an increase of $122 million for asbestos, environmental and other mass tort exposures, net of underlying reinsurance. Due to the NICO Cover, there was no impact to income or equity from the change in the estimate. OneBeacon reviews A&E activity each quarter and compares that activity to what was assumed in the most recently completed A&E study. Through December 31, 2013, that activity has been in line with expectations, generally, so OneBeacon has not revised its estimate of ultimate payments.
OneBeacon’s reserves for A&E losses, net of Third-Party Recoverables but prior to NICO recoveries, were $0.6 billion at December 31, 2013. 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 7.8 years at December 31, 2013. This was computed as the ratio of A&E reserves, net of Third-Party Recoverables prior to the NICO Cover of $0.6 billion plus the remaining unused portion of the NICO Cover of $198 million, to the average A&E loss payments over the three-year period ended December 31, 2013, net of Third-Party Recoverables. OneBeacon’s survival ratio was 10.4 years at December 31, 2012. 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 is consistent with industry survival ratios. However, the survival ratio is a simplistic measure estimating the number of years it would be before the current ending loss reserves for these claims would be paid using recent annual average payments subject to adjustments for unusual items. Many factors, such as aggressive settlement procedures, mix of business and coverage provided, have a significant effect on the amount of A&E reserves and payments and the resultant survival ratio. Thus, caution should be exercised in attempting to determine reserve adequacy for these claims based simply on this survival ratio.
OneBeacon’s A&E claims activity, substantially all of which relates to Runoff Business, the operations of which have been included in discontinued operations and the loss and LAE reserves of which are included in liabilities held for sale on the December 31, 2013 and 2012 consolidated balance sheets, is illustrated in the table below:
Sirius Group’s net loss and LAE reserves by class of business at December 31, 2013 and 2012 were as follows:
In order to reduce the potential uncertainty of loss reserve estimation, Sirius Group obtains information from numerous sources to assist in the reserving process. Sirius Group’s underwriting and pricing actuaries devote considerable effort to understanding and analyzing each insured’s operations and loss history during the underwriting of the business, using a combination of insured 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 and the risk characteristics of the underlying insureds, 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. For primary insured business, a similar portfolio analysis is performed for each program taking into account expected changes in the aggregated risk profile of the policyholders within each program. The aggregation of risks yields a more stable indication of expected losses that is used to estimate IBNR for recently written business.
Upon notification of a loss from an insured (typically a ceding company), Sirius Group establishes case reserves, including LAE reserves, based upon Sirius Group’s share of the amount of reserves established by the insured and Sirius Group’s independent evaluation of the loss. In cases where available information indicates that reserves established by a ceding company are inadequate, Sirius Group establishes case reserves or IBNR in excess of its share of the reserves established by the ceding company. Also, in certain instances, Sirius Group may decide not to establish case reserves or IBNR, when the information available indicates that reserves established by ceding companies are not adequately supported. In addition, specific claim information reported by insureds or obtained through claim audits can alert management 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 where customary. Generally, ceding company audits are not customary outside the United States. This information is often used to supplement estimates of IBNR.
In 2013, Sirius Group had net favorable loss reserve development of $48 million, which included $(24) million of favorable loss reserve development on prior years’ catastrophe losses. Other major reductions in loss reserve estimates recognized included property ($17 million), aviation/space ($10 million), and accident and health ($9 million) lines, partially offset by a $12 million increase in asbestos loss reserves. In 2012, Sirius Group had net favorable loss reserve development of $34 million. The major reductions in loss reserve estimates were recognized in casualty runoff ($32 million), property ($28 million), marine/energy ($12 million), trade credit ($7 million) and aviation/space ($5 million) lines, partially offset by a $46 million increase in asbestos loss reserves and a $4 million increase in accident and health. In 2011, Sirius Group had net favorable loss reserve development of $47 million, primarily attributable to $41 million of favorable development on property lines, including $13 million of loss reserve reductions for the 2010 Chile earthquake, partially offset by asbestos and environmental increases of $12 million.
The actuarial analysis is a primary consideration for management in determining its best estimate of loss and LAE reserves. In making its best estimate, management also considers other qualitative factors that may lead to a difference between its best estimate of loss and LAE reserves and the actuarial point estimate. Typically, these factors exist when management and the company’s actuaries conclude that there is insufficient historical incurred and paid loss information or that trends included in the historical incurred and paid loss information are unlikely to repeat in the future. These factors may include, among others, changes in the techniques used to assess underwriting risk, more accurate and detailed levels of data submitted with reinsurance applications, the uncertainty of the current reinsurance pricing environment, the level of inflation in loss costs, changes in ceding company reserving practices, and legal and regulatory developments. At December 31, 2013 and 2012, total carried net reserves were 3.1% and 2.4% above the actuarial central estimate, respectively.
The following table illustrates Sirius Group’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, 2013 and 2012.
The percentages shown in the following table represent the linear interpolation of where Sirius Group’s recorded loss and LAE reserves, net of reinsurance recoverable on unpaid losses, are within the range of reserves estimates by line of business at December 31, 2013 and 2012, where the low end of the range equals zero, the middle of the range equals 50% and the high end of the range equals 100%. The middle of the range (50%) does not necessarily represent the actuarial central estimate within the range of possible outcomes, provided above.
Sirius Group’s net reserves for A&E losses were $194 million and $189 million at December 31, 2013 and 2012, respectively. Sirius Group’s A&E three-year net paid survival ratio was approximately 8.0 years and 9.0 years at December 31, 2013 and 2012 which are consistent with industry survival ratios.
Sirius Group utilizes specialized claims handling processes on A&E exposures. The issues presented by these types of claims require expertise and an awareness of the various trends and developments in relevant jurisdictions. Generally, Sirius Group sets up claim files for each reported claim by each 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, 2013, Sirius Group had 2,023 open claim files for asbestos and 399 open claim files for environmental exposures.
The following table summarizes White Mountains’ fair value measurements and the percentage of Level 3 investments at December 31, 2013:
Excludes carrying value of $26.6 associated with other long-term investment limited partnerships accounted for using the equity method and $(.1) related to currency forward contracts.
Carrying value includes $236.3 and $338.1 at December 31, 2013 and January 1, 2013 that is classified as assets held for sale relating to discontinued operations.
Excludes carrying value of $635.9 and $630.6 at December 31, 2013 and January 1, 2013 classified as short-term investments.
Excludes $20.6 of realized and unrealized losses associated with the Prospector Funds consolidation of investment-related liabilities and $.2 of realized and unrealized gains associated with short-term investments.
Excludes carrying value of $35.0 and $33.0 at December 31, 2012 and January 1, 2012 associated with other long-term investment limited partnerships accounted for using the equity method and $(.1) at December 31, 2012 related to currency forward contracts.
Excludes carrying value of $630.6 and $846.0 at December 31, 2012 and January 1, 2012 classified as short-term investments.
asset-backed security for which the estimated fair value was determined using a single broker quote.
Other long-term investments accounted for at fair value at December 31, 2013 consist of $121 million in hedge funds and $118 million in private equity funds. At December 31, 2013, White Mountains held investments in 15 hedge funds and 39 private equity funds. The largest investment in a single fund was $18.3 million and $16.0 million at December 31, 2013 and 2012.
The fair value of White Mountains’ investments in hedge funds and private equity funds is based upon White Mountains’ proportionate interest in the underlying fund’s net asset value, which is deemed to approximate fair value. White Mountains employs a number of procedures to assess the reasonableness of the fair value measurements for its other long-term investments including obtaining and reviewing each fund’s audited financial statements and discussing each fund’s pricing with the fund’s manager. However, since the fund managers do not provide sufficient information to independently evaluate the pricing inputs and methods for each underlying investment, the inputs are considered to be unobservable. Accordingly, the fair values of White Mountains’ investments in hedge funds and private equity funds have been classified as Level 3.
Generally, the liabilities associated with these guarantees increase with declines in the equity markets, interest rates and currencies against the Japanese yen, as well as with increases in market volatilities. The collective account values were approximately 104% and 87% of the guarantee value at December 31, 2013 and 2012. In 2008, particularly in the fourth quarter, as a result of worldwide declines in equity markets, interest rates and the strengthening of the Japanese yen, the underlying investment accounts declined substantially and the collective account values were significantly lower than the guarantee value for several years. The liability is also affected by annuitant related behavioral and actuarial assumptions, including surrender and mortality rates. WM Life Re lowered its projected surrender rates in 2011 and 2010 to reflect the behavior observed during the turbulent markets experienced throughout those years. During 2013, equity markets rallied, most of the surrender charges in the underlying annuities expired and observed surrender rates increased to higher than expected levels, which caused WM Life Re to increase its projected surrender rates used in the valuation of its variable annuity reinsurance liability.
As of December 31, 2013, the value of bond funds tracking the WGBI was approximately ¥71 billion ($681 million). By country, the largest exposures, together comprising approximately 89% of the WGBI, were the United States (39%), France (10%), Italy (10%), Germany (9%), the United Kingdom (8%), Spain (5%), the Netherlands (3%), Belgium (3%) and Canada (2%). Eurozone countries together comprised approximately 44%. To reduce hedging basis risk (i.e., the risk that changes in the WGBI will cause WM Life Re's variable annuity guarantee liabilities to change in value at a different rate than the derivative hedges), in December 2009 WM Life Re entered into a series of total return swap contracts on the performance of the WGBI. As of December 31, 2010, approximately 49% of WM Life Re's WGBI-related liability was hedged with WGBI swaps. Because these swaps were denominated in US dollars, WM Life Re continued to hedge the results into Japanese yen to match the benchmark denominated in Japanese yen. In 2011, driven in large part by instability of Eurozone markets, WM Life Re significantly increased coverage of its WGBI exposure. Because the market for WGBI total return swaps was, and continues to be illiquid, WM Life Re entered into a series of total return swaps on the JP Morgan European Government Bond Index (JPM European GBI). Although the JPM European GBI is not an exact match for the European component of the WGBI, its structure and holdings are substantially similar. These swaps are denominated in Japanese yen. As of December 31, 2013, the total notional amounts of JPM European GBI swaps were ¥31 billion ($294 million). At that date, over 100% of the total exposure the European component of the WGBI was hedged with total return swaps. The JPM European GBI total return swaps have maturities laddered to approximate the maturities of the policies reinsured.
During 2009, WM Life Re entered into long term Japanese interest rate swaps, largely replacing its use of short term Japanese Government Bond (“JGB”) futures to hedge its discount rate exposure. By doing so, WM Life Re better matched the term structure of its discount rate exposure, substantially reduced its exposure to changes in Japanese interest rate swap spreads and significantly reduced the potential costs associated with rolling JGB futures contracts during times of relative market illiquidity. During December 2012, after the relevant Japanese interest rate swap rates fell to their lowest level in many years, the resulting potential benefit, net of cost, to WM Life Re of maintaining its Japanese interest rate swap hedge portfolio was deemed to be limited. Therefore, the decision was made to unwind or offset these Japanese interest rate swaps. During December 2012, approximately 24% of the notional amount of Japanese interest rate swap contracts was unwound and during January 2013 the remaining 76% was unwound or offset. As of December 31, 2013 and 2012, the notional amount of Japanese interest rate swaps hedging against a drop in Japanese discount rates was ¥0 billion and ¥153 billion ($1.8 billion), respectively.
In the unfavorable scenario, Japanese interest rates are decreased 70 bps, Japanese swap spreads are tightened by 25 bps, and foreign bond fund yields are increased 70 bps. Conversely, in the favorable scenario, Japanese interest rates are increased 70 bps, Japanese swap spreads are widened 25 bps and foreign bond fund yields are decreased 70 bps.
To test the impact of multiple variables moving simultaneously, WM Life Re performs capital market “shock” testing. Prior to 2009, in performing this testing, WM Life Re had not incorporated basis risk and other hedge underperformance relative to expectations in its models; it had assumed that its hedges would behave as modeled. However, the financial market turmoil of late 2008 and early 2009 demonstrated that, in periods of severe financial market disruption, various aspects of WM Life Re’s hedging program may underperform or over-perform. As a result, WM Life Re now also estimates the efficacy of its hedging program in its “shock” testing. Estimated hedge effectiveness is based on actual results during the recent stressed market environment encompassing the fourth quarter of 2008 and the first quarter of 2009. Hedge effectiveness assumptions also incorporate any subsequent changes to the hedging program that were not in place during this stress period. Although this period captures a historically volatile period that included large market movements over short time periods, hedges may be less effective than the current assumptions to the extent future market movements of the magnitude of these “shocks” occur more quickly than during this recent stress period.
The table below summarizes as of December 31, 2013 and 2012, the estimated financial impact of simultaneous market events, as well as December 31, 2012 on a proforma basis, adjusted for the unwinding or offsetting of the remaining Japanese interest rate swaps during January 2013. Unlike the individual sensitivity analysis illustrated above, the analysis in the table below reflects the inter-dependencies between individual variables.
WM Life Re projects future surrender rates by year for policies based on a combination of actual experience and expected policyholder behavior. Actual policyholder behavior, either individually or collectively, may differ from projected behavior as a result of a number of factors such as the level of the account value versus guarantee value and applicable surrender charge, views of the primary insurance company's financial strength and ability to pay the guarantee at maturity, annuitants' need for money in a prolonged recession and time remaining to receive the guarantee at maturity. Policyholder behavior is especially difficult to predict given that WM Life Re’s reinsurance contracts are relatively new and the market turmoil seen over the last several years is unprecedented for this type of product in the Japanese market. Actual policyholder behavior may differ materially from WM Life Re's projections.
The following table summarizes the changes in White Mountains’ variable annuity reinsurance liabilities and derivative instruments for the year ended December 31, 2013 and 2012:
There is a time lag from the point when premium and related commission and expense activity is recorded by a ceding company to the point when such information is reported by the ceding company to Sirius Group. This time lag can vary from one to several contractual reporting periods (i.e. quarterly/monthly). This lag is common in the reinsurance business, and slightly longer when a reinsurance intermediary is involved.
6 and 30 years. In December 2012, the Fed stated that it expects to continue to take actions to keep long-term interest rates low until unemployment reaches 6.5%. Lower long-term interest rates tend to reduce the return on equity that life insurers earn as they reinvest their cash flows from higher yielding long duration bonds into lower yielding long duration bonds. Quoted stock prices of life insurers tend to be highly correlated with their return on equity. Thus, as long-term interest rates decline, the quoted stock prices of life insurers tend to decline. At the same time, lower interest rates tend to increase the stated GAAP book values of life insurance companies, primarily from unrealized gains on fixed income investments, as the assets are marked-to-market, but the liabilities are not. Thus, the precipitous decline in long-term interest rates that occurred with Operation Twist caused a significant decline in the quoted stock prices of life insurance companies and an even more significant decline in those prices relative to stated GAAP book value. As a result, the quoted stock price of many life insurance companies at December 31, 2011, including Symetra, was well below their stated GAAP book value, a trend inconsistent with historical patterns. This trend has reversed somewhat in recent years as the quoted stock prices of many life insurance companies, including Symetra, have risen to levels more consistent with their stated GAAP book values at December 31, 2013.
White Mountains accounts for its investment in Symetra common shares using the equity method of accounting. Under the equity method, the GAAP carrying value of White Mountains’ investment in Symetra common shares is normally equal to the percentage of Symetra’s GAAP book value represented by White Mountains’ common share ownership, which was 17% and 15% at December 31, 2013 and 2012. Under GAAP, a decline in the fair value of an investment is considered to be other-than-temporary when the fair value of the investment is not expected to recover to its GAAP carrying value in the near term. Declines in the fair value of an investment that are considered to be other-than-temporary are recognized as a write-down to the GAAP carrying value of the investment. Having observed the divergence between the quoted market price for Symetra’s common shares and its GAAP carrying value, management evaluated White Mountains’ investment in Symetra common shares to determine whether an other-than-temporary impairment under GAAP existed at December 31, 2011. As a result of this evaluation, management concluded that White Mountains’ investment in Symetra common shares was other-than-temporarily impaired and wrote down the GAAP book value of the investment to its estimated fair value of $261 million at December 31, 2011, or approximately $15 per Symetra common share.
In December 2011, Tokio Marine announced that it had agreed to acquire Delphi Financial Group (“Delphi”) for $2.7 billion. The acquisition price for that transaction represented a multiple of approximately 1.6 times Delphi’s September 30, 2011 adjusted book value of $1.6 billion. The acquisition price of $43.875 per share represented a premium of approximately 73% over Delphi’s last traded market price prior to the announcement of the acquisition. If the same adjusted book value and market price multiples were applied to Symetra at December 31, 2011, the estimated fair value would range from $16 to $30 per share.
The Delphi acquisition highlights the wide disparity between values of life insurance companies based on quoted market prices and the value of those companies in a private market transaction. However, the range of fair value estimates generated by applying the adjusted book value per share multiple and market premium observed in the Delphi acquisition is wide, and there have been no other significant acquisitions of life insurance companies in 2011. Therefore, management did not ascribe significant weight to valuations determined using the adjusted book value per share multiple or market price premium observed in recent acquisition activity when determining the GAAP fair value of White Mountains’ investment in Symetra common shares at December 31, 2011.
After considering all of the above, management determined that the best estimate of the GAAP fair value of White Mountains’ investment in Symetra’s common shares at December 31, 2011 was $15 per share, which approximated Symetra’s adjusted statutory-basis net worth. The write down of $199 million to $261 million represented management’s best estimate of the amount by which the value of the investment had been other-than-temporarily impaired for GAAP at that date. After-tax, this represented a reduction of White Mountains adjusted book value per share of $6. Given the scarcity of relevant observable inputs and the wide range of estimates developed under the approaches used, the estimated GAAP fair value of White Mountains’ investment in Symetra’s common shares involved a significant degree of judgment, is very subjective in nature and, accordingly, is considered a Level 3 fair value measurement.
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’:
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 117 of this report.