The Company maintains two professional offices in Hamilton, Bermuda, which serve as its headquarters and its registered office. The Company’s principal executive office is in Hanover, New Hampshire. In addition, White Mountains maintains professional offices in Guilford, Connecticut, which house its investment and corporate finance functions, and Boston, Massachusetts, which house its corporate accounting, reporting and internal audit functions.
OneBeacon Ltd.’s headquarters are located in Hamilton, Bermuda and the headquarters of its U.S. operations and principal executive office are currently located in Minnetonka, Minnesota. OneBeacon also maintains branch offices in various cities throughout the United States.
The Company’s headquarters, registered office, principal executive office, and corporate accounting, reporting and internal audit offices are leased. White Mountains owns its investment and corporate finance office in Connecticut. OneBeacon’s headquarters, U.S. corporate headquarters and branch offices are leased. OneBeacon owns a building in Canton, Massachusetts, which is under agreement to be sold to a third party. Pursuant to the terms of the purchase and sale agreement, following the closing of the sale, OneBeacon intends to lease back the portion of the building it currently occupies, which houses certain limited corporate functions, as well as field and business operations personnel. The property is classified as held for sale on White Mountains’s December 31, 2014 consolidated balance sheet. Sirius Group’s home offices and substantially all of its branch offices are leased. HG Global’s and BAM’s offices are leased, as are Tranzact’s home office and substantially all of its call centers, and QuoteLab’s, Wobi’s and Star & Shield’s offices. Management considers its office facilities suitable and adequate for its current level of operations.
Selected consolidated income statement data and ending balance sheet data for each of the five years ended through December 31, 2014, follows:
Adjusted book value per share is a non-GAAP measure which is derived by expanding the GAAP book value per share calculation to include the effects of assumed conversion of all in-the-money convertible securities and to exclude the net unrealized gains (losses) from Symetra’s fixed maturity portfolio and unearned restricted common shares. See the reconciliation of adjusted book value per share to book value per share on page 52.
Includes outstanding options to acquire common shares, when applicable, and excludes unearned shares of restricted stock, the compensation of which, at the date of calculation, has yet to be amortized.
The following discussion also includes three non-GAAP financial measures, adjusted comprehensive income, adjusted book value per share and adjusted capital, that have been reconciled to their most comparable GAAP financial measures (see page 86). White Mountains believes these measures to be more relevant than comparable GAAP measures in evaluating White Mountains’s financial performance and condition.
Overview-Year Ended December 31, 2014 versus Year Ended December 31, 2013
OneBeacon’s book value per share increased 2.2% during 2014, including dividends, compared to an increase of 17.3% during 2013, including dividends. OneBeacon’s GAAP combined ratio was 102% for 2014 compared to 92% for 2013. OneBeacon’s results reflect a $109 million pre-tax increase to loss reserves in the fourth quarter, of which $75 million is related to prior accident years and $34 million related to the current accident year. Full year 2014 results reflect a $90 million pre-tax increase to prior accident year reserves. The reserve increases were driven primarily by professional liability (including lawyers’ professional liability) and management liability within the Professional Insurance business, and to a lesser extent the Entertainment and Government Risks businesses.
White Mountains’s total net written premiums increased 7% to $2,122 million in 2014, driven by growth at both OneBeacon and Sirius Group. OneBeacon’s net written premiums increased 12% to $1,217 million in 2014, primarily related to OneBeacon’s newer businesses, particularly OneBeacon Crop Insurance, OneBeacon Program Group and OneBeacon Surety Group. Sirius Group’s net written premiums increased 1% to $883 million in 2014, as increases in the accident and health, property (excluding property catastrophe excess) and aviation lines were mostly offset by decreases in property catastrophe excess and trade credit business.
White Mountains ended 2013 with an adjusted book value per share of $642, an increase of 9.5% during the year, including dividends, compared to an increase of 8.6% during 2012, including dividends. White Mountains reported adjusted comprehensive income of $340 million in 2013 compared to adjusted comprehensive income of $245 million in 2012. Good investment results driven by the effects of a rising stock market and White Mountains’s high-quality, short-duration fixed income portfolio, which performed well as interest rates rose in 2013, as well as solid underwriting performance at both OneBeacon and Sirius Group, contributed to growth in adjusted book value per share for 2013.
OneBeacon’s book value per share increased 17.3% during 2013, including dividends, compared to a decrease of 0.8% during 2012, including dividends. OneBeacon’s GAAP combined ratio was 92% for 2013 compared to 98% for 2012. The combined ratio for 2013 reflects lower catastrophe losses, which were negligible in 2013 while contributing 5 points to OneBeacon’s combined ratio in 2012, and a lower expense ratio. Sirius Group’s GAAP combined ratio was 82% for 2013 compared to 90% for 2012. The improvement in the combined ratio for 2013 was driven by lower catastrophe losses and higher favorable loss reserve development. Sirius Group’s combined ratio includes 10 points of catastrophe losses in 2013 compared to 13 points in 2012 and includes 6 points of favorable loss reserve development in 2013 compared to 4 points in 2012.
White Mountains’s GAAP pre-tax total return on invested assets was 4.1% for 2013, compared to 4.9% for 2012. Foreign currency translation did not meaningfully impact investment returns in 2013, while 2012 included 0.5% of foreign currency gains. In local currencies, the fixed income portfolio was up 0.5% for 2013, outperforming the longer duration Barclays Intermediate Aggregate Bond Index of (1.0)% as interest rates rose. In local currencies, the fixed income portfolio was up 3.8% for 2012.
In local currencies, the equity portfolio was up 18.9% for 2013, a strong absolute result for the year but behind benchmarks. The shortfall against benchmarks was due primarily to underperformance in White Mountains’s value oriented common equity security portfolio (up 23.2% versus the S&P 500 return of 32.4%) and the impact of convertible fixed maturity investments in the equity portfolio (as opposed to common equity securities), which tend to lag benchmarks in strong up markets.
The following table presents White Mountains’s adjusted book value per share, a non-GAAP financial measure, for the years ended December 31, 2014, 2013 and 2012 and reconciles this non-GAAP measure to the most comparable GAAP measure. (See “NON-GAAP FINANCIAL MEASURES” on page 86.)
Consolidated Results-Year Ended December 31, 2014 versus Year Ended December 31, 2013
White Mountains’s total expenses decreased 9% to $1,973 million in 2013. Losses and LAE decreased 13% in 2013, exceeding the 4% decrease in earned insurance and reinsurance premiums primarily as a result of lower catastrophe losses and higher favorable loss reserve development in 2013. Insurance and reinsurance acquisition expenses decreased 12% in 2013, exceeding the 9% decrease in net written premiums primarily due to changes in business mix at OneBeacon driven by the termination of the underwriting arrangement with Hagerty Insurance Agency and higher profit commissions accrued at Sirius Group on ceded European property business, while other underwriting expenses increased 3%, primarily due to higher incentive compensation expenses at Sirius Group.
White Mountains reported income tax expense of $77 million in 2013 on pre-tax income of $345 million. White Mountains’s effective tax rate for 2013 was 22%, which was lower than the U.S. statutory rate of 35% due primarily to income generated in jurisdictions with lower tax rates than the United States. In addition, the effective tax rate reflects a $7 million release of a valuation allowance at OneBeacon related to the restructuring of a surplus note issued to a consolidated insurance reciprocal exchange.
During 2014, White Mountains recorded a net loss on sale of discontinued operations of $2 million and a net loss from discontinued operations of $2 million. The net loss on sale of discontinued operations included a $19 million loss at OneBeacon on the Runoff Transaction, which included a $24 million after-tax loss from the change in the estimated value of the surplus notes issued with the Runoff Transaction, partially offset by a $5 million after-tax reduction in the loss on sale from the Runoff Transaction related to the change in the treatment of the $7 million pre-tax ($5 million after-tax) reserve charge recorded during the second quarter of 2013 (as described below). Previously, OneBeacon expected that the Runoff SPA would be amended to provide for the transfer of $7 million of additional assets to support the reserve charge. The Runoff SPA was instead revised to increase the cap on seller financing. The $19 million net loss on sale recorded in 2014 from the Runoff Transaction was partially offset by a $14 million gain from a payment received from Allianz, the purchaser of White Mountains’s former subsidiary Fireman’s Fund Insurance Company (“FFIC”), related to the utilization of alternative minimum tax credits associated with the tax loss on the sale of FFIC in 1991 and a $3 million gain from an interim payment from Allstate that primarily related to the favorable development on loss reserves transferred in the sale of Esurance and Answer Financial. The $2 million net loss from discontinued operations in 2014 related entirely to the Runoff Business.
During 2013, White Mountains recorded a net gain on sale of discontinued operations of $46 million and a net loss from discontinued operations of $42 million. During 2013, OneBeacon recorded a $79 million pre-tax loss and LAE provision for the Runoff Business. This reserve charge included a $7 million increase in loss and LAE reserves recorded in the second quarter of 2013, which partially offset $8 million of other revenue associated with a settlement award in the second quarter of 2013 in the Safeco v. American International Group, Inc. (“AIG”) class action related to AIG's alleged underreporting of workers' compensation premiums to the National Workers’ Compensation Reinsurance Pool. The net $71 million pre-tax ($46 million after-tax) of net losses from discontinued operations were fully offset by a $46 million after-tax reduction in the loss on sale of discontinued operations, as prescribed by the terms of the Runoff SPA, which stated that the buyer assumed the risk that loss and LAE reserves develop unfavorably from September 30, 2012 onward.
During 2012, White Mountains recorded a net loss from discontinued operations of $24 million and a net loss on sale of discontinued operations of $92 million, substantially all of which related to the Runoff Transaction and the results of the Runoff Business.
Financial results and GAAP combined ratios for OneBeacon for the years ended December 31, 2014, 2013 and 2012 follow:
Reinsurance protection. OneBeacon purchases reinsurance in order to minimize the loss from large risks or catastrophic events. OneBeacon also purchases individual property reinsurance coverage for certain risks to reduce large loss volatility through property-per-risk excess of loss reinsurance programs and individual risk facultative reinsurance. OneBeacon also maintains excess of loss casualty reinsurance programs that provide protection for individual risk or catastrophe losses involving workers compensation, general liability, automobile liability, professional liability or umbrella liability. The availability and cost of reinsurance protection is subject to market conditions, which are outside of management’s control. Limiting risk of loss through reinsurance arrangements serves to mitigate the impact of large losses; however, the cost of this protection in an individual period may exceed the benefit.
In October 2012, OneBeacon entered into a definitive agreement to sell its Runoff Business to Armour. The Runoff Transaction closed in the fourth quarter of 2014. See Note 22 - “Discontinued Operations” for more details regarding the Runoff Transaction. During 2014, OneBeacon reported a $21 million after-tax net loss in discontinued operations related to the Runoff Transaction, which included a $19 million after-tax loss from sale of the Runoff Business (further described below) and a $2 million after-tax loss from the underwriting results of the Runoff Business.
As part of closing the Runoff Transaction on December 23, 2014, OneBeacon provided financing in the form of surplus notes with a par value of $101 million issued by OneBeacon Insurance Company (“OBIC”), one of the entities that were transferred from OneBeacon to Armour as part of the transaction (the “OBIC Surplus Notes”). As of December 31, 2014, the OBIC Surplus Notes had a fair value of $65 million, based on a discounted cash flow model, resulting in a total valuation adjustment of $36 million pre-tax ($23 million after tax) included in loss from sale of discontinued operations. Subsequent to closing, the OBIC Surplus Notes are included in OneBeacon’s investment portfolio, categorized within other long-term investments, and subsequent changes in value thereon will be reflected in continuing operations. See “Critical Accounting Estimates” for a sensitivity analysis of potential changes in these key variables that can impact the estimated fair value of the OBIC Surplus Notes.
OneBeacon ended 2013 with a book value per share of $11.58, an increase of 17.3% during 2013, including dividends, compared to a decrease of 0.8% during 2012, including dividends. Investment and underwriting results both contributed to the increase in OneBeacon’s book value per share for 2013. OneBeacon’s 2013 results also included a $23 million pre-tax ($15 million after-tax) gain from the sale of Essentia Insurance Company (“Essentia”), a $7 million tax benefit related to the release of a valuation allowance at OneBeacon related to the restructuring of a surplus note issued to a consolidated insurance reciprocal exchange and a $4 million pre-tax ($3 million after-tax) benefit from the extension of the transition service agreement for services provided by OneBeacon on business sold to Tower in the personal lines transaction in 2010. OneBeacon’s GAAP return on investments was 3.8% for 2013, compared to a return of 4.4% for 2012.
OneBeacon’s GAAP combined ratio decreased to 92% for 2013 from 98% for 2012, which reflects both lower loss and expense ratios as compared to 2012. The decrease in the loss ratio was driven by a decrease in catastrophe losses which were negligible in 2013 compared to 5 points of net catastrophe losses ($56 million, including $8 million of ceded reinstatement premiums) for 2012, due primarily to the impact of hurricane Sandy. Favorable loss reserve development for 2013 was negligible, compared to 1 point ($7 million) for 2012. The decrease in the expense ratio for 2013 was primarily from lower insurance acquisition expenses due to changes in business mix driven by the termination of the underwriting arrangement with Hagerty Insurance Agency, partially offset by higher non-claims litigation expenses.
Reinsurance protection. OneBeacon's net combined ratio was higher than the gross combined ratio by 2 points for 2013 as a result of the cost of the reinsurance programs more than offsetting the benefits from ceded losses. OneBeacon’s net combined ratio for 2012 was lower than its gross combined ratio by 1 point, primarily due to the significant amount of reinsurance cessions related to hurricane Sandy, which were partially offset by the impact of the cost of facultative reinsurance and property reinsurance, and also the cost of catastrophe reinsurance and marine reinsurance.
As a result of a comprehensive actuarial analysis conducted by OneBeacon during the fourth quarter of 2013, OneBeacon recorded $72 million of unfavorable prior year non-A&E loss and LAE development related to the Runoff Business. The increase in loss reserves was concentrated in the workers compensation, personal auto liability and excess liability lines of business. In addition, OneBeacon increased its estimate of adjusting and other expenses, a component of LAE reserves.
For the full year 2013, OneBeacon recorded a $79 million loss and LAE provision for the Runoff Business. The $79 million loss and LAE adverse development recorded in 2013 was partially offset by other revenue of $8 million associated with a settlement award in the second quarter of 2013 in the Safeco v. American International Group, Inc. (“AIG”) class action related to AIG’s alleged underreporting of workers' compensation premiums to the National Workers' Compensation Reinsurance Pool.
During the fourth quarter of 2013, OneBeacon also increased the estimated pre-tax transaction costs associated with the Runoff Transaction, which was partially offset by the accretion of interest on the original sales price and, coupled with the $47 million after-tax provision for loss and LAE, resulted in a $46 million after-tax reduction in the ultimate loss on sale from discontinued operations. This reduction in the ultimate loss on sale was essentially offset by a $46 million after-tax loss from discontinued operations, driven by the unfavorable loss reserve development.
Sirius Group’s net combined ratio was 1 point lower than the gross combined ratio for 2014 and equaled the gross combined ratio for 2013. For 2014, the net combined ratio was lower than the gross combined ratio as ceded loss recoveries, primarily in the accident and health and aviation lines, mostly offset the premiums ceded under Sirius Group’s reinsurance protection programs. The net and gross combined ratios were the same for 2013 as the cost of property retrocessions was offset by loss recoveries on catastrophe losses in Europe and Asia and profit commissions on ceded business.
Sirius Group Results-Year Ended December 31, 2013 versus Year Ended December 31, 2012
Sirius Group’s gross written premiums decreased 5% for 2013 to $1,120 million, while net written premiums decreased 8% for 2013 to $877 million. These decreases were primarily from the accident and health and trade credit lines of business, partially offset by increases in the property lines. Net earned premiums decreased 7% for 2013 to $866 million due to lower accident and health and trade credit premiums. The effects of foreign currency translation on premiums were not material in 2013.
In 2013, Sirius Group’s other revenue primarily consisted of pre-tax transaction gains of $14 million from White Mountains Solutions’s acquisitions of Ashmere and Empire, compared to pre-tax transaction gains of $14 million in 2012 from White Mountains Solutions’s acquisitions of PICO, Citation, Woodridge and Oakwood. Other revenues in 2012 also included $15 million on the sale of Sirius Group’s interest in an affiliate, IMG, a managing general underwriter in the medical and travel business. Additionally, Sirius Group recorded $1 million of foreign currency translation losses in 2013 compared to $40 million of foreign currency translation gains in 2012. (See “Foreign Currency Translation” on page 73.)
Sirius Group’s insurance and reinsurance acquisition expenses decreased $14 million in 2013, primarily due to lower business volume and higher profit commissions earned on ceded European property treaties. Sirius Group’s other underwriting expenses increased $10 million in 2013, primarily due to increased incentive compensation expenses and higher professional fees, primarily related to Lloyd’s Syndicate 1945. General and administrative expenses decreased by $5 million, primarily due to lower severance and separation costs in 2013 as a result of reductions in staff in 2012. Accretion of fair value adjustment to losses and LAE reserves decreased by $9 million due to the acceleration of the amortization of the purchase accounting established for the acquisition of Scandinavian Reinsurance Company Ltd. (“Scandinavian Re”) due to a treaty commutation in the first quarter of 2012.
Reinsurance protection. Sirius Group’s net combined ratio equaled the gross combined ratio for 2013 and was 6 points higher than the gross combined ratio for 2012. The net and gross combined ratios were the same for 2013 as the cost of property retrocessions was offset by loss recoveries on catastrophe losses in Europe and Asia and profit commissions on ceded business. In 2012, the gross combined ratio was lower than the net combined ratio primarily due to the cost of property retrocessions with limited ceded property loss recoveries.
White Mountains reported $79 million of pre-tax losses on BAM in 2013, driven by $40 million of interest expense on the BAM Surplus Notes and $33 million of operating expenses, compared to $36 million in pre-tax losses in 2012 that were driven by $18 million of interest expense on the BAM Surplus Notes and startup and operational costs. BAM’s results for 2013 were also impacted by $9 million of realized and unrealized investment losses resulting from an increase in interest rates. BAM’s statutory net loss was $29 million in 2013 and $18 million in 2012.
The following table presents amounts from HG Global, which includes HG Re and its other wholly-owned subsidiaries, and BAM that are contained within White Mountains’s consolidated balance sheet as of December 31, 2014:
The following table presents the gross par value of policies priced and closed by BAM for the years ended December 31, 2014 and 2013:
White Mountains’s Other Operations segment reported pre-tax loss of $(53) million in 2014 compared to pre-tax income of $15 million in 2013. White Mountains’s Other Operations segment reported net realized and unrealized investment gains of $26 million in 2014 compared to $97 million in 2013. (See Summary of Investment Results on page 69.) The Other Operations segment reported net investment income of $15 million in both 2014 and 2013. Other revenues in 2014 included $65 million from QuoteLab and $43 million from Tranzact, which are revenues recorded since their acquisition in 2014. Other revenues in 2014 also included third-party investment management fee income at WM Advisors of $12 million, compared to $11 million in 2013. Other revenue in 2013 included $11 million of mark-to-market gains on the Symetra warrants prior to their exercise in the second quarter of 2013. (See Investment in Symetra Common Shares on page 72.)
White Mountains’s Other Operations segment reported $12 million of GAAP pre-tax losses relating to SSIE in 2014, which included $2 million of unfavorable loss reserve development reported in the second quarter, as well as a $3 million goodwill impairment charge. As a reciprocal insurance exchange that is owned by its policyholders, SSIE’s results are attributed to non-controlling interests and do not affect White Mountains’s adjusted book value per share.
Other Operations Results-Year Ended December 31, 2013 versus Year Ended December 31, 2012
White Mountains’s GAAP pre-tax total return on invested assets was 1.9% for 2014, compared to 4.1% for 2013. 2014 included 1.9% of foreign currency losses, while foreign currency translation did not meaningfully impact investment returns in 2013.
White Mountains maintains a high-quality, short-duration fixed income portfolio. As of December 31, 2014, the fixed income portfolio duration was approximately 2.0 years, including short-term investments, compared to 2.1 years as of December 31, 2013. In local currencies, the fixed income portfolio was up 2.7% for 2014, a decent absolute result for the year but behind the longer duration Barclays U.S. Intermediate Aggregate Bond Index return of 4.1%. The portfolio’s short duration positioning contributed to the underperformance versus the benchmark as interest rates fell in 2014. Including foreign currency losses, the fixed income portfolio was up 0.5% for 2014. In local currencies, the fixed income portfolio was up 0.5% for 2013, outperforming the longer duration Barclays U.S. Intermediate Aggregate Bond Index return of -1.0%. The portfolio’s short duration positioning contributed to the outperformance versus the benchmark as interest rates rose in 2013. Including foreign currency losses, the fixed income portfolio was up 0.4% for 2013.
White Mountains’s portfolio of common equity securities, convertibles and other long-term investments represented approximately 18% of GAAP invested assets as of December 31, 2014. In local currencies, the equity portfolio was up 8.0% for 2014, a strong absolute result for the year but mixed against benchmarks, underperforming the S&P 500 return of 13.7% and outperforming the small-cap Russell 2000 return of 4.9%. Including foreign currency losses, the equity portfolio was up 7.1% for 2014.
White Mountains’s portfolio of common equity securities, convertibles and other long-term investments represented approximately 20% of GAAP invested assets as of December 31, 2013. In local currencies, the equity portfolio was up 18.9% for 2013, a strong absolute result for the year but behind benchmarks. The shortfall against benchmarks was due primarily to underperformance in White Mountains’s value oriented common equity security portfolio (up 23.2% vs. the S&P 500 return of 32.4%) and the impact of convertibles in the equity portfolio (as opposed to common equity securities), which tend to lag benchmarks in strong up markets. Foreign currency translation did not meaningfully impact equity returns in 2013.
Using a value orientation, Prospector invests in positions in the United States and other developed markets. Prospector’s investment strategy consists of a bottom-up fundamental value analysis with an emphasis on balance sheet strength. Prospector puts particular emphasis on (i) private market value, (ii) free cash flow yield and (iii) absolute and relative valuation. Prospector invests across the capital structure and often invests in convertibles that it believes provide better risk/return tradeoffs, given their income and redemption features.
The Prospector portfolio accounted for approximately 30% of White Mountains’s common equity securities, convertibles and other long-term investments as of December 31, 2014. The Prospector portfolio returned 6.6% for 2014, lagging the S&P 500 return of 13.7%. Prospector’s underperformance relative to the S&P 500 in 2014 reflected an underweight position and underperformance in the technology and healthcare sectors. Like many managers, Prospector’s underweight position in large cap stocks also negatively impacted its performance relative to the S&P 500 in 2014. For reference, the small cap Russell 2000 Index returned 4.9% for 2014. The Prospector portfolio accounted for approximately 50% of White Mountains’s common equity securities, convertibles and other long-term investments as of December 31, 2013. The Prospector portfolio returned 23.2% for 2013, lagging the S&P 500 return of 32.4%. Prospector’s underperformance relative to the S&P 500 return in 2013 reflected an overweight position in gold mining, an underweight position in the consumer discretionary, technology and industrial sectors and the impact of convertible fixed maturity positions (as opposed to common equity securities), which tend to lag the index in strong up markets.
Total annualized total returns for White Mountains’s separate accounts managed by Prospector compared to the annualized total returns of the S&P 500 Index are as follows:
The Lateef separate account is a highly concentrated portfolio of high quality mid- and large-cap growth companies. Lateef is a growth at a reasonable price manager focused on investing in high return on invested capital businesses at reasonable valuations. Lateef uses a bottom up, fundamental research-driven investment process that is focused on absolute returns, low turnover and a long-term investment horizon. As a highly concentrated portfolio of 15 to 20 positions, relative performance to the S&P 500 is often driven, positively or negatively, by individual positions, especially in the short-term. The Lateef separate account returned 6.5% for 2014, lagging the S&P 500 return of 13.7%. The Lateef separate account returned 30.5% for 2013, compared to the S&P 500 return of 32.4%.
White Mountains also maintains a portfolio of other long-term investments that consists of private equity partnerships, hedge funds, certain unconsolidated insurance service businesses and surplus note investments. Approximately 60% of these long-term investments as of December 31, 2014 are in private equity funds, with a general emphasis on narrow, sector-focused funds and hedge funds, with a general emphasis on long-short equity funds. White Mountains’s other long-term investments returned 7.0% for 2014, outperforming the HFRX Equal Weighted Strategies Index return of -0.5%. White Mountains’s other long-term investments returned 6.9% for 2013, which outperformed the HFRX Equal Weighted Strategies Index return of 6.3%.
White Mountains’s portfolio of common equity securities, convertibles and other long-term investments represented approximately 20% of GAAP invested assets as of December 31, 2013. In local currencies, the equity portfolio was up 18.9% for 2013, a strong absolute result for the year but behind benchmarks. The shortfall against benchmarks was due primarily to underperformance in White Mountains’s value oriented common equity security portfolio (up 23.2% vs. the S&P 500 return of 32.4%) and the impact of convertible fixed maturity investments in the equity portfolio (as opposed to common equity securities), which tend to lag benchmarks in strong up markets. Foreign currency translation did not meaningfully impact equity returns in 2013.
White Mountains’s portfolio of common equity securities, convertibles and other long-term investments represented approximately 20% of GAAP invested assets as of December 31, 2012. In local currencies, the equity portfolio was up 7.8% in 2012, underperforming the S&P 500 return of 16.0%. Foreign currency translation did not meaningfully impact equity returns in 2012.
The Prospector portfolio returned 23.2% for 2013 and 7.7% for 2012, lagging the S&P 500 return of 32.4% and 16.0%, respectively, in both periods. Prospector’s underperformance relative to the S&P 500 returns for both periods reflected an overweight position in gold mining, an underweight position in the consumer discretionary, technology and industrial sectors and the impact of convertible fixed maturity investments (as opposed to common equity securities), which tend to lag benchmarks in strong up markets.
The Lateef separate account, which consists of a highly concentrated portfolio where relative performance is often influenced by one or two positions, returned 32.6% for 2013 compared to the S&P 500 return of 32.4%. Lateef’s performance in 2013 reflects specific positions in the industrial, technology and consumer discretionary sectors. The Lateef separate account, which was established on May 11, 2012, returned 7.0% for 2012, outperforming the S&P 500 return of 6.6%.
White Mountains’s other long-term investments returned 6.9% for 2013, which outperformed the HFRX Equal Weighted Strategies Index return of 6.3% for 2013. White Mountains’s other long-term investments returned 2.4% for 2012, which was essentially in line with the HFRX Equal Weighted Strategies Index return of 2.5%.
Value of the investment in Symetra’s common shares used in the calculation of White Mountains’s adjusted book value per share
During the second quarter of 2013, White Mountains executed a cashless exercise of its Symetra warrants. The warrants were marked up to their fair value of $41 million at the date of exercise, June 20, 2013, resulting in a $15 million realized gain reported in the second quarter of 2013. The cashless exercise resulted in the net issuance of 2,648,879 additional common shares of Symetra in exchange for the warrants to purchase 9,487,872 Symetra common shares.
Carrying value includes $236.3 as of December 31, 2013 that is classified as assets held for sale relating to discontinued operations.
The breakdown of White Mountains’s fixed maturity and convertibles as of December 31, 2014 by credit class, based upon issue credit ratings provided by Standard & Poor’s, or if unrated by Standard & Poor’s, long term obligation ratings provided by Moody’s, is as follows:
The cost or amortized cost and carrying value of White Mountains’s fixed maturity investments and convertible fixed maturity investments as of December 31, 2014 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.
Component of net realized and unrealized investments gains on the income statement.
The following table provides detail of White Mountains’s total investment portfolio denominated in various currencies and their corresponding U.S. dollar carrying values, as converted using spot exchange rates as of December 31, 2014 and 2013:
Sirius International holds a large portfolio of investments that are denominated in U.S. dollars, but its functional currency is the Swedish krona. When Sirius International prepares its stand-alone GAAP financial statements, it translates its U.S. dollar-denominated investments to Swedish krona and recognizes the related foreign currency translation gains or losses through pre-tax income. When White Mountains consolidates Sirius International, it translates Sirius International’s stand-alone GAAP financial statements to U.S. dollars and recognizes the foreign currency gains or losses arising from this translation, including those associated with Sirius International’s U.S. dollar-denominated investments, through other comprehensive income. Since White Mountains reports its financial statements in U.S. dollars, there is no net effect to adjusted book value per share or to investment returns from foreign currency translation on its U.S. dollar-denominated investments at Sirius International. However, net realized and unrealized investment gains, other revenues and other comprehensive income can be significantly affected during periods of high volatility in the foreign exchange rate between the U.S. dollar and other currencies, especially the Swedish krona.
The amount of foreign currency translation on Sirius International’s U.S. dollar denominated investments recognized as a decrease of other comprehensive income and an increase of net income was $116 million in 2014. The amount of foreign currency translation on Sirius International’s U.S. dollar denominated investments recognized as an increase of other comprehensive income and a decrease of net income was $10 million in 2013. The amount of foreign currency translation on Sirius International’s U.S. dollar denominated investments recognized as an increase of other comprehensive income and a decrease of net income was $40 million in 2012.
Operating subsidiary level. The primary sources of cash for White Mountains’s insurance and reinsurance operating subsidiaries are expected to be premium collections, net investment income, proceeds from sales and maturities of investments, contributions from holding companies, capital raising activities and, from time to time, proceeds from the sales of operating subsidiaries. The primary uses of cash are expected to be claim payments, policy acquisition costs, purchases of investments, payments on and repurchases/retirements of its debt obligations, distributions and tax sharing payments made to holding companies, 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. Claim settlements, premium levels and investment returns may be impacted by changing rates of inflation and other economic conditions. In many cases, significant periods of time, sometimes several years or more, 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 claims and benefits cannot be predicted with certainty. White Mountains’s insurance and reinsurance operating subsidiaries maintain portfolios of invested assets with varying maturities and a substantial amount of cash and short-term investments to provide adequate liquidity for the payment of claims.
Management believes that White Mountains’s cash balances, cash flows from operations, routine sales and maturities of investments and the liquidity provided by the WTM Bank Facility are adequate to meet expected cash requirements for the foreseeable future on both a holding company and insurance and reinsurance operating subsidiary level.
Split Rock has the ability to declare or pay dividends or make capital distributions during any 12-month period without the prior approval of Bermuda regulatory authorities on the condition that any such declaration or payment of dividends or capital distributions does not cause a breach of any of its regulatory solvency and liquidity requirements. During 2015, Split Rock has the ability to make capital distributions without the prior approval of regulatory authorities, subject to meeting all appropriate liquidity and solvency requirements, of $19 million, which is equal to 15% of its December 31, 2014 statutory capital (excluding earned surplus). During 2014, Split Rock paid $10 million of dividends and $10 million of capital distributions to its immediate parent.
During 2014, OneBeacon’s unregulated insurance operating subsidiaries paid $5 million of dividends to their immediate parent. As of December 31, 2014, OneBeacon’s unregulated insurance operating subsidiaries had $78 million of net unrestricted cash, short-term investments, and fixed maturity investments. As of December 31, 2014, OneBeacon’s unregulated insurance operating subsidiaries also had $101 million in par value of OBIC Surplus Notes, with a carrying value of $65 million classified as other long-term investments.
As of December 31, 2014, OneBeacon Ltd. and its intermediate holding companies had $107 million of net unrestricted cash, short-term investments and fixed maturity investments and $89 million of common equity securities, convertibles and other long-term investments outside of its regulated and unregulated insurance operating subsidiaries.
Subject to certain limitations under Swedish law, Sirius International is permitted to transfer certain portions of its pre-tax income to its Swedish parent companies to minimize taxes (referred to as a group contribution). On January 1, 2013, new tax legislation became effective in Sweden that limits the deductibility of interest paid on certain intra-group debt instruments. Uncertainty exists with respect to the interpretation of the legislation on existing intra-group debt instruments within the Sirius Group structure. In 2014 Sirius International did not transfer any of its 2013 pre-tax income to its Swedish parent companies.
Sirius America has the ability to pay dividends to Sirius International during any twelve-month period without the prior approval of regulatory authorities in an amount set by formula based on the lesser of net investment income, as defined by statute, or 10% of statutory surplus, in both cases as most recently reported to regulatory authorities, subject to the availability of earned surplus and subject to dividends paid in prior periods. Based upon the formula above, Sirius America does not have the ability to pay dividends during 2015 without prior approval of regulatory authorities. As of December 31, 2014, Sirius America had $621 million of statutory surplus and $82 million of earned surplus. During 2014, Sirius America did not pay any dividends to its immediate parent.
There is a capital maintenance agreement between Sirius International and Sirius America which obligates Sirius International to make contributions to Sirius America’s surplus in order for Sirius America to maintain surplus equal to at least 125% of the company action level risk based capital as defined in the NAIC Property/Casualty Risk-Based Capital Report. The agreement provides for a maximum contribution to Sirius America of $200 million. Sirius International also provides Sirius America with accident year stop loss reinsurance, which protects Sirius America’s accident year loss and allocated loss adjustment expense ratio in excess of 70%, with a limit of $90 million. This stop loss contract was in effect for all of 2014 and has been renewed for all of 2015 with the same terms.
Subject to certain limitations under Swedish law, Sirius International is permitted to transfer pre-tax income amounts into an untaxed reserve referred to as a safety reserve. As of December 31, 2014, Sirius International’s safety reserve amounted to SEK 10.4 billion, or $1.3 billion (based on the December 31, 2014 SEK to USD exchange rate). Under GAAP, an amount equal to the safety reserve, net of a related deferred tax liability established at the Swedish tax rate of 22.0%, is classified as shareholder’s equity. Generally, this deferred tax liability is only required to be paid by Sirius International if it fails to maintain prescribed levels of premium writings and loss reserves in future years. As a result of the indefinite deferral of these taxes, Swedish regulatory authorities apply no taxes to the safety reserve when calculating solvency capital under Swedish insurance regulations. Accordingly, under local statutory requirements, an amount equal to the deferred tax liability on Sirius International’s safety reserve ($296 million as of December 31, 2014) is included in solvency capital. Access to the safety reserve is restricted to coverage of insurance or reinsurance underwriting losses. Access for any other purpose requires the approval of Swedish regulatory authorities. Similar to the approach taken by Swedish regulatory authorities, most major rating agencies generally include the $1.3 billion balance of the safety reserve, without any provision for deferred taxes, in Sirius International’s regulatory capital when assessing Sirius International’s financial strength.
As of December 31, 2014, HG Global had $613 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 2014 or 2013. As of December 31, 2014, HG Global has accrued $96 million of dividends payable to holders of its preferred shares, $93 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 by amounts held in the collateral trusts pursuant to the FLRT with BAM. As of December 31, 2014, HG Re had statutory capital of $445 million, of which $403 million was held as collateral in the Supplemental Trust pursuant to the FLRT with BAM and $44 million relates to accrued interest on the BAM Surplus Notes held by HG Re.
Effective January 1, 2014, HG Global and BAM agreed to change the interest rate on the BAM Surplus Notes for the five years ending December 31, 2018 from a fixed rate of 8.0% to a variable rate equal to the one-year U.S. treasury rate plus 300 basis points, set annually, which was 3.13% for 2014 and is 3.15% for 2015. Prior to the end of 2018, BAM has the option to extend the variable rate period for an additional three years. At the end of the variable rate period, the interest rate will be fixed at the higher of the then current variable rate or 8.0%. BAM is required to seek regulatory approval to pay interest and principal on its surplus notes only when adequate capital resources have accumulated beyond BAM’s initial capitalization and a level that continues to support its outstanding obligations, business plan and ratings.
During 2014, White Mountains contributed $15 million to WM Advisors. During 2014, WM Advisors did not pay any dividends to its immediate parent. As of December 31, 2014, WM Advisors held $26 million of net unrestricted cash, short-term investments and fixed maturity investments.
In addition, from time to time WM Life Re borrows funds under an internal revolving credit facility with an intermediate holding company of White Mountains. $23 million was outstanding under this facility as of December 31, 2014.
The following table summarizes White Mountains’s capital structure as of December 31, 2014 and 2013:
On August 14, 2013, White Mountains entered into an unsecured revolving credit facility with a syndicate of lenders administered by Wells Fargo Bank, N.A., which has a total commitment of $425 million and a maturity date of August 14, 2018 (the “WTM Bank Facility”). As of December 31, 2014, the WTM Bank Facility was undrawn.
The WTM Bank Facility contains various affirmative, negative and financial covenants that White Mountains considers to be customary for such borrowings, including certain minimum net worth and maximum debt to capitalization standards. 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 Bank Facility, which would allow lenders to declare any amounts owed under the WTM Bank Facility to be immediately due and payable. In addition, a default under the WTM Bank Facility could occur if certain of White Mountains’s subsidiaries fail to pay principal and interest on “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 the principal amount of covered debt. As of December 31, 2014, White Mountains was in compliance with all of the covenants under the WTM Bank Facility and anticipates it will continue to remain in compliance with these covenants for the foreseeable future.
The Tranzact Bank Facility contains various affirmative, negative and financial covenants which White Mountains considers to be customary for such borrowings, including a minimum fixed charge coverage ratio and a minimum leverage ratio. Failure to meet one or more of these covenants could result in an event of default, which ultimately could eliminate availability under these facilities and result in acceleration of principal repayment on any amounts outstanding. As of December 31, 2014, Tranzact was in compliance with all of the covenants under the Tranzact Bank Facility and anticipates it will continue to remain in compliance with these covenants for the foreseeable future.
In March 2007, SIG issued $400 million face value of senior unsecured notes at an issue price of 99.715%. The SIG Senior Notes bear an annual interest rate of 6.375%, payable semi-annually in arrears on March 20 and September 20, until maturity in March 2017.
Below is a schedule of White Mountains’s material contractual obligations and commitments as of December 31, 2014:
Represents expected future cash outflows resulting from loss and LAE payments. The amounts presented are gross of reinsurance recoverables on unpaid losses of $484 and net of the discount on OneBeacon’s workers compensation loss and LAE reserves of $1 as of December 31, 2014.
White Mountains’s loss reserves do not have contractual maturity dates. However, based on historical payment patterns, the preceding table includes an estimate of when management expects White Mountains’s loss reserves to be paid. The timing of claim payments is subject to significant uncertainty. White Mountains maintains a portfolio of marketable investments with varying maturities and a substantial amount of short-term investments to provide adequate liquidity for the payment of claims.
The balances included in the table above regarding White Mountains’s long-term incentive compensation plans include amounts payable for performance shares and units, as well as deferred compensation balances. 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 in some cases the market price of the Company’s and OneBeacon Ltd.’s common shares at the time the payments are made.
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, 2014.
White Mountains purchases derivative instruments, including futures and over-the-counter option contracts on interest rates, major equity indices, and foreign currencies, to mitigate the risks associated with changes in the fair value of the reinsured variable annuity guarantees. As of December 31, 2014, the fair value of these derivative instruments was $56 million. In addition, WM Life Re held approximately $33 million of cash and fixed maturity investments as of December 31, 2014 posted as collateral to its reinsurance and derivatives counterparties.
During 2013, the Company repurchased 141,535 common shares for $80 million at an average share price of $564, which was 88% of White Mountains’s adjusted book value per share of $642 as of December 31, 2013. These repurchases were comprised of 140,000 common shares repurchased in a private transaction under the board authorization for $79 million at an average share price of $564 and 1,535 common shares repurchased pursuant to employee benefit plans.
Cash flows from operations for the years ended 2014, 2013 and 2012
Net cash flows provided from (used for) continuing operations was $207 million, $(29) million and $(30) million in 2014, 2013 and 2012, respectively. Cash flows from continuing operations increased $236 million in 2014 compared to 2013 primarily due to lower amounts of cash used for the settlement and purchase of derivative instruments at WM Life Re in 2014 compared to 2013. Cash used for continuing operations was relatively flat in 2013 when compared to 2012 as an increase at OneBeacon due to inflows from premiums exceeding loss and LAE payments and an increase in unrestricted cash collateral held in respect of its surety business, was partially offset by cash used for the settlements and purchases of derivative instruments at WM Life Re and payments made on losses related to hurricane Sandy. Net cash flows used for discontinued operations was $88 million, $72 million and $196 million in 2014, 2013 and 2012, respectively. The cash outflows from discontinued operations in all years presented were primarily due to the runoff of reserves related to the Runoff Business.
During 2014, OneBeacon paid a total of $13 million of interest on the OBH Senior Notes.
During 2014, Sirius Group paid $50 million of dividends to its immediate parent.
During 2014, White Mountains acquired approximately 45% of the outstanding common shares of durchblicker.at, for EUR 9 million (approximately $12 million based upon the foreign exchange spot rate at the date of acquisition).
During 2014, White Mountains acquired 60% of the outstanding Class A common units of QuoteLab for an initial purchase price of $28 million.
During the first quarter of 2013, White Mountains made payments totaling $11 million on WTM Performance Shares.
During the first quarter of 2013, White Mountains repaid $75 million that was outstanding under a previous revolving credit facility as of December 31, 2012. In addition, during 2013, White Mountains borrowed and repaid a total of $200 million under its revolving credit facilities and paid $4 million of interest on its revolving credit facilities.
During 2013, Sirius Group paid $19 million of dividends on the SIG Preference Shares and $26 million of interest on the SIG Senior Notes.
During 2013, Sirius Group executed the Interest Rate Cap for $10 million.
In December 2012, White Mountains borrowed $150 million under a previous revolving credit facility. White Mountains repaid $75 million of this amount in December 2012 and the remaining $75 million in January 2013. During 2012, White Mountains paid $2 million of interest on its previous revolving credit facility.
During 2012, OneBeacon completed the sale of a shell company, Pennsylvania General Insurance, and received $15 million as consideration.
See Note 20-“Transactions with Related Persons” in the accompanying Consolidated Financial Statements.
OneBeacon, like other insurance companies, categorizes and tracks its insurance reserves by “line of business”, such as general liability, automobile liability and workers compensation. Furthermore, OneBeacon regularly reviews the appropriateness of reserve levels at the line of business level, taking into consideration the variety of trends that impact the ultimate settlement of claims for the subsets of claims in each particular line of business.
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 reserves in the future. Typically, these factors exist when management and OneBeacon’s actuaries conclude that there is insufficient historical incurred and paid loss information or that trends included in the historical incurred and paid loss information are unlikely to repeat in the future. Such factors include, among others, recent entry into new markets or new products, improvements in the claims department that are expected to lessen future ultimate loss costs, legal and regulatory developments, or other volatilities that may arise.
(1) During 2014, OneBeacon changed its presentation of line of business reserves and restated the 2013 case reserves, IBNR and total reserves to report consistent line of business activity for both years presented. As a result, for "General liability - claims made," case reserves increased $0.6 million, IBNR increased $3.3 million, and total reserves increased by $3.9 million, with corresponding decreases to "General liability - occurrence", and for "Other," case reserves increases increased by $3.8 million, IBNR increased $8.6 million, and total reserves increased by $12.4 million, with corresponding decreases to "Property," compared to the previous presentation for 2013.
Additional causes of material uncertainty exist in most product lines and may impact the types of claims that could occur within a particular operating segment or book of business. Examples where reserving factors, within an underwriting unit or book of business, are subject to change include changing types of insured (e.g. type of insured vehicle, size of account, industry insured, jurisdiction, etc.), changing underwriting standards, or changing policy provisions (e.g. deductibles, policy limits, or endorsements).
General liability is generally considered a long tail line of business, as it takes a relatively long period of time to finalize and settle claims from a given accident year. The speed of claim reporting and claim settlement is a function of the specific coverage provided and the jurisdiction, among other factors. There are numerous components underlying the general liability product line. Some of these have relatively moderate payment patterns (with most of the claims for a given accident year closed within 5 to 7 years), while others can have extreme lags in both reporting and payment of claims (e.g., a reporting lag of a decade for “construction defect” claims).
Changes in claim handling philosophies (e.g., case reserving standards), including the use of third-party claims administrators
The general liability occurrence and property coverages described above are often provided under a multiple peril package policy sold to insureds includes general liability and property insurance. Because commercial multiple peril provides a combination of property and liability coverage, typically for small businesses, it includes both short- and long-tail coverages. The reserving risk for this line is dominated by the liability coverage portion of this product, except occasionally in the event of catastrophic or large single losses.
Mortality trends of injured workers with lifetime indemnity and medical treatment benefits
Multiperil crop and crop-hail is generally considered a very short tailed coverage yet the reserve estimate often contains a fair amount of uncertainty. As a new business, a lack of historical data means external data is heavily relied upon where available and applicable. Crop reserving factors that can change and, thus, affect estimated crop reserves include changes in
Surety is generally considered a short tailed coverage. As a new business, a lack of historical data means external data is heavily relied upon where available and applicable. Surety reserving factors that can change and, thus, affect estimated surety
reserves include probability of default of the bond which can be impacted by general economic conditions, size of payment
During 2014, OneBeacon experienced $90 million of net unfavorable loss and LAE reserve development on prior accident year reserves, of which $75 million related to the 2014 fourth quarter reserving increase and the remaining amount primarily driven by unfavorable development in the professional liability and management liability businesses included within Professional Insurance. See “RESULTS OF OPERATIONS - OneBeacon” on page 57.
During 2012, OneBeacon experienced $7 million of net favorable loss and LAE reserve development on prior accident year reserves. The favorable reserve development was primarily from workers' compensation, multiple peril liability and general liability lines. This favorable development was partially offset by unexpected adverse development on excess property claims.
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 range noted above because the range was developed by using several different generally accepted actuarial methods.
The volatility associated with the frequency and severity of large losses, defined as net claims greater than or equal to $2.5 million, can have a material impact on OneBeacon’s results. The frequency and severity of large claims is driven primarily by the random nature of the insurance process but also by claim cost inflation and parameter risk. These large losses often emerge over a long time period potentially leading to a material impact on OneBeacon’s reserves. One way OneBeacon considers this sensitivity is by examining the volatility of large losses in the current accident year using its economic capital model. At the 75th percentile of modeled outcomes, OneBeacon estimates that large losses could exceed the mean by $19 million, net of reinsurance.
Professional liability: Recorded loss and allocated LAE reserves, net of reinsurance recoverable, for professional liability were $527 million as of December 31, 2014. A key assumption for professional liability is the implicit loss cost trend, particularly the severity inflation trend component of loss costs. Across the entire reserve base, a 5.0 point change in assumed annual severity would have changed the estimated net reserve by approximately $82 million as of December 31, 2014, in either direction.
Workers compensation: Recorded workers compensation loss and LAE reserves, net of reinsurance recoverable, were $112 million as of December 31, 2014. The two most important assumptions for workers compensation reserves are loss development factors and loss cost trends, particularly medical cost inflation. Loss development patterns are dependent on medical cost inflation. Approximately half of the workers compensation net reserves are related to future medical costs. Across the entire reserve base, a 0.5 point change in calendar year medical inflation would have changed the estimated net reserve by approximately $8 million as of December 31, 2014, in either direction.
Included in this class are primarily the runoff exposures from various acquisitions.
In order to reduce the potential uncertainty of loss reserve estimation, Sirius Group obtains information from numerous sources to assist in the reserving process. Sirius Group’s underwriting and pricing actuaries devote considerable effort to understanding and analyzing each ceding company’s operations and loss history during the underwriting of the business, using a combination of client and industry statistics. Such statistics normally include historical premium and loss data by class of business, individual claim information for larger claims, distributions of insurance limits provided and the risk characteristics of the underlying insureds, loss reporting and payment patterns, and rate change history. This analysis is used to project expected loss ratios for each treaty during the upcoming contract period. These expected ultimate loss ratios are aggregated across all treaties and are input directly into the loss reserving process. For primary insured business, a similar portfolio analysis is performed for each MGU program taking into account expected changes in the aggregated risk profile of the policyholders within each program. The aggregation of risks yields a more stable indication of expected losses that is used to estimate ultimate losses and thus IBNR for recently written business.
Backlogs in the recording of assumed reinsurance can also complicate the accuracy of loss reserve estimation. As of December 31, 2014, there were no significant backlogs related to the processing of assumed reinsurance information at Sirius Group.
Sirius Group relies heavily on information reported by MGUs and ceding companies, as discussed above. In order to determine the accuracy and completeness of such information, Sirius Group underwriters, actuaries, and claims personnel perform audits of certain MGUs and ceding companies where customary. Generally, ceding company audits are not customary outside the United States. In such cases, Sirius Group reviews information from ceding companies for unusual or unexpected results. Any material findings are discussed with the ceding companies. Sirius Group sometimes encounters situations where it is determined that a claim presentation from a ceding company is not in accordance with contract terms. Most situations are resolved amicably and without the need for litigation or arbitration. However, in the infrequent situations where a resolution is not possible, Sirius Group will vigorously defend its position in such disputes.
Sirius Group also obtains reinsurance whereby another reinsurer contractually agrees to indemnify Sirius Group for all or a portion of the risks underwritten by Sirius Group. Such arrangements, where one reinsurer provides reinsurance to another reinsurer, are usually referred to as “retrocessional reinsurance” arrangements. Sirius Group establishes estimates of amounts recoverable from reinsurers on its direct business and retrocessional reinsurance on its reinsurance business in a manner consistent with the loss and LAE liability associated with reinsurance contracts offered to its customers, net of an allowance for uncollectible amounts, if any. Net reinsurance loss reserves represent loss and LAE reserves reduced by ceded reinsurance recoverable on unpaid losses.
The following table illustrates Sirius Group’s recorded net loss and LAE reserves and high and low estimates as of December 31, 2014 and 2013.
Sustained Economic and Tort Inflation. Future inflation beyond the recent historical levels could impact the required reserves. For example, Sirius America has casualty and runoff loss reserves of roughly $385 million excluding asbestos and environmental at the end of fourth quarter 2014. The estimated additional claim payments for Sirius America due to hypothetical increases in the inflation rate of 200 to 800 basis points beginning in 2017 and continuing through 2021 is estimated to be $36 to $182 million.
Catastrophe Losses. As time has passed, the emerging claims information for major events including natural catastrophes has been better than expected. There is $185 million in net reserves remaining for major events which occurred during 2010-2014, of which $44 million is held as net IBNR above client estimates formally rendered. Some, but perhaps not all, of this additional IBNR may be needed to handle adverse reporting from clients.
Sirius Group's A&E exposure is primarily from reinsurance contracts written between 1974 through 1985 by acquired companies, mainly MONY Reinsurance Company and Christiania General Insurance Company. The exposures are mostly higher layer excess of loss treaty and facultative coverages with relatively low limits exposed for each claim. In 2014 and 2013, Sirius Group increased its net A&E exposure through incoming runoff portfolios acquired by White Mountains Solutions. These acquisitions added $23 million in net asbestos reserves and $2 million in net environmental reserves in 2014 and $13 million in net asbestos reserves and $1 million in net environmental reserves in 2013. The acquisition of companies having modest portfolios of A&E exposure has been typical of several prior White Mountains Solutions transactions and is likely to be an element of at least some future acquisitions. However, the acquisition of new A&E liabilities is undertaken only after careful due diligence and utilizing conservative reserving assumptions in relation to industry benchmarks. In the case of the portfolios acquired during 2014 and 2013, the exposures arise almost entirely from old assumed reinsurance contracts having small limits of liability.
Sirius Group recorded $8 million and $12 million of asbestos-related incurred losses and LAE on its already existing asbestos reserves in 2014 and 2013. The 2014 and 2013 incurred losses were primarily the result of management’s monitoring of a variety of metrics including actual paid and reported claims activity as compared to the most recent in-depth analysis performed in 2012, net paid and reported survival ratios, peer comparisons, and industry benchmarks.
Sirius Group utilizes specialized claims handling processes on A&E exposures. The issues presented by these types of claims require expertise and an awareness of the various trends and developments in relevant jurisdictions. Generally, Sirius Group sets up claim files for each reported claim by each cedant for each individual insured. In many instances, a single claim notification from a cedant could involve several years and layers of coverage resulting in a file being set up for each involvement. Precautionary claim notices are submitted by the ceding companies in order to preserve their right to pursue coverage under the reinsurance contract. Such notices do not contain an incurred loss amount. Accordingly, an open claim file is not established. As of December 31, 2014, Sirius Group had 2,492 open claim files for asbestos and 490 open claim files for environmental exposures.
White Mountains measures certain assets and liabilities at estimated fair value in its consolidated financial statements, with changes therein recognized in current period earnings. In addition, White Mountains discloses estimated fair value for certain liabilities measured at historical or amortized cost. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants (an exit price) at a particular measurement date. Fair value measurements are categorized into a hierarchy that distinguishes between inputs based on market data from independent sources (“observable inputs”) and a reporting entity’s internal assumptions based upon the best information available when external market data is limited or unavailable (“unobservable inputs”). Quoted prices in active markets for identical assets have the highest priority (“Level 1”), followed by observable inputs other than quoted prices including prices for similar but not identical assets or liabilities (“Level 2”), and unobservable inputs, including the reporting entity’s estimates of the assumptions that market participants would use, having the lowest priority (“Level 3”).
White Mountains’s invested assets that are measured at fair value include fixed maturity investments, common equity securities, convertibles and other long-term investments, including hedge funds and private equity funds.
In those circumstances, White Mountains estimates the fair value using industry standard pricing models and observable inputs such as benchmark interest rates, market comparables, broker quotes, issuer spreads, bids, offers, credit rating prepayment speeds and other relevant inputs. White Mountains performs procedures to validate the market prices obtained from the outside pricing sources. Such procedures, which cover substantially all of its fixed maturity investments include, but are not limited to, evaluation of model pricing methodologies and a review of the pricing services’ quality control processes and procedures on at least an annual basis, comparison of market prices to prices obtained from a different independent pricing vendors on at least a semi-annual basis, monthly analytical reviews of certain prices, and review of assumptions utilized by the pricing service for selected 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 $1 million from the expected price based on these procedures are considered outliers. Also considered outliers are prices that haven’t 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 do not appear to support the market price provided by the pricing services, White Mountains challenges the price. During the past year, approximately 21 securities fell outside White Mountains’s expected results, thereby triggering the challenge with the pricing service. 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. The fair values of such securities are considered to be Level 3 measurements.
Other long-term investments accounted for at fair value as of December 31, 2014 include $92 million in hedge funds and $151 million in private equity funds. As of December 31, 2014, White Mountains held investments in 12 hedge funds and 32 private equity funds. The largest investment in a single fund was $22 million and $18 million as of December 31, 2014 and 2013.
The fair value of White Mountains’s investments in hedge funds and private equity funds is based upon White Mountains’s proportionate interest in the underlying fund’s net asset value, which is deemed to approximate fair value. White Mountains employs a number of procedures to assess the reasonableness of the fair value measurements for its other long-term investments including obtaining and reviewing each fund’s audited financial statements and discussing each fund’s pricing with the fund’s manager. However, since the fund managers do not provide sufficient information to independently evaluate the pricing inputs and methods for each underlying investment, the inputs are considered to be unobservable. Accordingly, the fair values of White Mountains’s investments in hedge funds and private equity funds have been classified as Level 3.
In circumstances where the underlying investments are publicly traded, such as the investments made by hedge funds, the fund manager uses current market prices to determine fair value. In circumstances where the underlying investments are not publicly traded, such as the investments made by private equity funds, the private equity fund managers generally consider the need for a liquidity discount on each of the underlying investments when determining the fund’s net asset value. In circumstances where White Mountains’s portion of a fund’s net asset value is deemed to differ from fair value due to illiquidity or other factors associated with White Mountains’s investment in the fund, the net asset value is adjusted accordingly. As of December 31, 2014, there were no circumstances where illiquidity or other factors required an adjustment to the net asset value related to any of its investments in hedge funds or private equity funds.
White Mountains’s investment portfolio includes investments in hedge funds and private equity funds. As of December 31, 2014, the value of investments in hedge funds and in private equity funds was $92 million and $151 million, respectively. The underlying investments are typically publicly traded and private common equity securities and investments, and, as such, are subject to market risks that are similar to White Mountains’s common equity securities. The following illustrates the estimated effect on December 31, 2014 fair value resulting from a 10% change and a 30% change in market value:
Generally, the liabilities associated with these guarantees increase with declines in the equity markets, interest rates and currencies against the Japanese yen, as well as with increases in market volatilities. The collective account values were approximately 113% and 104% of the guarantee value as of December 31, 2014 and 2013. In 2008, particularly in the fourth quarter, as a result of worldwide declines in equity markets, interest rates and the strengthening of the Japanese yen, the underlying investment accounts declined substantially and the collective account values were significantly lower than the guarantee value for several years. The liability is also affected by annuitant related behavioral and actuarial assumptions, including surrender and mortality rates. WM Life Re lowered its projected surrender rates in 2011 and 2010 to reflect the behavior observed during the turbulent markets experienced throughout those years. During 2014 and 2013, policyholder account values rallied, as surrender charges in the underlying annuities expired and observed surrender rates increased to higher than expected levels. WM Life Re, as a result, increased its projected surrender rates used in the valuation of its variable annuity reinsurance liability at the end of 2013 and again at the end of 2014.
As of December 31, 2014, the value of bond funds tracking the Nomura BPI was approximately ¥56 billion ($466 million). In January 2010, because the types and tenors of liquid Japanese bond futures currently available are extremely limited, to more closely track the performance of bond funds tracking the Nomura BPI, WM Life Re entered into its first total return swap contract on the performance of that index. As of December 31, 2014, the total notional amount of Nomura BPI swaps was ¥36 billion ($301 million), covering over 100% of WM Life Re's Nomura BPI-related liability exposure. Of these swaps, ¥13 billion ($109 million), which mature between 2015 and 2016, track the government bond component of the index only (approximately 80% of the index), leaving WM Life Re exposed to credit spread risk on the non-government portion. However, WM Life Re was able to temporarily convert these swaps into swaps that track the complete index through August 2014 and again through August 2015, at which time they will revert back to swaps that track the government bond component only unless WM Life Re is able to roll the conversion for another period of time. The remaining ¥33 billion ($276 million) track the complete index. Of these, one with a notional amount of ¥5 billion ($42 million) matured in February 2015. The market for these swaps is extremely illiquid and there is no guaranty that WM Life Re will be able to, if appropriate, add to or unwind its position at a reasonable cost. Under the contracts, WM Life Re receives cash flows based on a fixed return, reset at the beginning of each month based on current LIBOR and is required to pay cash flows based on the performance of the Nomura BPI during that period plus a fixed amount. Residual Nomura BPI exposure is hedged with liquid Japanese bond futures and is subject to basis risk relating to the difference between the tenor of the bond futures and the tenor of the assets in the annuity funds covered by WM Life Re’s variable annuity guarantees.
As of December 31, 2014, the value of equity funds tracking the MSCI Kokusai was approximately ¥23 billion ($189 million). To reduce hedging basis risk, in 2011 WM Life Re entered into a series of total return swaps on the MSCI Kokusai, denominated in Japanese yen with maturities laddered during 2015 and 2016 to approximate the maturities of the policies reinsured. As of December 31, 2014, the total notional amount of MSCI Kokusai swaps was ¥15 billion ($125 million) and the percent of MSCI Kokusai fund exposure hedged by these swaps was over 100%. Residual MSCI Kokusai exposure is hedged with a variety of more liquid instruments, including exchange-traded futures.
The following table summarizes the estimated financial impact on WM Life Re's derivatives and benefit guarantee liabilities of instantaneous changes in individual market variables as of December 31, 2014. The table below assumes that all other market variables are constant and does not reflect the inter-dependencies between individual variables.
White Mountains’s sensitivities for market implied volatilities vary by term. For equity implied volatilities, White Mountains changes implied volatilities by 15% and 13% for years one and two, respectively. For foreign currency implied volatilities, White Mountains changes implied volatilities by 6% and 5.5% for years one and two, respectively.
The table below summarizes as of December 31, 2014 and 2013, the estimated financial impact of simultaneous market events. Unlike the individual sensitivity analysis illustrated above, the analysis in the table below reflects the inter-dependencies between individual variables.
WM Life Re applies shocks to the Japanese interest rates and foreign bond fund yields in opposite directions. In the down market scenario, Japanese interest rates are decreased 70 bps, Japanese interest rate swap spreads are tightened by 25 bps, and foreign bond fund yields are increased 70 bps. The “up market” scenario assumes opposite movements in the same variables. For other variables, the “down market” scenario assumes equity indices decrease 20%, foreign currencies depreciate by 15% against the Japanese yen and implied market volatility increases as described in footnote 3 to the table above. The “up market” scenario assumes opposite movements in the same variables. The size of the estimated impact on the liability of simultaneous market events, in both the “up market” and “down market” scenarios, is impacted by several factors, including the applicable account value to guaranty value ratios, term to maturity and surrender assumptions of policies reinsured. The decrease in magnitude of both the “up market” and “down market” shocks as of December 2014 versus the prior year was driven by the substantial decrease in WM Life Re’s liability, owing primarily to higher account values, shorter terms to maturity and lower implied volatilities.
During 2013, improved markets led to significantly higher ratios of annuitants’ account values to guarantee values and, as a result, annuitants have been surrendering their policies at higher rates than WM Life Re has observed in the past. In response to this trend, WM Life Re adjusted the projected surrender assumptions used in the valuation of its variable annuity reinsurance liability upward in the second quarter of 2013, which resulted in a gain of $2 million and again in the fourth quarter of 2013, which resulted in a gain of $5 million. In 2014 surrender rates continued to outpace assumptions and another adjustment was made in the fourth quarter of 2014. This adjustment resulted in a loss of $0.2 million because the policies most impacted have account values that are significantly higher than their guaranty values.
In addition to derivative instruments, WM Life Re held cash, short-term and fixed maturity investments of $33.2 and $81.3 as of December 31, 2014 and 2013 posted as collateral to its counterparties.
Periodically, White Mountains’s management reviews the recoverability of amounts recorded from the BAM Surplus Notes and, as of December 31, 2014, believes such notes and interest thereon to be fully recoverable. However, the determination of future recoverability is judgmental, as BAM was recently established and the ability of BAM to repay the principal and interest due on the BAM Surplus Notes is dependent upon BAM’s expected results, particularly premium and MSC collections, years into the future. Any write-off of the carried amount of the BAM Surplus Notes and/or the accrued interest thereon would adversely impact White Mountains’s adjusted book value per share. See Item 1A., Risk Factors, “If BAM does not pay some or all of the interest and principal due on the BAM Surplus Notes, our adjusted book value per share, results of operations and financial condition could be materially adversely affected.” on page 39.
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. All interest and principal due on the seller priority note must first be paid before any interest or principal can be paid on the pari passu note. As required by the 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.
Below is a table illustrating the valuation adjustments taken to arrive at the estimated fair value of the OBIC Surplus Notes as of December 31, 2014:
Represents anticipated delay in securing regulatory approvals of interest and principal payments to reflect graduated changes in Issuer’s statutory surplus.
The internal valuation model used to estimate the fair value is based on discounted expected cash flows. The estimated fair value of the OBIC 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. OneBeacon has assumed for estimating the fair value that interest payouts begin in year five and principal repayments begin on a graduating basis in year ten for the seller priority note and year fifteen for the pari passu note. Although these variables involve considerable judgment, the Company does not currently expect any resulting changes in the estimated value of the surplus notes to be material to its financial position.
As a means to provide the degree of variability for each of the key assumptions that affect the fair value of the OBIC Surplus Notes, below is a table of sensitivities which measure hypothetical changes in such variables and the resulting pre-tax increase (or decrease) impact on the valuation of the OBIC Surplus Notes as of December 31, 2014.
(1) Represents the sensitivity to changes in the estimate of the liquidity spread added to account for OneBeacon’s sole ownership of the OBIC Surplus Notes, lack of a liquid trading market, and ongoing regulatory approval risk.
(2) Represents the sensitivity to changes in the estimate of the underlying equivalent credit quality of the OBIC Surplus Notes. Such credit quality is approximated by comparing the expected percentage of discounted payments missed, as calculated in a proprietary Stochastic simulation, to a series of benchmarks derived from data published by Standard & Poor’s. Note that “notch” is defined as the difference between, for example. a “B” and “B+” rated instrument.
Sirius Group closely monitors its estimation process on a quarterly basis and adjusts its estimates as more information and actual amounts become known. There is no assurance that the amounts estimated by Sirius Group will not deviate from the amounts reported by the ceding company or reinsurance intermediary. Any such deviations are reflected in the results of operations when they become known.
the risks associated with Item 1A of this Report on Form 10-K;
an economic downturn or other economic conditions adversely affecting its financial position;
Consequently, all of the forward-looking statements made in this report are qualified by these cautionary statements, and there can be no assurance that the actual results or developments anticipated by White Mountains will be realized or, even if substantially realized, that they will have the expected consequences to, or effects on, White Mountains or its business or operations. White Mountains assumes no obligation to publicly update any such forward-looking statements, whether as a result of new information, future events or otherwise.