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Variable Annuity Reinsurance

6 Months Ended

Jun. 30, 2011

Note 8. Variable Annuity Reinsurance

White Mountains has entered into agreements to reinsure death and living benefit guarantees associated with certain variable annuities in Japan. At June 30, 2011 and December 31, 2010, the total guarantee value was approximately ¥235.3 billion (approximately $2.9 billion at exchange rates on that date) and ¥237.4 billion (approximately $2.9 billion at exchange rates on that date). The collective account values of the underlying variable annuities were approximately 83% and 82% of the guarantee value at June 30, 2011 and December 31, 2010. The following table summarizes the pre-tax operating results of WM Life Re for the three and six months ended June 30, 2011 and 2010:

	Three Months Ended June 30,						Six Months Ended June 30,
Millions	2011			2010			2011			2010
Fees, included in other revenues	$	8.0		$	7.2		$	15.9		$	14.5
Change in fair value of variable annuity liability, included in other revenues	(35.9		)	(186.2		)	16.4			(151.2		)
Change in fair value of derivatives, included in other revenues	22.0			172.8			(43.5		)	130.5
Foreign exchange, included in other revenues	6.9			7.7			2.3			5.6
Other investment income and gains (losses)	(.2		)	(.2		)	(.6		)	(.5		)
Total revenues	.8			1.3			(9.5		)	(1.1		)
Change in fair value of variable annuity death benefit liabilities, included in other expenses	(.5		)	(8.1		)	2.5			(6.1		)
Death benefit claims paid, included in other expenses	(.7		)	(.4		)	(1.7		)	(.8		)
General and administrative expenses	(1.4		)	(1.4		)	(2.1		)	(3.6		)
Pre-tax (loss) income	$	(1.8	)	$	(8.6	)	$	(10.8	)	$	(11.6	)

All of White Mountains’ variable annuity reinsurance liabilities were classified as Level 3 measurements at June 30, 2011. The following table summarizes the changes in White Mountains’ variable annuity reinsurance liabilities and derivative instruments for the three and six month periods ended June 30, 2011:

	Variable Annuity (Liabilities)			Derivative Instruments
Millions	Level 3			Level 3 (1)			Level 2 (1)(2)			Level 1 (3)			Total (4)
Balance at January 1, 2011	$	(610.2	)	$	275.3		$	72.2		$	—		$	347.5
Purchases	—			5.0			—			—			5.0
Realized and unrealized gains (losses)	18.9			(18.5		)	(8.2		)	(16.8		)	(43.5		)
Transfers in (out)	—			—			—			—			—
Sales/settlements	—			(29.1		)	(15.8		)	4.9			(40.0		)
Balance at June 30, 2011	$	(591.3	)	$	232.7		$	48.2		$	(11.9	)	$	269.0

	Variable Annuity (Liabilities)			Derivative Instruments
Millions	Level 3			Level 3 (1)		Level 2 (1)(2)			Level 1 (3)			Total (4)
Balance at March 31, 2011	$	(554.9	)	$	226.0	$	54.8		$	7.3		$	288.1
Purchases	—			—		—			—			—
Realized and unrealized gains (losses)	(36.4		)	6.7		12.5			2.8			22.0
Transfers in (out)	—			—		—			—			—
Sales/settlements	—			—		(19.1		)	(22.0		)	(41.1		)
Balance at June 30, 2011	$	(591.3	)	$	232.7	$	48.2		$	(11.9	)	$	269.0

(1) Comprises over-the-counter instruments.

(2) Comprises interest rate swaps, total return swaps and foreign currency forward contracts. Fair value measurement based upon bid/ask pricing quotes for similar instruments that are actively traded, where available. Swaps for which an active market does not exist have been priced using observable inputs including the swap curve and the underlying bond index.

(3) Comprises exchange traded equity index, foreign currency and interest rate futures. Fair value measurements based upon quoted prices for identical instruments that are actively traded.

(4) In addition to derivative instruments, WM Life Re held cash, short-term and fixed maturity investments of $370.5 at June 30, 2011 posted as collateral to its reinsurance counterparties.

The following summarizes realized and unrealized derivative gains (losses) recognized in other revenues for the three and six months ended June 30, 2011 and 2010 and the carrying values, included in other assets, at June 30, 2011 and December 31, 2010, by type of instrument:

	Three Months Ended					Six Months Ended					Carrying Value
	June 30,					June 30,					June 30,		December 31,
Millions	2011			2010		2011			2010		2011		2010
Fixed income/Interest rate	$	(6.3	)	$	19.2	$	(12.5	)	$	23.4	$	48.8	$	43.9
Foreign exchange	17.1			74.5		(30.2		)	68.5		161.2		225.3
Equity	11.2			79.1		(.8		)	38.6		59.0		78.3
Total	$	22.0		$	172.8	$	(43.5	)	$	130.5	$	269.0	$	347.5

WM Life Re enters into both over-the-counter (“OTC”) and exchange traded derivative instruments to economically hedge the liability from the variable annuity benefit guarantee. In the case of OTC derivatives, WM Life Re has exposure to credit risk for amounts that are uncollateralized by counterparties. WM Life Re’s internal risk management guidelines establish net counterparty exposure thresholds that take into account OTC counterparties’ credit ratings. WM Life Re has entered into master netting agreements with certain of its counterparties whereby the collateral provided (held) is calculated on a net basis. The following summarizes collateral provided to WM Life Re from counterparties:

Millions	June 30, 2011		December 31, 2010
Short-term investments	$	51.6	$	52.4
Fixed maturity securities	1.0		48.6
Total	$	52.6	$	101.0

Collateral held by or provided by WM Life Re in the form of fixed maturity securities comprise U.S. Treasury securities, which are recorded at fair value. Collateral in the form of short-term investments consists of money-market instruments, carried at amortized cost, which approximates fair value. The following summarizes the value, collateral provided (held) by WM Life Re and net exposure to credit losses on OTC derivative instruments recorded within other assets:

Millions	June 30, 2011			December 31, 2010
OTC derivative instruments(1)	$	284.2		$	351.5
Collateral held	(52.6		)	(101.0		)
Collateral provided	35.4			25.3
Net exposure to credit losses on fair value of OTC instruments	$	267.0		$	275.8

(1) Value of OTC derivative instruments as of June 30, 2011 and December 31, 2010 excludes adjustments for counterparty credit risk of $(3.3) and $(4.0) included in fair value under GAAP.

The following table summarizes uncollateralized amounts due under WM Life Re’s OTC derivative contracts:

Millions	Uncollateralized balance as of June 30, 2011		S&P Rating(1)

Citigroup (3)	$	73.5	A
Royal Bank of Scotland	73.4		A
Bank of America	50.1		A
Barclays	25.9		A+
Goldman Sachs(3)	9.8		A
Other	34.3		(2)
Total	$	267.0

(1) Standard & Poor’s (“S&P”) ratings as detailed above are: “A+” (which is the fifth highest of twenty-one creditworthiness ratings) and “A” (which is the sixth highest of twenty-one creditworthiness ratings).

(2) The S&P ratings of the counterparties included in “Other” were “AA” (Very Strong, which is the third highest of twenty-one creditworthiness ratings) (17%), “A+” (27%) and “BBB+” (Adequate, which is the eighth highest of twenty-one creditworthiness ratings) (56%).

(3) Collateral provided (held) calculated under master netting agreement.

The OTC derivative contracts are subject to restrictions on liquidation of the instruments and distribution of proceeds under collateral agreements. In addition, WM Life Re held cash, short-term and fixed maturity investments posted as collateral to its reinsurance counterparties. The additional collateral comprises the following:

Millions	June 30, 2011		December 31, 2010
Cash	$	345.9	$	291.1
Short-term investments	13.2		31.6
Fixed maturity investments	11.4		3.3
Total	$	370.5	$	326.0