Reserves for Unpaid Losses and Loss Adjustment Expenses

Insurance

White Mountains’ insurance subsidiaries establish loss and LAE reserves that are estimates of amounts needed to pay claims and related expenses in the future for insured events that have already occurred. The process of estimating reserves involves a considerable degree of judgment by management and, as of any given date, is inherently uncertain.

Loss and LAE reserves are typically comprised of (1) case reserves for claims reported and (2) reserves for losses that have occurred but for which claims have not yet been reported, referred to as incurred but not reported (“IBNR”) reserves, which include a provision for expected future development on case reserves. Case reserves are estimated based on the experience and knowledge of claims staff regarding the nature and potential cost of each claim and are adjusted as additional information becomes known or payments are made. IBNR reserves are derived by subtracting paid loss and LAE and case reserves from estimates of ultimate loss and LAE. Actuaries estimate ultimate loss and LAE using various generally accepted actuarial methods applied to known losses and other relevant information. Like case reserves, IBNR reserves are adjusted as additional information becomes known or payments are made.

Ultimate loss and LAE are generally determined by extrapolation of claim emergence and settlement patterns observed in the past that can reasonably be expected to persist into the future. In forecasting ultimate loss and LAE with respect to any line of business, past experience with respect to that line of business is the primary resource, but cannot be relied upon in isolation. White Mountains’ own experience, particularly claims development experience, such as trends in case reserves, payments on and closings of claims, as well as changes in business mix and coverage limits, is the most important information for estimating its reserves. External data, available from organizations such as statistical bureaus, consulting firms and reinsurance companies, is sometimes used to supplement or corroborate White Mountains’ own experience, and can be especially useful for estimating costs of new business. For some lines of business, such as “long-tail” coverages discussed below, claims data reported in the most recent accident year is often too limited to provide a meaningful basis for analysis due to the typical delay in reporting of claims. For this type of business, White Mountains uses a selected loss ratio method for the initial accident year or years. This is a standard and accepted actuarial reserve estimation method in these circumstances in which the loss ratio is selected based upon information used in pricing policies for that line of business, as well as any publicly available industry data, such as industry pricing, experience and trends, for that line of business.

Uncertainties in estimating ultimate loss and LAE are magnified by the time lag between when a claim actually occurs and when it is reported and settled. This time lag is sometimes referred to as the “claim-tail”. The claim-tail for most property coverages is typically short (usually a few days up to a few months). The claim-tail for liability/casualty coverages, such as automobile liability, general liability, products liability, multiple peril coverage, and workers compensation, can be especially long as claims are often reported and ultimately paid or settled years, even decades, after the related loss events occur. During the long claims reporting and settlement period, additional facts regarding coverages written in prior accident years, as well as about actual claims and trends may become known and, as a result, White Mountains may adjust its reserves. If management determines that an adjustment is appropriate, the adjustment is booked in the accounting period in which such determination is made in accordance with GAAP. Accordingly, should reserves need to be increased or decreased in the future from amounts currently established, future results of operations would be negatively or positively impacted, as applicable.

In determining ultimate loss and LAE, the cost to indemnify claimants, provide needed legal defense and other services for insureds and administer the investigation and adjustment of claims are considered. These claim costs are influenced by many factors that change over time, such as expanded coverage definitions as a result of new court decisions, inflation in costs to repair or replace damaged property, inflation in the cost of medical services and legislated changes in statutory benefits, as well as by the particular, unique facts that pertain to each claim. As a result, the rate at which claims arose in the past and the costs to settle them may not always be representative of what will occur in the future. The factors influencing changes in claim costs are often difficult to isolate or quantify and developments in paid and incurred losses from historical trends are frequently subject to multiple and conflicting interpretations. Changes in coverage terms or claims handling practices may also cause future experience and/or development patterns to vary from the past. A key objective of actuaries in developing estimates of ultimate loss and LAE, and resulting IBNR reserves, is to identify aberrations and systemic changes occurring within historical experience and accurately adjust for them so that the future can be projected reliably. Because of the factors previously discussed, this process requires the use of informed judgment and is inherently uncertain.

White Mountains’ actuaries use several generally accepted actuarial methods to evaluate its loss reserves, each of which has its own strengths and weaknesses. Management places more or less reliance on a particular method based on the facts and circumstances at the time the reserve estimates are made.

These methods generally fall into one of the following categories or are hybrids of one or more of the following categories:

•

Historical paid loss development methods: These methods use historical loss payments over discrete periods of time to estimate future losses. Historical paid loss development methods assume that the ratio of losses paid in one period to losses paid in an earlier period will remain constant. These methods necessarily assume that factors that have affected paid losses in the past, such as inflation or the effects of litigation, will remain constant in the future. Because historical paid loss development methods do not use case reserves to estimate ultimate losses, they can be more reliable than the other methods discussed below that look to case reserves (such as actuarial methods that use incurred losses) in situations where there are significant changes in how case reserves are established by a company’s claims adjusters. However, historical paid loss development methods are more leveraged, meaning that small changes in payments have a larger impact on estimates of ultimate losses, than actuarial methods that use incurred losses because cumulative loss payments take much longer to equal the expected ultimate losses than cumulative incurred amounts. In addition, and for similar reasons, historical paid loss development methods are often slow to react to situations when new or different factors arise than those that have affected paid losses in the past.

•

Historical incurred loss development methods: These methods, like historical paid loss development methods, assume that the ratio of losses in one period to losses in an earlier period will remain constant in the future. However, instead of using paid losses, these methods use incurred losses (i.e., the sum of cumulative historical loss payments plus outstanding case reserves) over discrete periods of time to estimate future losses. Historical incurred loss development methods can be preferable to historical paid loss development methods because they explicitly take into account open cases and the claims adjusters’ evaluations of the cost to settle all known claims. However, historical incurred loss development methods necessarily assume that case reserving practices are consistently applied over time. Therefore, when there have been significant changes in how case reserves are established, using incurred loss data to project ultimate losses can be less reliable than other methods.

•

Expected loss ratio methods: These methods are based on the assumption that ultimate losses vary proportionately with premiums. Expected loss ratios are typically developed based upon the information used in pricing, and are multiplied by the total amount of premiums written to calculate ultimate losses. Expected loss ratio methods are useful for estimating ultimate losses in the early years of long-tailed lines of business, when little or no paid or incurred loss information is available.

•

Adjusted historical paid and incurred loss development methods: These methods take traditional historical paid and incurred loss development methods and adjust them for the estimated impact of changes from the past in factors such as inflation, the speed of claim payments or the adequacy of case reserves. Adjusted historical paid and incurred loss development methods are often more reliable methods of predicting ultimate losses in periods of significant change, provided the actuaries can develop methods to reasonably quantify the impact of changes.

White Mountains performs an actuarial review of its recorded reserves each quarter. White Mountains’ actuaries compare the previous quarter’s estimates of paid loss and LAE, case reserves and IBNR to amounts indicated by actual experience. Differences between previous estimates and actual experience are evaluated to determine whether a given actuarial method for estimating loss and LAE should be relied upon to a greater or lesser extent than it had been in the past. While some variance is expected each quarter due to the inherent uncertainty in loss and LAE, persistent or large variances would indicate that prior assumptions and/or reliance on certain reserving methods may need to be revised going forward.

The actuarial analysis is a primary consideration for management in determining its best estimate of loss and LAE reserves. In making its best estimate, management also considers other qualitative factors that may lead to a difference between its best estimate of loss and LAE reserves and the actuarial point estimate. Typically, these factors exist when management and the company’s actuaries conclude that there is insufficient historical incurred and paid loss information or that trends included in the historical incurred and paid loss information are unlikely to repeat in the future. These factors may include, among others, changes in the techniques used to assess underwriting risk, more accurate and detailed levels of data submitted with reinsurance applications, the uncertainty of the current reinsurance pricing environment, the level of inflation in loss costs, changes in ceding company reserving practices, and legal and regulatory developments.

Reinsurance

Sirius Group establishes loss and LAE reserves that are estimates of future amounts needed to pay claims and related expenses for events that have already occurred. Sirius Group also obtains reinsurance whereby another reinsurer contractually agrees to indemnify White Mountains for all or a portion of the reinsurance risks underwritten by White Mountains. Such arrangements, where one reinsurer provides reinsurance to another reinsurer, are usually referred to as “retrocessional reinsurance” arrangements. White Mountains establishes estimates of amounts recoverable from retrocessional reinsurance in a manner consistent with the loss and LAE liability associated with reinsurance contracts offered to its customers (the “ceding companies”), net of an allowance for uncollectible amounts. Net reinsurance loss reserves represent loss and LAE reserves reduced by retrocessional reinsurance recoverable on unpaid losses.

The estimation of net reinsurance loss and LAE reserves is subject to the same risk as the estimation of insurance loss and LAE reserves. In addition to those risk factors which give rise to inherent uncertainties in establishing insurance loss and LAE reserves, the inherent uncertainties of estimating such reserves are even greater for the reinsurer, due primarily to: (1) the claim-tail for reinsurers being further extended because claims are first reported to the original primary insurance company and then through one or more intermediaries or reinsurers, (2) the diversity of loss development patterns among different types of reinsurance treaties or facultative contracts, (3) the necessary reliance on the ceding companies for information regarding reported claims and (4) the differing reserving practices among ceding companies.

As with insurance reserves, the process of estimating reinsurance reserves involves a considerable degree of judgment by management and, as of any given date, is inherently uncertain. Based on the above, such uncertainty may be larger relative to the reserves for a company that principally writes reinsurance compared to an insurance company, and certainty may take a longer time to emerge.

Upon notification of a loss from an insured (typically a ceding company), Sirius Group establishes case reserves, including LAE reserves, based upon Sirius Group’s share of the amount of reserves established by the insured and Sirius Group’s independent evaluation of the loss. In cases where available information indicates that reserves established by a ceding company are inadequate, Sirius Group establishes case reserves or IBNR in excess of its share of the reserves established by the ceding company. Also, in certain instances, Sirius Group may decide not to establish case reserves or IBNR, when the information available indicates that reserves established by ceding companies are not adequately supported. In addition, specific claim information reported by insureds or obtained through claim audits can alert management to emerging trends such as changing legal interpretations of coverage and liability, claims from unexpected sources or classes of business, and significant changes in the frequency or severity of individual claims where customary. Generally, ceding company audits are not customary outside the United States. This information is often used to supplement estimates of IBNR.

Although loss and LAE reserves are initially determined based on underwriting and pricing analyses, Sirius Group regularly reviews the adequacy of its recorded reserves by using a variety of generally accepted actuarial methods, including historical incurred and paid loss development methods. If actual loss activity differs substantially from expectations, an adjustment to recorded reserves may be warranted. As time passes, loss reserve estimates for a given year will rely more on actual loss activity and historical patterns than on initial assumptions based on pricing indications.

The actuarial methods described above are used to calculate a point estimate of loss and LAE reserves for each company within Sirius Group. These point estimates are then aggregated to produce an actuarial point estimate for the entire segment. Once a point estimate is established, Sirius Group’s actuaries estimate loss reserve ranges to measure the sensitivity of the actuarial assumptions used to set the point estimates. These ranges are calculated from historical variations in loss ratios, payment and reporting patterns by class and type of business.

Loss and Loss Adjustment Expense Reserve Summary

The following table summarizes the loss and LAE reserve activities of White Mountains’ insurance and reinsurance subsidiaries for the years ended December 31, 2012, 2011 and 2010:



	Year Ended December 31,
Millions	2012			2011			2010
Gross beginning balance	$	5,702.3		$	5,736.8		$	6,379.2
Less beginning reinsurance recoverable on unpaid losses	(2,507.3		)	(2,344.0		)	(2,771.5		)
Net loss and LAE reserves	3,195.0			3,392.8			3,607.7

Less: Beginning net loss and LAE reserves for AutoOne and the Runoff Transaction ⁽¹⁾	(383.3		)	(619.6		)	(759.0		)

Loss and LAE reserves acquired ⁽²⁾	17.0			21.0			17.6
Loss and LAE reserves sold—OneBeacon Personal Lines	—			—			(231.0		)

Losses and LAE incurred relating to:
Current year losses	1,235.8			1,251.0			1,309.7
Prior year losses	(41.9		)	(76.7		)	(93.1		)
Total incurred losses and LAE	1,193.9			1,174.3			1,216.6

Accretion of fair value adjustment to net loss and LAE reserves	10.6			8.3			8.5
Foreign currency translation adjustment to net loss and LAE reserves	12.9			.1			4.7

Loss and LAE paid relating to:
Current year losses	(404.7		)	(387.9		)	(445.9		)
Prior year losses	(901.6		)	(777.3		)	(646.0		)
Total loss and LAE payments	(1,306.3		)	(1,165.2		)	(1,091.9		)

Plus: Ending net loss and LAE reserves for AutoOne and the Runoff Transaction ⁽¹⁾	—			383.3			619.6

Net ending balance	2,739.8			3,195.0			3,392.8
Plus ending reinsurance recoverable on unpaid losses	429.1			2,507.3			2,344.0
Gross ending balance	$	3,168.9		$	5,702.3		$	5,736.8


⁽¹⁾	Loss and LAE reserve balances from OneBeacon’s runoff business prior to December 31, 2012 and AutoOne prior to December 31, 2011 were not classified as held for sale. Adjustment is to present loss and LAE reserve activities for continuing operations.


⁽²⁾	Loss and LAE reserves acquired relate to WM Solutions purchases of PICO, Citation, American General and American General Property in 2012, Old Lyme in 2011 and Central National in 2010.

Loss and LAE development —2012

During the year ended December 31, 2012, White Mountains experienced $41.9 million of net favorable loss reserve development, which consisted of $7.4 million of net favorable loss reserve development at OneBeacon and $34.5 million of net favorable loss reserve development at Sirius Group.

During 2012, OneBeacon experienced $7.4 million of net favorable loss and LAE reserve development on prior accident year reserves. The favorable reserve development at OneBeacon was primarily from workers' compensation, multiple peril liability and general liability lines. This favorable development was offset somewhat by adverse development on excess property claims.

In 2012, Sirius Group had net favorable loss reserve development of $34.5 million. The major reductions in loss reserve estimates at Sirius Group were recognized in casualty runoff ($31.5 million), property ($28.4 million), marine/energy ($11.6 million), trade credit ($6.8 million) and aviation/space ($5.3 million) lines, partially offset by a $46.4 million increase in asbestos loss reserves and a $4.3 million increase in accident and health.

Loss and LAE development —2011

During the year ended December 31, 2011, White Mountains experienced $76.7 million of net favorable loss reserve development, which consisted of $29.8 million of net favorable loss and LAE reserve development on prior accident year loss reserves at OneBeacon and $46.9 million of net favorable loss reserve development at Sirius Group.

OneBeacon’s net favorable loss and LAE reserve development was primarily due to lower than expected severity on non catastrophe losses related to professional liability lines, multiple peril liability lines and other general liability lines. With respect to the favorable loss reserve development in specialty insurance operations, at December 31, 2010, management had revised its expectations downward for future loss emergence in the professional liability business, which had initially been based on market analysis when this business was initiated in 2002 and 2003. However, during 2011, losses continued to be significantly lower than these revised expectations. As a result, management lowered its selected reserves on the earliest years which affected more recent years as total loss expectations for those years are based in part on prior years’ results. The impact of this revised estimate was a decrease to professional liability reserves of $11.5 million.

During 2010, management began separately reviewing loss reserves for some business which had been previously managed as a part of OneBeacon’s former commercial lines underwriting unit. As of December 31, 2010, the reserves for these businesses had been selected based on expected emergence that was based on the historic loss development of former commercial lines underwriting unit. However, during 2011 the actual emerged experience for these businesses was

significantly lower than the expected emergence. As a result of this favorable emergence, management lowered the loss

reserves for these businesses by $14.0 million during 2011.

In addition to the development described for the lines of business above, OneBeacon also recorded a $4.3 million net decrease in reserves in other lines of business as a result of its review of loss reserves at December 31, 2011.

The net favorable loss reserve development at Sirius Group was primarily attributable to $41.2 million of favorable development on property lines including, $13.1 million of loss reserve reductions for the 2010 Chile earthquake, partially offset by asbestos and environmental increases of $12.3 million.

Loss and LAE development —2010

During the year ended December 31, 2010, White Mountains experienced $93.1 million of net favorable loss reserve development, which consisted of $36.0 million of net favorable loss and LAE reserve development on prior accident year loss reserves at OneBeacon and $57.1 million of net favorable loss reserve development at Sirius Group.

OneBeacon’s net favorable loss reserve development was primarily due to lower than expected severity on non-catastrophe losses related to professional liability lines, multiple peril liability lines and other general liability lines, as well as development on personal lines business. The favorable development also included a $7.5 million release of commercial catastrophe reserves associated with storms occurring in 2004 and 2005.

Specifically, at December 31, 2009, management had revised its expectations downward with respect to future loss emergence in the professional liability business, which had initially been based on market analysis when this business was initiated in 2002 and 2003. However, during 2010, losses continued to be significantly lower than these revised expectations. As a result, management lowered its selected reserves on the earliest years which affected more recent years as total loss expectations for those years are based in part on prior years’ results. The impact of this revised estimate was a decrease to professional liability reserves of $19.3 million.

At December 31, 2009, OneBeacon had recorded $7.5 million of reserves for certain claims related to catastrophes from accident years 2004 and 2005 related to OneBeacon’s excess property business. During 2010, these claims were resolved for amounts below OneBeacon’s policy coverage therefore the reserves were no longer necessary.

In addition to the development described for the lines of business above, OneBeacon also recorded a $9.2 million net decrease in IBNR in other lines of business, primarily personal lines, as a result of its review of loss reserves at December 31, 2010.

The net favorable loss reserve development at Sirius Group was primarily related to short-tailed lines, such as property, accident and health and marine, in recent underwriting years. Included in the $57.1 million favorable loss reserve development was the recognition of $16.3 million in deferred gains from a retrocessional reinsurance contract that incepted in 2000 and was fully collected in 2010.

Fair value adjustment to loss and LAE reserves

In connection with purchase accounting for acquisitions, White Mountains is required to adjust loss and LAE reserves and the related reinsurance recoverables to fair value on their respective acquired balance sheets. The net reduction to loss and LAE reserves is being recognized through an income statement charge ratably with and over the period the claims are settled.

White Mountains recognized $10.6 million, $8.3 million and $8.5 million of such charges, recorded as loss and LAE during 2012, 2011 and 2010. As of December 31, 2012, the pre-tax un-accreted adjustment was $5.7 million.

Asbestos and Environmental Loss and Loss Adjustment Expense Reserve Activity

White Mountains’ reserves include provisions made for claims that assert damages from asbestos and environmental related exposures. Asbestos claims relate primarily to injuries asserted by those who came in contact with asbestos or products containing asbestos. Environmental claims relate primarily to pollution and related clean-up cost obligations, particularly as mandated by U.S. federal and state environmental protection agencies. In addition to the factors described above regarding the reserving process, White Mountains estimates its A&E reserves based upon, among other factors, facts surrounding reported cases and exposures to claims, such as policy limits and deductibles, current law, past and projected claim activity and past settlement values for similar claims, as well as analysis of industry studies and events, such as recent settlements and asbestos-related bankruptcies. The cost of administering A&E claims, which is an important factor in estimating loss reserves, tends to be higher than in the case of non-A&E claims due to the higher legal costs typically associated with A&E claims.

Substantially all of OneBeacon's reserves for unpaid loss and LAE for asbestos and environmental exposures relates to discontinued operations (see Note 20). As of December 31, 2012, the remaining unpaid loss and LAE loss reserves for asbestos and environmental exposures related to continuing operations is less than $1.0 million on both a gross and net basis at December 31, 2012.

In 2012, Sirius Group increased its net A&E exposure through two incoming runoff portfolios acquired by White Mountains Solutions. These acquisitions added $11.0 million in net asbestos reserves and $0.7 million in net environmental reserves.

The acquisition of companies having modest portfolios of A&E exposure has been typical of several prior White Mountains Solutions transactions and is likely to be an element of at least some future acquisitions. However, the acquisitions of new A&E liabilities is undertaken only after careful due diligence and utilizing conservative reserving assumptions in relation to industry benchmarks. In the case of those portfolios acquired during 2012, the exposures arise almost entirely from old assumed reinsurance contracts having small limits of liability.

In addition to the $11.0 million increase in asbestos reserves from the two incoming portfolios acquired by White Mountains Solutions mentioned above, Sirius Group recorded $46.4 million and $10.3 million of asbestos-related incurred losses and LAE on its already existing asbestos reserves in 2012 and 2011, respectively. In the first six months of 2012, Sirius Group increased net asbestos reserves by $12.0 million in response to its quarterly monitoring of newly reported claims. Based on the monitoring trends noted in the first six months 2012, Sirius Group conducted an in-depth analysis of its asbestos exposure, which was completed in third quarter. The main focus of the analysis was on the internal claims analysis of all treaty and facultative contracts likely to have asbestos exposure. An external expert with extensive asbestos claims experience was utilized to enhance the review. This analysis entailed examining total expected asbestos losses and LAE from a variety of information sources, including previous asbestos studies, reported client data and external benchmarking scenarios. The analysis resulted in a net asbestos loss reserve increase of $33.0 million recognized in third quarter. An additional $2.0 million of asbestos losses were recognized in fourth quarter 2012. The 2011 incurred losses were primarily the result of management's monitoring of a variety of metrics including: actual paid and reported claims activity; net survival ratios; peer comparisons; and industry benchmarks.

Offsetting the $0.7 million increase in environmental reserves mentioned above, Sirius Group recorded a decrease of $0.5 million in 2012 of environmental-related losses on its already existing reserves in 2012. In 2011, Sirius Group recorded $2.0 million of environmental losses.

Sirius Group’s net reserves for A&E losses were $189.4 million and $162.7 million at December 31, 2012 and 2011, respectively. Sirius Group’s A&E three-year net loss paid survival ratio was approximately 9.0 years and 11.1 years at December 31, 2012 and 2011. The decrease in the paid survival ratio in 2012 was driven by an unusually high net paid loss of $8.5 million made in first quarter 2012 to commute one of Sirius Group's top five asbestos exposures.

White Mountains’ reserves for A&E losses at December 31, 2012 represent management’s best estimate of its ultimate liability based on information currently available. However, as case law expands, and medical and clean-up costs increase and industry settlement practices change, White Mountains may be subject to asbestos and environmental losses beyond currently estimated amounts. White Mountains cannot reasonably estimate at the present time loss reserve additions arising from any such future adverse developments and cannot be sure that allocated loss reserves, plus the remaining capacity under the NICO Cover and other reinsurance contracts, will be sufficient to cover additional liability arising from any such adverse developments.

Sirius Group



Net A&E Loss Reserve Activity	Year Ended December 31,
	2012						2011						2010
Millions	Gross			Net			Gross			Net			Gross			Net
Asbestos:
Beginning balance	$	185.1		$	146.2		$	191.9		$	151.5		$	187.0		$	146.6
Losses and LAE acquired	11.0			11.0			—			—			10.4			9.7
Incurred losses and LAE	46.8			46.4			13.6			10.3			9.0			7.3
Paid losses and LAE	(34.7		)	(29.4		)	(20.4		)	(15.6		)	(14.5		)	(12.1		)
Ending balance	208.2			174.2			185.1			146.2			191.9			151.5
Environmental:
Beginning balance	22.1			16.5			22.4			18.1			22.2			17.9
Losses and LAE acquired	0.7			0.7			—			—			3.5			2.4
Incurred losses and LAE	(0.1		)	(0.5		)	2.9			2.0			(2.5		)	(1.3		)
Paid losses and LAE	(2.3		)	(1.5		)	(3.2		)	(3.6		)	(.8		)	(.9		)
Ending balance	20.4			15.2			22.1			16.5			22.4			18.1
Total asbestos and environmental:
Beginning balance	207.2			162.7			214.3			169.6			209.2			164.5
Losses and LAE acquired	11.7			11.7			—			—			13.9			12.1
Incurred losses and LAE	46.7			45.9			16.5			12.3			6.5			6.0
Paid losses and LAE	(37.0		)	(30.9		)	(23.6		)	(19.2		)	(15.3		)	(13.0		)
Ending balance	$	228.6		$	189.4		$	207.2		$	162.7		$	214.3		$	169.6