HG Global’s headquarters are located in Hamilton, Bermuda. BAM’s headquarters are located in New York, New York. NSM’s headquarters are located in Conshohocken, Pennsylvania. MediaAlpha’s headquarters are located in Los Angeles, California. Buzz’s headquarters are located in London, United Kingdom. Wobi’s headquarters are located in in Ramat Gan, Israel.
The Company’s headquarters, registered office, principal executive office, and corporate accounting, reporting and internal audit offices are leased. White Mountains owns its corporate finance and investment office in Guilford, Connecticut. HG Global’s, BAM’s, NSM’s, MediaAlpha’s, Buzz’s and Wobi’s offices are leased. Management considers its office facilities suitable and adequate for its current level of operations.
The following table presents selected consolidated income statement data and ending balance sheet data for each of the five years ended through December 31, 2018:
Adjusted book value per share is a non-GAAP measure. See “NON-GAAP FINANCIAL MEASURES” on page 55.
Overview-Year Ended December 31, 2018 versus Year Ended December 31, 2017
On February 26, 2019, MediaAlpha completed the sale of a significant minority stake to Insignia Capital Group in connection with a recapitalization and cash distribution to existing equityholders. MediaAlpha also repurchased a portion of the holdings of existing equityholders. The transaction valued MediaAlpha at approximately $350 million. The transaction results in an estimated gain of approximately $55 to each of White Mountains’s book value per share and adjusted book value per share. Including the estimated gain of $55 per share for the MediaAlpha transaction, December 31, 2018 book value per share would have been $951 and adjusted book value per share would have been $943. See “MediaAlpha” on page 41.
Gross written premiums and MSC collected in the HG Global/BAM segment totaled $101 million in 2017, compared to $77 million in 2016, as higher pricing more than offset a decrease in issuance volume. BAM insured municipal bonds with par value of $10.4 billion in 2017, compared to $11.3 billion in 2016. Total pricing was 99 basis points, up from 68 basis points in 2016. BAM’s total claims paying resources were $708 million as of December 31, 2017, compared to $644 million as of December 31, 2016. The increase in claims paying resources was driven by positive cash flow from operations. During 2017, BAM paid $5 million of principal and interest on the surplus notes held by HG Global.
Beginning in the second quarter of 2017, White Mountains changed its calculation of adjusted book value per share (i) to include a discount for the time value of money arising from the expected timing of cash payments of principal and interest on the BAM Surplus Notes and (ii) to add back the unearned premium reserve, net of deferred acquisition costs, at HG Global. See “NON-GAAP FINANCIAL MEASURES” on page 55.
White Mountains’s pre-tax total return on invested assets was 5.6% for 2017, compared to 2.7% for 2016.
White Mountains’s fixed income portfolio returned 3.5% for 2017, outperforming the Bloomberg Barclays U.S. Intermediate Aggregate Index return of 2.3%. White Mountains’s fixed income portfolio returned 2.4% for 2016, outperforming the Bloomberg Barclays U.S. Intermediate Aggregate Index return of 2.0%.
Adjusted book value per share at December 31, 2016 includes the impact of 40,000 non-qualified stock options exercisable for $742 per common share. All non-qualified options were exercised prior to their expiration date of January 20, 2017.
Amounts reflects White Mountains’s preferred share ownership in HG Global of 96.9%.
The following tables presents goodwill and other intangible assets that are included in White Mountains’s adjusted book value as of December 31, 2018, 2017 and 2016:
As a result of the OneBeacon, Sirius Group and Tranzact transactions, the results of operations for OneBeacon, Sirius Group and Tranzact have been classified as discontinued operations and are now presented separately, net of related income taxes, in the statement of comprehensive income. Prior year amounts have been reclassified to conform to the current period’s presentation. See Note 19 - “Held for Sale and Discontinued Operations” on page.
Total pricing, which is based on gross written premiums and MSC from new business, was 93 basis points in 2018, down from 99 basis points in 2017. See “NON-GAAP FINANCIAL MEASURES” on page 55. Total pricing in the primary market, which includes assumed business, increased slightly to 75 basis points in 2018, compared to 74 basis points in 2017.
HG Global reported GAAP pre-tax income of $32 million and $26 million in 2018 and 2017, which was driven by $23 million and $19 million of interest income on the BAM Surplus Notes, respectively.
Mountains’s GAAP financial statements and attributed to non-controlling interests. White Mountains reported $61 million of GAAP pre-tax losses on BAM in 2018, driven primarily by $23 million of interest expense on the BAM Surplus Notes and $47 million of general and administrative expenses, compared to $50 million of pre-tax losses in 2017, driven primarily by $19 million of interest expense on the BAM Surplus Notes and $42 million of general and administrative expenses. The increase in general and administrative expenses was primarily due to financing expense from the reinsurance agreement with Fidus Re, which is accounted for using the deposit method under GAAP. During 2018, BAM paid $23 million of principal and interest on the BAM Surplus Notes held by HG Global.
BAM’s “claims paying resources” represent the capital and other financial resources BAM has available to pay claims and, as such, is a key indication of BAM’s financial strength. In 2018, BAM expanded its claims paying resources by $100 million through the collateralized reinsurance agreement with Fidus Re, a special-purpose insurer created solely to provide collateralized reinsurance protection to BAM.
BAM’s claims paying resources increased 23% to $871 million as of December 31, 2018. The increase was driven primarily by the $100 million reinsurance agreement with Fidus Re, $54 million of MSC collected and a $52 million increase in the invested assets of the HG Re Collateral Trusts, partially offset by BAM’s 2018 statutory net loss of $35 million.
BAM’s claims paying resources increased 10% to $708 million as of December 31, 2017. The increase was driven primarily by $37 million of MSC collected and a $44 million increase in the invested assets of the HG Re Collateral Trusts, partially offset by BAM’s 2017 statutory net loss of $25 million.
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’s consolidated balance sheet as of December 31, 2018 and 2017:
Under GAAP, the BAM Surplus Notes are classified as debt by the issuer. Under U.S. Statutory accounting, they are classified as policyholders’ surplus.
The following table presents the gross par value of policies issued and priced by BAM for the years ended December 31, 2018 and 2017:
During 2018, White Mountains acquired a 95.0% equity interest in NSM for cash consideration of $276 million. NSM is a full-service MGU and program administrator for specialty property and casualty insurance. As part of the acquisition, White Mountains assumed estimated contingent consideration earnout liabilities related to NSM’s previous acquisitions of its U.K.-based operations of $10 million.
The following table presents the components of GAAP net loss and adjusted EBITDA included in White Mountains’s NSM segment for the 2018 ownership period:
The following is a discussion of the trends in NSM’s business including periods prior to White Mountains’s ownership of NSM. White Mountains believes this is useful in understanding the newly acquired business.
NSM’s business consists of over 15 active programs that are broadly categorized into five market verticals. The following table presents the controlled premium and commission revenues by vertical for the years ended December 31, 2018, 2017 and 2016:
Year Ended December 31, 2017 versus Year Ended December 31, 2016
Real Estate: NSM’s real estate controlled premium and commission and fee revenue grew in 2017 primarily due to the CHAMP program with increased penetration in the southeast U.S. market.
Social Services: NSM’s social services controlled premium and commission and fee revenue experienced a decline in 2017 primarily due to pull back of a key carrier partner and the decision to non-renew certain programs within the vertical.
The following table presents the components of GAAP net income (loss) and adjusted EBITDA included in White Mountains’s MediaAlpha segment for the years ended 2018, 2017 and 2016:
On February 26, 2019, MediaAlpha completed the sale of a significant minority stake to Insignia Capital Group in connection with a recapitalization and cash distribution to existing equityholders. MediaAlpha also repurchased a portion of the holdings of existing equityholders. The transaction valued MediaAlpha at approximately $350 million. White Mountains retained a 42% ownership interest in MediaAlpha on a fully-diluted basis, and received a net cash distribution of approximately $88 million. As a result of the transaction, White Mountains also expects that it will no longer consolidate MediaAlpha in its financial statements and will mark its interest in MediaAlpha to fair value at the transaction closing date and in subsequent periods.
MediaAlpha Results-Year Ended December 31, 2018 versus Year Ended December 31, 2017
Advertising and commission revenues were $163 million in 2017, compared to $117 million in 2016. The increase in revenues was driven primarily by growth generated from the newly acquired assets in the HLM vertical and growth in the P&C vertical. The HLM vertical revenues increased $27 million, to $56 million for the year ended December 31, 2017. The P&C vertical revenues increased $11 million, to $88 million for the year ended December 31, 2017.
White Mountains’s Other Operations segment reported pre-tax loss of $153 million in 2018, compared to pre-tax income of $32 million in 2017. The results were driven primarily by lower investment returns in 2018. Net realized and unrealized investment losses were $101 million in 2018, compared to net realized and unrealized investment gains of $133 million in 2017. See “Summary of Investment Results” on page 43. Other revenues were $1 million in 2018, compared to $6 million in 2017. In 2017, other revenues included $4 million of third-party investment management fee income at WM Advisors.
For the year ended December 31, 2018, White Mountains repurchased and retired 592,458 of its common shares for $519 million, at an average share price of $877. The average share price paid was approximately 98% and 99%, respectively, of White Mountains’s December 31, 2018 book value per share and adjusted book value per share. The average share price paid was approximately 92% and 93%, respectively, of White Mountains’s December 31, 2018 book value per share including the estimated gain from the MediaAlpha transaction and adjusted book value per share including the estimated gain from the MediaAlpha transaction.
Other Operations Results-Year Ended December 31, 2017 versus Year Ended December 31, 2016
For the year ended December 31, 2017, White Mountains repurchased and retired 832,725 of its common shares for $724 million at an average share price of $869. The average share price paid was approximately 93% and 95%, respectively, of White Mountains’s December 31, 2017 book value per share and adjusted book value per share.
White Mountains’s total investment results include continuing operations and discontinued operations. The OneBeacon and Sirius Group investment results are included in discontinued operations for each respective period.
White Mountains’s portfolio of common equity securities returned -7.7% for 2018, underperforming the S&P 500 Index return of -4.4%. White Mountains’s portfolio of common equity securities returned 20.1% for 2017, underperforming the S&P 500 Index return of 21.8%. White Mountains’s portfolio of common equity securities primarily consists of passive ETFs and publicly-traded common equity securities that are actively managed by third-party registered investment advisers.
During 2017, White Mountains entered into foreign currency forward contracts, which were recorded in other long-term investments, to manage its foreign currency exposure relating to a portion of the non-U.S. common equity portfolios managed by Highclere and Silchester. These foreign currency forward contracts were closed as of December 31, 2017.
In the fourth quarter of 2017, White Mountains established a U.S. investment grade corporate bond mandate with Principal Global Investors, LLC (“Principal”), a third-party registered investment adviser. As of December 31, 2018, the fair value of the Principal investment grade corporate bond mandate was $247 million, with a duration of approximately 4.6 years.
During 2016, White Mountains established a GBP investment grade corporate bond mandate with a third-party registered investment adviser and entered into a foreign currency forward contract, which was recorded in other long-term investments, to manage the foreign currency exposure relating to this mandate. In the first quarter of 2018, White Mountains terminated this mandate and closed the associated foreign currency forward contract. White Mountains also established a portfolio of high-yield fixed maturity investments managed by a third-party registered investment adviser during 2016. In the third quarter of 2018, White Mountains liquidated the high-yield fixed maturity portfolio and reinvested the bulk of the proceeds into U.S. government securities.
Investment Returns-Year Ended December 31, 2017 versus Year Ended December 31, 2016
White Mountains’s other long-term investments portfolio returned -5.8% for 2017. The results were driven primarily by losses from foreign currency forward contracts and unconsolidated entities. These losses were partially offset by strong performance from private equity funds and favorable fair value adjustments to the OneBeacon Surplus Notes. White Mountains’s other long-term investments portfolio returned 0.8% for 2016. The results were driven primarily by favorable fair value adjustments to the OneBeacon Surplus Notes, mostly offset by losses from private equity funds and unconsolidated entities.
White Mountains may enter into foreign currency forward contracts from time to time in order to mitigate its foreign currency exposure on certain invested assets. In the fourth quarter of 2017, White Mountains closed the foreign currency forward contracts associated with the investment assets managed by Silchester and Highclere. In conjunction with the liquidation of the GBP investment grade corporate bond mandate in the first quarter of 2018, White Mountains closed the associated foreign currency forward contract.
For the 2016 period, White Mountains reported Sirius Group’s comprehensive income of $27 million and a combined ratio of 102%, which was driven primarily by $17 million of recorded losses from the Ecuador earthquake that occurred on April 16, 2016.
On July 21, 2016, White Mountains completed the sale of Tranzact to an affiliate of Clayton, Dubilier & Rice, LLC. Tranzact's results inured to White Mountains until the closing date of the transaction. For the 2016 period, White Mountains reported Tranzact’s net loss from discontinued operations of $3 million.
The primary sources of cash for the Company and certain of its intermediate holding companies are expected to be distributions and tax sharing payments received from its operating subsidiaries, capital raising activities, net investment income, proceeds from sales, repayments and maturities of investments and, from time to time, proceeds from sales of operating subsidiaries. The primary uses of cash are expected to be repurchases of the Company’s common shares, payments on and repurchases/retirements of its debt obligations, dividend payments to holders of the Company’s common shares, distributions to non-controlling interest holders of consolidated subsidiaries, purchases of investments, payments to tax authorities, contributions to operating subsidiaries, operating expenses and, from time to time, purchases of operating subsidiaries.
The primary sources of cash for White Mountains’s operating subsidiaries are expected to be premium and fee collections, net investment income, proceeds from sales, repayments and maturities of investments, contributions from holding companies, capital raising activities and, from time to time, proceeds from sales of operating subsidiaries. The primary uses of cash are expected to be loss payments, policy acquisition and other underwriting costs, cost of sales, purchases of investments, payments on and repurchases/retirements of its debt obligations, distributions and tax sharing payments made to holding companies, distributions to non-controlling interest holders, operating expenses and, from time to time, purchases of operating subsidiaries.
Both internal and external forces influence White Mountains’s financial condition, results of operations and cash flows. Premium and fee levels, loss payments, cost of sales and investment returns may be impacted by changing rates of inflation and other economic conditions. Some time may lapse between the occurrence of an insured loss, the reporting of the loss to White Mountains and the settlement of the liability for that loss. The exact timing of the payment of losses and benefits cannot be predicted with certainty.
As of December 31, 2018, HG Global had $619 million face value of preferred shares outstanding, of which White Mountains owned 96.9%. Holders of the HG Global preferred shares receive cumulative dividends at a fixed annual rate of 6.0% on a quarterly basis, when and if declared by HG Global. HG Global did not declare or pay any preferred dividends in 2018. As of December 31, 2018, HG Global had accrued $288 million of dividends payable to holders of its preferred shares, $279 million of which is payable to White Mountains and eliminated in consolidation. As of December 31, 2018, HG Global and its subsidiaries had $2 million of cash outside of HG Re.
Amount reflects White Mountains's preferred share ownership in HG Global of 96.9%.
White Mountains had an unsecured revolving credit facility with a syndicate of lenders administered by Wells Fargo Bank, N.A., which had a total commitment of $425 million. White Mountains terminated the WTM Bank Facility on May 8, 2018.
The MediaAlpha Bank Facility is secured by intellectual property and the common stock of MediaAlpha’s subsidiaries, and contains various affirmative, negative and financial covenants that White Mountains considers to be customary for such borrowings, including a maximum leverage ratio.
The long-term incentive compensation balances included in the table above include amounts payable for performance shares and units. Exact amounts to be paid for performance shares cannot be predicted with certainty, as the ultimate amounts of these liabilities are based on the future performance of White Mountains and the market price of the Company’s common shares at the time the payments are made.
White Mountains also has future binding commitments to fund certain other long-term investments. These commitments, which totaled approximately $170 million as of December 31, 2018, do not have fixed funding dates and, are therefore, excluded from the table above.
White Mountains’s board of directors has authorized the Company to repurchase its common shares from time to time, subject to market conditions. The repurchase authorizations do not have a stated expiration date. As of December 31, 2018, White Mountains may repurchase an additional 635,705 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. On May 11, 2018, White Mountains completed a “modified Dutch auction” tender offer, through which it repurchased 575,068 of its common shares at a purchase price of $875 per share for a total cost of approximately $505 million, including expenses. Shares repurchased under this tender offer did not impact the remaining number of shares authorized for repurchase.
The following table presents common shares repurchased by the Company as well as the average price per share as a percent of adjusted book value per share. For 2018, the table also presents the average price per share as a percent of adjusted book value per share, including the estimated gain from the MediaAlpha transaction of $55 per share.
Net cash flows used for continuing operations was $31 million, $62 million and $179 million for the years ended 2018, 2017 and 2016. Cash used from continuing operations was lower in 2018 compared to 2017, primarily due to $28 million of payments made in 2017 related to the departures of the Company’s former Chairman and CEO and former CFO. Cash used in 2016 included $166 million in payments from the settlement of certain liabilities and transaction costs in connection with the Sirius Group and Tranzact sales. White Mountains does not believe that these trends will have a meaningful impact on its future liquidity or its ability to meet its future cash requirements. White Mountains has $536 million of net unrestricted cash, short-term investments and fixed maturity investments, $926 million of common equity securities and $67 million of other long-term investments as of December 31, 2018.
During 2018, BAM repaid $18 million of principal and $5 million of accrued interest on the BAM Surplus Notes.
During 2018, NSM borrowed $51 million under the NSM Bank Facility to fund the Fresh Insurance acquisition and $30 million to fund the KBK acquisition.
During the period from May 11, 2018 through December 31, 2018, NSM repaid $1 million on the term loans and $2 million on the revolving credit loan under the NSM Banking Facility.
In August 2018, White Mountains contributed ILS 91 million (approximately $25 million) to Wobi.
During 2018, Wobi repaid its internal credit facility to White Mountains consisting of ILS 88 million of principal and ILS 3 million of accrued interest (totaling approximately $25 million).
In October 2018, White Mountains contributed an additional ILS 10 million (approximately $3 million) to Wobi.
On May 18, 2018, NSM acquired 100% of Fresh Insurance for a purchase price of GBP 37 million (approximately $50 million).
During 2018, White Mountains made gross investments into the Tuckerman Capital Funds totaling $1 million and received a total of $15 million of distributions from these funds.
During 2017, MediaAlpha borrowed $20 million on the term loan and $6 million on the revolving loan under the MediaAlpha Bank Facility. During 2017, MediaAlpha repaid $13 million under the previous MediaAlpha Bank Facility and $2 million on the term loan under the MediaAlpha Bank Facility.
During 2017, White Mountains made gross investments into the Enlightenment Capital Funds totaling $13 million and received a total of $24 million of distributions from these funds.
During 2016, the Company declared and paid a $5 million cash dividend to its common shareholders.
During 2016, MediaAlpha paid $3 million of dividends, of which $2 million was paid to White Mountains.
During 2016, MediaAlpha repaid $2 million of the term loan portion and borrowed $3 million and repaid $3 million under the revolving loan portion of the previous MediaAlpha bank facility.
During 2016, White Mountains received $60 million of dividends from OneBeacon, which is reported as discontinued operations.
On February 26, 2016, White Mountains paid $8 million in settlement of the contingent purchase adjustment for its acquisition of MediaAlpha in 2014.
On August 4, 2016, White Mountains purchased 110,461 common shares of Buzz for GBP 4 million (approximately $5 million) and 54,172 shares of newly issued convertible preferred shares of Buzz for GBP 2 million (approximately $3 million).
During 2016, White Mountains increased its investment in Wobi through the purchase of newly-issued convertible preferred shares for a total of NIS 36 million (approximately $10 million).
This report includes four non-GAAP financial measures that have been reconciled with their most comparable GAAP financial measures.
Adjusted book value per share is a non-GAAP financial measure which is derived by adjusting (i) the GAAP book value per share numerator and (ii) the common shares outstanding denominator, as described below. Beginning in 2017, the GAAP book value per share numerator has been adjusted (i) to include a discount for the time value of money arising from the expected timing of cash payments of principal and interest on the BAM Surplus Notes and (ii) to add back the unearned premium reserve, net of deferred acquisition costs, at HG Global. Under GAAP, White Mountains is required to carry the BAM Surplus Notes, including accrued interest, at nominal value with no consideration for time value of money. Based on a debt service model that forecasts operating results for BAM through maturity of the BAM Surplus Notes, the present value of the BAM Surplus Notes, including accrued interest, was estimated to be $146 million and $162 million less than the nominal GAAP carrying values as of December 31, 2018 and December 31, 2017, respectively. The value of HG Global’s unearned premium reserve, net of deferred acquisition costs, was $106 million and $82 million as of December 31, 2018 and December 31, 2017, respectively. White Mountains believes these adjustments are useful to management and investors in analyzing the intrinsic value of HG Global, including the value of the BAM Surplus Notes and the value of the in-force business at HG Re, HG Global’s reinsurance subsidiary. For 2016, the numerator used in the calculation of adjusted book value per share also includes the dilutive effects of future proceeds from the outstanding non-qualified options for periods prior to January 20, 2017, the expiration date of the non-qualified options. The denominator used in the calculation of adjusted book value per share equals the number of common shares outstanding adjusted to exclude unearned restricted common shares, the compensation cost of which, at the date of calculation, has yet to be amortized. Restricted common shares are amortized on a straight-line basis over their vesting periods. For 2016, the denominator used in the calculation of adjusted book value per share also includes the dilutive effects of outstanding non-qualified options for periods prior to January 20, 2017, the expiration date of the non-qualified options. The reconciliation of GAAP book value per share to adjusted book value per share is included on page 31.
Adjusted EBITDA is a non-GAAP financial measure, which is defined as net income (loss) excluding interest expense on debt, income tax benefit (expense), depreciation and amortization, and certain adjustments at NSM and MediaAlpha. In the case of NSM, adjusted EBITDA also excludes the change in the fair value of NSM’s contingent consideration earnout liabilities related to prior transactions. In the case of MediaAlpha, adjusted EBITDA also excludes non-cash equity-based compensation expense. White Mountains believes that adjusted EBITDA is useful to management and investors in analyzing NSM’s and MediaAlpha’s fundamental economic performance. White Mountains believes that investors commonly use adjusted EBITDA as a supplemental measurement to evaluate the overall operating performance of companies within the same industry. See page 39 for the reconciliation of NSM’s GAAP net income (loss) to adjusted EBITDA and page 41 for the reconciliation of MediaAlpha’s GAAP net income (loss) to adjusted EBITDA.
Total capital at White Mountains is comprised of White Mountains’s common shareholders’ equity, debt and non-controlling interests other than non-controlling interests attributable to BAM. Total adjusted capital is a non-GAAP financial measure, which is derived by adjusting total capital (i) to include a discount for the time value of money arising from the expected timing of cash payments of principal and interest on the BAM Surplus Notes and (ii) to add back the unearned premium reserve, net of deferred acquisition costs, at HG Global. The reconciliation of total capital to total adjusted capital is included on page 50.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Certain of these estimates are considered critical in that they involve a higher degree of judgment and are subject to a significant degree of variability. On an ongoing basis, management evaluates its estimates and bases its estimates on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.
Assets and liabilities carried at fair value include substantially all of the investment portfolio, derivative instruments, both exchange traded and over the counter instruments, and reinsurance assumed liabilities associated with variable annuity benefit guarantees. Valuation of assets and liabilities measured at fair value require management to make estimates and apply judgment to matters that may carry a significant degree of uncertainty. In determining its estimates of fair value, White Mountains uses a variety of valuation approaches and inputs. Whenever possible, White Mountains estimates fair value using valuation methods that maximize the use of observable prices and other inputs. Where appropriate, assets and liabilities measured at fair value have been adjusted for the effect of counterparty credit risk.
White Mountains’s process to assess the reasonableness of the market prices obtained from the outside pricing sources covers substantially all of its fixed maturity investments and includes, but is not limited to, the evaluation of pricing methodologies and a review of the pricing services’ quality control procedures on at least an annual basis, a comparison of its invested asset prices obtained from alternate independent pricing vendors on at least a semi-annual basis, monthly analytical reviews of certain prices and a review of the underlying assumptions utilized by the pricing services for select measurements on an ad hoc basis throughout the year. White Mountains also performs back-testing of selected sales activity to determine whether there are any significant differences between the market price used to value the security prior to sale and the actual sale price on an ad-hoc basis throughout the year. Prices provided by the pricing services that vary by more than 5% and $0.5 million from the expected price based on these assessment procedures are considered outliers, as are prices that have not changed from period to period and prices that have trended unusually compared to market conditions. In circumstances where the results of White Mountains’s review process does not appear to support the market price provided by the pricing services, White Mountains challenges the vendor provided price. If White Mountains cannot gain satisfactory evidence to support the challenged price, White Mountains will rely upon its own pricing methodologies to estimate the fair value of the security in question.
Income Approach: The income approach converts future amounts to a single current discounted amount, based on expected future cash flows that a company will generate, along with expected proceeds from disposition. The cash flows are discounted to their present value using a discount rate that incorporates the risk-free rate for the use of funds, the expected rate of inflation, and risks associated with the particular investment.
Cost Approach: The cost approach reflects the amount that would be required currently to replace the service capacity of an asset, or the current replacement cost. When applied to the valuation of equity interests in businesses, value is based on the net aggregate fair market value of the entity’s underlying individual assets.
In the fourth quarter of 2018, White Mountains completed a valuation analysis of its investment in PassportCard/DavidShield, which represents White Mountains’s most significant unconsolidated entity. White Mountains used an income approach to valuation based on discounted cash flows. The valuation model included key inputs of expected future cash flows, a discount rate, and a terminal premium and other revenue exit multiple. The expected future cash flows were based on management judgment, considering current performance along with budgets and projected future results. The discount rate reflected the weighted average cost of capital, considering comparable public company data, adjusted for risks specific to the investee and industry. The exit multiple was based on expectations of a premium and other revenue multiple for the investee in an exit year, considering comparable companies and similar transaction multiple data. Once a range of values was determined, White Mountains concluded that a discount rate of approximately 18% and a terminal exit multiple of 1 times premium and other revenue was appropriate for the valuation of its investment in PassportCard/DavidShield. A 15% liquidity discount was also applied for lack of marketability and White Mountains’s lack of control over the unconsolidated investee. As a result, the carrying value of White Mountains’s investment in PassportCard/DavidShield was $75 million as of December 31, 2018.
With an income approach, small changes to inputs in a valuation model may result in significant changes to fair value. The following table presents the estimated effect on the fair value of White Mountains’s investment in PassportCard/DavidShield as of December 31, 2018, resulting from changes in key inputs to the discounted cash flow analysis, including the discount rate and terminal exit multiple:
Any write down of the carried amount of the BAM Surplus Notes and/or the accrued interest thereon could adversely impact White Mountains’s results of operations and financial condition. See Item 1A., Risk Factors, “If BAM does not pay some or all of the principal and interest due on the BAM Surplus Notes, it could materially adversely affect our results of operations and financial condition.” on page 20.
Periodically, White Mountains’s management reviews the recoverability of amounts recorded from the BAM Surplus Notes. As of December 31, 2018, White Mountains believes such notes and interest thereon to be fully recoverable.
White Mountains’s review is based on a debt service model that forecasts operating results for BAM, and related payments on the BAM Surplus Notes, through maturity of the BAM Surplus Notes in 2042. The model depends on assumptions regarding future trends for the issuance of municipal bonds, interest rates, credit spreads, insured market penetration, competitive activity in the market for municipal bond insurance and other factors affecting the demand for and price of BAM’s municipal bond insurance. Assumptions regarding future trends for these factors are a matter of significant judgment. White Mountains expects both par insured and total premiums to increase gradually over the next six years and to flatten thereafter. White Mountains continues to project that the BAM Surplus Notes will be fully repaid approximately nine years prior to final maturity, which is consistent with the previous forecast as of December 31, 2017.
As of December 31, 2018, goodwill and other intangible assets recognized in connection with business and asset acquisitions totaled $538 million, of which $497 million was attributable to White Mountains’s common shareholders. Goodwill and other intangible assets are recorded at their acquisition date fair values. The determination of the acquisition date fair values of goodwill and other intangible assets involves significant management judgment, the use of valuation models and assumptions that are inherently subjective. Goodwill and indefinite-lived intangible assets are not amortized but rather reviewed for potential impairment at least annually. Finite-lived intangible assets, which are amortized over their estimated economic lives, are reviewed for impairment only when events occur or there are changes in circumstances indicating that their carrying value may exceed fair value. Impairment exists when the carrying value of goodwill or other intangible assets exceeds fair value.
incurred loss and loss adjustment expenses and the adequacy of its loss and loss adjustment expense reserves;
actions taken by ratings agencies from time to time, such as financial strength or credit ratings downgrades or placing ratings on negative watch;