10-K 1 a12-1085_110k.htm 10-K

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-K

 

x

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2011

 

OR

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from          to          

 

Commission file number 1-8993

 

WHITE MOUNTAINS INSURANCE GROUP, LTD.

(Exact name of Registrant as specified in its charter)

 

Bermuda

 

94-2708455

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification No.)

 

 

 

80 South Main Street

 

 

Hanover, New Hampshire

 

03755-2053

(Address of principal executive offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code: (603) 640-2200

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Name of each exchange on which registered

Common Shares, par value $1.00

 

New York Stock Exchange

per share

 

Bermuda Stock Exchange

 

Securities registered pursuant to Section 12(g) of the Act:

None

 

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No o

 

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes o No x

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

 

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months. Yes  x No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

 

The aggregate market value of voting shares (based on the closing price of those shares listed on the New York Stock Exchange and the consideration received for those shares not listed on a national or regional exchange) held by non-affiliates of the Registrant as of June 30, 2011, was $2,888,052,532.

 

As of February 27, 2012, 7,454,585 common shares, par value of $1.00 per share, were outstanding (which includes 100,460 restricted common shares that were not vested at such date).

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Registrant’s Definitive Proxy Statement to be filed with the Securities and Exchange Commission (“SEC”) pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), relating to the Registrant’s Annual General Meeting of Members scheduled to be held May 24, 2012 are incorporated by reference into Part III of this Form 10-K. With the exception of the portions of the Proxy Statement specifically incorporated herein by reference, the Proxy Statement is not deemed to be filed as part of this Form 10-K.

 

 

 



Table of Contents

 

TABLE OF CONTENTS

 

PART I

ITEM 1.

Business

 

1

 

General

 

1

 

OneBeacon

 

2

 

Sirius Group

 

10

 

Esurance

 

19

 

Other Operations

 

19

 

Investments

 

21

 

Regulation

 

22

 

Ratings

 

27

 

Employees

 

27

 

Available Information

 

28

ITEM 1A.

Risk Factors

 

28

ITEM 1B.

Unresolved Staff Comments

 

34

ITEM 2.

Properties

 

34

ITEM 3.

Legal Proceedings

 

35

ITEM 4

Mine Safety Disclosures

 

35

Executive Officers of the Registrant and its Subsidiaries

 

36

PART II

ITEM 5.

Market for the Company’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities

 

37

ITEM 6.

Selected Financial Data

 

38

ITEM 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

39

 

Liquidity and Capital Resources

 

55

 

Non-GAAP Financial Measures

 

64

 

Critical Accounting Estimates

 

65

 

Forward Looking Statements

 

90

ITEM 7A.

Quantitative and Qualitative Disclosures About Market Risk

 

90

ITEM 8.

Financial Statements and Supplementary Data

 

92

ITEM 9.

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

 

92

ITEM 9A.

Controls and Procedures

 

93

ITEM 9B.

Other Information

 

93

PART III

ITEM 10.

Directors, Executive Officers and Corporate Governance

 

93

ITEM 11.

Executive Compensation

 

93

ITEM 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

93

ITEM 13.

Certain Relationships and Related Transactions, and Director Independence

 

93

ITEM 14.

Principal Accountant Fees and Services

 

93

PART IV

ITEM 15.

Exhibits and Financial Statement Schedules

 

94

 

CERTIFICATIONS

 

C-1

 



Table of Contents

 

PART I

 

Item 1.  Business

 

GENERAL

 

White Mountains Insurance Group, Ltd. (the “Company” or the “Registrant”) is an exempted Bermuda limited liability company whose principal businesses are conducted through its property and casualty insurance and reinsurance subsidiaries. Within this report, the term “White Mountains” is used to refer to one or more entities within the consolidated organization, as the context requires. The Company’s headquarters is located at 14 Wesley Street, Hamilton, Bermuda HM 11, its principal executive office is located at 80 South Main Street, Hanover, New Hampshire 03755-2053 and its registered office is located at Clarendon House, 2 Church Street, Hamilton, Bermuda HM 11. White Mountains’ reportable segments are OneBeacon, Sirius Group, and Other Operations. On October 7, 2011, White Mountains completed its sale of Esurance Holdings, Inc. and its subsidiaries (“Esurance Insurance”) and Answer Financial Inc. and its subsidiaries (“AFI”) (collectively, “Esurance”). Accordingly, Esurance is no longer a reportable segment and is included in discontinued operations in White Mountains’ financial statements.

 

The OneBeacon segment consists of OneBeacon Insurance Group, Ltd. (“OneBeacon Ltd.”), an exempted Bermuda limited liability company that owns a family of U.S. based property and casualty insurance companies (collectively, “OneBeacon”), most of which operate in a multi-company pool. OneBeacon is a specialty property and casualty insurance writer that offers a wide range of insurance products through independent agencies, regional and national brokers, wholesalers and managing general agencies. During 2006, White Mountains sold 27.6 million, or 27.6%, of OneBeacon Ltd.’s common shares in an initial public offering.  As of December 31, 2011, White Mountains owned 75.5% of OneBeacon Ltd.’s outstanding common shares.  On August 30, 2011, OneBeacon entered into a definitive agreement to sell its AutoOne Insurance business (“AutoOne”). Accordingly, AutoOne is included in discontinued operations in White Mountains’ financial statements. The sale of AutoOne closed in February 2012.

 

The Sirius Group segment consists of Sirius International Insurance Group, Ltd. (formerly White Mountains Re Ltd.), an exempted Bermuda limited liability company, and its subsidiaries (collectively, “Sirius Group”). Sirius Group provides insurance and reinsurance products for property, accident and health, aviation and space, trade credit, marine, casualty, agriculture and certain other exposures on a worldwide basis through its subsidiaries, Sirius International Insurance Corporation (“Sirius International”), Sirius America Insurance Company (“Sirius America”) and Lloyd’s Syndicate 1945 (“Syndicate 1945”). Sirius Group also specializes in the acquisition and management of run-off insurance and reinsurance companies both in the United States and internationally through its White Mountains Solutions division.  On December 30, 2011, Sirius Group completed a transaction led by White Mountains Solutions to acquire the run-off loss reserve portfolio of Old Lyme Insurance Company Ltd. (“Old Lyme”). Sirius Group also includes Scandinavian Reinsurance Company, Ltd. (“Scandinavian Re”), which is in run-off, and Central National Insurance Company of Omaha (“Central National”), which was acquired during the first quarter of 2010 and is in run-off.

 

White Mountains’ Other Operations segment consists of the Company and its intermediate holding companies, its wholly-owned investment management subsidiary, White Mountains Advisors LLC (“WM Advisors”), the consolidated results of the Tuckerman Capital, LP fund (“Tuckerman Fund I”), White Mountains’ variable annuity reinsurance business, White Mountains Life Reinsurance (Bermuda) Ltd. (“WM Life Re”), which is in run-off, as well as various other entities not included in other segments.

 

White Mountains’ Operating Principles

 

White Mountains strives to operate within the spirit of four operating principles. These are:

 

Underwriting Comes First.  An insurance enterprise must respect the fundamentals of insurance. There must be a realistic expectation of underwriting profit on all business written, and demonstrated fulfillment of that expectation over time, with focused attention to the loss ratio and to all the professional insurance disciplines of pricing, underwriting and claims management.

 

Maintain a Disciplined Balance Sheet.  The first concern here is that insurance liabilities must always be fully recognized. Loss reserves and expense reserves must be solid before any other aspect of the business can be solid. Pricing, marketing and underwriting all depend on informed judgment of ultimate loss costs and that can be managed effectively only with a disciplined balance sheet.

 

Invest for Total Return.  Historical insurance accounting has tended to hide unrealized gains and losses in the investment portfolio and over reward reported investment income (interest and dividends). Regardless of the accounting, White Mountains must invest for the best growth in value over time. In addition to investing our bond portfolios for total after-tax return, that will mean prudent investment in equities consistent with leverage and insurance risk considerations.

 

Think Like Owners.  Thinking like owners has a value all its own. There are stakeholders in a business enterprise and doing good work requires more than this quarter’s profit. But thinking like an owner embraces all that without losing the touchstone of a capitalist enterprise.

 

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ONEBEACON

 

OneBeacon, whose U.S. corporate headquarters are in Minnetonka, Minnesota, is a specialty property and casualty insurance writer that offers a wide range of insurance products through independent agencies, regional and national brokers, wholesalers and managing general agencies. As a specialty company, OneBeacon is guided by a focus on certain customer groups and/or geographic territories where it believes its targeted products and expertise deliver a competitive advantage. OneBeacon believes specialization will result in superior returns as compared to a more “generalist” underwriting approach and that its knowledge regarding its targeted industries, classes and risk characteristics provides it with a competitive edge when determining the terms and conditions on individual accounts. OneBeacon’s products relate to: professional liability, marine, collector cars and boats, energy, entertainment, sports and leisure, group accident, property and inland marine, public entities, technology, tuition refund and excess and surplus lines.

 

At December 31, 2011 and 2010, OneBeacon had $5.8 billion and $6.1 billion of total assets and $1.1 billion and $1.2 billion of common shareholders’ equity, respectively. At December 31, 2011 and 2010, White Mountains reported $273 million and $295 million of noncontrolling interest related to its ownership in OneBeacon. OneBeacon wrote $1.1 billion and $1.2 billion in net written premiums in 2011 and 2010, respectively.

 

The following table presents the financial strength ratings assigned to OneBeacon’s principal insurance operating subsidiaries as of February 28, 2012:

 

 

 

A.M. Best(1)

 

Standard & Poor’s(2)

 

Moody’s(3)

 

Fitch(4)

 

Rating

 

“A” (Excellent)

 

“A-” (Strong)

 

“A2” (Good)

 

“A” (Strong)

 

Outlook

 

Stable

 

Stable

 

Stable

 

Stable

 

 


(1)

 

“A” is the third highest of fifteen financial strength ratings assigned by A.M. Best Company (“A.M. Best”).

(2)

 

“A-” is the seventh highest of twenty-one financial strength ratings assigned by Standard & Poor’s Financial Services LLC (“Standard & Poor’s”).

(3)

 

“A2” is the sixth highest of twenty-one financial strength ratings assigned by Moody’s Investor Service (“Moody’s”).

(4)

 

“A” is the sixth highest of twenty-one financial strength ratings assigned by Fitch Ratings (“Fitch”).

 

Property and Casualty Insurance Overview

 

Generally, property and casualty insurance companies write insurance policies in exchange for premiums paid by their customers (the insured). An insurance policy is a contract between the insurance company and the insured where the insurance company agrees to pay for losses suffered by the insured that are covered under the contract. Such contracts often are subject to subsequent legal interpretation by courts, legislative action and arbitration. Property insurance generally covers the financial consequences of accidental losses to the insured’s property, such as a business’ building, inventory and equipment or personal property. Casualty insurance (often referred to as liability insurance) generally covers the financial consequences of a legal liability of an individual or an organization resulting from negligent acts and omissions causing bodily injury and/or property damage to a third party. Claims on property coverage generally are reported and settled in a relatively short period of time, whereas those on casualty coverage can take years, even decades, to settle.

 

OneBeacon derives substantially all of its revenues from earned premiums, investment income and net realized and unrealized investment gains and losses on investment securities. Earned premiums represent premiums received from insureds, which are recognized as revenue over the period of time that insurance coverage is provided (i.e., ratably over the life of the policy). A significant period of time normally elapses between the receipt of insurance premiums and the payment of insurance claims. During this time, OneBeacon invests the premiums, earns investment income and generates net realized and unrealized gains and losses on investment activities.

 

Insurance companies incur a significant amount of their total expenses from policyholder losses, which are commonly referred to as claims. In settling policyholder losses, various loss adjustment expenses (“LAE”) are incurred such as insurance adjusters’ fees and litigation expenses. In addition, insurance companies incur policy acquisition expenses, such as commissions paid to agents and premium taxes, and other expenses related to the underwriting process, including their employees’ compensation and benefits. The key measure of relative underwriting performance for an insurance company is the combined ratio. An insurance company’s combined ratio under accounting principles generally accepted in the United States (“GAAP”) is calculated by adding the ratio of incurred loss and LAE to earned premiums (the “loss and LAE ratio”) and the ratio of policy acquisition and other underwriting expenses to earned premiums (the “expense ratio”). A combined ratio under 100% indicates that an insurance company is generating an underwriting profit. However, when considering investment income and investment gains or losses, insurance companies operating at a combined ratio of greater than 100% can be profitable.

 

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Lines of Business

 

Historically, OneBeacon offered a range of specialty, commercial and personal products. However, as a result of recent transactions, OneBeacon is now focused exclusively on specialty business. The transactions freed up significant capital, increased OneBeacon’s financial flexibility and substantially reduced its catastrophe exposure. On December 3, 2009, OneBeacon sold the renewal rights to its non-specialty commercial lines business to the Hanover Insurance Group Ltd. (“The Hanover”), beginning with January 1, 2010 effective dates (the “Commercial Lines Transaction”) and on July 1, 2010, OneBeacon completed the sale of its traditional personal lines business to Tower Group Inc. (“Tower”) (the “Personal Lines Transaction”). In addition, on August 30, 2011, OneBeacon entered into a definitive agreement to sell its AutoOne business, which closed in February 2012 (the “AutoOne Sale”).

 

OneBeacon’s net written premiums for the years ended December 31, 2011, 2010 and 2009 consist of on-going specialty insurance operations and other insurance operations, which are primarily businesses that are now in run-off or have been sold as a result of the Commercial Lines Transaction and the Personal Lines Transaction.

 

Net written premiums by line of business

 

Year Ended December 31,

 

Millions

 

2011

 

2010

 

2009

 

Specialty insurance operations

 

$

1,062.7

 

$

988.0

 

$

946.2

 

Other insurance operations

 

.2

 

171.0

 

871.6

 

Total

 

$

1,062.9

 

$

1,159.0

 

$

1,817.8

 

 

Specialty Insurance Operations

 

OneBeacon’s specialty insurance operations include a collection of niche businesses that focus on solving the unique needs of particular customer or industry groups on a national scale. OneBeacon provides distinct products and offers tailored coverages and services, managed by seasoned teams of market specialists. Some of these businesses maintain stand-alone operations and distribution channels targeting their specific customer groups. The majority of these businesses are focused on smaller property-casualty insurance segments where particular expertise and relationships with similarly focused distribution partners have resulted historically in strong operating results. These businesses maintain their competitive advantage through a deep knowledge of their respective customers and markets. OneBeacon has added, and expects to continue to add, new businesses both organically and through acquisition, guided by its focus on profitable growth while prudently managing underwriting risk.  OneBeacon’s specialty insurance businesses are described below.

 

Collector Cars and Boats

 

Through its exclusive partnership with Hagerty Insurance Agency (“Hagerty”), OneBeacon offers tailored coverages for collectible vehicles and wooden boats, automotive museums and restoration shops. Notable features include agreed value for the insured vehicle or boat, flexible usage, and overseas shipping/foreign touring coverage — supported by in-house claims expertise. OneBeacon’s relationship with Hagerty has an initial term of five years and will be up for renewal in the second quarter of 2013.

 

A.W.G. Dewar (“Dewar”)

 

Dewar has been a leading provider of tuition reimbursement insurance since 1930. Dewar’s product protects both schools and parents from the financial consequences of a student’s withdrawal or dismissal from school. OneBeacon owns approximately 83% of the Dewar agency.

 

OneBeacon Entertainment (“OBE”)

 

OBE is an underwriting facility that includes the managing general agency, Entertainment Brokers International Insurance Services (“EBI”), which OneBeacon acquired in July 2008. OBE’s primary focus is providing specialized commercial insurance products, including professional liability coverages, for the entertainment, sports, and leisure industries, through a network of independent agents and brokers.

 

International Marine Underwriters (“IMU”)

 

IMU, which traces its roots to the early 1900s, offers a full range of ocean marine insurance products including, but not limited to, commercial hull and marine liabilities at both the primary and excess levels; ocean and air cargo with coverage extensions such as inland transit, warehousing, and processing; yachts; and several marine “package” products with comprehensive property, auto, and liability coverage.

 

OneBeacon Technology Insurance (“OBTI”)

 

OBTI delivers targeted insurance solutions for specific Technology segments including InfoTech, MedTech, Telecommunications, Electronic Manufacturing, Integration Contractors, Instrument Manufacturers and Clean Tech/Solar. OBTI’s tailored products and coverages include property, general liability, business auto, commercial umbrella, workers compensation, international, technology errors or omissions, data privacy and communications liability. OBTI delivers specialized expertise, innovation and service through dedicated underwriting, risk control and claims staff.

 

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Table of Contents

 

OneBeacon Accident Group (“OBA”)

 

OBA focuses on providing solutions for the transportation, non-subscription and corporate accident marketplace. OBA’s product suite includes accidental death and dismemberment, occupational accident, sports accident, non-truckers liability, vehicle physical damage and other accident coverages. OBA also manages OneBeacon Services, which provides employers and affinity groups with access to services including a discounted prescription drug program, identity theft management services and travel assistance services.

 

OneBeacon Government Risks (“OBGR”)

 

OBGR provides solutions for midsized municipalities and counties, special districts including water and sanitation, non-rail transit authorities and other publicly funded agencies. Products include property, casualty and professional liability comprised of law enforcement, public officials and employment practices liability offered on a fully insured, deductible, self-insured retention or assumed reinsurance basis.

 

OneBeacon Energy Group (“OBEG”)

 

OBEG focuses on middle-market upstream and midstream conventional energy business, alternative and renewable energy producers, alternative fuel producers and related service and manufacturing enterprises. OBEG offers a full array of property, inland marine and casualty insurance, including property damage, boiler and machinery breakdown, general liability, auto liability and umbrella liability. OBEG continues to develop and expand product offerings to serve its customers’ needs. OBEG does not offer offshore energy products.

 

OneBeacon Professional Insurance (“OBPI”)

 

OBPI specializes in professional liability solutions for targeted industries including hospitals, managed care organizations, long-term care facilities, medical facilities, physician groups, media organizations, lawyers, real estate professionals, design professionals, financial services and technology providers. Additionally, OBPI provides employment practices liability, management liability and tailored products for complex organizations including health care provider excess insurance and HMO reinsurance. General liability, property and workers’ compensation coverages are also available for financial institutions. OBPI’s policies are primarily issued on a “claims made” basis, which generally covers claims that are made against an insured during the time period when a liability policy is in effect. This coverage differs from the typical “occurrence” basis policies, which generally cover losses that occur while the policy is in force, regardless of when the claim is reported.

 

OneBeacon Property and Inland Marine (“PIM”)

 

PIM provides monoline property and inland marine products for targeted classes of business. The business focuses on builders’ risks, contractors’ equipment, installation floaters, fine arts, motor truck cargo, transportation, miscellaneous articles floaters, warehousemen’s legal liability, and other inland marine opportunities. For property, the target is nursing homes, assisted living, and independent living as well as cultural institutions and related property to support inland marine accounts, including property for contracting accounts.

 

OneBeacon Specialty Property (“OBSP”)

 

OBSP provides excess property and inland marine solutions that augment primary policies or self-insured retentions. Target classes of business include apartments and condominiums, commercial real estate, small-to-medium manufacturing, retail/wholesale, education and public entities. OBSP products are provided primarily through surplus lines wholesalers.

 

OneBeacon Excess and Surplus (“OBES”)

 

OneBeacon’s newest business, OBES was established in July 2010 to support its current businesses and write selectively in the excess and surplus market. OBES includes OneBeacon Environmental, which offers specialized environmental insurance products designed to address a broad range of exposures faced by businesses. Capabilities include commercial general liability, contractors environmental liability, professional liability, environmental premises liability, products pollution liability and follow-form excess.

 

Other Insurance Operations

 

OneBeacon’s other insurance operations consist of run-off business, primarily non-specialty commercial lines business, the renewal rights to which were sold in 2009 as described below, as well as national accounts, certain specialty programs and regional agency business transferred to Liberty Mutual Insurance Group in 2001. Additionally, OneBeacon’s other insurance operations included the traditional personal lines business until the business was sold in 2010 as described below.

 

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Table of Contents

 

On December 3, 2009, OneBeacon sold the renewal rights to its 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.  OneBeacon continues to manage claims from its non-specialty commercial lines policies written prior to the Commercial Lines Transaction. Through June 30, 2010, OneBeacon also managed claims from business fronted by OneBeacon and reinsured to The Hanover. OneBeacon continues to provide claims system access and first notice of loss service to The Hanover. The Hanover reimburses OneBeacon for its expenses incurred to provide the claims administration services.

 

On July 1, 2010, OneBeacon completed the sale of its traditional personal lines business to Tower. The transaction primarily included two insurance companies containing the personal lines business and two attorneys-in-fact managing the reciprocal exchanges that write the personal lines business in New York and New Jersey. OneBeacon also entered into a Transition Services Agreement (“TSA”), pursuant to which it provides certain services to Tower during the three-year term of the TSA. Tower reimburses OneBeacon for its expenses incurred to provide these services.

 

Discontinued Operations

 

On August 30, 2011, OneBeacon entered into a definitive agreement (the “AutoOne Purchase Agreement”) to sell its AutoOne business to Interboro Holdings, Inc. (“Interboro”). OneBeacon formed AutoOne in 2001 to provide products and services to automobile assigned risk markets primarily in New York and New Jersey. AutoOne had previously been included within OneBeacon’s other insurance operations, however, as a result of entering into the AutoOne Purchase Agreement, AutoOne is now presented as a discontinued operation. Upon closing in February 2012, OneBeacon transferred to Interboro AutoOne Insurance Co. and AutoOne Select Insurance Co., which contained the assets, liabilities, and the capital of the business, and transferred substantially all of the AutoOne infrastructure including systems and office space as well as certain staff.

 

Geographic Concentration

 

Substantially all of OneBeacon’s net written premiums are derived from business produced in the United States. Business from specialty insurance operations was produced in the following states:

 

Specialty insurance operations

 

Year Ended December 31,

 

Net written premiums by state 

 

2011

 

2010

 

2009

 

California

 

14

%

13

%

13

%

New York

 

9

 

9

 

9

 

Texas

 

7

 

7

 

7

 

Florida

 

5

 

6

 

6

 

Massachusetts

 

5

 

5

 

5

 

Other(1)

 

60

 

60

 

60

 

Total

 

100

%

100

%

100

%

 


(1)

No individual state is greater than 5% of specialty net written premiums for the years ended December 31, 2011, 2010 and 2009.

 

Marketing and Distribution

 

OneBeacon offers its products through a network of select independent agents, regional and national brokers and wholesalers. Overall, OneBeacon has approximately 2,700 distribution relationships across the country. In recent years, OneBeacon has expanded its distribution channels to include select managing general agencies (“MGAs”), either through acquisitions or exclusive relationships. These MGAs focus on a particular customer group with tailored products and services, and related expertise.

 

OneBeacon protects the integrity of its franchise value by selectively appointing distribution partners that demonstrate business and industry knowledge and geographic profiles that align with its target markets and specialized capabilities. OneBeacon believes in the added value provided by independent distribution partners as they conduct more complete assessments of their clients’ needs, which result in more appropriate coverages and prudent risk management. OneBeacon also believes that agents and brokers will continue to be a significant force in overall industry premium production.

 

Underwriting and Pricing

 

OneBeacon believes there must be a realistic expectation of attaining an underwriting profit on all the business it writes, as well as a demonstrated fulfillment of that expectation over time. Consistent with the “underwriting comes first” operating principle, adequate pricing is a critical component for achieving an underwriting profit. OneBeacon underwrites its book with a disciplined approach towards pricing its insurance products and is willing to forgo a business opportunity if it believes it is not priced appropriately to the exposure.

 

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OneBeacon actively monitors pricing activity and measures usage of tiers, credits, debits and limits. In addition, OneBeacon regularly updates base rates to achieve targeted returns on capital and attempts to shift writings away from lines and classes where pricing is inadequate. To the extent changes in premium rates, policy forms or other matters are subject to regulatory approval (see “REGULATION—United States” on page 22 and “Risk Factors—Regulation may restrict our ability to operate on page 32), OneBeacon proactively monitors its pending regulatory filings to facilitate, to the extent possible, their prompt processing and approval. Lastly, OneBeacon expends considerable effort to measure and verify exposures and insured values.

 

Competition

 

Property and casualty insurance is highly competitive. OneBeacon’s businesses each compete against a different subset of companies.  OneBeacon competes with most specialty companies, such as Allied World Assurance Company, HCC Insurance Holdings, Inc., Ironshore Inc., Markel Corporation, RLI Corp. and W.R. Berkley Corporation. OneBeacon also competes in certain of its businesses with various local and regional insurance companies.  OneBeacon also competes to varying degrees in one or more of its businesses with most of the large multi-line insurance companies, such as ACE Limited, Chartis Insurance, Chubb Group of Insurance Companies, CNA Insurance, Liberty Mutual Insurance Group, Travelers Insurance Group Holdings Inc. and Zurich Financial Services Ltd.

 

The more significant competitive factors for most insurance products OneBeacon offers are price, product terms and conditions, agency and broker relationships and claims service. OneBeacon’s underwriting principles and dedication to independent distribution partners are unlikely to make it the low-cost provider in most markets. While it is often difficult for insurance companies to differentiate their products, OneBeacon believes that by providing superior specialty products to satisfy well-defined market needs and relying on agents and brokers who value its targeted expertise, superior claims service, and disciplined underwriting, they establish their competitive advantage. The continued existence of carriers operating with lower cost structures places ongoing pressure on OneBeacon’s pricing and terms and conditions, which may impact its ability to compete.

 

Claims Management

 

Effective claims management is a critical factor in achieving satisfactory underwriting results. OneBeacon maintains an experienced staff of appraisers, medical specialists, managers and field adjusters strategically located throughout its operating territories. OneBeacon also maintains a special investigative unit designed to detect insurance fraud and abuse and support efforts by regulatory bodies and trade associations to curtail fraud.

 

Following the Commercial Lines and Personal Lines Transactions, claims operations are now organized into ongoing claims and run-off claims, with specific claims resources supporting the respective operations. This approach allows OneBeacon to better identify and manage claims handling costs. In addition, a shared claims service unit manages costs related to all claims staff and vendors. OneBeacon has adopted a total claims cost management approach that gives equal importance to controlling claims handling expenses, legal expenses and claims payments, enabling it to lower the sum of the three. This approach requires the utilization of a considerable number of conventional metrics to monitor the effectiveness of various programs implemented to lower total loss costs. OneBeacon utilizes the metrics to guard against implementation of expense containment programs that will cost more than it expects to save.

 

OneBeacon’s claims department utilizes a claims workstation to record reserves, payments and adjuster activity and, with support from expert tools, assists each claim handler in identifying recovery potential, estimating property damage, evaluating claims and identifying fraud. OneBeacon’s commitment and performance in fighting insurance fraud has reduced claim costs and aided law enforcement investigations.

 

OneBeacon has a reinsurance contract with National Indemnity Company (“NICO”) to help protect against potential asbestos and environmental (“A&E”) claims (the “NICO Cover”).  See “Catastrophe Risk Management and Reinsurance Protection” below.  NICO has retained a third-party administrator (“TPA”), Resolute New England (“Resolute”) to manage the claims processing for A&E claims reinsured under the NICO Cover. OneBeacon’s claims department personnel are consulted by NICO and Resolute on major claims. As with all TPAs, claims department personnel continually monitor Resolute to ensure its controls, processes and settlements are appropriate.

 

Catastrophe Risk Management and Reinsurance Protection

 

In the normal course of its business, OneBeacon purchases reinsurance from high-quality, highly rated, third-party reinsurers in order to minimize loss from large losses or catastrophic events.

 

The timing and size of catastrophe losses are unpredictable and the level of losses experienced in any year could be material to OneBeacon’s operating results and financial position. Examples of catastrophes include losses caused by earthquakes, wildfires, hurricanes and other types of storms and terrorist acts. The extent of losses caused by catastrophes is a function of the amount and type of insured exposure in the area affected by the event as well as the severity of the event. OneBeacon uses models (primarily AIR Worldwide (“AIR”) Version 12) to estimate the probability of the occurrence of a catastrophic event as well as potential losses under various scenarios. OneBeacon uses this model output in conjunction with other data to manage its exposure to catastrophe losses through individual risk selection and by limiting its concentration of insurance written in catastrophe-prone areas such as coastal regions. In addition, OneBeacon imposes wind deductibles on existing coastal windstorm exposures.

 

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OneBeacon seeks to further reduce its potential loss from catastrophe exposures through the purchase of catastrophe reinsurance. Effective May 1, 2011, OneBeacon renewed its property catastrophe reinsurance program through April 30, 2012. The program provides coverage for OneBeacon’s property business for losses resulting from natural catastrophes, as well as certain acts of terrorism. Under the program, the first $50 million of losses resulting from any single catastrophe are retained and the next $175 million of losses resulting from the catastrophe are reinsured, although OneBeacon retains a co-participation of 26% of losses from $50 million to $100 million and 10% of losses from $100 million to $175 million. Losses from $175 million to $225 million are fully reinsured. Any loss above $225 million would be retained in full. In the event of a catastrophe, OneBeacon’s property catastrophe reinsurance program is reinstated for the remainder of the original contract term by paying a reinstatement premium that is based on the percentage of coverage reinstated and the original property catastrophe coverage premium. OneBeacon anticipates that the $225 million limit is sufficient to cover its largest single event natural catastrophe exposure with a modeled 0.4%-0.5% probability of occurrence (1-in-250-year event to 1-in-200-year event).  This $225 million limit was reduced from the $275 million limit that our previous catastrophe reinsurance program provided. This reduction was in response to lower catastrophe exposure as OneBeacon’s run-off business winds down.

 

OneBeacon’s property catastrophe reinsurance program does not cover property losses resulting from any nuclear events or biological, chemical or radiological terrorist attacks or losses resulting from acts of terrorism as defined under the Terrorism Risk Insurance Act of 2002 (the “Terrorism Act” or “TRIA”), as amended, committed by an individual or individuals acting on behalf of any foreign person or foreign interest, as well as domestic acts of terrorism. Such losses are subject to coverage provided to insurance companies by TRIA (See “Terrorism” on page 7).

 

OneBeacon also purchases property-per-risk reinsurance coverage to reduce large loss volatility. The property-per-risk reinsurance program reinsures losses in excess of $10 million up to $100 million. Individual risk facultative reinsurance may be purchased above $100 million where OneBeacon deems it appropriate. The property-per-risk treaty also provides one limit of reinsurance protection for losses in excess of $10 million up to $100 million on an individual risk basis for terrorism losses. However, any nuclear events, or biological, chemical or radiological terrorist attacks are not covered.

 

OneBeacon also maintains a casualty reinsurance program that provides protection for individual policies involving workers compensation, general liability, automobile liability, professional liability or umbrella liability in excess of $5 million up to $21 million ($20 million for healthcare professional liability). Casualty losses involving more than one insured are covered by a dedicated treaty up to $40 million in excess of a retention of $10 million.

 

In addition, OneBeacon has reinsurance contracts with two reinsurance companies rated “AA+” (Very Strong, the second highest of twenty-one financial strength ratings) by Standard & Poor’s and “A++” (Superior, the highest of fifteen financial strength ratings) by A.M. Best. One contract is the reinsurance cover with NICO, which entitles OneBeacon to recover up to $2.5 billion in ultimate loss and LAE incurred related primarily to claims arising from business written by OneBeacon prior to 1992 for asbestos claims and prior to 1987 for environmental claims and certain other exposures. As of December 31, 2011, OneBeacon has ceded estimated incurred losses of approximately $2.3 billion to the NICO Cover. Net losses paid totaled $1.4 billion as of December 31, 2011. The other contract is a reinsurance cover with General Reinsurance Corporation (“GRC”) for up to $570 million of additional losses on all claims arising from accident years 2000 and prior (the “GRC Cover”). Through December 31, 2011, OneBeacon had ceded estimated incurred losses of $562 million to the GRC Cover. Pursuant to the GRC Cover, OneBeacon is not entitled to recover losses to the full contract limit if such losses are reimbursed by GRC more quickly than anticipated at the time the contract was signed. OneBeacon intends to only seek reimbursement from GRC for claims which result in payment patterns similar to those supporting OneBeacon’s recoverables recorded pursuant to the GRC Cover. The economic cost of not submitting certain other eligible claims to GRC is primarily the investment spread between the rate credited by GRC and the rate achieved by OneBeacon on its own investments. This cost, if any, is expected to be nominal. During the year ended December 31, 2011, OneBeacon collected $74 million under the GRC Cover.

 

Reinsurance contracts do not relieve OneBeacon of its obligation to its policyholders. Therefore, collectibility of balances due from reinsurers is critical to OneBeacon’s financial strength. See Note 4—“Third-Party Reinsurance” of the accompanying consolidated financial statements.

 

Terrorism

 

Since the terrorist attacks of September 11, 2001, OneBeacon has sought to mitigate the risk associated with any future terrorist attacks by limiting the aggregate insured value of policies in geographic areas with exposure to losses from terrorist attacks. This is accomplished by either limiting the total insured values exposed, or, where applicable, through the use of terrorism exclusions.

 

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In December 2007, the U.S. government extended the Terrorism Act until December 31, 2014. The Terrorism Act established a federal “backstop” for commercial property and casualty losses, including workers compensation, resulting from acts of terrorism by or on behalf of any foreign person or foreign interest. As extended, the law now also covers domestic acts of terrorism. The law limits the industry’s aggregate liability by requiring the federal government to share 85% of certified losses once a company meets a specific retention or deductible as determined by its prior year’s direct written premiums and limits the aggregate liability to be paid by the government and industry without further action by Congress at $100 billion. In exchange for this “backstop,” primary insurers are required to make coverage available to commercial insureds for losses from acts of terrorism as specified in the Terrorism Act. The following types of coverage are excluded from the program: commercial automobile, burglary and theft, surety, farmowners multi-peril and all professional liability coverage except directors and officers coverage.

 

OneBeacon estimates its individual retention level for commercial policies subject to the Terrorism Act to be approximately $100 million in 2012. The federal government will pay 85% of covered terrorism losses that exceed OneBeacon’s or the industry’s retention levels in 2012, up to a total of $100 billion.

 

OneBeacon closely monitors and manages its concentration of risk by geographic area. OneBeacon’s guideline is to control its exposures so that its total maximum expected loss from a likely terrorism event within any half-mile radius in a metropolitan area or around a target risk will not exceed $200 million, or $300 million in all other areas, before considering the Terrorism Act. Reports monitoring OneBeacon’s terrorism exposures are generated quarterly, and the exposure of potential new business located in areas of existing concentration or that individually present significant exposure is evaluated during the underwriting process. As a result, OneBeacon believes that it has taken appropriate actions to limit its exposure to losses from terrorist attacks and will continue to monitor its terrorism exposure in the future. Nonetheless, risks insured by OneBeacon, including those covered by the Terrorism Act, remain exposed to terrorist attacks and the possibility remains that losses resulting from future terrorist attacks could prove to be material.

 

Loss and Loss Adjustment Expense Reserves

 

OneBeacon establishes loss and LAE reserves that are estimates of amounts needed to pay claims and related expenses in the future for insured events that have already occurred. The process of estimating reserves involves a considerable degree of judgment by management and, as of any given date, is inherently uncertain. See “CRITICAL ACCOUNTING ESTIMATES — Loss and LAE Reserves — OneBeacon” on page 67 for a full discussion regarding OneBeacon’s loss reserving process.

 

The following information presents (1) OneBeacon’s reserve development over the preceding ten years and (2) a reconciliation of reserves on a regulatory basis to reserves determined in accordance with GAAP, each as prescribed by Securities Act Industry Guide No. 6.

 

Section I of the 10 year table shows the estimated liability that was recorded at the end of each of the indicated years for all current and prior accident year unpaid loss and LAE. The liability represents the estimated amount of loss and LAE for claims that were unpaid at the balance sheet date, including incurred but not reported (“IBNR”) reserves. In accordance with GAAP, the liability for unpaid loss and LAE is recorded in the balance sheet gross of the effects of reinsurance with an estimate of reinsurance recoverables arising from reinsurance contracts reported separately as an asset. The net balance represents the estimated amount of unpaid loss and LAE outstanding as of the balance sheet date, reduced by estimates of amounts recoverable under reinsurance contracts.

 

Section II shows the cumulative amount of net loss and LAE paid relating to recorded liabilities as of the end of each succeeding year. Section III shows the re-estimated amount of the previously recorded net liability as of the end of each succeeding year. Estimates of the liability for unpaid loss and LAE are increased or decreased as payments are made and more information regarding individual claims and trends, such as overall frequency (the average number of claims submitted per policy during a given period of time) and severity (the average value of claims submitted per policy during a given period of time) patterns, becomes known. Section IV shows the cumulative net (deficiency)/redundancy representing the aggregate change in the liability from original balance sheet dates and the re-estimated liability through December 31, 2011. Section V shows the re-estimated gross liability and re-estimated reinsurance recoverables through December 31, 2011. Section VI shows the cumulative gross (deficiency)/redundancy representing the aggregate change in the liability from original balance sheet dates and the re-estimated liability through December 31, 2011.

 

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Table of Contents

 

 

 

OneBeacon Loss and LAE(1)(2)

 

 

 

Year ended December 31,

 

($ in millions)

 

2001

 

2002

 

2003

 

2004

 

2005

 

2006

 

2007

 

2008

 

2009

 

2010

 

2011

 

I. Liability for unpaid loss and LAE:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross balance

 

$

8,424.8

 

$

7,531.4

 

$

6,104.8

 

$

5,298.0

 

$

5,530.7

 

$

4,926.0

 

$

4,587.2

 

$

4,402.4

 

$

4,029.5

 

$

3,394.7

 

$

3,521.9

 

Less reinsurance recoverable on unpaid losses and LAE

 

(3,609.7

)

(3,560.6

)

(2,980.4

)

(2,704.5

)

(3,382.0

)

(3,079.7

)

(2,850.6

)

(2,708.4

)

(2,383.4

)

(2,069.7

)

(2,330.8

)

Net balance

 

4,815.1

 

$

3,970.8

 

$

3,124.4

 

$

2,593.5

 

$

2,148.7

 

$

1,846.3

 

$

1,736.6

 

$

1,694.0

 

$

1,646.1

 

$

1,325.0

 

$

1,191.1

 

II. Cumulative amount of net liability paid through:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1 year later

 

1,891.2

 

1,617.2

 

1,408.8

 

1,164.8

 

922.7

 

689.1

 

620.0

 

605.7

 

737.4

 

493.4

 

 

2 years later

 

3,100.2

 

2,775.3

 

2,287.5

 

1,817.6

 

1,430.4

 

1,098.7

 

990.0

 

1,008.8

 

1,043.8

 

 

 

 

 

3 years later

 

4,039.2

 

3,523.6

 

2,804.4

 

2,228.6

 

1,751.0

 

1,382.6

 

1,232.1

 

1,176.8

 

 

 

 

 

 

 

4 years later

 

4,633.3

 

3,967.0

 

3,119.8

 

2,482.2

 

1,965.9

 

1,526.0

 

1,328.7

 

 

 

 

 

 

 

 

 

5 years later

 

4,979.4

 

4,230.9

 

3,319.6

 

2,648.5

 

2,063.3

 

1,577.8

 

 

 

 

 

 

 

 

 

 

 

6 years later

 

5,195.7

 

4,401.3

 

3,453.3

 

2,736.1

 

2,094.5

 

 

 

 

 

 

 

 

 

 

 

 

 

7 years later

 

5,337.0

 

4,521.6

 

3,487.5

 

2,732.0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

8 years later

 

5,446.2

 

4,541.3

 

3,514.0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

9 years later

 

5,520.4

 

4,554.7

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

10 years later

 

5,482.8

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

III. Net Liability re-estimated as of:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1 year later

 

4,872.4

 

4,137.1

 

3,232.6

 

2,688.9

 

2,176.5

 

1,815.2

 

1,663.6

 

1,577.3

 

1,588.9

 

1,322.1

 

 

2 years later

 

5,154.5

 

4,253.0

 

3,344.6

 

2,692.2

 

2,219.7

 

1,763.8

 

1,558.5

 

1,509.8

 

1,599.6

 

 

 

 

 

3 years later

 

5,243.5

 

4,358.4

 

3,358.0

 

2,786.9

 

2,182.7

 

1,688.2

 

1,513.1

 

1,517.2

 

 

 

 

 

 

 

4 years later

 

5,326.0

 

4,377.0

 

3,468.1

 

2,768.6

 

2,133.4

 

1,642.6

 

1,547.5

 

 

 

 

 

 

 

 

 

5 years later

 

5,347.4

 

4,509.8

 

3,485.6

 

2,762.0

 

2,123.7

 

1,703.2

 

 

 

 

 

 

 

 

 

 

 

6 years later

 

5,475.9

 

4,513.6

 

3,480.1

 

2,756.3

 

2,175.3

 

 

 

 

 

 

 

 

 

 

 

 

 

7 years later

 

5,475.9

 

4,524.0

 

3,486.5

 

2,796.9

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

8 years later

 

5,489.1

 

4,531.9

 

3,529.8

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

9 years later

 

5,495.8

 

4,570.9

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

10 years later

 

5,531.3

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

IV. Cumulative net (deficiency)/redundancy

 

$

(716.2

)

$

(600.1

)

$

(405.4

)

$

(203.4

)

$

(26.6

)

$

143.1

 

$

189.1

 

$

176.8

 

$

46.5

 

$

2.9

 

$

 

Percent (deficient)/redundant

 

(14.9

)%

(15.1

)%

(13.0

)%

(7.8

)%

(1.2

)%

7.8

%

10.9

%

10.4

%

2.8

%

.2

%

 

V. Reconciliation of net liability re-estimated as of the end of the latest re-estimation period (see III above):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross re-estimated liability

 

$

10,689.9

 

$

9,675.8

 

$

7,952.1

 

$

6,851.4

 

$

6,111.7

 

$

5,302.2

 

$

4,923.5

 

$

4,769.4

 

$

4,508.2

 

$

3,911.2

 

$

 

Less: gross re-estimated reinsurance recoverable

 

(5,158.6

)

(5,104.9

)

(4,422.3

)

(4,054.5

)

(3,936.4

)

(3,599.0

)

(3,376.0

)

(3,252.2

)

(2,908.6

)

(2,589.1

)

 

Net re-estimated liability

 

$

5,531.3

 

$

4,570.9

 

$

3,529.8

 

$

2,796.9

 

$

2,175.3

 

$

1,703.2

 

$

1,547.5

 

$

1,517.2

 

$

1,599.6

 

$

1,322.1

 

$

 

VI. Cumulative gross (deficiency)/redundancy

 

$

(2,265.1

)

$

(2,144.4

)

$

(1,847.3

)

$

(1,553.4

)

$

(581.0

)

$

(376.2

)

$

(336.3

)

$

(367.0

)

$

(478.7

)

$

(516.5

)

$

 

Percent (deficient)/redundant

 

(26.8

)%

(28.4

)%

(30.2

)%

(29.3

)%

(10.5

)%

(7.6

)%

(7.3

)%

(8.3

)%

(11.9

)%

(15.2

)%

 

 


(1)  Amounts reported in the table do not include adjustments for purchase accounting related to the acquisition of OneBeacon.

(2)  For purposes of the 10-year table, loss and LAE reserves related to AutoOne have been excluded for all periods presented to conform to the current presentation of assets and liabilities associated with the AutoOne business, which are presented as held for sale in the December 31, 2011 balance sheet.

 

The following table reconciles loss and LAE reserves determined on a regulatory basis to loss and LAE reserves determined in accordance with GAAP at December 31, as follows:

 

 

 

Year Ended December 31,

 

Millions

 

2011

 

2010

 

2009

 

Regulatory reserves

 

$

2,604.6

 

$

2,681.7

 

$

3,285.4

 

Reinsurance recoverable on unpaid losses and LAE(1)

 

997.2

 

813.1

 

866.9

 

AutoOne(2)

 

(64.7

)

(77.3

)

(95.8

)

Discount on loss reserves(3)

 

(15.2

)

(22.8

)

(27.0

)

Reserves before purchase accounting

 

3,521.9

 

3,394.7

 

4,029.5

 

Purchase accounting

 

(163.3

)

(176.5

)

(190.5

)

GAAP reserves

 

$

3,358.6

 

$

3,218.2

 

$

3,839.0

 

 


(1) Represents adjustments made to add back reinsurance recoverables included with the presentation of reserves under regulatory accounting.

(2) Represents loss and LAE reserves related to AutoOne, which are presented as liabilities held for sale in the December 31, 2011 balance sheet and have been excluded from the 10-year table for all periods presented.

(3) Represents long-term workers compensation loss and LAE reserve discount recorded in excess of statutorily defined discount.

 

OneBeacon’s Senior Notes

 

In May 2003, OneBeacon U.S. Holdings, Inc. (“OBH”), an intermediate holding company of OneBeacon, issued $700 million face value of senior unsecured notes through a public offering, at an issue price of 99.7% (the “OBH Senior Notes”). The OBH Senior Notes bear an annual interest rate of 5.875%, payable semi-annually in arrears on May 15 and November 15, until maturity in May 2013. Since their issuance through December 31, 2011, OneBeacon has repurchased $430 million face value of the OBH Senior Notes. As a result, at December 31, 2011, $270 million face value of the OBH Senior Notes remained outstanding.

 

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White Mountains provides an irrevocable and unconditional guarantee as to the payment of principal and interest on the OBH Senior Notes. In consideration of this guarantee OneBeacon pays White Mountains a guarantee fee equal to 25 basis points per annum on the outstanding principal amount of the OBH Senior Notes. If White Mountains’ voting interest in OneBeacon Ltd.’s common shares ceases to represent more than 50% of all of OneBeacon Ltd.’s voting securities, OneBeacon Ltd. is obligated to redeem, exchange or otherwise modify the OBH Senior Notes in order to fully and permanently eliminate White Mountains’ obligations under the guarantee. In the event that White Mountains’ guarantee is not eliminated, the guarantee fee will increase over time up to a maximum of 450 basis points.

 

SIRIUS GROUP

 

Sirius Group provides insurance and reinsurance products for property, accident and health, aviation and space, trade credit, marine, agriculture, and certain other exposures on a worldwide basis through its subsidiary, Sirius International. Sirius International, which is the largest reinsurance company domiciled in Scandinavia based on gross written premiums, also owns Sirius America and Syndicate 1945.  Sirius Group also specializes in the acquisition and management of run-off liabilities for insurance and reinsurance companies both in the United States and internationally through its White Mountains Solutions division (See “White Mountains Solutions”) on page 12.

 

In 2011, Sirius Group established Syndicate 1945, which is currently focused on writing accident and health and contingency business.  Syndicate 1945 began writing business effective July 1, 2011 and had gross written premiums net of commissions of $5 million in 2011.  Syndicate 1945 has Lloyd’s approved net capacity for 2012 of £67 million ($104 million based on the December 31, 2011 GBP to USD exchange rate).

 

During the fourth quarter of 2011, White Mountains completed a rebranding and reorganization (the “Reorganization”) of its reinsurance business.  As part of the Reorganization, White Mountains’ reinsurance businesses adopted the Sirius name globally and Sirius America (formerly WMRe America) became a wholly owned subsidiary of Sirius International (formerly WMRe Sirius).

 

Sirius Group has offices in Australia, Belgium, Bermuda, Connecticut, Copenhagen, Hamburg, London, Miami, New York, Singapore, Stockholm, Toronto and Zurich. At December 31, 2011 and 2010, the Sirius Group segment had $5.3 billion and $5.6 billion of total assets and $1.3 billion and $1.5 billion of common shareholder’s equity, respectively.  The Sirius Group segment wrote $916 million and $866 million in net written premiums in 2011 and 2010, respectively.

 

The following table presents the financial strength ratings assigned to the principal reinsurance operating subsidiaries of Sirius Group as of February 28, 2012:

 

 

 

A.M. Best(1)

 

Standard & Poor’s(2)

 

Moody’s(3)

 

Fitch(4)

 

Rating

 

“A” (Excellent)

 

“A-” (Strong)

 

“A3” (Good)

 

“A-” (Strong)

 

Outlook

 

Stable

 

Stable

 

Stable

 

Stable

 

 


(1)“A” is the third highest of fifteen financial strength ratings assigned by A.M. Best.

(2)“A-” is the seventh highest of twenty-one financial strength ratings assigned by Standard & Poor’s.

(3)“A3” is the seventh highest of twenty-one financial strength ratings assigned by Moody’s.

(4)“A-” is the seventh highest of twenty-one financial strength ratings assigned by Fitch.

 

In connection with the Reorganization, A.M. Best upgraded the financial strength rating of Sirius America from “A-” (Excellent, the fourth highest of fifteen ratings) to a group “A” (Excellent, the third highest of fifteen ratings), consistent with Sirius International’s rating, and all financial strength ratings from the four major ratings agencies were affirmed with stable outlooks.

 

Reinsurance Overview

 

Reinsurance is an arrangement in which a reinsurance company (the ‘‘reinsurer’’) agrees to indemnify an insurance company (the ‘‘ceding company’’) for all or a portion of the insurance risks underwritten by the ceding company under one or more insurance policies. Reinsurance can benefit a ceding company in a number of ways, including reducing exposure on individual risks, providing catastrophe protections from large or multiple losses, and assisting in maintaining acceptable capital levels as well as financial and operating leverage ratios. Reinsurance can also provide a ceding company with additional underwriting capacity by permitting it to accept larger risks and underwrite a greater number of risks without a corresponding increase in its capital. Reinsurers may also purchase reinsurance, known as retrocessional reinsurance, to cover their own risks assumed from ceding companies. Reinsurance companies often enter into retrocessional agreements for many of the same reasons that ceding companies enter into reinsurance agreements.

 

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Reinsurance is generally written on a treaty or facultative basis. Treaty reinsurance is an agreement whereby the reinsurer assumes a specified portion or category of risk under all qualifying policies issued by the ceding company during the term of the agreement, usually one year. When underwriting treaty reinsurance, the reinsurer does not evaluate each individual risk and generally accepts the original underwriting decisions made by the ceding company. Treaty reinsurance is typically written on either a proportional or excess of loss basis. A proportional reinsurance treaty is an arrangement whereby a reinsurer assumes a predetermined proportional share of the premiums and losses generated on specified business. An excess of loss treaty is an arrangement whereby a reinsurer assumes losses that exceed a specific retention of loss by the ceding company. Facultative reinsurance, on the other hand, is underwritten on a risk-by-risk basis, which allows the reinsurer to determine pricing for each exposure.

 

Sirius Group writes treaty and facultative reinsurance, as well as primary direct business. The majority of Sirius Group’s premiums are derived from excess of loss and proportional reinsurance contracts, which in 2011 amounted to 66% and 19%, respectively, of its total net written premiums, while primary direct business represented 15% of total net written premiums.

 

A significant period of time normally elapses between the receipt of reinsurance premiums and the payment of reinsurance claims. While premiums are generally paid to the reinsurer upon inception of the underlying coverage, the claims process is delayed and generally begins upon the occurrence of an event causing an insured loss followed by: (1) the reporting of the loss by the insured to its broker or agent; (2) the reporting by the broker or agent to the ceding company; (3) the reporting by the ceding company to its reinsurance intermediary or agent; (4) the reporting by the reinsurance intermediary or agent to the reinsurer; (5) the ceding company’s adjustment and payment of the loss; and (6) the payment to the ceding company by the reinsurer. During this time, reinsurers invest the premiums and earn investment income and generate net realized and unrealized investment gains and losses on investments. The period of time between the receipt of premiums and the payment of claims is typically longer for a reinsurer than for a primary insurer.

 

Classes of Business

 

The following table shows Sirius Group’s net written premiums by class of business for the years ended December 31, 2011, 2010 and 2009:

 

Business class

 

Year Ended December 31,

 

Millions

 

2011

 

2010

 

2009

 

Accident and health

 

$

245.8

 

$

211.4

 

$

184.3

 

Other property

 

217.0

 

243.7

 

260.5

 

Property catastrophe excess

 

201.5

 

185.4

 

188.0

 

Trade credit

 

79.6

 

51.5

 

6.7

 

Aviation and space

 

60.8

 

58.1

 

58.4

 

Marine

 

45.3

 

41.8

 

39.5

 

Agriculture

 

32.8

 

27.2

 

25.7

 

Casualty

 

18.0

 

32.8

 

30.4

 

Contingency

 

15.1

 

13.9

 

13.3

 

Total

 

$

915.9

 

$

865.8

 

$

806.8

 

 

For each of the years ended December 31, 2011, 2010, and 2009, 85%, 86%, and 87%, respectively, of Sirius Group’s net written premiums were for reinsurance products, with the remainder being insurance products.

 

Accident and Health

 

Sirius Group’s accident and health business is composed of three major classes of business. In the largest class of business, Sirius Group is a surplus lines insurer of international medical expenses written through International Medical Group, Inc., which is the agent writing on Sirius Group’s behalf. The second major class of business comprises proportional treaties covering employer medical stop loss for per person (specific) and per employer (aggregate) exposures. The third major class of business comprises medical, health and personal accident coverages written on an excess treaty and facultative basis.

 

Other Property

 

Sirius Group is a leader in the broker market for property treaties written on a proportional and excess of loss basis.  For its international business, the book consists of treaty, written on both a proportional and non-proportional basis, facultative, and direct business, primarily in Europe. In the United States, the book predominantly centers on significant participations on proportional and excess of loss treaties for carefully chosen partners in the excess & surplus lines segment of the market.

 

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Property Catastrophe Excess

 

Property catastrophe excess of loss treaties cover losses from catastrophic events. Sirius Group writes a worldwide portfolio with the largest concentration of exposure in Europe and the United States, and seeks to set prices and terms on treaties wherever possible. The current U.S. book has a national account focus supporting the lower and/or middle layers of large capacity programs. The catastrophe portfolio mainly consists of select large national, small regional and standard lines carriers. The exposures written in the international portfolio are diversified across many countries, regions and perils.

 

Trade Credit

 

Sirius Group writes credit and bond reinsurance, mostly on companies with worldwide operations. Most debtors are based in Europe, representing approximately 62% of Sirius Group’s exposure. The bulk of the business is traditional short term commercial credit insurance, covering pre-agreed domestic and export sales of goods and services with typical coverage periods of 60 to 120 days.  Losses under these policies (protection of undisputed debts against declared insolvency and protracted default) are closely correlated to adverse changes in a respective country’s gross national product.

 

Aviation and Space

 

Aviation insurance covers loss of or damage to an aircraft and the aircraft operations’ liability to passengers, cargo and hull as well as to third parties. Additionally, liability arising out of non-aircraft operations such as hangars, airports and aircraft products can be covered. Space insurance covers loss of or damage to a satellite during launch and in orbit.  The book consists of treaty, written on both on a proportional and non-proportional basis, facultative, and direct business.

 

Marine

 

Sirius Group provides marine reinsurance, primarily written on an excess of loss and proportional basis.  Coverage offered includes damage to ships and goods in transit, marine liability lines, and offshore energy industry insurance. The marine portfolio is diversified across many countries and regions.

 

Agriculture

 

Sirius Group primarily provides proportional and stop loss coverage to companies writing U.S. government-sponsored Multi-Peril Crop Insurance (“MPCI”). Sirius Group’s participation is net of the government’s stop loss reinsurance protection. Sirius Group also provides coverage for crop-hail and certain named perils when bundled with MPCI business.  Sirius Group also writes a small amount of agriculture business outside of the United States.

 

Casualty

 

Through 2011, Sirius Group’s casualty treaty division accepted reinsurance submissions for all lines of general casualty and professional liability business.  Due to insufficient U.S. casualty premium rates and global interest rates, the overall casualty book of business has decreased over time and effective January 1, 2012, Sirius Group no longer writes casualty business other than incidental exposures. Sirius Group could resume writing casualty business if premium rates and contract terms improve to favorable levels.

 

Contingency

 

Sirius Group underwrites contingency insurance, primarily for event cancellation and non-appearance, primarily on a direct policy and facultative reinsurance basis.  Additionally, coverage for liabilities arising from contractual bonus, prize redemption and over redemption are also offered.  The contingency portfolio is diversified across many countries and regions.

 

White Mountains Solutions

 

White Mountains Solutions is a Connecticut-based division of Sirius Group specializing in the acquisition and management of run-off liabilities for insurance and reinsurance companies both in the United States and internationally.  The White Mountains Solutions team is comprised of a dedicated group of financial, actuarial and claims professionals experienced in the management and resolution of complex insurance liabilities as well as the structuring of transactions designed to enable owners to exit an insurance business and extract trapped capital. Acquisitions typically involve purchases at a significant discount to book value and undergo an extensive due diligence process. Value to the Sirius Group is derived not only from the discount purchase price, but also from the investment income on insurance float on reserves under management, the settlement of claims below the carried level of reserves and the harvesting of other embedded assets, including the value of shell companies and licenses.

 

Cumulative net income, after-tax, related to seven transactions executed by White Mountains Solutions from the formation of the division through December 31, 2011 is approximately $149 million.

 

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On December 30, 2011, Sirius Group completed a transaction led by White Mountains Solutions to acquire the run-off loss reserve portfolio of Old Lyme, a Bermuda reinsurer in run-off since 2008. Old Lyme’s loss reserves of approximately $23 million were transferred via novation agreements into White Shoals Re Ltd., a wholly-owned Bermuda reinsurance company established by Sirius Group earlier in 2011. The transaction resulted in a gain of $7 million recorded in other revenues.

 

On February 26, 2010, White Mountains Solutions completed the acquisition of Central National from Drum Financial Corporation for $5 million. Central National ceased writing business in 1989 and has operated under the control of the Nebraska Department of Insurance since 1990. The transaction resulted in a gain of $13 million recorded in other revenues.

 

Geographic Concentration

 

The following table shows Sirius Group’s net written premiums by geographic region based on the location of the ceding company or reinsurer for the years ended December 31, 2011, 2010 and 2009:

 

Geographic region

 

Year Ended December 31,

 

Millions

 

2011

 

2010

 

2009

 

United States

 

$

436.5

 

$

398.9

 

$

443.7

 

Europe

 

271.8

 

284.7

 

265.5

 

Canada, the Caribbean, Bermuda and Latin America

 

100.7

 

102.8

 

40.3

 

Asia and Other

 

106.9

 

79.4

 

57.3

 

Total

 

$

915.9

 

$

865.8

 

$

806.8

 

 

Marketing and Distribution

 

Sirius Group obtains most of its reinsurance submissions from reinsurance intermediaries. Business submissions come from intermediaries that represent the ceding company. The process of placing an intermediary reinsurance program typically begins when a ceding company enlists the aid of a reinsurance intermediary in structuring a reinsurance program. The ceding company and the reinsurance intermediary will often consult with one or more lead reinsurers as to the pricing and contract terms for the reinsurance protection being sought. Once the ceding company has approved the terms quoted by the lead reinsurer, the reinsurance intermediary will offer participation to qualified reinsurers until the program is fully subscribed. Sirius Group considers both the reinsurance intermediary and the ceding company to be its clients in any placement. Sirius Group has developed strong business relationships over a long period of time with the management of many of its ceding companies.

 

Sirius Group pays ceding companies a ceding commission under most proportional reinsurance treaties and some excess of loss reinsurance treaties. The ceding commission is generally based on the ceding company’s cost of acquiring and administering the business being reinsured (e.g., agent commissions, premium taxes and certain miscellaneous expenses). The ceding commissions paid to ceding companies constitute the majority of Sirius Group’s total acquisition costs. Additionally, Sirius Group pays reinsurance intermediaries commissions based on negotiated percentages of the premium they produce by treaty or certificate.

 

During the years ended December 31, 2011, 2010, and 2009, Sirius Group received no more than 10% of its gross written premiums from any individual ceding company. During the years ended December 31, 2011, 2010, and 2009, Sirius Group received a majority of its gross reinsurance premiums written from three major, third-party reinsurance intermediaries as detailed in the following table:

 

 

 

Year Ended December 31,

 

Gross written premium by intermediary

 

2011

 

2010

 

2009

 

AON Re/Benfield

 

31

%

35

%

37

%

Guy Carpenter

 

19

 

19

 

16

 

Willis Re

 

10

 

10

 

7

 

 

 

60

%

64

%

60

%

 

Underwriting and Pricing

 

Sirius Group maintains a disciplined underwriting strategy which, while considering overall exposure, focuses on writing more business when market terms and conditions are favorable and reducing business volume during soft markets when terms and conditions become less favorable. Sirius Group offers clients a wide range of reinsurance products across multiple lines of business to satisfy their risk management needs.

 

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Sirius Group derives its reinsurance business from a broad spectrum of ceding companies, including national, regional, specialty, and excess and surplus lines writers, both internationally and in the United States. Sirius Group prices its products by assessing the desired return on the expected capital needed to write a given contract and on the expected underwriting results of the contract. Sirius Group’s pricing indications are based on a number of underwriting factors including historical results, analysis of exposure and estimates of future loss costs, a review of other programs displaying similar exposure characteristics and the ceding company’s underwriting and claims experience. Additionally, in the United States, Sirius Group’s underwriters, actuaries and claims personnel perform audits of certain ceding companies. Generally, ceding company audits are not customary outside the United States. Sirius Group’s staff reviews the financial stability and creditworthiness of all ceding companies globally. Such reviews provide important input to support underwriting decisions.

 

Reinsurers do not have the stringent regulations with respect to contract terms and policy exclusions that are generally imposed on primary insurers. For example, the Terrorism Act is not applicable to reinsurers. As a result, terrorism exclusions on reinsurance contracts are dictated by the marketplace. Sirius Group evaluates terrorism exposure from its ceding companies and applies exclusions as it deems appropriate and as are permitted by market conditions. Reinsurance on U.S. commercial risks written by Sirius Group subsequent to the terrorist acts of September 11, 2001 generally contains clauses that exclude acts of terrorism certified under the Terrorism Act. Reinsurance on personal risks written by Sirius Group subsequent to the terrorist acts of September 11, 2001 generally contains exclusions related to nuclear, biological, radiological and chemical attacks.

 

Competition

 

The worldwide insurance and reinsurance markets are highly competitive. Competition is influenced by a variety of factors, including price charged and other terms and conditions offered, financial strength ratings, prior history and relationships, as well as expertise and the speed at which the company has historically paid claims.

 

Sirius Group competes for business in Europe, Bermuda, the United States, and other international markets with numerous global competitors. Sirius Group’s competitors include other insurance and reinsurance companies and underwriting syndicates at Lloyd’s of London. Some of the companies that Sirius Group competes directly with include Alterra Capital Holdings, Ltd., Arch Capital Group Ltd., Aspen Insurance Holdings Ltd., Axis Capital Holdings, Ltd., Endurance Specialty Holdings Ltd., Everest Re Group, Ltd., Flagstone Re Holdings SA, General Reinsurance Corporation, Hannover Ruckversicherung AG, Montpelier Re Holdings, Ltd., Munich Re Group, Odyssey Re Holdings Corp., PartnerRe Ltd., Platinum Underwriters Holdings Ltd., Renaissance Re Holdings Ltd., Scor Global P&C, Swiss Re Group, Transatlantic Holdings, Inc., Validus Holdings, Ltd., and XL Capital Ltd.

 

Claims Management

 

Sirius Group maintains a staff of experienced insurance and reinsurance claim specialists.  Its reinsurance claims specialists work closely with intermediaries to obtain specific claims information from ceding companies. Where customary and appropriate, Sirius Group’s claims staff performs selective on-site claim reviews to assess ceding companies’ claim handling abilities and reserve techniques. In addition, Sirius Group’s claims specialists review loss information provided by ceding companies for adequacy and accuracy. The results of these claim reviews are shared with the underwriters and actuaries to assist them in pricing products and establishing loss reserves.

 

Sirius Group also uses TPAs for certain claims, including claims arising from certain of Sirius Group’s run-off claims related to certain acquired companies. Sirius Group’s claims staff performs on-site claim audits of certain TPAs to ensure the propriety of the controls and processes over claims serviced by the TPAs.

 

Catastrophe Risk Management

 

Sirius Group has exposure to losses caused by hurricanes, earthquakes, tornadoes, winter storms, windstorms, floods, tsunamis, terrorist acts and other catastrophic events. In the normal course of business, Sirius Group regularly manages its concentration of exposures to catastrophic events, primarily by limiting concentrations of exposure to what it deems acceptable levels and, if necessary, purchasing reinsurance. In addition, Sirius Group seeks to limit losses that might arise from acts of terrorism in its insurance and reinsurance contracts by exclusionary provisions, where applicable. Sirius Group licenses third-party global property catastrophe models from AIR and Risk Management Solutions Inc. (“RMS”), which are two of the leading vendors of industry-standard catastrophe modeling software, as well as utilizing its own proprietary models to calculate expected probable maximum loss (“PML”) from various natural property catastrophe scenarios.  Sirius Group prices its property catastrophe contracts using the aforementioned third-party software and internal models and other methods. For contracts that Sirius Group determines to have exposure to natural catastrophic perils, it models and assesses the exposure using the results in its underwriting process to assess that the contracts it writes have an appropriate premium for the exposure.

 

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In addition, to better manage its aggregate exposure to very large catastrophic events, Sirius Group monitors the largest modeled net financial impact (“NFI”) it would suffer in the worst aggregate loss year as calculated by third-party models (i.e., the 10,000-year global annual aggregate PML). The calculation of the NFI begins with the modeled 10,000-year global annual aggregate PML and takes account of estimated reinstatement premiums, reinsurance recoverables (net of estimated uncollectible balances) and tax benefits. This amount is deducted from Sirius Group’s planned legal entity comprehensive income for the year (before any planned losses for catastrophe events) to arrive at the NFI. The NFI does not include the potential impact of the loss events on Sirius Group’s investment portfolio. The NFI calculation is subject to future fluctuation from a variety of factors, including available interest rates, foreign currency movements, changes in third-party models, insurance market pricing, terms and conditions, as well as the availability and pricing of retrocessional protections.

 

Sirius Group’s NFI at January 31, 2012 was under $750 million. The $750 million amount represents approximately 37% and 56% of Sirius Group’s total legal entity GAAP capital and common shareholder’s equity at December 31, 2011, respectively. During 2011, Sirius Group had targeted its NFI to be under $700 million.  The $700 million amount represented approximately 29% and 40% of Sirius Group’s total legal entity GAAP capital and common shareholder’s equity at December 31, 2010, respectively.  The increase in 2012 reflects the impact of model changes and lower forecasted comprehensive net income principally reflecting a lower interest rate environment in 2012 combined with moderate growth in exposures. The 10,000-year Sirius Group annual aggregate PML produced by the AIR model at January 31, 2012 is the most conservative estimate at the tail among AIR, RMS and Sirius Group’s internal models.  However, AIR and RMS do not have all-perils models for every territory where Sirius Group writes business and Sirius Group does not use both AIR and RMS in every territory where it writes business. Sirius Group’s NFI is driven principally by three potential large earthquakes in the United States New Madrid zone occurring within a short period of time, events that would generate almost $400 billion of insured losses for the industry per AIR.

 

The following table provides an estimate of Sirius Group’s three largest PML zones on a per occurrence basis at January 31, 2012:

 

 

 

 

 

 

 

 

 

Sirius Group Net After-Tax Loss

 

($ in millions)

 

Modeled
Industry Loss

 

Sirius Group
Gross Loss

 

Net After
Reinsurance
and
Reinstatements

 

Net
After Tax

 

Net After-Tax
as % of
GAAP Capital(1)

 

Net After-Tax
as % of GAAP
Common
Shareholder’s
Equity(1)

 

 

 

1 in 250 year event

 

Southeast U.S.

 

$

227,758

 

$

396

 

$

350

 

$

254

 

13

%

19

%

Northeast U.S.

 

61,240

 

405

 

324

 

236

 

12

%

17

%

Europe

 

28,896

 

703

 

308

 

227

 

11

%

17

%

 

 

 

1 in 10,000 year event

 

Northeast U.S.

 

$

237,577

 

$

619

 

$

495

 

$

361

 

18

%

27

%

Europe

 

101,815

 

1,067

 

478

 

352

 

18

%

26

%

Southeast U.S.

 

351,383

 

546

 

481

 

350

 

17

%

26

%

 


(1)         GAAP capital and common shareholder’s equity at December 31, 2011 for Sirius Group is determined on a legal-entity basis.

 

In addition to the above, Sirius Group also has significant exposure to United States Gulf Coast windstorms (i.e., Florida to Texas), California and New Madrid earthquakes, and, to a lesser extent, Japanese and Latin American windstorms and earthquakes.

 

Third party catastrophe modelers provide new versions of their models on a periodic basis, usually annually or bi-annually.  In 2011, RMS released Version 11, which significantly increased expected losses to the wind models in the United States and Europe.  For example, United States and European RMS insured industry annual aggregate expected wind loss increased 35% and 65%, respectively, versus the prior RMS version. Two of the main drivers of the United States wind increases were slower inland decay of winds from the coast, which would cause larger losses farther inland, and updates to structure and contents vulnerability, especially for commercial lines.  Key drivers of the European model change include a full spectrum of smaller storm events which significantly increase short term losses and annual aggregate losses, and an improved clustering model. Clustering is defined as the heightened risk that many losses might occur in a single year based on atmospheric conditions.

 

Prior to January 2012, Sirius Group used AIR Version 12 to estimate its PMLs in the United States.  In 2011, Sirius Group enhanced its PML reporting methodology for exposures in the United States to approximate an averaging of AIR and RMS, further adjusted for each treaty by underwriting judgment regarding the specific exposures underlying each cedent’s portfolio.  This change in PML methodology for exposures in the United States increased Sirius Group’s Florida 250-year and 10,000-year all perils occurrence PMLs at January 31, 2012 by approximately $40 million and $4 million, respectively. The smaller increase for the 10,000 year PML reflects the fact that U.S. catastrophe exposed treaties include occurrence caps that limit the upwards loss exposure.

 

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For exposures in countries other than the United States, Sirius Group chooses either AIR or RMS for PML reporting based on underwriting and actuarial assessment as to the integrity of the model by territory and underlying data availability.  The model of choice is then further adjusted for each treaty by underwriting judgment regarding the specific exposures underlying each cedent’s portfolio.

 

For Europe, which is Sirius Group’s most significant PML zone outside the United States, Sirius Group uses RMS. Prior to January 2012, Sirius Group used RMS Version 10 to estimate its PMLs for European exposures.  RMS Version 10 was predominantly used by insurers and reinsurers for January 1, 2012 renewals.  However, to produce its PMLs at January 31, 2012, Sirius Group adjusted the RMS Version 10 loss scenarios for each treaty by applying underwriting judgment regarding the specific exposures underlying each cedent’s portfolio.  Sirius Group believes its Eurpoean PMLs at January 31, 2012 would approximate PMLs produced by using RMS Version 11. Sirius Group’s 250-year and 10,000-year all perils occurrence PMLs for European exposures at January 31, 2012 are 29% and 18% higher, respectively, than at January 2011 reflecting both actual exposure growth and the impact of adjusting loss scenarios produced by RMS Version 10.

 

Sirius Group also monitors its global annual aggregate tail value at risk (“TVaR”) at the 100, 250, 500, and 1,000 year periods. TVaR represents the average loss for the named period through 10,000 years (e.g., TVaR 250 represents the average loss for the worst forty modeled years).

 

Catastrophe modeling is dependent upon several broad economic and scientific assumptions, such as storm surge (the water that is pushed toward the shore by the force of a windstorm), demand surge (the localized increase in prices of goods and services that often follow a catastrophe) and zone density (the percentage of insured perils that would be affected in a region by a catastrophe). Third-party modeling software also does not provide information for all territories or perils (e.g. tsunami) for which Sirius Group writes business.

 

Catastrophe modeling is inherently uncertain due to process risk (i.e., the probability and magnitude of the underlying event) and parameter risk (i.e., the probability of making inaccurate model assumptions). In particular, obtaining geographic and policy coverage data on the primary policies reinsured by Sirius Group is essential. Accordingly, Sirius Group’s ability to develop its catastrophe exposure is dependent on the quality and accuracy of data obtained from its clients.

 

If Sirius Group’s assumptions about any of the above variables are incorrect, the potential incurred losses from an actual catastrophe could be materially higher than the expectation of losses generated from modeled catastrophe scenarios; as a result, Sirius Group’s results of operations and financial condition could be materially adversely affected.

 

Sirius Group does not believe that it can rely solely upon catastrophe modeling to measure its exposure to natural catastrophe risk. For example, the losses arising from hurricane Katrina for both Sirius Group and the industry were substantially in excess of losses previously predicted by third-party models from such an event. This was due to issues such as inadequate storm surge and demand surge assumptions in the models, as well as flooding from levees breaking which was not fully contemplated in these models. Sirius Group monitors gross and net property catastrophe occurrence limits by country and region globally.  Occurrence limits for peak zones in Europe, Japan, and the United States are assessed versus modeled catastrophe risk as another measure in understanding total property catastrophe exposure to large events.

 

Reinsurance Protection

 

Sirius Group’s reinsurance protection primarily consists of pro-rata and excess of loss protections to cover aviation, trade credit, and certain 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 around the world. In addition to its proportional reinsurance purchases, Sirius Group also purchases excess of loss reinsurance protection for $15 million in excess of a retention of $5 million for the facultative and direct property portfolios written by the Stockholm, Hamburg and London branches (excluding business written in the United States).  For the London branch, an additional $5 million of protection in excess of a retention of $5 million for facultative and direct U.S.-catastrophe exposed business was also purchased.  Industry loss warranties (“ILW”) purchased in 2011 for European wind exposures and floods were not renewed, and subsequently expired on January 25, 2012.

 

In 2011, 2010 and 2009, Sirius Group purchased group excess of loss retrocessional coverage for its non-U.S. and non-Japan earthquake-related exposures. The non-U.S. and non-Japan earthquake cover was renewed for one year at April 1, 2011, providing $61 million of reinsurance protection through partially placed coverage layers in excess of Sirius Group’s retention of $35 million. Sirius Group will recognize the full $61 million recovery if a covered earthquake loss reaches $110 million. At April 1, 2010, Sirius Group purchased coverage for $65 million in excess of $45 million. At December 31, 2011, losses incurred for the February 2011 New Zealand earthquake totaled $44 million, which is less than the $45 million retention; accordingly, Sirius Group has not recovered any losses from this coverage.  At April 1, 2009, Sirius Group purchased coverage for $65 million in excess of $35 million, and this coverage applies to losses incurred from the Chile earthquake. During 2010, Sirius Group recovered the full $65 million limit under the earthquake cover as a result of the Chile Earthquake in February 2010.

 

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Sirius Group’s aviation reinsurance program is intended to reduce exposure to a frequency of small losses, a single large loss, or a combination of both.  In 2012, for the proportional and facultative aviation portfolios, reinsurance protection was purchased based on average in excess of a market loss of $150 million up to a full airline policy limit of $2.25 billion. For the non-proportional aviation portfolio, reinsurance protection includes a 15% quota share treaty and several excess of loss covers with varying attachment points and limits. In addition, the non-proportional portfolio is protected by $30 million in the form of first event ILWs, and $6 million of available limit in the form of second event ILWs. The first event ILWs attach at industry event levels between $400 million and $900 million. The second event ILWs attach at industry levels between $300 million and $600 million.

 

For accident and health, Sirius Group has excess of loss protection covering personal accident and life of €10 million ($13 million based on the December 31, 2011 EUR to USD exchange rate) of protection in excess of a €5 million ($7 million based on the December 31, 2011 EUR to USD exchange rate) retention for the Stockholm, Hamburg, Liege and Singapore branches.

 

For 2011, Sirius Group ceded 19% of its trade credit business under a quota share retrocession, which supported growth in this line.  The treaty was renewed for 2012 at a 20% cession percentage for credit business and 50% for bond business.

 

All of Sirius Group’s excess of loss reinsurance protections include provisions that reinstate coverage at a cost of 100% or more of the original reinsurance premium.

 

At December 31, 2011, Sirius Group had $14 million of reinsurance recoverables on paid losses and $340 million of reinsurance recoverables on unpaid losses that will become recoverable if claims are paid in accordance with current reserve estimates. The combined reinsurance recoverable on losses of $354 million is down significantly from the December 31, 2009 balance of $596 million, as a result of paid loss commutations and other settlement activities. Because retrocessional reinsurance contracts do not relieve Sirius Group of its obligation to its insureds, the collectability of balances due from Sirius Group’s reinsurers is critical to its financial strength. Sirius Group monitors the financial strength and ratings of retrocessionaires on an ongoing basis. See Note 4- “Third-party Reinsurance” to the accompanying consolidated financial statements for a discussion of Sirius Group’s top reinsurers.

 

Loss and Loss Adjustment Expense Reserves

 

Sirius Group establishes loss and LAE reserves that are estimates of future amounts needed to pay claims and related expenses for insured events that have already occurred. The process of estimating reserves involves a considerable degree of judgment by management and, as of any given date, is inherently uncertain. See “CRITICAL ACCOUNTING ESTIMATES — Loss and LAE Reserves — Sirius Group” on page 76 for a full discussion regarding Sirius Group’s loss reserving process.

 

The following information presents (1) Sirius Group’s reserve development over the preceding ten years and (2) a reconciliation of reserves on a regulatory basis to reserves determined in accordance with GAAP, each as prescribed by Securities Act Industry Guide No. 6.

 

Section I of the 10 year table shows the estimated liability that was recorded at the end of each of the indicated years for all current and prior accident year unpaid loss and LAE. The liability represents the estimated amount of loss and LAE for claims that were unpaid at the balance sheet date, including IBNR reserves. In accordance with GAAP, the liability for unpaid loss and LAE is recorded in the balance sheet gross of the effects of reinsurance with an estimate of reinsurance recoverables arising from reinsurance contracts reported separately as an asset. The net balance represents the estimated amount of unpaid loss and LAE outstanding as of the balance sheet date, reduced by estimates of amounts recoverable under reinsurance contracts.

 

Section II shows the cumulative amount of net loss and LAE paid relating to recorded liabilities as of the end of each succeeding year. Section III shows the re-estimated amount of the previously recorded net liability as of the end of each succeeding year. Estimates of the liability for unpaid loss and LAE are increased or decreased as payments are made and more information regarding individual claims and trends, such as overall frequency and severity patterns, becomes known. Section IV shows the cumulative net (deficiency)/redundancy representing the aggregate change in the liability from original balance sheet dates and the re-estimated liability through December 31, 2011. Section V shows the re-estimated gross liability and re-estimated reinsurance recoverables through December 31, 2011. Section VI shows the cumulative gross (deficiency)/redundancy representing the aggregate change in the liability from original balance sheet dates and the re-estimated liability through December 31, 2011.

 

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Table of Contents

 

 

 

Sirius Group Loss and LAE

 

 

 

Year ended December 31,

 

($ in millions)

 

2001

 

2002

 

2003

 

2004

 

2005

 

2006

 

2007

 

2008

 

2009

 

2010

 

2011

 

I. Liability for unpaid loss and LAE:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross balance

 

$

1,581.4

 

$

1,588.4

 

$

1,699.4

 

$

3,864.3

 

$

4,308.8

 

$

3,708.8

 

$

3,252.3

 

$

2,735.5

 

$

2,444.4

 

$

2,441.3

 

$

2,343.7

 

Less reinsurance recoverable on unpaid losses and LAE

 

(879.5

)

(809.8

)

(741.1

)

(1,149.8

)

(1,633.6

)

(1,142.5

)

(806.4

)

(545.6

)

(578.6

)

(450.5

)

(339.7

)

Net balance

 

$

701.9

 

$

778.6

 

$

958.3

 

$

2,714.5

 

$

2,675.2

 

$

2,566.3

 

$

2,445.9

 

$

2,189.9

 

$

1,865.8

 

$

1,990.8

 

$

2,004.0

 

II. Cumulative amount of net liability paid through:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1 year later

 

230.6

 

250.7

 

321.5

 

941.0

 

949.4

 

721.7

 

726.2

 

637.4

 

276.2

 

475.3

 

 

2 years later

 

391.2

 

420.8

 

521.8

 

1,369.4

 

1,442.9

 

1,302.0

 

1,164.5

 

760.8

 

533.0

 

 

 

 

 

3 years later

 

501.4

 

559.1

 

710.8

 

1,684.9

 

1,942.5

 

1,645.2

 

1,207.4

 

972.5

 

 

 

 

 

 

 

4 years later

 

602.7

 

690.9

 

834.7

 

2,052.4

 

2,225.6

 

1,649.2

 

1,486.6

 

 

 

 

 

 

 

 

 

5 years later

 

739.3

 

804.5

 

941.0

 

2,246.0

 

2,192.3

 

1,804.3

 

 

 

 

 

 

 

 

 

 

 

6 years later

 

830.6

 

885.7

 

1,015.7

 

2,170.9

 

2,325.5

 

 

 

 

 

 

 

 

 

 

 

 

 

7 years later

 

895.8

 

926.5

 

901.6

 

2,265.1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

8 years later

 

922.1

 

807.1

 

910.7

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

9 years later

 

799.7

 

812.3

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

10 years later

 

796.7

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

III. Net Liability re-estimated as of:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1 year later

 

704.9

 

828.9

 

984.9

 

2,771.9

 

2,893.2

 

2,575.4

 

2,525.7

 

2,159.4

 

1,808.5

 

1,943.9

 

 

2 years later

 

758.7

 

856.9

 

1,059.6

 

2,802.9

 

3,032.5

 

2,775.8

 

2,539.8

 

2,140.6

 

1,797.5

 

 

 

 

 

3 years later

 

800.5

 

929.8

 

1,148.1

 

2,917.9

 

3,164.9

 

2,749.3

 

2,517.2

 

2,124.6

 

 

 

 

 

 

 

4 years later

 

872.2

 

1,023.8

 

1,270.2

 

3,063.6

 

3,133.3

 

2,743.4

 

2,510.7

 

 

 

 

 

 

 

 

 

5 years later

 

968.4

 

1,138.6

 

1,425.0

 

3,021.4

 

3,124.8

 

2,741.7

 

 

 

 

 

 

 

 

 

 

 

6 years later

 

1,077.8

 

1,280.5

 

1,382.7

 

3,013.1

 

3,134.3

 

 

 

 

 

 

 

 

 

 

 

 

 

7 years later

 

1,196.4

 

1,228.5

 

1,379.8

 

3,017.9

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

8 years later

 

1,150.4

 

1,226.0

 

1,383.3

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

9 years later

 

1,142.9

 

1,230.5

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

10 years later

 

1,145.2

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

IV. Cumulative net (deficiency)/redundancy

 

$

(443.3

)

$

(451.9

)

$

(425.0

)

$

(303.4

)

$

(459.1

)

$

(175.4

)

$

(64.8

)

$

65.4

 

$

68.3

 

$

46.9

 

$

 

Percent (deficient)/redundant

 

(63.2

)%

(58.0

)%

(44.3

)%

(11.2

)%

(17.2

)%

(6.8

)%

(2.6

)%

3.0

%

3.7

%

2.4

%

 

V. Reconciliation of net liability re-estimated as of the end of the latest re-estimation period (see III above):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross re-estimated liability

 

$

2,228.9

 

$

2,173.5

 

$

2,271.8

 

$

4,379.9

 

$

5,011.5

 

$

3,931.8

 

$

3,344.1

 

$

2,677.5

 

$

2,372.7

 

$

2,381.3

 

$

 

Less: gross re-estimated reinsurance recoverable

 

(1,083.7

)

(943.0

)

(888.5

)

(1,362.0

)

(1,877.2

)

(1,190.1

)

(833.4

)

(553.0

)

(575.2

)

(437.4

)

 

Net re-estimated liability

 

$

1,145.2

 

$

1,230.5

 

$

1,383.3

 

$

3,017.9

 

$

3,134.3

 

$

2,741.7

 

$

2,510.7

 

$

2,124.5

 

$

1,797.5

 

$

1,943.9

 

$

 

VI. Cumulative gross (deficiency)/redundancy

 

$

(647.5

)

$

(585.1

)

$

(572.4

)

$

(515.6

)

$

(702.7

)

$

(223.0

)

$

(91.8

)

$

58.0

 

$

71.7

 

$

60.0

 

$

 

Percent (deficient)/redundant

 

(40.9

)%

(36.8

)%

(33.7

)%

(13.3

)%

(16.3

)%

(6.0

)%

(2.8

)%

2.9

%

2.9

%

2.5

%

 

 

The cumulative net (deficiency)/redundancy in the table above includes adverse development from A&E claims. Sirius Group’s exposure to A&E claims results mainly from asbestos claims arising from treaty and facultative contracts written prior to 1985 at two companies acquired by Sirius America—MONY Reinsurance Corporation in 1991 and Christiania General Insurance Corporation in 1996. As a result, the table above reflects reserve development on A&E business that was not underwritten by Sirius Group.

 

Sirius Group’s net incurred losses from A&E claims have totaled $218 million over the past ten years. Although losses arising from A&E claims were on contracts that were not underwritten by Sirius Group, Sirius Group is liable for any additional losses arising from such contracts. Accordingly, Sirius Group cannot guarantee that it will not incur additional A&E losses in the future. Refer to “CRITICAL ACCOUNTING ESTIMATES” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for further details of Sirius Group’s A&E reserves.

 

The following table reconciles loss and LAE reserves determined on a regulatory basis to loss and LAE reserves determined in accordance with GAAP at December 31, as follows:

 

 

 

December 31,

 

Millions

 

2011

 

2010

 

2009

 

Regulatory reserves

 

$

1,934.4

 

$

2,151.6

 

$

2,196.8

 

Reinsurance recoverable on unpaid losses and LAE(1)

 

1,177.4

 

1,190.4

 

965.4

 

Discount on loss reserves

 

9.1

 

16.4

 

27.1

 

Reserves allocated to Esurance

 

 

(286.9

)

(333.4

)

WM Life Re reserves(2)

 

(765.2

)

(610.2

)

(380.7

)

Purchase accounting and other

 

(12.0

)

(20.0

)

(30.8

)

GAAP reserves

 

$

2,343.7

 

$

2,441.3

 

$

2,444.4

 

 


(1)         Represents adjustments made to add back reinsurance recoverables included with the presentation of reserves under regulatory accounting. Includes recoverables from WM Life Re business and recoverables on intercompany treaties that are eliminated in consolidation.

(2)         Sirius Group fronted the reinsurance contracts for, and is 100% reinsured by, WM Life Re.  These instruments are reported as reinsurance contracts under Swedish statutory regulations.  For GAAP purposes, the liabilities are transferred to WM Life Re and reported as derivative instruments.

 

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Table of Contents

 

Sirius Group’s Preference Shares and Senior Notes

 

In May 2007, Sirius International Group, Ltd. (“SIG”), an intermediate holding company of Sirius Group, issued $250 million non-cumulative perpetual preference shares, with a $1,000 per share liquidation preference (the “SIG Preference Shares”), and received $246 million of proceeds, net of $4 million of issuance costs and commissions. These shares were issued in an offering that was exempt from the registration requirements of the Securities Act of 1933. Holders of the SIG Preference Shares receive dividends on a non-cumulative basis when and if declared by SIG. The holders of the SIG Preference Shares have the right to elect two directors to SIG’s board in the event of non-payment of dividends for six quarterly dividend periods. The right ceases upon the payment of dividends for four quarterly periods or the redemption of the SIG Preference Shares. In addition, SIG may not declare or pay dividends on its common shares (other than stock dividends and dividends paid for purposes of any employee benefit plans of SIG and its subsidiaries) unless it is current on its most recent dividend period. The dividend rate is fixed at an annual rate of 7.506% until June 30, 2017 and dividends are paid on a semi-annual basis. After June 30, 2017, the dividend rate will be paid at a floating annual rate, equal to the greater of (1) the 3 month LIBOR plus 3.20% or (2) 7.506% and dividends will be paid on a quarterly basis. The SIG Preference Shares are redeemable solely at the discretion of SIG on or after June 30, 2017 at their liquidation preference of $1,000 per share, plus any declared but unpaid dividends. Prior to June 30, 2017, SIG may elect to redeem the SIG Preference Shares at an amount equal to the greater of (1) the aggregate liquidation preference of the shares to be redeemed and (2) the sum of the present values of the aggregate liquidation preference of the shares to be redeemed and the remaining scheduled dividend payments on the shares to be redeemed (excluding June 30, 2017), discounted to the redemption date on a semi-annual basis at a rate equal to the rate on a comparable treasury issue plus 45 basis points. In the event of liquidation of SIG, the holders of the SIG Preference Shares would have preference over the common shareholders and would receive a distribution equal to the liquidation preference per share, subject to availability of funds.

 

In March 2007, SIG issued $400 million face value of senior unsecured notes at an issue price of 99.715% (the “SIG Senior Notes”). The SIG Senior Notes, which were issued in an offering that was exempt from the registration requirements of the Securities Act of 1933, bear an annual interest rate of 6.375%, payable semi-annually in arrears on March 20 and September 20, until maturity in March 2017.

 

ESURANCE

 

On October 7, 2011, White Mountains completed the sale of Esurance to The Allstate Corporation (“Allstate”) for a cash payment of $1.01 billion, which was equal to $700 million plus the estimated pro forma tangible book value at closing of the legal entities sold of approximately $310 million (the “Esurance Sale”). As a result of the transaction, Esurance is reported as discontinued operations in White Mountains’ financial statements.

 

Esurance Insurance wrote personal auto insurance in 30 states through its website and over the phone and also sold other lines of personal insurance for unaffiliated insurance companies. Esurance Insurance also wrote personal auto policies through select on-line agents and provided other insurance products through partnerships with industry leading online providers. The 30 states in which Esurance Insurance wrote business represent approximately 87% of the premium volume for the entire U.S. personal auto insurance market. AFI earned commissions by selling personal auto, homeowners, renters and condo insurance policies online and over the phone using a comparison quoting platform. AFI sold policies in 50 states and the District of Columbia for many insurance companies, including Esurance Insurance.

 

OTHER OPERATIONS

 

White Mountains’ Other Operations segment consists of the Company and its intermediate holding companies, its wholly-owned investment management subsidiary (WM Advisors), the consolidated results of Tuckerman Fund I, its variable annuity reinsurance business (WM Life Re), which is in run-off, as well as various other entities not included in other segments.

 

WM Advisors

 

WM Advisors is a registered investment adviser that manages White Mountains’ investments in fixed income and equity securities, including hedge funds and private equities. WM Advisors also has investment management agreements with third parties, most notably with Symetra Financial Corporation (“Symetra”). At December 31, 2011, WM Advisors had approximately $34 billion in assets under management, $8 billion of which related to consolidated subsidiaries of White Mountains.

 

WM Advisors has a sub-advisory agreement with Prospector Partners LLC (“Prospector”), a registered investment adviser, under which Prospector manages most of White Mountains’ publicly-traded common equity securities and convertible fixed maturity securities. Prospector also provides consulting and advisory services to White Mountains through a separate agreement on matters such as asset allocation, hedge fund and private equity investments, capital management and mergers and acquisitions.

 

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Table of Contents

 

WM Life Re

 

WM Life Re reinsures death and living benefit guarantees associated with certain variable annuities issued in Japan.  Sirius Group fronted the reinsurance contracts for and is 100% reinsured by WM Life Re. WM Life Re is in run-off.

 

WM Life Re has assumed the risk related to a shortfall between the account value and the guaranteed value that must be paid by the ceding company to an annuitant or to an annuitant’s beneficiary in accordance with the underlying annuity contracts.  The guaranteed value of the annuity contracts is equal to the initial single premium paid by the annuitant.  The annuity accounts are invested in four index funds: a Japanese government bond fund indexed to the Nomura Bond Performance Index (“Nomura BPI”) (roughly 35%), a foreign government bond fund indexed to the Citi World Group Government Bond Index, excluding Japan (“WGBI”) (roughly 35%), a Japanese equity fund indexed to the TOPIX Total Return Index (roughly 15%) and a foreign equity fund indexed to the MSCI Kokusai Total Return Index (roughly 15%).  The account is rebalanced monthly to maintain these same investment allocations. As of December 31, 2011, annuity contracts mature within 4 years on average (with a maximum of 4½ years and a minimum of 3½ years remaining).  The guarantee made by the ceding company to its annuitants was economically equivalent to guaranteeing that the underlying investment accounts would earn a return of approximately 2.7% per annum.  The average account value of annuity contracts covered by WM Life Re was approximately 104% of their guarantee value at the inception of the reinsurance contracts.  Accordingly, the guarantee made in WM Life Re’s contracts was economically equivalent to guaranteeing that the underlying investment accounts would earn a return of approximately 2.3% per annum.

 

WM Life Re reinsured ¥200 billion (approximately $1.7 billion at the then current exchange rate) of guarantees in September 2006 and an additional ¥56 billion (approximately $0.5 billion at the then current exchange rate) in March 2007.  WM Life Re has not subsequently written any additional business.  As of December 31, 2011, the total guarantee value was approximately ¥233.7 billion (approximately $3.0 billion at exchange rates on that date).  The average annual premium charged by WM Life Re under these contracts is equal to 1.11% times the total guarantee value.

 

WM Life Re uses derivative instruments, including put options, interest rate swaps, total return swaps on bond indices, forward contracts and futures contracts on major equity indices, currency pairs and government bonds, to mitigate the market risks associated with changes in the fair value of the reinsured variable annuity guarantees. WM Life Re measures its net exposure to changes in relevant interest rates, foreign exchange rates, implied volatilities and equity markets on a daily basis and adjusts its economic hedge positions within risk guidelines established by a risk committee that contains members of White Mountains’ and WM Life Re’s senior management. WM Life Re continually fair values its liability and the related hedge assets.  The guarantee is economically substantially similiar to having sold put options on a basket of the four index funds. WM Life Re also monitors the effects of annuitant related experience against actuarial assumptions (surrender and mortality rates) on a weekly basis and adjusts relevant assumptions and economic hedge positions if required.

 

Under the terms of its reinsurance contracts, WM Life Re is required to hold eligible assets (generally cash, short-term investments and hedge assets such as options and futures) equal to the fair value of the liability, as defined in the reinsurance contracts, for the benefit of the cedant.  Increases in the fair value of the liability in excess of the increase in value of the hedge assets, such as occurs in the case of decreases in surrender assumptions or underperformance of the hedging portfolio, must therefore be funded on a current basis while the actual amounts that must be paid to settle the contracts may not be known and generally will not become payable for a number of years.  White Mountains contributed an additional $20 million, $45 million and $133 million into WM Life Re during 2011, 2010 and 2009, respectively, to fulfill this requirement.

 

See CRITICAL ACCOUNTING ESTIMATES - Fair Value Measurements on page 80 for a discussion of the sensitivity of WM Life Re’s results to changes in market and annuitant-related variables.

 

Tuckerman Fund I

 

On December 31, 2011, the Tuckerman Fund I was dissolved and all of the net assets of the fund were distributed to the owners of the fund, of which White Mountains owned approximately 94%. In conjunction with the dissolution, White Mountains received a portion of the shares of two small manufacturing companies that were owned by the Tuckerman Fund I.  Prior to the dissolution, Tuckerman Fund I was consolidated within White Mountains’ financial statements.  At December 31, 2010, Tuckerman Fund I had $19 million of total assets and accounted for $7 million of White Mountains’ net assets.

 

Weather Risk Management

 

During 2006, White Mountains began selling weather and weather contingent derivative products through its subsidiary, Galileo Weather Risk Management Ltd. (“Galileo”). Weather derivatives, which usually take the form of swaps or options, are contracts with financial settlements based on the performance of an index linked to a quantifiable weather element, such as temperature, precipitation, snowfall or windspeed.  Weather contingent derivative products are weather derivatives with an additional commodity price trigger.

 

During 2009, White Mountains sold Galileo, Galileo Weather Risk Management Advisors LLC and Galileo Weather Risks Advisors Limited for nominal consideration.  White Mountains retained the outstanding weather derivative contracts and stopped writing any new contracts.  Effective December 2009, White Mountains entered into an agreement to novate the remaining outstanding weather derivative contracts to an unrelated third party.  White Mountains was released from any liability related to the weather derivative contracts and all guaranties related to the weather business were terminated.

 

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Table of Contents

 

Berkshire Exchange

 

On October 31, 2008, White Mountains completed the transaction with Berkshire Hathaway Inc. (“Berkshire”) that was announced on March 10, 2008, through which Berkshire exchanged substantially all of its 16.3% stake in White Mountains (1,634,921 of its 1,724,200 common shares) for 100% of a White Mountains subsidiary which held Commercial Casualty Insurance Company (“CCIC”), the International American Group, Inc. and $708 million in cash (the “Berkshire Exchange”). Upon the closing of the exchange transaction, CCIC and the International American Group, Inc. had a combined fair value of $85 million and a combined GAAP book value of $59 million.

 

INVESTMENTS

 

White Mountains’ investment philosophy is to maximize long-term total returns (after-tax) while taking prudent levels of risk and maintaining a diversified portfolio.  Under White Mountains’ philosophy, each dollar of after-tax investment income or investment gains (realized or unrealized) is valued equally.

 

In response to significant declines in market levels, heightened market volatility and a lack of market liquidity during late 2008 and early 2009, White Mountains temporarily shifted its focus from total return to capital preservation. In particular, White Mountains significantly reduced the size of its equity portfolio and managed its fixed income portfolio to avoid realizing losses. During 2010 and 2011, White Mountains gradually shifted back from a focus on capital preservation to its traditional total return investment philosophy.

 

White Mountains’ investment portfolio mix as of December 31, 2011 consisted in large part of high-quality, short-duration, fixed maturity investments and short-term investments, but also included common equity securities, convertible fixed maturity securities and other long-term investments, such as hedge funds and private equities. White Mountains’ management believes that prudent levels of investments in common equity securities, convertible fixed maturity securities and other long-term investments are likely to enhance long-term after-tax total returns. See “Portfolio Composition” on page 51.

 

White Mountains’ overall fixed maturity investment strategy is to purchase securities that are attractively priced in relation to their investment risks. White Mountains also actively manages the average duration of the portfolio.  Duration is about 2.2 years including short-term investments and about 2.4 years excluding short-term investments at December 31, 2011.

 

Prospector’s equity investment strategy is to maximize risk-adjusted absolute return through investments in a variety of equity and equity-related instruments, using a bottom-up, value investing approach. Preservation of capital is of the utmost importance.  Prospector invests in the United States and other developed markets.

 

Prospector Fund

 

White Mountains owns approximately 63% of the limited partnership interests in Prospector Offshore Fund, Ltd. and OneBeacon owns approximately 73% of the limited partnership interests in Prospector Turtle Fund (collectively, the “Prospector Funds”).  These funds are managed by Prospector, a registered investment adviser, and are consolidated within White Mountains’ financial statements. The Prospector Funds are hedge funds that pursue investment opportunities in a variety of equity and equity-related instruments, chiefly in the financial services sector.

 

At December 31, 2011 and 2010, the Prospector Funds had $217 million and $236 million of total assets and accounted for $98 million and $97 million of White Mountains’ net assets.

 

Investments in Unconsolidated Affiliates

 

Symetra

 

In 2004, White Mountains, Berkshire and several other private investors capitalized Symetra in order to purchase the life and investment operations of Safeco Corporation for $1.35 billion. The acquired companies focus mainly on group insurance, individual life insurance, structured settlements and retirement services. Symetra had an initial capitalization of approximately $1.4 billion, consisting of $1,065 million of common equity and $315 million of debt. White Mountains invested $195 million in Symetra in exchange for 17.4 million common shares, as adjusted for stock splits, of Symetra. In addition, White Mountains and Berkshire each received warrants to acquire an additional 9.5 million common shares of Symetra at $11.49 per share, as adjusted for stock splits.  Two White Mountains designees serve on Symetra’s seven member board of directors. White Mountains accounts for its investment in common shares of Symetra under the equity method and accounts for its Symetra warrants as a derivative investment at fair value.

 

In January 2010, Symetra completed an initial public offering at a price of $12 per share, whereby 25.3 million primary shares were sold to the public and 9.7 million secondary shares were sold by existing shareholders. White Mountains did not sell any of its shares of Symetra in the offering. As a result of the offering, White Mountains’ ownership in Symetra has decreased from 19% to 15% of the outstanding common shares of Symetra and from 24% to 20% of Symetra on a fully-converted basis including the warrants.

 

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Table of Contents

 

The following table presents the financial strength ratings assigned to Symetra’s principal insurance operating subsidiaries as of February 28, 2012:

 

 

 

A.M. Best(1)

 

Standard & Poor’s(2)

 

Moody’s(3)

 

Fitch(4)

Rating

 

“A” (Excellent)

 

“A” (Strong)

 

“A3” (Good)

 

“A+” (Strong)

Outlook

 

Stable

 

Negative

 

Stable

 

Negative

 


(1)         “A” is the third highest of sixteen financial strength ratings assigned by A.M. Best.

(2)         “A” is the sixth highest of twenty-one financial strength ratings assigned by Standard & Poor’s.

(3)         “A3” is the seventh highest of twenty-one financial strength ratings assigned by Moody’s.

(4)         “A+” is the fifth highest of twenty-four financial strength ratings assigned by Fitch.

 

Symetra’s total revenues and net income for the years ended December 31, 2011, 2010, and 2009 were $1,999 million and $200 million, $1,879 million and $201 million, and $1,714 million and $128 million. As of December 31, 2011and 2010, Symetra had total assets of $28.2 billion and $25.6 billion and shareholders’ equity of $3.1 billion and $2.4 billion. Symetra’s shareholders’ equity excluding unrealized gains (losses) from its fixed maturity investments was $2.1 billion and $1.9 billion at December 31, 2011 and 2010.

 

As of December 31, 2011 and 2010, White Mountains’ investment in Symetra common shares was $261 million and $287 million, excluding $64 million at December 31, 2010 of equity in unrealized gains from Symetra’s fixed maturity investments. As of December 31, 2011 and 2010, White Mountains’ investment in Symetra warrants was $13 million and $37 million. Since inception, White Mountains has received cash dividends from Symetra of $53 million on its common share investment and $29 million on its warrant investment.

 

During the fourth quarter of 2011, White Mountains recorded a GAAP other-than-temporary impairment write-down on its investment in Symetra common shares. White Mountains concluded that the accounting impairment on its investment in Symetra common shares arose due to the prolonged low interest rate environment in which life insurance companies currently operate and not due to reasons specific to Symetra.  As a result, White Mountains does not believe that the accounting impairment equates to an impairment in Symetra’s long-term intrinsic business value. See CRITICAL ACCOUNTING ESTIMATES — White Mountains’ Investment in Symetra Common Shares on page 88 for a complete discussion of the methodology used to determine the GAAP other-than-temporary impairment on Symetra at December 31, 2011.

 

Delos

 

In August 2006, Sirius Group sold a wholly-owned subsidiary to an investor group led by Lightyear Capital for $139 million in cash and recognized a pre-tax gain of $14 million in other revenue. As part of this transaction, White Mountains acquired an equity interest of approximately 18% for $32 million in the acquiring entity, Lightyear Delos Acquisition Corporation (“Delos”), and accounted for its investment in Delos under the equity method. In December 2010, White Mountains sold its investment in Delos for $22 million and recognized a pre-tax loss of $11 million in other revenue.

 

Pentelia

 

White Mountains obtained an equity interest of 33% in Pentelia Capital Management (“PCM”) for $1.6 million in April 2007. This investment is accounted for under the equity method. As of December 31, 2011, White Mountains investment in PCM was $1.7 million. White Mountains also holds an investment Pentelia Investment Limited (“PIL”), a fund that invests in insurance-related investment assets and is held as an other long-term investment. As of December 31, 2011, the carrying value of White Mountains’ investment in PIL was $17 million.

 

REGULATION

 

United States

 

White Mountains’ U.S.-based insurance and reinsurance operating subsidiaries are subject to regulation and supervision in each of the states where they are domiciled and licensed to conduct business. Generally, state regulatory authorities have broad supervisory and administrative powers over such matters as licenses, standards of solvency, premium rates, policy forms, investments, security deposits, methods of accounting, form and content of financial statements, reserves for unpaid loss and LAE, reinsurance, minimum capital and surplus requirements, dividends and other distributions to shareholders, periodic examinations and annual and other report filings. In general, such regulation is for the protection of policyholders rather than shareholders. White Mountains believes that it is in compliance with all applicable laws and regulations pertaining to its business that would have a material effect on its financial position in the event of non-compliance.

 

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Most states have laws that establish standards for current, as well as continued, state accreditation. In addition, the National Association of Insurance Commissioners (“NAIC”) has risk-based capital (“RBC”) standards for property and casualty insurers as a means of monitoring certain aspects affecting the overall financial condition of insurance companies. The current RBC ratios of White Mountains’ active U.S.-based insurance and reinsurance operating subsidiaries are satisfactory and such ratios are not expected to result in any adverse regulatory action. White Mountains is not aware of any current recommendations by regulatory authorities that would be expected to have a material effect on its results of operations or liquidity.

 

The NAIC’s Annual Financial Reporting Model Regulation, or the Model Audit Rule (“MAR”), includes provisions that are similar to certain Sarbanes-Oxley requirements for public companies and requires certain insurance companies to appoint audit committees to oversee accounting and financial reporting processes as well as the audit of the statutory financial statements of the insurer.  Audit committees also are required to appoint independent auditors, among other things.  The appointed audit committee receives reports regarding significant deficiencies, material weaknesses and solvency concerns at the insurance company level.  Certain insurance companies are also required to annually file a management report on internal control over financial reporting.

 

As a condition of its license to do business in certain states, White Mountains’ U.S.-based insurance and reinsurance operating subsidiaries are required to participate in mandatory shared market mechanisms. Each state dictates the types of insurance and the level of coverage that must be provided. The most common type of shared market mechanism in which White Mountains is required to participate is an assigned risk plan. Many states operate assigned risk plans. These plans require insurers licensed within the applicable state to accept the applications for insurance policies of customers who are unable to obtain insurance in the voluntary market. The total number of such policies an insurer is required to accept is based on its market share of voluntary business in the state. Underwriting results related to assigned risk plans are typically adverse. Accordingly, White Mountains may be required to underwrite policies with a higher risk of loss than it would otherwise accept.

 

Reinsurance facilities are another type of shared market mechanism. Reinsurance facilities require an insurance company to accept all applications submitted by certain state designated agents. The reinsurance facility then allows the insurer to cede some of its business to the reinsurance facility so that the facility will reimburse the insurer for claims paid on ceded business. Typically, however, reinsurance facilities operate at a deficit, which is funded through assessments against the same insurers. As a result, White Mountains could be required to underwrite policies with a higher risk of loss than it would otherwise voluntarily accept.

 

The insurance laws of many states generally provide that property and casualty insurers doing business in those states belong to a statutory property and casualty guaranty association. The purpose of these guaranty associations is to protect policyholders by requiring that solvent property and casualty insurers pay certain insurance claims of insolvent insurers. These guaranty associations generally pay these claims by assessing solvent insurers proportionately based on the insurer’s share of voluntary written premiums in the state. While most guaranty associations provide for recovery of assessments through rate increases, surcharges or premium tax credits, there is no assurance that insurers will ultimately recover these assessments. At December 31, 2011, the reserve for such assessments at White Mountains totaled $16 million.

 

Many states have laws and regulations that limit an insurer’s ability to exit a market. For example, certain states limit a private passenger automobile insurer’s ability to cancel and non-renew policies. Furthermore, certain states prohibit an insurer from withdrawing from one or more lines of insurance business in the state, unless the state regulators approve the company’s withdrawal plans. State regulators may refuse to approve such plans on the grounds that they could lead to market disruption. Such laws and regulations may restrict White Mountains’ ability to exit unprofitable markets.

 

Nearly all states have insurance laws requiring property and casualty insurance companies to file price schedules, policy or coverage forms, and other information with the state’s regulatory authority. In most cases, such price schedules and/or policy forms must be approved prior to use. While pricing laws vary from state to state, their objectives are generally to ensure that prices are adequate, not excessive and not discriminatory.

 

White Mountains’ U.S.-based insurance and reinsurance operating subsidiaries are subject to state laws and regulations that require investment portfolio diversification and that limit the amount of investment in certain categories. Non-compliance may cause non-conforming investments to be non-admitted in measuring statutory surplus and, in some instances, may require divestiture. White Mountains’ investment portfolio at December 31, 2011 complied with such laws and regulations in all material respects.

 

One of the primary sources of cash inflows for the Company and certain of its intermediary holding companies is dividends received from its insurance and reinsurance operating subsidiaries. Under the insurance laws of the states under which White Mountains’ U.S.-based insurance and reinsurance operating subsidiaries are domiciled, an insurer is restricted with respect to the timing or the amount of dividends it may pay without prior approval by regulatory authorities. See “Dividend Capacity” on page 56 for further discussion.

 

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White Mountains is subject to regulation under certain state insurance holding company acts. These regulations contain reporting requirements relating to the capital structure, ownership, financial condition and general business operations of White Mountains’ insurance and reinsurance operating subsidiaries. These regulations also contain special reporting and prior approval requirements with respect to certain transactions among affiliates. Since the Company is an insurance holding company, the domiciliary states of its insurance and reinsurance operating subsidiaries impose regulatory application and approval requirements on acquisitions of White Mountains’ common shares which may be deemed to confer control over those subsidiaries, as that concept is defined under the applicable state laws. Acquisition of 10% of White Mountains’ common shares, or in some states as little as 5%, may be deemed to confer control under the insurance laws of some jurisdictions, and the application process for approval can be extensive and time consuming.

 

While the federal government does not directly regulate the insurance business, federal legislation and administrative policies affect the insurance industry. In addition, legislation has been introduced from time to time in recent years that, if enacted, could result in the federal government assuming a more direct role in the regulation of the insurance industry. For example, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was enacted in 2010 and created the Federal Insurance Office (“FIO”) within the Treasury Department, which is responsible for gathering information and monitoring the insurance industry to identify gaps in the regulation of insurers that could contribute to a systemic crisis in the insurance industry or U.S. financial system. The FIO can also recommend changes to state insurance laws and regulations. The FIO is expected to issue its first report on modernizing and improving insurance regulation in 2012. White Mountains cannot predict whether the FIO will recommend any changes or whether states will adopt any such changes. In addition, the U.S. government enacted the Terrorism Act in 2002 and established a federal “backstop” for commercial property and casualty losses, including workers compensation, resulting from acts of terrorism by or on behalf of any foreign person or foreign interest.  In December of 2007, the Terrorism Act was extended until December 31, 2014. As extended, the law now covers domestic acts of terrorism. In exchange for this “backstop”, primary insurers are required to make coverage available to commercial insureds for losses from acts of terrorism as specified in the Terrorism Act. OneBeacon is actively complying with the requirements of the Terrorism Act in order to ensure its ability to be reimbursed by the federal government for any losses it may incur as a result of future terrorist acts. (See “ONEBEACON — Terrorism” on page 7 for a further discussion of the Terrorism Act). A number of additional enacted and pending legislative measures could lead to increased consolidation and increased competition for business and for capital in the financial services industry. White Mountains cannot predict whether any state or federal measures will be adopted to change the nature or scope of the regulation of the insurance business or what effect such measures may have on its insurance and reinsurance operations.

 

The NAIC’s 2010 amendment to the Model Insurance Company Holding Company System Regulatory Act (the “Model Law”) enhances the authority of state insurance regulators in the adopting state to regulate insurers as well as their affiliated entities, on an enterprise risk basis. The amendment to the Model Law requires the ultimate controlling person in an insurer’s holding company structure to identify and report to state insurance regulators material risks within the structure that could pose enterprise risk to the insurer. The amendment to the Model Law will need to be adopted by individual state legislatures before they become binding on any given state. States may also deviate from these Model Law revisions as states differ in their approaches on several requirements. White Mountains cannot predict whether states will adopt the amendment to the Model Law, or if adopted, whether the amendment will differ from the Model Law.

 

Environmental cleanup of polluted waste sites is subject to both federal and state regulation. The Comprehensive Environmental Response Compensation and Liability Act of 1980 (“Superfund”) and comparable state statutes govern the cleanup and restoration of waste sites by potentially responsible parties (“PRPs”). These laws can impose liability for the entire cost of clean-up upon any PRP, regardless of fault. The insurance industry in general is involved in extensive litigation regarding coverage issues arising out of the cleanup of waste sites by insured PRPs and as a result has disputed many such claims. From time to time, comprehensive Superfund reform proposals are introduced in Congress, but none has yet been enacted. At this time, it remains unclear as to whether Superfund reform legislation will be enacted or that any such legislation will provide for a fair, effective and cost-efficient system for settlement of Superfund related claims. The NICO Cover includes coverage for such exposures at OneBeacon; however, there can be no assurance that the coverage provided under the NICO Cover will ultimately prove to be adequate.

 

Europe

 

Sweden

 

Sirius International is subject to regulation and supervision by the Swedish Financial Supervisory Authorities (the “Swedish FSA”). As Sweden is a member of the European Union (the “EU”), the Swedish FSA supervision is recognized across all locations within the EU. Generally, the Swedish FSA has broad supervisory and administrative powers over such matters as licenses, standards of solvency, investments, methods of accounting, form and content of financial statements, minimum capital and surplus requirements, and annual and other report filings. In general, such regulation is for the protection of policyholders rather than shareholders. White Mountains believes that it is in compliance with all applicable laws and regulations pertaining to its business that would have a material effect on its financial position in the event of non-compliance.

 

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In accordance with provisions of Swedish law, Sirius International is permitted to transfer up to the full amount of its pre-tax income, subject to certain limitations, into an untaxed reserve referred to as a safety reserve, which equaled SEK 9.6 billion or $1.4 billion at December 31, 2011. 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 shareholder’s equity. Generally, this deferred tax liability is only required to be paid by Sirius International 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 Sirius International’s safety reserve ($370 million at December 31, 2011) 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 Sirius International’s regulatory capital when assessing Sirius International’s financial strength.

 

United Kingdom

 

The financial services industry in the United Kingdom is regulated by the Financial Services Authority (“UK FSA”). The UK FSA regulates insurers, insurance intermediaries and Lloyd’s.  The UK FSA and Lloyd’s have common objectives in ensuring that the Lloyd’s market is appropriately regulated. Lloyd’s is required to implement certain rules prescribed by the UK FSA by the powers it has under the Lloyd’s Act of 1982 (“Lloyd’s Act”) relating to the operation of the Lloyd’s market. In addition, each year the UK FSA requires Lloyd’s to satisfy an annual solvency test that measures whether Lloyd’s has sufficient assets in the aggregate to meet all the outstanding liabilities of its members.

 

Lloyd’s permits its corporate and individual members (“Members”) to underwrite insurance risks through Lloyd’s syndicates. Members of Lloyd’s may participate in a syndicate for one or more underwriting years by providing capital to support the syndicate’s underwriting. All syndicates are managed by Lloyd’s approved managing agents. Managing agents receive fees and profit commissions in respect of the underwriting and administrative services they provide to the syndicates. Lloyd’s prescribes, in respect of its managing agents and Members, certain minimum standards relating to their management and control, solvency and various other requirements.

 

Sirius Group participates in the Lloyd’s market through the 100% ownership of White Mountains Sirius Capital Ltd., a Lloyd’s corporate Member, which in turn provides underwriting capacity to Syndicate 1945. Syndicate 1945 commenced underwriting on July 1, 2011 and Whittington Capital Management Ltd. is its managing agent.  The Syndicate 1945 stamp capacity for 2012 is £67 million ($104 million based on the December 31, 2011 GBP to USD exchange rate). Stamp capacity is a measure of the amount of net premium (premiums written less acquisition costs) that a syndicate is authorized by Lloyd’s to write.

 

A corporate Member of Lloyd’s is bound by the rules of the Society of Lloyd’s which are prescribed by the by-laws and requirements of the Council of Lloyd’s under powers conferred by the Lloyd’s Act. These rules govern Sirius Group’s corporate Member participation in Syndicate 1945 and among other things prescribe Syndicate 1945’s membership subscription and level of contribution to the Lloyd’s Central Fund (“Central Fund”).

 

The underwriting capacity of a Member of Lloyd’s must be supported by providing a deposit in the form of cash, securities or letters of credit (“Funds at Lloyd’s”) in an amount to be determined pursuant to the capital adequacy requirements set by the UK FSA. The amount of such deposit is calculated for each member through the completion of an annual capital adequacy exercise. Pursuant to these requirements Lloyd’s must demonstrate that each Member has sufficient assets to meet its underwriting liabilities plus a required solvency margin.

 

At the syndicate level, managing agents are required to calculate the capital resources requirement of the members of each syndicate they manage. They perform an Individual Capital Assessment (“ICA”) in accordance with the UK FSA criteria. During the ICA process the managing agent evaluates the risks faced by the syndicate, including insurance, operational, market, liquidity, and credit risks and assesses the amount of capital syndicate Members should hold against that risk. The ICA is reviewed annually by Lloyd’s. Each syndicate is also required to submit a business plan to Lloyd’s on an annual basis, which is subject to the review and approval of the Lloyd’s Performance Management Directorate.

 

Lloyd’s has wide discretionary powers to regulate a Member’s underwriting. For example, Lloyd’s may change the way that syndicate expenses are allocated or vary the Funds at Lloyd’s investment criteria.  Any such change may affect the Member’s return on investment. If a Member is unable to pay its obligations to policyholders, such obligations may be payable by the Central Fund, which, in many ways, resembles a state guaranty fund in the United States. If Lloyd’s determines that the Central Fund needs to be increased, it may levy premiums on current Lloyd’s Members. The Council of Lloyd’s has discretion to assess up to 3% of a Member’s underwriting capacity in any one year as a Central Fund contribution.

 

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Solvency II

 

The European Commission, which is the executive body of the European Union, has proposed a directive on insurance regulation and solvency requirements known as Solvency II. The European Insurance and Occupational Pensions Authority (“EIOPA”) is an independent advisory body to the European Parliament and the Council of the European Union, which is drafting the guidelines and standards to support the implementation of Solvency II. The Omnibus II Directive will set the date of entry into force of Solvency II. Without pre-empting the final decision of the European Parliament and the Council of the European Union on the timeline and the scope of the further regulatory measures, EIOPA has adopted a working assumption for the timeline of Solvency II, setting January 1, 2014 as a basis the entry into force of Solvency II. This timeline should allow EIOPA, its members and the industry to progress in preparing for the implementation of Solvency II according to specific milestones.

 

Solvency II has set the framework for the next generation of supervisory rules for insurance and reinsurance companies in the EU, and will impose economic risk-based solvency requirements across all EU Member States.  The aim of the Solvency II framework is to ensure that insurance and reinsurance undertakings are financially sound and can withstand adverse events in order to protect policyholders and the stability of the financial system as a whole. In addition to quantitative requirements, such as capital requirements (Pillar 1), insurance and reinsurance companies will be required to meet qualitative requirements relating to governance and risk-management (Pillar 2), as well as to regularly disclose information to supervisors and to the public (Pillar 3). Sirius International and its wholly-owned subsidiary, Sirius America, will be required to comply with Solvency II requirements.  In addition, it is possible that the NAIC could adopt part or all of Solvency II, including minimum capital requirements that could be in excess of the current minimum capital requirements for White Mountains’ U.S.-based insurance and reinsurance subsidiaries established by state regulations.  If the NAIC adopted Solvency II, White Mountains’ U.S.-based insurance and reinsurance operating subsidiaries’ businesses and results of operations could be materially impacted.

 

Bermuda

 

Insurance Regulation

 

The Insurance Act 1978 of Bermuda and related regulations, as amended (the “Insurance Act”), regulates the insurance businesses of the Bermuda branch of Sirius International, Star Re Ltd., a newly formed wholly-owned reinsurance subsidiary of the Sirius Group, White Shoals, WM Life Re and Scandinavian Re, and provides that no person may carry on any insurance business in or from within Bermuda unless registered as an insurer under the Insurance Act by the Bermuda Monetary Authority (“BMA”). The BMA, in deciding whether to grant registration, has broad discretion to act as it thinks fit in the public interest. The BMA is required by the Insurance Act to determine whether the applicant is a fit and proper body to be engaged in the insurance business and, in particular, whether it has, or has available to it, adequate knowledge and expertise to operate an insurance business. In addition, the BMA is required by the Insurance Act to determine whether a person who proposes to control 10 percent, 20 percent, 33 percent or 50 percent (as applicable) of the voting powers of a Bermuda registered insurer or its parent company is a fit and proper person to exercise such degree of control.

 

The continued registration of an applicant as an insurer is subject to the applicant complying with the terms of its registration and such other conditions as the BMA may impose from time to time. The Insurance Act also grants to the BMA powers to supervise, investigate and intervene in the affairs of insurance companies.

 

The Insurance Act imposes solvency and liquidity standards on Bermuda insurance companies, as well as auditing and reporting requirements. White Mountains believes that it is in compliance with all applicable laws and regulations pertaining to its business that would have a material effect on its financial position in the event of non-compliance.

 

Certain Other Bermuda Law Considerations

 

The Company is an exempted company organized under the Companies Act 1981 of Bermuda (the “Companies Act”). As a result, the Company needs to comply with the provisions of the Companies Act regulating the payment of dividends and making of distributions from contributed surplus. A company is prohibited from declaring or paying a dividend, or making a distribution out of contributed surplus, if there are reasonable grounds for believing that:

 

(1)         the company is, or would after the payment be, unable to pay its liabilities as they become due; or

(2)         the realizable value of the company’s assets would thereby be less than its liabilities.

 

Under the Company’s bye-laws, each common share is entitled to dividends if, and when, dividends are declared by its board of directors, subject to any preferred dividend rights of the holders of any preference shares. Issued share capital is the aggregate par value of the company’s issued shares, and the share premium account is the aggregate amount paid for issued shares over and above their par value. Share premium accounts may be reduced in certain limited circumstances. In addition, the Companies Act regulates return of capital, reduction of capital and any purchase or redemption of shares by the Company.

 

Although the Company is incorporated in Bermuda, it has been designated as a non-resident of Bermuda for exchange control purposes by the BMA. Pursuant to its non-resident status, the Company may hold any currency other than Bermuda dollars and convert that currency into any other currency, other than Bermuda dollars, without restriction.

 

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Shares may be offered or sold in Bermuda only in compliance with the provisions of the Investment Business Act 2003 and the Exchange Control Act 1972, and related regulations of Bermuda which regulate the sale of securities in Bermuda. In addition, specific permission is required from the BMA pursuant to the provisions of the Exchange Control Act 1972 and related regulations, for all issuances and transfers of securities of Bermuda companies, other than in cases where the BMA has granted a general permission. The BMA in its policy dated June 1, 2005 provides that where any equity securities, including the Company’s common shares, of a Bermuda company are listed on an appointed stock exchange, general permission is given for the issue and subsequent transfer of any securities of a company from and/or to a non-resident, for as long as any equity securities of such company remain so listed. The New York Stock Exchange is deemed to be an appointed stock exchange under Bermuda law. Notwithstanding the above general permission, the BMA has granted the Company permission to, subject to its common shares being listed on an appointed stock exchange, (a) issue and transfer its shares, up to the amount of its authorized capital from time to time, to persons resident and non-resident of Bermuda for exchange control purposes; (b) issue and transfer options, warrants, depositary receipts, rights, and other securities; and (c) issue and transfer loan notes and other debt instruments and options, warrants, receipts, rights over loan notes and other debt instruments to persons resident and non-resident of Bermuda for exchange control purposes.

 

Under Bermuda law, exempted companies are companies formed for the purpose of conducting business outside Bermuda from a principal place in Bermuda. As an exempted company, the Company may not, without the express authorization of the Bermuda legislature or under a license granted by the Bermuda Minister of Finance, participate in various specified business transactions, including

 

·                  the acquisition or holding of land in Bermuda, except land held by way of lease or tenancy agreement which is required for the Company’s business and held for a term not exceeding 50 years, or which is used to provide accommodation or recreational facilities for the Company’s officers and employees and held with the consent of the Bermuda Minister of Finance, for a term not exceeding 21 years;

·                  the taking of mortgages on land in Bermuda in excess of $50,000;

·                  the acquisition of any bonds or debentures secured by any land in Bermuda, other than certain types of Bermuda government or public authority securities; or

·                  subject to some exceptions, the carrying on of business of any kind in Bermuda for which the Company is not licensed in Bermuda.

 

Under Bermuda law, non-Bermudians (other than spouses of Bermudians) may not engage in any gainful occupation in Bermuda without an appropriate governmental work permit. Work permits may be granted or extended by the Bermuda government upon showing that, after proper public advertisement in most cases, no Bermudian (or spouse of a Bermudian) is available who meets the minimum standard requirements for the advertised position. The Bermuda government’s policy limits the duration of work permits to six years, with certain exemptions for key employees.

 

RATINGS

 

Insurance and reinsurance companies are evaluated by various rating agencies in order to measure each company’s financial strength. Higher ratings generally indicate financial stability and a stronger ability to pay claims. White Mountains believes that strong ratings are important factors in the marketing of insurance and reinsurance products and services to agents and consumers and ceding companies.

 

The following table presents the financial strength ratings assigned to White Mountains’ principal insurance and reinsurance operating subsidiaries as of February 28, 2012:

 

 

 

A.M. Best(1)

 

Standard & Poor’s(2)

 

Moody’s(3)

 

Fitch(4)

OneBeacon

 

 

 

 

 

 

 

 

Rating

 

“A” (Excellent)

 

“A-” (Strong)

 

“A2” (Good)

 

“A” (Strong)

Outlook

 

Stable

 

Stable

 

Stable

 

Stable

Sirius Group

 

 

 

 

 

 

 

 

Rating

 

“A” (Excellent)

 

“A-” (Strong)

 

“A3” (Good)

 

“A-” (Strong)

Outlook

 

Stable

 

Stable

 

Stable

 

Stable

 


(1)         “A” is the third highest fifteen financial strength ratings assigned by A.M. Best.

(2)         “A-” is the seventh highest of twenty-one financial strength ratings assigned by Standard & Poor’s.

(3)         “A2” is the sixth highest and “A3” is the seventh highest of twenty-one financial strength ratings assigned by Moody’s.

(4)         “A” is the sixth highest and “A-” is the seventh highest of twenty-one financial strength ratings assigned by Fitch.

 

EMPLOYEES

 

As of December 31, 2011, White Mountains employed 1,813 persons (consisting of 40 persons at the Company and its intermediate holding companies, 1,300 persons at OneBeacon, 431 persons at Sirius Group, 34 persons at WM Advisors and 8 persons at WM Life Re). Management believes that White Mountains has satisfactory relations with its employees.

 

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AVAILABLE INFORMATION

 

The Company is subject to the informational reporting requirements of the Exchange Act. In accordance therewith, the Company files reports, proxy statements and other information with the SEC. These documents are available at www.whitemountains.com shortly after such material is electronically filed with or furnished to the SEC. In addition, the Company’s code of business conduct and ethics as well as the various charters governing the actions of certain of the Company’s Committees of its Board of Directors, including its Audit Committee, Compensation Committee and Nominating and Governance Committee, are available at www.whitemountains.com.

 

The Company will provide to any shareholder, upon request and without charge, copies of these documents (excluding any applicable exhibits unless specifically requested). Written or telephone requests should be directed to the Corporate Secretary, White Mountains Insurance Group, Ltd., 14 Wesley Street, Hamilton, HM 11 Bermuda, telephone number (441) 278-3160. Additionally, all such documents are physically available at the Company’s registered office at Clarendon House, 2 Church Street, Hamilton, HM 11 Bermuda.

 

Item 1A.  Risk Factors

 

The information contained in this report may contain “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. SeeFORWARD-LOOKING STATEMENTS(page 90) for specific important factors that could cause actual results to differ materially from those contained in forward-looking statements. The Company’s actual future results and trends may differ materially depending on a variety of factors including, but not limited to, the risks and uncertainties discussed below.

 

Our investment portfolio may suffer reduced returns or losses which could adversely affect our results of operations and financial condition. Adverse changes in interest rates, foreign currency exchange rates, equity markets, debt markets or market volatility could result in significant losses to the fair value of our investment portfolio and could generate significant losses in our life reinsurance business.

 

Our investment portfolio consists of fixed maturity securities, convertible fixed maturity securities, short-term investments, common equity securities and other long-term investments such as hedge funds and private equities. We invest to maximize long-term after-tax total risk-adjusted return subject to our investment guidelines and various regulatory restrictions. However, investing entails substantial risks. We cannot assure you that we will achieve our investment objectives, and our investment performance may vary substantially over time. Investment returns are an important part of our strategy to grow adjusted book value per share, and fluctuations in the fixed income or equity markets could impair our results of operations and financial condition. Investments generate both income, consisting primarily of interest earned on fixed maturity investments and dividends earned on equity securities, and realized and unrealized investment gains on securities.

 

Both the investment income we generate and the fair market value of our investment portfolio are affected by general economic and market conditions, including fluctuations in interest rates, foreign currency exchange rates, debt market levels, equity market levels and market volatility. Interest rates are highly sensitive to many factors, including governmental monetary policies, domestic and international economic and political conditions and other factors beyond our control. Although we attempt to manage the risks of changes in interest rates, we may not be able to do so. In particular, a significant increase in interest rates could result in significant losses in the fair value of our investment portfolio and, consequently, could have an adverse effect on our results of operations and financial condition. We are exposed to changes in equity markets. Because a portion of our investment portfolio is invested in securities denominated in currencies other than U.S. dollar, the value of our portfolio is sensitive to changes in foreign currency rates. We are also exposed to changes in the volatility levels of various investment markets. The underlying conditions are outside of our control and could adversely affect the value of our investments and our results of operations and financial condition.

 

Our life reinsurance business has reinsured the risk related to a shortfall between the account value and the guaranteed value that must be paid in respect of certain Japanese variable annuity contracts. We use derivative instruments to mitigate the market risks associated with changes in the fair value of these guarantees.  These derivative instruments include put options, interest rate swaps, total return swaps and futures contracts on major equity indices, currency pairs and government bonds. However, these derivatives may not fully mitigate our exposure to the changes in the fair value of the guarantees.  For example, WM Life Re reported significant losses in 2008 because the increase in the fair value of its liabilities exceeded the increase in the fair value of the related derivative instruments.

 

The fair value of our life reinsurance contracts and the related derivative instruments is significantly affected by general economic and market conditions such as equity market returns and volatility, interest rate fluctuations and foreign currency exchange rates.  These conditions are outside of our control and could generate significant losses that would adversely affect our results of operations and financial condition.

 

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Unpredictable catastrophic events could adversely affect our results of operations and financial condition.

 

We write insurance and reinsurance policies that cover losses from catastrophic events. Our policies cover unpredictable natural and other disasters, such as hurricanes, windstorms, earthquakes, floods, fires and explosions. In recent years, the frequency of major catastrophes has increased.  We have significant exposure to windstorm damage in the Northeast United States, a major earthquake or series of earthquakes in California, the Midwestern United States or Japan and windstorm damage in Northern Europe, the United States Atlantic Coast (i.e., Massachusetts to Florida) and the United States Gulf Coast region (i.e., Florida to Texas). In addition, we are exposed to losses from terrorist attacks, such as the attacks on the United States on September 11, 2001.

 

The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the area affected by the event and the severity of the event. Increases in the value of insured property, the effects of inflation and changes in cyclical weather patterns may increase the severity of claims from catastrophic events in the future. Claims from catastrophic events could materially adversely affect our results of operations and financial condition. Our ability to write new insurance and reinsurance policies could also be impacted as a result of corresponding reductions in our capital levels.

 

We manage our exposure to catastrophic losses by limiting the aggregate insured value of policies in geographic areas with exposure to catastrophic events by estimating a PML for many different catastrophe scenarios and by buying reinsurance. In addition, to better manage the aggregate exposure to very large catastrophic events in our reinsurance business, Sirius Group monitors the largest NFI that we would suffer in the worst aggregate loss year as calculated by third-party models (i.e., the 10,000-year global annual aggregate PML). The calculation of the NFI begins with the modeled 10,000-year global annual aggregate PML and takes account of estimated reinstatement premiums, reinsurance recoverables (net of estimated uncollectible balances) and tax benefits. This amount is deducted from Sirius Group’s planned legal entity comprehensive income for the year (before any planned losses for catastrophe events) to arrive at the NFI.

 

To manage and analyze aggregate insured values, PML and NFI, we use a variety of tools, including catastrophe modeling software packages. Our estimates of PML and NFI are dependent on many variables, including assumptions about the demand surge and storm surge, loss adjustment expenses, insurance-to-value and storm intensity in the aftermath of weather- related catastrophes utilized to model the event, the relationship of the actual event to the modeled event and the quality of data provided to us by ceding companies (in the case of our reinsurance operations). Accordingly, if our assumptions about the variables are incorrect, the losses we might incur from an actual catastrophe could be materially higher than our expectation of losses generated from modeled catastrophe scenarios and our results of operations and financial condition could be materially adversely affected.

 

We may not maintain favorable financial strength or creditworthiness ratings which could adversely affect our ability to conduct business.

 

Third-party rating agencies assess and rate the financial strength, including claims-paying ability, of insurers and reinsurers. These ratings are based upon criteria established by the rating agencies and are subject to revision at any time at the sole discretion of the agencies. Some of the criteria relate to general economic conditions and other circumstances outside the rated company’s control. These financial strength ratings are used by policyholders, agents and brokers as an important means of assessing the suitability of insurers and reinsurers as business counterparties and have become an increasingly important factor in establishing the competitive position of insurance and reinsurance companies. These financial strength ratings do not refer to our ability to meet non-insurance obligations and are not a recommendation to purchase or discontinue any policy or contract issued by us or to buy, hold or sell our securities. The maintenance of an “A-” or better financial strength rating from A.M. Best and/or Standard & Poor’s is particularly important to our ability to write new or renewal business in most markets.  General creditworthiness ratings are used by existing or potential investors to assess the likelihood of repayment on a particular debt issue. The maintenance of an investment grade creditworthiness rating (e.g., “BBB-” or better from Standard & Poor’s and “Baa3” or better from Moody’s) is particularly important to our ability to raise new debt with acceptable terms.  We believe that strong creditworthiness ratings are important factors that provide better financial flexibility when issuing new debt or restructuring existing debt.

 

Rating agencies periodically evaluate us to confirm that we continue to meet the criteria of the ratings previously assigned to us. See “RATINGS” on page 27 for a summary of financial strength ratings on our significant insurance and reinsurance operating subsidiaries. A downgrade, withdrawal or negative watch/outlook of our financial strength ratings could severely limit or prevent our insurance and reinsurance operating subsidiaries from writing new insurance or reinsurance policies or renewing existing policies, which could have a material adverse effect on our results of operations and financial condition. A downgrade, withdrawal or negative watch/outlook of our creditworthiness ratings could limit our ability to raise new debt or could make new debt more costly and/or have more restrictive conditions.

 

Additionally, some of Sirius Group’s assumed reinsurance contracts written in the United States contain optional cancellation, commutation and/or funding provisions that would be triggered if A.M. Best and/or Standard & Poor’s were to downgrade Sirius Group’s financial strength ratings below “A-”. A client may choose to exercise these rights depending on, among other things, the reasons for such a downgrade, the extent of the downgrade, the prevailing market conditions, the degree of unexpired coverage, and the pricing and availability of replacement reinsurance coverage. We cannot predict in advance how many of our clients would actually exercise such rights in the event of such a downgrade but widespread exercise of these options could be materially adverse.

 

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The property and casualty insurance and reinsurance industries are highly competitive and cyclical and we may not be able to compete effectively in the future.

 

The property and casualty insurance and reinsurance industries are highly competitive and have historically been cyclical, experiencing periods of severe price competition and less selective underwriting standards (“soft markets”) followed by periods of relatively high prices and more selective underwriting standards (“hard markets”). OneBeacon competes with most of the specialty companies, such as Allied World Assurance Company, HCC Insurance Holdings, Inc., Ironshore Inc., Markel Corporation, RLI Corp. and W.R. Berkley Corporation. OneBeacon’s businesses each compete against a different subset of companies. In general terms, OneBeacon also competes to varying degrees in one or more of its businesses with most of the large multi-line insurance companies, such as ACE Limited, Chartis Insurance, Chubb Group of Insurance Companies, CNA Insurance, Liberty Mutual Insurance Group, Travelers Insurance Group Holdings Inc. and Zurich Financial Services Ltd. and with various local and regional insurance companies.  Sirius Group competes with numerous reinsurance companies throughout the world, including Alterra Capital Holdings, Ltd., Arch Capital Group Ltd., Aspen Insurance Holdings Ltd., Axis Capital Holdings, Ltd., Endurance Specialty Holdings Ltd., Everest Re Group, Ltd., Flagstone Re Holdings SA, General Reinsurance Corporation, Hannover Ruckversicherung AG, Lloyd’s of London, Montpelier Re Holdings, Ltd., Munich Re Group, Odyssey Re Holdings Corporation, Partner Re Ltd., Platinum Underwriters Holdings Ltd., Renaissance Re Holdings Ltd., Scor Global P&C, Swiss Re Group, Transatlantic Holdings, Inc., Validus Holdings, Ltd. and XL Capital Ltd. Many of these competitors have greater resources than we do and have established long-term and continuing business relationships throughout the insurance industry, which can be a significant competitive advantage for them.

 

OneBeacon offers its products through a number of distribution partners, consisting of independent agents, regional and national brokers, wholesalers and MGAs. Many of OneBeacon’s distribution partners offer insurance products sold by other insurance companies in addition to OneBeacon’s insurance products.  We could be adversely affected if these distribution partners place more of their business with other insurance companies as a result of price competition or other factors.  Additionally, OneBeacon’s distribution partners compete with other independent agents, regional and national brokers, wholesalers and MGAs to place insurance products.  We could be adversely affected if OneBeacon’s distribution partners are unable to maintain a competitive position in their respective markets.

 

The supply of reinsurance is related to prevailing prices, the level of insured losses and the level of industry surplus which, in turn, may fluctuate in response to changes in rates of return earned in the reinsurance industry. As a result, the reinsurance business historically has been a cyclical industry characterized by periods of intense price competition due to excess underwriting capacity as well as periods when shortages of capacity permitted favorable premium rate levels. For example, the industry experienced a soft casualty market of lower prices and less favorable terms from 1997 to 2001 during which profitability suffered while the losses incurred from the 2005 U.S. hurricanes triggered price increases. In addition to these considerations, changes in the frequency and severity of losses suffered by insureds and insurers significantly affect the reinsurance industry cycle. Soft insurance markets could lead to a significant reduction in premium rates, less favorable contract terms, fewer submissions for our underwriting capacity and potential regulatory response.

 

We expect to continue to experience the effects of the insurance and reinsurance industries’ cyclicality.  If we are unable to maintain our competitive position throughout soft and hard market cycles, our insurance and reinsurance businesses may be adversely affected and we may not be able to compete effectively in the future.

 

Our loss and loss adjustment expense reserves may be inadequate to cover our ultimate liability for losses and as a result our financial results could be adversely affected.

 

We are required to maintain adequate reserves to cover our estimated ultimate liabilities for loss and loss adjustment expenses. Loss and LAE reserves are typically comprised of (1) case reserves for claims reported and (2) IBNR reserves for losses that have occurred but for which claims have not yet been reported which include a provision for expected future development on case reserves. These reserves are estimates based on actuarial, claims and underwriting assessments of what we believe the settlement and administration of claims will cost based on facts and circumstances then known to us. Because of the uncertainties that surround estimating ultimate loss and LAE reserves, we cannot be certain that our reserves are adequate and actual claims and claim expenses paid might exceed our reserves due to the uncertainties that surround estimating loss and LAE reserves. If we determine in the future that our reserves are insufficient to cover our actual losses and LAE, we would have to add to our reserves, which could have a material adverse effect on our results of operations and financial condition.  For further discussion of our loss and LAE reserves, including our asbestos and environmental reserves, see CRITICAL ACCOUNTING ESTIMATES - Loss and LAE Reserves” on page 65.

 

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We may not be able to successfully alleviate risk through reinsurance and retrocessional arrangements. Additionally, we may not be able to collect all amounts due from our reinsurers under our existing reinsurance and retrocessional arrangements.

 

We attempt to limit our risk of loss through reinsurance and retrocessional arrangements. Retrocessional arrangements refer to reinsurance purchased by a reinsurer to cover its own risks assumed from ceding companies. The availability and cost of reinsurance and retrocessional protection is subject to market conditions, which are outside of our control. In addition, the coverage under our reinsurance and retrocessional arrangements may be inadequate to cover our future liabilities. As a result, we may not be able to successfully alleviate risk through these arrangements, which could have a material adverse effect on our results of operations and financial condition.

 

We are not relieved of our obligations to our policyholders or ceding companies by purchasing reinsurance. Accordingly, we are subject to credit risk with respect to our reinsurance and retrocessions in the event that a reinsurer is unable to pay amounts owed to us as a result of a deterioration in its financial condition. A number of reinsurers in the industry experienced such a deterioration in the aftermath of the 2001 terrorist attacks and the active 2005 hurricane season. To mitigate this risk, we annually review and periodically monitor our reinsurers’ financial condition. While we believe that our reinsurers’ financial condition is strong, it is possible that one or more of our reinsurers will be significantly adversely affected by future significant loss events, causing them to be unable to pay amounts owed to us. We also may be unable to recover amounts due under our reinsurance and retrocessional arrangements if our reinsurers choose to withhold payment due to a dispute or other factors beyond our control.

 

Our reinsurance operations are largely dependent upon ceding companies’ evaluation of risk.

 

Sirius Group, like other reinsurance companies that write treaty reinsurance, generally does not evaluate separately each of the assumed individual insurance risks under our reinsurance contracts. As such, we are largely dependent upon the cedents’ original underwriting decisions. We are subject to the risk that the cedents may not have adequately or accurately evaluated the risks that they have insured, and we have reinsured, and that the premiums ceded may not adequately compensate us for the risks we assume. If our reserves are insufficient to cover our actual loss and LAE arising from our treaty reinsurance business, we would have to strengthen our reserves and incur charges to our earnings. These charges could be significant and could have a material adverse effect on our results of operations and financial condition.

 

We have significant foreign operations that expose us to certain additional risks, including foreign currency risks and political risk.

 

Sirius Group conducts a significant portion of its business outside of the United States. As a result, a significant portion of our assets, liabilities, revenues and expenses are denominated in currencies other than the U.S. dollar and are therefore subject to foreign currency risk. Our foreign currency risk cannot be eliminated entirely and significant changes in foreign exchange rates may adversely affect our results of operations and financial condition.

 

Our foreign operations are also subject to legal, political and operational risks that may be greater than those present in the United States. As a result, our operations at these foreign locations could be temporarily or permanently disrupted.

 

Our debt, preferred stock and related service obligations could adversely affect our business.

 

As of December 31, 2011, we had approximately $672 million face value of indebtedness and $250 million face value of non-cumulative perpetual preference shares outstanding.

 

Our ability to meet our debt, preferred stock and related service obligations will depend on our future performance, which will be affected by financial, business, economic, regulatory and other factors, many of which are beyond our control. We are also subject to restrictive financial covenants contained in our revolving credit facility that require us to maintain specified financial ratios and to satisfy financial condition tests.  These covenants can restrict us in several ways, including our ability to incur additional indebtedness.  A breach of these covenants could result in an event of default under our revolving credit facility which would allow lenders to declare any amounts owed under the revolving credit facility to be immediately due and payable. A failure to pay principal and interest on a credit facility, mortgage or similar debt agreement with a principal amount greater than $25 million, where such a default results in the acceleration of such debt, could trigger cross acceleration provisions contained in the indenture of the OBH Senior Notes.  A failure to pay principal and interest on the OBH Senior Notes or the SIG Senior Notes could trigger a cross acceleration provision contained in our revolving credit facility.  If we do not have enough cash to repay accelerated debt, we may be required to refinance all or part of our existing debt, sell assets, borrow more cash or sell equity. We cannot assure you that we will be able to accomplish any of these alternatives on terms acceptable to us, if at all.

 

We could incur additional indebtedness and issue additional preferred stock in the future. To the extent new debt, new preferred stock and other obligations are added to our and our subsidiaries’ current debt and preferred stock levels, the risks described in the previous paragraph would increase.

 

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We are a holding company with no direct operations, and our insurance and reinsurance subsidiaries’ ability to pay dividends to us is restricted by law.

 

As a holding company with no direct operations, we rely on net investment income and dividends, tax sharing payments and other permitted payments from our subsidiaries to pay our expenses. Our subsidiaries may not be able to generate cash flow sufficient to pay a dividend or distribute funds to us. In addition, under the insurance laws of the jurisdictions in which our insurance and reinsurance subsidiaries are domiciled, an insurer or reinsurer is restricted with respect to the timing or the amount of dividends it may pay without prior approval by regulatory authorities.

 

Our top tier regulated insurance and reinsurance operating subsidiaries have the ability to pay approximately $696 million of dividends and group contributions without prior approval of regulatory authorities during 2012.  At December 31, 2011, the Company and its intermediate holding companies had $1,554 million of net unrestricted cash, short-term investments and fixed maturity investments and $350 million of common equity securities and other long-term investments outside of OneBeacon and Sirius Group and $375 million available to be drawn from its revolving credit facility.  In addition, at December 31, 2011 OneBeacon Ltd. and its intermediate holding companies had $183 million of net unrestricted cash, short-term investments and fixed maturity investments and $30 million of common equity securities and convertible fixed maturity investments outside of its regulated and unregulated insurance operating subsidiaries; Sirius Group and its intermediate holding companies had $75 million of net unrestricted cash, short-term investments and fixed maturity investments and $16 million of other long-term investments outside of its regulated and unregulated insurance and reinsurance operating subsidiaries. See Dividend Capacity” on page 56. Management believes that our cash balances, cash flows from operations and cash flows from investments are adequate to meet expected cash requirements for the foreseeable future on both a holding company and operating subsidiary level. However, if our insurance and reinsurance subsidiaries cannot pay dividends in future periods or if we contribute additional funds to fulfill our obligations under our life reinsurance contracts, we may have difficulty servicing our debt, paying dividends on our common and preferred shares and meeting our holding company expenses. For additional information relating to insurance and reinsurance regulations governing our operations, see “Regulation” on page 22.

 

We may suffer losses from unfavorable outcomes from litigation and other legal proceedings.

 

In the ordinary course of business, we are subject to litigation and other legal proceedings as part of the claims process, the outcomes of which are uncertain. We maintain reserves for these legal proceedings as part of our loss and LAE reserves. We also maintain separate reserves for legal proceedings that are not related to the claims process.  Additionally, we have agreed to indemnify Allstate in respect of certain litigation and other matters arising out of the operations of Esurance prior to the closing of the Esurance Sale.  In the event of an unfavorable outcome in one or more legal matters, our ultimate liability may be in excess of amounts we have currently reserved for and such additional amounts may be material to our results of operations and financial condition. For a description of our material legal proceedings, see “Legal Proceedings on page 35 and Note 19 Commitments and Contingencies on page F-66.

 

As industry practices and legal, judicial, social and other conditions change, unexpected and unintended issues related to claims and coverage may emerge. These issues may adversely affect our results of operations and financial condition by either extending coverage beyond our underwriting intent or by increasing the number and size of claims. In some instances, these changes may not become apparent until sometime after we have issued insurance and reinsurance contracts that are affected by the changes.

 

Regulation may restrict our ability to operate.

 

The insurance and reinsurance industries are subject to extensive regulation under U.S., state and foreign laws. Governmental agencies have broad administrative power to regulate many aspects of the insurance business, which include premium rates, marketing practices, advertising, policy forms and capital adequacy. These governmental agencies are concerned primarily with the protection of policyholders rather than shareholders. Insurance laws and regulations impose restrictions on the amount and type of investments, prescribe solvency standards that must be met and maintained and require the maintenance of reserves. In our insurance underwriting, we rely heavily upon information gathered from third parties such as credit report agencies and other data aggregators. The use of this information is also highly regulated and any changes to the current regulatory structure could materially affect how we underwrite and price premiums.

 

Changes in laws and regulations may restrict our ability to operate and/or have an adverse effect upon the profitability of our business within a given jurisdiction. In addition, state and federal legislation has been proposed to establish catastrophe funds and underwriting in coastal areas which could impact our business.

 

In addition, the Dodd-Frank Act, which was enacted in 2010, created the FIO within the Treasury Department. The FIO is responsible for gathering information and monitoring the insurance industry to identify gaps in the regulation of insurers that could contribute to a systemic crisis in the insurance industry or U.S. financial system. The FIO also has the authority to recommend changes to state insurance laws and regulations. The FIO is expected to issue its first report on modernizing and improving insurance regulation in 2012. We cannot predict whether the FIO will recommend any such changes, whether any states will adopt any such changes, or what effect such changes may have on our insurance operations.

 

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Our non-U.S. reinsurance companies are subject to foreign regulations, including Solvency II which will be effective January 1, 2014 and will regulate insurance firms that operate in the EU.  Solvency II was enacted to reduce the risk that insurers would not be able to pay claims to policyholders as well as promote financial stability through minimum capital requirements as well as other requirements for the governance and risk management of insurers and the supervision of insurers.  We cannot predict what regulations will be adopted to implement Solvency II nor the impact of such regulation upon our non-U.S. reinsurers.  In addition, it is possible that the NAIC could adopt part or all of Solvency II including minimum capital requirements that could be in excess of our current minimum capital requirements established by state regulations.  If the NAIC adopted Solvency II including additional capital requirements, our business and results of operations could be materially impacted.

 

We could be subject to litigation, regulatory enforcement action and damage to our reputation if confidential personally identifiable information is mishandled or stolen.

 

Our operating entities, particularly OneBeacon, collect and store personally identifiable information from consumers.  If our data security measures fail and personally identifiable information is mishandled or stolen, we could be subject to litigation and regulatory enforcement action.  Further, such a failure could damage our reputation, which could have an adverse effect on our business, results of operations and financial condition.

 

Our profitability may be adversely impacted by inflation, legislative actions and judicial decisions.

 

The effects of inflation could cause claim costs to rise in the future. In addition, legislative actions and judicial decisions continue to broaden liability and policy definitions and to increase the severity of claim payments, such as described above with respect to asbestos and environmental claims. To the extent inflation and these legislative actions and judicial decisions cause claim costs to increase above reserves established for these claims, we will be required to increase our loss and LAE reserves with a corresponding reduction in our net income in the period in which the deficiency is identified.

 

We have successfully created shareholder value through acquisitions and dispositions of insurance and reinsurance entities. We may not be able to continue to create shareholder value through such transactions in the future.

 

In past years, we have completed numerous acquisitions and dispositions of insurance and reinsurance entities, many of which have contributed significantly to our growth in adjusted book value. Failure to identify and complete future acquisition and disposition opportunities could limit our ability to achieve our target returns. Even if we were to identify and complete future acquisition or disposition opportunities, there is no assurance that such opportunities will ultimately achieve their anticipated benefits.

 

We have significant deferred tax assets which we may be unable to utilize if we do not generate sufficient future taxable income.

 

We have a deferred tax asset of $109 million (net of a valuation allowance of $7 million) related to net operating loss carryforwards, capital loss carryforwards and tax credit carryforwards at December 31, 2011 that are subject to carryforward limitations in the United States.  We also have a deferred tax asset of $276 million (net of a valuation allowance of $225 million) related to net operating loss carryforwards in Luxembourg at December 31, 2011 that are not subject to limitation. The loss carryforwards in Luxembourg primarily relate to tax deductible write-downs in 2007 and 2008 of investments in U.S. subsidiaries held by Luxembourg subsidiaries. Utilization of these assets and other assets included in our worldwide net deferred tax asset of $171 million (net of a valuation allowance of $233 million) is dependent on generating sufficient future taxable income of the appropriate character (i.e., ordinary income or capital gains) in the appropriate jurisdiction. If it is determined that it is more likely than not that sufficient future taxable income will not be generated, we would be required to increase the valuation allowance in future periods, which would have an adverse effect on our results of operations and financial condition.

 

Changes in tax laws or tax treaties may cause more of the income of certain non-U.S. companies in our group to become subject to taxes in the United States.

 

The taxable income of our U.S. subsidiaries is subject to U.S. federal, state and local income tax and other taxes. The income of the non-U.S. companies in our group is generally subject to a lower effective tax rate than that imposed by the United States. Certain of our non-U.S. companies are eligible for the benefits of tax treaties between the United States and other countries. We believe our non-U.S. companies will continue to be eligible for treaty benefits. However, it is possible that factual changes or changes to U.S. tax laws or changes to tax treaties that presently apply to our non-U.S. companies could increase income, or the tax rate on income, subject to tax in the United States.  Similarly, changes to the applicable tax laws, treaties or regulations of other countries could subject the income of members of our group to higher rates of tax outside the United States.  For example, legislation has been introduced to Congress to amend the Internal Revenue Code of 1986 to disallow the deduction for excess non-taxed reinsurance premiums with respect to United States risks paid to affiliates.

 

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We depend on our key personnel to manage our business effectively and they may be difficult to replace.

 

Our performance substantially depends on the efforts and abilities of our management team and other executive officers and key employees. Furthermore, much of our competitive advantage is based on the expertise, experience and know-how of our key management personnel. We do not have fixed term employment agreements with any of our key employees nor key man life insurance and the loss of one or more of these key employees could adversely affect our business, results of operations and financial condition. Our success also depends on the ability to hire and retain additional personnel. Difficulty in hiring or retaining personnel could adversely affect our results of operations and financial condition.

 

Bermuda law differs from the laws in effect in the United States and may afford less protection to shareholders.

 

We are organized under the laws of Bermuda, and a portion of our assets are located outside the United States. As a result, it may not be possible for our shareholders to enforce court judgments obtained in the United States against us based on the civil liability provisions of the federal or state securities laws of the United States, either in Bermuda or in countries other than the United States where we will have assets. In addition, there is some doubt as to whether the courts of Bermuda and other countries would recognize or enforce judgments of U.S. courts obtained against us or our directors or officers based on the civil liabilities provisions of the federal or state securities laws of the United States or would hear actions against us or those persons based on those laws.

 

Our corporate affairs are governed by the Companies Act. The Companies Act differs in some material respects from laws generally applicable to U.S. corporations and shareholders, including the provisions relating to interested directors, amalgamations, mergers and acquisitions, takeovers, shareholder lawsuits and indemnification of directors. Generally, the duties of directors and officers of a Bermuda company are owed to the company only. Shareholders of Bermuda companies generally do not have rights to take action against directors or officers of the company and may only do so in limited circumstances. Class actions and derivative actions are generally not available to shareholders under Bermuda law. The Bermuda courts, however, would ordinarily be expected to permit a shareholder to commence an action in the name of a company to remedy a wrong to the company where the act complained of is alleged to be beyond the corporate power of the company or illegal, or would result in the violation of the company’s memorandum of association or bye-laws. Furthermore, consideration would be given by a Bermuda court to acts that are alleged to constitute a fraud against noncontrolling shareholders or, for instance, where an act requires the approval of a greater percentage of the company’s shareholders than that which actually approved it.

 

When the affairs of a company are being conducted in a manner that is oppressive or prejudicial to the interests of some part of the shareholders, one or more shareholders may apply to the Supreme Court of Bermuda, which may make such order as it sees fit, including an order regulating the conduct of the company’s affairs in the future or ordering the purchase of the shares of any shareholders by other shareholders or by the company. Additionally, under our bye-laws and as permitted by Bermuda law, each shareholder has waived any claim or right of action against our directors or officers for any action taken by directors or officers in the performance of their duties, except for actions involving fraud or dishonesty. In addition, the rights of our shareholders and the fiduciary responsibilities of our directors under Bermuda law are not as clearly established as under statutes or judicial precedent in existence in jurisdictions in the United States, particularly the State of Delaware. Therefore, our shareholders may have more difficulty protecting their interests than would shareholders of a corporation incorporated in a jurisdiction within the United States.

 

1B.  Unresolved Staff Comments

 

As of the date of this report, the Company had no unresolved comments from the Commission staff regarding its periodic or current reports under the Exchange Act.

 

Item 2.  Properties

 

The Company maintains two professional offices in Hamilton, Bermuda which serve as its headquarters and its registered office. The Company’s principal executive office is in Hanover, New Hampshire. In addition, White Mountains maintains professional offices in Guilford, Connecticut, which house its investment and corporate finance functions, and Boston, Massachusetts, which house its corporate accounting, reporting and internal audit functions.

 

OneBeacon Ltd.’s headquarters are located in Hamilton, Bermuda and its United States corporate headquarters and principal executive office is located in Minnetonka, Minnesota. OneBeacon also maintains branch offices in various cities throughout the United States.

 

Sirius 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 branch offices in the United States and in Toronto, Canada.

 

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. Sirius Group’s home offices and substantially all of its branch offices are leased.  OneBeacon owns a building in Canton, Massachusetts that houses its corporate and other shared services functions, while its principal executive office and branch offices are leased. Management considers its office facilities suitable and adequate for its current level of operations.

 

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Item 3.  Legal Proceedings

 

White Mountains, and the insurance and reinsurance industry in general, is subject to litigation and arbitration in the normal course of business. Other than those items listed below, White Mountains was not a party to any material litigation or arbitration other than as routinely encountered in claims activity, none of which is expected by management to have a material adverse effect on its financial condition and/or cash flows.

 

Tribune Company

 

In June 2011, Deutsche Bank Trust Company Americas, Law Debenture Company of New York and Wilmington Trust Company (collectively referred to as the “Plaintiff”), in their capacity as trustees for certain senior notes issued by the Tribune Company (“Tribune”), filed lawsuits in various jurisdictions against numerous defendants including certain of White Mountains’ subsidiaries in their capacity as former shareholders of the Tribune seeking recovery of the proceeds from the sale of common stock of the Tribune in connection with the Tribune’s leveraged buyout in 2007 (the “LBO”). The Plaintiff seeks recovery of the proceeds received by the former Tribune shareholders on the basis that the Tribune purchased or repurchased its common shares without receiving fair consideration at a time when it was, or as a result of the purchases of shares, was rendered, insolvent.  Certain subsidiaries of White Mountains, received a total of approximately $39 million for the Tribune common stock it tendered in connection with the leveraged buyout. The various cases are now pending before a Multi District Litigation panel (“MDL”) in the federal district court in New York.

 

In December 2011, the MDL granted a motion to consolidate all of the lawsuits brought by Plaintiffs for pretrial matters and transfer all such proceedings to the United States District Court for the Southern District of New York. The consolidated cases are currently stayed pending further order of the Bankruptcy Court.

 

In addition OneBeacon, OBIC-sponsored benefit plans and other affiliates of White Mountains in their capacity as former shareholders of Tribune, along with thousands of former Tribune shareholders, have been named as defendants in an adversary proceeding brought by the Official Committee of Unsecured Creditors of the Tribune Company, on behalf of the Tribune Company, which seeks to avoid the repurchase of shares by Tribune in the LBO on a theory of intentional fraudulent transfer. The adversary proceeding is currently pending in Bankruptcy Court.  That case is also stayed pending further order of the Bankruptcy Court.

 

Scandinavian Re

 

On August 19, 2009, the arbitration panel hearing the arbitration proceeding between Scandinavian Re and St. Paul Fire & Marine Insurance Company, et. al. (“St. Paul”) issued a final decision.  This arbitration related to a dispute over a multi-year Retrocessional Casualty Aggregate Stop Loss Agreement (“Agreement”) concerning certain classes of casualty reinsurance written by St. Paul during the 1999-2001 underwriting years. Scandinavian Re had argued that the Agreement should be reformed or rescinded. The final decision stated, among other things, that the Agreement is valid and enforceable and shall be applied based on the written terms of the Agreement.

 

On November 16, 2009, Scandinavian Re filed a motion to vacate the arbitration award in federal court in the Southern District of New York. On February 23, 2010, the court issued an order granting Scandinavian Re’s motion to vacate the arbitration award. On March 15, 2010, St. Paul filed a notice of appeal with the 2nd Circuit Court of Appeals. On February 3, 2012, the 2nd Circuit Court of Appeals issued an opinion reversing the district court order. The appeals court remanded the action back to the district court with instructions to confirm the arbitration award. The circuit court’s decision did not have a material effect on White Mountains’ financial condition, results of operations or cash flows.

 

Item 4.   Mine Safety Disclosures

 

None.

 

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Executive Officers of the Registrant and its Subsidiaries (As of February 28, 2012)

 

Name

 

Position

 

Age

 

Executive
officer
since

Raymond Barrette

 

Chairman and CEO

 

61

 

2007

Reid T. Campbell

 

Managing Director of White Mountains Capital, Inc.

 

44

 

2007

David T. Foy

 

Executive Vice President and Chief Financial Officer

 

45

 

2003

T. Michael Miller

 

President and CEO of OneBeacon Ltd.

 

53

 

2005

J. Brian Palmer

 

Vice President and Chief Accounting Officer

 

39

 

2001

G. Manning Rountree

 

Managing Director of White Mountains Capital, Inc. and President of WM Advisors

 

39

 

2009

Robert L. Seelig

 

Managing Director and General Counsel

 

43

 

2002

Allan L. Waters

 

President and CEO of Sirius Group Ltd.

 

54

 

2007

 

All executive officers of the Company and its subsidiaries are elected by the Board for a term of one year or until their successors have been elected and have duly qualified. Information with respect to the principal occupation and relevant business experience of the Executive Officers follows:

 

Mr. Barrette has served as Chairman and CEO of the Company since January 2007. He served as a director of the Company from 2000 to 2005 and was re-appointed as a director in August 2006. He previously served as President and CEO of the Company from 2003 to 2005, as CEO of OneBeacon from 2001 to 2002, as President of the Company from 2000 to 2001 and as Executive Vice President and Chief Financial Officer of the Company from 1997 to 2000. Mr. Barrette also serves as a director of OneBeacon Ltd.

 

Mr. Campbell has served as a Managing Director of White Mountains Capital, Inc. since January 2004. He joined White Mountains in 1994 and has served in a variety of financial management positions with White Mountains. Prior to joining White Mountains, Mr. Campbell spent three years with KPMG LLP. Mr. Campbell also serves as a director of OneBeacon Ltd.

 

Mr. Foy was appointed Executive Vice President and Chief Financial Officer of the Company in April 2003. Prior to joining White Mountains in 2003, Mr. Foy served as Senior Vice President and Chief Financial Officer of Hartford Life Inc. and joined that company in 1993. Prior to joining Hartford Life, Mr. Foy was with Milliman and Robertson, an actuarial consulting firm. Mr. Foy also serves as a director of OneBeacon Ltd. and Symetra.

 

Mr. Miller was appointed President and CEO of OneBeacon in July 2005 and joined OneBeacon as its Chief Operating Officer in April 2005. Mr. Miller also serves as a director of OneBeacon Ltd. Prior to joining White Mountains, Mr. Miller spent 10 years at St. Paul Travelers, most recently as Co-Chief Operating Officer. Prior to joining St. Paul Travelers, Mr. Miller spent 14 years with The Chubb Corporation.

 

Mr. Palmer has served as Chief Accounting Officer of the Company since 2001 and previously served as Controller of a subsidiary of White Mountains from 1999 to 2001. Prior to joining White Mountains in 1999, Mr. Palmer was with PricewaterhouseCoopers LLP.

 

Mr. Rountree is a Managing Director of White Mountains Capital, Inc. and President of WM Advisors.  He joined White Mountains in 2004.  Prior to joining White Mountains, Mr. Rountree worked with both Putnam Investments and McKinsey & Company.

 

Mr. Seelig