Discontinued Operations

Runoff Business

As described in Note 1 and Note 2, in October 2012, OneBeacon entered into the Stock Purchase Agreement with respect to the sale of its Runoff Business to Armour. Pursuant to the terms of the Stock Purchase Agreement, at closing, OneBeacon will transfer to Armour all of the issued and outstanding shares of common stock 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. Additionally, as part of the Runoff Transaction, OneBeacon may provide, under certain scenarios, financing in the form of surplus notes.

In anticipation of the Runoff Transaction, OneBeacon received regulatory approval as required from various state departments of insurance effective October 1, 2012 to terminate the then-existing pooling agreement and intercompany 100% quota share reinsurance agreements and to enter into new 100% quota share reinsurance agreements. The result is that the Runoff Business is assumed and retained by OBIC, one of the legal entities that will be transferred to Armour at closing, and that the ongoing specialty business is assumed and retained by Atlantic Specialty Insurance Company ("ASIC"), one of the entities that OneBeacon will continue to own post-closing.

The Pennsylvania Insurance Department is currently conducting a required examination of the Runoff Business as part of its regulatory review of the Runoff Transaction. The Company expects the Runoff Transaction to close in the second half of 2014.

Summary of Reclassified Balances and Related Items

As of March 31, 2014 and December 31, 2013, the Runoff 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, are presented separately as single line items in the asset and liability sections of the consolidated balance sheets as of March 31, 2014 and December 31, 2013, respectively. The following summarizes the major categories of assets and liabilities associated with the business classified as held for sale:



	March 31, 2014		December 31, 2013
	($ in millions)
Assets:
Investments	$	222.2	$	236.3
Premiums receivable	12.8		9.1
Reinsurance recoverable on unpaid losses⁽¹⁾	1,540.0		1,604.7
Reinsurance recoverable on paid losses	9.5		10.7
Net deferred tax asset	3.2		3.3
Other assets	15.4		16.0
Total assets held for sale	$	1,803.1	$	1,880.1

Liabilities:
Unpaid loss and loss adjustment expense reserves⁽¹⁾	$	1,717.3	$	1,793.1
Unearned premiums	0.2		0.2
Ceded reinsurance payable	12.1		12.3
Other liabilities⁽²⁾	73.5		74.5
Total liabilities held for sale	$	1,803.1	$	1,880.1

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⁽¹⁾

The March 31, 2014 and December 31, 2013 balances include the remaining purchase accounting fair value adjustments of $133.6 million and $136.9 million, respectively, relating to the OneBeacon Acquisition. As of March 31, 2014 and December 31, 2013, reinsurance recoverable on unpaid losses, gross of purchase accounting adjustments, were $1,673.6 million and $1,741.6 million, respectively, and unpaid loss and LAE reserves, gross of purchase accounting adjustments, were $1,850.9 million and $1,930.0 million for each period.


⁽²⁾	Other liabilities as of March 31, 2014 and December 31, 2013 include the accrual related to the pre-tax loss on sale of the Runoff Business of $69.0 million for both periods.

As described in Note 1 and Note 2, the results of operations for the Runoff Business have been classified as discontinued operations and are presented as such, net of related income taxes, in the statements of operations and comprehensive income and cash flows for all periods. Investing and financing activities for OneBeacon are managed on a consolidated basis reported within the Investing, Financing and Corporate segment. Therefore, no investment or financing activity is included in discontinued operations.

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



		Three months ended March 31,
		2014			2013
	($ in millions)
Net written premiums		$	(0.1	)	$	0.8
Revenues
Earned premiums		$	(0.1	)	$	0.9
Total revenues		(0.1		)	0.9
Expenses
Loss and loss adjustment expenses		—			—
Policy acquisition expenses		—			0.1
Other underwriting expenses		0.7			0.1
Total expenses		0.7			0.2
Pre-tax income (loss)		(0.8		)	0.7
Income tax benefit (expense)		0.3			(0.2		)
Income (loss) from discontinued operations, net of tax		$	(0.5	)	$	0.5

Income (Loss) per Share Related to Discontinued Operations

Basic income (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 income (loss) per share for discontinued operations attributable to OneBeacon's common shareholders for the three months ended March 31, 2014 and 2013:



	Three months ended March 31,
	2014			2013
Income (loss) attributable to OneBeacon's common shareholders—basic and diluted (in millions):
Net income (loss) from discontinued operations attributable to OneBeacon's common shareholders	$	(0.5	)	$	0.5
Allocation of loss for participating unvested restricted common shares	—			—
Net income (loss) from discontinued operations attributable to OneBeacon's common shareholders, net of restricted common share amounts	$	(0.5	)	$	0.5

Income (loss) per share denominator—basic and diluted (in millions):
Total weighted average common shares outstanding	95.4			95.4
Weighted average unvested restricted common shares⁽¹⁾	(0.8		)	(0.9		)
Basic and diluted income (loss) per share denominator	94.6			94.5

Income (loss) per share attributable to OneBeacon's common shareholders—basic and diluted (in dollars):
Net income (loss) from discontinued operations attributable to OneBeacon's common shareholders per share	$	(0.01	)	$	—

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

Additional Disclosures

Due to the relative significance of the transactions described above, OneBeacon has expanded the disclosures herein to provide additional insight into the balances and related activity reclassified to held for sale and discontinued operations.

Results of Discontinued Operations

The loss from discontinued operations, net of tax, was $0.5 million for the three months ended March 31, 2014, compared to income of $0.5 million for the three months ended March 31, 2013. The loss for the three months ended March 31, 2014 was substantially a result of non-claims expenses related to the Runoff Business, including dedicated staff. The income for the three months ended March 31, 2013 primarily related to earned premiums from involuntary pools in our Runoff Business.

For the three months ended March 31, 2014 and 2013, the Company recorded no incurred loss and LAE for the Runoff Business. As of March 31, 2014, the recorded net unpaid loss and LAE reserves associated with the Runoff Business totaled $177.3 million. Management believes that the recorded net loss and LAE reserves reflect a reasonable provision for expected future loss and LAE payments and represent management’s best estimate within a range of reasonable estimates.

Fair Value Adjustment

In connection with purchase accounting for the OneBeacon Acquisition, the Company was required to adjust to fair value the loss and LAE reserves and the related reinsurance recoverables. Loss and LAE reserves and the related reinsurance recoverable presented in the summary of reclassified balances within assets and liabilities held for sale as of March 31, 2014 and December 31, 2013, are net of $133.6 million and $136.9 million, respectively, related to the outstanding pre-tax unaccreted adjustment.

Reinsurance

As described in Note 4—"Reinsurance," in the normal course of business, OneBeacon's insurance subsidiaries seek to limit losses that may arise from catastrophes or other events by reinsuring with third-party reinsurers. OneBeacon remains liable for risks reinsured even if the reinsurer does not honor its obligations under reinsurance contracts.

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.

NICO Cover

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 March 31, 2014. Net losses paid totaled approximately $1.7 billion as of March 31, 2014. 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 March 31, 2014.

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 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. As of March 31, 2014, OneBeacon has ceded estimated incurred losses of $562.0 million to GRC under the GRC Cover. As of March 31, 2014, OneBeacon has $359.7 million of reinsurance recoverable on unpaid losses outstanding under the GRC Cover.

At March 31, 2014, OneBeacon had $9.5 million of reinsurance recoverable on paid losses and $1,673.6 million (gross of $133.6 million in purchase accounting adjustments, as described above) that will become recoverable if claims are paid in accordance with current reserve estimates, related to the Runoff Business that have been reclassified to assets held for sale. Reinsurance contracts do not relieve OneBeacon of its obligations. Therefore, collectibility of balances due from reinsurers is critical to OneBeacon's financial strength. The following table provides a listing of the top reinsurers related to the Runoff Business reported in assets held for sale, excluding industry pools and associations, based on reinsurance recoverable amounts on paid and unpaid losses, the percentage of the total reported as held for sale (gross of the $133.6 million in purchase accounting adjustment), and the reinsurers' A.M. Best ratings.



($ in millions)	Balance at March 31, 2014		% of total		A.M. Best Rating⁽¹⁾
National Indemnity Company ("NICO") and General Reinsurance Corporation⁽²⁾	$	1,188.8	71	%	A++
Hanover Insurance Company	38.7		2	%	A
Tokio Marine and Nichido Fire⁽³⁾	26.1		2	%	A++
Munich Reinsurance America	14.1		1	%	A+
Tower Insurance Company	9.9		1	%	B⁽⁴⁾

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


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


⁽³⁾	Excludes $21.4 million of reinsurance recoverables from the various reinsurers that are guaranteed by Tokio Marine and Nichido Fire.


⁽⁴⁾	Under review with developing implications.