OneBeacon Ltd.’s headquarters are located in Hamilton, Bermuda and its United States corporate headquarters and principal executive office is located in Minnetonka, Minnesota. OneBeacon also maintains branch offices in various cities throughout the United States.
Selected consolidated income statement data and ending balance sheet data for each of the five years ended through December 31, 2011, follows:
(a) Due to the global financial crisis, during 2008 White Mountains experienced significant decreases in: realized and unrealized investment returns reported in revenues; net income; total assets; and adjusted book value per share.
(c) As a result of the Esurance Sale and the AutoOne Sale, 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 2011, discontinued operations, net of tax, includes a $678 gain related to the Esurance Sale and a $19 loss related to the AutoOne Sale.
(d) During 2011 and 2010, OneBeacon repurchased $150 and $187 face value of the OBH Senior Notes. At December 31, 2008, White Mountains had $200 outstanding under its credit facility, which was repaid during 2009.
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 90 for specific important factors that could cause actual results to differ materially from those contained in forward-looking statements.
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2011, 2010 and 2009
OneBeacon ended 2011 with a book value per share of $11.56, an increase of 3%, including dividends, from December 31, 2010. OneBeacon’s total GAAP combined ratio was 96% for 2011 compared to 100% for 2010, while its specialty insurance GAAP combined ratio was 92% for 2011 compared to 94% for 2010. OneBeacon’s total GAAP combined ratio for 2011 was not impacted by loss reserve development, as favorable loss reserve development of $30 million (3 points) in specialty business was essentially offset by adverse loss reserve development of $27 million (3 points) in run-off business resulting from a detailed review of run-off expenses, principally unallocated loss adjustment expenses (“ULAE”), completed during the fourth quarter of 2011. OneBeacon’s total GAAP combined ratio for 2010 included a number of large losses, particularly from personal and non-specialty commercial lines businesses that OneBeacon no longer writes. The improvement in OneBeacon’s specialty insurance combined ratio for 2011 was primarily due to improved current accident year results. Sirius Group reported a GAAP combined ratio of 100% in 2011 compared to 94% in 2010. Both years were impacted by significant catastrophe losses as the 2011 GAAP combined ratio included 24 points of catastrophe losses compared to 23 points in 2010.
White Mountains ended 2010 with an adjusted book value per share of $441, an increase of 6%, including dividends, from December 31, 2009. White Mountains reported adjusted comprehensive income of $141 million in 2010 compared to $560 million in 2009. The increase in adjusted book value per share in 2010 was driven by decent investment and underwriting results and share repurchases, offset somewhat by losses at WM Life Re from reduced surrender assumptions. White Mountains’ investment return was 5.0% in 2010, an acceptable result given the conservative positioning of the portfolio. Underwriting results for 2010 were solid but worse than 2009, as OneBeacon’s underwriting results were adversely impacted by losses in businesses it recently exited, while Sirius Group was adversely impacted by large catastrophe losses, principally from the Chile earthquake in February 2010. Share repurchases increased adjusted book value per share by $7 in 2010.
Total net written premiums decreased 23% to $2,025 million in 2010 from $2,625 million in 2009, primarily due to lower net written premiums at OneBeacon, partially offset by increases at the Sirius Group. OneBeacon’s net written premiums decreased 36% to $1,159 million in 2010, reflecting the Commercial Lines Transaction beginning with January 1, 2010 renewals and the Personal Lines Transaction in July 2010. OneBeacon’s specialty insurance premiums increased 4% in 2010 to $988 million. Sirius Group’s net written premiums increased 7% in 2010 to $866 million, due mainly to increases in the trade credit and accident and health lines and the effects of foreign currency translation.
The following table presents White Mountains’ adjusted book value per share, a non-GAAP financial measure, for the years ended December 31, 2011, 2010 and 2009 and reconciles this non-GAAP measure to the most comparable GAAP measure (See NON-GAAP FINANCIAL MEASURES on page 64):
White Mountains’ total revenues decreased 15% to $2,178 million in 2011 compared to $2,567 million in 2010, primarily due to lower earned insurance and reinsurance premiums, partially offset by higher net investment gains and lower losses at WM Life Re. Earned premiums were down 14% to $1,928 million in 2011 as a 28% decrease at OneBeacon, which was driven by the Personal Lines Transaction and the Commercial Lines Transaction, was partially offset by an 8% increase at Sirius Group. Excluding the $425 million of earned premiums in 2010 related to the exited businesses at OneBeacon, White Mountains’ earned premiums increased 6% in 2011. Net investment income was down 26% to $185 million in 2011, due primarily to lower fixed maturity yields and a reduction in invested assets from the Personal Lines Transaction, OBH Senior Notes repurchases at OneBeacon and share repurchases. White Mountains reported net realized and unrealized investment gains of $123 million in 2011 compared to $83 million in 2010. Both periods were significantly impacted by foreign currency translation on U.S. dollar-denominated investments at Sirius International, the effects of which are offset in other comprehensive income (see “Impact of Foreign Currency on Investment Returns” on page 51). Other revenues decreased to a loss of $57 million in 2011 from a gain of $23 million in 2010, due primarily to foreign currency translation losses and higher mark-to-market losses on the Symetra warrants, partially offset by lower losses reported by WM Life Re. Other revenues included a $27 million loss from WM Life Re in 2011 compared to a $61 million loss in 2010. Other revenues in 2011 also included a $7 million pre-tax gain from Sirius Group’s acquisition of Old Lyme, while other revenues in 2010 also included a $13 million pre-tax gain from Sirius Group’s acquisition of Central National.
White Mountains’ total expenses decreased 12% to $2,117 million in 2011 compared to $2,413 million in 2010. Losses and LAE expenses decreased $182 million, or 13%, insurance and reinsurance acquisition expenses decreased $79 million, or 17%, and other underwriting expenses decreased $54 million, or 16%, all due primarily to the Personal Lines Transaction and Commercial Lines Transaction. Excluding $487 million in expenses reported in 2010 related to the exited businesses at OneBeacon, White Mountains’ total expenses increased 10% in 2011, as losses and LAE expenses, insurance and reinsurance acquisition expenses and other underwriting expenses increased 13%, 5% and 6%. General and administrative expenses increased 14% to $167 million in 2011 compared to $147 million in 2010, due primarily to increased compensation expenses as a result of the gain from the Esurance Sale and to the increase in White Mountains’ stock price during 2011. Interest expense on debt decreased 4% to $55 million in 2011 compared to $57 million in 2010, primarily due to reductions of outstanding debt resulting from repurchases of OBH Senior Notes.
White Mountains’ total revenues decreased 25% to $2,567 million in 2010 compared to $3,443 million in 2009, primarily due to lower net investment gains and lower earned premiums due to the Commercial and Personal Lines Transactions. White Mountains reported net realized and unrealized investment gains of $83 million in 2010 compared to $362 million in 2009. Earned premiums decreased 17% in 2010 compared to 2009, with decreases at both OneBeacon and Sirius Group. Excluding earned premiums in 2010 and 2009 related to the exited businesses at OneBeacon, White Mountains’ earned premiums increased 3% in 2010. Net investment income was down 16% to $209 million in 2010, due primarily to lower fixed maturity yields and a reduction in invested assets from the Personal Lines Transaction, including a shift to lower yielding short-term investments during the first six months of 2010 in preparation for the sale, the OBH Senior Notes repurchases at OneBeacon and share repurchases. Other revenues decreased to $23 million in 2010 from $114 million in 2009, primarily due to a $44 million decrease in foreign currency translation gains at Sirius Group and a $39 million decrease related to the deconsolidation of Tuckerman Fund II effective January 1, 2010, partially offset by a $13 million pre-tax gain from Sirius Group’s acquisition of Central National. Other revenues included $23 million of foreign currency translation gains at Sirius Group in 2010 compared to $67 million in 2009.
A summary of the impact of foreign currency translation on White Mountains’ consolidated financial results for the years ended December 31, 2011, 2010 and 2009 follows:
(1) Component of net realized and unrealized investments gains on the income statement.
In connection with the Sirius Group Reorganization and in light of global market conditions, White Mountains significantly reduced its exposure to foreign currency translation gains and losses in 2011. See “Qualitative and Quantitative Disclosures About Market Risk - Foreign Currency Exchange Risk” on page 92.
The following tables provide OneBeacon’s GAAP ratios, net written premiums and earned insurance premiums for the years ended December 31, 2011, 2010 and 2009:
OneBeacon’s specialty combined ratio for 2011 decreased to 92% from 94% for 2010, primarily due to lower current accident year non-catastrophe losses and other underwriting expenses, partially offset by higher catastrophe losses. The specialty combined ratio for 2011 included 4 points of catastrophe losses compared to 2 points in 2010. The specialty combined ratio included 3 points of favorable loss reserve development for both years.
Policy acquisition expenses decreased 30% to $219 million and other underwriting expenses decreased 26% to $173 million in 2011, reflecting the Commercial Lines Transaction and the Personal Lines Transaction. Interest expense decreased 31% to $21 million in 2011, reflective of actions taken to reduce outstanding debt.
OneBeacon ended 2010 with a book value per share of $13.02, an increase of 9%, including dividends, from December 31, 2009. OneBeacon reported a GAAP combined ratio of 100% for 2010 compared to 91% for 2009. The increase in OneBeacon’s combined ratio was primarily due to higher catastrophe losses and higher-than-average levels of large losses experienced early in the year, particularly in businesses OneBeacon later exited through the Commercial Lines Transaction and the Personal Lines Transaction. Catastrophe losses added 4 points to OneBeacon’s combined ratio in 2010 compared to 1 point in 2009.
Policy acquisition expenses decreased 17% to $312 million and other underwriting expenses decreased 24% to $233 million in 2010, reflecting the Commercial Lines Transaction and the Personal Lines Transaction. Interest expense decreased 25% to $30 million in 2010, reflective of actions taken to reduce outstanding debt.
OneBeacon’s net combined ratio for 2010 was higher than its gross combined ratio by 6 points, primarily due to the cost of catastrophe reinsurance and the business fronted under the Commercial Lines Transaction. OneBeacon’s net combined ratio for 2009 was higher than its gross combined ratio by 5 points, primarily due to the cost of catastrophe, property and facultative reinsurance.
(1) As a result of White Mountains’ adoption of the revisions to the guidance for variable interest entities under ASU 2009-17, effective January 1, 2010 Sirius Group no longer consolidates the results of Tuckerman Fund II. See Note 1.
Sirius Group Results-Year Ended December 31, 2011 versus Year Ended December 31, 2010
Sirius Group’s GAAP combined ratio was 100% for 2011 compared to 94% for 2010. Both years were impacted by significant catastrophe losses as the 2011 GAAP combined ratio included 24 points of catastrophe losses compared to 23 points in 2010. For 2011, catastrophe losses included $81 million (9 points) of losses from the Japan earthquake and tsunami, $51 million (6 points) of losses from the February and June 2011 New Zealand earthquakes, $34 million (4 points) from floods in Thailand, and $25 million (3 points) of losses from severe weather and tornados in the Midwestern United States. Catastrophe losses for 2010 were primarily due to the Chile and New Zealand earthquakes, European floods and Deepwater Horizon. Favorable net loss reserve development for 2011 was 5 points, 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. Favorable loss reserve development for 2010 was 7 points, mostly from short-tailed lines of business, primarily property, accident and health, and marine. The increase in the 2011 GAAP combined ratio also reflects worse current accident year underwriting results in the accident and health, marine, and aviation lines, partially offset by improved underwriting results in the trade credit line.
Sirius Group’s recorded property losses from the earthquake and tsunami in Japan have been estimated based on information from ceding companies, third party and internal catastrophe models, and by applying overall estimates of industry insured losses to Sirius Group’s exposure information. As of December 31, 2011, 58% of Sirius Group’s ultimate loss estimate for the Japan earthquake had been paid or reported. In relation to the Chile earthquake in 2010, at the same relative point in time (10 months post-event), 85% of Sirius Group’s ultimate loss estimate for the Chile earthquake had been paid or reported.
Sirius Group Results-Year Ended December 31, 2010 versus Year Ended December 31, 2009
Sirius Group’s GAAP combined ratio for 2010 was 94% compared to 80% for 2009. The increase in the combined ratio was principally due to an increase in catastrophe losses of 16 points, partially offset by an increase in favorable loss reserve development of 4 points. Sirius Group recorded catastrophe losses of $192 million in 2010, net of reinsurance and reinstatements, including $130 million of losses from the earthquake in Chile, $14 million of losses from the earthquake in New Zealand, $11 million from flood losses in Europe, and $11 million of losses from Deepwater Horizon. Catastrophe losses were $57 million in 2009, primarily from summer windstorms in Europe and European winter storm Klaus. Favorable loss reserve development for 2010 was $57 million and was primarily related to short-tailed lines, such as property, accident and health and marine, in recent underwriting years. Included in the $57 million favorable loss reserve development was the recognition of $16 million in deferred gains from a retrocessional reinsurance contract that incepted in 2000 and was fully collected in 2010. Favorable loss reserve development for 2009 was $30 million and was principally due to favorable commutation activity on certain old casualty treaties, as well as $20 million of losses ceded under a retrocessional reinsurance contract related to the 2001 accident year, partially offset by $18 million of additional losses related to A&E exposures.
Sirius Group’s insurance and reinsurance acquisition expenses decreased 2% to $168 million in 2010 from $171 million in 2009. The decrease is proportional with the decrease in earned premium.
Sirius Group’s other underwriting expenses increased $2 million in 2010, primarily due to foreign exchange and higher professional fees mainly from systems initiatives, somewhat offset by lower incentive compensation costs. General and administrative expenses decreased to $23 million in 2010 from $68 million in 2009 as a result of a reduction of $38 million from the deconsolidation of Tuckerman Fund II and a reduction of $7 million related to the reorganization of the Sirius Group legal and operating structure incurred during the third quarter of 2009.
Reinsurance protection. Sirius Group’s reinsurance protection primarily consists of pro-rata and excess of loss protections to cover aviation, trade credit and certain property exposures. These reinsurance protections are designed to increase underwriting capacity, where appropriate, and to reduce potential loss exposure to any large event or frequency of smaller catastrophic events. In addition to its proportional reinsurance purchases for certain property exposures, in 2010 and 2009, Sirius Group purchased group excess of loss retrocessional protection for its non-U.S. and non-Japan earthquake-related exposures. During 2010, Sirius Group also purchased ILW contracts that covered adverse impact of the occurrence of wind and flood catastrophic events in Europe as well as a potential New Madrid earthquake event.
A summary of White Mountains’ financial results from its Other Operations segment for the years ended December 31, 2011, 2010 and 2009 follows:
As discussed on page 80 under “Fair Value Measurements”, in determining the fair value of the benefit guarantees that WM Life Re reinsures, management makes assumptions about future policyholder surrender rates. If actual surrenders are lower than the surrender assumptions used in WM Life Re’s liability valuation model, the liability for the benefit guarantees would increase. The change in surrender assumptions made by WM Life Re during the third quarter of 2010 reduced the potential impact of lower surrenders in the future. For example, a 50% reduction in the surrender assumptions used in WM Life Re’s valuation model at December 31, 2011 would have increased the fair value of the liability by approximately $5 million, compared to an increase of $12 million based on assumptions in place at December 31, 2010.
Other Operations Results-Year Ended December 31, 2010 versus Year Ended December 31, 2009
White Mountains’ Other Operations segment’s pre-tax loss was $100 million in 2010 compared to $110 million in 2009. The decrease in pre-tax loss was mainly due to higher investment gains in 2010, the absence of a $7 million pre-tax loss from the weather-risk business in 2009, lower interest expense and lower compensation expenses, partially offset by a decrease in the value of the Symetra warrants (a decrease of $1 million in 2010 compared to an increase of $11 million in 2009) and an $11 million loss on the disposition of Delos in 2010.
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, 2011, 2010 and 2009 follows:
Excludes non-investment related foreign currency gains (losses) of $74.9, $(53.1) and $(112.1).
White Mountains’ GAAP pre-tax total return on invested assets was 2.9% for 2011, which includes 0.2% of foreign currency losses, compared to 5.0% for 2010, which includes 0.5% of foreign currency gains. White Mountains’ fixed income portfolio returned 3.1% for 2011, lagging the Barclays U.S. Intermediate Aggregate Index return of 6.0%. White Mountains’ high-quality, short-duration, fixed income portfolio trailed the longer-duration benchmark as rates declined during 2011. White Mountains’ equity portfolio, approximately 14% of GAAP invested assets at December 31, 2011, returned 1.4% for 2011, compared to the S&P 500 Index return of 2.1%, while the equity portfolio returned 12.6% in 2010, compared to the S&P 500 Index return of 15.1%. White Mountains’ equity portfolio included convertible fixed maturity investments whose returns were hurt by rising credit spreads on the fixed maturity component of the instruments.
White Mountains’ GAAP pre-tax total return on invested assets was 5.0% for 2010, which includes 0.5% of foreign currency gains, compared to 9.4% for 2009, which includes 1.3% of foreign currency gains. Excluding the effects of foreign currency translation, White Mountains’ fixed income portfolio returned 3.2% for 2010, lagging the Barclays U.S. Intermediate Aggregate Index return of 6.1%, primarily as a result of the shorter duration of White Mountains’ fixed income portfolio. White Mountains’ equity, convertible fixed maturities, and other long-term investment portfolio return of 12.6% underperformed the S&P 500 Index, as above index returns generated on assets managed by Prospector were more than offset by lower returns on other equity assets. Net investment income was down 16% to $209 million in 2010, due primarily to lower fixed maturity yields and a reduction in invested assets resulting from the Personal Lines Transaction, the OBH Senior Notes repurchases at OneBeacon and share repurchases.
White Mountains’ foreign assets and liabilities are valued using period-end exchange rates, and its foreign revenues and expenses are valued using average exchange rates over the period. Foreign currency exchange rate risk is the risk that White Mountains will incur losses on a U.S. dollar basis due to adverse changes in foreign currency exchange rates. See “Foreign Currency Exchange Risk” on page 92.
Carrying value includes $111.8 that is classified as assets held for sale relating to AutoOne discontinued operations.
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 80% of White Mountains’ fixed, common equity and convertible investment portfolio. White Mountains has minimal sovereign risk exposure to European peripheral countries such as Ireland, Greece, Portugal, Spain and Italy (“peripheral countries”). White Mountains’ portfolio includes 0.4% of total fixed, convertible fixed maturities and common equity investments issued from peripheral countries at December 31, 2011. However, White Mountains could still 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 maturities, common equities and convertible fixed maturities at December 31, 2011 categorized as financial or non-financial investments and by country of issue:
The amounts reflected within discontinued operations differ from amounts previously presented within the Esurance segment. The segment results of operations for Esurance reported in previous periods included investment income and realized and unrealized investment gains and losses allocated to Esurance related to capital that was used by Esurance but contained within Sirius Group’s legal entities. These allocations do not have separately identifiable cash flows and have therefore been excluded from amounts classified in discontinued operations and are now included in the Sirius Group segment. For 2011, 2010 and 2009, $(3) million, $7 million and $13 million of net investment income and realized and unrealized investment gains and losses that had been previously included in the Esurance segment were excluded from net income (loss) from discontinued operations.
Adjusted expense and combined ratios include acquisition expenses net of referral fee revenue. See “NON-GAAP FINANCIAL MEASURES” on page 64 for a reconciliation of Esurance’s adjusted expense ratio and adjusted combined ratio to its GAAP expense and combined ratios.
Net loss from discontinued operations related to AutoOne was $(6) million and $(7) million and $(33) million in 2011, 2010 and 2009. During 2011, OneBeacon also recorded a $19 million after-tax loss ($30 million pre-tax) on the sale of AutoOne.
In conjunction with the Reorganization, the following capital transactions occurred in October 2011:
· Sirius America paid $250 million to its immediate parent, which included $67 million of dividends and a $183 million return of capital;
· Sirius Group distributed $425 million to White Mountains, which included approximately $300 million that was freed up at Sirius International and Sirius America as a result of the Reorganization and the commutation of quota-share agreements between Sirius Group and Esurance as a result of the Esurance Sale;
· White Mountains contributed a portion of its common share investment in Symetra to an intermediate holding company of Sirius Group. At December 31, 2011, White Mountains’ entire common share investment in Symetra, which had a carrying value of $261 million, was held by Sirius Group.
During 2011, OneBeacon’s unregulated insurance operating subsidiaries paid $4 million of dividends to their immediate parent. At December 31, 2011, OneBeacon’s unregulated insurance operating subsidiaries had $17 million of net unrestricted cash, short-term investments and fixed maturity investments.
At December 31, 2011, OneBeacon Ltd. and its intermediate holding companies had $183 million of net unrestricted cash, short-term investments and fixed maturity investments and $30 million of common equity securities and convertible fixed maturity investments outside of its regulated and unregulated insurance operating subsidiaries.
Sirius America has the ability to pay dividends to its immediate parent, which is an indirect wholly-owned subsidiary of Sirius International, 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. Based upon December 31, 2011 statutory surplus of $534 million, Sirius America has the ability to pay $53 million of dividends during 2012 without prior approval of regulatory authorities, subject to the availability of earned surplus. At December 31, 2011, Sirius America had $76 million of earned surplus.
During 2011, WM Advisors paid $5 million of dividends to its immediate parent. At December 31, 2011, WM Advisors had $26 million of net unrestricted cash, short-term investments and fixed maturity investments.
As of December 31, 2011, the Company and its intermediate holding companies had $1,554 million of net unrestricted cash, short-term investments and fixed maturity investments, $317 million of common equity securities and $33 million of other long-term investments included in its Other Operations segment.
(1) The noncontrolling interest arising from White Mountains’ investments in consolidated limited partnerships has not been included in insurance float or total capital because White Mountains does not benefit from the return on or have the ability to utilize the net assets supporting this noncontrolling interest.
(2) Excludes preferred stock subject to mandatory redemption having an aggregate accreted liquidation preference at December 31, 2007 of $278 and $306 of investments held in irrevocable grantor trusts for the purpose of economically defeasing the preferred stock as of this date).
(4) Excludes funds held by White Mountains under reinsurance treaties for which White Mountains does not provide interest credits.
During 2011, insurance float decreased by $507 million, primarily due to the Esurance Sale, the release of a $130 million valuation allowance against a deferred tax asset of a subsidiary and the continued run-off of reserves as a result of the Commercial Lines Transaction at OneBeacon.
During 2010, insurance float decreased by $3 million. Decreases in insurance float were primarily due to the Personal Lines Transaction at OneBeacon, which reduced insurance float by approximately $390 million, and favorable loss reserve development of $126 million were partially offset by growth in Esurance’s in-force business, losses at WM Life Re and the portion of the $250 million of catastrophe losses in 2010 that were unpaid as of December 31, 2010. These catastrophe losses create a temporary increase in insurance float when they are first recorded, which later reverses and decreases insurance float as the catastrophe losses are paid in the future.
During 2009, insurance float decreased by $171 million, primarily from loss reserve run-off of approximately $250 million and favorable loss reserve development of $122 million, partially offset by a change of $139 million in deferred taxes on investments, as White Mountains’ investment portfolio recovered a large portion of investment losses from the global financial crisis in 2008, and $57 million of losses at WM Life Re. Additionally, the large investment and foreign currency gains experienced in 2009 significantly decreased White Mountains’ operational leverage metrics.
During 2008, insurance float decreased by $440 million, primarily from loss reserve run-off of approximately $150 million, a change of $185 million in deferred taxes on investments that arose primarily as a result of the global financial crisis, the release of a $162 million valuation allowance against a deferred tax asset of a subsidiary, the transfer of CCIC and International American Group, Inc. as a part of the Berkshire Exchange, which caused insurance float to decrease by approximately $170 million, and the acquisition of AFI, which caused insurance float to decrease by approximately $65 million. These decreases were partially offset by $187 million in losses at WM Life Re. Additionally, severe investment and foreign currency losses experienced during the global financial crisis and the Berkshire Exchange caused significant increases in White Mountains’ operational leverage metrics during 2008.
Management believes that White Mountains generally has the flexibility and capacity to obtain funds externally as needed through debt or equity financing on both a short-term and long-term basis. White Mountains can provide no assurance that, if needed, it would be able to obtain additional debt or equity financing on satisfactory terms, if at all.
The WTM Bank Facility contains various affirmative, negative and financial covenants that White Mountains considers to be customary for such borrowings, including certain minimum net worth and maximum debt to capitalization standards. Failure to meet one or more of these covenants could result in an event of default, which ultimately could eliminate availability under these facilities and result in acceleration of principal repayment on any amounts outstanding. At December 31, 2011, White Mountains was in compliance with all of the covenants under the WTM Bank Facility and anticipates it will continue to remain in compliance with these covenants for the foreseeable future.
It is possible that, in the future, one or more of the rating agencies may lower White Mountains’ existing ratings. If one or more of its ratings were downgraded, White Mountains could incur higher borrowing costs 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 downgrade in their financial strength ratings, including a possible reduction in demand for their products in certain markets.
(1) Represents expected future cash outflows resulting from loss and LAE payments. The amounts presented are gross of reinsurance recoverables on unpaid losses of $2,331 and include the discount on OneBeacon’s workers compensation loss and LAE reserves of $108 as of December 31, 2011. These balances add back the remaining purchase accounting fair value adjustment of $163 related to the acquisition of OneBeacon as it is a non-cash item.
The estimated payments reflected in the table are based on current accrual factors (including performance relative to targets and common share price) and assume that all outstanding balances were 100% vested as of December 31, 2011.
White Mountains does not finance its operations through the securitization of its trade receivables, through special purpose entities or through synthetic leases. Further, except as noted in the following paragraph, White Mountains has not entered into any material arrangements requiring it to guarantee payment of third-party debt or lease payments or to fund losses of an unconsolidated special purpose entity.
In 2006, White Mountains’ board of directors authorized the Company to repurchase up to 1 million of its common shares, from time to time, subject to market conditions. On August 26, 2010, White Mountains’ board of directors authorized the Company to repurchase an additional 600,000 common shares. Shares may be repurchased on the open market or through privately negotiated transactions. The repurchase authorization does not obligate the Company to acquire any specific number of shares, nor is there a stated expiration date. Since the inception of this program through December 31, 2011, the Company repurchased 1,411,703 common shares for $537 million. During 2011, the Company repurchased 313,967 common shares under this program for $114 million. During 2012, through February 22, 2012, the Company has repurchased and retired 157,629 of its common shares under this program for $76 million. As of February 24, 2012, the Company had 30,668 shares remaining under its share repurchase authorization.
In 2007, OneBeacon Ltd.’s board of directors authorized OneBeacon Ltd. to repurchase up to $200 million of its Class A common shares from time to time, subject to market conditions. Shares may be repurchased on the open market or through privately negotiated transactions. This program does not have a stated expiration date. OneBeacon did not repurchase any shares in 2011. During 2010, OneBeacon repurchased and retired 0.7 million of its Class A common shares under this program for $11 million. OneBeacon did not repurchase any shares in 2009.
Detailed information concerning White Mountains’ cash flows during 2011, 2010 and 2009 follows:
Cash flows from investing and financing activities for the year ended December 31, 2011
During 2011, OBH repurchased and retired a portion of the outstanding OBH Senior Notes for $162 million.
During 2011, OneBeacon paid a total of $20 million of interest on the OBH Senior Notes.
During 2011, Sirius Group paid $26 million of interest on the SIG Senior Notes, $19 million of dividends on the SIG Preference Shares.
During 2011, White Mountains contributed $104 million to Esurance and received $95 million of capital distributions from Esurance.
Cash flows from investing and financing activities for the year ended December 31, 2010
During 2010, Sirius Group paid $26 million of interest on the SIG Senior Notes and $19 million of cash dividends on the SIG Preference Shares.
During the third quarter of 2010, OneBeacon completed the Personal Lines Transaction and received consideration of approximately $167 million.
During 2010, OneBeacon received $10 million of additional consideration from the Commercial Lines Transaction.
During 2009, OneBeacon paid $37 million of interest on the OBH Senior Notes.
Adjusted book value per share is a non-GAAP measure which is derived by expanding the GAAP calculation of book value per White Mountains common share to exclude equity in net unrealized gains and losses from Symetra’s fixed maturity portfolio, net of applicable taxes. In addition, the number of common shares outstanding used in the calculation of adjusted book value per share are adjusted to exclude unearned restricted common shares, the compensation cost of which, at the date of calculation, has yet to be amortized. The reconciliation of adjusted book value per share to GAAP book value per share is included on page 40.
Esurance’s adjusted expense ratio and adjusted combined ratio are non-GAAP financial measures. To calculate the adjusted expense ratio and adjusted combined ratio, acquisition expenses are reduced by referral fee revenue. Referral fee revenue, which is recorded as a component of other revenues under GAAP, represents fees that Esurance receives for referring customers for whom it does not write policies to other insurance carriers and aggregators. Management believes that Esurance’s adjusted expense ratio and adjusted combined ratio are better measures to evaluate Esurance’s underwriting results than its GAAP expense ratio and GAAP combined ratio because the expenses that are incurred to acquire policyholders at Esurance, particularly advertising expenses, also lead to referral fee revenue. The reconciliation of Esurance’s adjusted expense ratio and adjusted combined ratio to its GAAP expense ratio and GAAP combined ratio follows:
Ultimate loss and LAE are generally determined by extrapolation of claim emergence and settlement patterns observed in the past that can reasonably be expected to persist into the future. In forecasting ultimate loss and LAE with respect to any line of business, past experience with respect to that line of business is the primary resource, but cannot be relied upon in isolation. White Mountains’ own experience, particularly claims development experience, such as trends in case reserves, payments on and closings of claims, as well as changes in business mix and coverage limits, is the most important information for estimating its reserves. External data, available from organizations such as statistical bureaus, consulting firms and reinsurance companies, is sometimes used to supplement or corroborate White Mountains’ own experience, and can be especially useful for estimating costs of new business. For some lines of business, such as “long-tail” coverages discussed below, claims data reported in the most recent accident year is often too limited to provide a meaningful basis for analysis due to the typical delay in reporting of claims. For this type of business, White Mountains uses a selected loss ratio method for the initial accident year or years. This is a standard and accepted actuarial reserve estimation method in these circumstances in which the loss ratio is selected based upon information used in pricing policies for that line of business, as well as any publicly available industry data, such as industry pricing, experience and trends, for that line of business.
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, 2011 and 2010, total carried reserves were 10% and 13% above the actuarial point estimate, respectively.
· Changes in the interpretations and processes of various workers compensation bureaus’ oversight of claims
· Changes in the cost of medical treatments, including prescription drugs, and underlying fee schedules
With respect to the adverse loss reserve development in other insurance operations, management completed a detailed review of loss and defense and cost containment expenses (ALAE) and other adjusting expenses (ULAE) during the fourth quarter of 2011. The analysis considered costs, based on current non-staff expenses and staffing projections for the run-off business, as management continues efforts to segregate its claims operations between ongoing claims and run-off claims. The analysis also factored in the revised definition of run-off operations to include the non-specialty commercial lines business that was exited via the Commercial Lines Transaction.
In 2010, OneBeacon experienced $57 million of 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. The favorable development also included an $8 million release of commercial catastrophe reserves associated with storms occurring in 2004 and 2005.
At December 31, 2009, management had recorded $8 million of reserves for certain claims related to catastrophes from accident years 2004 and 2005 related to OneBeacon’s excess property business. During 2010, these claims were resolved for amounts below OneBeacon’s policy coverage therefore the reserves were no longer necessary.
Additionally, during 2010, AutoOne experienced $6 million in adverse loss reserve development which is included in discontinued operations.
Additionally, during 2009, AutoOne, which is included in discontinued operations, experienced $33 million in adverse development. At December 31, 2008, management had estimated that future payments from personal injury protection litigation from OneBeacon’s AutoOne business would be approximately $8 million. During 2009, the legal expenses related to this litigation were higher than expected. As a result, management increased estimates of all accident years for AutoOne.
The following table shows the recorded reserves and the high and low ends of OneBeacon’s range of reasonable loss and LAE reserve, net of reinsurance recoverable on unpaid losses, estimates by line of business at December 31, 2011.
· Workers compensation: Recorded reserves for workers compensation were $272 million at December 31, 2011. The two most important assumptions for workers compensation reserves are loss development factors and loss cost trends, particularly medical cost inflation. Loss development patterns are dependent on medical cost inflation. Approximately half of the workers compensation net reserves are related to future medical costs. Across the entire reserve base, a 0.5 point change in calendar year medical inflation would have changed the estimated net reserve by approximately $49 million at December 31, 2011, in either direction.
· Professional liability: Recorded reserves for professional liability were $388 million across all lines at December 31, 2011. A key assumption for professional liability is the implicit loss cost trend, particularly the severity inflation trend component of loss costs. Across the entire reserve base, a 5.0 point change in assumed annual severity would have changed the estimated net reserve by approximately $64 million at December 31, 2011, in either direction.
Historically, most asbestos claims have been asserted as product liability claims. Recently, insureds who have exhausted the available products liability limits of their insurance policies have sought from insurers such as OneBeacon payment for asbestos claims under the premises and operations coverage of their liability policies, which may not be subject to similar aggregate limits. OneBeacon expects this trend to continue. However, to date there have been fewer of these premises and operations coverage claims than product liability coverage claims. This may be due to a variety of factors, including that it may be more difficult for underlying plaintiffs to establish losses as stemming from premises and operations exposures, which requires proof of the defendant’s negligence, rather than products liability under which strict legal liability applies. Premises and operations claims may vary significantly and policyholders may seek large amounts, although such claims frequently settle for a fraction of the initial alleged amount. Accordingly, there is a great deal of variation in damages awarded for the actual injuries. As of December 31, 2011, there were approximately 225 active claims by insureds against OneBeacon without product liability coverage asserting operations or premises coverage, which may not be subject to aggregate limits under the policies.
OneBeacon’s reserves for A&E losses, net of Third-Party Recoverables but prior to NICO recoveries, were $0.8 billion at December 31, 2011. 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 13.3 years at December 31, 2011. This was computed as the ratio of A&E reserves, net of Third-Party Recoverables prior to the NICO Cover of $0.8 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, 2011, net of Third-Party Recoverables. OneBeacon’s survival ratio was 10.7 years at December 31, 2010. OneBeacon believes that as a result of the NICO Cover and its historical third-party reinsurance programs, OneBeacon should not experience material financial loss from A&E exposures under current coverage interpretations and that its survival ratio compares favorably to industry survival ratios. However, the survival ratio is a simplistic measure estimating the number of years it would be before the current ending loss reserves for these claims would be paid using recent annual average payments subject to adjustments for unusual items. Many factors, such as aggressive settlement procedures, mix of business and coverage provided, have a significant effect on the amount of A&E reserves and payments and the resultant survival ratio. Thus, caution should be exercised in attempting to determine reserve adequacy for these claims based simply on this survival ratio.
OneBeacon’s A&E claim activity for the last two years is illustrated in the table below:
Sirius Group’s net loss and LAE reserves by class of business at December 31, 2011 and 2010 were as follows:
(1) Sirius Group’s A&E exposures are principally the result of run-off of businesses acquired in the 1990s.
Backlogs in the recording of assumed reinsurance can also complicate the accuracy of loss reserve estimation. As of December 31, 2011, there were no significant backlogs related to the processing of assumed reinsurance information at Sirius Group.
Sirius Group relies heavily on information reported by ceding companies, as discussed above. In order to determine the accuracy and completeness of such information, Sirius Group underwriters, actuaries, and claims personnel perform audits of certain ceding companies where customary. Generally, ceding company audits are not customary outside the United States. In such cases, Sirius Group reviews information from ceding companies for unusual or unexpected results. Any material findings are discussed with the ceding companies. Sirius Group sometimes encounters situations where it is determined that a claim presentation from a ceding company is not in accordance with contract terms. Most situations are resolved amicably and without the need for litigation or arbitration. However, in the infrequent situations where a resolution is not possible, Sirius Group will vigorously defend its position in such disputes.
In 2011, Sirius Group had net favorable loss reserve development of $47 million, primarily attributable to $41 million of favorable development on property lines, including $13 million of loss reserve reductions for the 2010 Chile earthquake, partially offset by asbestos and environmental increases of $12 million. In 2010, Sirius Group had net favorable loss reserve development of $57 million, primarily related to short-tailed lines, such as property, accident and health, and marine, in recent underwriting years. Included in the $57 million favorable loss reserve development was the recognition of $16 million in deferred gains from a retrocessional reinsurance contract that incepted in 2000 and was fully collected in 2010.
The actuarial analysis is a primary consideration for management in determining its best estimate of loss and LAE reserves. In making its best estimate, management also considers other qualitative factors that may lead to a difference between its best estimate of loss and LAE reserves and the actuarial point estimate. Typically, these factors exist when management and the company’s actuaries conclude that there is insufficient historical incurred and paid loss information or that trends included in the historical incurred and paid loss information are unlikely to repeat in the future. These factors may include, among others, changes in the techniques used to assess underwriting risk, more accurate and detailed levels of data submitted with reinsurance applications, the uncertainty of the current reinsurance pricing environment, the level of inflation in loss costs, changes in ceding company reserving practices, and legal and regulatory developments. At December 31, 2011 and 2010, total carried reserves were 2.7% and 2.6% above the actuarial point estimate, respectively.
Sirius Group’s A&E exposure is primarily from reinsurance contracts written between 1974 through 1985 by acquired companies, mainly MONY Reinsurance Company and Christiania General Insurance Company. The exposures are mostly higher layer excess of loss treaty and facultative coverages with relatively low limits exposed for each claim. Sirius Group has a specialized unit that handles claims relating to 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. Net incurred loss activity for asbestos and environmental in the last two years was as follows:
In 2010, Sirius Group completed an in-depth analysis of its asbestos exposure. The main focus of the analysis was on the internal claims analysis of all treaty and facultative contracts likely to have asbestos exposure at June 30, 2010. This analysis entailed examining total expected asbestos losses and LAE from a variety of information sources, including previous asbestos studies, reported data and external benchmarking scenarios. Since the 2010 study, management has monitored quarterly activity against established metrics to maintain adequate loss reserves.
Sirius Group’s net reserves for A&E losses were $163 million and $170 million at December 31, 2011 and 2010, respectively. Sirius Group’s A&E three-year net loss paid survival ratio was approximately 11.1 years and 12.5 years at December 31, 2011 and 2010.
The following tables show gross and net loss and LAE payments for A&E exposures for the years ending December 31, 2003 through December 31, 2011:
Where available, the estimated fair value of investments is based upon quoted prices in active markets. In circumstances where quoted prices are unavailable, White Mountains uses fair value estimates based upon other observable inputs including matrix pricing, benchmark interest rates, market comparables, and other relevant inputs. Where observable inputs are not available, the estimated fair value is based upon internal pricing models using assumptions that include inputs that may not be observable in the marketplace but which reflect management’s best judgment given the circumstances and consistent with what other market participants would use when pricing such instruments.
The following table summarizes White Mountains’ fair value measurements and the percentage of Level 3 investments at December 31, 2011:
(1) Carrying value includes $111.8 that is classified as assets held for sale relating to AutoOne.
White Mountains uses quoted market prices where available as the inputs to estimate fair value for its investments in active markets. Such measurements are considered to be either Level 1 or Level 2 measurements, depending on whether the quoted market price inputs are for identical securities (Level 1) or similar securities (Level 2). Level 3 measurements for fixed maturities at December 31, 2011 comprise securities for which the estimated fair value has not been determined based upon quoted market price inputs for identical or similar securities.
The following table summarizes the changes in White Mountains’ fair value measurements by level for the year ended December 31, 2011:
White Mountains holds warrants to acquire common shares of Symetra. The warrants are recorded at fair value. White Mountains uses a Black-Scholes valuation model to determine the fair value of the Symetra warrants. The major assumptions used in valuing the Symetra warrants at December 31, 2011 were a risk free rate of 0.31%, volatility of 36%, an expected life of 2.58 years, a strike price of $11.49 per share and a share price of $9.07 per share. The inputs used in the valuation model are observable inputs. However, since a quoted market price is not available for the warrants themselves, they are categorized as a Level 2 measurement.
Other long-term investments accounted for at fair value at December 31, 2011 consist of $125 million in hedge funds and $129 million in private equity funds. At December 31, 2011, White Mountains held investments in 16 hedge funds and 32 private equity funds. The largest investment in a single fund was $27 million and $49 million at December 31, 2011 and 2010.
In circumstances where the underlying investments are publicly traded, such as the investments made by hedge funds, the fund manager uses current market prices to determine fair value. In circumstances where the underlying investments are not publicly traded, such as the investments made by private equity funds, the private equity fund managers generally consider the need for a liquidity discount on each of the underlying investments when determining the fund’s net asset value. In circumstances where White Mountains’ portion of a fund’s net asset value is deemed to differ from fair value due to illiquidity or other factors associated with White Mountains’ investment in the fund, the net asset value is adjusted accordingly. At December 31, 2011, White Mountains did not record an adjustment to the net asset value related to any of its investments in hedge funds or private equity funds.
White Mountains’ investment portfolio includes investments in hedge funds and private equity funds. At December 31, 2011, the value of investments in hedge funds and in private equity funds was $125 million and $129 million, respectively. The underlying investments are typically publicly traded and private common equity investments, and, as such, are subject to market risks that are similar to White Mountains’ common equity securities. The following illustrates the estimated effect on December 31, 2011 fair value resulting from a 10% change and a 30% change in market value:
White Mountains has entered into agreements to reinsure death and living benefit guarantees associated with certain variable annuities in Japan. White Mountains carries the benefit guarantees at fair value. The fair value of the guarantees is estimated using actuarial and capital market assumptions related to the projected discounted cash flows over the term of the reinsurance agreement. The valuation uses assumptions about surrenders rates, market volatilities and other factors, and includes a risk margin which represents the additional compensation a market participant would require to assume the risks related to the business. The selection of surrender rates, market volatility assumptions, risk margins and other factors require the use of significant management judgment. Assumptions regarding future policyholder behavior, including surrender and lapse rates, are generally unobservable inputs and significantly impact the fair value estimate. Market conditions including, but not limited to, changes in interest rates, equity indices, market volatility and foreign currency exchange rates as well as variations in actuarial assumptions regarding policyholder behavior may result in significant fluctuations in the fair value of the liabilities associated with these guarantees that could materially affect results of operations. All of White Mountains’ variable annuity reinsurance liabilities ($768.5 million) were classified as Level 3 measurements at December 31, 2011.
Generally, the liabilities associated with these guarantees increase with declines in the equity markets, interest rates and currencies against the Japanese yen, as well as with increases in market volatilities. In 2008, particularly in the fourth quarter, as a result of worldwide declines in equity markets, interest rates and the strengthening of the Japanese yen, the underlying investment accounts declined substantially and have stayed low. The collective account values were approximately 78% and 82% of the guarantee value at December 31, 2011 and December 31, 2010. 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, 2010 and 2009 to reflect the behavior observed during the turbulent markets experienced throughout those years.
Since the fourth quarter of 2008, WM Life Re has made significant modifications and adjustments to improve the effectiveness of its economic hedging program.
As of December 31, 2011, the value of bond funds tracking the WGBI was approximately ¥61 billion ($791.2 million). By country, the largest exposures, together comprising over 90% of the WGBI, were the United States (42%), Germany (10%), France (10%), the United Kingdom (9%), Italy (8%), Spain (4%), Canada (3%), the Netherlands (3%), and Belgium (2%). Eurozone countries together comprised approximately 40%. 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 by entering 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 construction rules and holdings are substantially similar. These swaps are denominated in Japanese yen and, therefore, need not be hedged into Japanese yen. As of December 31, 2011, the total notional amounts of WGBI and JPM European GBI swaps were $200 million and ¥25.3 billion ($329 million), respectively. At that date, approximately 76% and 100% of the total WGBI and European component of the WGBI, respectively, were hedged with total return swaps. Of the $200 million notional amount of WGBI swaps, $75 million matured in January 2012, $50 million will mature in July of 2012 and the remaining $75 million in 2013. The market for WGBI swaps continues to be illiquid and, while WM Life Re continues to look for counterparties to increase its coverage and replace swaps as they mature, there is no guaranty that WM Life Re will be able to do so. The JPM European GBI total return swaps have maturities laddered during 2015 and 2016 to approximate the maturities of the policies reinsured.
The following table summarizes the estimated financial impact on WM Life Re’s derivatives and benefit guarantee liabilities of instantaneous changes in individual market variables as of December 31, 2011. The table below assumes that all other market variables are constant and does not reflect the inter-dependencies between individual variables.
(2) 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.
(1) Assumed hedge effectiveness in down and up markets of 93% and 107%, respectively, as of December 31, 2011 and 89% and 105%, respectively, as of December 31, 2010.
WM Life Re applies shocks to the Japanese interest rates and foreign bond fund yields in opposite directions. In the down market 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. The “up market” scenario assumes opposite movements in the same variables. For other variables, the “down market” scenario assumes equity indices decrease 20%, foreign currencies depreciate by 15% against the Japanese yen and implied market volatility increases as described in footnote 3 to the table above. The “up market” scenario assumes opposite movements in the same variables. Both up and down scenarios produce an expected net loss due to the convexity of the liability value, coupled with the assumption that the shock scenarios happen instantaneously without adjustment of the hedging portfolio.
As of December 31, 2011, WM Life Re’s surrender assumptions vary from 0.1% currently to 3.0% depending on the level of account value versus guarantee value; at the current levels of account value, the average surrender rate is approximately 0.6% per annum. The potential increase in the fair value of the liability due to a change in current actuarial assumptions is as follows:
As of December 31, 2011, WM Life Re increased the variable annuity guaranty liability by $6 million to partially reflect a “basis swap” implied by foreign exchange rates which results in lower projected returns (in Japanese yen) for the portion of funds invested in countries outside of Japan. Since the financial crisis in 2008, there has been a break in expected arbitrage free relationships between swap interest rates and foreign exchange rates (in particular, between the U.S. and Japan). This adjustment recognizes that this anomaly of trading values may be more than temporary.
In connection with White Mountains’ acquisition of OneBeacon in 2001, Aviva caused OneBeacon to purchase reinsurance contracts with two reinsurance companies rated “AA+” (Very Strong, the second highest of twenty-one financial strength ratings) by Standard & Poor’s and “A++” (Superior, the highest of fifteen financial strength ratings) by A.M. Best. One is a reinsurance cover with NICO which entitles OneBeacon to recover up to $2.5 billion in ultimate loss and LAE incurred related primarily to claims arising from business written by its predecessor prior to 1992 for asbestos claims and 1987 for environmental claims, respectively. As of December 31, 2011, OneBeacon has ceded estimated incurred losses of approximately $2.3 billion to NICO under the NICO Cover. The other contract is a reinsurance cover with GRC for up to $570 million of additional losses on all claims arising from accident years 2000 and prior. As of December 31, 2011, OneBeacon has ceded estimated incurred losses of $562 million to GRC under the GRC Cover. The NICO Cover and GRC Cover, which were contingent on and occurred contemporaneously with the acquisition of OneBeacon, were put in place in lieu of a seller guarantee of loss and LAE reserves and are therefore accounted for as a seller guarantee under GAAP in accordance with Emerging Issues Task Force Topic No. D 54. NICO and GRC are wholly-owned subsidiaries of Berkshire.
In September 2011, the U.S. Federal Reserve Bank (the “Fed”) began “Operation Twist”, which has decreased long-term interest rates on fixed maturity investments. Under Operation Twist, the Fed has sold shorter-term U.S. treasury securities, which have maturities of generally 3 years or less, to fund the purchase of longer-term U.S. securities, with maturities between 6 and 30 years. The Fed has also stated that it expects to continue to take actions to keep long-term interest rates low until late-2014. 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, including Symetra, is now well below their stated GAAP book value, a trend inconsistent with historical patterns.
When determining the value of life insurance holding companies that are acquisition targets, market participants commonly utilize an approach that values the company as the sum of (A) adjusted statutory net worth of any regulated life insurance companies (i.e. statutory surplus plus asset valuation reserve) plus the GAAP net assets of any non-life businesses, less holding company debt and (B) the present value of future earnings related to business in force as of the valuation date plus the present value of future earnings related to business written after the valuation date. White Mountains used this approach when it acquired its initial investment in Symetra in 2004. Part A of the calculation can be performed using observable inputs from the statutory and GAAP financial statements. Part B of the calculation requires a large number of actuarial calculations including assumptions such as discount rates, mortality, persistency and future investment results that, while based on historical data and are supportable, are nonetheless judgmental and largely unobservable. For Symetra, part A is approximately $15 per share as of December 31, 2011. Symetra management provided its Board of Directors (of which White Mountains has 2 representatives) with an internal actuarial appraisal that demonstrates that part B would be a meaningful positive value in most reasonable scenarios. When determining the GAAP fair value of White Mountains’ investment in Symetra common shares at December 31, 2011, management ascribed the greatest weight to part A, as it is observable and less subjective.
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 approximates Symetra’s adjusted statutory-basis net worth. The write down of $199 million to $261 million represents management’s best estimate of the amount by which the value of the investment has been other-than-temporarily impaired for GAAP. 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.
· incurred losses and the adequacy of its loss and LAE reserves and related reinsurance;
· claims arising from catastrophic events, such as hurricanes, earthquakes, floods or terrorist attacks;
· business opportunities (or lack thereof) that may be presented to it and pursued;
· competitive forces, including the conduct of other property and casualty insurers and reinsurers;