Discontinued Operations

9 Months Ended

Sep. 30, 2012

Discontinued Operations

Discontinued Operations

NOTE 14. Discontinued Operations

Description of transactions

On October 17, 2012, OneBeacon entered into the Stock Purchase Agreement to sell the Runoff Business to Armour.  The Runoff Business had been included within the Other Insurance Operations segment; however, based on management’s intent as of September 30, 2012 to execute the Stock Purchase Agreement, the Runoff Business has been presented as held for sale in the consolidated balance sheet as of September 30, 2012. The Runoff Transaction includes the sale of certain legal entities that will contain the assets, liabilities (including gross and ceded loss reserves) and capital supporting the business as well as certain elements of the Runoff Business infrastructure, including staff and office space. As described in Note 2, the Runoff Transaction requires the completion of the Internal Restructuring steps. The Runoff Transaction is expected to close in the second half of 2013, subject to regulatory approvals.

On February 22, 2012, OneBeacon completed the sale of the AutoOne business to Interboro. The AutoOne Transaction included the sale of two insurance entities, AOIC and AOSIC, through which substantially all of the AutoOne business was written on a direct basis. The AutoOne Transaction required the completion of various steps, including amendment of the Pooling Agreement to remove AOIC and AOSIC as parties to the agreement in order for them to retain 100% of their respective direct business, the contribution of specified assets supporting the AutoOne operations, and the sale, transfer or exchange of all of AOIC’s and AOSIC’s investment assets, other than those on deposit with governmental authorities. The AutoOne Transaction also included the execution of a reinsurance agreement with certain subsidiaries of the Company pursuant to which OneBeacon cedes, on a 100% quota share basis, AutoOne business not directly written by AOIC and AOSIC.

Summary of balances reclassified and related items

As of September 30, 2012 and December 31, 2011, respectively, the Runoff Transaction and the AutoOne Transaction met the criteria for held for sale accounting. As a result, the assets and liabilities associated with the businesses being sold, after effecting the various steps contemplated by the Stock Purchase Agreement and the AutoOne Purchase Agreement, are presented separately as single line items in the asset and liability sections of the consolidated balance sheets as of September 30, 2012 and December 31, 2011, respectively. The following summarizes the major categories of assets and liabilities associated with the business classified as held for sale:

	September 30, 2012		December 31, 2011
	($ in millions)
Investments	$	377.3	$	111.8
Cash	—		5.5
Reinsurance recoverable on unpaid losses (1)	1,956.6		0.0
Reinsurance recoverable on paid losses	17.6		0.0
Premiums receivable	13.6		8.8
Deferred acquisition costs	—		2.2
Net deferred tax asset	6.1		1.9
Other assets	17.0		2.4
Total assets held for sale	$	2,388.2	$	132.6
Loss and LAE reserves (1)	$	2,212.9	64.7
Unearned premiums	0.6		34.1
Ceded reinsurance payable	19.5		0.0
Other liabilities (2)	155.2		8.8
Total liabilities held for sale	$	2, 388.2	$	107.6
Net assets held for sale	$	—	$	25.0

(1)

The September 30, 2012 balances include the remaining purchase accounting fair value adjustments of $153.4 million relating to the OneBeacon Acquisition. Gross of the purchase accounting adjustments, reinsurance recoverable on unpaid losses and LAE reserves were $2,110.0 million and $2,366.3 million, respectively. The September 30, 2012 balances also include $36.7 million of loss and LAE reserves relating to Runoff Business that will be ceded by ASIC to OBIC pursuant to the reinsurance described in Note 2.

(2)

Other liabilities for September 30, 2012 includes the accrual related to the pre-tax loss on sale of the Runoff Business of $140.7 million.

As described in Note 1, the results of operations for the Runoff Business and AutoOne have been classified as discontinued operations and are presented as such, net of related income taxes, in the statements of comprehensive (loss) income and cash flows for all periods. Amounts reflected within discontinued operations are consistent with the pre-tax amounts previously reported within the Other Insurance Operations segment for the Runoff Business and AutoOne, respectively. Investing and financing activities for OneBeacon are managed on a consolidated basis and currently reported within the Investing, Financing and Corporate Operations segment. Therefore, no investment or financing activity is included in discontinued operations.

During the third quarter of 2012, OneBeacon recorded an after tax charge of $107.0 million in discontinued operations reflecting a $91.5 million after tax ($140.7 million pre-tax) estimated loss on sale of the Runoff Business and $9.0 million of after tax incurred loss and loss adjustment expenses relating to an adjustment to the workers compensation discount rate applied to the loss reserves being transferred.  In addition, OneBeacon also recorded $6.5 million of after tax underwriting losses primarily related to adverse prior year loss reserve development related to a legacy assumed reinsurance treaty that were included in discontinued operations during the third quarter of 2012.

During the third quarter of 2012, OneBeacon and Interboro reached conclusion on post-closing adjustments to the closing balance sheet resulting in OneBeacon recording a net gain of $0.5 million after tax, reflecting a true up of the estimated loss on sale of the AutoOne business. This after tax gain is included in loss from sale of discontinued operations in the statements of comprehensive (loss) income for the three and nine months ended September 30, 2012. During the third quarter of 2011, OneBeacon recorded a charge of $18.2 million after tax, reflecting the estimated loss on sale of the AutoOne business, which included the $25.0 million of net assets held for sale as well, including transaction costs. This after tax charge is included in loss from sale of discontinued operations in the statements of comprehensive (loss) income for the three and nine months ended September 30, 2011.

The following summarizes the results of operations, including related income taxes associated with the business classified as discontinued operations:

	Three months ended						Nine months ended
	September 30,						September 30,
	2012			2011			2012			2011
	($ in millions)
Net written premiums	$	(1.2	)	$	12.7		$	0.6		$	47.2
Revenues
Earned premiums	$	(0.4	)	$	15.7		$	10.0		$	55.3
Net other revenues	—			0.1			—			1.6
Total revenues	(0.4		)	15.8			10.0			56.9
Expenses
Loss and LAE	27.7			12.9			48.4			37.7
Policy acquisition expenses	(0.8		)	1.9			(1.3		)	5.4
Other underwriting expenses	(1.1		)	5.2			1.1			16.6
Total expenses	25.8			20.0			48.2			59.7
Pre-tax loss	(26.2		)	(4.2		)	(38.2		)	(2.8		)
Income tax benefit	10.4			1.7			13.4			1.3
Loss from discontinued operations, net of tax	(15.8		)	(2.5		)	(24.8		)	(1.5		)
Loss from sale of discontinued operations, net of tax	(91.0		)	(18.2		)	(91.0		)	(18.2		)
Net loss from discontinued operations, net of tax	$	(106.8	)	$	(20.7	)	$	(115.8	)	$	(19.7	)

Reinsurance related to balances classified as held for sale

Included in assets held for sale as of September 30, 2012 are reinsurance recoverables on paid and unpaid losses of $17.6 million and $1,956.6 million, respectively related to the Runoff Transaction.  The reinsurance recoverable on unpaid losses amount is net of $153.4 million in purchase accounting adjustments as described in Note 3.  Also, $36.7 million of the amount that is currently included in assets held for sale on the balance sheet will be reported in reinsurance recoverables on unpaid losses when the Runoff Transaction closes (at the then current value) as a result of a related reinsurance contract with a current OneBeacon affiliate.

See note 4 for further description on reinsurance recoverables in general.  The following table provides a listing of the top reinsurers related to balances reported in assets held for sale on the September 30, 2012 balance sheet, which exclude industry pools and associations and those with affiliates within OneBeacon. The table shows the recoverable amounts, the percentage of total reinsurance recoverables reported as held for sale (excluding the $153.4 million purchase accounting adjustment) and the reinsurers’ A.M. Best Company, Inc. (“A.M. Best”) ratings.

	Balance at				A.M. Best
($ in millions)	September 30, 2012		% of total		Rating (1)
National Indemnity Company and General Reinsurance Corporation (2)	$	1,449.2	68	%	A	++
Hanover Insurance Company	62.4		3	%	A
Tokio Marine and Nichido Fire (3)	54.7		3	%	A	++
Munich Reinsurance America	23.2		1	%	A	+
Tower Insurance Company	24.7		1	%	A	-

(1)A.M. Best ratings as detailed above are: “A++” (Superior, which is the highest of fifteen financial strength ratings), “A+” (Superior, which is the second highest of fifteen financial strength ratings), “A” (Excellent, which is the third highest of fifteen financial strength ratings) and “A-” (Excellent, which is the fourth highest of fifteen financial strength ratings).

(2)Includes $198.3 million of Third Party Recoverables (as defined below), which NICO (as defined below) would pay under the terms of the NICO Cover (as defined below) if they are unable to collect from third party reinsurers.

(3)Includes $28.7 million of reinsurance recoverables from the various reinsurers that are guaranteed by Tokio Marine and Nichido Fire under the terms of a 100% quota share reinsurance agreement between Houston General Insurance Company and Tokio Marine and Nichido Fire.

In connection with the OneBeacon Acquisition, Aviva caused OneBeacon to purchase two reinsurance contracts from subsidiaries of Berkshire Hathaway Inc.: a reinsurance contract with National Indemnity Company (“NICO”) for up to $2.5 billion in old asbestos and environmental (“A&E”) claims and certain other exposures (the “NICO Cover”) and an adverse loss reserve development cover from General Reinsurance Corporation (“GRC”) for up to $570.0 million, comprised of $400.0 million of adverse loss reserve development occurring in years 2000 and prior (the “GRC Cover”) in addition to $170.0 million of reserves ceded as of the date of the OneBeacon Acquisition. The NICO Cover and GRC Cover, which were contingent on and occurred contemporaneously with the OneBeacon Acquisition, were put in place in lieu of a seller guarantee of loss and LAE reserves and are therefore accounted for under GAAP as a seller guarantee.

Under the terms of the NICO Cover, NICO receives the economic benefit of reinsurance recoverables from certain of OneBeacon’s third party reinsurers (“Third Party Reinsurers”) in existence at the time the NICO Cover was executed (“Third Party Recoverables”). As a result, the underlying Third Party Recoverables serve to protect the $2.5 billion limit of NICO coverage for the benefit of OneBeacon. OneBeacon estimates that on an incurred basis it has used approximately $2.3 billion of the coverage provided by NICO at September 30, 2012. Net losses paid totaled approximately $1.5 billion as of September 30, 2012. To the extent that actual experience differs from OneBeacon’s estimate of ultimate A&E losses and Third Party Recoverables, future losses could exceed the $198.3 million of protection remaining under the NICO Cover at September 30, 2012.

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 seek reimbursement from GRC only for claims which result in payment patterns similar to those supporting its 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. OneBeacon has ceded estimated incurred losses of $562.0 million to GRC under the GRC Cover. As of September 30, 2012, OneBeacon has $409.3 million of reinsurance recoverable on unpaid losses outstanding under the GRC Cover.

Earnings per share related to discontinued operations

Basic loss per share amounts are based on the weighted average number of common shares outstanding including unvested restricted shares that are considered participating securities. Diluted earnings per share amounts are based on the weighted average number of common shares including unvested restricted shares and the net effect of potentially dilutive common shares outstanding.

The following table outlines the computation of loss per share for discontinued operations attributable to OneBeacon’s common shareholders for the three and nine months ended September 30, 2012 and 2011:

	Three months ended						Nine months ended
	September 30,						September 30,
	2012			2011			2012			2011
Loss attributable to OneBeacon’s common shareholders — basic and diluted (in millions):
Net loss attributable to OneBeacon’s common shareholders	$	(106.8	)	$	(20.7	)	$	(115.8	)	$	(19.7	)
Allocation of loss for participating unvested restricted common shares	1.0			0.1			1.0			0.1
Net loss attributable to OneBeacon’s common shareholders, net of restricted common share amounts	$	(105.8	)	$	(20.6	)	$	(114.8	)	$	(19.6	)
Loss per share denominator — basic and diluted (in millions):
Total weighted average common shares outstanding	95.4			95.1			95.3			94.7
Weighted average unvested restricted common shares(1)	(0.9		)	(0.6		)	(0.9		)	(0.3		)
Basic earnings per share denominator(2)	94.5			94.5			94.4			94.4
Loss per share attributable to OneBeacon’s common shareholders — basic and diluted (in dollars):
Net loss attributable to OneBeacon’s common shareholders per share	$	(1.12	)	$	(0.22	)	$	(1.22	)	$	(0.21	)

(1)Restricted shares outstanding vest in equal installments upon a stated date or upon the occurrence of a specified event (see Note 9).

(2)Common shares issuable upon exercise of the options (see Note 9) were not included as their inclusion would be anti-dilutive for the periods presented. During the three and nine months ended September 30, 2012, the remaining outstanding options were unexercised and expired (see Note 9).