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 Plymouth, Minnesota. OneBeacon also maintains branch offices in various cities throughout the United States.
Sirius International Insurance Group Ltd.’s headquarters are located in Hamilton, Bermuda and its principal executive office is located in New York, New York. Sirius International is headquartered in Stockholm, Sweden with various branch offices in Europe, Australia, Asia and Bermuda. Sirius America is headquartered in New York, New York with various offices in the United States and in Toronto, Canada.
Tranzact is headquartered in Fort Lee, New Jersey with various other offices and call centers throughout the United States. Tranzact has additional offices located in Lima, Peru, Guatemala City, Guatemala and Gothenburg, Sweden. MediaAlpha’s headquarters are located in Los Angeles, California, Wobi’s headquarters are located in Tel Aviv, Israel, Star & Shield Services LLC’s and Star & Shield Claims Services LLC’s headquarters are located in Alpharetta, Georgia and Star & Shield Risk Management LLC’s headquarters are located in Orlando, Florida.
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. In 2015, OneBeacon completed the sale of their building in Canton, Massachusetts for $58 million. The building was 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 MediaAlpha’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, 2015, follows:
As a result of the Sirius Group Sale, Esurance Sale, the AutoOne Sale, and the Runoff Transaction, White Mountains has reclassified the results from these businesses for the past five years in the table above to discontinued operations, net of tax. In 2013, discontinued operations, net of tax, includes a $47 gain related to the sale of the Runoff Business and a net loss of $42 related to the operations of the Runoff Business. In 2012, discontinued operations, net of tax, includes a $91 loss related to the sale of the Runoff Business and a net loss of $24 related to the operations of the Runoff Business. In 2011, discontinued operations, net of tax, includes a $678 gain related to the Esurance Sale, a $19 loss related to the AutoOne Sale, and a $37 net loss related to the Runoff Business.
See Note 14 - “Common Shareholders’ Equity and Non-controlling Interests” for a detailed breakdown of non-controlling interests by consolidated entity.
During 2015, 2014, 2013, 2012 and 2011, White Mountains repurchased 387,495, 217,879, 141,535, 1,329,640 and 646,502, respectively, of its common shares through a combination of tender offers, open market transactions and other transactions.
The following discussion contains “forward-looking statements”. White Mountains intends statements that are not historical in nature, which are hereby identified as forward-looking statements, to be covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. White Mountains cannot promise that its expectations in such forward-looking statements will turn out to be correct. White Mountains’s actual results could be materially different from and worse than its expectations. See “FORWARD-LOOKING STATEMENTS” on page 96 for specific important factors that could cause actual results to differ materially from those contained in forward-looking statements.
The following discussion also includes five non-GAAP financial measures, adjusted comprehensive income, adjusted book value per share, adjusted capital, consolidated portfolio returns excluding Symetra and common equity securities and other long-term investment returns excluding Symetra that have been reconciled to their most comparable GAAP financial measures (see page 75). White Mountains believes these measures to be more relevant than comparable GAAP measures in evaluating White Mountains’s financial performance and condition.
RESULTS OF OPERATIONS FOR THE YEARS ENDED December 31, 2015, 2014 and 2013
White Mountains ended 2015 with an adjusted book value per share of $699, an increase of 5.3% during the year, including dividends, compared to an increase of 3.6% during 2014, including dividends. During 2015, White Mountains signed a definitive agreement to sell Sirius Group to CMI, and Symetra announced that it entered into a definitive merger agreement with Sumitomo Life pursuant to which Sumitomo Life will acquire all of the outstanding shares of Symetra. Substantially all of the benefit from the Symetra transaction was recorded in 2015, while the benefit from the Sirius Group transaction will be recorded at closing, which is expected in the first quarter of 2016. Including dividends, Symetra produced $264 million of adjusted comprehensive income for White Mountains in 2015, of which $241 million was recognized as an after-tax unrealized investment gain in the fourth quarter. Including the estimated gain of $84 per share for the Sirius Group sale, adjusted book value per share is approximately $783, an increase of 18.0% for the year ended December 31, 2015, including dividends. See page 44 for the calculation of the estimated gain per share from the Sirius Group transaction.
White Mountains reported adjusted comprehensive income of $232 million in 2015 compared to $135 million in 2014. The increase is driven by $264 million of adjusted comprehensive income from Symetra and lower foreign currency losses, partially offset by lower investment returns excluding Symetra and increased incentive compensation expense recorded in connection with the agreements to sell Sirius Group and Symetra.
White Mountains’s GAAP pre-tax total return on invested assets was 3.6% for year ended December 31, 2015. Excluding the returns from Symetra, the GAAP pre-tax total return on invested assets was -0.2% for year ended December 31, 2015, which included 0.9% of currency losses, compared to a return of 1.9% for the year ended December 31, 2014, which included 1.9% of currency losses. In local currencies, the fixed income portfolio was up 1.1% for 2015, a decent absolute result for the year and essentially in-line with the Barclays Intermediate Aggregate Index. In local currencies and including Symetra, the equity (common equity securities and other long-term investments) portfolio was up 19.6% for the year; excluding Symetra, the equity portfolio was down 1.4% for the year. White Mountains’s portfolio of common stocks and ETFs, excluding Symetra, was up 3.3%, which was a good result and ahead of the S&P 500 while other long-term investments were down 10.1% reflecting unfavorable mark-to-market adjustments to the OneBeacon runoff surplus notes and losses in energy exposed private equity funds.
Sirius Group’s GAAP combined ratio was 76% for 2014 compared to 82% for 2013. The improvement in the combined ratio for 2014 was driven by lower catastrophe losses and higher favorable loss reserve development, partially offset by higher acquisition expenses. Sirius Group’s combined ratio includes 7 points of catastrophe losses in 2014 compared to 10 points in 2013 and includes 11 points of favorable loss reserve development in 2014 compared to 6 points in 2013.
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. 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 Intermediate Aggregate Index as interest rates fell. In local currencies, the fixed income portfolio was up 0.5% for 2013. In local currencies, the equity portfolio (common equity securities and other long-term investments) was up 8.0% for 2014, a strong absolute result for the year but mixed against benchmarks, underperforming the S&P 500 and outperforming the small-cap Russell 2000. In local currencies, the equity portfolio was up 19.0% for 2013.
The following table presents White Mountains’s adjusted book value per share, a non-GAAP financial measure, for the years ended December 31, 2015, 2014 and 2013 and reconciles this non-GAAP measure to the most comparable GAAP measure. (See “NON-GAAP FINANCIAL MEASURES” on page 75.)
The following table presents the estimated net gain from the sale of Sirius Group as of December 31, 2015:
Assets to be contributed in exchange for December 31, 2015 carrying value of Symetra
The following table is a summary of goodwill and intangible assets that are included in White Mountains’s adjusted book value as of December 31, 2015, 2014 and 2013:
(1) See Note 6 - “Goodwill and Other Intangible Assets” for details of other intangible assets.
A summary of White Mountains’s consolidated financial results for the years ended December 31, 2015, 2014 and 2013 follows:
Change in equity in net unrealized gains (losses) from investments in Symetra common shares, net of tax
Adjusted comprehensive income is a non-GAAP measure. For a description of the most comparable GAAP measure (see NON-GAAP FINANCIAL MEASURES on page 75).
Consolidated Results-Year Ended December 31, 2015 versus Year Ended December 31, 2014
White Mountains’s total revenues increased 7% to $1.5 billion in 2014, which was driven by other revenues from the newly-acquired insurance services businesses, offset by a decrease in net unrealized gains from the investment portfolio. Earned insurance premiums increased 6%, driven by an increase from OneBeacon’s newer businesses, particularly OneBeacon Crop Insurance, OneBeacon Program Group and OneBeacon Surety Group. Net investment income was in line with 2013 while net realized and unrealized investment gains decreased to $79 million in 2014 from $134 million in 2013. See “Summary of Investment Results” on page 58 for a discussion and analysis of White Mountains’s investment returns. Other revenue increased to $131 million in 2014 from $47 million in 2013. Other revenue in 2014 included $65 million from MediaAlpha and $43 million from Tranzact. Other revenue in 2013 included transaction gains of $27 million, composed of a $23 million gain on OneBeacon’s sale of Essentia and a $4 million gain 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. In addition, 2013 included $11 million of mark-to-market gains on the Symetra warrants, which were exercised in June 2013. Other revenue included $4 million of WM Life Re’s losses in 2014 compared to $13 million of WM Life Re’s losses in 2013. See Note 9 - “Derivatives” for details regarding WM Life Re’s total impact on White Mountains’s statement of operations. Other revenues in 2014 also included third-party investment management fee income at WM Advisors of $17 million, compared to $16 million in 2013.
White Mountains’s total expenses increased 23% to $1.5 billion in 2014, driven by higher loss and LAE expenses at OneBeacon. Losses and LAE increased 32%, while insurance acquisition expenses and other underwriting expenses decreased 2% and 12% in 2014. The increase in loss and LAE includes the $109 million reserve charge recorded by OneBeacon related to the actuarial analysis performed in the fourth quarter of 2014, which was partially offset by lower incentive compensation expense accruals, contributing to the decrease in other underwriting expenses in 2014 (see “Summary of Operations by Segment” on page 47). General and administrative expenses in 2014 included $61 million from MediaAlpha and $37 million from Tranzact.
White Mountains reported income tax benefit of $1 million in 2015 on pre-tax income of $155 million. White Mountains’s effective tax rate for 2015 was near zero, 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.
White Mountains reported income tax benefit of $15 million in 2014 on pre-tax loss of $29 million. White Mountains’s effective tax rate for 2014 was 51%, which was higher than the U.S. statutory rate of 35% due primarily to losses generated in the U.S. and income generated in jurisdictions with lower tax rates than the United States.
White Mountains reported an income tax expense of $33 million in 2013 on pre-tax income of $159 million. White Mountains’s effective tax rate for 2013 was 21%, 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.
As a result of the Sirius Group sale, the results of operations for Sirius Group have been classified as discontinued operations and are now presented separately, net of related income taxes, in the statement of comprehensive income. Prior year amounts have been reclassified to conform to the current period’s presentation (See Note 22 - “Discontinued Operations”.)
Financial results and GAAP combined ratios for OneBeacon for the years ended December 31, 2015, 2014 and 2013 follow:
OneBeacon’s GAAP combined ratio decreased to 96% for 2015 from 102% for 2014. The decrease was primarily driven by a 9 point decrease in the loss ratio from non-recurrence of adverse prior accident year loss reserve development in 2015, partially offset by an increase in the expense ratio and the impact of increasingly competitive markets on the current year accident loss ratio. There was no net loss reserve development in 2015, primarily attributable to favorable net loss reserve development from the Technology, Collector Cars and Boats, Specialty Property and Financial Services lines of business, offset by unfavorable net loss reserve development from the Entertainment and Ocean Marine lines of business. In 2014, there was $90 million, or 8 points, of unfavorable net prior accident year adverse loss reserve development (described below in “2014 Fourth Quarter Loss and LAE Reserve Increase.”). The increase in the expense ratio for 2015 was primarily due to higher incentive compensation expense, higher acquisition costs due to changes in business mix and the impact of exiting the crop business.
During 2015, OneBeacon recognized a loss of $4 million in other revenues in connection with an assessment from the Michigan Catastrophic Claims Association payable to Markel Corporation pursuant to the indemnification provisions in the stock purchase agreement governing the sale of Essentia. OneBeacon previously recognized a pretax gain of $23 million in 2013 on its sale of Essentia, an indirect wholly-owned subsidiary which wrote legacy collector cars and boats business, to Markel Corporation.
OneBeacon ended 2014 with a book value per share of $10.97, an increase of 2.1% during 2014, including dividends, compared to an increase of 17.2% during 2013, including dividends. During 2014, OneBeacon’s book value per share was significantly impacted by (1) a fourth quarter increase in loss and LAE reserves of $109 million ($71 million after-tax) resulting from an actuarial and claims analysis of its ongoing specialty loss reserves, as further described below; (2) a $21 million after-tax loss from discontinued operations, driven primarily by valuation adjustments related to the surplus notes provided in conjunction with the seller financing of the Runoff Transaction; and (3) an after-tax other comprehensive loss of $12 million, primarily due to a decrease in the weighted average discount rate (from 4.7% to 3.9%), as well as a change in the mortality assumptions, used for the annual remeasurement of OneBeacon’s legacy pension plan.
OneBeacon’s GAAP combined ratio increased to 102% for 2014 from 92% for 2013. The increase was primarily driven by a 13 point increase in the loss ratio (primarily due to the fourth quarter reserve increase described below), partially offset by a 3 point improvement in the expense ratio. Net unfavorable loss and LAE reserve development was 8 points ($90 million) for 2014, driven primarily by professional liability, especially lawyers’ liability claims, which OneBeacon put into runoff and sold the renewal rights to in December 2014, and management liability businesses. Net loss reserve development for 2013 was negligible. A large loss in Specialty Property and elevated Crop losses due to lower corn prices also contributed to the increase in OneBeacon’s 2014 loss ratio. Catastrophe losses contributed 1 point to OneBeacon’s GAAP combined ratios for both 2014 and 2013. The decrease in the expense ratio was driven by lower incentive compensation expenses.
Through the first nine months of 2014, OneBeacon recorded $14.3 million of unfavorable loss and LAE reserve development, driven by greater-than-expected large losses in several underwriting units, primarily in the professional and management liability lines within Professional Insurance. In 2015, Professional Insurance was reorganized into Other Professional Lines, Management Liability, Financial Services and Healthcare. This large loss activity, which occurred mostly during the second and third quarters of 2014, also impacted the current accident year loss and LAE estimates. Additionally, OneBeacon incurred higher-than-usual claim coverage determination costs, a component of LAE expenses, during the first nine months of 2014. Other underwriting units also reported increased claim activity, including Entertainment, Government Risks, and Accident.
Reinsurance protection. OneBeacon’s net combined ratio was higher than the gross combined ratio by 2 points for both 2014 and 2013 as a result of the cost of the reinsurance programs more than offsetting the benefits from ceded losses.
In 2015, BAM’s claims paying resources increased 3% to $601.3 million at December 31, 2015. The increase was primarily driven by $29 million of Member Surplus Contributions and a $17 million increase in the HG Re collateral trusts, partially offset by BAM’s 2015 statutory net loss of $32 million.
As a mutual insurance company that is owned by its members, BAM’s results do not affect White Mountains’s adjusted book value per share. However, White Mountains is required to consolidate BAM’s results in its GAAP financial statements and its results are attributed to non-controlling interests.
White Mountains reported $47 million of GAAP pre-tax losses on BAM in 2015, driven by $16 million of interest expense on the BAM Surplus Notes and $35 million of operating expenses, compared to $41 million in pre-tax losses in 2014, driven by $16 million of interest expense on the BAM Surplus Notes and $36 million of operating expenses, partially offset by $7 million of net realized and unrealized investment gains.
BAM’s claims paying resources as of December 31, 2014 increased $3 million from December 31, 2013. The increase was primarily driven by $16 million of Member Surplus Contributions, a $15 million increase in the HG Re collateral trusts and a $3 million increase in net unearned premiums, offset by BAM’s 2014 statutory net loss of $32 million.
HG Global reported pre-tax income of $18 million in 2014, which was driven by $16 million of interest income on the BAM Surplus Notes, compared to $38 million in 2013, which was driven by $40 million of interest income on the BAM Surplus Notes. The decrease in interest income on the BAM Surplus Notes was due to a change in the interest rate. (See “LIQUIDITY AND CAPITAL RESOURCES, HG Global/BAM”, on page 65.)
White Mountains reported $41 million of pre-tax losses on BAM in 2014, driven by $16 million of interest expense on the BAM Surplus Notes and $36 million of operating expenses, partially offset by $7 million of net realized and unrealized investment gains, compared to $79 million in pre-tax losses in 2013, driven by $40 million of interest expense on the BAM Surplus Notes, $33 million of operating expenses and $9 million of net realized and unrealized investment losses.
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, 2015 and 2014:
The following table presents the gross par value of policies priced and closed by BAM for the years ended December 31, 2015 and 2014:
White Mountains’s Other Operations segment reported pre-tax loss of $49 million in 2014 compared to pre-tax income of $16 million in 2013. White Mountains’s Other Operations segment reported net realized and unrealized investment gains of $30 million in 2014 compared to $96 million in 2013. (See “Summary of Investment Results” on page 58.) The Other Operations segment reported net investment income of $9 million in 2014 compared to $11 million in 2013. Other revenues in 2014 included $65 million from MediaAlpha 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 $17 million, compared to $16 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 63.)
Share repurchases. White Mountains repurchased and retired 217,879 of its common shares for $134 million in 2014 at an average price per share of $617.29, or approximately 93% of White Mountains’s December 31, 2014 adjusted book value per share.
On July 24, 2015, White Mountains entered into an agreement to sell Sirius Group to CM International Holding PTE Ltd., the Singapore-based investment arm of CMI. The purchase price will be paid in cash in an amount equal to 127.3% of Sirius Group’s closing date tangible common shareholder’s equity, plus $10 million. The transaction is expected to close in the first quarter of 2016 and is subject to regulatory approvals and other customary closing conditions. As a result of the agreement to sell Sirius Group, its results are reported as discontinued operations within White Mountains’s GAAP financial statements. Sirius Group’s results continue to inure to White Mountains through the closing date of the sale.
Sirius Group's GAAP combined ratio was 85% for the year ended December 31, 2015 compared to 76% for 2014. Loss and expense ratios for the 2015 periods were increased by a higher frequency of non-catastrophe per risk and pro rata loss events, which primarily impacted the property, aviation, contingency, and marine lines of business, as well as continued pressure on rates and terms due to continued competitive market conditions. The 2015 results included $18 million of losses after reinstatement premiums from the Tianjin port explosion. Also, the combined ratios for the year ended December 31, 2015 were higher by 1 point due to the cost of ILW Covers. The 2015 period included 3 points of catastrophe losses, primarily from the Chennai flood in Southern India and winter storms in the Northeastern United States, compared to 7 points in 2014. Favorable net loss reserve development was 6 points in 2015 primarily due to decreases in casualty and property loss reserves, compared to 11 points of favorable net loss reserve development in 2014.
Reinsurance protection. In addition to the ILW Covers, Sirius Group’s reinsurance protection primarily consists of pro-rata and excess of loss protections to cover aviation, trade credit, and certain accident and health and property exposures. Sirius Group’s proportional reinsurance programs provide protection for part of the non-proportional treaty accounts written in Europe, the Americas, Asia, the Middle East and Australia. This reinsurance is designed to increase underwriting capacity where appropriate, and to reduce exposure both to large catastrophe losses and to a frequency of smaller loss events. Attachment points and coverage limits vary by region and line of business around the world.
Sirius Group’s net combined ratio was 6 points higher than the gross combined ratio for the year ended December 31, 2015 and 1 point lower than the gross combined ratio for 2014. In 2015, the net combined ratio was higher than the gross combined ratio primarily due to the cost of property retrocessional coverage, including the ILW Covers, with limited or no loss recoveries. In 2014, the net combined ratio was lower than the gross combined ratio because ceded loss recoveries, primarily in the accident and health and aviation lines, mostly offset the premiums ceded under Sirius Group’s reinsurance protection programs.
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 $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 2014, White Mountains recorded a gain in discontinued operations of $14 million 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.
White Mountains's total operations investment results include continuing operations and discontinued operations. As a result of the agreement to sell Sirius Group, its results are reported in discontinued operations within White Mountains’s GAAP financial statements. Sirius Group’s results continue to inure to White Mountains through the closing date of the sale. White Mountains will continue to manage Sirius Group's investment portfolio for a transition period after the sale.
Investment Returns-Year Ended December 31, 2015 versus Year Ended December 31, 2014
White Mountains’s GAAP pre-tax total return on invested assets was 3.6% for 2015, compared to 1.9% for 2014. The 2015 results were primarily driven by $259 million in pre-tax unrealized investment gains recognized in the fourth quarter of 2015 resulting from the Symetra transaction. The 2015 and 2014 returns included 0.9% and 1.9% of foreign currency losses. Excluding the results from Symetra, the GAAP total return on invested assets was 0.7% in local currencies for the year ended December 31, 2015. White Mountains’s total operations after tax realized and unrealized investment gains were $203 million and $214 million for 2015 and 2014.
White Mountains maintains a high-quality, short-duration fixed income portfolio. As of December 31, 2015, the fixed income portfolio duration was approximately 2.2 years, including short-term investments, compared to 2.0 years as of December 31, 2014.
White Mountains maintains an equity portfolio that consists of common equity securities and other long-term investments, including hedge funds, private equity funds, direct investments in privately held common and convertible securities and the OneBeacon surplus notes. White Mountains’s management believes that prudent levels of investments in common equity securities and other long-term investments are likely to enhance long-term after-tax total returns. White Mountains’s portfolio of common equity securities and other long-term investments represented approximately 23% and 18% of GAAP invested assets as of December 31, 2015 and December 31, 2014. When reflecting the closing of the Symetra sale on February 1, 2016, White Mountains’s portfolio of common equity securities and other long-term investments represented approximately 14% of GAAP invested assets as of December 31, 2015.
In local currencies, the equity portfolio, including the Symetra gain, returned 19.6% for 2015. In local currencies, excluding the Symetra gain, the equity portfolio returned -1.4% for 2015, underperforming the S&P 500 Index return of 1.4%. The underperformance versus the benchmark for 2015 was primarily due to unfavorable mark-to-market adjustments to the OneBeacon runoff surplus notes, losses from energy exposed private equity funds, the write-off of TaCerto and unfavorable results from a distressed hedge fund. Within the equity portfolio, White Mountains’s portfolio of common equity securities, excluding Symetra, returned 3.3% in local currencies for 2015, a good absolute result for the year and ahead of the S&P 500 Index return of 1.4%. Including foreign currency losses and the Symetra gain, the equity portfolio returned 19.3% for 2015.
White Mountains has established relationships with third party registered investment advisers to manage publicly-traded common equity securities and convertibles. The largest of these relationships have been with Prospector Partners LLC (“Prospector”), Lateef Investment Management (“Lateef”) and Silchester International Investors (“Silchester”). During the second quarter of 2015, White Mountains instructed Prospector to liquidate its separate account portfolios and redeemed its investments in the Prospector Funds. White Mountains has since terminated its investment management agreements with Prospector. White Mountains continues to have publicly-traded common equity securities actively managed by Lateef and Silchester.
During the second quarter of 2015, White Mountains purchased exchange traded funds (ETFs) that seek to provide investment results that, before expenses, generally correspond to the performance of the S&P 500 Index, Russell 1000 and Russell 1000 Value Indices. As of December 31, 2015, White Mountains had $355.8 million invested in ETFs (including discontinued operations). The following summarizes White Mountains's investments in ETFs by exposure to each index:
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 Index return is often driven, positively or negatively, by individual positions, especially in the short-term. In U.S. dollars and local currencies, the Lateef separate account returned 3.6% for 2015, outperforming the S&P 500 Index return of 1.4% for 2015. In U.S. dollars and local currencies, the Lateef separate account returned 6.5% for 2014, lagging the S&P 500 Index return of 13.7%.
White Mountains also maintains a portfolio of other long-term investments that consists primarily of hedge funds, private equity funds, direct investments in privately held common and convertible securities, the OneBeacon surplus notes and various other investments in limited partnerships. As of December 31, 2015, approximately 49% of these other long-term investments were 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.
As of December 31, 2014, White Mountains had investments in TaClaro Holdings B.V., which owns TaCerto.com (“TaCerto”), in the form of convertible preferred shares ($4.5 million), loans ($1.7 million) and common shares ($0.3 million). During the first quarter of 2015, TaCerto initiated a wind-down of its business. As a result, White Mountains reduced the carrying value of these investments to $0.
In U.S. dollars, the other long-term investments portfolio returned -10.1% for 2015 underperforming the HFRX Equal Weighted Strategies Index return of -1.5% for 2015. The portfolio’s underperformance relative to the HFRX Equal Weighted Strategies Index return for 2015 was primarily due to unfavorable mark-to-market adjustments to the OneBeacon surplus notes, losses from energy exposed private equity funds, the write-off of TaCerto and unfavorable results from a distressed hedge fund. In U.S. dollars, the other long-term investments portfolio returned 6.5% for 2014, outperforming the HFRX Equal Weighted Strategies Index return of -0.5%.
White Mountains’s GAAP pre-tax total return on invested assets was 1.9% for 2014, compared to 4.1% for 2013. The 2014 results 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 returned 2.7% for 2014, a decent absolute result for the year but behind the longer duration Barclays U.S. Intermediate Aggregate 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 returned 0.5% for 2014. In local currencies, the fixed income portfolio returned 0.5% for 2013, outperforming the Barclays U.S. Intermediate Aggregate Index return of -1.0%. Including foreign currency losses, the fixed income portfolio returned 0.4% for 2013.
White Mountains’s portfolio of common equity securities and other long-term investments represented approximately 18% and 20% of GAAP invested assets as of December 31, 2014 and December 31, 2013. In local currencies, the equity portfolio returned 8.1% for 2014, a strong absolute result for the year but mixed against benchmarks, underperforming the S&P 500 Index return of 13.7% and outperforming the small-cap Russell 2000 return of 4.9%. In U.S. dollars, the equity portfolio returned 7.2% for 2014.
In local currencies, the equity portfolio returned 19.0% for 2013, a strong absolute result for the year but behind the S&P 500 Index return of 32.4% The shortfall against the benchmark was due primarily to an underperformance in White Mountains’s value oriented common equity security portfolio, which returned 23.2%. Foreign currency translation did not meaningfully impact equity returns in 2013.
In U.S. dollars, the other long-term investments returned 6.5% for 2014, outperforming the HFRX Equal Weighted Strategies Index return of -0.5%. In U.S. dollars, other long-term investments returned 7.6% for 2013, outperforming the HFRX Equal Weighted Strategies Index return of 6.3%.
A summary of White Mountains’s continuing operations pre-tax investment results for the years ended December 31, 2015, 2014 and 2013 follows:
The following table presents the composition of White Mountains’s continuing operations investment portfolio as of December 31, 2015 and 2014:
The cost or amortized cost and carrying value of White Mountains’s fixed maturity investments as of December 31, 2015 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.
Operating subsidiary level. The primary sources of cash for White Mountains’s insurance, reinsurance and other operating subsidiaries are expected to be premium and fee 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.
Management believes that White Mountains’s cash balances, cash flows from operations, routine sales and maturities of investments and the liquidity provided by White Mountains’s revolving credit facility (the “WTM Bank Facility”) and other revolving credit facilities are adequate to meet expected cash requirements for the foreseeable future on both a holding company and insurance and reinsurance operating subsidiary level.
Under the insurance laws of the states and jurisdictions that White Mountains’s insurance and reinsurance operating subsidiaries are domiciled, an insurer is restricted with respect to the timing and the amount of dividends it may pay without prior approval by regulatory authorities. Accordingly, there can be no assurance regarding the amount of such dividends that may be paid by such subsidiaries in the future. Following is a description of the dividend capacity of White Mountains’s insurance and reinsurance operating subsidiaries:
Split Rock has the ability to declare or pay dividends or make capital distributions to its immediate parent 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 2016, Split Rock has the ability to pay dividends or make capital distributions without the prior approval of regulatory authorities, subject to meeting all appropriate liquidity and solvency requirements, of $37 million, which is equal to 15% of its December 31, 2015 statutory capital (excluding earned surplus). During 2015, Split Rock did not pay any dividends or make any capital distributions to its immediate parent. During 2015, OneBeacon contributed $85 million to Split Rock.
As of December 31, 2015, OneBeacon Ltd. and its intermediate holding companies had $65 million of net unrestricted cash, short-term investments and fixed maturity investments and $55 million of common equity securities and $52 million of other long-term investments outside of its regulated and unregulated insurance operating subsidiaries.
As of December 31, 2015, 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 2015 or 2014. As of December 31, 2015, HG Global has accrued $140 million of dividends payable to holders of its preferred shares, $135 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 first loss reinsurance treaty (“FLRT”) with BAM. As of December 31, 2015, HG Re had statutory capital of $461 million, of which $54 million primarily relates to accrued interest on the BAM Surplus Notes held by HG Re, and $402 million was held as collateral in the Supplemental Trust pursuant to the FLRT with BAM.
During 2015, WM Advisors did not pay any dividends to its immediate parent. As of December 31, 2015, WM Advisors had $14 million of net unrestricted cash, short-term investments and fixed maturity investments.
During 2015, White Mountains paid a $6 million common share dividend. As of December 31, 2015, the Company and its intermediate holding companies had $74 million of net unrestricted cash, short-term investments and fixed maturity investments, $292 million of common equity securities and $18 million of other long-term investments included in its Other Operations segment.
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. There was no outstanding balance under this facility as of December 31, 2015.
During 2015, Sirius Group did not pay any dividends to its immediate parent. As of December 31, 2015, Sirius Group and its intermediate holding companies had $94 million of net unrestricted cash, short-term investments and fixed maturity investments outside of its regulated and unregulated insurance and reinsurance operating subsidiaries.
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. During 2015, Sirius International has not made any contributions to the surplus of Sirius America. 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 2015 and has been renewed for all of 2016 with the same attachment point and limits.
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, 2015, Sirius International’s safety reserve amounted to SEK 10.7 billion, or $1.3 billion (based on the December 31, 2015 SEK to USD exchange rate). During 2015, Sirius International transferred SEK 243 million or $28 million to the Safety reserve. 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 ($279 million as of December 31, 2015) is included in solvency capital. Access to the safety reserve is restricted to coverage of insurance and reinsurance 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.
Total capital only includes non-controlling interests that White Mountains (i) benefits from the return on or (ii) has the ability to utilize the net assets supporting the non-controlling interest.
White Mountains has 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. During 2015, White Mountains borrowed $125 million and subsequently repaid $75 million under the WTM Bank Facility, resulting in a $50 million outstanding balance as of December 31, 2015.
On September 29, 2015, OneBeacon Ltd. and OBH, as co-borrowers and co-guarantors, entered into a revolving credit facility administered by U.S. Bank N.A. and also including BMO Harris Bank N.A., which has a total commitment of $65 million and has a maturity date of September 29, 2019 (the “OneBeacon Bank Facility”). As of December 31, 2015 the OneBeacon Bank Facility was undrawn.
The WTM and OneBeacon Bank Facilities contain various affirmative, negative and financial covenants that White Mountains considers to be customary for such borrowings, including certain minimum net worth and maximum debt to capitalization standards.
Tranzact has a secured credit facility with a syndicate of lenders administered by The PrivateBank and Trust Company that has a maturity date of October 10, 2019 (the “Tranzact Bank Facility”). During 2015, Tranzact amended the Tranzact Bank Facility, which now consists of a $101 million term loan facility, which had an outstanding balance of $94 million as of December 31, 2015, and a revolving credit facility for an additional $15 million, which had an outstanding balance of $11 million as of December 31, 2015. The amendment increased the term loan facility by $31 million, the proceeds of which were used by Tranzact to finance its acquisition of TruBridge. During 2015, Tranzact repaid $7 million under the term loan portion and borrowed $24 million and repaid $13 million under the revolving portion of the Tranzact Bank Facility.
The Tranzact Bank Facility is secured by the intellectual property and the common stock of Tranzact’s subsidiaries and 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 maximum leverage ratio. The Tranzact Bank Facility carries a variable interest rate, based on the U.S. dollar LIBOR rate. Tranzact has entered into an interest rate swap agreement to effectively fix the rate it pays on $70 million of the $101 million term loan portion of the facility. (See Note 9 - “Derivatives”).
In December 2011, OneBeacon sold the majority of its fixed assets and capitalized software. OneBeacon entered into lease financing arrangements with US Bancorp Equipment Finance, Inc. (“US Bancorp”) and Fifth Third Equipment Finance Company (“Fifth Third”) whereby OneBeacon sold furniture and equipment and capitalized software, respectively, at a cost equal to net book value. OneBeacon then leased the fixed assets back from US Bancorp for a lease term of five years and leased the capitalized software back from Fifth Third for a lease term of four years. OneBeacon received cash proceeds of $23 million as a result of entering into the sale-leaseback transactions.
In March 2007, Sirius Group issued $400 million face value of senior unsecured notes at an issue price of 99.715% (the “SIG Senior Notes”). 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.
On November 25, 2014, Sirius International entered into two stand by letter of credit facility agreements totaling $200 million to provide capital support for its Lloyds Syndicate 1945. One letter of credit is a $125 million facility from Nordea Bank Finland plc (“the Nordea facility”), $100 million of which is issued on an unsecured basis. The second letter of credit is a $75 million facility with Lloyds Bank plc (“the Lloyds Bank facility”), $25 million of which is issued on an unsecured basis. The Nordea facility and the Lloyds Bank facility are renewable annually. The unsecured portions of the Nordea and Lloyds Bank facilities are subject to 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.
Sirius International has other secured letter of credit and trust arrangements with various financial institutions to support its insurance operations.
At December 31, 2015, White Mountains was in compliance with all of the covenants under all of its debt and unsecured letter of credit facilities and expects to remain in compliance with these covenants for the foreseeable future.
Below is a schedule of White Mountains’s material contractual obligations and commitments as of December 31, 2015:
Represents expected future cash outflows resulting from loss and LAE payments. The amounts presented are gross of reinsurance recoverables on unpaid losses of $187 and net of the discount on OneBeacon’s workers compensation loss and LAE reserves of $1 as of December 31, 2015.
The SIG Preference Shares are not included in the table above, as these perpetual preferred shares have no stated maturity date and are redeemable only at the option of Sirius Group.
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, 2015.
During the past several years, White Mountains’s board of directors has authorized the Company to repurchase its common shares, from time to time, subject to market conditions. Most recently, in February 2016, White Mountains’s Board of Directors authorized the Company to repurchase an additional 1 million common shares. The repurchase authorizations do not have a stated expiration date. As of February 25, 2016, White Mountains may purchase an additional 1,393,532 shares under the board authorizations. In addition, from time to time White Mountains has also repurchased its common shares through tender offers that were separately approved by its board of directors.
In 2007, OneBeacon Ltd.’s board of directors authorized the repurchase of up to $200 million of OneBeacon’s Class A common shares from time to time, subject to market conditions. This authorization does not have a stated expiration date. During 2015, 166,368 shares were repurchased under the share repurchase authorization for $2 million at an average share price of $12.62. Since the inception of this authorization, OneBeacon has repurchased and retired 5.8 million of its Class A common shares. During 2014 and 2013, no shares were repurchased under the share repurchase authorization. The amount of authorization remaining is $86 million as of December 31, 2015.
Cash flows from continuing operations for the years ended 2015, 2014 and 2013
Cash flows from investing and financing activities for the year ended December 31, 2015
During 2015, the Company repurchased and retired 387,495 of its common shares for $284 million, which included 12,156 common shares repurchased under employee benefit plans and 13,500 common shares from the Prospector Offshore Fund redemption.
During 2015, White Mountains borrowed a total of $125 million and subsequently repaid a total of $75 million under the WTM Bank Facility.
During 2015, MediaAlpha paid $4 million of dividends, of which $2 million was paid to White Mountains. During 2015, MediaAlpha borrowed $15 million under the term loan portion of the MediaAlpha Bank Facility and used the proceeds to make a $15 million return of capital payment to its shareholders, of which White Mountains received $9 million.
On December 22, 2015, White Mountains purchased a non-controlling interest in Captricity for $27 million.
On September 1, 2015, Tranzact acquired 100% of the outstanding share capital of TruBridge for a purchase price of $31 million in cash.
On February 23, 2015, Wobi acquired 56.2% of the outstanding share capital of Cashboard for NIS 9.5 million (approximately $2.4 million based upon the foreign exchange spot rate at the date of acquisition). During the second quarter of 2015, Wobi purchased newly issued common shares of Cashboard for NIS 10 million (approximately $3 million) and during the fourth quarter of 2015, Wobi purchased all of the remaining shares from non-controlling interest holders for NIS 16 million (approximately $4 million).
Cash flows from investing and financing activities for the year ended December 31, 2014
During the first quarter of 2014, the Company declared and paid a $6 million cash dividend to its common shareholders.
During 2014, WTM Life Re borrowed a total of $82 million and repaid a total of $89 million under an internal revolving credit facility with an intermediate holding company of White Mountains.
During 2014, White Mountains purchased 63% of Tranzact for a purchase price of $178 million. Immediately after the closing, Tranzact completed a recapitalization that allowed for the return of $44 million to White Mountains.
During 2014, White Mountains acquired 54% of the outstanding common shares of Wobi for NIS 14 million (approximately $4 million based upon the foreign exchange spot rate at the date of acquisition). In addition to the common shares, White Mountains also purchased NIS 32 million (approximately $9 million based upon the foreign exchange spot rates at the dates of acquisition) of newly-issued convertible preferred shares of Wobi.
During 2013, the Company repurchased and retired 141,535 of its common shares for $80 million, which included 1,535 common shares repurchased under employee benefit plans.
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.
During 2013, OneBeacon Ltd. declared and paid $80 million of cash dividends to its common shareholders. White Mountains received a total of $60 million of these dividends.
This report includes five non-GAAP financial measures that have been reconciled to their most comparable GAAP financial measures. White Mountains believes these measures to be more relevant than comparable GAAP measures in evaluating White Mountains’s results of operations and financial condition.
Adjusted book value per share is a non-GAAP measure which is derived by expanding the GAAP calculation of book value per White Mountains common share to exclude equity in net unrealized gains and losses from Symetra’s fixed maturity portfolio, net of applicable taxes. In addition, the number of common shares outstanding used in the calculation of adjusted book value per share are adjusted to exclude unearned restricted common shares, the compensation cost of which, at the date of calculation, has yet to be amortized. The reconciliation of adjusted book value per share to GAAP book value per share is included on page 43.
For loss and allocated LAE reserves, the key assumption as of December 31, 2015 was that the impact of the various reserving factors, as described below, on future paid losses would be similar to the impact of those factors on the historical loss data with the exception of severity trends. Severity trends have been relatively stable over the relevant historical period. The actuarial methods used would project losses assuming continued stability in severity trends. Management has considered a range of assumptions regards future increases in loss severity trends, including the impact of inflation, in making its reserve selections.
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 policies are written on a claims made or occurrence form.
General liability occurrence policies cover businesses for any liability resulting from bodily injury and property damage arising from general business operations, accidents on a premises and the products manufactured or sold. General liability-occurrence reserves generally include two components: bodily injury and property damage. Bodily injury payments reimburse the claimant for damages pertaining to physical injury as a result of the policyholder's legal obligation arising from nonintentional acts such as negligence, subject to the insurance policy provisions. In some cases the damages can include future wage loss (which is a function of future earnings power and wage inflation) and future medical treatment costs. Property damage payments result from damages to the claimant's private property arising from the policyholder's legal obligation for non-intentional acts. In most cases, property damage losses are a function of costs as of the loss date, or soon thereafter. Defense costs are also a part of the insured costs covered by liability policies and can be significant, sometimes greater than the cost of the actual paid claims, though for some products this risk is mitigated by policy language such that the insured portion of defense costs erodes the amount of policy limit available to pay the claim.
The general liability occurrence and property coverages described above are often provided under a multiple peril package policy, which includes both 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.
Time required to recover from the injury and return to regular or transitional work
The commercial automobile product line is a mix of property and liability coverages and, therefore, includes both short and long tail coverages. The payments that are made quickly typically pertain to automobile physical damage (included in the property line) claims and property damage (liability) claims. The payments that take longer to finalize and are more difficult to estimate relate to bodily injury claims. Commercial automobile reserves are typically analyzed in two components; liability and collision/comprehensive claims. This second component has minimum reserve risk and fast payouts and, accordingly, separate reserving factors are not presented. The liability component includes claims for both bodily injury and property damage. In general, claim reporting lags are minor, claim complexity is not a major issue, and the line is viewed as high frequency, low to moderate severity.
Surety is generally considered a short tailed coverage. As a new business, 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
As OneBeacon starts up new businesses, its initial loss estimates and development patterns are often based on industry data. As actual losses develop OneBeacon will revise its initial expectations with its actual experience. However, depending on the tail for the specific business, it can be a few years before OneBeacon has sufficient internal data to rely on. As of December 31, 2015, OneBeacon has $259 million of inception-to-date premium from its newer businesses (Programs, Environmental and Surety). A 10% error in OneBeacon’s initial loss ratio estimates could result in approximately $26 million adverse net variance in loss reserves.
Workers compensation: Recorded workers compensation loss and LAE reserves, net of reinsurance recoverable, were $116 million as of December 31, 2015. 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 1 point change in calendar year medical inflation would have changed the estimated net reserve by approximately $34 million as of December 31, 2015, in either direction.
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 underwriters 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 managing general underwriter (“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.
Asbestos and Environmental (A&E). The internal actuarial and claims analysis suggests that Sirius Group’s A&E losses are covered by its previous paid activity and current reserves. However, the ongoing nature of the litigation surrounding these complex exposures can significantly affect Sirius Group’s liabilities. Sirius Group ended 2015 with $190 million in net reserves for A&E claims. Applying varying assumptions and industry benchmarks yielded a net range of A&E reserves from $164 million to $213 million. Further information is detailed below about Sirius Group’s A&E exposure.
White Mountains used quoted market prices or other observable inputs to determine fair value for the 91% of its investment portfolio. Investments valued using Level 1 inputs include fixed maturity investments, primarily investments in U.S. Treasuries, common equity securities and short-term investments, which include U.S. Treasury Bills. Investments valued using Level 2 inputs are primarily comprised of fixed maturity investments, which have been disaggregated into classes, including debt securities issued by corporations, municipal obligations, mortgage and asset-backed securities, foreign government obligations and preferred stocks. Fair value estimates for investments that trade infrequently and have few or no observable market prices are classified as Level 3 measurements. Investments valued using Level 2 inputs also include certain ETFs that track U.S. stock indices such as the S&P 500 but are traded on foreign exchanges and that management values using the fund's published NAV to account for the difference in market close times. Level 3 fair value estimates based upon unobservable inputs include White Mountains's investments in hedge funds and private equity funds, surplus notes, as well as certain investments in fixed maturity investments, common equity securities, and convertible fixed and preferred maturity investments where quoted market prices are unavailable or are not considered reasonable. White Mountains determines when transfers between levels have occurred as of the beginning of the period.
The valuation process above is generally applicable to all of White Mountains’s fixed maturity investments. The techniques and inputs specific to asset classes within White Mountains’s fixed maturity investments for Level 2 securities that use observable inputs are as follow:
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 the audited annual financial statements of hedge funds and private equity funds and periodically discussing each fund’s pricing with the fund manager. However, since the fund managers do not provide sufficient information to 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 measurements. The fair value of White Mountains’s investments in hedge funds and private equity funds has been determined using net asset value.
The following table summarizes White Mountains’s continuing operations fair value measurements and the percentage of Level 3 investments as of December 31, 2015. The major security types were based on the legal form of the securities. White Mountains has disaggregated its fixed maturity investments based on the issuing entity type, which impacts credit quality, with debt securities issued by U.S. government entities carrying minimal credit risk, while the credit and other risks associated with other issuers, such as corporations, foreign governments, municipalities or entities issuing asset-backed securities vary depending on the nature of the issuing entity type:
Excludes carrying value of $3.8 associated with other long-term investment limited partnerships accounted for using the equity method. Excludes carrying value of $14.7 associated with a tax advantaged federal affordable housing development fund accounted for using the proportional amortization method.
White Mountains’s continuing operations other long-term investments accounted for at fair value as of December 31, 2015 include $37 million in hedge funds and $91 million in private equity funds. As of December 31, 2015, White Mountains held investments in 5 hedge funds and 22 private equity funds. The largest investment in a single fund was $23 million and $22 million as of December 31, 2015 and 2014.
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 the event White Mountains believes that the valuation provided by the fund manager differs from its expectations due to illiquidity or other factors associated with its investment in the fund, White Mountains will adjust the fund manager’s net asset value to more appropriately represent the fair value of its interest in the investment. As of December 31, 2015, White Mountains determined that circumstances relating to certain underlying investments held in four separate private equity funds required an adjustment to the fund manager's net asset value. The total adjustment relating to these underlying investments resulted in a $5 million valuation adjustment to the private equity fund managers' net asset value as of December 31, 2015.
White Mountains’s continuing operations investment portfolio includes investments in hedge funds and private equity funds. As of December 31, 2015, the value of investments in hedge funds and in private equity funds was $37 million and $91 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, 2015 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 and currencies against the Japanese yen, as well as with increases in market volatilities. Currently, declines in interest rates generally have a positive impact on bond values and are associated with a decrease in liabilities. The collective account values were approximately 109% and 113% of the guarantee value as of December 31, 2015 and 2014. 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, 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 2014.
As of December 31, 2015, the value of equity funds tracking the MSCI Kokusai was approximately ¥8.2 billion ($68.4 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, 2015, the total notional amount of MSCI Kokusai swaps was ¥5.6 billion ($46.7 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.
During 2009, WM Life Re entered into long term Japanese interest rate swaps, largely replacing its use of short-term Japanese Government Bond (“JGB”) futures to hedge its discount rate exposure. By doing so, WM Life Re better matched the term structure of its discount rate exposure, substantially reduced its exposure to changes in Japanese interest rate swap spreads and significantly reduced the potential costs associated with rolling JGB futures contracts during times of relative market illiquidity. During December 2012, after the relevant Japanese interest rate swap rates fell to their lowest level in many years, the resulting potential benefit, net of cost, to WM Life Re of maintaining its Japanese interest rate swap hedge portfolio was deemed to be limited. Therefore, the decision was made to unwind or offset these Japanese interest rate swaps. During December 2012, approximately 24% of the notional amount of Japanese interest rate swap contracts was unwound and during January 2013 the remaining 76% was unwound or offset. Because the valuation of WM Life Re’s put options and foreign exchange forwards incorporate Japanese interest rates, WM Life Re does continue to have minimal exposure to Japanese swap rates.
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, 2015. 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%. For foreign currency implied volatilities, White Mountains changes implied volatilities by 6%.
At the account value levels as of December 31, 2015, the average assumed surrender rate was approximately 40% per annum. The potential change in the fair value of the liability due to a change in current surrender assumptions is as follows:
Includes exchange traded equity index, foreign currency and interest rate futures. Fair value measurements based upon quoted prices for identical instruments that are actively traded.
Periodically, White Mountains’s management reviews the recoverability of amounts recorded from the BAM Surplus Notes and, as of December 31, 2015, 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 30.
No payment of the interest or principal on the BAM Surplus Notes may be made without the approval of the New York State Department of Financial Services. 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. In addition, BAM’s ability to pay the interest and principal on the BAM Surplus Notes is dependent upon, among other things, whether BAM collects sufficient premiums and member surplus contributions. Interest payments on the BAM Surplus Notes are due quarterly but are subject to deferral, without penalty or default and without compounding, for repayment in the future. BAM has the right at any time to prepay principal in whole or in part.
Pursuant to the notes, the Issuer shall seek to redeem the notes annually each March 15 at a requested redemption amount such that the Issuer’s total adjusted capital following the proposed redemption payment would equal 200% of the Issuer’s “authorized control level RBC”, as such term is defined by the insurance laws of the Commonwealth of Pennsylvania and as prescribed by the PID. All redemptions or repayments of principal and payments of interest on the notes are subject to approval by the PID.
Represents anticipated delay in securing regulatory approvals of interest and principal payments to reflect graduated changes in Issuer's statutory surplus. The monetary impact of the anticipated delay is measured based on credit spreads of public securities with roughly equivalent percentages of discounted payments missed.
Represents impact of liquidity spread to account for OneBeacon’s sole ownership of the surplus notes, lack of a trading market and ongoing regulatory approval risk.
The internal valuation model used to estimate the fair value is based on discounted expected cash flows using information as of the measurement date. The estimated fair value of the OneBeacon Surplus Notes is sensitive to changes in treasury rates and public debt credit spreads, as well as changes in estimates with respect to other variables including a discount to reflect the private nature of the notes (and the related lack of liquidity), the credit quality of the notes - based on the financial performance of the Issuer relative to expectations, and the timing, amount, and likelihood of interest and principal payments on the notes, which are subject to regulatory approval and therefore may vary from the contractual terms. As of December 31, 2015 and 2014, OneBeacon has assumed for estimating the fair value that interest payouts begin in year five (2020) and principal repayments begin on a graduating basis in year ten (2025) for the seller priority note and year fifteen (2030) 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 OneBeacon 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 OneBeacon surplus notes as of December 31, 2015.
claims arising from catastrophic events, such as hurricanes, earthquakes, floods, fires, terrorist attacks or severe winter weather;
The financial statements and supplementary data have been filed as a part of this Annual Report on Form 10-K as indicated in the Index to Consolidated Financial Statements and Financial Statement Schedules appearing on page 105 of this report.