Municipal Bond Guarantee Insurance

In 2012, HG Global was capitalized with $594.5 million from White Mountains and $14.5 million from non-controlling interests to fund the initial capitalization of BAM, a newly formed mutual municipal bond insurer. As of December 31, 2018, White Mountains owned 96.9% of HG Global’s preferred equity and 88.4% of its common equity. HG Global, together with its subsidiaries, provided the initial capitalization of BAM through the purchase of $503.0 million of BAM Surplus Notes. At inception, BAM and HG Re also entered into a first loss reinsurance treaty (“FLRT”). HG Re provides first loss protection up to 15%-of-par outstanding on each municipal bond insured by BAM. For capital appreciation bonds, par is adjusted to the estimated equivalent par value for current interest paying bonds. In return, BAM cedes 60% of the risk premium charged for insuring the municipal bond, net of a ceding commission. During 2017, HG Global and BAM made certain changes to the ceding commission arrangements under the FLRT. These changes serve to accelerate growth in BAM’s statutory capital but do not impact the net risk premium ceded from BAM to HG Re.

HG Re’s obligations under the FLRT are limited to the assets in two collateral trusts: a Regulation 114 Trust and a supplemental collateral trust (the “Supplemental Trust” and together with the Regulation 114 Trust, the “Collateral Trusts”). Losses required to be reimbursed under the FLRT are subject to an aggregate limit equal to the assets held in the Collateral Trusts at any point in time.

Effective January 1, 2014, HG Global and BAM agreed to change the interest rate on the BAM Surplus Notes for the five years ending December 31, 2018 from a fixed rate of 8.0% to a variable rate equal to the one-year U.S. treasury rate plus 300 basis points, set annually, which was 3.78%, 4.60% and 5.70% for 2017, 2018 and 2019. In 2018, BAM exercised its option to extend the variable rate period for an additional three years. At the end of the variable rate period, the interest rate will be fixed at the higher of the then current variable rate or 8.0%. No payment of interest or principal on the BAM Surplus Notes may be made without the approval of the New York State Department of Financial Services (“NYDFS”). BAM has stated its intention to seek regulatory approval to pay interest and principal on its surplus notes to the extent that its remaining qualified statutory capital and other capital resources continue to support its outstanding obligations, its business plan and its “AA/stable” rating from Standard & Poor’s. BAM repaid $17.7 million of the BAM Surplus Notes and $5.3 million of accrued interest during the year ended December 31, 2018. BAM repaid $4.0 million of the BAM Surplus Notes and $1.0 million of accrued interest during the year ended December 31, 2017.

At inception, the Supplemental Trust contained the original $300 million of Series B Notes and $100 million of cash and fixed income securities. During 2017, in order to further support BAM’s long-term capital position and business prospects, HG Global agreed to contribute the original $203.0 million of Series A Notes into the Supplemental Trust. At the same time HG Global and BAM also changed the payment terms of the Series B Notes, so that payments will reduce principal and accrued interest on a pro rata basis, consistent with the payment terms on the Series A Notes. The terms of the Series B Notes had previously stipulated that payments would first reduce interest owed, then reduce principal owed once all accrued interest had been paid. The NYDFS approved the change during 2017. In connection with the contribution and change in payment terms of the Series B Notes, the Series A Notes were merged into the Series B Notes to become the Series S-1 Surplus Notes.

On December 3, 2018, the Series S-1 Surplus Notes were exchanged for Series S-2 Surplus Notes, which reflect all of the unpaid principal and accrued interest from the Series S-1 Surplus Notes. The Series S-2 Surplus Notes are held in an HG Re sponsored vehicle within the Supplemental Trust.

The Regulation 114 Trust target balance is equal to gross ceded unearned premiums and unpaid ceded loss and LAE expenses, if any. The Supplemental Trust target balance is equal to $603.0 million. As the BAM Surplus Notes are repaid over time, the BAM Surplus Notes will be replaced in the Supplemental Trust by cash and fixed income securities. The Collateral Trust balances must be at target levels before excess funds can be distributed out of the Supplemental Trust.

Under GAAP, if the terms of a debt instrument are amended, unless there is a greater than 10% change in the expected discounted future cash flows of such instrument, a change in the instrument’s carrying value is not permitted. White Mountains has determined that the impact of the changes made during 2017 to the terms of the BAM Surplus Notes on the expected discounted future cash flows was not greater than 10%.

As of December 31, 2018 and 2017, the Collateral Trusts held assets of $757.4 million and $715.1 million, which included $481.3 million and $499.0 million of BAM Surplus Notes. As of December 31, 2018 and 2017, HG Global has accrued $143.7 million and $126.0 million of interest receivable on the BAM Surplus Notes.

The following table presents a schedule of BAM’s insured obligations as of December 31, 2018 and 2017:



	December 31, 2018		December 31, 2017
Contracts outstanding	7,525		6,371
Remaining weighted average contract period (in years)	10.7		10.9
Contractual debt service outstanding (in millions):
Principal	$	52,201.6	$	42,090.6
Interest and capital appreciation	26,560.3		21,057.1
Total debt service outstanding	$	78,761.9	$	63,147.7

Gross unearned insurance premiums	$	176.0	$	136.8

The following table presents a schedule of BAM’s future premium revenues as of December 31, 2018:



Millions	December 31, 2018
January 1, 2019 - March 31, 2019	$	4.1
April 1, 2019 - June 30, 2019	4.0
July 1, 2019 - September 30, 2019	4.0
October 1, 2019 - December 31, 2019	3.8
	15.9
2020	15.0
2021	14.0
2022	13.2
2023	12.3
2024 and thereafter	105.6
Total gross unearned insurance premiums	$	176.0

The following table presents a schedule of net written premiums and net earned premiums included in White Mountains’s HG Global/BAM segment for the years ended December 31, 2018, 2017 and 2016:



Millions	December 31, 2018		December 31, 2017		December 31, 2016
Written premiums:
Direct	$	44.8	$	63.2	$	38.6
Assumed	8.1		—		—
Net written premiums	$	52.9	$	63.2	$	38.6
Earned premiums:
Direct	$	13.6	$	9.4	$	5.9
Assumed	.3		—		—
Net earned premiums	$	13.9	$	9.4	$	5.9

In April 2018, BAM entered into a collateralized financial guarantee excess of loss reinsurance agreement with Fidus Re, Ltd. (“Fidus Re”), a Bermuda based special purpose insurer created solely to provide reinsurance protection to BAM. Fidus Re was capitalized by the issuance of $100.0 million of insurance linked securities. The proceeds from issuance were placed in a collateral trust supporting Fidus Re’s obligations to BAM. The insurance linked securities were issued by Fidus Re with an initial term of twelve years and are callable five years after the date of issuance. Under the agreement, BAM retains the first $165.0 million of aggregate losses, before giving effect to HG’s reinsurance coverage, on the ceded business. Fidus Re reinsures 90% of aggregate losses exceeding $165.0 million on a portion of BAM’s financial guarantee portfolio up to a total reimbursement of $100 million. The aggregate loss limit under the agreement is $276.1 million. The agreement is accounted for using deposit accounting and any related financing expenses are recorded in general and administrative expenses as the agreement does not meet the risk transfer requirements necessary to be accounted for as reinsurance.

In November 2018, BAM entered into a 100% quota share facultative reinsurance agreement under which it assumed a portfolio of municipal bond guarantee contracts with a par value of $2.2 billion. None of the contracts assumed were non-performing and no loss reserves have been established for any of the contracts, either at the transaction date or subsequent thereto. The agreement, which covers future claims exposure only, meets the risk transfer criteria under ASC 944-20, Insurance Activities and accordingly has been accounted for as reinsurance.