The Company maintains two professional offices in Hamilton, Bermuda which serve as its headquarters and its registered office. Fund American Re maintains branch offices in Stockholm, Sweden and in Singapore. WMU maintains offices in Dublin, Ireland and Bermuda. The home offices of OneBeacon and Folksamerica are located in Boston, Massachusetts and New York, New York, respectively, with branch offices in various cities throughout the United States. In addition, the Company maintains a professional office in Hanover, New Hampshire which serves as its principal executive office, and an office in Guilford, Connecticut, which houses its investment and corporate finance functions.
The Company’s headquarters, registered office, principal executive office and investment and corporate finance office are leased. Fund American Re’s branch offices in Sweden and Singapore and WMU’s offices in Ireland and Bermuda are leased. The home offices of OneBeacon and Folksamerica and most of its branch offices are leased with the exception of branch offices located in New Jersey and New York which are owned by OneBeacon. Certain leased and owned OneBeacon office locations have been leased or subleased to Liberty Mutual in connection with the Liberty Agreement for a period of no more than three years. Management considers its office facilities suitable and adequate for its current level of operations.
(c) Includes gains resulting from the sale of Valley Group, Inc. (“VGI”) and the sale of substantially all the mortgage banking assets of White Mountains Services Corporation.
(d) Reflects a significant repayment of debt by Folksamerica during 2000.
(f) Deferred credits added during 1999 resulted principally from the purchase of the International American Group.
(g) Reflects an increase in common shareholders’ equity in 2001 resulting from capital raising activities undertaken in connection with the OneBeacon Acquisition. See Note 2. Also reflects an increase in shareholders’ equity in 2002 resulting from the recognition of $660 million in net deferred credits as a result of a change in accounting principles. See Note 1.
(h) Includes the dilutive effects of outstanding options and warrants to acquire Common Shares.
(j) Includes outstanding convertible preference shares, options and warrants to acquire Common Shares.
Within the following discussion, references made to OneBeacon’s operations relating to periods prior to the OneBeacon Acquisition have been made solely to illustrate significant trends and changes in OneBeacon’s business that have occurred post-acquisition. White Mountains’ reported results for periods prior to June 1, 2001 did not include the financial results of OneBeacon.
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 and 2001
White Mountains ended 2003 with a fully converted tangible book value per Common Share of $291.27. This represents an increase of 13% (including dividends) over the fully converted tangible book value per Common Share of $258.82 as of December 31, 2002, which represented an increase of 15% over the fully converted tangible book value per Common Share of $225.81 as of December 31, 2001. White Mountains’ management believes that the growth in fully converted tangible book value per common share represents a measure of value created at the Company over time that is more relevant than traditional GAAP measurements. A table showing the details of White Mountains’ fully converted tangible book value per common and equivalent share can be found on page 53.
• $30 million release of a liability for New York assigned risks at OneBeacon as future assignments have been mitigated by OneBeacon’s successful LAD operation, AutoOne Insurance;
• $50 million in gains (included in other revenue) in 2003 on the sale of several real estate properties previously written-off under purchase accounting for OneBeacon, compared to $16.6 million in 2002;
Total expenses decreased by 16% in 2003 as compared to 2002, as loss and LAE, as well as insurance acquisition and other underwriting expenses, continued to decrease at OneBeacon as a result of improved underwriting performance on its core businesses and as the non-core business runs-off through the Liberty Agreement. In addition, interest expense on debt decreased to $48.6 million in 2003 from $71.8 million in 2002 as a result of the repayment of the $260.0 million Seller Note in November 2002 and the issuance of the $700.0 million Senior Notes in May 2003 at a rate of 5.9% interest, which replaced the Old Bank Facility that had an interest rate of 7.0%, after giving effect to a series of interest rate swap agreements. Also contributing to the decrease in expenses was a decrease in the accretion of the fair value adjustment to the reserves acquired as part of the OneBeacon Acquisition. This accretion will continue to decrease as those acquired reserves are paid over time. Partially offsetting these expense decreases was an increase in general and administrative expense of $109.1 million in 2003 over 2002. This increase in general and administrative expenses was primarily related to share-based compensation expense at the holding company level, as a result of the run-up in the market price of Common Shares over the year resulting from the above-target performance of White Mountains in 2003. White Mountains expenses its full cost of all incentive compensation programs. This expense in spread amongst loss and lae, other underwriting expense and general and administrative expense for White Mountains insurance’ and reinsurance operating subsidiaries, depending upon the function of the employees being compensated, and it is entirely included in general and administrative expenses in Other Operations.
A tabular summary of White Mountains’ financial results from its OneBeacon segment for the twelve months ended December 31, 2003 and 2002 and the seven months ended December 31, 2001 follows:
OneBeacon’s pre-tax income for 2003 was $419.6 million, compared to pre-tax income of $200.3 million for 2002 and its GAAP combined ratio was 98% for 2003 compared to 107% for 2002. All of OneBeacon’s ongoing businesses, its “core” operations of personal, commercial, and specialty businesses, delivered combined ratios below 100% in 2003 and, in the second half of 2003, its core premiums grew for the first time since the OneBeacon Acquisition. OneBeacon’s run-off business, its “non-core” operations, continued to shrink as the Liberty Agreement expired on October 31, 2003 and OneBeacon did not exercise its option to take a 10% quota share for the next three years.
OneBeacon’s total revenues for 2003 declined by 20% compared to 2002, due principally to a 24% decline in earned premiums. The decline in earned premiums was due primarily to a reduction in premiums assumed under the Liberty Agreement. Total revenues for 2003 were also impacted by a 26% decrease in net investment income due to the runoff of loss reserves from OneBeacon’s non-core business as well as the reduced interest rate environment. Other revenues increased significantly in 2003 due mainly to fee revenue generated by New Jersey Skylands Management LLC and certain consolidated limited partnerships.
OneBeacon’s total expenses for 2003 declined by 29% compared to 2002, primarily as a result of reduced premium writings and improved underwriting performance. Total expenses in 2003 include a net $145.2 million reserve increase in OneBeacon’s non-core operations, primarily related to prior year construction defect claims, that was partially offset by an approximate $30 million release of the New York assigned risk liability. General and administrative expenses increased significantly in 2003 due mainly to expenses generated by New Jersey Skylands Management LLC and certain consolidated limited partnerships.
Core operations consist of personal and commercial lines sold through agents in the Northeast, and specialty businesses underwritten in various geographic areas throughout the United States. Core operations do not include business transferred to Liberty Mutual through the Liberty Agreement and certain other operations in run-off.
OneBeacon’s GAAP combined ratio for core operations improved to 90% in 2003 from 97% in 2002, primarily from improved loss ratios. Expense ratios for 2003 were relatively consistent with 2002. The 2003 expense ratio was favorably impacted by the release of $30.0 million of the New York assigned risk liability, while the 2002 expense ratio was favorably impacted by a pre-tax gain of $35.1 million from the curtailment of OneBeacon’s pension and retiree medical plan. Net written premiums and earned premiums for core operations were down 6% and 3% in 2003 as compared to 2002, primarily as a result of continued efforts to re-underwrite the Massachusetts automobile and New York commercial lines books, offset in part by price increases and new business generated by OBPP.
Personal Lines. Throughout its personal lines business, OneBeacon has focused on improving its underwriting and pricing. During 2003, OneBeacon continued to improve premium adequacy through rate increases approved by regulators, re-underwriting efforts, aggressive rate pursuit actions and continued improvement in insurance-to-value programs in its homeowners line. As a result, OneBeacon achieved average price increases of 2% and 16% in automobile and homeowners, respectively, in 2003.
Non-core operations include the business subject to the reinsurance provisions of the Liberty Agreement. Written premiums for Non-core operations were $135.2 million in 2003, a decrease of 74% compared to 2002, as written premiums on business subject to the Liberty Agreement decreased to $130.4 million in 2003 from $496.7 million in 2002. This decrease was due primarily to the change in OneBeacon’s share of the underwriting results under the Liberty Agreement from two-thirds to one-third and also a decline in renewals of policies subject to the Liberty Agreement. As further described below, non-core results also included prior accident year reserve development of $145.2 million during 2003, of which $97.7 million related to construction defect claims which emerged from commercial multiple peril and general liability coverages written in the 1990s and $12.0 million related to a significant 1995 property claim from a pool in which OneBeacon had participated (the Industrial Risk Insurers pool) that was settled through an arbitration decision during 2003.
OneBeacon’s and Liberty’s claims adjusters, such as the identification and coding of construction defect claims. However, the study also indicated that some of the increase in activity related to an increase in the severity of construction defect claims stemming from increased litigation and resulting adverse court decisions. As a result, OneBeacon recorded an increase for construction defect claim reserves of $97.7 million in the third quarter of 2003. See page 11 for further background on construction defect claims.
Personal Lines. OneBeacon improved premium adequacy in 2002 through rate increases approved by regulators, re-underwriting efforts, aggressive rate pursuit actions and continued improvement in insurance-to-value programs in its homeowners line. As a result, OneBeacon achieved price increases of 19% and 22% in automobile and homeowners, respectively, during 2002, compared with increases of 4% and 7% in 2001. OneBeacon’s personal lines written premium volume from core operations for 2002 increased 27% as compared to all of 2001 due primarily to new business produced by AutoOne Insurance. Excluding AutoOne Insurance written premium and LAD servicing fees, written premium volume decreased 9% from written premium for all of 2001. This decrease was due to actions to reduce exposure to windstorms on property located in coastal areas, a decision to reduce exposure to the private passenger automobile business in Massachusetts due to unfavorable market conditions and the formation of a reciprocal insurance carrier in New Jersey.
Commercial Lines. Commercial lines results significantly improved in 2002 due to the positive impact of underwriting and pricing initiatives as well as good weather. However, they fell short of OneBeacon’s target due to the effects of large losses and a significant decrease in OneBeacon’s premium base. Premium written for 2002 decreased 33% from all of 2001 primarily due to actions to reduce the concentration of risks subject to terrorism exposure, as well as continued efforts to re-underwrite the commercial book, terminate underperforming accounts and agencies and tighten credit terms toward market standards. The GAAP combined ratio for 2001 includes approximately 13 points of losses attributable to the Attacks. Price increases of 21% were achieved for business written during 2002 as compared to 16% for all of 2001.
White Mountains’ Reinsurance segment consists of Folksamerica, WMU, Fund American Re and White Mountains’ investment in Montpelier. Pre-tax income for White Mountains’ Reinsurance segment was $192.6 million in 2003, compared to $165.5 million in 2002 and a pre-tax loss of $46.1 million in 2001. Pre-tax income included net realized investment gains of $40.3 million in 2003, versus $88.3 million in 2002 and $23.9 million in 2001. Net realized investment gains in 2003 and 2002 included $32.5 million and $58.0 million, respectively, from the Montpelier Warrants. A tabular summary of White Mountains’ financial results from its Reinsurance segment for the years ended December 31, 2003, 2002 and 2001 follows:
Folksamerica. The following table provides GAAP combined ratios for Folksamerica for the years ended December 31, 2003, 2002 and 2001:
Folksamerica’s GAAP combined ratio improved to 95% for 2003, from 100% for 2002. The improvement in Folksamerica’s combined ratio resulted primarily from more favorable terms and conditions in the reinsurance marketplace, and fewer catastrophe losses affecting Folksamerica in 2003 as compared to 2002. The GAAP combined ratio for 2002 included three points of catastrophe losses, mainly due to $9.7 million of additional losses related to the Attacks and $6.6 million of net incurred losses related to European floods during 2002.
Folksamerica’s gross written premiums increased 46% from 2002 to 2003, while net written premiums increased 31% and earned premiums increased 36%. The increases in net written and earned premiums were due to increased pricing on Folksamerica’s expiring and renewed contracts, increased shares on renewed contacts and new contracts resulting from the increased demand of reinsurance buyers for placing reinsurance with responsible, well-capitalized reinsurers. Folksamerica expects that favorable terms and conditions will continue in most classes of business, however, increasing competition may begin to adversely impact the current favorable environment. Also contributing to the increase in net written premiums was Folksamerica’s relationship with WMU, which began in 2002 and has resulted in referrals of international reinsurance placements to Folksamerica. Additionally, under quota share agreements, Folksamerica cedes up to 75% of substantially all underwritten business referred to it by WMU and 75% of substantially all of its short-tailed, non-casualty excess of loss business, as well as 50% of its property proportional business, to Olympus. During 2003, Folksamerica ceded $449.1 million in written premiums and $107.0 million in losses and LAE to Olympus. The additional capacity provided by the quota share relationship with Olympus and the $400.0 million cash contribution Folksamerica received from OneBeacon in December 2001 enhanced Folksamerica’s ability to provide significant reinsurance capacity, resulting in the increases described above.
Folksamerica’s loss and LAE also included income from the amortization of deferred gains on retroactive reinsurance provided by the Imagine Cover of $8.2 million and $8.5 million during 2003 and 2002. The reinsurance benefits for adverse development on prior years’ reserves are deferred and recognized into income over the expected settlement period of the underlying claims. The amounts ceded and deferred under the retroactive portion of this contract totaled $5.0 million and $21.7 million during 2003 and 2002. As of December 31, 2003, the entire $115.0 million limit on this contract was fully utilized.
As a result of the renewal rights agreement with CNA Re, Folksamerica entered into reinsurance contracts that resulted in written premiums of approximately $95 million through January 1, 2004. These premiums will be recorded as revenue as they are earned.
Folksamerica’s GAAP combined ratio improved to 100% for 2002, from 128% for 2001 (which included twelve points of catastrophe losses, including approximately six points as a result of the Attacks). The GAAP combined ratio for 2002 included three points of catastrophe losses, mainly due to $9.7 million of additional losses related to the Attacks and $6.6 million of net incurred losses related to European floods during the third quarter of 2002.
Folksamerica’s net written and earned premiums were $678.7 million and $620.5 million for 2002, respectively, representing an approximately 48% and 47% increase over 2001. The reasons for the increase in net written and earned premiums in 2002 were similar to those described above for the corresponding increases in 2003. Additionally, during 2002 Folksamerica recorded $11.7 million of other revenues, of which $7.3 million related to PCA.
Folksamerica’s 2001 losses and LAE included $25.0 million in losses related to prior accident years representing (i) higher than expected reported losses in Folksamerica’s property excess line and (ii) an increase in reserves related to losses arising from the portfolios acquired from the USF Re and Risk Capital. Folksamerica’s losses and LAE for 2000 included $22.9 million related principally to prior accident years representing losses arising from the portfolios acquired with USF Re and Risk Capital, nearly all of which was covered under the Imagine Cover described below.
Folksamerica’s results do not take into account the full favorable impact of the retroactive coverage provided by the Imagine Cover or the indemnification of losses associated with certain of Folksamerica’s acquisitions in recent years. The reinsurance benefit recorded on recoverables for adverse development on prior years’ reserves are deferred and recognized into income over the expected settlement period of the underlying claims. The reinsurance benefits obtained from this contract totaled $21.7 million and $22.2 million for 2002 and 2001, respectively. The adverse loss development ceded under the retroactive reinsurance agreement in 2002 included A&E losses of $11.4 million and losses relating to the business acquired with Risk Capital of $7.3 million.
Fund American Re’s 2003 results reported in the table on page 42 do not include $27.4 million of realized gains recognized under SFAS 133 (as defined below) related to changes in the fair value of the Montpelier Warrants, which were contributed to Fund American Re by one of the Company’s intermediate holding companies on October 1, 2003. A discussion of White Mountains’ investment in Montpelier on a consolidated basis follows below.
Pre-tax amounts recorded by White Mountains relating to its investment in Montpelier as of and for the periods ended December 31, 2003, 2002 and 2001 follow:
As of December 31, 2003, Montpelier’s shareholders’ equity totalled approximately $1.7 billion versus $1.3 billion as of December 31, 2002. Montpelier wrote net premiums of $778.0 million and had total earned premiums of $705.4 million in 2003, compared to $565.9 million and $329.9 million, respectively, for 2002. During 2003, Montpelier reported net income of $407.1 million, with comprehensive net income of $425.3 million, compared to $152.0 million and $185.7 million, respectively, for 2002. Montpelier’s 2003 reported return on equity on a diluted basis was 30% and its GAAP combined ratio was 50%, compared to 18% and 67%, respectively, for 2002.
A large portion of Montpelier’s business is global specialty property reinsurance which has large aggregate exposures to natural and man-made disasters. As such, management expects that Montpelier’s claim experience from this business will be the result of relatively few claims of high magnitude. The occurrence of claims from catastrophic events is likely to result in substantial volatility in, and could have a material adverse effect on, Montpelier’s financial condition and results and their ability to write new business.
White Mountains’ Other Operations segment consists of the International American Group and Esurance (“Other Insurance Operations”), as well as the operations of the Holding Companies. A tabular summary of White Mountains’ financial results from its Other Operations segment for the years ended December 31, 2003, 2002 and 2001 follows:
The International American Group contributed $.9 million of pretax losses for 2003, compared to $5.9 million and $10.3 million in 2002 and 2001. During the periods presented, Peninsula was the only active company in the group, and therefore it accounts for all of the premiums reported in the tables above. During January of 2004, White Mountains sold Peninsula for $23.3 million. The operations of American Centennial and British Insurance Company are not significant to White Mountains, as those companies have been in run-off since they were acquired in 1999.
Holding company and financing activities. White Mountains’ capital raising and capital allocation activities are principally conducted through the Holding Companies. In this regard, the results of its Holding Companies primarily relate to financing activities, purchase accounting adjustments relating to the OneBeacon Acquisition, gains and losses recognized from the purchase and sale of certain of the Company’s subsidiaries and other assets and general and administrative expenses incurred at the holding company level.
White Mountains’ Holding Companies reported a pretax loss of $203.1 million for 2003, compared to pretax losses of $210.8 million and $84.1 million in 2002 and 2001. The loss in 2003 was net of $43 million in gains that were included as other revenue in this segment related to the sale of several real estate properties at OneBeacon previously written-off under purchase accounting. White Mountains’ Holding Companies recorded $39.2 million of other revenues during 2002, which consisted primarily of (i) gains from sales of certain real estate assets that had previously been written-off as part of purchase accounting for the OneBeacon Acquisition and (ii) interest income recorded on amounts due resulting from Internal Revenue Service examinations which were finalized during the period. White Mountains’ Holding Companies recorded other revenues of $25.6 million during 2001, which consisted primarily of net gains on the sales of certain insurance subsidiaries (mainly Waterford Insurance Company) and net gains on sales of certain real estate assets that had previously been written-off as part of purchase accounting for the
OneBeacon Acquisition. Total revenues at the Holding Companies for 2003, 2002 and 2001 were net of $4.2 million, $47.4 million and $4.8 million, respectively, in realized investment losses related to White Mountains’ interest rate swap agreements.
During 2003, White Mountains adopted the presentation provisions of SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (“SFAS 150”). As a result, White Mountains reclassified its mandatorily redeemable preferred stock from mezzanine equity to liabilities on its balance sheet. Also under SFAS 150, beginning in the third quarter of 2003, White Mountains began presenting all accretion and dividends on its mandatorily redeemable preferred stock as interest expense. White Mountains recorded $22.3 million of such interest expense for the six months ended December 31, 2003 in addition to recording $21.5 million of dividends and accretion for the six months ending June 30, 2003 prior to its adoption of SFAS 150.
White Mountains manages all of its consolidated investments through its wholly-owned subsidiary, WM Advisors. White Mountains’ investment philosophy is to invest its assets with a view towards maximizing its after-tax total return over extended periods of time. Under this approach, each dollar of after-tax investment income and realized and unrealized gains and losses is valued equally. White Mountains seeks to maximize risk-adjusted returns over the long term.
White Mountains was pleased with its overall investment results during 2003, as its fixed maturity portfolios achieved positive returns while generally avoiding credit problems and its equity portfolio generated strong returns in 2003, despite its conservative value approach and use of convertibles. In addition, “one off” investments (Montpelier, etc.) that round out White Mountains’ equity investment exposure moved sharply higher in 2003.
White Mountains reduced the mortgage and asset-backed securities portfolio in size, duration and convexity risk (a measure of exposure to changes in value from interest rate movements) in 2003. Positive returns this past year were earned with a lower risk profile than the overall securitized market, a market WM Advisors considers generally unattractive since it contains both material extension risk and prepayment risk.
White Mountains’ total return on its investment portfolio for the years ended December 31, 2003, 2002 and 2001 appear below. The amount of pretax investment return included in net income (loss) follows:
White Mountains’ total return also includes changes in net unrealized gains, which are reported net of tax as a separate component of common shareholders’ equity and included in comprehensive net income (loss). The amount of investment return, after tax, resulting from changes in net unrealized gains follows:
White Mountains’ realized investment gains and losses result principally from sales of fixed maturity investments and to a lesser extent common equity securities. The investment gains realized in 2003 reflect sales of mortgage backed securities to reduce the duration of the bond portfolio. Also included in net realized investment gains are amounts recognized under SFAS 133 related to changes in the fair value of the Montpelier Warrants (gain of $32.5 million for 2003 versus a gain of $58.0 million in 2002) and Fund American’s interest rate swap agreements (loss of $4.2 million for 2003 versus losses of $47.4 million and $4.9 million during 2002 and 2001).
Temporary losses on investment securities are recorded as unrealized losses. Temporary losses do not impact net income and earnings per common share but serve to reduce comprehensive net income, shareholders’ equity and tangible book value. Unrealized losses subsequently identified as other-than-temporary impairments are recorded as realized losses. Other-than-temporary impairments previously recorded as unrealized losses do not impact comprehensive net income, shareholders’ equity and tangible book value but serve to reduce net income and earnings per common share.
Book value per share is derived by dividing the Company’s total GAAP shareholders’ equity as of a given date by the number of Common Shares outstanding as of that date, including the dilutive effects of outstanding Options and Warrants, as well as the unamortized accretion of preferred stock. Fully converted tangible book value per share is derived by expanding the book value per share calculation to include (i) the effects of assumed conversion of all convertible securities and (ii) any remaining unamortized goodwill or deferred credits as of the applicable date.
White Mountains’ consolidated sources of cash consist primarily of premium collections, net investment income, financing activities and proceeds from sales and maturities of investment securities. White Mountains’ consolidated uses of cash are primarily claim payments, operating expenses, financing costs and the purchase of investment securities.
One of the means by which White Mountains calculates its insurance float is by taking its net investment assets and subtracting its total capital. The following table illustrates White Mountains’ consolidated insurance float position for the past four years:
White Mountains has historically obtained its float primarily through acquisitions, as opposed to organic growth. In the case of OneBeacon, the substantial amount of float initially acquired with the OneBeacon Acquisition has shrunk as a result of OneBeacon’s re-underwriting efforts and the effects of the Liberty Agreement. OneBeacon’s float is expected to continue to shrink over the next few years as older, long-tailed loss reserves are paid and are not replaced with the same level of new writings as those written in the past. In the case of Folksamerica, its float is expected to gradually increase in the next few years as a result of higher premium writings as a result of its increase in capital base over the past two years. It is White Mountains’ intention to generate low-cost float over time through a combination of acquisitions and/or by organic growth in its existing insurance and reinsurance operations, but only when market conditions indicate a high likelihood of generating underwriting profits.
Management believes that White Mountains’ strong financial position provides it with the flexibility and capacity to obtain funds externally as needed through debt or equity financing on both a short-term and long-term basis. White Mountains has recently enhanced its access to the capital markets by having a shelf registration declared effective by the SEC in July 2003 for offerings of up to $2.0 billion in debt and/or equity securities.
In December 2003, Folksamerica entered into a definitive agreement to acquire the Sierra Group, consisting of California Indemnity Insurance Company and its three subsidiaries, from Nevada-based Sierra Health Services, Inc. Under the terms of the agreement, Folksamerica will pay $74.3 million, which includes $12.3 million in cash and a $62 million purchase note, of which $58 million will be adjusted over its six-year term to reflect favorable or adverse loss reserve development on the acquired reserve portfolio and runoff of remaining policies in force as well as certain other balance sheet protections. The acquired companies’ historical net assets at December 31, 2003 were approximately $88.6 million. White Mountains expects the transaction to close in the first or second quarter of 2004. The transaction is subject to regulatory approvals and other customary closing conditions.
In June 1999, White Mountains sold VGI to Unitrin, Inc. (“Unitrin”) (the “VGI Sale”). As part of the VGI Sale, White Mountains has provided Unitrin with adverse loss development protection of up to $50.0 million on loss reserves sold to Unitrin. Unitrin has made a demand for the full $50.0 million.
During 2003, Fund American made scheduled principal amortization payments of $6.5 million on the Old Bank Facility prior to the repayment and paid a total of $22.5 million in interest under the Old Bank Facility, including $10.6 million paid under the interest rate swap agreements.
During 2003, White Mountains declared and paid a total of $30.3 million in dividends to holders of preferred stock with a face value of $320.0 million.
During 2003, OneBeacon declared and paid a total of $235.3 million in cash dividends to Fund American, its immediate parent company. Also during 2003, WMU paid a total of $35.0 million of dividends to its immediate parent, WM Investment Management (Bermuda) Ltd, and WM Advisors paid a total of $10.0 million in dividends to Fund American.
During 2003, the Company issued a total of 11,116 Common Shares to its employees through the exercise of Options and, as a result, the Company received cash proceeds of $1.5 million in connection with these Option exercises.
During the first quarter of 2003, White Mountains made payments amounting to $25.7 million with respect to performance shares relating to the 2000-2002 performance period in cash or by deferral into certain non-qualified compensation plans of the Company or its subsidiaries. In the second quarter of 2003, White Mountains made performance share payments amounting to $13.1 million in cash or by deferral into certain non-qualified compensation plans of the Company. The payments on these additional performance shares in the second quarter represented accelerated payments to certain non-employee directors of the Company for performance periods originally scheduled to end on December 31, 2003, 2004 and 2005.
In October 2002, White Mountains sold $225.0 million of its equity securities in a private transaction. Investment funds managed by Franklin Mutual Advisers, LLC purchased 677,966 convertible preference shares of the Company at a price of $200.0 million ($295.00 per share) and investment funds managed by Highfields Capital Management LP (“Highfields”) purchased 84,745 Common Shares for $25.0 million ($295.00 per Common Share). Upon shareholder approval at the Company’s Annual Meeting held on May 19, 2003, the convertible preference shares were repurchased and cancelled in consideration of the issuance of 677,966 Common Shares. Because the redemption value of the convertible preference shares was in excess of the cash received upon their issuance, they were required to be marked-to-market until the date they were converted to shareholders’ equity, resulting in a $68.5 million charge to retained earnings ($49.5 million of which was recorded during 2003), with an offsetting increase to paid-in surplus.
On November 29, 2002, White Mountains repaid in full the $260.0 million Seller Note to Aviva, along with approximately $22.6 million of related accrued interest.
In July and August of 2002, White Mountains received federal tax refunds totalling $166.7 million representing accelerated recoveries of carryback losses from 2001 under the Job Creation and Worker Assistance Act of 2002 (the “Economic Stimulus Bill”).
On April 25, 2002, Folksamerica acquired Imperial for $4.2 million including related expenses ($.5 million net of cash acquired). Significant assets and liabilities acquired included investments of $22.8 million and loss and LAE reserves of $11.9 million.
In December 2001, OneBeacon invested $180.0 million in Montpelier consisting of 10,800,000 common shares of Montpelier valued at $16.67 per share and the Company received warrants to acquire an additional 4,781,572 common shares of Montpelier at $16.67 per share, which are exercisable until December 2011.
In December 2001, White Mountains acquired the net assets of the international reinsurance operations of Folksam International, which were valued at approximately $66.9 million on the date of purchase. The purchase price including related expenses consisted of approximately $30.9 million in cash, $3.0 million in a note payable to the seller and 86,385 Common Shares (valued at approximately $30.0 million).
In September 2001, OneBeacon repaid all its outstanding long-term debt of $3.2 million.
In June 2001, White Mountains acquired OneBeacon for cash and the Seller Note. The total consideration paid for OneBeacon was $2,114.3 million, including related expenses, and the net book value of the assets acquired was $2,796.3 billion. Significant assets and liabilities acquired through OneBeacon included $7,442.6 million of cash and investments, $2,448.9 million of reinsurance recoverable on paid and unpaid losses, $1,267.3 million of insurance balances receivable, $6,364.2 million of loss and LAE and $1,897.7 million of unearned insurance premiums.
In connection with the OneBeacon Acquisition, the Company issued convertible preference shares for $437.6 million (which were retired and converted to Common Shares in August 2001) and issued the warrants to Berkshire for $75.0 million (the “Warrants”). The Warrants have a term of seven years from the date of issuance although the Company has the right to call the Warrants for $60.0 million in cash commencing on the fourth anniversary of their issuance.
In April 2001, the Company paid $100.8 million in cash to complete the Debt Tender and to establish the Debt Escrow. Completion of the Debt Tender permitted the Company to effect an amendment to the indenture governing the Notes which facilitated the OneBeacon Acquisition.
During 2001, OneBeacon declared and paid a total of $153.5 million in dividends to Fund American, its immediate parent company.
In 2003 and 2002, Folksamerica entered into quota share retrocessional arrangements with Olympus. Under these arrangements, Folksamerica cedes up to 75% of substantially all of its short-tailed excess of loss business, mainly property and marine, and 50% of its proportional property business to Olympus and receives an override commission on the premiums ceded to Olympus. During 2003 and 2002, Folksamerica ceded $449.1 million and $229.7 million, respectively, in written premiums and $107.0 million and $54.4 million, respectively, in losses and LAE to Olympus. White Mountains, through either Folksamerica or WMU, receives fee income on reinsurance placements referred to Olympus and is entitled to additional fees based on net underwriting profits on referred business. During 2003 and 2002, White Mountains earned $98.4 million and $48.9 million of fee income from Olympus. Certain directors, officers and affiliates of White Mountains own approximately 5% of the common shares of Olympus Re Holdings, Ltd. (“Olympus Holdings”). Mr. Joseph S. Steinberg, a director of the Company, is Chairman of Olympus Holdings and is President of Leucadia National Corporation (“Leucadia”). Leucadia owned approximately 16% of common shares of Olympus Holdings at December 31, 2003.
On an ongoing basis, management evaluates its estimates, including those related to loss and LAE reserves, purchase accounting and related deferred credits and goodwill, reinsurance transactions and its pension benefit obligations. Management bases its estimates on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgements about the carrying values of assets and liabilities that are not readily apparent from other sources.
Loss and LAE reserve estimates at OneBeacon are subject to additional uncertainty as a consequence of numerous factors that occurred prior to White Mountains’ acquisition of OneBeacon on June 1, 2001. As previously discussed, OneBeacon is the result of the 1998 merger of the U.S. operations of General Accident and Commercial Union, two companies with different underwriting and claims management philosophies and practices. Beginning in the mid-1990s, and continuing through the CGU Merger, the subsequent operational integration of General Accident plc and Commercial Union plc and the OneBeacon Acquisition, OneBeacon experienced an environment of significant change, both in its business and operations. Generally accepted actuarial techniques used to estimate reserves rely in large degree on projecting historical trends (such as patterns of claim development (i.e., reported claims and paid losses)) into the future. Accordingly, estimating reserves becomes more uncertain if business mix, case reserve adequacy, claims payment rates, coverage limits and other factors change over time. The breadth and depth of the business and operational changes that occurred at OneBeacon (1) led to a wider range in the reserve estimates produced by a variety of actuarial loss reserving techniques, especially those that rely upon consistent claim development patterns, and (2) introduced greater complexity to the judgments required to be made by management in determining the impact of the business and operational changes on the development patterns used to estimate reserves.
OneBeacon’s net loss and LAE reserves by line of business at December 31, 2003 and 2002 were as follows:
For OneBeacon, the range of reserve estimates at December 31, 2003 was evaluated to consider the strengths and weaknesses of the actuarial methods applied against OneBeacon’s historical claims experience data. The following table shows the recorded reserves and the high and low ends of OneBeacon’s range of reasonable loss reserve estimates at December 31, 2003. The high and low ends of OneBeacon’s range of reserve estimates in the table below are based on the results of various actuarial methods described above. The recorded reserve for each line is the result of the actuarial method that management believes to be most appropriate based on known facts and trends.
The probability that ultimate losses will fall outside of the ranges of estimates by line of business is higher for each line of business individually than it is for the sum of the estimates for all lines taken together due to the effects of diversification. Although management believes OneBeacon’s reserves are reasonably stated, ultimate losses may deviate, perhaps materially, from the recorded reserve amounts and could be above the high end of the range of actuarial projections. Further adverse development, if any, would impact OneBeacon’s future results of operations. For further discussion of OneBeacon’s loss and LAE, see “Loss and Loss Adjustment Expense Reserves” within the “ONEBEACON” section of Item 1 and “I. Summary of Operations By Segment” in Item 7 of this report.
Immediately prior to White Mountains’ acquisition of OneBeacon, OneBeacon purchased a reinsurance contract with NICO under which OneBeacon is entitled to recover from NICO up to $2.5 billion in the future for asbestos claims arising from business written by OneBeacon in 1992 and prior, environmental claims arising from business written by OneBeacon in 1987 and prior, and certain other exposures. Under the terms of the NICO Cover, NICO receives the economic benefit of Third Party Recoverables in existence at the time the NICO Cover was executed. As a result, the Third Party Recoverables serve to protect the $2.5 billion limit of NICO coverage for the benefit of OneBeacon. Any amounts uncollectible from third party reinsurers due to dispute or the reinsurers’ financial inability to pay are covered by NICO under its agreement with OneBeacon.
OneBeacon’s A&E liabilities have resulted primarily from the operations of the Employers Group, an entity acquired by one of the legacy companies in 1971. These operations provided primary and excess liability insurance for commercial insureds, including Fortune 500-sized accounts, some of whom subsequently experienced claims for A&E losses. Employers Group stopped writing such coverage in 1984.
OneBeacon also incurred A&E losses via its participation in industry pools and associations. The most significant of these pools was ECRA, which provided excess liability reinsurance to U.S. insurers from 1950 until the early 1980s. ECRA incurred significant liabilities for A&E, of which OneBeacon bears approximately a 4.7% share, or $65.9 million at December 31, 2003 (compared to $68.0 million at December 31, 2002), which is fully reflected in OneBeacon’s loss and LAE reserves.
More recently, since the 1990s, OneBeacon has experienced an influx of claims from commercial insureds, including many non-Fortune 500-sized accounts written during the 1970s and 1980s, who are named as defendants in asbestos lawsuits. As a number of large well-known manufacturers of asbestos and asbestos-containing products have gone into bankruptcy, plaintiffs have sought recoveries from peripheral defendants, such as installers, transporters or sellers of such products, or from owners of premises on which exposure to asbestos allegedly occurred.
Historically, most asbestos claims have been asserted as product liability claims. Recently, insureds who have exhausted the available products liability limits of their insurance policies have sought payment for asbestos claims under the premises and operations coverage of their liability policies. It is more difficult for plaintiffs to establish losses as stemming from premises and operations exposures, which requires proof of the defendant’s negligence, rather than products liability under which strict legal liability applies. Hence, there are fewer of such claims for which there is a great deal of variation in payments for actual injuries. Additionally, several accounts that seek such coverage find that previously paid losses were subject to product liability and operations aggregate limits that were previously exhausted. There are currently 97 active claims against OneBeacon without product liability coverage asserting operations or premises coverage.
The cost of administering A&E claims, which is an important factor in estimating loss reserves, tends to be higher than in the case of non-A&E claims due to the higher legal costs typically associated with A&E claims.
For more information regarding OneBeacon’s A&E reserves, see Note 3 to the financial statements and “Loss and Loss Adjustment Expense Reserves” within the “ONEBEACON” section of Item 1 and “I. Summary of Operations By Segment” in Item 7 of this report.
White Mountains’ reinsurance subsidiaries establish loss and LAE reserves that are estimates of amounts needed to pay claims and related expenses in the future for reinsured events that have already occurred. White Mountains’ reinsurance subsidiaries also obtain reinsurance whereby another reinsurer contractually agrees to indemnify White Mountains for all or a portion of the reinsurance risks underwritten by White Mountains. Such arrangements, where one reinsurer provides reinsurance to another reinsurer, are usually referred to as “retrocessional reinsurance” arrangements. White Mountains establishes estimates of amounts recoverable from retrocessional reinsurance in a manner consistent with the loss and LAE liability associated with reinsurance contracts offered to its customers (the “ceding companies”), net of an allowance for uncollectible amounts. Net reinsurance loss reserves represent loss and LAE reserves reduced by retrocessional reinsurance recoverable on unpaid losses.
White Mountains establishes loss reserves for its Reinsurance segment based on a single point estimate, which is management’s best estimate of ultimate losses and loss expenses. This “best estimate” is derived from a combination of methods. For current accident year business the estimate is based on an expected loss ratio method. The parameters underlying this method are developed during the underwriting and pricing process. Loss ratio expectations are derived for each contract and these are aggregated by class of business and type of contract. These loss ratios are then applied to the actual earned premiums by class and type of business to estimate ultimate losses. Paid losses are deducted to determine loss and loss expense reserves.
The following table illustrates White Mountains’ recorded net loss and loss adjustment expense reserves for its Reinsurance segment, and high and low estimates for those classes of business for which a range is calculated, at December 31, 2003.
The probability that ultimate losses will fall outside of the ranges of estimates by class of business is higher for each class of business individually than it is for the sum of the estimates for all classes taken together due to the effects of diversification. Although management believes reserves for White Mountains’ Reinsurance segment are reasonably stated, ultimate losses may deviate, perhaps materially, from the recorded reserve amounts and could be above the high end of the range of actuarial projections. Further adverse development, if any, would impact future results of operations of the Reinsurance segment. For more information regarding the loss and LAE reserves of the Reinsurance segment, see “Loss and Loss Adjustment Expense Reserves” within the “REINSURANCE” section of Item 1 and “I. Summary of Operations By Segment” in Item 7 of this report.
Folksamerica’s A&E exposure is primarily from reinsurance contracts written between 1974 through 1985 by predecessor companies (MONY Reinsurance and Christiania General). The exposures are predominately higher layer excess of loss treaty and facultative coverages with relatively low limits exposed for each claim. Net incurred loss activity for asbestos and environmental in the last two years was as follows:
In recent years, most of Folksamerica’s reported activity in the asbestos area has related to (1) higher layer excess policies that are being reached by larger target defendants, (2) new notices for smaller regional defendants that are now exposed because of the larger defendant bankruptcies, and (3) new notices on “premises” and “non-products” cases, where coverage is being sought by insureds against the non-aggregating portion of the underlying policy. Concerning this third point, many of these types of claims will not impact Folksamerica’s layers of coverage due to high attachment points and the contractual requirement of multiple retentions for these type of claims.
Folksamerica’s A&E claim activity for the last two years is illustrated in the table below.
The collectibility of reinsurance recoverables is subject to the solvency and willingness to pay of the reinsurers. The Company is selective in regard to its reinsurers, placing reinsurance principally with those reinsurers with a strong financial condition, industry ratings and underwriting ability. Management monitors the financial condition and ratings of its reinsurers on an ongoing basis. See “Reinsurance Protection” within the “ONEBEACON” and “REINSURANCE” sections of Item 1 of this report for additional information on White Mountains’ reinsurance programs.
The majority of OneBeacon’s pension and retiree medical plans were curtailed in the fourth quarter of 2002. The OneBeacon Pension Plan no longer adds new participants or increases benefits for existing participants. Non-vested participants already in the plan continue to vest during their employment with OneBeacon. Retirees are also eligible for medical benefits if they meet certain age and service requirements. However, due to the curtailment, the plan will no longer accepts new participants. The majority of retiree medical costs are capped at defined dollar amounts, with retirees contributing the remainder.
A hypothetical 1% increase in the discount rate would result in a decrease in pension and retiree medical projected benefit obligations of approximately $55.0 million and $4.6 million, respectively, and would result in a decrease in OneBeacon’s total pretax pension/post-retirement expense of approximately $0.3 million. A hypothetical 1% decrease in the discount rate would result in an increase in pension and retiree medical projected benefit obligations of approximately $65.0 million and $5.1 million, respectively, and would result in an increase in OneBeacon’s total pretax pension/post-retirement expense of approximately $0.6 million.
In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”), White Mountains will amortize its existing and prospective goodwill only when the asset acquired is deemed to have been impaired rather than systematically over a perceived period of benefit.
• incurred losses and the adequacy of its loss and LAE reserves;
• the failure of White Mountains to complete any or all of its recently announced acquisitions or, if White Mountains completes any such acquisition, the failure of any or all of such completed acquisitions to add value or enhance White Mountains’ business;
• claims arising from catastrophic events, such as hurricanes, earthquakes, floods or terrorist attacks;
• competitive forces, including the conduct of other property and casualty insurers and reinsurers;
• an economic downturn or other economic conditions, such as changes in foreign currency exchange rates, adversely affecting its financial position;
• loss reserves established subsequently proving to have been inadequate; and