Employee Share-Based Incentive Compensation Plans

9 Months Ended

Sep. 30, 2011

Employee Share-Based Incentive Compensation Plans

Employee Share-Based Incentive Compensation Plans

NOTE 10.  Employee Share-Based Incentive Compensation Plans

OneBeacon’s share-based compensation plans consist of performance shares, stock options granted in connection with the initial public offering, restricted stock units and restricted shares. OneBeacon’s share-based compensation plans are designed to maximize shareholder value over long periods of time by aligning the financial interests of its management with those of its owners. Performance shares are payable only upon achievement of pre-defined business goals and are valued based on the market value of OneBeacon’s common shares at the time awards are earned. See “Performance Shares” below. Performance shares are typically paid in cash, though, in some instances, they may be paid in common shares or may be deferred in accordance with the terms of one of the deferred compensation plans of the Company’s subsidiaries. OneBeacon expenses the full cost of all its share-based compensation.

OneBeacon records its share-based compensation in accordance with ASC 718. ASC 718 applies to new grants of share-based awards, award modifications and the remaining portion of the fair value of unvested awards. The unvested portion of OneBeacon performance share awards, as well as the stock options granted in connection with the initial public offering and also restricted shares, are subject to the fair value measurement and recognition requirements of ASC 718.

Performance Shares

The following summarizes performance share activity for performance shares whose value is based upon the market price of an underlying OneBeacon common share (“OB Performance Shares”) for the three and nine months ended September 30, 2011 and 2010:

	Three months ended September 30,
	2011					2010
	Target OB Performance Shares outstanding		Accrued expense			Target OB Performance Shares outstanding		Accrued expense
	($ in millions)
Beginning of period	671,727		$	10.0		1,770,423		$	15.2
Payments and deferrals (1)	—		—			(199,774	)	(2.2		)
New awards	—		—			14,618		—
Forfeitures and net change in assumed forfeitures	(19,583	)	0.1			(20,438	)	(0.3		)
(Income) expense recognized	—		(0.5		)	—		1.7
End of period	652,144		$	9.6		1,564,829		$	14.4

	Nine months ended September 30,
	2011					2010
	Target OB Performance Shares outstanding		Accrued expense			Target OB Performance Shares outstanding		Accrued expense
	($ in millions)
Beginning of period	1,464,295		$	18.5		2,224,215		$	15.1
Payments and deferrals (1)(2)(3)	(936,150	)	(10.5		)	(882,118	)	(4.5		)
New awards	194,900		—			293,478		—
Forfeitures and net change in assumed forfeitures	(70,901	)	(0.2		)	(70,746	)	(0.7		)
Expense recognized	—		1.8			—		4.5
End of period	652,144		$	9.6		1,564,829		$	14.4

(1) As a result of the Commercial Lines Transaction and the Personal Lines Transaction, payments were made to certain former employees of OneBeacon prior to the end of the performance cycle (2008-2010, 2009-2011 and 2010-2012 performance cycles) on a pro rata basis based upon a performance factor of 100%.

(2) Performance share payments in 2011 for the 2008-2010 performance cycle were based upon a performance factor of 68.5%.

(3) Performance share payments in 2010 for the 2007-2009 performance cycle were based upon a performance factor of 14.2%.

The following summarizes performance shares outstanding and accrued performance share expense at September 30, 2011 for each performance cycle:

	Target OB Performance Shares outstanding		Accrued expense
	($ in millions)
Performance cycle:
2009—2011	259,102		$	7.2
2010—2012	251,557		1.9
2011—2013	151,563		0.6
Sub-total	662,222		9.7
Assumed forfeitures	(10,078	)	(0.1		)
Total at September 30, 2011	652,144		$	9.6

If 100% of the outstanding performance shares had been vested at September 30, 2011, the total additional compensation cost to be recognized would have been $3.7 million, based on current accrual factors at September 30, 2011 (common share price and payout assumptions).

All performance shares earned and paid for the 2010-2012, 2009-2011, 2008-2010 and 2007-2009 performance cycles were settled in cash or by deferral into certain non-qualified deferred compensation plans of the Company’s subsidiaries.

Stock Options

As described in the Company’s 2010 Annual Report on Form 10-K, in November 2006, in connection with the initial public offering, OneBeacon issued to its key employees 1,420,000 options to acquire common shares of the Company at an above-market fixed exercise price. The following summarizes option activity for the three and nine months ended September 30, 2011 and 2010:

	Three months ended September 30,
	2011				2010
	Target options outstanding		Accrued expense		Target options outstanding		Accrued expense
	($ in millions)
Beginning of period	750,130		$	4.8	879,783		$	4.1
Forfeitures	(9,260	)	—		—		—
Vested and expired (1)	—		—		(43,218	)	—
Expense recognized	—		0.1		—		0.2
End of period	740,870		$	4.9	836,565		$	4.3

	Nine months ended September 30,
	2011				2010
	Target options outstanding		Accrued expense		Target options outstanding		Accrued expense
	($ in millions)
Beginning of period	768,652		$	4.5	1,015,610		$	3.6
Forfeitures	(27,782	)	—		(37,044	)	—
Vested and expired (1)	—		—		(142,001	)	—
Expense recognized	—		0.4		—		0.7
End of period	740,870		$	4.9	836,565		$	4.3

(1) During the three and nine months ended September 30, 2010, 43,218 and 142,001, respectively, options that vested as a result of the Commercial Lines Transaction and Personal Lines Transaction were unexercised and expired.

The options vest in equal installments on each of the third, fourth and fifth anniversaries of their issuance. These options expire five and a half years from the anniversary of issuance. The fair value of each option award at grant date was estimated using a Black-Scholes option pricing model using an expected volatility assumption of 30%, a risk-free interest rate assumption of 4.6%, a forfeiture assumption of 5%, an expected dividend rate assumption of 3.4% and an expected term assumption of 5.5 years. The options originally had a per share exercise price of $30.00. On May 27, 2008, the Compensation Committee of the Board (the “Compensation Committee”) amended the exercise price to $27.97 as a result of the $2.03 per share special dividend paid in the first quarter of 2008.  On November 16, 2010, the Compensation Committee adjusted the exercise price to $25.47 as a result of the $2.50 per share special dividend paid in the third quarter of 2010. The compensation expense associated with the options and the incremental fair value of the award modifications are being recognized ratably over the remaining period.

Restricted Stock Units

The options granted in connection with OneBeacon’s initial public offering did not include a mechanism in the options to reflect the contribution to total return from the regular quarterly dividend. As a result, on February 26, 2008, OneBeacon granted 116,270 Restricted Stock Units (“RSUs”) to actively employed option holders. Consistent with the terms of the RSU plan, the first and second tranches of RSUs vested by the 2010 vesting date, were deferred into one of the non-qualified deferred compensation plans of the Company’s subsidiaries and will be paid out in 2012 in cash or shares at the discretion of the Compensation Committee. The third tranche of RSUs will vest on November 9, 2011 subject to various factors including but not limited to the attainment of growth of 4% per cycle in adjusted book value per share. The expense associated with the RSUs is being recognized over the vesting period. For both the three and nine months ended September 30, 2011, OneBeacon recognized $0 in expense. For the three and nine months ended September 30, 2010, OneBeacon recognized $0 and $0.2 million, respectively, in expense. As of September 30, 2011, there were 22,773 RSUs outstanding to actively employed option holders.

Restricted Shares

On May 25, 2011, OneBeacon issued 630,000 shares of restricted stock to its CEO that vest in equal installments on February 22, 2014, 2015, 2016 and 2017. Concurrently with the grant of the restricted stock, 35,000 performance shares issued to the CEO for the 2011-2013 performance share cycle were forfeited. Performance share awards to the CEO for the next five years will be reduced by a similar number of shares. The restricted shares contain dividend participation features, and therefore, are considered participating securities. At September 30, 2011, the Company had 630,000 unvested restricted shares outstanding. During the three and nine months ended September 30, 2011, OneBeacon recognized $0.4 million and $0.5 million, respectively in expense. As of September 30, 2011, the unrecognized compensation cost associated with the outstanding restricted share awards was $8.1 million, to be recognized ratably over the remaining vesting periods.