(b) Includes the acquisitions of PCA and Risk Capital as well as the gain on the sale of White Mountains Holdings, Inc., which controlled a substantial portion of White Mountains’ holdings in Financial Security Holdings, Ltd. (“FSA”), to Dexia S.A.
White Mountains reported pre-tax income of $372.3 million for 2003, which represents a $252.9 million increase over the result for 2002 of $119.4 million. This was primarily due to the strong underwriting performance at OneBeacon and Folksamerica, as the GAAP combined ratios for 2003 of these businesses have improved by 9 and 5 points, respectively, over 2002. The following items impacted White Mountains’ pre-tax results for 2003:
• $98 million net reserve increase for construction defect claims as part of the review of all claims recalled from Liberty Mutual by OneBeacon;
OneBeacon’s core personal lines expenses for 2003 include the impact of a $30.0 million reduction in a liability for New York assigned risks, which reduced the core personal lines combined ratio by 3 points for 2003. The release of this liability resulted from changes in the New York assigned risk market, including a depopulation of the assigned risk pool and favorable revisions to the structure of credit programs. Additionally, during 2003, AutoOne Insurance’s prior year reserves developed favorably by $17.2 million, representing a reduction of 2 points in the personal lines combined ratio for 2003.
White Mountains’ overall fixed maturity investment strategy is to purchase securities that are attractively priced in relation to perceived credit risks. White Mountains generally manages the interest rate risk associated with holding fixed maturity investments by actively monitoring and maintaining the average duration of the portfolio with the goal of achieving an adequate after-tax total return without subjecting the portfolio to an unreasonable level of interest rate risk. White Mountains’ investment portfolio mix as of December 31, 2003 was focused on capital preservation and consisted in large part of high-quality, fixed maturity investments and short-term investments.
In May 2003, White Mountains reduced its cost of capital and significantly reduced its near-term obligations by fully prepaying its $739.9 million amortizing Old Bank Facility principally through the net proceeds from the issuance of $700.0 million face value of 10-year, fixed-rate Senior Notes, which were issued by Fund American in a public offering. The Senior Notes, which are fully and unconditionally guaranteed as to the payment of principal and interest by the Company, bear a fixed interest rate of 5.9%. The interest rate on $700.0 million of the previous Old Bank Facility was 7.0%, after giving effect to a series of interest rate swap agreements. Fund American unwound these swap agreements immediately following the Old Bank Facility prepayment by paying consideration of $56.4 million in cash.
In September 2003, Fund American terminated the Old Bank Facility, which then consisted solely of an undrawn $175.0 million revolving credit line, and replaced it with a new $300.0 million revolving credit facility.
During 2002, the Company issued a total of 23,200 Common Shares to its employees in satisfaction of performance share and Option obligations under White Mountains’ Long-Term Incentive Plan (the “Incentive Plan”). The Company received proceeds of $1.3 million as a result of exercises of Options to acquire 11,500 Common Shares during the period.
For prior accident years, White Mountains’ Reinsurance segment gradually replaces this expected loss ratio approach with estimates based on historical loss reporting patterns. For both current and prior accident years estimates change when new information becomes available, such as changing loss emergence patterns, or claim and underwriting audits.
White Mountains accounts for its pension plans in accordance with SFAS No. 87, “Employers’ Accounting for Pensions” (“SFAS 87”) and accounts for its retiree medical plan in accordance with SFAS No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions” (“SFAS 106”). SFAS 87 and SFAS 106 require that the cost of pension/retiree medical benefits be accrued over the period during which an employee provides service.
During 2003, OneBeacon recognized pension income of $1.6 million related to settlements and recognized pension expense of $11.7 million comprising of net periodic benefit cost of $1.9 million, special termination benefits of $9.7 million, and consulting fees of $0.1 million. Included in the net periodic benefit cost is $30.5 million of expected return on pension plan assets. OneBeacon contributed $0.3 million to the pension plan in 2003. No unrecognized losses on pension assets were recorded since the Company uses the market value method to value plan assets.