In connection with the OneBeacon Offering in 2006, White Mountains recognized a $171 gain in other revenues and recorded $479 in noncontrolling interest.
White Mountains’ total expenses decreased 10% to $3,684 million in 2009 compared to $4,094 million in 2008. Losses and LAE expenses decreased $387 million, or 15%, due primarily to $122 million of net favorable loss reserve development in 2009 compared to $21 million of net adverse loss reserve development in 2008 and to lower catastrophe losses at White Mountains Re, which reported $57 million of catastrophe losses in 2009 compared to $156 million in 2008. General and administrative expenses increased to $233 million in 2009 from $220 million in 2008 as an increase in incentive compensation expenses was partially offset by a decrease in expenses from consolidated limited partnerships. Interest expense on debt decreased 14% to $71 million in 2009 compared to $82 million in 2008, primarily due to reductions of outstanding debt resulting from the full repayment of the WTM Bank Facility and the Mortgage Note at OneBeacon and repurchases of OBH Senior Notes.
White Mountains’ total revenues decreased 38% to $2,956 million in 2008 compared to $4,734 million in 2007. White Mountains reported $588 million of net unrealized losses through net income in 2008 as a result of the FAS 159 election compared to $10 million net unrealized investment gains reported in other comprehensive income in 2007. In addition, White Mountains reported net realized investment losses of $569 million in 2008 compared to net realized investment gains of $263 million in 2007. Earned premiums decreased 2% in 2008 when compared to 2007, as earned premium increases at OneBeacon and Esurance were more than offset by a decrease in earned premiums at White Mountains Re. Net investment income decreased by 23% to $410 million in 2008 compared to $533 million in 2007. Other revenues decreased by $161 million to a loss of $8 million in 2008, due mainly to the net effect of the increase in the fair value of WM Life Re’s variable annuity liabilities exceeding the increase in the fair value of the related derivative contracts, which reduced other revenues by a $194 million in 2008, compared to a $27 million reduction in other revenues in 2007. The net reduction in 2008 was driven predominantly by a change in assumptions that fewer customers than previously expected will surrender their contracts as the value of their guaranteed annuity benefits went significantly in-the-money during 2008. Other revenues also included $59 million of foreign currency translation losses at White Mountains Re in 2008 compared to $13 million of foreign currency translation losses reported in 2007.
Esurance’s other revenue was $55 million in 2009, an increase of 27% from 2008. The increase resulted primarily from the inclusion of a full year of commission revenue in 2009 from Answer Financial, which Esurance acquired in the second quarter of 2008, along with an increase in the revenue from unaffiliated third parties participating in Esurance’s comparison quotes program. General and administrative expenses increased by $3 million to $35 million in 2009, due to the inclusion of a full year of Answer Financial’s operating expenses in 2009. The amortization of Answer Financial’s purchase accounting adjustments in 2009 was $16 million related to the intangible asset associated with the acquired business in force and $2 million related to their information technology infrastructure.
Other revenues increased to $43 million in 2008 from $14 million in 2007, primarily due to Answer Financial’s commissions on new and renewal business. General and administrative expenses increased to $32 million in 2008, primarily due to the addition of Answer Financial’s operational expenses in 2008. The amortization of Answer Financial’s purchase accounting adjustments was $15 million related to the intangible asset associated with the acquired business in force and $1 million related to their information technology infrastructure.
White Mountains’ Other Operations segment’s pre-tax loss in 2008 was $218 million, compared to pre-tax income of $59 million in 2007. WM Life Re reported $187 million in pre-tax losses in 2008, including $163 million of these losses in the fourth quarter, compared to $12 million of pre-tax losses in 2007. This loss was due mainly to the net effect of the increase in the fair value of WM Life Re’s variable annuity liabilities exceeding the increase in the fair value of the related derivative contracts. 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, at December 31, 2008, the collective account values were approximately 82% of the guarantee value. The liability is also affected by annuitant-related behavioral and actuarial assumptions, including surrender and mortality rates. Approximately $93 million of the loss at WM Life Re resulted from changes during the fourth quarter in assumptions that significantly fewer customers than previously expected will surrender their contracts as the value of their guaranteed annuity benefits goes further in-the-money.
In addition because of extremely volatile markets and hedging programs that were not fully effective, WM Life Re incurred realized and unrealized losses, particularly in the fourth quarter of 2008. Realized losses of approximately $35 million were a result of increased market volatility and correlations, particularly in October. A portion of the hedging program is dynamic, and requires the company to rebalance the portfolio by buying or selling additional futures contracts as markets rise or fall. This dynamic hedge coverage was not fully maintained as liability values changed rapidly in volatile, gapping markets, resulting in realized hedge related losses. Although expectations of these rebalancing costs are factored into the premium rates charged, losses will be incurred when realized volatility and correlations exceed the levels assumed in the liability valuation. Additional mark-to-market losses of approximately $33 million were incurred as a result of increases in assumed future equity and currency volatilities, the exposure to which WM Life Re was only partially hedged. Losses also resulted from mismatches between the available hedging instruments and certain components of the liability. The losses described above were partially offset by gains from investment income and other items.
White Mountains’ GAAP total return on invested assets for 2009 was 9.5% compared to -9.5% for 2008. White Mountains’ fixed maturity portfolio outperformed the Barclays Intermediate Aggregate by over 250 basis points, driven by an approximately 18% return on the corporate bond portfolio, into which WM Advisors added approximately $800 million of net exposure in the first half of 2009. White Mountains’ equity, convertible fixed maturities, and other long-term investment portfolio return of 12.7% underperformed S&P 500 Index, reflecting the repositioning of White Mountains’ equity portfolio to a capital preservation stance. White Mountains believes its portfolio is conservatively positioned as the fixed income portfolio has weighted average credit quality of AA and has limited exposure to problem sectors. As overall financial markets, and White Mountains’ investment results, continue to stabilize, White Mountains is gradually shifting back from a focus on capital preservation to its traditional total return investment philosophy. As of December 31, 2009, White Mountains had $2 billion of cash and short term investments available for reinvestment.
The strengthening of the U.S. dollar also adversely impacted investment returns in 2008, while the weakened U.S. dollar had a positive impact on the 2007 net unrealized gains.
The following table presents the composition of White Mountains’ investment portfolio as of December 31, 2009 and 2008:
Subject to certain limitations under Swedish law, WMRe Sirius is permitted to transfer up to the full amount of its pre-tax income into an untaxed reserve referred to as a safety reserve. At December 31, 2009, WMRe Sirius’ safety reserve amounted to $1.4 billion. Under GAAP, an amount equal to the safety reserve, net of a related deferred tax liability established at the Swedish tax rate of 26.3%, is classified as shareholders’ equity. Generally, this deferred tax liability is only required to be paid by WMRe Sirius if it fails to maintain predetermined levels of premium writings and loss reserves in future years. As a result of the indefinite deferral of these taxes, Swedish regulatory authorities do not apply any 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 WMRe Sirius’ safety reserve ($356 million at December 31, 2009) is included in solvency capital. Access to the safety reserve is restricted to coverage of insurance 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 $1.4 billion balance of the safety reserve, without any provision for deferred taxes, in WMRe Sirius’ capital when assessing WMRe Sirius’ financial strength.
Insurance float is an important aspect of White Mountains’ insurance operations. Insurance float represents funds that an insurance or reinsurance company holds for a limited time. In an insurance or reinsurance operation, float arises because premiums are collected before losses are paid. This interval can extend over many years. During that time, the insurer or reinsurer invests the funds. When the premiums that an insurer or reinsurer collects do not cover the losses and expenses it eventually must pay, the result is an underwriting loss, which is considered to be the cost of insurance float. The amount and cost of insurance float for White Mountains is affected by underlying market conditions, as well as acquisitions or dispositions of insurance and reinsurance businesses. White Mountains has historically obtained its insurance float primarily through acquisitions, as opposed to organic growth. It is White Mountains’ intention to generate low-cost float over time through a combination of acquisitions and/or by organic growth in its existing insurance and reinsurance operations. However, White Mountains will seek to increase its insurance float organically only when market conditions allow for an expectation of generating underwriting profits.
During the third quarter of 2008, OneBeacon repurchased $24 million face value of its outstanding OBH Senior Notes for $22 million.
During 2008, the Company issued a total of 3,300 common shares to its employees through the exercise of Options during the period for cash proceeds of approximately $1 million.
During 2007, Sirius International contributed $136 million to WMRe Bermuda. In addition, White Mountains Re contributed the $246 million net proceeds from the WMRe Preference Share issuance and $250 million of $285 million redemption of WMRe America common shares to further capitalize WMRe Bermuda.
During 2007, OneBeacon sold one of its inactive licensed subsidiaries, American Employers’ Insurance Company, to a third party for $48 million in cash.
During 2007, White Mountains made payments totaling $56 million, in cash or by deferral into certain non-qualified compensation plans of the Company and its subsidiaries, to participants in the long-term incentive compensation plans of the Company and its subsidiaries.
During 2007, OneBeacon reallocated loss and LAE reserves from specialty and personal lines to run-off, which reduced specialty and personal lines’ GAAP loss and LAE ratios and GAAP combined ratios, but had no impact on OneBeacon’s total GAAP combined ratio. OneBeacon’s specialty and personal lines’ loss and LAE ratios and combined ratios prior to reserve reallocation are non-GAAP financial measures that are derived by excluding the impact of the reserve reallocation from specialty and personal lines’ loss and LAE ratios and combined ratios. OneBeacon believes that a presentation excluding the effect of the reserve reallocation on specialty and personal lines’ loss and LAE ratios and combined ratios is meaningful for investors to understand the performance of its underwriting units during 2007. The reconciliation of these non-GAAP financial measures to the GAAP loss and LAE ratios and GAAP combined ratios is included on page 53.
In 2007, OneBeacon experienced $48 million of favorable loss reserve development, primarily related to lower than expected frequency for professional liability and lower than expected severity for personal automobile liability, partially offset by adverse loss reserve development for multiple peril and workers compensation, primarily for accident years 2001 and prior.
Specifically, at December 31, 2006, management continued to expect losses to emerge in the professional liability business (which is included in OneBeacon’s general liability line of business) in line with initial expectations based on market analysis when this business was initiated in 2002 and 2003. During 2007, losses continued to be significantly lower than initial expectations. As a result, management lowered its selected reserves on the earliest years which affected more recent years as total loss expectations for those years are based in part on prior years’ results. The impact of this revised estimate was a decrease to professional liability reserves of $80 million.
The following table summarizes the amount of total gains (losses) included in earnings attributable to unrealized investment gains (losses) for Level 3 investments for years ended December 31, 2009 and 2008:
White Mountains’ investment portfolio includes investments in hedge funds and private equity funds. At December 31, 2009, the value of investments in hedge funds and in private equity funds was $201 million and $110 million, respectively. The hedge funds’ and private equity funds’ underlying investments are typically publicly traded and private common equity investments, and, as such, are subject to market risks that are similar to those in White Mountains’ common equity portfolio.
At current account values, WM Life Re’s surrender assumptions vary from 0.7% currently to 6% when surrender charges drop off, and down to 0.3% near maturity; the average is approximately 2.1% per annum. The potential increase in the fair value of the liability due to a change in current actuarial assumptions is as follows: