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 BAM, a newly formed mutual municipal bond insurer. As of September 30, 2014, 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. Through HG Re, which had statutory capital of $445.7 million at September 30, 2014, HG Global provides first loss reinsurance protection for policies underwritten by BAM of up to 15% of par outstanding, on a per policy basis. HG Re’s obligations to BAM are collateralized in trusts, and there is an aggregate loss limit that is equal to the total assets in the collateral trusts at any point in time.

For the three and nine months ended September 30, 2014, HG Global had pre-tax income of $3.8 million and $13.4 million, which included $3.9 million and $11.8 million of interest income on the BAM surplus notes. For the three and nine months ended September 30, 2013, HG Global had pre-tax income of $10.5 million and $28.2 million, which included $10.1 million and $30.2 million of interest income on the BAM surplus notes.

For the three and nine months ended September 30, 2014, White Mountains reported pre-tax losses of $13.1 million and $29.7 million on BAM that were recorded in net loss attributable to non-controlling interests, which included $3.9 million and $11.8 million of interest expense on the BAM surplus notes. For the three and nine months ended September 30, 2013, White Mountains reported pre-tax losses of $15.1 million and $60.2 million on BAM that were recorded in net loss attributable to non-controlling interests, which included $10.1 million and $30.2 million of interest expense on the BAM surplus notes.

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% to a variable rate equal to the one-year U.S. treasury rate plus 300 basis points, set annually, which is 3.13% for 2014. Prior to the end of 2018, BAM has the 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%. BAM is required to seek regulatory approval to pay interest and principal on its surplus notes only when adequate capital resources have accumulated beyond BAM’s initial capitalization and a level that continues to support its outstanding obligations, business plan and ratings.

All of the contracts issued by BAM are accounted for as insurance contracts under ASC 944-605, Financial Guarantee Insurance Contracts. Premiums are received upfront and an unearned premium revenue liability, equal to the amount of the cash received, is established at contract inception. Premium revenues are recognized in revenue over the period of the contracts in proportion to the amount of insurance protection provided using a constant rate. The constant rate is calculated based on the relationship between the par outstanding in a given reporting period compared with the sum of each of the par amounts outstanding for all periods.

The following table provides a schedule of BAM’s insured obligations:



	September 30, 2014		December 31, 2013
Contracts outstanding	1,431		701
Remaining weighted average contract period outstanding (in years)	12.9		13.8
Contractual debt service outstanding (in millions):
Par	$	9,963.6	$	4,703.7
Interest	5,945.5		3,264.4
Total debt service outstanding	$	15,909.1	$	7,968.1

Gross unearned insurance premiums (in millions)	$	23.4	$	13.2