Our headquarters are located at 14 Wesley Street, 5th Floor, Hamilton HM 11, Bermuda. Our U.S. corporate headquarters are located at 601 Carlson Parkway, Minnetonka, Minnesota 55305 and our registered office is located at Clarendon House, 2 Church Street, Hamilton HM 11, Bermuda. We also maintain branch offices in various cities throughout the United States. Our headquarters, U.S. corporate headquarters and our branch offices are leased. We also own a building in Canton, Massachusetts that houses certain corporate functions, as well as field and business operations personnel. In November 2011, we entered into a lease for most of our Canton building. The lease begins in June 2012. We will retain a portion of the building to house certain of our corporate functions, as well as field and business operations personnel. Management considers our office facilities suitable and adequate for our current level of operations.
(1)Effective January 1, 2008, we adopted the fair value option, subsequently codified within Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 825, which allows companies the election to report financial assets and liabilities at fair value with unrealized gains and losses reported in revenues. We adopted ASC 825 for our available-for-sale securities and our investments in hedge funds, private equity funds and our investment in a community reinvestment vehicle. Subsequent to adoption, we report changes in fair value in revenues. Accordingly, total revenues and pre-tax income (loss) from continuing operations for 2011, 2010, 2009 and 2008, which included $(46.2) million, $(7.3) million, $269.1 million and $444.7 million, respectively, of change in net unrealized investment gains and losses, are not directly comparable to such measures for the 2007 period presented above.
(3)In connection with purchase accounting for the OneBeacon Acquisition, we were required to adjust to fair value our loss and LAE reserves and the related reinsurance recoverables by $646.9 million and $346.9 million, respectively, on our balance sheet as of June 1, 2001. This net charge to loss and LAE reserves of $300.0 million is being accreted through an income statement charge ratably with and over the period the claims are settled. As of both December 31, 2011 and 2010, the outstanding pre-tax unaccreted adjustment was $0.
(4)Weighted average common shares outstanding includes the impact of unvested restricted shares as well as the impact of repurchases of Class A common shares made under the Company's share repurchase authorization.
(7)The combined ratio is the sum of the loss and LAE ratio and the expense ratio, including long-term incentive compensation expense. Long-term incentive compensation expense increased our consolidated combined ratio by 0.7 points, 1.8 points, 2.2 points, 0.7 points and 1.6 points for the years ended December 31, 2011, 2010, 2009, 2008 and 2007, respectively.
(10)Includes our long-term incentive compensation expense. Long-term incentive compensation expense increased our combined ratio for the Other Insurance Operations segment by 1.8 points, 1.9 points, 0.4 points and 1.3 points for the years ended December 31, 2010, 2009, 2008 and 2007, respectively.
(11)The Berkshire Hathaway Inc. Preferred Stock was redeemed in May 2008 for $300.0 million, its redemption value.
The following discussion contains "forward-looking statements." Statements that are not historical in nature are forward-looking statements. OneBeacon cannot promise that its expectations in such forward-looking statements will turn out to be correct. OneBeacon's actual results could be materially different from and worse than its expectations. See "Forward-Looking Statements" on page 99 for specific important factors that could cause actual results to differ materially from those contained in forward-looking statements.
(1)Common shares outstanding includes the impact of unvested restricted shares and also the impact of repurchases of Class A common shares made under the Company's share repurchase authorization.
We ended the full year 2011 with a book value per share of $11.56, reflecting an increase of 3.1%, including dividends (a quarterly dividend of $0.21 per share and a special dividend of $1.00 per share paid in June 2011), on an internal rate of return basis for the year ended December 31, 2011. The increase includes a 3.0% total return on invested assets for the year ended December 31, 2011. Results for the year ended December 31, 2011 were adversely impacted by investment results in the pension plan, the debt tender completed in April, the shares of restricted stock granted in May, as well as the estimated loss on sale of AutoOne. Results for AutoOne and the estimated loss on sale are reported as discontinued operations. We reported comprehensive income attributable to OneBeacon's common shareholders of $43.9 in the year ended December 31, 2011, compared to $124.8 million in the year ended December 31, 2010. Our 2011 results include a $19.2 million after tax ($29.6 million pre-tax) estimated loss on the sale of AutoOne, as well as a $7.8 million after tax ($12.0 million pre-tax) loss related to the purchase of a portion of the Senior Notes. Change in other comprehensive income and loss items in the year ended December 31, 2011 includes the impact of an $11.2 million after tax decrease in our pension plans primarily related to a decrease in the over-funded status of our qualified pension plan driven by a decline in value of the investment assets in the plan.
Other Insurance Operations. Our Other Insurance Operations segment includes the results of the non-specialty commercial lines business and the traditional personal lines business, other run-off business and certain purchase accounting adjustments relating to the OneBeacon Acquisition. See "Business-Other Insurance Operations".
Investing, Financing and Corporate Operations. Investing, Financing and Corporate Operations includes the investing and financing activities for OneBeacon on a consolidated basis, and certain other activities conducted through our top holding company, OneBeacon Insurance Group, Ltd., and our intermediate subsidiary holding companies which include OneBeacon U.S. Enterprises Holdings, Inc. and OneBeacon U.S. Holdings, Inc., both U.S.- domiciled companies, as well as various intermediate holding companies domiciled in the United States, Gibraltar, Luxembourg and Bermuda.
As consideration, based upon the carrying value of the traditional personal lines business as of July 1, 2010, we received $166.6 million. The consideration represented the statutory surplus in the reciprocals (as consideration for surplus notes issued by the reciprocals), the combined GAAP equity in the insurance companies and attorneys-in-fact being sold, plus $32.5 million. During the year ended December 31, 2010, we recorded a total after tax net gain on the sale of $24.6 million that is comprised of $8.5 million included in net other revenues and $16.1 million included in the tax provision. During the second quarter of 2011, OneBeacon and Tower reached agreement on post-closing adjustments resulting in no material change to the $24.6 million after tax net gain on sale that OneBeacon had recorded during 2010.
Commercial lines. On December 3, 2009, we sold the renewal rights to our non-specialty commercial lines business to The Hanover. The transaction included small commercial accounts and the non-specialty portion of the middle-market business, beginning with January 1, 2010 effective dates. As consideration for the Commercial Lines Transaction, we received $23.2 million and recorded a pre-tax gain of the same amount, reflected in net other revenues in the year ended December 31, 2009. We continue to manage claims from business written prior to the Commercial Lines Transaction. Through June 30, 2010, we also managed claims from business fronted by OneBeacon and reinsured to The Hanover. We continue to provide claims system access and first notice of loss service to The Hanover. The Hanover reimburses us for our expenses incurred to provide the claims administration services. During the years ended December 31, 2011 and 2010, we recorded $0.8 million and $10.2 million, respectively, in additional consideration for aggregate premium renewals exceeding $200 million.
We account for insurance policies that we write in accordance with ASC 944. Premiums written are recognized as revenues and are earned ratably over the term of the related policy. Unearned premiums represent the portion of premiums written that are applicable to future insurance coverage provided by policies.
Deferred acquisition costs represent commissions, premium taxes, brokerage expenses and other costs that are directly attributable to and vary with the production of business. These costs are deferred and amortized over the applicable premium recognition period. Deferred acquisition costs are limited to the amount expected to be recovered from future earned premiums and anticipated investment income. This limitation is referred to as a premium deficiency. A premium deficiency is recognized if the sum of expected loss and LAE, unamortized acquisition costs, and maintenance costs exceeds related unearned premiums and anticipated investment income. A premium deficiency is recognized by charging any unamortized acquisition costs to expense to the extent required in order to eliminate the deficiency. On January 1, 2012, we adopted Accounting Standards Update (ASU) 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts, codified within ASC 944. ASU 2010-26 is effective for interim periods and annual fiscal years beginning after December 15, 2011. We have elected to adopt ASU 2010-26 on a prospective basis. Under the new guidance, deferrable acquisition costs are limited to costs related to successful contract acquisitions. Acquisition costs that are not eligible for deferral are to be charged to expense in the period incurred. See Note 1-"Nature of Operations and Summary of Significant Accounting Policies" of the accompanying consolidated financial statements.
Loss and LAE are charged against income as incurred. Unpaid loss and LAE reserves are based on estimates (generally determined by claims adjusters, legal counsel and actuarial staff) of the ultimate costs of settling claims, including the effects of inflation and other societal and economic factors. Unpaid loss and LAE reserves represent management's best estimate of ultimate loss and LAE, net of estimated salvage and subrogation recoveries, if applicable. Such estimates are reviewed and updated on a quarterly basis and any adjustments resulting therefrom are reflected in current operations. The process of estimating loss and LAE involves a considerable degree of judgment by management and the ultimate amount of expense to be incurred could be considerably greater than or less than the amounts currently reflected in the consolidated financial statements.
Compensation of our senior management team, including our named executive officers, consists primarily of three components: base salary, annual bonus and long-term incentive awards. Base salaries have been capped at $500,000. Annual bonus targets for all senior executives are 50%, with the exception of the Chief Executive Officer at 75%, of base salary. Long-term incentives for senior executives have in the past been comprised of performance shares and/or performance units. Under
OneBeacon revised the design of its long-term incentive plans from prior plan designs principally to use OneBeacon performance units instead of White Mountains performance shares, with performance targets primarily tied to OneBeacon's adjusted combined ratio. Each unit was initially valued at $100 and compounded in value over the performance period by the underwriting return on capital achieved by OneBeacon. In the case of certain senior officers, a portion of their long-term incentive compensation in these periods had been denominated in White Mountains performance shares. As a result of the shift from White Mountains performance shares to OneBeacon performance units, OneBeacon's incentive compensation expense associated with these performance cycles is no longer significantly impacted by changes in the market price of White Mountains common shares. Prior to February 2007, the value of OneBeacon's performance shares was based upon the market price of an underlying White Mountains common share (WTM Performance Shares). In February 2007, the Compensation Committee canceled all of OneBeacon's WTM Performance Shares outstanding and replaced the awards with a two-year 2007-2008 performance cycle, whose value was based upon the market price of an underlying OneBeacon common share. In the 2007-2008 performance cycle, a total of 137,400 performance shares were earned based upon a performance factor of 1.4%.
In February 2008, the Compensation Committee defined GIBVPS for the 2008-2010 performance cycle to be a weighted measure comprised of growth in adjusted book value per share and underwriting return on equity. In the 2008-2010 performance cycle, a total of 929,849 performance shares were earned based upon a performance factor of 68.5%.
In February 2009, 2010 and 2011, the Compensation Committee granted performance shares with a goal of growth in book value per share for the 2009-2011 performance cycle, the 2010-2012 performance cycle and the 2011-2013 performance cycle, respectively. As of December 31, 2011, 256,751 performance shares, 244,248 performance shares and 151,563 performance shares, respectively, were outstanding with respect to the 2009-2011, 2010-2012 and 2011-2013 performance cycles.
As a result of the Commercial Lines Transaction and the Personal Lines Transaction, payments were made to certain former employees of OneBeacon prior to the end of the performance cycle on a pro rata basis. Performance shares earned and paid for the 2008-2010, 2009-2011 and 2010-2012 performance cycles were based upon a performance factor of 100%.
In connection with OneBeacon's initial public offering, options were issued to certain key employees as a one-time incentive. The options did not include a mechanism to reflect the contribution to total return from the regular quarterly dividend. As a result, in February 2008, the Compensation Committee approved a grant of restricted stock units as a supplement to the initial public offering stock grant. The RSUs were scheduled to vest one-third on each of November 9, 2009, 2010 and 2011 subject to growth in adjusted book value per share from January 1, 2008 through the end of the calendar year immediately following the applicable vesting date. Consistent with the terms of the RSU plan, all three tranches of RSUs vested and were deferred into our deferred compensation plan and will be paid out in May 2012 in cash or shares at the discretion of the Compensation Committee.
basis and deconsolidation of the companies sold as part of the Personal Lines Transaction, partially offset by an increase in the valuation allowance for insurance reciprocals. Our effective tax rate for the year ended December 31, 2009 was lower than the U.S. statutory rate of 35% primarily due to income generated in jurisdictions other than the United States, principally representing interest income taxed in a jurisdiction with a lower effective tax rate, and the settlement of federal income tax audits for 2003 and 2004. For the years ended December 31, 2011, 2010 and 2009, the effective tax rate on non-U.S. income was 0.3%, 0.5% and 0.4%, respectively, and the effective rate on U.S. income was 19.1%, 19.5% and 30.5%, respectively.
(3)Includes loss and LAE relating to catastrophes. For the years ended December 31, 2011, 2010 and 2009, total calendar year incurred loss and LAE relating to catastrophes increased our loss and LAE and total combined ratios by 4.0 points, 3.2 points and 0.8 points, respectively, including development on prior accident year catastrophes which increased (decreased) our loss and LAE and total combined ratios by 0.4 points, (0.7) points and (0.5) points, respectively.
Our comprehensive income attributable to OneBeacon's common shareholders was $43.9 million in the year ended December 31, 2011, compared to $124.8 million in the year ended December 31, 2010. Change in other comprehensive income and loss items in the year ended December 31, 2011 included the impact of an $11.2 million after tax decrease in our pension plans primarily related to a decrease in the over-funded status of our qualified pension plan driven by a decline in the value of the investment results, as compared to a $5.8 million after tax increase in our pension plans in the prior year also driven by investment assets in the plan. Net income attributable to OneBeacon's common shareholders was $55.1 million in the year ended December 31, 2011, compared to $118.3 million in the year ended December 31, 2010.
Our total revenues decreased 31.4% to $1,086.8 million in the year ended December 31, 2011, compared to $1,584.7 million in the year ended December 31, 2010. The decrease was mainly due to a 27.7% decrease in earned premiums primarily due to the Personal Lines Transaction and Commercial Lines Transaction. Net realized and unrealized investment gains decreased 85.8% to $10.6 million, compared to $74.6 million in the year ended December 31, 2010. Net investment income decreased 26.1% to $71.4 million in the year ended December 31, 2011, primarily due to an 18.5% decline in average invested assets, including invested assets of $111.8 million reclassified to assets held for sale as part of the AutoOne Transaction. The decline in average invested assets since December 31, 2010 was driven by the Personal Lines Transaction, return of capital to shareholders, repurchases of debt and the Commercial Lines Transaction, including the impact of claim payments related to non-specialty commercial lines reserves. Net other (expenses) revenues decreased $20.3 million to $(10.7) million in the year ended December 31, 2011, compared to $9.6 million in the year ended December 31, 2010. The year ended December 31, 2011 included a $12.0 million loss related to the purchase of a portion
of our Senior Notes. The year ended December 31, 2010 included the $8.5 million net gain on the Personal Lines Transaction and $10.2 million of additional consideration related to the Commercial Lines Transaction, both described above, partially offset by a $10.8 million loss related to the purchase of a portion of our Senior Notes.
acquisition costs, primarily related to the Commercial Lines Transaction and Personal Lines Transaction, essentially offset by other underwriting expenses that have not decreased proportionately with the reduction in earned premium associated with the exited businesses.
Our total expenses decreased 17.3% in the year ended December 31, 2010 to $1,445.5 million, compared to $1,748.3 million in the year ended December 31, 2009. Loss and LAE decreased 14.6% to $858.2 million in the year ended December 31, 2010, reflective of the shrink in our book of business resulting from the Commercial Lines Transaction and the Personal Lines Transaction, partially offset by higher current accident year catastrophe losses and a number of large losses experienced earlier in the year, particularly in businesses we have exited. Current accident year catastrophe losses were $55.3 million in the year ended December 31, 2010, compared to $23.8 million in the year ended December 31, 2009. Other underwriting expenses decreased 24.4% to $233.1 million and policy acquisition expenses decreased 17.2% to $311.6 million in the year ended December 31, 2010, reflecting the change in our book of business resulting from the Commercial Lines Transaction and the Personal Lines Transaction. Interest expense decreased by 25.4% to $29.6 million in the year ended December 31, 2010, reflective of actions taken to reduce outstanding debt. General and administrative expenses were flat as compared to the prior year.
Specialty Insurance Operations is comprised of twelve underwriting units that are aggregated into three major underwriting units: MGA Business, Specialty Industries and Specialty Products. Other Insurance Operations includes the non-specialty commercial lines business and traditional personal lines business, other run-off business and certain purchase accounting adjustments relating to the OneBeacon Acquisition. Investing, Financing and Corporate Operations includes the investing and financing activities for OneBeacon on a consolidated basis, and certain other activities conducted through our holding companies. Prior periods have been reclassified to conform to the current presentation. Our segment information is presented in Note 12-"Segment Information" of the accompanying consolidated financial statements.
Financial results for our Specialty Insurance Operations segment for the years ended December 31, 2011, 2010 and 2009 were as follows:
(1)Includes our long-term incentive compensation expense. For the years ended December 31, 2011, 2010 and 2009, long-term incentive compensation expense increased
(2)Includes loss and LAE relating to catastrophes. For the years ended December 31, 2011, 2010 and 2009, total calendar year incurred loss and LAE relating to catastrophes increased our Specialty Insurance Operations loss and LAE and total combined ratios by 3.8 points, 1.5 points and 1.0 points, respectively, including development on prior accident year catastrophes which increased (decreased) our Specialty Insurance Operations loss and LAE and total combined ratios by 0.2 points, (0.7) points and (0.6) points, respectively.
(3)Prior accident year development, including development on catastrophes, for the years ended December 31, 2011, 2010 and 2009 decreased our Specialty Insurance Operations loss and LAE and total combined ratios by 2.9 points, 2.8 points and 9.2 points, respectively.
Specialty Insurance Operations-Year ended December 31, 2011 versus year ended December 31, 2010
Overview. We reported a GAAP combined ratio of 92.1% for the year ended December 31, 2011, compared to 93.5% for the year ended December 31, 2010. The decrease in our combined ratio was primarily due to lower current accident year non-catastrophe losses and other underwriting expenses, partially offset by higher catastrophe losses.
The MGA Business combined ratio for the year ended December 31, 2011 decreased slightly to 90.4% from 91.2% for the year ended December 31, 2010. The loss and LAE ratio decreased by 1.8 points to 48.0% while the expense ratio increased by 1.0 point to 42.4%. The decrease in the loss and LAE ratio is primarily due to a 2.1 point decrease in current accident year non-catastrophe losses primarily related to OBE and Dewar, compared with the year ended December 31, 2010. The year ended December 31, 2011 also reflects the impact of 0.4 points of adverse loss reserve development, compared to 0.6 points of adverse loss reserve development primarily related to OBE in the prior year period. These were partially offset by a 0.5 point increase in catastrophe losses. The year ended December 31, 2011 included 1.8 points of current accident year catastrophe losses primarily related to hurricane Irene and tornados in the southeastern and Midwestern United States which impacted our collector cars and boats business as well as OBE, as compared to 1.3 points in the year ended December 31, 2010. The increase in the expense ratio was driven by higher other underwriting expenses, partially offset by a decrease in policy acquisition expenses related to OBE.
Specialty Industries. Net written premiums for Specialty Industries increased 18.7% to $376.9 million in the year ended December 31, 2011 from $317.6 million in the year ended December 31, 2010. The increase compared to the prior year was due to a $19.9 million increase in net written premiums from OBA, a $19.0 million increase in net written premiums from OBTI, a $17.5 million increase in net written premiums from OBGR and a $7.8 million increase in net written premiums from OBEG. These increases were primarily due to new business as well as solid retention levels despite competition in the marketplace. These increases were partially offset by a $4.9 million decrease in net written premiums from IMU which reflects the competitive marketplace.
the first quarter. The year ended December 31, 2009 included 0.7 points of current accident year catastrophe losses. The expense ratio was essentially flat.
Specialty Products. Net written premiums for Specialty Products increased by 1.0% to $401.2 million in the year ended December 31, 2010 from $397.2 million in the year ended December 31, 2009. The increase was primarily due to a $20.2 million increase in net written premiums from OBPI, partially offset by a $10.2 million decrease in net written premiums from PIM reflecting a revised underwriting strategy and a $6.0 million decrease in net written premiums from OBSP, reflecting competition in the marketplace.
As Other Insurance Operations consists of business in run-off, GAAP ratios are not meaningful for the 2011 period. The following table provides underwriting ratios for Other Insurance Operations for the year ended December 31, 2009:
(2)Includes loss and LAE relating to catastrophes. For the years ended December 31, 2010 and 2009, total calendar year incurred loss and LAE relating to catastrophes increased our Other Insurance Operations loss and LAE and total combined ratios by 7.3 points and 0.6 points, respectively, including development on prior accident year catastrophes which decreased our loss and LAE and total combined ratios by 0.7 points and 0.3 points, respectively.
(3)Prior accident year development, including development on catastrophes, for the years ended December 31, 2010 and 2009 decreased our Other Insurance Operations loss and LAE and total combined ratios by 6.9 points and 3.4 points, respectively.
Other Insurance Operations-Year ended December 31, 2011 versus year ended December 31, 2010
As described in "Critical Accounting Estimates", we have a reinsurance contract with NICO for up to $2.5 billion in old A&E claims and certain other exposures. Under the terms of the NICO Cover, NICO receives the economic benefit of reinsurance recoverables from certain of our third party reinsurers in existence at the time the NICO Cover was executed (Third Party Recoverables). As a result, the Third Party Recoverables serve to protect the $2.5 billion limit of NICO coverage for our benefit.
Our reserves for A&E losses at December 31, 2011 represent management's best estimate of our ultimate liability based on information currently available. However, significant uncertainties, including but not limited to case law developments, medical and clean-up cost increases and industry settlement practices, limit our ability to accurately estimate ultimate liability and we may be subject to A&E losses beyond currently estimated amounts. In addition, we remain liable for risks reinsured in the event that a reinsurer does not honor its obligations under reinsurance contracts. To the extent that actual experience differs from our estimate of incurred A&E losses and Third Party Recoverables, future losses could exceed the $198.3 million of protection remaining under the NICO Cover.
A summary of results from our Investing, Financing and Corporate Operations segment for the years ended December 31, 2011, 2010 and 2009 is as follows:
Investing, Financing and Corporate Operations-Year ended December 31, 2011 versus year ended December 31, 2010
Investing, Financing and Corporate Operations reported pre-tax income from continuing operations of $40.5 million in the year ended December 31, 2011, compared to $119.2 million in the year ended December 31, 2010. The decrease was primarily related to a decrease in net realized and unrealized investment gains and net investment income. As further described below, net realized and unrealized investment gains decreased to $10.6 million in the year ended December 31, 2011, compared to $74.6 million in the prior year period, and net investment income decreased to $71.4 million in the year ended December 31, 2011, compared to $96.6 million in the prior year period. See "Management's Discussion and Analysis of Financial Condition and Results of Operations-Summary of Investment Results". The decrease in interest expense reflects actions taken to reduce outstanding debt. See "Management's Discussion and Analysis of Financial Condition and Results of Operations-Financing". Further, net other expenses increased mainly due to a $12.0 million loss related to the purchase of a portion of our Senior Notes in the year ended December 31, 2011, compared to a $10.8 million loss in the prior year period. General and administrative expenses decreased 23.6% as compared with the prior year period.
Investing, Financing and Corporate Operations-Year ended December 31, 2010 versus year ended December 31, 2009
Investing, Financing and Corporate Operations reported pre-tax income from continuing operations of $119.2 million in the year ended December 31, 2010, compared to $320.3 million in the year ended December 31, 2009. The decrease was primarily related to a decrease in net investment income and net realized and unrealized investment gains. As further described below, net realized and unrealized investment gains decreased to $74.6 million in the year ended December 31, 2010, compared to $248.6 million in the prior year period and net investment income decreased to $96.6 million in the year ended December 31, 2010, compared to $125.5 million in the prior year period. See "Management's Discussion and Analysis of Financial Condition and Results of Operations-Summary of Investment Results". The decrease in interest expense reflects actions taken to reduce outstanding debt. See "Management's Discussion and Analysis of Financial Condition and Results of Operations-Financing". Further, net other expenses increased mainly due to a $10.8 million loss related to the purchase of a portion of our Senior Notes in the year ended December 31, 2010, compared with a $5.4 million gain related to the purchase of a portion of our Senior Notes, partially offset by a $7.4 million realized loss related to the settlement of the interest rate swap in the prior year period. General and administrative expenses were essentially flat as compared with the prior year period.
A summary of our consolidated pre-tax investment results for the years ended December 31, 2011, 2010 and 2009 is as follows:
(1)Gross investment returns exclude investment expenses of $6.9 million, $8.9 million and $10.9 million, respectively, for the years ended December 31, 2011, 2010 and 2009.
Our total common equity securities, convertible fixed maturity and other investments portfolio returned 13.2% for the year ended December 31, 2010, compared to 10.8% for the year ended December 31, 2009. Our total common equity securities and convertible fixed maturity investments portfolio returned 16.4% and 10.8% for the years ended December 31, 2010 and 2009, respectively, or 130 basis points better and 1,570 basis points worse, respectively, than the S&P 500 Index benchmark. The S&P 500 rebounded during 2009; as a result of the timing of sales of common equity securities in 2009 in order to reduce our equity exposure discussed previously and given that we were more heavily weighted in convertible fixed maturity investments than in common equity securities, our portfolio underperformed the S&P 500 Index benchmark. We recorded $20.4 million in net realized gains in the year ended December 31, 2010. Our other investments portfolio returned 6.0% for the year ended December 31, 2010, compared to 10.8% for the year ended December 31, 2009.
We purchase commercial and residential mortgage backed securities to maximize our risk adjusted returns in the context of a diversified portfolio. Our non-agency commercial mortgage-backed portfolio (CMBS) is generally short tenor and structurally senior, with more than 20 points of subordination on average for fixed rate CMBS and approximately 50 points of subordination on average for floating rate CMBS as of December 31, 2011. In general, subordination represents the percentage of principal loss on the underlying collateral that would have to occur before the security incurs a loss. These collateral losses, instead, are first absorbed by other securities lower in the capital structure. We believe this structural protection mitigates the risk of loss tied to refinancing challenges facing the commercial real estate market. As of December 31, 2011, on average approximately 2% of the underlying loans were reported as non-performing for all CMBS held by us. We are not an originator of residential mortgage loans and did not hold any residential mortgage-backed securities (RMBS) categorized as sub-prime as of December 31, 2011. Our investments in hedge funds and private equity funds contain negligible amounts of sub-prime mortgage-backed securities as of December 31, 2011. We consider sub-prime mortgage-backed securities to be those that have underlying loan pools that exhibit weak credit
characteristics or are issued from dedicated sub-prime shelves or dedicated second-lien shelf registrations (i.e., we consider investments backed primarily by second-liens to be sub-prime risks regardless of credit scores or other metrics).
(3)At issuance, Subordinate were not rated AAA by Standard & Poor's or Aaa by Moody's and were junior to other bonds.
Both internal and external forces influence our financial condition, results of operations and cash flows. Claim settlements, premium levels and investment returns may be impacted by changing rates of inflation and other economic conditions. In many cases, significant periods of time, ranging up to several years or more, may lapse between the occurrence of an insured loss, the reporting of the loss to us and the settlement of the liability for that loss. The exact timing of the payment of claims and benefits cannot be predicted with certainty. Our operating subsidiaries maintain portfolios of invested assets with varying maturities and a substantial amount of cash and short-term investments to provide adequate liquidity for the payment of claims.
based on the greater of prior year statutory net income or 10% of prior year end statutory surplus, subject to the availability of unassigned funds. Our top tier regulated insurance operating subsidiaries have the ability to pay $103 million of dividends during 2012 without the prior approval of regulatory authorities, subject to the availability of unassigned funds. At December 31, 2011, OneBeacon's top tier regulated insurance operating subsidiaries had $0.7 billion of unassigned funds and statutory surplus of $1.0 billion. At December 31, 2011, we had approximately $200 million of net unrestricted cash, short-term investments and fixed maturity investments and approximately $30 million of common equity securities and convertible fixed maturity investments outside of our regulated insurance operating subsidiaries.
During the year ended December 31, 2011, our top tier regulated operating subsidiaries distributed $150.0 million of extraordinary dividends to OneBeacon LLC. During the year ended December 31, 2010, our top tier regulated operating subsidiaries distributed $776.0 million of dividends, including $71.0 million of ordinary dividends, $535.0 million of extraordinary dividends and $170.0 million representing return of capital to OneBeacon LLC. During the year ended December 31, 2009, our top tier regulated operating subsidiaries distributed $80.0 million of ordinary dividends to OneBeacon LLC. During the years ended December 31, 2011, 2010 and 2009, our unregulated operating subsidiaries paid $4.3 million, $8.3 million and $11.9 million, respectively, of dividends to their immediate parent.
During the year ended December 31, 2011, we paid cash dividends totaling $174.8 million, including $79.7 million of regular quarterly cash dividends and $95.1 million of a special dividend. During the year ended December 31, 2010, we paid cash dividends totaling $315.6 million, including $79.5 million of regular quarterly cash dividends and $236.1 million of a special dividend. During the year ended December 31, 2009, we paid cash dividends totaling $79.9 million consisting entirely of regular quarterly cash dividends.
repurchases/repayments, common share issuances and repurchases and dividends paid to shareholders are all activities that do not change insurance float but that can meaningfully impact operational leverage metrics.
The following table summarizes our debt to capital ratio at December 31, 2011 and 2010:
On March 24, 2011, OBH commenced a cash tender offer for up to $150.0 million in aggregate principal amount of the Senior Notes at a price of $1,045 per $1,000 principal amount. The cash tender offer, which was not subject to the tender of any minimum principal amount of Senior Notes, expired on April 20, 2011. Holders of Senior Notes who tendered on or before April 6, 2011 received an early tender payment of $30 for every $1,000 principal amount of Senior Notes validly tendered. Payment for the Senior Notes included accrued and unpaid interest up to the settlement date. OBH accepted and retired $150.0 million aggregate principal amount of the Senior Notes for $161.6 million, which resulted in a $12.0 million pre-tax loss, including transaction fees.
On May 3, 2010, OBH commenced a cash tender offer for up to $200.0 million in aggregate principal amount of the Senior Notes at a price of $1,027.50 per $1,000 principal amount. The cash tender offer, which was not subject to the tender of any minimum principal amount of Senior Notes, expired on May 28, 2010. Holders of Senior Notes who tendered on or before May 14, 2010 received an early tender payment of $30 for every $1,000 principal amount of Senior Notes validly tendered. Payment for the Senior Notes included accrued and unpaid interest up to the settlement date. OBH accepted and retired $156.4 million aggregate principal amount of the Senior Notes, of which $155.2 million was tendered by the early tender deadline, for purchase for $165.4 million, which resulted in a $9.6 million pre-tax loss, including transaction fees.
White Mountains provides an irrevocable and unconditional guarantee as to the payment of principal and interest on the Senior Notes. In consideration of this Guarantee, we have agreed to pay a specified fee to White Mountains in the amount of 25 basis points per annum on the outstanding principal amount of the Senior Notes. We have further agreed that if White Mountains' voting interest in us ceases to represent more than 50% of all our voting securities, we are obligated to seek to redeem, exchange or otherwise modify the Senior Notes in order to fully and permanently eliminate White Mountains' obligations under the Guarantee (the Guarantee Elimination). White Mountains has agreed to provide written notice to us when its voting interest in us has been reduced below 50%. We will have 180 days from the receipt of such notification to complete the Guarantee Elimination. If the Guarantee Elimination is not completed within the initial 180-day period, the Guarantee fee shall increase by 200 basis points. The Guarantee fee shall further increase by 100 basis points for each subsequent 90-day period thereafter, up to a maximum Guarantee fee of 425 basis points, until the Guarantee Elimination has been completed.
We also have future binding commitments to fund certain limited partnership investments. These commitments, which total $16.1 million as of December 31, 2011, do not have fixed funding dates and are therefore excluded from the table above. Our future binding commitments to fund an investment in a tax advantaged federal affordable housing development fund are $7.3 million and $2.8 million for 2012 and 2013, respectively.
Net cash flows (used for) provided from operations were $(118.5) million, $22.4 million and $165.4 million, respectively, for the years ended December 31, 2011, 2010 and 2009. Net cash flows for operations in the years ended December 31, 2011 and 2010 were reduced by the run-off of reserves related to the Commercial Lines Transaction. Net cash flows for operations in the years ended December 31, 2011, 2010 and 2009 were reduced by declining net investment income, primarily due to lower overall portfolio yields, shifts in portfolio mix to lower risk, lower yield investments and a decrease in the overall invested asset base. In addition, cash flows from operations for the year ended December 31, 2010 reflects the impact of the Personal Lines Transaction.
During 2010, OBIC purchased a portion of the Senior Notes for $1.1 million.
During 2010, OBH repurchased and retired a portion of the Senior Notes for $30.8 million.
During 2009, we sold the renewal rights to our non-specialty commercial lines business for $23.2 million to a third party.
During 2009, we reported net decreases in our loss and LAE reserves and reinsurance recoverables on paid and unpaid losses, primarily due to the decline of our business exposures related to legacy run-off.
During 2009, we made payments with respect to our long-term incentive compensation plans totaling $27.3 million, in cash or by deferral into certain of our non-qualified compensation plans. These payments were made primarily with respect to 137,400 performance shares and 148,422 performance units for various performance cycles.
Management's Discussion and Analysis of Financial Condition and Results of Operations discusses our consolidated financial statements, which have been prepared in accordance with GAAP. The consolidated financial statements presented herein include all adjustments considered necessary by management to fairly present our financial position, results of operations and cash flows.
Management believes that certain of these estimates are considered critical in that they involve a higher degree of judgment and are subject to a significant degree of variability. The descriptions below summarize the more significant estimates used in the preparation of our historical consolidated financial statements.
(2)Excludes the carrying value of $21.8 million and $21.2 million, respectively, associated with a tax advantaged federal affordable housing development fund accounted for using the equity method as of December 31, 2011 and 2010.
At December 31, 2011 and 2010, we held one private preferred stock that represented approximately 85% and 86%, respectively, of our preferred stock portfolio. We used quoted market prices for similar securities that were adjusted to reflect management's best estimate of fair value; this security is classified as a Level 3 measurement.
(1)Excludes the carrying value of $21.8 million associated with a tax advantaged federal affordable housing development fund accounted for using the equity method.
"Transfers out" of Level 3 fixed maturity investments of $109.8 million for the year ended December 31, 2011 were comprised of securities which had been previously classified as a Level 3 measurement and were recategorized as a Level 2 measurement when quoted market prices for similar securities that were considered reliable and could be validated against an alternative source became available.
changes in how case reserves are established by a company's claims adjusters. However, historical paid loss development methods are more leveraged, meaning that small changes in payments have a larger impact on estimates of ultimate losses, than actuarial methods that use incurred losses because cumulative loss payments take much longer to equal the expected ultimate losses than cumulative incurred amounts. In addition, and for similar reasons, historical paid loss development methods are often slow to react to situations when new or different factors arise than those that have affected paid losses in the past.
Upon completion of each quarterly review, our actuaries select indicated reserve levels based on the results of the actuarial methods described previously, which are the primary consideration in determining management's best estimate of required reserves. However, in making its best estimate, management also considers other qualitative factors that may lead to a difference between held reserves and actuarially recommended levels in the future. Typically, these factors exist when management and our actuaries conclude that there is insufficient historical incurred and paid loss
information or that trends included in the historical incurred and paid loss information are unlikely to repeat in the future. Such factors include, among others, recent entry into new markets or new products, improvements in the claims department that are expected to lessen future ultimate loss costs and legal and regulatory developments. At December 31, 2011 and 2010, total carried reserves were 10% and 13% above the actuarial point estimate, respectively.
Our reserves include provisions made for claims that assert damages from A&E related exposures. Asbestos claims relate primarily to injuries asserted by those who allegedly came in contact with asbestos or products containing asbestos. Environmental claims relate primarily to pollution and related clean-up cost obligations, particularly as mandated by Federal and state environmental protection agencies. In addition to the factors described above under "Reserves other than Asbestos and Environmental Reserves" regarding the reserving process, we estimate our A&E reserves based upon, among other factors, facts surrounding reported cases and exposures to claims, such as policy limits and deductibles, current law, past and projected claim activity and past settlement values for similar claims, as well as analysis of industry studies and events, such as recent settlements and asbestos-related bankruptcies. The cost of administering A&E claims, which is an important factor in estimating loss and LAE 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.
A large portion of our A&E losses resulted from the operations of the Employers Group, an entity acquired by one of the legacy companies in 1971. These operations, including business of Employers Surplus Lines Insurance Company and Employers Liability Assurance Corporation, provided primary and excess liability insurance for commercial insureds, including Fortune 500-sized accounts, some of whom subsequently experienced claims for A&E losses. We stopped writing such coverage in 1984.
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 from insurers such as us payment for asbestos claims under the premises and operations coverage of their liability policies, which may not be subject to similar aggregate limits. We expect this trend to continue. However, to date there have been fewer of these premises and operations coverage claims than product liability coverage claims. This may be due to a variety of factors, including that it may be more difficult for underlying 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. Premises and operations claims may vary significantly and policyholders may seek large amounts, although such claims frequently settle for a fraction of the initial alleged amount. Accordingly, there is a great deal of variation in damages awarded for the actual injuries. As of December 31, 2011, there were approximately 225 active claims by insureds against us without product liability coverage asserting operations or premises coverage, which may not be subject to aggregate limits under the policies.
Immediately preceding the OneBeacon Acquisition, we purchased a reinsurance contract with NICO under which we are entitled to recover from NICO up to $2.5 billion in the future for asbestos claims arising from business written by us in 1992 and prior, environmental claims arising from business written by us in 1987 and prior, and certain other exposures. Under the terms of the NICO Cover, NICO receives the economic benefit of reinsurance recoverables from certain of our third-party reinsurers in existence at the time the NICO Cover was executed, or Third-Party Recoverables. As a result, the Third-Party Recoverables serve to protect the $2.5 billion limit of NICO coverage for the benefit of us. 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 us. Third-Party Recoverables are typically for the amount of loss in excess of a stated level each year. Of claim payments from 2001 through 2011, approximately 47% of A&E losses have been recovered under the historical third-party reinsurance.
Our reserves for A&E losses, net of Third-Party Recoverables but prior to NICO recoveries, were $0.8 billion at December 31, 2011. An industry benchmark of reserve adequacy is the "survival ratio", computed as a company's reserves divided by its historical average yearly loss payments. This ratio indicates approximately how many more years of payments the reserves can support, assuming future
yearly payments are equal to historical levels. Our survival ratio was 13.3 at December 31, 2011. This was computed as the ratio of A&E reserves, net of Third-Party Recoverables prior to the NICO Cover of $0.8 billion plus the remaining unused portion of the NICO Cover of $198.3 million, to the average A&E loss payments over the three-year period ended December 31, 2011, net of Third-Party Recoverables. Our survival ratio was 10.7 at December 31, 2010. We believe that as a result of the NICO Cover and our historical third-party reinsurance programs, we should not experience material financial loss from A&E exposures under current coverage interpretations and that our survival ratio compares favorably to industry survival ratios. However, the survival ratio is a simplistic measure estimating the number of years it would be before the current ending loss reserves for these claims would be paid using recent annual average payments subject to adjustments for unusual items. Many factors, such as aggressive settlement procedures, mix of business and coverage provided, have a significant effect on the amount of A&E reserves and payments and the resultant survival ratio. Thus, caution should be exercised in attempting to determine reserve adequacy for these claims based simply on this survival ratio.
Our reserves for A&E losses at December 31, 2011 represent management's best estimate of its ultimate liability based on information currently available. However, significant uncertainties, including but not limited to case law developments, medical and clean-up cost increases and industry settlement practices, limit our ability to accurately estimate ultimate liability and we may be subject to A&E losses beyond currently estimated amounts. In addition, we remain liable for risks reinsured in the event that a reinsurer does not honor its obligations under reinsurance contracts. See Note 3-"Reserves for Unpaid Loss and LAE-Asbestos and environmental loss and LAE reserve activity" of the accompanying consolidated financial statements for more information regarding our A&E reserves.
The process of establishing loss reserves is complex and imprecise as it must consider many variables that are subject to the outcome of future events. As a result, informed subjective estimates and judgments as to our ultimate exposure to losses are an integral component of our loss reserving process. We, like other insurance companies, categorize and track our insurance reserves by "line of business", such as automobile liability, multiple peril liability and workers compensation. Furthermore, we regularly review the appropriateness of reserve levels at the line of business level, considering the variety of trends that impact the ultimate settlement of claims for the subsets of claims in each particular line of business.
There are numerous components underlying the multiple peril liability product line. Some of these have relatively moderate payment patterns (with most of the claims for a given accident year closed within 5 to 7 years), while others can have extreme lags in both reporting and payment of claims (e.g., a reporting lag of a decade for "construction defect" claims).
During the year ended December 31, 2011, we experienced $2.9 million of favorable loss and LAE reserve development on prior accident year loss reserves, with $29.6 million of favorable development in Specialty Insurance Operations, substantially offset by $26.7 million of adverse loss reserve development in Other Insurance Operations. The favorable loss reserve development in Specialty Insurance Operations was primarily due to lower than expected severity on non-catastrophe losses related to professional liability lines, multiple peril liability lines and other general liability lines. The adverse loss reserve development in Other Insurance Operations resulted from a detailed review of run-off expenses, principally unallocated loss adjustment expenses (ULAE), completed during the fourth quarter of 2011.
these accident years. As a result, at December 31, 2010, the IBNR was determined to be $86.2 million, or approximately 57% of the remaining case reserves. The impact of this revised estimate was a decrease to multiple peril liability reserves of $18.4 million, with $7.6 million in Specialty Insurance Operations and $10.8 million in Other Insurance Operations.
At December 31, 2009, based on actuarial techniques described above, management estimated that IBNR related to general liability occurrence was $107.1 million, or approximately 265% of case reserves of $40.4 million for accident years 2004 through 2009. During the year ended December 31, 2010, case incurred loss and ALAE was $33.1 million, which was less than expected for this line of business. As a result of the lower than expected case incurred loss and ALAE during the year ended December 31, 2010, the actuarial methods based on case incurred losses produced lower estimated ultimate losses for these accident years. As a result, at December 31, 2010, the IBNR was determined to be $61.7 million, or approximately 164% of the remaining case reserves. The impact of this revised estimate was a decrease to general liability occurrence reserves of $12.3 million, with $1.5 million in Specialty Insurance Operations and $10.8 million in Other Insurance Operations.
In addition to the development described for the lines of business above, management also recorded a $0.4 million net increase in IBNR in other lines of business as a result of its review of loss reserves at December 31, 2010. The change in IBNR for each other line of business was not individually significant.
Additionally, during the year ended December 31, 2010, AutoOne, which is included in discontinued operations, experienced $6.0 million in adverse loss reserve development.
Loss and LAE reserves, net of reinsurance recoverables on unpaid losses, at December 31, 2011 and 2010 were as follows:
Loss and LAE reserves, net of reinsurance recoverables on unpaid losses, by line of business at December 31, 2011 and 2010 were as follows:
The following discussion includes disclosure of possible variations from current estimates of loss reserves due to a change in certain key assumptions. Each of the impacts described below is estimated individually, without consideration for any correlation among key assumptions or among lines of business. Therefore, it would be inappropriate to take each of the amounts described below and add
•Workers compensation: Recorded loss and LAE reserves, net of reinsurance recoverables, for workers compensation were $271.5 million at December 31, 2011. The two most important assumptions for workers compensation reserves are loss development factors and loss cost trends, particularly medical cost inflation. Loss development patterns are dependent on medical cost inflation. Approximately half of the workers compensation net reserves are related to future medical costs. Across the entire reserve base, a 0.5 point change in calendar year medical inflation would have changed the estimated net reserve by approximately $49 million at December 31, 2011, in either direction.
•Professional liability: Recorded loss and LAE reserves, net of reinsurance recoverables, for professional liability were $387.8 million at December 31, 2011. A key assumption for professional liability is the implicit loss cost trend, particularly the severity inflation trend component of loss costs. Across the entire reserve base, a 5.0 point change in assumed annual severity would have changed the estimated net reserve by approximately $64 million at December 31, 2011, in either direction.