Municipal Bond Guarantee

9 Months Ended

Sep. 30, 2019

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 then newly formed mutual municipal bond insurer. As of September 30, 2019, 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 reinsurance 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.

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. 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%. The variable rate was set at 5.70% for 2019 and 4.60% for 2018.

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.

In order to further support BAM’s long-term capital position and business prospects, in 2017 HG Global agreed to contribute the $203.0 million of Series A BAM Surplus Notes (“Series A Notes”) into the Supplemental Trust at HG Re. The Supplemental Trust already held the $300.0 million of Series B BAM Surplus Notes (“Series B Notes”). 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. The BAM Surplus Notes are currently 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 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 September 30, 2019 and December 31, 2018, the collateral trusts held assets of $787.4 million and $757.4 million, which both included $481.3 million of BAM Surplus Notes. As of September 30, 2019 and December 31, 2018, HG Global has accrued $164.2 million and $143.7 million of interest receivable on the BAM Surplus Notes.

The following table presents a schedule of BAM’s insured obligations as of September 30, 2019 and December 31, 2018:



	September 30, 2019		December 31, 2018
Contracts outstanding	8,508		7,525
Remaining weighted average contract period outstanding (in years)	10.7		10.7
Contractual debt service outstanding (in millions):
Principal	$	59,190.9	$	52,201.6
Interest	30,701.7		26,560.3
Total debt service outstanding	$	89,892.6	$	78,761.9

Gross unearned insurance premiums (in millions)	$	203.5	$	176.0

The following table presents a schedule of BAM’s future premium revenues as of September 30, 2019:



Millions	September 30, 2019
October 1, 2019 - December 31, 2019	$	4.9

January 1, 2020 - March 31, 2020	4.8
April 1, 2020 - June 30, 2020	4.8
July 1, 2020 - September 30, 2020	4.6
October 1, 2020 - December 31, 2020	4.5
Total 2020	18.7

2021	17.4
2022	16.3
2023	15.3
2024	14.3
2025 and thereafter	116.6
Total gross unearned insurance premiums	$	203.5

The following table presents a schedule of net written premiums included in White Mountains’s HG Global/BAM segment for the three and nine months ended September 30, 2019 and 2018:



	Three Months Ended September 30,				Nine Months Ended September 30,
Millions	2019		2018		2019		2018
Written premiums:
Direct	$	10.2	$	3.9	$	30.6	$	28.9
Assumed	10.6		—		10.6		—
Gross written premiums	$	20.8	$	3.9	$	41.2	$	28.9
Earned premiums:
Direct	$	4.4	$	3.3	$	11.9	$	9.7
Assumed	.8		—		1.8		—
Gross earned premiums	$	5.2	$	3.3	$	13.7	$	9.7

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 $100.0 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, because 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. In September 2019, BAM entered into facultative quota share reinsurance agreements under which it assumed a portfolio of municipal bond guarantee contracts with a par value of $1.1 billion. None of the contracts assumed were non-performing and no loss reserves have been established for any of the contracts, either as of the transaction date or as of September 30, 2019. 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.