OneBeacon Ltd.’s headquarters are located in Hamilton, Bermuda and the headquarters of its U.S. operations and principal executive office are located in Plymouth, Minnesota. OneBeacon also maintains branch offices in various cities throughout the United States.
MediaAlpha’s headquarters are located in Los Angeles, California, Wobi’s headquarters are located in Tel Aviv, Israel, Buzzmove’s headquarters are located in London, United Kingdom, Star & Shield Services LLC’s and Star & Shield Claims Services LLC’s headquarters are located in Alpharetta, Georgia and Star & Shield Risk Management LLC’s headquarters are located in Orlando, Florida.
As a result of the Sirius Group Sale, the Tranzact sale, Esurance and the Runoff Transaction, White Mountains has reclassified the results from these businesses for the past five years in the table above to discontinued operations, net of tax. In 2016, discontinued operations, net of tax, includes a gain from sale of Sirius and Tranzact of $363 and $52. In 2015, discontinued operations, net of tax, includes a gain from sale of Esurance of $18 and net income of $79. In 2014, discontinued operations, net of tax, includes a loss on sale of other discontinued operations of $19, mostly offset by a gain from sale of Fireman’s Fund Insurance Company (“FFIC”) of $14, and net income of $261, primarily related to the operations of Sirius Group. See Note 22 - “Held for Sale and Discontinued Operations” on page. In 2013, discontinued operations, net of tax, includes a gain from sale of the Runoff Business of $47 and a net loss of $42 related to the operations of the Runoff Business. In 2012, discontinued operations, net of tax, includes a gain from sale of the Runoff Business $91 and a net loss of $24 related to the operations of the Runoff Business.
Adjusted book value per share as of December 31, 2016 includes the impact of 40,000 non-qualified options exercisable for $742 per common share. Prior periods exclude the non-qualified stock options, which were anti-dilutive to adjusted book value.
During 2016, 2015, 2014, 2013 and 2012, White Mountains repurchased 1,106,145, 387,495, 217,879, 141,535 and 1,329,640, respectively, of its common shares through a combination of tender offers, open market transactions and other transactions.
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’s actual results could be materially different from and worse than its expectations. See “FORWARD-LOOKING STATEMENTS” on page 75 for specific important factors that could cause actual results to differ materially from those contained in forward-looking statements.
The following discussion also includes four non-GAAP financial measures, adjusted comprehensive income, adjusted book value per share, consolidated portfolio returns excluding Symetra and common equity securities and other long-term investment returns excluding Symetra, and the return on common equity and other long-term investments including high-yield fixed maturity investments that have been reconciled to their most comparable GAAP financial measures on page 64. White Mountains believes these measures to be useful in evaluating White Mountains’s financial performance and condition.
White Mountains ended 2016 with book value per share of $790 and adjusted book value per share of $794, an increase of 13.6% and 13.7% for the year, including dividends. Comprehensive income attributable to common shareholders increased to $558 million in 2016 compared to $197 million in 2015. The increases in 2016 are driven by larger transaction related gains. In 2016, a gain of $477 million from the sale of Sirius Group increased book value per share and adjusted book value per share by $90, while $82 million of comprehensive income generated from the sale of Tranzact increased book value per share and adjusted book value per share by $16. In 2015, White Mountains recognized $241 million of comprehensive income that increased book value per share and adjusted book value per share by $43, which was the result of a change in accounting for the investment in Symetra from the equity method to fair value, caused by White Mountains’s relinquishment of its representation on Symetra’s board of directors subsequent to Symetra entering into a merger agreement with Sumitomo Life. See Note 2 - “Significant Transactions” on page for a description of each transaction.
OneBeacon’s book value per share increased 11.1% during 2016, including dividends, compared to an increase of 3.8% during 2015, including dividends. OneBeacon’s GAAP combined ratio was 97% for 2016 compared to 96% for 2015. OneBeacon’s current accident year loss ratio was 58% for the year ended December 31, 2016, compared to 60% for year ended December 31, 2015. OneBeacon had one point of net unfavorable loss reserve development in the year ended December 31, 2016 compared to insignificant loss reserve development in the year ended December 31, 2015. The decrease in the current accident year loss ratio reflects improved relative performance across most business units. The expense ratio was 38% for the year ended December 31, 2016, compared to 36% for the year ended December 31, 2015. The increase in the expense ratio was primarily due to lower earned premium volume and changing business mix. The increase in book value per share for the year ended December 31, 2016 included a $16 million tax benefit related to the settlement of IRS examinations for tax years 2007-2012. OneBeacon’s net written premiums were $1.1 billion for both the year ended December 31, 2016 and the year ended December 31, 2015.
Sirius Group’s results inured to White Mountains until April 18, 2016, the closing date of the sale to CMI. For the 2016 period, White Mountains reported Sirius Group’s comprehensive income of $27 million and a combined ratio of 102%, which was driven by $17 million of recorded losses from the Ecuador earthquake that occurred on April 16, 2016.
In 2016, White Mountains returned approximately $900 million of capital to shareholders, primarily through share repurchases.
White Mountains ended 2015 with book value per share of $696 and adjusted book value per share of $699, an increase of 4.4% and 5.3% for the year, including dividends. During 2015, White Mountains signed an agreement to sell Sirius Group to CMI, and Symetra announced that it entered into a merger agreement with Sumitomo Life pursuant to which Sumitomo Life will acquire all of the outstanding shares of Symetra. Substantially all of the benefit from the Symetra transaction was recorded in 2015, while the benefit from the Sirius Group transaction was recorded at closing in the second quarter of 2016. Including dividends, Symetra produced $264 million of adjusted comprehensive income for White Mountains in 2015, of which $241 million was recognized as an after-tax unrealized investment gain in the fourth quarter.
For the year ended December 31, 2015, White Mountains repurchased and retired 387,495 of its common shares for $284 million at an average share price of $733, approximately 105% of White Mountains’s December 31, 2015 adjusted book value per share. The average share price paid was approximately 94% of White Mountains’s December 31, 2015 adjusted book value per share including the estimated gain on the Sirius Group transaction, which was announced previous to when the vast majority of the 2015 share repurchases were completed but prior to the recording of the gain in adjusted book value per share, which occurred at closing on April 18, 2016.
OneBeacon’s book value per share increased 3.8% during 2015, including dividends, compared to an increase of 2.1% during 2014, including dividends. OneBeacon’s GAAP combined ratio was 96% for 2015 compared to 102% for 2014. The lower combined ratio was primarily the result of the $109 million loss reserve charge in the fourth quarter of 2014, partially offset by higher expense ratios driven by higher incentive compensation expense, changes in business mix and the impact of exiting the Crop Business. OneBeacon’s net written premiums decreased 7% to $1.1 billion in 2015, primarily due to the exit from the Crop Business and lawyers liability business, a decrease in the Healthcare business and the termination of an affiliated reinsurance treaty, partially offset by increases in OneBeacon’s newer Programs and Surety businesses.
BAM insured municipal bonds with par value of $10.6 billion in 2015, compared to $7.8 billion in 2014. The average total premium (including both risk premiums and Member Surplus Contributions), weighted by insured par, of insurance provided by BAM in the primary and secondary markets in 2015 was 52 basis points, up from 43 basis points in 2014. As of December 31, 2015, BAM’s total claims paying resources were $601 million on total par insured of $22.6 billion. Total claims paying resources increased $20 million from December 31, 2014.
Equity in net unrealized investment losses from Symetra’s fixed maturity portfolio (2)
For the year ended December 31, 2014, equity in net unrealized investment losses from Symetra’s fixed maturity portfolio includes tax expense of $2.6.
The following table is a summary of goodwill and intangible assets that are included in White Mountains’s adjusted book value as of December 31, 2016, 2015 and 2014:
(1) See Note 6 - “Goodwill and Other Intangible Assets” on page for details of other intangible assets.
A summary of White Mountains’s consolidated financial results for the years ended December 31, 2016, 2015 and 2014 follows:
Change in equity in net unrealized investment (losses) gains from investments in Symetra common shares
Change in foreign currency translation and other items from discontinued operations
Adjusted comprehensive income is a non-GAAP measure. For a description of the most comparable GAAP measure. See NON-GAAP FINANCIAL MEASURES on page 64.
Change in equity in net unrealized investment losses from investments in Symetra common shares includes tax benefit of $2.6 and tax expense of $5.8 for the years ended December 31, 2015 and 2014.
White Mountains’s total revenues decreased 16% to $1.4 billion in 2016, which was driven by lower net realized and unrealized investment gains, primarily from $259 million of net unrealized investment gains recognized in 2015 related to Symetra that did not recur in 2016. Earned insurance premiums decreased by 6% in 2016, primarily due to OneBeacon writing less premiums in several lines of business. Net investment income increased 43% to $87 million, driven by a higher invested asset base resulting primarily from the sale of Sirius Group. White Mountains reported net realized and unrealized investment gains of $10 million in 2016, compared to gains of $225 million in 2015, which included the gain from Symetra. See “Summary of Investment Results” on page 50 for a discussion and analysis of White Mountains’s investment returns. Other revenue increased to $150 million in 2016 from $147 million in 2015. Other revenue in 2016 included $117 million from MediaAlpha compared to $106 million in 2015. Other revenue also included a $20 million pre-tax gain in 2015 from the sale of Hamer LLC, a small manufacturing company that White Mountains received in 2012 in connection with the liquidation of a limited partnership fund.
White Mountains’s total revenues increased 15% to $1.6 billion in 2015, which was driven by other revenues associated with consolidated WM Capital Investments. Earned insurance premiums in 2015 were in line with 2014. Net investment income increased 2% to $61 million, as lower investment expenses were mostly offset by lower common stock dividends. White Mountains reported net realized and unrealized investment gains of $225 million in 2015, which included $259 million from Symetra, compared to $79 million of gains in 2014. See “Summary of Investment Results” on page 50 for a discussion and analysis of White Mountains’s investment returns. Other revenue increased to $147 million in 2015 from $88 million in 2014. Other revenue in 2015 included $106 million from MediaAlpha compared to $65 million from MediaAlpha in 2014. Other revenue also included a $20 million pre-tax gain in 2015 from the sale of Hamer LLC, a small manufacturing company that White Mountains received in 2012 in connection with the liquidation of a limited partnership fund.
White Mountains’s total expenses increased 2% to $1.5 billion in 2015, which was driven by increases in other expenses associated with consolidated WM Capital Investments, partially offset by lower expenses in OneBeacon’s insurance business. Losses and LAE decreased 14%, primarily due to the $109 million reserve charge recorded by OneBeacon related to the actuarial analysis performed in the fourth quarter of 2014, while insurance acquisition expenses and other underwriting expenses increased 7% and 22% in 2015 due to changes in business mix and higher incentive compensation expense. See “Summary of Operations by Segment” on page 39. General and administrative expenses in 2015 included $99 million from MediaAlpha compared to $61 million from MediaAlpha in 2014.
White Mountains reported income tax benefit of $45 million in 2016 on pre-tax loss of $40 million. White Mountains’s effective tax rate for 2016 was different than the U.S. statutory rate of 35% due primarily to a $21 million tax benefit recognized in continuing operations related to the reversal of a valuation allowance that resulted from income that was recognized within discontinued operations, a $12.8 million favorable settlement of the 2007-2009 IRS exam and a $3.5 million favorable settlement of the 2010-2012 IRS exam. The rate was also impacted by income generated in jurisdictions with lower tax rates than the United States. The $21 million tax benefit recorded in continuing operations in 2016 related to the reversal of a valuation allowance was generated by the Tranzact Sale, which is accounted for in discontinued operations. See Note 8 - “Income Taxes” on page.
White Mountains reported an income tax benefit of $15 million in 2014 on pre-tax loss of $29 million. White Mountains’s effective tax rate for 2014 was 51%, which was higher than the U.S. statutory rate of 35% due primarily to losses generated in the United States and income generated in jurisdictions with lower tax rates than the United States.
Financial results and GAAP combined ratios for OneBeacon for the years ended December 31, 2016, 2015 and 2014 follow:
OneBeacon’s net written premiums were $1.101 billion for the year ended December 31, 2016, a decrease of 3% compared to the year ended December 31, 2015. Decreases in the Programs ($32 million), Entertainment ($27 million) and Healthcare ($15 million) businesses were partially offset by increases in Financial Institutions ($18 million) and various other businesses.
For 2016 and 2015, OneBeacon’s net combined ratio was higher than the gross combined ratio by 4 points and 1 point as a result of the cost of the reinsurance programs more than offsetting the benefits from ceded losses.
OneBeacon Surplus Notes issued pursuant to the Runoff Transaction. As part of closing the Runoff Transaction on December 23, 2014, OneBeacon provided financing in the form of the OneBeacon Surplus Notes with a par value of $101 million issued by OneBeacon Insurance Company (“OBIC”), one of the entities that was transferred from OneBeacon to Armour as part of the transaction. As of December 31, 2016 and December 31, 2015, the OneBeacon Surplus Notes had a fair value of $72 million and $52 million, based on a discounted cash flow model. The OneBeacon Surplus Notes are included in OneBeacon’s investment portfolio, categorized within other long-term investments, and subsequent changes in value thereon are reflected in continuing operations. See “Critical Accounting Estimates” on page 65 for a sensitivity analysis of potential changes in these key variables that can impact the estimated fair value of the OneBeacon Surplus Notes and “Summary of Investment Results” on page 50 for a discussion and analysis of White Mountains’s investment returns.
During 2015, OneBeacon recognized a loss of $4 million in other revenues in connection with an assessment from the Michigan Catastrophic Claims Association payable to Markel Corporation pursuant to the indemnification provisions in the stock purchase agreement governing the sale of Essentia.
OneBeacon’s net written premiums decreased 7% in 2015 to $1.1 billion, primarily due to the exit from the Crop Business ($44 million) and lawyers liability business ($28 million), a decrease in the Healthcare business ($33 million) and the termination of an affiliated reinsurance treaty ($20 million), partially offset by increases in OneBeacon’s newer Programs and Surety businesses ($67 million). Excluding the impact of OneBeacon’s exit from the Crop Business and lawyers liability business and the affiliated reinsurance treaty termination, consolidated net written premiums increased $13 million, or 1.1%.
Through the first nine months of 2014, OneBeacon recorded $14 million of net unfavorable loss and LAE reserve development, driven by greater-than-expected large losses in several underwriting units, primarily in the professional and management liability lines within Professional Insurance. This large loss activity, which occurred mostly during the second and third quarters of 2014, also impacted the current accident year loss and LAE estimates. Additionally, OneBeacon incurred higher-than-usual claim coverage determination costs, a component of LAE expenses, during the first nine months of 2014. Other underwriting units also reported increased claim activity, including Entertainment, Government Risks, and Accident.
Since the increased level of loss and LAE activity continued into the early part of the fourth quarter, the high level of activity in the second and third quarters no longer seemed to be isolated occurrences. As such, during the fourth quarter of 2014, OneBeacon enhanced its actuarial and claims review in several areas. OneBeacon isolated the recent large loss activity in each of its underwriting units and examined the emergence of large losses relative to the timing and amounts of expected large losses. OneBeacon also conducted additional analyses in the lawyers’ professional liability line within Professional Insurance. These new analyses included a claim level review and the application of additional actuarial methods and loss development assumptions. The results of these analyses indicated that the assumed tail risk included in the loss development patterns used to record IBNR reserves for this line were insufficient and needed to be increased for remaining long-tail exposures. OneBeacon’s claims and actuarial staff also conducted an in-depth review of coverage determination, litigation and other claim-specific adjusting expenses as a result of an emerging trend of increased expenses in these areas over recent quarters, particularly coverage determination expenses. This review concluded that the ultimate costs of these loss adjustment expenses were larger than previously estimated, causing management to record an increase in estimated LAE expenses, primarily in Professional Insurance. Finally, OneBeacon also recorded unfavorable prior year development in other underwriting units, including Entertainment and Government Risks. The unfavorable loss development in Entertainment and Government Risks resulted from heavier than expected claim activity during the fourth quarter, predominantly in the general liability and commercial auto liability lines.
The following table presents the components of pre-tax income included in White Mountains’s HG Global/BAM segment related to the consolidation of HG Global, which includes HG Re and its other wholly-owned subsidiaries, and BAM for the years ended December 31, 2016, 2015 and 2014:
In 2016, BAM insured $11.3 billion of municipal bonds, $10.3 billion of which were in the primary market, up 7% from 2015. The average total premium (including both risk premiums and Member Surplus Contributions), weighted by insured par, of insurance provided by BAM in the primary and secondary markets in 2016 was 68 basis points, up from 52 basis points in 2015.
HG Global reported GAAP pre-tax income of $22 million and $18 million in 2016 and 2015, which was driven by $18 million and $16 million of interest income on the BAM Surplus Notes.
As a mutual insurance company that is owned by its members, BAM’s results do not affect White Mountains’s book value per share and adjusted book value per share. However, White Mountains is required to consolidate BAM’s results in its GAAP financial statements and its results are attributed to non-controlling interests. White Mountains reported $49 million of GAAP pre-tax losses on BAM in 2016, driven by $18 million of interest expense on the BAM Surplus Notes and $38 million of operating expenses, compared to $47 million of pre-tax losses in 2015, driven by $16 million of interest expense on the BAM Surplus Notes and $35 million of operating expenses.
The following table presents BAM’s total claims paying resources as of December 31, 2016 and 2015:
In 2015, BAM insured $10.6 billion of municipal bonds, $10.0 billion of which were in the primary market, up 36% from 2014. The average total premium (including both risk premiums and Member Surplus Contributions), weighted by insured par, of insurance provided by BAM in the primary and secondary markets in 2015 was 52 basis points, up from 43 basis points in 2014.
White Mountains reported $47 million of GAAP pre-tax losses on BAM in 2015, driven by $16 million of interest expense on the BAM Surplus Notes and $35 million of operating expenses, compared to $41 million of pre-tax losses in 2014, driven by $16 million of interest expense on the BAM Surplus Notes and $36 million of operating expenses, partially offset by $7 million of net realized and unrealized investment gains.
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, 2016 and 2015:
WM Life Re reported losses of $3 million in 2016 compared to $6 million in 2015. WM Life Re has completed its run-off as all of its contracts matured as of June 30, 2016. See Note 9 - “Derivatives” on page for details regarding WM Life Re’s total impact on White Mountains’s statement of operations.
During the year ended December 31, 2016, White Mountains wrote down its investment in the SSIE Surplus Notes, which reduced book value per share by approximately $4. White Mountains consolidates SSIE, the issuer of the SSIE Surplus Notes. As a result, the impact of the write down is eliminated in pre-tax income. However, the write down resulted in a $21 million decrease to White Mountains’s book value and a corresponding increase to non-controlling interest equity.
White Mountains’s Other Operations segment reported pre-tax income of $161 million in 2015 compared to a pre-tax loss of $50 million in 2014. White Mountains’s Other Operations segment reported net realized and unrealized investment gains of $260 million in 2015 compared to $30 million in 2014, primarily related to the $259 million unrealized investment gain from the investment in Symetra common shares. See “Summary of Investment Results” on page 50. The Other Operations segment reported net investment income of $9 million in both 2015 and 2014. Other revenues in 2015 includes $106 million from MediaAlpha compared to $65 million from MediaAlpha in 2014. Other revenue also includes a $20 million pre-tax gain in 2015 from the sale of Hamer LLC, a small manufacturing company that White Mountains received in 2012 in connection with the liquidation of a limited partnership fund. In addition, other revenues in 2015 included third-party investment management fee income at WM Advisors of $13 million, compared to $17 million in 2014.
During 2016, 2015 and 2014, White Mountains entered into a number of sale transactions that have been accounted for as discontinued operations within its consolidated financial statements. See Note 22 - “Held for Sale and Discontinued Operations” on page for detailed financial information on each business sold.
Reinsurance protection. In addition to the ILW covers, Sirius Group’s reinsurance protection primarily consists of pro-rata and excess of loss protections to cover aviation, trade credit, and certain accident and health and property exposures. Sirius Group’s proportional reinsurance programs provide protection for part of the non-proportional treaty accounts written in Europe, the Americas, Asia, the Middle East and Australia. This reinsurance is designed to increase underwriting capacity where appropriate, and to reduce exposure both to large catastrophe losses and to a frequency of smaller loss events. Attachment points and coverage limits vary by region and line of business around the world.
Sirius Group’s net combined ratio was 6 points higher than the gross combined ratio for the year ended December 31, 2015 and 1 point lower than the gross combined ratio for 2014. In 2015, the net combined ratio was higher than the gross combined ratio primarily due to the cost of property retrocessional coverage, including the ILW covers, with limited or no loss recoveries. In 2014, the net combined ratio was lower than the gross combined ratio because ceded loss recoveries, primarily in the accident and health and aviation lines, mostly offset the premiums ceded under Sirius Group’s reinsurance protection programs.
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. Tranzact’s results were near break-even for the year ended December 31, 2015.
For the year ended 2015, White Mountains recorded $0.3 million to the gain from sale of discontinued operations related to an adjustment on the estimated loss on sale of the Runoff Transaction, which included the final settlement of certain post-closing items. For year ended 2015, the net loss from discontinued operations relating to the Runoff Transaction, net of tax, was $0.5 million.
During 2015 and 2014, White Mountains recognized $18 million and $3 million of net income from discontinued operations related to the final settlement with Allstate for favorable development on loss reserves transferred in the sale of Esurance and Answer Financial. Since the closing of the transaction through September 30, 2015, White Mountains received a net amount of $28 million from Allstate, primarily related to the favorable development on loss reserves.
White Mountains’s total operations investment results include continuing operations and discontinued operations. During the third quarter of 2015, White Mountains signed an agreement to sell Sirius Group, which closed on April 18, 2016. Sirius Group’s results inured to White Mountains through the closing date of the transaction.
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 management fees and trading expenses. A summary of White Mountains’s consolidated total operations’ pre-tax investment results, including the returns from discontinued operations, for the years ended December 31, 2016, 2015 and 2014 follows:
(1) The impact of excluding high-yield fixed maturity investments from the GAAP fixed maturity investment returns was insignificant in 2016.
White Mountains’s GAAP pre-tax total return on invested assets was 2.7% for 2016, which included 0.2% from foreign currency gains, compared to 3.6% for 2015, which included 0.9% from foreign currency losses. The 2015 results were primarily driven by $259 million in pre-tax unrealized investment gains recognized in the fourth quarter of 2015 resulting from the Symetra transaction. Excluding the results from Symetra, the GAAP total return on invested assets was -0.2% for 2015, which included 0.9% from foreign currency losses. White Mountains’s total operations after-tax net realized and unrealized investment gains were $2 million and $203 million for 2016 and 2015.
White Mountains entered into a foreign currency forward contract to manage its GBP foreign currency exposure relating to this new mandate. As of December 31, 2016, this contract had a total gross notional value of approximately $185 million (GBP 150 million). While White Mountains actively manages its overall foreign currency position, mismatches between movements in foreign currency rates and its foreign currency forward contract may result in foreign currency positions being outside pre-defined ranges and/or foreign currency losses. The results of White Mountains’s forward foreign currency contract is included in other long-term investments.
Common equity securities, other long-term investments, and high-yield fixed maturity investments results
White Mountains’s portfolio of common equity securities, other long-term investments and high-yield fixed maturity investments represented approximately 20% and 23% of total GAAP invested assets as of December 31, 2016 and December 31, 2015. When reflecting the close of the Symetra sale on February 1, 2016 and the close of the Sirius Group sale on April 18, 2016, White Mountains’s portfolio of common equity securities and other long-term investments represented approximately 12% of total GAAP invested assets as of December 31, 2015.
White Mountains’s portfolio of common equity securities, other long-term investments and high-yield fixed maturity investments returned 4.0% for 2016, underperforming the S&P 500 Index return of 12.0%. The underperformance versus the S&P 500 Index return was primarily attributable to the overall conservative positioning of the risk asset portfolio, including the new high-yield mandate, which we do not expect to keep pace with strong up markets. The underperformance was also due to unfavorable results from publicly-traded common equity securities managed by third party investment advisers and pockets of poor performance in other long-term investments, including unfavorable results from private capital investments and private equity funds and non-controlling interests in private capital investments.
White Mountains’s portfolio of common equity securities and other long-term investments returned 19.3% for 2015. Excluding the results from Symetra, the portfolio of common equity securities and other long-term investments returned -1.8% for 2015, underperforming the S&P 500 Index return of 1.4%. The underperformance versus the S&P 500 Index return was primarily attributable to unfavorable mark-to-market adjustments to the OneBeacon Surplus Notes and unfavorable results from energy exposed private equity funds and a distressed hedge fund.
White Mountains’s portfolio of common equity securities returned 6.2% for 2016, underperforming the S&P 500 Index return of 12.0%. White Mountains’s portfolio of common equity securities returned 33.2% for 2015. Excluding the results from Symetra, the portfolio of common equity securities returned 2.9% for 2015, outperforming the S&P 500 Index return of 1.4%.
The following summarizes White Mountains’s investments in ETFs by exposure to each index:
In 2016 and 2015, the ETFs essentially earned the effective index return, before expenses, over the period in which White Mountains was invested in each respective fund.
White Mountains has established relationships with third party registered investment advisers to actively manage publicly-traded common equity securities and convertibles. The largest of these relationships have been with Prospector Partners LLC (“Prospector”), Lateef and Silchester. During the second quarter of 2015, White Mountains instructed Prospector to liquidate its separate account portfolios and redeemed its investments in hedge funds managed by Prospector and reallocated a portion of the proceeds into ETFs. White Mountains has since terminated its investment management agreements with Prospector. White Mountains continues to have publicly-traded common equity securities actively managed by Lateef and Silchester.
White Mountains has an investment in the Calleva Trust, an open-ended unit trust established as an Undertaking for Collective Investment in Transferable Securities (“UCITS”) under the European Communities Regulations that is managed by Silchester. Silchester invests primarily in value-oriented non-U.S. equity securities. Silchester’s investment strategy focuses on companies with low market multiples of earnings, cash flow, asset value or dividends. In U.S. dollars, the Silchester portfolio returned 8.2% for 2016, underperforming the S&P 500 Index return of 12.0%. In local currencies, the Silchester portfolio returned 12.5% for 2016, outperforming the MCSI EAFE Index return of 5.3%. In U.S. dollars, the Silchester portfolio returned 1.2% for 2015, underperforming the S&P 500 Index return of 1.4%. In local currencies, the Silchester portfolio returned 6.5% for 2015, outperforming the MCSI EAFE Index return of 5.3%.
White Mountains’s GAAP pre-tax total return on invested assets was 3.6% for 2015, compared to 1.9% for 2014. The 2015 results were primarily driven by $259 million in pre-tax unrealized investment gains recognized in the fourth quarter of 2015 resulting from the Symetra transaction. The 2015 and 2014 returns included 0.9% and 1.9% of foreign currency losses. Excluding the results from Symetra, the GAAP total return on invested assets was -0.2% for 2015. White Mountains’s total operations after tax realized and unrealized investment gains were $203 million and $214 million for 2015 and 2014.
As of December 31, 2015, the fixed income portfolio duration, including short-term investments, was approximately 2.2 years compared to 2.0 years as of December 31, 2014.
The fixed income portfolio returned 0.2% for 2015. In local currencies, the fixed income portfolio returned 1.1% for 2015, which was essentially in-line with the longer duration Bloomberg Barclays U.S. Intermediate Aggregate Index return of 1.2%. The fixed income portfolio returned 0.5% for 2014. In local currencies, the fixed income portfolio returned 2.7% for 2014, underperforming the longer duration Bloomberg Barclays U.S. Intermediate Aggregate Index return of 4.1%. The portfolio’s short duration positioning contributed to the underperformance versus the longer duration Bloomberg Barclays U.S. Intermediate Aggregate Index return as interest rates fell in 2014.
White Mountains’s portfolio of common equity securities and other long-term investments represented approximately 23% and 18% of GAAP invested assets as of December 31, 2015 and December 31, 2014.
The portfolio of common equity securities and other long-term investments returned 19.3% for 2015. Excluding the results from Symetra, the portfolio of common equity securities and other long-term investments returned -1.8% for 2015, underperforming the S&P 500 Index return of 1.4%. The underperformance versus the S&P 500 Index return was primarily due to unfavorable mark-to-market adjustments to the OneBeacon Surplus Notes and unfavorable results from energy exposed private equity funds and a distressed hedge fund. The portfolio of common equity securities and other long-term investments returned 7.2% for 2014, underperforming the S&P 500 Index return of 13.7%.
White Mountains’s investment in the Calleva Trust, which is managed by Silchester and invests primarily in value-oriented non-U.S. equity securities returned 1.2% in U.S. dollars for 2015, underperforming the S&P 500 Index return of 1.4%. In local currency, the Silchester portfolio returned 6.5% for 2015, outperforming the MCSI EAFE Index return of 5.3%. The Silchester portfolio returned -1.7% in U.S. dollars for 2014, underperforming the S&P 500 Index return of 13.7%. In local currencies, the Silchester portfolio returned 8.6% for 2014, outperforming the MCSI EAFE Index return of 5.9%
White Mountains’s other long-term investment portfolio returned -10.1% for 2015, underperforming the S&P 500 Index return of 1.4%. The portfolio’s underperformance versus the S&P 500 Index return was primarily due to unfavorable mark-to-market adjustments to the OneBeacon Surplus Notes and write-downs in energy exposed private equity funds and a distressed hedge fund. For 2014, the other long-term investments portfolio returned 6.5%, underperforming the S&P 500 Index return of 13.7%.
The cost or amortized cost and carrying value of White Mountains’s fixed maturity investments as of December 31, 2016 is presented below by contractual maturity. Actual maturities could differ from contractual maturities because certain borrowers may call or prepay their obligations with or without call or prepayment penalties.
During 2016, OneBeacon’s unregulated insurance subsidiaries paid $6 million of dividends to their immediate parent. As of December 31, 2016, OneBeacon’s unregulated insurance subsidiaries had $56 million of net unrestricted cash, short-term investments and fixed maturity investments and $72 million of other long-term investments, consisting of the OneBeacon Surplus Notes.
During 2016, OneBeacon Ltd. paid $79 million of regular quarterly dividends to its common shareholders. White Mountains received $60 million of these dividends.
As of December 31, 2016, OneBeacon Ltd. and its intermediate holding companies had $65 million of net unrestricted cash, short-term investments and fixed maturity investments and $12 million of common equity securities outside of its regulated and unregulated insurance subsidiaries.
As of December 31, 2016, 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 2016. As of December 31, 2016, HG Global has accrued $186 million of dividends payable to holders of its preferred shares, $180 million of which is payable to White Mountains and eliminated in consolidation.
HG Re is a Special Purpose Insurer subject to regulation and supervision by the BMA, but does not require regulatory approval to pay dividends. However, HG Re’s dividend capacity is limited to amounts held outside of the collateral trusts pursuant to the FLRT with BAM. As of December 31, 2016, HG Re had statutory capital and surplus of $467 million, of which $465 million was held in the collateral trusts pursuant to the FLRT with BAM.
During 2016, WM Advisors did not pay any dividends to its immediate parent. As of December 31, 2016, WM Advisors had $18 million of net unrestricted cash, short-term investments and fixed maturity investments.
Insurance float is an important aspect of White Mountains’s insurance operations. Insurance float represents funds that an insurance company holds for a limited time. In an insurance operation, float arises because premiums are collected before losses are paid. This interval can extend over many years. During that time, the insurer invests the funds. When the premiums that an insurer collects do not cover the losses and expenses it eventually must pay, the result is an underwriting loss, which can be considered as the cost of insurance float. One manner to calculate insurance float is to take insurance liabilities and subtract insurance assets. Although insurance float can be calculated using numbers determined under GAAP, insurance float is not a GAAP concept and, therefore, there is no comparable GAAP measure.
Insurance float can increase in a number of ways, including through acquisitions of insurance operations, organic growth in existing insurance operations and recognition of losses that do not immediately cause a corresponding reduction in investment assets. Conversely, insurance float can decrease in a number of other ways, including sales of insurance operations, shrinking or runoff of existing insurance operations, the acquisition of operations that do not have substantial investment assets (e.g., an agency) and the recognition of gains that do not cause a corresponding increase in investment assets. It is White Mountains’s intention to generate low-cost float over time through a combination of acquisitions and organic growth in its existing insurance operations. However, White Mountains seeks to increase overall profitability, which sometimes reduces insurance float, such as in the Sirius Group transaction.
Certain operational leverage metrics can be measured with ratios that are calculated using insurance float. There are many activities that do not change the amount of insurance float at an insurance company but can have a significant impact on the company’s operational leverage metrics. For example, investment gains and losses, foreign currency gains and losses, debt issuances and repurchases/retirements, common and preferred share issuances and repurchases and dividends paid to shareholders are all activities that do not change insurance float but that can meaningfully impact operational leverage metrics that are calculated using insurance float.
Insurance float as a multiple of White Mountains’s common shareholders’ equity
(1) Included in Net Assets Held for Sale. See Note 22-“Held for Sale and Discontinued Operations” on page.
During 2016, insurance float from continuing operations increased by $51 million, primarily due to an increase of unrestricted collateral held related to OneBeacon’s surety business.
The following table summarizes White Mountains’s capital structure as of December 31, 2016 and 2015:
The WTM and OneBeacon Bank Facilities contain 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. These covenants can restrict White Mountains in several ways, including its ability to incur additional indebtedness. An uncured breach of these covenants could result in an event of default under the WTM or OneBeacon Bank Facilities, which would allow lenders to declare any amounts owed under the WTM or OneBeacon Bank Facilities to be immediately due and payable. In addition, a default under the WTM or OneBeacon Bank Facilities could occur if certain of White Mountains’s subsidiaries fail to pay principal and interest on a credit facility, mortgage or similar debt agreement (collectively, “covered debt”), or fail to otherwise comply with obligations in such covered debt agreements where such a default gives the holder of the covered debt the right to accelerate at least $75 million of principal amount of covered debt.
The OBH Senior Notes were issued under indentures that contain restrictive covenants which, among other things, limit the ability of OneBeacon Ltd., OBH and their respective subsidiaries to create liens and enter into sale and leaseback transactions and limits the ability of OneBeacon Ltd. and OBH to consolidate, merge or transfer its properties and assets. The indentures do not contain any financial ratios or specified levels of net worth or liquidity to which OneBeacon Ltd. or OBH must adhere. In addition, a failure by OneBeacon Ltd. or OBH or their respective subsidiaries to pay principal and interest on covered debt, where such failure results in the acceleration of at least $75 million of principal amount of covered debt, could trigger the acceleration of the OBH Senior Notes.
Represents expected future cash outflows resulting from loss and LAE payments. The amounts presented are gross of reinsurance recoverables on unpaid losses of $173 and net of the discount on OneBeacon’s workers compensation loss and LAE reserves of $2 as of December 31, 2016.
Excludes amount related to SSIE. See Note 22 - “Held for Sale and Discontinued Operations” on page.
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, 2016.
White Mountains also has future binding commitments to fund certain other long-term investments. These commitments, which total approximately $138 million, do not have fixed funding dates and are therefore excluded from the table above.
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 2015, the table also presents the average price per share as a percent of adjusted book value per share, including the estimated gain from the Sirius Group sale of $84 per share as of December 31, 2015 that was reported in the Company’s 2015 Form 10-K.
In 2007, OneBeacon’s board authorized management to repurchase up to $200 million of OneBeacon’s 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 authorization does not have a stated expiration date. Since the inception of this authorization, OneBeacon has repurchased and retired 6.7 million of its Class A common shares. During 2016, OneBeacon repurchased and retired 850,349 of its common shares under the share repurchase authorization for $11 million at an average share price of $12.42. During 2015, OneBeacon repurchased and retired 166,368 of its common shares under the share repurchase authorization for $2 million at an average price of $12.62. During 2014, no shares were repurchased under the share repurchase authorization. The amount of authorization remaining is $75 million as of December 31, 2016.
OneBeacon paid a total of $13 million of interest on the OBH Senior Notes during each of 2016, 2015 and 2014.
During 2016, OneBeacon Ltd. declared and paid $79 million of cash dividends to its common shareholders. White Mountains received a total of $60 million of these dividends.
On various occasions 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). As of December 31, 2016, White Mountains’s ownership share of Wobi was 95% on a fully converted basis.
During 2015, OneBeacon Ltd. declared and paid $80 million of cash dividends to its common shareholders. White Mountains received a total of $60 million of these dividends.
During 2015, MediaAlpha borrowed $15 million under the term loan portion of the MediaAlpha Bank Facility and used the proceeds to make a $15 million return of capital payment to its unit holders, of which White Mountains received $9 million.
During 2015, White Mountains contributed $8 million to WM Life Re.
On February 23, 2015, Wobi acquired 56.2% of the outstanding share capital of Cashboard for NIS 10 million (approximately $2 million based upon the foreign exchange spot rate at the date of acquisition). During the second quarter of 2015, Wobi purchased newly issued common shares of Cashboard for NIS 10 million (approximately $3 million).
During 2015, White Mountains increased its ownership interest in Wobi through (i) the purchase of common and convertible preferred shares from a non-controlling interest shareholder for NIS 35 million (approximately $9 million) and (ii) the purchase of newly-issued convertible preferred shares for NIS 56 million (approximately $15 million). As of December 31, 2015, White Mountains’s ownership share of Wobi was 96.1% on a fully converted basis.
During 2014, the Company declared and paid a $6 million cash dividend to its common shareholders.
During 2014, the Company borrowed and repaid a total of $65 million under the WTM Bank Facility.
On February 19, 2014, White Mountains acquired 54% of the outstanding common shares of Wobi for NIS 14 million (approximately $4 million based upon the foreign exchange spot rate at the date of acquisition). In addition to the common shares, White Mountains also purchased NIS 32 million (approximately $9 million based upon the foreign exchange spot rates at the dates of acquisition) of newly-issued convertible preferred shares of Wobi.
On July 3, 2014, White Mountains acquired approximately 45% of the outstanding common shares of durchblicker, for EUR 9 million (approximately $12 million based upon the foreign exchange spot rate at the date of acquisition).
See Note 20 - “Transactions with Related Persons” on page in the accompanying Consolidated Financial Statements.
This report includes four non-GAAP financial measures that have been reconciled to their most comparable GAAP financial measures. White Mountains believes these measures to be useful in evaluating White Mountains’s results of operations and financial condition.
Adjusted book value per share is a non-GAAP financial measure which is derived by expanding the calculation of GAAP book value per share to exclude equity in net unrealized investment gains (losses) from Symetra’s fixed maturity portfolio for periods that White Mountains accounted for its investment in Symetra under the equity method. White Mountains accounted for its investment in Symetra under the equity method until November 5, 2015, when it changed its accounting to fair value. Adjusted book value per share includes the dilutive effects of outstanding non-qualified options. In addition, the number of common shares outstanding used in the calculation of adjusted book value per share per White Mountains’s common share is 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 GAAP book value per share to adjusted book value per share is included on page 36.
(1) High-yield fixed maturity investments returned 1.0% for the full year of 2016. The impact of excluding high-yield fixed maturity investments from the GAAP fixed maturity investment returns was insignificant in 2016.
White Mountains establishes loss and LAE reserves that are estimates of amounts needed to pay claims and related expenses in the future for insured events that have already occurred. The process of estimating reserves involves a considerable degree of judgment by management and, as of any given date, is inherently uncertain. See Note 3 - “Reserves for Unpaid Losses and Loss Adjustment Expenses” on page for a description of White Mountains’s loss and LAE reserves and actuarial methods.
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 indicated reserve levels. Typically, these factors exist when management and OneBeacon’s actuaries conclude that there is insufficient historical incurred and paid loss information or that there is particular uncertainty about whether trends included in the historical incurred and paid loss information are unlikely to repeat in the future. Such factors include, among others, recent entry into new markets or new products, improvements in the claims department that are expected to lessen future ultimate loss costs, legal and regulatory developments, or other volatilities that may arise.
The process of establishing loss and LAE reserves, including amounts incurred but not reported, is complex and imprecise as it must consider many variables that are subject to the outcome of future events. As a result, informed subjective estimates and judgments as to OneBeacon’s ultimate exposure to losses are an integral component of the loss and LAE reserving process. OneBeacon categorizes and tracks insurance reserves by “line of business” as either property short-tailed lines, casualty long-tailed lines, or other (accident, surety and credit) lines.
For loss and allocated LAE reserves, the key assumption as of December 31, 2016 was that the impact of the various reserving factors, as described in Note 3 - “Reserves for Unpaid Losses and Loss Adjustment Expenses”, on future paid losses would be similar to the impact of those factors on the historical loss data with the exception of severity trends. Severity trends have been relatively stable over the relevant historical period. The actuarial methods used would project losses assuming continued stability in severity trends. Management has considered a range of assumptions regards future increases in loss severity trends, including the impact of inflation, in making its reserve selections.
The major causes of material uncertainty (“reserving factors”) generally will vary for each line, as well as for each separately analyzed component of the line. Also, reserving factors can have offsetting or compounding effects on estimated reserves. For example, in workers compensation, the use of expensive medical procedures that result in medical cost inflation may enable workers to return to work faster, thereby lowering indemnity costs. Thus, in almost all cases, it is impossible to discretely measure the effect of a single reserving factor and construct a meaningful sensitivity expectation. Actual results will likely vary from expectations for each of these assumptions, resulting in an ultimate claim liability that is different from that being estimated currently.
OneBeacon’s range of loss and LAE reserve estimates was evaluated to consider the strengths and weaknesses of the various actuarial methods applied against OneBeacon’s historical claims experience data. The following table shows the recorded loss and LAE reserves and the high and low ends of OneBeacon’s range of reasonable loss reserve estimates, net of reinsurance recoverable on unpaid losses, as of December 31, 2016 and 2015. The high and low ends of the range of reserve estimates in the table below are based on the results of various actuarial methods. See Note 3 - “Reserves for Unpaid Losses and Loss Adjustment Expenses” on page for a description of White Mountains’s loss and LAE reserves and actuarial methods.
The recorded reserves represent management's best estimate of unpaid loss and LAE reserves. OneBeacon uses the results of several different actuarial methods to develop its estimate of ultimate reserves. While it has not determined the statistical probability of actual ultimate paid losses falling within the range, OneBeacon believes that it is reasonably likely that actual ultimate paid losses will fall within the ranges noted above because the ranges were developed by using several different generally accepted actuarial methods.
The following discussion includes disclosure of possible variations from current estimates of loss and LAE reserves due to changes in a few of the many key assumptions. Each of the impacts described below is estimated individually, without consideration for any correlation among key assumptions. Further, there is uncertainty around other assumptions not explicitly quantified in the discussion below. Therefore, it would be inappropriate to take each of the amounts described below and add them together in an attempt to estimate volatility for OneBeacon’s reserves in total. It is important to note that the volatilities and variations discussed below are not meant to be a worst-case scenarios or an all-inclusive list, and therefore it is possible that future volatilities and variations may be more than amounts discussed below.
Various sources of inflation volatility impact all of OneBeacon’s reserves in different ways. Using its internal economic capital model, OneBeacon has derived a distribution of future loss payments under the range of inflation scenarios and related claim cost trends in its economic scenario set, holding all other sources of reserve volatility constant. At the 75th percentile of modeled outcomes, the estimated impact of claim cost inflation above OneBeacon’s actuarially indicated reserves is $34 million, net of reinsurance. The following are intended to provide additional insight into the impact of inflation on key lines of business:
Professional liability: Recorded loss and LAE reserves, net of reinsurance recoverables, for professional liability were $438 million as of December 31, 2016. 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 trend would have changed the estimated net reserve by approximately $84 million as of December 31, 2016, in either direction.
White Mountains used quoted market prices or other observable inputs to determine fair value for 94% of its investment portfolio as of December 31, 2016. Investments valued using Level 1 inputs include fixed maturity investments, primarily investments in U.S. Treasuries, short-term investments, which include U.S. Treasury Bills, and common equity securities. Investments valued using Level 2 inputs are primarily comprised of fixed maturity investments, which have been disaggregated into classes, including debt securities issued by corporations, municipal obligations, mortgage and asset-backed securities, foreign government, agency and provincial obligations and preferred stocks. Investments valued using Level 2 inputs also include certain ETFs that track U.S. stock indices such as the S&P 500 but are traded on foreign exchanges and that management values using the fund’s published net asset value (“NAV”) to account for the difference in market close times. Fair value estimates for investments that trade infrequently and have few or no observable market prices are classified as Level 3 measurements. Level 3 fair value estimates based upon unobservable inputs include White Mountains’s investments in surplus notes, as well as certain investments in fixed maturity investments, common equity securities and other long-term investments where quoted market prices are unavailable or are not considered reasonable. Transfers between levels are based on investments held as of the beginning of the period.
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 $1.0 million from the expected price based on these procedures are considered outliers. Also considered outliers 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 price. If White Mountains cannot gain satisfactory evidence to support the challenged price, it relies upon its own pricing methodologies to estimate the fair value of the security in question.
Debt securities issued by corporations: The fair value of debt securities issued by corporations is determined from a pricing evaluation technique that uses information from market sources and integrates relative credit information, observed market movements, and sector news. Key inputs include benchmark yields, reported trades, broker-dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data including sector, coupon, credit quality ratings, duration, credit enhancements, early redemption features and market research publications.
Mortgage and asset-backed securities: The fair value of mortgage and asset-backed securities is determined from a pricing evaluation technique that uses information from market sources and leveraging similar securities. Key inputs include benchmark yields, reported trades, underlying tranche cash flow data, collateral performance, plus new issue data, as well as broker-dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data including issuer, vintage, loan type, collateral attributes, prepayment speeds, default rates, recovery rates, cash flow stress testing, credit quality ratings and market research publications.
Municipal obligations: The fair value of municipal obligations is determined from a pricing evaluation technique that uses information from market makers, brokers-dealers, buy-side firms, and analysts along with general market information. Key inputs include benchmark yields, reported trades, issuer financial statements, material event notices and new issue data, as well as broker-dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data including type, coupon, credit quality ratings, duration, credit enhancements, geographic location and market research publications.
The following table summarizes White Mountains’s fair value measurements and the percentage of Level 3 investments as of December 31, 2016. The major security types were based on the legal form of the securities. White Mountains has disaggregated its fixed maturity investments based on the issuing entity type, which impacts credit quality, with debt securities issued by U.S. government entities carrying minimal credit risk, while the credit and other risks associated with other issuers, such as debt securities issued by corporations, foreign governments, municipalities or entities issuing mortgage and asset-backed securities vary depending on the nature of the issuing entity type:
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). See Note 5 - “Investment Securities” on page for tables that summarize the changes in White Mountains’s fair value measurements by level for the years ended December 31, 2016 and 2015 and for amount of total gains (losses) included in earnings attributable to net unrealized investment gains (losses) for Level 3 investments for years ended December 31, 2016, 2015 and 2014.
White Mountains’s other long-term investments as of December 31, 2016 include $60 million in hedge funds and $71 million in private equity funds. As of December 31, 2016, White Mountains held investments in 5 hedge funds and 23 private equity funds. The largest investment in a single fund was $37 million and $23 million as of December 31, 2016 and 2015.
Periodically, White Mountains’s management reviews the recoverability of amounts recorded from the BAM Surplus Notes. As of December 31, 2016, White Mountains believes such notes and interest thereon to be fully recoverable.
The model assumes increases in insured market penetration, annual par insured volume and premium rates, which in turn lead to substantial increases in total premium written over the next six years (flattening thereafter). Under these assumptions, we project that BAM can begin making payments on the BAM Surplus Notes in 2019 and can fully repay all principal and interest due on the BAM Surplus Notes approximately 15 years prior to final maturity.
Under the contractual terms of both the seller priority and pari passu notes, scheduled interest payments accrue at 6.0% until the scheduled maturity date of March 15, 2020 and at a floating interest rate thereafter, should any principal remain outstanding. As required by the Pennsylvania Insurance Department (“PID”), interest on the notes does not compound. The notes restrict the Issuer’s ability to make distributions to holders of its equity interest. All such distributions are prohibited while the seller priority note is outstanding, and while the pari passu note is outstanding, distributions are permitted only if the Issuer concurrently repays a pro rata amount of any outstanding principal on the pari passu note.
Pursuant to the notes, the Issuer shall seek to redeem the notes annually each March 15 at a requested redemption amount such that the Issuer’s total adjusted capital following the proposed redemption payment would equal 200% of the Issuer’s “authorized control level RBC,” as such term is defined by the insurance laws of the Commonwealth of Pennsylvania and as prescribed by the PID. All redemptions or repayments of principal and payments of interest on the notes are subject to approval by the PID.
Below is a table illustrating the valuation adjustments taken to arrive at the estimated fair value of the OneBeacon Surplus Notes as of December 31, 2016 and December 31, 2015:
(1) Represents the value of the surplus notes, at current market yields on comparable publicly traded debt, and assuming issuer is allowed to make principal and interest payments when its financial capacity is available, as measured by statutory capital in excess of a 250% RBC score under the NAIC’s risk-based capital standards for property and casualty companies. The favorable year-over-year change in impact is due principally to the narrowing of non-investment grade credit spreads as well as the time value of money benefit from moving one year closer to modeled cash receipts.
(3) Represents impact of liquidity spread to account for OneBeacon’s sole ownership of the OneBeacon Surplus Notes, lack of a trading market and unique nature of the ongoing regulatory approval process. The unfavorable year-over-year change in impact is due largely to the increased fair value of the notes as well as a higher effective duration resulting from a lower overall yield to maturity; there was no change in the magnitude of the liquidity spread in 2016.
(4) The increase in the fair value of the OneBeacon Surplus Notes during the year ended December 31, 2016 was driven primarily by the narrowing of non-investment grade credit spreads, partially offset by the impact of a change in estimates and assumptions regarding the timing of regulatory approval of principal and interest payments on the notes.
The internal valuation model used to estimate the fair value is based on discounted expected cash flows using information as of the measurement date. The estimated fair value of the OneBeacon Surplus Notes is sensitive to changes in treasury rates and public debt credit spreads, as well as changes in estimates with respect to other variables including a discount to reflect the private nature of the notes (and the related lack of liquidity), the credit quality of the notes - based on the financial performance of the Issuer relative to expectations, and the timing, amount, and likelihood of interest and principal payments on the notes, which are subject to regulatory approval and therefore may vary from the contractual terms. Anticipating a change in the assumed timeline, amounts, and process necessary to obtain regulatory approval, OneBeacon made a change in its estimate as of December 31, 2016 with regard to the timing of regulatory approval of principal and interest payments on the notes. For the purpose of estimating fair value, OneBeacon has currently assumed that all accrued unpaid interest on the seller priority note since the date of issuance is paid in 2020, with regular annual interest payments on both the seller priority note and pari passu note beginning thereafter, all accrued but unpaid interest on the pari passu note since the date of issuance is paid in 2025, and principal repayments begin on a graduated basis in 2030 for the seller priority note and 2035 for the pari passu note. Previously, including as of December 31, 2015, OneBeacon had assumed for the purpose of estimating fair value that interest payouts, including all accrued but unpaid amounts, began in 2020 for both notes and that principal repayments began on a graduated basis in 2025 for the seller priority note and 2030 for the pari passu note.
(1) Represents the sensitivity to changes in the estimate of the liquidity spread added to account for OneBeacon’s sole ownership of the OneBeacon Surplus Notes, lack of a liquid trading market and unique nature of the ongoing regulatory approval process.
(4) Represents the sensitivity to changes in the estimate of timing of the first interest payment received by OneBeacon. The fair value model assumes a delay in the receipt of interest cash flows as a result of the regulatory approval required before such payments may occur; and assuming repayments are made with a graduated impact on statutory surplus.
business opportunities (or lack thereof) that may be presented to it and pursued;