Table of Contents

 

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 

x

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the period ended March 31, 2009

 

 

 

OR

 

 

 

o

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

For the transition period from          to

 

Commission file number 1-33128

 

ONEBEACON INSURANCE GROUP, LTD.

(Exact name of Registrant as specified in its charter)

 

Bermuda

 

98-0503315

(State or other jurisdiction of
incorporation or organization)

 

(I.R.S. Employer
Identification No.)

 

 

 

601 Carlson Parkway

 

 

Minnetonka, Minnesota

 

55305

(Address of principal executive offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code: (952) 852-2431

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes  x    No   o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months. Yes  x    No   o

 

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer o

 

Accelerated Filer x

 

Non-accelerated filer o

 

Smaller reporting company o

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o    No   x

 

As of April 30, 2009, 23,339,461 Class A common shares, par value of $0.01 per share, and 71,754,738 Class B common shares, par value of $0.01 per share, were outstanding.

 

 

 



Table of Contents

 

ONEBEACON INSURANCE GROUP, LTD.

 

TABLE OF CONTENTS

 

PART I

 

FINANCIAL INFORMATION

 

 

 

 

 

 

 

ITEM 1.

 

Financial Statements (Unaudited)

 

 

 

 

 

 

 

 

 

Consolidated Balance Sheets:
March 31, 2009 and December 31, 2008

 

2

 

 

 

 

 

 

 

Consolidated Statements of Operations and Comprehensive Income (Loss):
Three months ended March 31, 2009 and 2008

 

3

 

 

 

 

 

 

 

Consolidated Statements of Shareholders’ Equity:
Three months ended March 31, 2009 and 2008

 

4

 

 

 

 

 

 

 

Consolidated Statements of Cash Flows:
Three months ended March 31, 2009 and 2008

 

5

 

 

 

 

 

 

 

Notes to Consolidated Financial Statements

 

6

 

 

 

 

 

ITEM 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

23

 

 

 

 

 

 

 

Results of Operations — For the three months ended March 31, 2009 and 2008

 

24

 

 

 

 

 

 

 

Summary of Investment Results

 

28

 

 

 

 

 

 

 

Non-GAAP Financial Measures

 

34

 

 

 

 

 

 

 

Liquidity and Capital Resources

 

35

 

 

 

 

 

 

 

Critical Accounting Estimates

 

39

 

 

 

 

 

 

 

Forward-Looking Statements

 

40

 

 

 

 

 

ITEM 3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

41

 

 

 

 

 

ITEM 4.

 

Controls and Procedures

 

41

 

 

 

 

 

PART II

 

OTHER INFORMATION

 

 

 

 

 

 

 

ITEM 1.

 

Legal Proceedings

 

41

 

 

 

 

 

ITEM 1A.

 

Risk Factors

 

41

 

 

 

 

 

ITEM 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

41

 

 

 

 

 

ITEM 6.

 

Exhibits

 

42

 

 

 

 

 

SIGNATURES

 

 

43

 



Table of Contents

 

PART 1. FINANCIAL INFORMATION

 

ITEM 1. Financial Statements

 

ONEBEACON INSURANCE GROUP, LTD.

CONSOLIDATED BALANCE SHEETS

 

 

 

March 31,

 

December 31,

 

 

 

2009

 

2008

 

 

 

(Unaudited)

 

 

 

 

 

($ in millions, except
share and per share
amounts)

 

Assets

 

 

 

 

 

Investment Securities:

 

 

 

 

 

Fixed maturity investments, at fair value (amortized cost $2,551.2 and $2,246.4)

 

$

2,479.5

 

$

2,134.8

 

Common equity securities, at fair value (cost $102.0 and $284.6)

 

103.3

 

276.7

 

Convertible bonds, at fair value (amortized cost $221.7 and $255.0)

 

206.2

 

241.2

 

Short-term investments, at amortized cost (which approximates fair value)

 

802.5

 

962.2

 

Other investments, at fair value (cost $175.6 and $178.6)

 

189.3

 

196.6

 

Total investments

 

3,780.8

 

3,811.5

 

Cash

 

52.7

 

53.0

 

Reinsurance recoverable on unpaid losses

 

832.6

 

859.4

 

Reinsurance recoverable on unpaid losses—Berkshire Hathaway, Inc.

 

1,608.3

 

1,643.9

 

Reinsurance recoverable on paid losses

 

19.8

 

21.7

 

Premiums receivable

 

520.1

 

527.6

 

Securities lending collateral

 

 

100.7

 

Deferred acquisition costs

 

217.4

 

225.5

 

Net deferred tax asset

 

194.4

 

252.7

 

Investment income accrued

 

25.1

 

25.7

 

Ceded unearned premiums

 

68.7

 

66.5

 

Accounts receivable on unsettled investment sales

 

12.4

 

49.0

 

Other assets

 

348.1

 

303.6

 

Total assets

 

$

7,680.4

 

$

7,940.8

 

Liabilities

 

 

 

 

 

Loss and LAE reserves

 

$

4,211.2

 

$

4,294.0

 

Unearned premiums

 

1,072.0

 

1,088.2

 

Debt

 

719.1

 

731.9

 

Securities lending payable

 

48.6

 

107.7

 

Ceded reinsurance payable

 

63.5

 

70.5

 

Accounts payable on unsettled investment purchases

 

1.9

 

6.8

 

Other liabilities

 

375.4

 

469.4

 

Total liabilities

 

6,491.7

 

6,768.5

 

Shareholders’ equity and noncontrolling interests

 

 

 

 

 

OneBeacon’s shareholders’ equity:

 

 

 

 

 

Common shares and paid-in surplus (par value $0.01; authorized, 200,000,000 shares; issued and outstanding, 95,094,199 shares)

 

1,017.0

 

1,016.7

 

Retained earnings

 

176.2

 

163.4

 

Accumulated other comprehensive loss, after tax:

 

 

 

 

 

Net unrealized foreign currency translation losses

 

(0.6

)

(0.6

)

Other comprehensive loss items

 

(23.3

)

(24.4

)

Total OneBeacon’s shareholders’ equity

 

1,169.3

 

1,155.1

 

Total noncontrolling interests

 

19.4

 

17.2

 

Total OneBeacon’s shareholders’ equity and noncontrolling interests

 

1,188.7

 

1,172.3

 

Total liabilities, OneBeacon’s shareholders’ equity and noncontrolling interests

 

$

7,680.4

 

$

7,940.8

 

 

See Notes to Consolidated Financial Statements.

 

2



Table of Contents

 

ONEBEACON INSURANCE GROUP, LTD.

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

(Unaudited)

 

 

 

Three months ended
March 31,

 

 

 

2009

 

2008

 

 

 

($ in millions, except per
share amounts)

 

Revenues

 

 

 

 

 

Earned premiums

 

$

487.8

 

$

455.3

 

Net investment income

 

21.9

 

50.1

 

Net realized and unrealized investment losses

 

(5.9

)

(55.4

)

Net other revenues

 

9.4

 

3.6

 

Total revenues

 

513.2

 

453.6

 

Expenses

 

 

 

 

 

Loss and LAE

 

288.0

 

300.9

 

Policy acquisition expenses

 

95.9

 

84.7

 

Other underwriting expenses

 

72.7

 

70.1

 

General and administrative expenses

 

5.5

 

2.9

 

Accretion of fair value adjustment to loss and LAE reserves

 

1.4

 

3.0

 

Interest expense on debt

 

10.9

 

11.5

 

Interest expense—dividends on preferred stock subject to mandatory redemption

 

 

7.1

 

Interest expense—accretion on preferred stock subject to mandatory redemption

 

 

10.5

 

Total expenses

 

474.4

 

490.7

 

Pre-tax income (loss)

 

38.8

 

(37.1

)

Income tax (expense) benefit

 

(5.5

)

13.9

 

Net income (loss) including noncontrolling interests

 

33.3

 

(23.2

)

Less: Net income attributable to noncontrolling interests

 

(0.5

)

(1.1

)

Net income (loss) attributable to OneBeacon’s shareholders

 

32.8

 

(24.3

)

Change in other comprehensive income and loss items

 

1.1

 

(1.2

)

Comprehensive net income (loss) attributable to OneBeacon’s shareholders

 

$

33.9

 

$

(25.5

)

 

 

 

 

 

 

Basic and diluted earnings (loss) per share attributable to OneBeacon’s shareholders

 

 

 

 

 

Basic:

 

 

 

 

 

Net income (loss) attributable to OneBeacon’s shareholders

 

$

0.34

 

$

(0.25

)

Diluted:

 

 

 

 

 

Net income (loss) attributable to OneBeacon’s shareholders

 

$

0.34

 

$

(0.25

)

 

 

 

 

 

 

Dividends declared and paid per common share

 

$

0.21

 

$

2.24

 

 

See Notes to Consolidated Financial Statements.

 

3



Table of Contents

 

ONEBEACON INSURANCE GROUP, LTD.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(Unaudited)

 

 

 

OneBeacon’s Shareholders’ Equity

 

 

 

 

 

Common
shareholders’ 
equity

 

Common
shares and
paid-in
surplus

 

Retained
earnings

 

Accum. other
comprehensive
(loss) income,
after tax

 

Noncontrolling
interests,
after tax

 

 

 

($ in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

Balances at January 1, 2009

 

$

1,155.1

 

$

1,016.7

 

$

163.4

 

$

(25.0

)

$

17.2

 

Net income

 

32.8

 

 

32.8

 

 

0.5

 

Accrued option expense

 

0.3

 

0.3

 

 

 

 

Repurchases and retirements of common shares

 

 

 

 

 

0.3

 

Dividends

 

(20.0

)

 

(20.0

)

 

(0.6

)

Contributions

 

 

 

 

 

2.0

 

Other comprehensive income, after tax

 

1.1

 

 

 

1.1

 

 

Balances at March 31, 2009

 

$

1,169.3

 

$

1,017.0

 

$

176.2

 

$

(23.9

)

$

19.4

 

 

 

 

OneBeacon’s Shareholders’ Equity

 

 

 

 

 

Common
shareholders’ 
equity

 

Common
shares and
paid-in
surplus

 

Retained
earnings

 

Accum. other
comprehensive
income (loss),
after tax

 

Noncontrolling
interests,
after tax

 

 

 

($ in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

Balances at January 1, 2008

 

$

1,906.5

 

$

1,084.4

 

$

641.0

 

$

181.1

 

$

21.3

 

Adjustment to adopt SFAS No. 159, after tax

 

 

 

180.6

 

(180.6

)

 

Net (loss) income

 

(24.3

)

 

(24.3

)

 

1.1

 

Accrued option expense

 

0.3

 

0.3

 

 

 

 

Repurchases and retirements of common shares

 

(52.8

)

(52.8

)

 

 

0.3

 

Dividends

 

(215.5

)

 

(215.5

)

 

(0.6

)

Contributions

 

 

 

 

 

0.8

 

Other comprehensive loss, after tax

 

(1.2

)

 

 

(1.2

)

 

Balances at March 31, 2008

 

$

1,613.0

 

$

1,031.9

 

$

581.8

 

$

(0.7

)

$

22.9

 

 

See Notes to Consolidated Financial Statements.

 

4



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ONEBEACON INSURANCE GROUP, LTD.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

 

 

Three months ended
March 31,

 

 

 

2009

 

2008

 

 

 

($ in millions)

 

Cash flows from operations:

 

 

 

 

 

Net income (loss)

 

$

32.8

 

$

(24.3

)

Charges (credits) to reconcile net income (loss) to cash flows used for operations:

 

 

 

 

 

Net realized and unrealized investment losses

 

5.9

 

55.4

 

Net realized gains from sale of common stock of subsidiary

 

 

(1.0

)

Deferred income tax expense (benefit)

 

57.9

 

(0.2

)

Other operating items:

 

 

 

 

 

Net change in loss and LAE reserves

 

(82.8

)

(19.9

)

Net change in unearned premiums

 

(16.2

)

(19.0

)

Net change in ceded reinsurance payable

 

(7.0

)

6.0

 

Net change in premiums receivable

 

7.5

 

5.8

 

Net change in reinsurance recoverable on paid and unpaid losses

 

64.3

 

29.6

 

Net change in other assets and liabilities

 

(120.2

)

(128.4

)

Net cash used for operations

 

(57.8

)

(96.0

)

Cash flows from investing activities:

 

 

 

 

 

Net maturities, purchases and sales of short-term investments

 

162.2

 

(96.8

)

Purchases of short-term held-to-maturity investments

 

 

(7.1

)

Maturities of fixed maturity investments

 

76.5

 

112.7

 

Maturities of fixed maturity investments held-to-maturity

 

 

3.4

 

Sales of fixed maturity investments

 

248.3

 

541.2

 

Sales of common equity securities

 

156.9

 

75.8

 

Sales of convertible bonds

 

83.5

 

55.1

 

Distributions of other investments

 

7.2

 

18.4

 

Purchases of fixed maturity investments

 

(611.7

)

(265.8

)

Purchases of common equity securities

 

(13.9

)

(108.8

)

Purchases of convertible bonds

 

(50.2

)

(41.9

)

Contributions of other investments

 

(3.5

)

(18.5

)

Net change in fixed maturity investments held for collateral under securities lending

 

(44.7

)

 

Net change in short-term investments held for collateral under securities lending

 

(2.2

)

 

Sale of common stock of subsidiary, net of sales costs

 

 

4.2

 

Net change in unsettled investment purchases and sales

 

31.7

 

89.0

 

Net acquisitions of property and equipment

 

0.6

 

(0.1

)

Net cash provided from investing activities

 

40.7

 

360.8

 

Cash flows from financing activities:

 

 

 

 

 

Net change in securities lending payable

 

46.9

 

 

Repayment of debt

 

(2.0

)

(2.0

)

Repurchases and retirements of Class A common shares

 

 

(52.8

)

Repurchases of debt

 

(8.1

)

 

Cash dividends paid to common shareholders

 

(20.0

)

(215.5

)

Net cash provided from (used for) financing activities

 

16.8

 

(270.3

)

Net decrease in cash during period

 

(0.3

)

(5.5

)

Cash balance at beginning of period

 

53.0

 

49.4

 

Cash balance at end of period

 

$

52.7

 

$

43.9

 

 

 

 

 

 

 

Supplemental cash flows information:

 

 

 

 

 

Interest paid

 

$

0.8

 

$

0.8

 

Net tax payments to national governments

 

1.4

 

18.6

 

 

See Notes to Consolidated Financial Statements.

 

5



Table of Contents

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 1. Nature of Operations and Summary of Significant Accounting Policies

 

Basis of presentation

 

These interim consolidated financial statements include the accounts of OneBeacon Insurance Group, Ltd. (the “Company” or the “Registrant”) and its subsidiaries (collectively, “OneBeacon”) and have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The OneBeacon operating companies are U.S.-based property and casualty insurance writers, most of which operate in a multi-company pool. OneBeacon offers a wide range of specialty, commercial and personal products and services sold through select independent agencies, brokers and managing general agencies.

 

OneBeacon was acquired by White Mountains Insurance Group, Ltd. (“White Mountains”) from Aviva plc (“Aviva”, formerly CGNU) in 2001 (the “OneBeacon Acquisition”). White Mountains is a holding company whose businesses provide property and casualty insurance, reinsurance and certain other products. During the fourth quarter of 2006, White Mountains sold 27.6 million or 27.6% of the Company’s common shares in an initial public offering. Prior to the initial public offering, OneBeacon was a wholly-owned subsidiary of White Mountains. As of March 31, 2009 and December 31, 2008, White Mountains owned 75.5% of the Company’s common shares. Within this report, the term “OneBeacon” is used to refer to one or more entities within the consolidated organization, as the context requires. The Company is a Bermuda exempted limited company with its headquarters located at 14 Wesley Street, 5th Floor, Hamilton HM 11, Bermuda. The Company’s U.S. headquarters are located at 1 Beacon Lane, Canton, Massachusetts 02021, its principal executive office is located at 601 Carlson Parkway, Minnetonka, Minnesota 55305 and its registered office is located at Clarendon House, 2 Church Street, Hamilton HM 11, Bermuda. OneBeacon’s reportable segments are Insurance Operations and Other Operations, as defined below.

 

OneBeacon’s Insurance Operations segment, formerly known as Primary Insurance Operations, includes the results of substantially all of its insurance operations. OneBeacon’s Other Operations segment consists of the Company and its intermediate holding companies which include OneBeacon U.S. Enterprises Holdings, Inc., formerly known as Fund American Enterprises Holdings, Inc. and OneBeacon U.S. Holdings, Inc. (“OBH”), formerly know as Fund American Companies, Inc., both U.S.-domiciled companies, as well as various intermediate holding companies domiciled in the United States, Gibraltar, Luxembourg and Bermuda.

 

All significant intercompany transactions have been eliminated in consolidation. These interim financial statements include all adjustments, consisting of a normal recurring nature, considered necessary by management to fairly present the financial position, results of operations and cash flows of OneBeacon. These interim financial statements may not be indicative of financial results for the full year and should be read in conjunction with the Company’s 2008 Annual Report on Form 10-K. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Refer to the Company’s 2008 Annual Report on Form 10-K for a complete discussion regarding OneBeacon’s significant accounting policies. Certain amounts in the prior period financial statements have been reclassified to conform to the current presentation.

 

Recently Adopted Changes in Accounting Principles

 

Business Combinations and Noncontrolling Interests

 

On January 1, 2009, OneBeacon adopted Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 141 (Revised 2007), “Business Combinations — A Replacement of FASB Statement No. 141” (“SFAS 141R”) and SFAS No. 160, “Noncontrolling Interests — an amendment to ARB 51” (“SFAS 160”).

 

SFAS 141R requires the acquiring company to recognize the fair value of all assets acquired and liabilities assumed at their fair values at the acquisition date, with certain exceptions including income taxes which will continue to be accounted for under SFAS No. 109, “Accounting for Income Taxes” (“SFAS 109”). This represents a basic change in approach from the old cost allocation method originally described in SFAS No. 141, “Business Combinations” (“SFAS 141”). In addition, SFAS 141R changes the accounting for step acquisitions since it requires recognition of all assets acquired and liabilities assumed, regardless of the acquirer’s percentage of ownership in the acquiree. This means that the acquirer will measure and recognize all of the assets, liabilities and goodwill, not just the acquirer’s share. Assets and liabilities arising from contractual contingencies are to be recognized at the acquisition date, at fair value. Non-contractual contingencies are to be recognized

 

6



Table of Contents

 

when it is more likely than not that they meet the Statement of Financial Accounting Concepts No. 6, “Elements of Financial Statements (A Replacement of FASB Concepts Statement No. 3—Incorporating an Amendment of FASB Concepts Statement No. 2)” criteria for an asset or liability. Previously under SFAS 141, recognition of preacquisition contingencies was deferred until the criteria in SFAS No. 5, “Accounting for Contingencies” had been met. Changes in the amount of deferred taxes arising from a business combination are to be recognized in either income or through a change in contributed capital, depending on the circumstances. Previously under SFAS 109, such changes were recognized through goodwill. Acquisition related costs, such as legal fees and due diligence costs would be expensed and would not be recognized as part of goodwill. The classification of insurance and reinsurance contracts are re-evaluated at the acquisition date only if their terms were changed in connection with the acquisition. SFAS 141R applies prospectively to business combinations effective January 1, 2009. SFAS 141R did not impact OneBeacon’s previous transactions involving purchase accounting.

 

SFAS 160 requires all companies to account for noncontrolling interests (formerly referred to as “minority interests”) in subsidiaries as equity, clearly identified and presented separately from parent company equity. Once a controlling interest has been acquired, any subsequent acquisitions or dispositions of noncontrolling interests that do not result in a change of control are to be accounted for as equity transactions. Assets and liabilities acquired are measured at fair value only once; at the original acquisition date, i.e., the date at which the acquirer gained control. When a subsidiary is deconsolidated, any retained noncontrolling equity investment is to be measured at fair value with the gain or loss on the deconsolidation being measured using fair value rather than the carrying amount of the retained ownership interest. The recognition and measurement requirements of SFAS 160 apply prospectively upon adoption; the presentation and disclosure requirements must be retrospectively applied. Accordingly, upon adoption of SFAS 160, OneBeacon has changed the presentation of its financial statements for prior periods to conform to the required presentation as follows: noncontrolling interests are presented on the balance sheets within equity, separate from OneBeacon’s shareholders’ equity; the portion of net income and comprehensive income attributable to OneBeacon’s common shareholders and the noncontrolling interests are presented separately on the consolidated statements of operations and comprehensive income (loss); and the consolidated statements of shareholders’ equity include a reconciliation of the noncontrolling interests from the beginning to the end of each reporting period.

 

Derivatives and Hedging Activities

 

On January 1, 2009, OneBeacon adopted SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities – an Amendment of FASB Statement No. 133” (“SFAS 161”). SFAS 161 requires companies that use derivatives to disclose the following:  objectives and strategies for using derivative instruments in terms of underlying risk and accounting designation; the fair values of derivative instruments and their gains and losses in a tabular format; and information about credit-risk-related contingent features. The adoption of SFAS 161 had no impact on OneBeacon’s financial position or results of operations. See Note 6 for required disclosures.

 

Participating Securities Granted in Share-Based Payment Transactions

 

On January 1, 2009, OneBeacon adopted FASB Staff Position (“FSP”) EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Transactions are Participating Securities.” The FSP addresses whether instruments granted in share-based payment transactions should be considered participating securities prior to vesting. The FSP requires that such instruments that hold unforfeitable rights to dividends or dividend equivalents, regardless of whether paid or unpaid, should be considered participating securities and accordingly should be included in the calculation of earnings per share under the two-class method instead of the treasury stock method. Unvested restricted stock issued under employee incentive compensation plans containing such dividend participation features would be considered participating securities. None of OneBeacon’s share-based payment transactions include participating securities. This FSP did not impact OneBeacon’s earnings per share calculation. See Note 11 for the calculation of earnings per share.

 

Fair Value Measurements

 

On January 1, 2009, OneBeacon adopted FSP FAS 157-2, “Effective Date of FASB Statement No. 157” (“FSP FAS 157-2”). FSP FAS 157-2 delayed the effective date of SFAS No. 157, “Fair Value Measurements” (“SFAS 157) for nonfinancial assets and nonfinancial liabilities to fiscal years beginning after November 15, 2008. OneBeacon adopted SFAS 157 for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually) as of January 1, 2008 with respect to its investments securities. Refer to Note 5 for the required disclosures related to investment securities. The adoption of FSP FAS 157-2 had no impact on OneBeacon’s financial position or results of operations.

 

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Recent Accounting Pronouncements

 

Other-Than-Temporary Impairments

 

In April 2009, the FASB issued FSP FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments” (“FSP FAS 115-2 and FAS 124-2”) which amends the guidance for other-than temporary impairments for debt securities classified as held-to-maturity or available-for-sale. FSP FAS 115-2 and FAS 124-2 requires that in evaluating if an impairment of a debt security is other-than-temporary, the entity is to assess whether it has the intent to sell the security or if it is more likely than not that it will be required to sell the security before the recovery of its amortized cost basis. If the present value of cash flows expected to be collected is less than the amortized cost of the security, a credit loss is deemed to exist and the security is considered to be impaired. The portion of the impairment loss related to a credit loss is to be recognized in earnings. The portion of the impairment loss related to factors other than credit loss is recognized in other comprehensive income. Upon adoption of FSP FAS 115-2 and FAS 124-2, a cumulative effect adjustment to the opening balance of retained earnings shall be recorded with a corresponding adjustment to accumulated other comprehensive income. FSP FAS 115-2 and FAS 124-2 is effective for interim financial reporting periods ending after June 15, 2009, but may be adopted early. OneBeacon intends to adopt FSP FAS 115-2 and FAS 124-2 for the interim reporting period ending June 30, 2009.

 

OneBeacon accounts for its investments in debt securities under SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”) and accordingly, all changes in the fair value of its debt securities are recognized in revenues regardless of whether or not such changes in fair value represent a temporary or other-than-temporary decline in value. Accordingly, adoption of FSP FAS 115-2 and FAS 124-2 would have no effect on OneBeacon’s method of accounting for its portfolio of investment securities.

 

Determining Fair Values in an Inactive Market and Distressed Transactions

 

In April 2009, the FASB issued FSP FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly” (“FSP FAS 157-4”). This FSP provides guidance for estimating fair value in accordance with SFAS 157 when the volume and level of activity for the asset or liability have significantly decreased and on identifying circumstances that indicate a transaction is not orderly. Factors to consider include few recent transactions, price quotations that are not based on current information or which vary substantially over time or among market makers, a significant increase in implied liquidity risk premiums, yields, or performance indicators, a wide bid-ask spread, a significant decline or absence of a market for new issuances or limited information released publicly. A reporting entity should evaluate whether there has been a significant decrease in the volume and level of activity for the asset or liability when compared with normal activity for the asset or liability or similar assets or liabilities. If the reporting entity concludes that there has been a significant decrease in the volume and level of activity, transactions or quoted prices may not be determinative of fair value. Further analysis of the transactions or quoted prices is needed, and a significant adjustment to the transactions or quoted prices may be necessary to estimate fair value in accordance with SFAS 157, which defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction. In addition, FSP FAS 157-4 would expand interim disclosures to require a description of the inputs and valuation techniques used to estimate fair value and a discussion of changes during the period. FSP FAS 157-4 is effective for interim and annual periods ending after June 15, 2009, and shall be applied prospectively. Early adoption is permitted for periods ending after March 15, 2009. OneBeacon intends to adopt FSP FAS 157-4 for the interim reporting period ending June 30, 2009. Adoption of FSP FAS 157-4 is not expected to have a material impact on OneBeacon’s financial position or results of operations.

 

Interim Fair Value Disclosures

 

In April 2009, the FASB issued FSP FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (“FSP FAS 107-1 and APB 28-1”) which amends SFAS No. 107, “Disclosures about Fair Value of Financial Instruments” and Accounting Principles Board Opinion (“APB”) No. 28, “Interim Financial Reporting”. Under FSP FAS 107-1 and APB 28-1, a publicly traded company shall disclose in the body or the accompanying notes of its summarized financial information for interim reporting periods and in its financial statements for its annual reporting periods the fair value of all financial instruments for which it is practicable to estimate that value. An entity shall also disclose the method(s) and significant assumptions used to estimate the fair value of the financial instruments and any changes in the method(s) and significant assumptions, if any, during the period. The FSP is effective for interim and annual reporting periods ending after June 15, 2009 with early adoption permitted if the entity early adopts FSP FAS 157-4 and FSP FAS 115-2 and FAS 124-2. OneBeacon intends to adopt FSP FAS 107-1 and APB 28-1 for the interim reporting period ending June 30, 2009.

 

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Disclosures about Postretirement Benefit Plan Assets

 

In December 2008, the FASB issued FSP SFAS 132(R)-1, “Employers’ Disclosures about Postretirement Benefit Plan Assets.” The FSP requires additional disclosures regarding plan assets of a defined benefit pension or other postretirement plan. The disclosures are to provide users of financial statements with an understanding of how investment allocation decisions are made, the major categories of plan assets, the inputs and valuation techniques used to measure the fair value of plan assets, the effect of fair value measurements using significant unobservable inputs on changes in plan assets for the period and significant concentrations of risk within plan assets. This FSP is effective for fiscal years ending after December 15, 2009 with earlier adoption permitted. OneBeacon is currently evaluating the potential impact of adopting this FSP.

 

NOTE 2. Acquisitions and Dispositions

 

During the first quarter of 2009, there were no acquisitions or dispositions. During the first quarter of 2008, OneBeacon sold one of its inactive licensed subsidiaries, Midwestern Insurance Company, to National Guaranty Insurance Company for $4.2 million in cash and recorded a pre-tax gain of $1.0 million through net other revenues.

 

NOTE 3. Reserves for Unpaid Loss and LAE

 

The following table summarizes the loss and LAE reserve activities of OneBeacon’s insurance subsidiaries for the three months ended March 31, 2009 and 2008:

 

 

 

Three months ended
March 31,

 

 

 

2009

 

2008

 

 

 

($ in millions)

 

Gross beginning balance

 

$

4,294.0

 

$

4,480.3

 

Less beginning reinsurance recoverable on unpaid losses

 

(2,503.3

)

(2,629.5

)

Net loss and LAE reserves

 

1,790.7

 

1,850.8

 

Loss and LAE incurred relating to:

 

 

 

 

 

Current year losses

 

302.8

 

313.5

 

Prior year losses

 

(14.8

)

(12.6

)

Total incurred loss and LAE

 

288.0

 

300.9

 

Accretion of fair value adjustment to net loss and LAE reserves

 

1.4

 

3.0

 

Loss and LAE paid relating to:

 

 

 

 

 

Current year losses

 

(76.3

)

(68.1

)

Prior year losses

 

(233.5

)

(227.5

)

Total loss and LAE payments

 

(309.8

)

(295.6

)

Net ending balance

 

1,770.3

 

1,859.1

 

Plus ending reinsurance recoverable on unpaid losses

 

2,440.9

 

2,601.3

 

Gross ending balance

 

$

4,211.2

 

$

4,460.4

 

 

During the three months ended March 31, 2009, OneBeacon experienced $14.8 million of favorable loss and LAE reserve development on prior accident year loss reserves. The favorable loss reserve development was primarily due to lower than expected severity on non-catastrophe losses related to professional liability in specialty lines and commercial multi-peril in commercial lines, partially offset by adverse loss reserve development primarily related to New York personal injury protection litigation at AutoOne Insurance. During the three months ended March 31, 2008, OneBeacon experienced $12.6 million of favorable loss and LAE reserve development on prior accident year loss reserves. The favorable loss reserve development was primarily due to lower than expected severity on non-catastrophe losses and favorable loss reserve development on a prior accident year catastrophe. The favorable non-catastrophe loss reserve development was primarily related to property in commercial lines and professional liability in specialty lines.

 

In connection with purchase accounting for the OneBeacon Acquisition, loss and LAE reserves and the related reinsurance recoverables were adjusted to fair value on the balance sheets. The net reduction to loss and LAE reserves is being accreted through an income statement charge ratably with and over the period the claims are settled. Accordingly, OneBeacon recognized $1.4 million and $3.0 million of such charges for the three months ended March 31, 2009 and 2008, respectively. As of March 31, 2009, the outstanding pre-tax unaccreted adjustment was $4.0 million.

 

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NOTE 4. Reinsurance

 

In the normal course of business, OneBeacon’s insurance subsidiaries seek to limit losses that may arise from catastrophes or other events by reinsuring with third party reinsurers. OneBeacon remains liable for risks reinsured even if the reinsurer does not honor its obligations under reinsurance contracts.

 

Effective July 1, 2008, OneBeacon renewed its property catastrophe reinsurance program through June 30, 2009. The program provides coverage for OneBeacon’s personal and commercial property business as well as certain acts of terrorism. Under the program, the first $150 million of losses resulting from any single catastrophe are retained and $650 million of the next $700 million of losses resulting from the catastrophe are reinsured. Any loss above $850 million would be retained. In the event of a catastrophe, OneBeacon’s property catastrophe reinsurance program is reinstated for the remainder of the original contract term by paying a reinstatement premium that is based on the percentage of coverage reinstated and the original property catastrophe coverage premium.

 

OneBeacon entered into a 30% quota share agreement with a group of reinsurers that runs from January 1, 2009 through December 31, 2009. During the first quarter of 2009, OneBeacon ceded $13.6 million of written premiums from its Northeast homeowners business written through OneBeacon Insurance Company and its subsidiary companies, along with Adirondack Insurance Exchange and New Jersey Skylands Insurance Association in New York and New Jersey, respectively.

 

At March 31, 2009, OneBeacon had $19.8 million of reinsurance recoverables on paid losses and $2,642.4 million (gross of $201.5 million in purchase accounting adjustments, as described in Note 3) that will become recoverable if claims are paid in accordance with current reserve estimates. Reinsurance contracts do not relieve OneBeacon of its obligations to its insureds. Therefore, collectibility of balances due from its reinsurers is critical to OneBeacon’s financial strength. OneBeacon is selective in regard to its reinsurers, principally placing reinsurance with those reinsurers with strong financial condition, industry ratings and underwriting ability. Management monitors the financial condition and ratings of its reinsurers on an ongoing basis. As a result, uncollectible amounts have historically not been significant. The following table provides a listing of OneBeacon’s top reinsurers for its insurance operations, excluding industry pools and associations and affiliates of OneBeacon, based upon recoverable amounts, the percentage of total reinsurance recoverables and the reinsurers’ A.M. Best Company, Inc. (“A.M. Best”) ratings.

 

($ in millions)

 

Balance at
March 31, 2009

 

% of total

 

A.M. Best
Rating (1)

 

National Indemnity Company and General Reinsurance Corporation (2)

 

$

1,928.5

 

72

%

A

++

Tokio Marine and Nichido Fire (3)

 

55.2

 

2

%

A

++

QBE Insurance Corporation

 

45.3

 

2

%

A

 

Munich Reinsurance America

 

41.2

 

2

%

A

+

Swiss Re

 

22.9

 

1

%

A

 

 


(1)          A.M. Best ratings as detailed above are: “A++” (Superior, which is the highest of fifteen ratings), “A+” (Superior, which is the second highest of fifteen ratings) and “A” (Excellent, which is the third highest of fifteen ratings).

 

(2)          Includes $320.2 million of Third Party Recoverables, which NICO would pay under the terms of the NICO Cover if they are unable to collect from third party reinsurers. OneBeacon also has an additional $264.7 million of Third Party Recoverables from various reinsurers, the majority of which are rated “A” or better by A.M. Best.

 

(3)          Excludes $41.1 million of reinsurance recoverables from various reinsurers that are guaranteed by Tokio Marine and Nichido Fire under the terms of a 100% quota share reinsurance agreement between Houston General Insurance Company and Tokio Marine and Nichido Fire.

 

In connection with the OneBeacon Acquisition, Aviva caused OneBeacon to purchase two reinsurance contracts: a reinsurance contract with National Indemnity Company (“NICO”), for up to $2.5 billion in old asbestos and environmental (“A&E”) claims and certain other exposures (the “NICO Cover”) and an adverse loss reserve development cover from General Reinsurance Corporation (“GRC”) for up to $570.0 million, comprised of $400.0 million of adverse loss reserve development occurring in years 2000 and prior (the “GRC Cover”) in addition to $170.0 million of reserves ceded as of the date of the OneBeacon Acquisition. The NICO Cover and GRC Cover, which were contingent on and occurred contemporaneously with the OneBeacon Acquisition, were put in place in lieu of a seller guarantee of loss and LAE reserves and are therefore accounted for as a seller guarantee under GAAP in accordance with Emerging Issues Task Force Technical Matter Document No. D-54. NICO and GRC are wholly-owned subsidiaries of Berkshire Hathaway, Inc.

 

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Under the terms of the NICO Cover, NICO receives the economic benefit of reinsurance recoverables from certain of OneBeacon’s third party reinsurers (“Third Party Reinsurers”) in existence at the time the NICO Cover was executed (“Third Party Recoverables”). As a result, the Third Party Recoverables serve to protect the $2.5 billion limit of NICO coverage for the benefit of OneBeacon. OneBeacon estimates that on an incurred basis it has used approximately $2.2 billion of the coverage provided by NICO at March 31, 2009. Since entering into the NICO Cover, $44.7 million of the $2.2 billion of utilized coverage relates to uncollectible Third Party Recoverables. Net losses paid totaled approximately $1.1 billion as of March 31, 2009. To the extent that actual experience differs from OneBeacon’s estimate of ultimate A&E losses and Third Party Recoverables, future losses could exceed the $320.2 million of protection remaining under the NICO Cover.

 

Pursuant to the GRC Cover, OneBeacon is not entitled to recover losses to the full contract limit if such losses are reimbursed by GRC more quickly than anticipated at the time the contract was signed. OneBeacon intends to seek reimbursement from GRC only for claims which result in payment patterns similar to those supporting its recoverables recorded pursuant to the GRC Cover. The economic cost of not submitting certain other eligible claims to GRC is primarily the investment spread between the rate credited by GRC and the rate achieved by OneBeacon on its own investments. This cost, if any, is expected to be nominal.

 

NOTE 5. Investment Securities

 

OneBeacon’s invested assets are comprised of securities and other investments held for general investment purposes. Refer to the Company’s 2008 Annual Report on Form 10-K for a complete discussion.

 

On January 1, 2008, OneBeacon adopted SFAS 159, which allows companies to make an election, on an individual instrument basis, to report financial assets and liabilities at fair value. The election must be made at the inception of a transaction and may not be reversed. The election may also be made for existing financial assets and liabilities at the time of adoption. Unrealized gains and losses on assets or liabilities for which the fair value option has been elected are reported in revenues. In connection with the adoption of SFAS 159, OneBeacon recorded an adjustment of $180.6 million to reclassify net unrealized gains, after tax, and net unrealized foreign currency translation gains, after tax, related to investments from accumulated other comprehensive income to opening retained earnings.

 

In accordance with its adoption of SFAS 159, OneBeacon classifies its portfolio of fixed maturity investments and common equity securities, including convertible bonds, held for general investment purposes as trading. Trading securities are reported at fair value as of the balance sheet date as determined by quoted market prices when available. Realized and unrealized investment gains and losses on trading securities are reported pre-tax in revenues.

 

Short-term investments consist of money market funds, certificates of deposit and other securities which, at the time of purchase, mature or become available for use within one year. Short-term investments are carried at amortized cost, which approximated fair value as of March 31, 2009 and December 31, 2008.

 

Other investments include limited partnerships, hedge funds and private equity interests. Upon adoption of SFAS 159, OneBeacon measures its investments in limited partnerships, hedge funds and private equity interests at fair value with changes therein reported in revenues on a pre-tax basis.

 

OneBeacon participates in a securities lending program as a mechanism for generating additional investment income on its fixed maturity and common equity portfolios. Under the securities lending arrangements, certain of its fixed maturity and common equity investments are loaned to other institutions for short periods of time through a lending agent. OneBeacon maintains control over the securities it lends, retains the earnings and cash flows associated with the loaned securities and receives a fee from the borrower for the temporary use of the asset. Collateral, in the form of cash and United States government securities, is required at a rate of 102% of the fair value of the loaned securities. An indemnification agreement with the lending agent protects OneBeacon in the event a borrower becomes insolvent or fails to return any of the securities on loan. In the event of a shortfall in the collateral amount required to be returned to the securities lending counterparty (e.g., as a result of investment losses), OneBeacon is obligated to make up any deficiency.

 

In February 2009, OneBeacon amended the terms of the securities lending program to give it more control over the investment of borrowers’ collateral and to separate the assets supporting that collateral into a segregated account. Pursuant to the amendment, (i) the guidelines for the investment of any new cash collateral as well as the reinvestment of cash were narrowed to permit investment in only cash equivalent securities, (ii) OneBeacon has the authority to direct the lending agent to both sell specific collateral securities in the segregated account and to not sell certain collateral securities which the lending agent proposes to sell, and (iii) OneBeacon and the lending agent agreed to manage the securities lending program toward an orderly wind-down, which OneBeacon believes will be completed over an approximately 1 to 2 year period.

 

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As a result of this amendment, the securities lending program is now recorded  with assets in the segregated account included within the investment securities of OneBeacon. Accordingly, purchases and sales of invested assets held in the segregated account as well as changes in the payable to the borrower for the return of collateral are reflected in the investing and financing sections of the cash flow statement commencing with the three months ended March 31, 2009. Prior to February 2009, the collateral was controlled by the lending agent. The lending agent managed the investment of the cash collateral, however, other than in the event of default by the borrower, this collateral was not available to OneBeacon and was remitted to the borrower by the lending agent upon the return of the loaned securities. Because of these restrictions, OneBeacon considered its securities lending activities to be non-cash transactions. The fair value of the securities lending collateral was recorded as both an asset and liability on the balance sheet.

 

As of March 31, 2009, OneBeacon had $48.6 million in securities on loan. Collateral supporting the securities on loan was valued at $46.9 million; $44.7 million is included in fixed maturity investments and $2.2 million is included in short-term investments. For the three months ended March 31, 2009, the net impact of the securities lending program was a net unrealized gain of $3.2 million recognized in net realized and unrealized investment losses. At December 31, 2008, prior to the amendment of the terms of the securities lending program, the total market value of OneBeacon’s securities on loan was $107.7 million with a corresponding collateral of $100.7 million.

 

OneBeacon’s net investment income is comprised primarily of interest income associated with OneBeacon’s fixed maturity investments, dividend income from its equity investments and interest income from its short-term investments. Net investment income for the three months ended March 31, 2009 and 2008 consisted of the following:

 

 

 

Three months ended
March 31,

 

 

 

2009

 

2008

 

 

 

($ in millions)

 

Investment income:

 

 

 

 

 

Fixed maturity investments

 

$

21.0

 

$

42.9

 

Common equity securities

 

0.4

 

4.8

 

Convertible bonds

 

1.5

 

1.6

 

Short-term investments

 

1.6

 

3.6

 

Other investments

 

0.3

 

0.5

 

Gross investment income

 

24.8

 

53.4

 

Less investment expenses

 

(2.9

)

(3.3

)

Net investment income, pre-tax

 

$

21.9

 

$

50.1

 

 

The composition of net realized investment (losses) gains, a component of net realized and unrealized investment losses, consisted of the following:

 

 

 

Three months ended
March 31,

 

 

 

2009

 

2008

 

 

 

($ in millions)

 

Fixed maturity investments

 

$

(18.2

)

$

(6.7

)

Common equity securities

 

(39.6

)

4.1

 

Convertible bonds

 

0.7

 

3.7

 

Short-term investments

 

0.1

 

 

Other investments

 

0.7

 

2.6

 

Net realized investment (losses) gains, pre-tax

 

$

(56.3

)

$

3.7

 

 

The components of OneBeacon’s ending net unrealized investment gains and losses, excluding the impact of net unrealized foreign currency translation gains and losses, on its trading investment portfolio as of March 31, 2009 and December 31, 2008 were as follows:

 

 

 

March 31,

 

December 31,

 

 

 

2009

 

2008

 

 

 

($ in millions)

 

Investment securities:

 

 

 

 

 

Gross unrealized investment gains

 

$

86.3

 

$

74.1

 

Gross unrealized investment losses

 

(146.2

)

(170.6

)

Net unrealized losses from investment securities

 

(59.9

)

(96.5

)

Income taxes attributable to such losses

 

21.0

 

33.7

 

Total net unrealized investment losses, after tax

 

$

(38.9

)

$

(62.8

)

 

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Table of Contents

 

The cost or amortized cost, gross unrealized investment gains and losses, and carrying values of OneBeacon’s fixed maturity investments as of March 31, 2009 and December 31, 2008, were as follows:

 

 

 

March 31, 2009

 

 

 

Cost or
amortized
cost

 

Gross
unrealized
gains

 

Gross
unrealized
losses

 

Net foreign
currency
losses

 

Carrying
value

 

 

 

 

 

 

 

($ in millions)

 

 

 

 

 

U.S. Government and agency obligations

 

$

330.6

 

$

12.6

 

$

(0.3

)

$

 

$

342.9

 

Debt securities issued by industrial corporations

 

1,366.1

 

19.2

 

(48.7

)

(12.3

)

1,324.3

 

Municipal obligations

 

4.9

 

0.3

 

 

 

5.2

 

Asset-backed securities

 

757.7

 

9.8

 

(32.7

)

 

734.8

 

Foreign government obligations

 

20.6

 

0.6

 

(1.2

)

 

20.0

 

Preferred stocks

 

71.3

 

0.2

 

(19.2

)

 

 

52.3

 

Total fixed maturity investments

 

$

2,551.2

 

$

42.7

 

$

(102.1

)

$

(12.3

)

$

2,479.5

 

 

 

 

December 31, 2008

 

 

 

Cost or
amortized
cost

 

Gross
unrealized
gains

 

Gross
unrealized
losses

 

Net foreign
currency
losses

 

Carrying
value

 

 

 

 

 

 

 

($ in millions)

 

 

 

 

 

U.S. Government and agency obligations

 

$

417.3

 

$

5.3

 

$

(13.0

)

$

 

$

409.6

 

Debt securities issued by industrial corporations

 

914.9

 

13.2

 

(39.2

)

(18.7

)

870.2

 

Municipal obligations

 

4.8

 

0.2

 

 

 

5.0

 

Asset-backed securities

 

791.9

 

9.3

 

(42.3

)

 

758.9

 

Foreign government obligations

 

46.0

 

0.4

 

(7.8

)

 

38.6

 

Preferred stocks

 

71.5

 

0.2

 

(19.2

)

 

52.5

 

Total fixed maturity investments

 

$

2,246.4

 

$

28.6

 

$

(121.5

)

$

(18.7

)

$

2,134.8

 

 

The cost or amortized cost, gross unrealized investment gains and losses, and carrying values of OneBeacon’s common equity securities, convertible bonds and other investments as of March 31, 2009 and December 31, 2008, were as follows:

 

 

 

March 31, 2009

 

 

 

Cost or
amortized
cost

 

Gross
unrealized
gains

 

Gross
unrealized
losses

 

Net foreign
currency
gains (losses)

 

Carrying
value

 

 

 

 

 

 

 

($ in millions)

 

 

 

 

 

Common equity securities

 

$

102.0

 

$

2.8

 

$

(1.5

)

$

 

$

103.3

 

Convertible bonds

 

 

221.7

 

 

2.1

 

 

(17.6

)

 

 

 

206.2

 

Other investments

 

 

175.6

 

 

38.7

 

 

(25.0

)

 

 

 

189.3

 

 

 

 

December 31, 2008

 

 

 

Cost or
amortized
cost

 

Gross
unrealized
gains

 

Gross
unrealized
losses

 

Net foreign
currency
losses

 

Carrying
value

 

 

 

 

 

 

 

($ in millions)

 

 

 

 

 

Common equity securities

 

$

284.6

 

$

6.4

 

$

(14.2

)

$

(0.1

)

$

276.7

 

Convertible bonds

 

 

255.0

 

 

2.4

 

 

(16.2

)

 

 

 

241.2

 

Other investments

 

 

178.6

 

 

36.7

 

 

(18.7

)

 

 

 

196.6

 

 

Fair value measurements at March 31, 2009

 

On January 1, 2008, OneBeacon adopted SFAS 157 which provides a revised definition of fair value, establishes a framework for measuring fair value and expands financial statement disclosure requirements for fair value information. Under SFAS 157, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants (an “exit price”). SFAS 157 establishes a fair value hierarchy that distinguishes between inputs based on market data from independent sources (“observable inputs”) and a reporting entity’s internal assumptions based upon the best information available when external market data is limited or unavailable (“unobservable inputs”). The fair value hierarchy in SFAS 157 prioritizes fair value measurements into three levels based on the nature of the inputs as follows:

 

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Level 1 — Valuations based on quoted prices in active markets for identical assets;

 

Level 2 — Valuations based on observable inputs that do not meet the criteria for Level 1, including quoted prices in inactive markets and quoted prices in active markets for similar, but not identical instruments; and

 

Level 3 — Valuations based on unobservable inputs.

 

As of both March 31, 2009 and December 31, 2008, approximately 92% of the investment portfolio recorded at fair value was priced based upon observable inputs.

 

Fair values for securities for which quoted prices are unavailable are estimated based upon reference to observable inputs other than quoted prices, such as benchmark interest rates, market comparables, broker quotes and other relevant observable inputs. In circumstances where observable inputs are adjusted to reflect management’s best estimate of fair value, such fair value measurements are considered a lower level measurement in the SFAS 157 fair value hierarchy.

 

Other investments, which are comprised of limited partnerships, hedge funds and private equity interests for which the SFAS 159 fair value option has been elected, are carried at fair value based upon OneBeacon’s proportionate interest in the underlying partnership’s or fund’s net asset value, which is deemed to approximate fair value. These investments are not publicly traded and, accordingly, quoted market prices are not available. In circumstances where the partnership net asset value is deemed to differ from fair value due to illiquidity or other factors, net asset value is adjusted accordingly. As of both March 31, 2009 and December 31, 2008, other investments represented approximately 5% of the investment portfolio recorded at fair value. At March 31, 2009 and December 31, 2008, OneBeacon did not adjust the net asset values used to determine fair value.

 

The fair value measurements at March 31, 2009 and December 31, 2008 and their related inputs are as follows:

 

 

 

Fair value at
March 31, 2009

 

Level 1 Inputs

 

Level 2 Inputs

 

Level 3 Inputs

 

 

 

($ in millions)

 

Fixed maturity investments

 

$

2,479.5

 

$

362.8

 

$

2,024.7

 

$

92.0

 

Common equity securities

 

103.3

 

76.9

 

 

26.4

 

Convertible bonds

 

206.2

 

 

205.7

 

0.5

 

Short-term investments

 

802.5

 

802.5

 

 

 

Other investments

 

189.3

 

 

 

189.3

 

Total

 

$

3,780.8

 

$

1,242.2

 

$

2,230.4

 

$

308.2

 

 

 

 

Fair value at
December 31, 2008

 

Level 1 Inputs

 

Level 2 Inputs

 

Level 3 Inputs

 

 

 

($ in millions)

 

Fixed maturity investments

 

$

2,134.8

 

$

429.8

 

$

1,625.7

 

$

79.3

 

Common equity securities

 

276.7

 

249.2

 

1.3

 

26.2

 

Convertible bonds

 

241.2

 

 

241.2

 

 

Short-term investments

 

962.2

 

962.2

 

 

 

Other investments

 

196.6

 

 

 

196.6

 

Total

 

$

3,811.5

 

$

1,641.2

 

$

1,868.2

 

$

302.1

 

 

The changes in Level 3 fair value measurements for the three months ended March 31, 2009 and 2008 are as follows:

 

 

 

Fixed
maturity
investments

 

Common
equity
securities

 

Convertible
bonds

 

Other
investments

 

Total

 

 

 

($ in millions)

 

Balance at January 1, 2009

 

$

79.3

 

$

26.2

 

$

 

$

196.6

 

$

302.1

 

Total net realized and unrealized gains (losses)

 

(1.0

)

0.2

 

 

(4.6

)

(5.4

)

Purchases and sales, net

 

5.6

 

 

0.5

 

(2.7

)

3.4

 

Transfers in (out) of Level 3, net

 

8.1

 

 

 

 

8.1

 

Balance at March 31, 2009

 

$

92.0

 

$

26.4

 

$

0.5

 

$

189.3

 

$

308.2

 

 

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Fixed
maturity
investments

 

Common
equity
securities

 

Convertible
bonds

 

Other
investments

 

Total

 

 

 

($ in millions)

 

Balance at January 1, 2008

 

$

169.2

 

$

70.3

 

$

19.3

 

$

348.6

 

$

607.4

 

Total net realized and unrealized gains (losses)

 

(4.6

)

0.3

 

 

(9.9

)

(14.2

)

Purchases and sales, net

 

 

 

 

0.1

 

0.1

 

Transfers in (out) of Level 3, net

 

(53.5

)

(36.3

)

(17.1

)

 

(106.9

)

Balance at March 31, 2008

 

$

111.1

 

$

34.3

 

$

2.2

 

$

338.8

 

$

486.4

 

 

There were no significant transfers in (out) of Level 3 during the three months ended March 31, 2009. The majority of the transfers out of Level 3 within fixed maturity investments during the three months ended March 31, 2008 represent securities for which observable inputs were unavailable as of December 31, 2007 mainly because the securities were relatively new issuances and/or limited market data was available. Such securities were manually priced using a combination of market inputs such as benchmark interest rates, market comparables and/or broker quotes. With respect to common equity securities, as a result of efforts to adopt SFAS 157 and 159, OneBeacon was able to obtain additional information on the underlying common equity securities for a limited partnership that it consolidates in its financial statements. These common equity securities which are priced based on quoted prices were transferred out of Level 3 into Level 1 during the three months ended March 31, 2008. During the three months ended March 31, 2008, there were no material assets transferred into Level 3.

 

The following table summarizes the change in net unrealized gains or losses for assets designated as Level 3 at March 31, 2009 and 2008:

 

 

 

Three months ended March 31,

 

 

 

2009

 

2008

 

 

 

($ in millions)

 

Fixed maturity investments

 

$

(1.0

)

$

(6.0

)

Common equity securities

 

0.2

 

0.9

 

Convertible bonds

 

 

 

Short-term investments

 

 

 

Other investments

 

(4.3

)

(11.0

)

Total

 

$

(5.1

)

$

(16.1

)

 

The net changes in fair value for the three months ended March 31, 2009 and 2008 are as follows:

 

 

 

Three months ended March 31, 2009

 

 

 

Changes in
net unrealized
gains and losses (1)(2)

 

Changes in net foreign
currency
translation gains and
losses (1)

 

Total net changes in fair
value reflected in
revenues (1)(2)

 

 

 

($ in millions)

 

Fixed maturity investments

 

$

33.7

 

$

6.4

 

$

40.1

 

Common equity securities

 

9.1

 

0.1

 

9.2

 

Convertible bonds

 

(1.7

)

 

(1.7

)

Short-term investments

 

(0.1

)

0.2

 

0.1

 

Other investments

 

2.7

 

 

2.7

 

Total

 

$

43.7

 

$

6.7

 

$

50.4

 

 

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Three months ended March 31, 2008

 

 

 

Changes in
net unrealized
gains and losses (1)

 

Changes in net foreign
currency
translation gains and
losses (1)

 

Total net changes in fair
value reflected in
revenues (1)

 

 

 

($ in millions)

 

Fixed maturity investments

 

$

3.0

 

$

0.7

 

$

3.7

 

Common equity securities

 

(35.4

)

(0.8

)

(36.2

)

Convertible bonds

 

(15.0

)

 

(15.0

)

Short-term investments

 

 

1.0

 

1.0

 

Other investments

 

(12.6

)

 

(12.6

)

Total

 

$

(60.0

)

$

0.9

 

$

(59.1

)

 


(1)          Includes changes in net deferred gains and losses on sales of investments between OneBeacon and entities under White Mountains’ common control of $0.3 million and $(0.3) million, pre-tax, for the three months ended March 31, 2009 and 2008, respectively.

 

(2)          Includes net unrealized gains related to OneBeacon’s securities lending program of $3.2 million, pre-tax, for the three months ended March 31, 2009.

 

In addition to the investment portfolio described above, OneBeacon has $19.6 million and $20.2 million, respectively, of liabilities recorded at fair value in accordance with SFAS 157 and included in other liabilities as of March 31, 2009 and December 31, 2008. These liabilities relate to securities that have been sold short by a limited partnership that OneBeacon invests in and is required to consolidate in accordance with GAAP. All of the liabilities included in the $19.6 million and $20.2 million, respectively, have been deemed to have a Level 1 designation as of March 31, 2009 and December 31, 2008.

 

NOTE 6. Debt

 

OneBeacon’s debt outstanding as of March 31, 2009 and December 31, 2008 consisted of the following:

 

 

 

March 31, 2009

 

December 31, 2008

 

 

 

($ in millions)

 

Senior unsecured notes (“Senior Notes”), at face value

 

$

665.3

 

$

676.0

 

Unamortized original issue discount

 

(0.8

)

(0.9

)

Senior Notes, carrying value

 

664.5

 

675.1

 

Mortgage note on real estate owned

 

40.6

 

40.8

 

Atlantic Specialty Note

 

14.0

 

16.0

 

Total debt

 

$

719.1

 

$

731.9

 

 

Senior Notes

 

In May 2003, OBH, a wholly-owned subsidiary of the Company, issued $700.0 million face value of senior unsecured debt through a public offering, at an issue price of 99.7% (the “Senior Notes”). The Senior Notes bear an annual interest rate of 5.875%, payable semi-annually in arrears on May 15 and November 15, until maturity on May 15, 2013, and are fully and unconditionally guaranteed as to the payment of principal and interest by White Mountains. OBH incurred $7.3 million in expenses related to the issuance of the Senior Notes (including the $4.5 million underwriting discount), which have been deferred and are being recognized into interest expense over the life of the Senior Notes. Taking into effect the amortization of the original issue discount and all underwriting and issuance expenses, the Senior Notes have an effective yield to maturity of approximately 6.0% per annum. At March 31, 2009, OBH was in compliance with all of the covenants under the Senior Notes. During the first quarter of 2009, OneBeacon repurchased $10.6 million of outstanding Senior Notes for $8.1 million, which resulted in a $2.5 million gain on extinguishment of debt. During the third quarter of 2008, OneBeacon repurchased $24.0 million of the outstanding Senior Notes for $22.3 million, which resulted in a $1.6 million gain on extinguishment of debt.

 

White Mountains has provided and, pursuant to a separation agreement, continues to provide an irrevocable and unconditional guarantee as to the payment of principal and interest on the Senior Notes.  Refer to “Note 18. Related Party Disclosures” of the Company’s 2008 Annual Report on Form 10-K.

 

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Mortgage Note on Real Estate Owned

 

In connection with its December 2005 purchase of land and an office building that is now its U.S. headquarters, OneBeacon entered into a $40.8 million, 18-year mortgage note which has a variable interest rate based upon the lender’s 30-day LIBOR rate. As of March 31, 2009, OneBeacon had drawn the full amount of $40.8 million on the mortgage note. Repayment on the mortgage note commenced in January 2009. During the three months ended March 31, 2009, OneBeacon repaid $0.2 million of principal in accordance with the terms of the mortgage note.

 

Concurrent with entering into the mortgage note, OneBeacon also entered into an interest rate swap to hedge its exposure to the variability in the interest rate on the mortgage note. The notional amount of the swap is equal to the debt outstanding on the mortgage note and will be adjusted to match the drawdowns and repayments on the mortgage note so that the principal amount of the mortgage note and the notional amount of the swap are equal at all times. Under the terms of the swap, OneBeacon pays a fixed interest rate of approximately 6% and receives a variable interest rate based on the same LIBOR index used for the mortgage note. Interest paid or received on the swap is reported in interest expense. In accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, OneBeacon has accounted for the swap as a cash flow hedge and recorded the interest rate swap at fair value on the balance sheet in other assets or liabilities depending on the value as of the balance sheet date. Changes in the fair value of the interest rate swap are reported as a component of other comprehensive income or loss. Any gains and losses on the derivatives representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recorded in revenues. As of March 31, 2009, OneBeacon’s interest rate contract was included in other liabilities with a fair value of $9.1 million. During the three months ended March 31, 2009, OneBeacon recognized income, after tax, of $0.8 million in other comprehensive income.

 

Other Debt of Operating Subsidiaries

 

In connection with the acquisition of Atlantic Specialty Insurance Company on March 31, 2004, OneBeacon issued a $20.0 million ten-year note to the seller (the “Atlantic Specialty Note”). OneBeacon is required to repay $2.0 million of principal on the Atlantic Specialty Note each year, commencing in January 2007. The Atlantic Specialty Note accrues interest at a rate of 5.2% except that the outstanding principal amount in excess of $15.0 million accrues interest at a rate of 3.6%. During each of the three months ended March 31, 2009 and 2008, OneBeacon repaid $2.0 million on the Atlantic Specialty Note.

 

Refer to “Note 7. Debt” of the Company’s 2008 Annual Report on Form 10-K for a description of other debt.

 

NOTE 7. Segment Information

 

OneBeacon’s segments consist of the following: (1) Insurance Operations, formerly known as Primary Insurance Operations; and (2) Other Operations. OneBeacon has made its segment determination based on consideration of the following criteria: (i) the nature of the business activities of each of the Company’s subsidiaries and affiliates; (ii) the manner in which the Company’s subsidiaries and affiliates are organized; (iii) the existence of primary managers responsible for specific subsidiaries and affiliates; and (iv) the organization of information provided to the Board of Directors (the “Board”). Significant intercompany transactions among OneBeacon’s segments have been eliminated herein. Financial information for OneBeacon’s segments follows:

 

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Insurance
Operations

 

Other
Operations

 

Total

 

 

 

($ in millions)

 

Three months ended March 31, 2009

 

 

 

 

 

 

 

Earned premiums

 

$

487.8

 

$

 

$

487.8

 

Net investment income

 

21.6

 

0.3

 

21.9

 

Net realized and unrealized investment losses

 

(5.9

)

 

(5.9

)

Net other revenues

 

7.3

 

2.1

 

9.4

 

Total revenues

 

510.8

 

2.4

 

513.2

 

Loss and LAE

 

288.0

 

 

288.0

 

Policy acquisition expenses

 

95.9

 

 

95.9

 

Other underwriting expenses

 

72.7

 

 

72.7

 

General and administrative expenses

 

4.0

 

1.5

 

5.5

 

Accretion of fair value adjustment to loss and LAE reserves

 

 

1.4

 

1.4

 

Interest expense on debt

 

0.8

 

10.1

 

10.9

 

Interest expense on preferred stock subject to mandatory redemption

 

 

 

 

Total expenses

 

461.4

 

13.0

 

474.4

 

Pre-tax income (loss) (1)

 

$

49.4

 

$

(10.6

)

$

38.8

 

Three months ended March 31, 2008

 

 

 

 

 

 

 

Earned premiums

 

$

455.3

 

$

 

$

455.3

 

Net investment income

 

43.1

 

7.0

 

50.1

 

Net realized and unrealized investment losses

 

(52.7

)

(2.7

)

(55.4

)

Net other revenues (expenses)

 

4.0

 

(0.4

)

3.6

 

Total revenues

 

449.7

 

3.9

 

453.6

 

Loss and LAE

 

300.9

 

 

300.9

 

Policy acquisition expenses

 

84.7

 

 

84.7

 

Other underwriting expenses

 

70.1

 

 

70.1

 

General and administrative expenses

 

0.6

 

2.3

 

2.9

 

Accretion of fair value adjustment to loss and LAE reserves

 

 

3.0

 

3.0

 

Interest expense on debt

 

1.0

 

10.5

 

11.5

 

Interest expense on preferred stock subject to mandatory redemption

 

 

17.6

 

17.6

 

Total expenses

 

457.3

 

33.4

 

490.7

 

Pre-tax loss (1)

 

$

(7.6

)

$

(29.5

)

$

(37.1

)

March 31, 2009

 

 

 

 

 

 

 

Total investments

 

$

3,654.4

 

$

126.4

 

$

3,780.8

 

Reinsurance recoverable on paid and unpaid losses

 

2,662.2

 

(201.5

)

2,460.7

 

Total assets

 

7,718.4

 

(38.0

)

7,680.4

 

Loss and LAE reserves

 

4,416.7

 

(205.5

)

4,211.2

 

Total liabilities

 

5,960.9

 

530.8

 

6,491.7

 

Total OneBeacon’s shareholders’ equity

 

1,738.1

 

(568.8

)

1,169.3

 

Total OneBeacon’s shareholders’ equity and noncontrolling interests

 

1,757.5

 

(568.8

)

1,188.7

 

December 31, 2008

 

 

 

 

 

 

 

Total investments

 

$

3,653.3

 

$

158.2

 

$

3,811.5

 

Reinsurance recoverable on paid and unpaid losses

 

2,730.1

 

(205.1

)

2,525.0

 

Total assets

 

7,962.7

 

(21.9

)

7,940.8

 

Loss and LAE reserves

 

4,504.5

 

(210.5

)

4,294.0

 

Total liabilities

 

6,241.8

 

526.7

 

6,768.5

 

Total OneBeacon’s shareholders’ equity

 

1,703.7

 

(548.6

)

1,155.1

 

Total OneBeacon’s shareholders’ equity and noncontrolling interests

 

1,720.9

 

(548.6

)

1,172.3

 

 


(1)   Includes income from noncontrolling interests.

 

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The following tables provide ratios, net written premiums and earned premiums for OneBeacon’s Insurance Operations by major underwriting unit and in total for the three months ended March 31, 2009 and 2008:

 

 

 

Specialty

 

Commercial

 

Personal

 

Total(1)

 

 

 

($ in millions)

 

Three months ended March 31, 2009

 

 

 

 

 

 

 

 

 

Ratios:

 

 

 

 

 

 

 

 

 

Loss and LAE

 

31.3

%

58.1

%

89.4

%

59.0

%

Expense

 

39.3

 

36.9

 

27.7

 

34.6

 

Total GAAP combined

 

70.6

%

95.0

%

117.1

%

93.6

%

Net written premiums

 

$

178.7

 

$

158.9

 

$

131.7

 

$

469.4

 

Earned premiums

 

162.7

 

174.8

 

150.2

 

487.8

 

Three months ended March 31, 2008

 

 

 

 

 

 

 

 

 

Ratios:

 

 

 

 

 

 

 

 

 

Loss and LAE

 

55.3

%

72.3

%

64.9

%

66.1

%

Expense

 

31.9

 

38.0

 

30.8

 

34.0

 

Total GAAP combined

 

87.2

%

110.3

%

95.7

%

100.1

%

Net written premiums

 

$

110.9

 

$

169.7

 

$

144.7

 

$

425.7

 

Earned premiums

 

110.4

 

181.0

 

163.6

 

455.3

 

 


(1)   Includes results from run-off.

 

NOTE 8. Retirement Plans

 

OneBeacon sponsors qualified and non-qualified, non-contributory, defined benefit pension plans covering substantially all employees who were employed as of December 31, 2001 and remain actively employed with OneBeacon. Current plans include a OneBeacon qualified pension plan (the “Qualified Plan”) and a OneBeacon non-qualified pension plan (the “Non-qualified Plan”) (collectively the “Plans”). OneBeacon’s Plans were frozen and curtailed in the fourth quarter of 2002.

 

The components of net periodic benefit costs for the three months ended March 31, 2009 and 2008 were as follows:

 

 

 

Three months ended March 31,

 

 

 

2009

 

2008

 

 

 

($ in millions)

 

Service cost

 

$

0.1

 

$

0.2

 

Interest cost

 

1.6

 

1.7

 

Expected return on plan assets

 

(1.6

)

(2.1

)

Amortization of unrecognized loss

 

0.4

 

0.1

 

Net periodic benefit cost (income)

 

$

0.5

 

$

(0.1

)

 

OneBeacon does not expect to make a contribution to its Qualified Plan in 2009. OneBeacon anticipates contributing $2.9 million to the Non-qualified Plan, for which OneBeacon has assets held in rabbi trusts. As of March 31, 2009, $1.5 million in contributions have been made to the Non-qualified Plan.

 

NOTE 9.  Employee Share-Based Incentive Compensation Plans

 

OneBeacon’s share-based compensation plans consist of performance shares, stock options granted in connection with the initial public offering and restricted stock units. OneBeacon’s share-based compensation plans are designed to maximize shareholder value over long periods of time by aligning the financial interests of its management with those of its owners. Performance shares are payable only upon achievement of pre-defined business goals and are valued based on the market value of OneBeacon’s common shares at the time awards are earned. See “Performance Shares” below. Performance shares are typically paid in cash, though, in some instances, they may be paid in common shares or may be deferred in accordance with the terms of the Company’s deferred compensation plans. OneBeacon expenses the full cost of all its share-based compensation.

 

OneBeacon records its share-based compensation in accordance with SFAS No. 123(R), “Share-Based Payment” (“SFAS 123R”), which is a revision to SFAS No. 123, “Accounting for Stock Based Compensation” and supersedes APB No. 25, “Accounting for Stock Issued to Employees”. SFAS 123R applies to new grants of share-based awards, award modifications and the remaining portion of the fair value of unvested awards. The unvested portion of OneBeacon performance

 

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share awards, as well as new awards, such as the stock options granted in connection with the initial public offering, are subject to the fair value measurement and recognition requirements of SFAS 123R.

 

Performance Shares

 

The following summarizes performance share activity for performance shares whose value is based upon the market price of an underlying OneBeacon common share (“OB Performance Shares”) for the three months ended March 31, 2009 and 2008:

 

 

 

Three Months Ended March 31,

 

 

 

2009

 

2008

 

 

 

Target
OB
Performance
Shares
outstanding

 

Accrued
expense

 

Target
OB
Performance
Shares
outstanding

 

Accrued
expense

 

 

 

($ in millions)

 

Beginning of period

 

2,212,313

 

$

4.6

 

1,058,194

 

$

9.2

 

Payments and deferrals (1)

 

(137,400

)

 

(117,363

)

(1.6

)

New awards

 

364,982

 

 

1,327,142

 

 

Forfeitures and net change in assumed forfeitures

 

(121,046

)

(0.3

)

(136,079

)

(0.4

)

Expense (income) recognized

 

 

1.4

 

 

(0.3

)

End of period

 

2,318,849

 

$

5.7

 

2,131,894

 

$

6.9

 

 


(1)             Performance share payments in 2009 for the 2007-2008 performance cycle were based upon a performance factor of 1.4%.

 

The following summarizes performance shares outstanding and accrued performance share expense at March 31, 2009 for each performance cycle:

 

 

 

Target
OB
Performance
Shares
outstanding

 

Accrued
expense

 

 

 

($ in millions)

 

Performance cycle:

 

 

 

 

 

2007—2009

 

713,070

 

$

0.3

 

2008—2010

 

1,300,255

 

5.2

 

2009—2011

 

364,982

 

0.3

 

Sub-total

 

2,378,307

 

5.8

 

Assumed forfeitures

 

(59,458

)

(0.1

)

Total at March 31, 2009

 

2,318,849

 

$

5.7

 

 

If 100% of the outstanding performance shares had been vested on March 31, 2009, the total additional compensation cost to be recognized would have been $10.4 million, based on current accrual factors (common share price and payout assumptions).

 

All performance shares earned for the 2007-2008 performance cycle were settled in cash or by deferral into certain non-qualified deferred compensation plans of the Company’s subsidiaries.

 

Stock Options

 

As described in the Company’s 2008 Annual Report on Form 10-K, in connection with the initial public offering, OneBeacon issued options to acquire 1,420,000 common shares of the Company to certain members of management. The following summarizes option activity for the three months ended March 31, 2009 and 2008:

 

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Three Months Ended March 31,

 

 

 

2009

 

2008

 

 

 

Target
options
outstanding

 

Accrued
expense

 

Target
options
outstanding

 

Accrued
expense

 

 

 

($ in millions)

 

Beginning of period

 

1,237,872

 

$

2.5

 

1,324,306

 

$

1.4

 

New awards

 

 

 

 

 

Forfeitures

 

(89,522

)

 

(66,215

)

 

Expense recognized

 

 

0.3

 

 

0.3

 

End of period

 

1,148,350

 

$

2.8

 

1,258,091

 

$

1.7

 

 

The options vest in equal installments on each of the third, fourth and fifth anniversaries of their issuance. These options expire five and a half years from the anniversary of issuance. The fair value of each option award at grant date was estimated using a Black-Scholes option pricing model using an expected volatility assumption of 30%, a risk-free interest rate assumption of 4.6%, a forfeiture assumption of 5%, an expected dividend rate assumption of 3.4% and an expected term assumption of 5.5 years. The options originally had a per share exercise price of $30.00. On May 27, 2008, the Compensation Committee of the Board (the “Compensation Committee”) amended the exercise price to $27.97 as a result of the $2.03 per share special dividend paid in the first quarter of 2008. The compensation expense associated with the options and the incremental fair value of the award modification is being recognized ratably over the remaining period.

 

Restricted Stock Units

 

The options granted in connection with OneBeacon’s initial public offering did not include a mechanism in the options to reflect the contribution to total return from the regular quarterly dividend. As a result, on February 26, 2008, OneBeacon granted 116,270 Restricted Stock Units (“RSUs”) to actively employed option holders. The RSUs vest one-third on each of November 9, 2009, 2010 and 2011 subject to, for each vesting tranche of units, the attainment of growth of 4% per cycle in adjusted book value per share. Upon vesting, the RSUs will be mandatorily deferred into one of the Company’s non-qualified deferred compensation plans and will be paid out in 2012 in cash or shares at the discretion of the Compensation Committee. The expense associated with the RSUs is being recognized over the vesting period. For the three months ended March 31, 2009 and 2008, OneBeacon recognized $0.1 million and $0.2 million in expense. As of March 31, 2009, 105,790 RSUs were outstanding.

 

NOTE 10. Income Taxes

 

While OneBeacon is subject to taxation in several jurisdictions, the majority of OneBeacon’s subsidiaries file a consolidated tax return in the United States. Income earned or losses generated by companies outside the United States are generally subject to an overall effective rate lower than that imposed by the United States.

 

OneBeacon’s income tax expense (benefit) related to pre-tax income or loss for the three months ended March 31, 2009 and 2008 represented effective tax rates of 14.2% and (37.5)%, respectively. The effective tax rate for the three months ended March 31, 2009 was lower than the U.S. statutory rate of 35% due to income generated in jurisdictions other than the United States. In arriving at the effective tax rate for the three months ended March 31, 2009, OneBeacon is treating the net realized and unrealized investment losses as a discrete item separate from the other components of pre-tax income or loss. Therefore, the benefit of these net losses is calculated at the statutory rate applicable to the jurisdiction in which the losses are recorded. The majority of the investment assets incurring current period net realized and unrealized losses for the three months ended March 31, 2009 are recorded in the U.S. and are taxed at the statutory rate of 35%. Net realized and unrealized investment losses were treated as a discrete item due to the inability to reliably estimate this amount for the full year. The effective tax rate for the three months ended March 31, 2008 was higher than the U.S. statutory rate of 35% due to a pre-tax loss resulting from the reporting of the change in net unrealized investment gains and losses, a component of net realized and unrealized investment losses, in revenues pursuant to SFAS 159 and income generated in jurisdictions other than the United States, partially offset by non-deductible dividends and accretion on the Berkshire Hathaway, Inc. Preferred Stock which was redeemed in May 2008.

 

Under FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN48”), OneBeacon classifies all interest and penalties on unrecognized tax benefits as part of income tax expense.  With few exceptions, OneBeacon is no longer subject to U.S. federal, state or non-U.S. income tax examinations for years before 2003. The Internal Revenue Service (“IRS”) commenced an examination of OneBeacon’s U.S. income tax returns for 2003 through 2004 in the second quarter of 2006. On January 22, 2009, OneBeacon received Form 4549-A (Income Tax Examination Changes) from the IRS relating to the audit of tax years 2003 and 2004 assessing an additional $65.7 million of tax. The estimated total assessment, including interest, withholding tax and utilization of alternative minimum and foreign tax credit carryovers, is $132.0 million.

 

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OneBeacon disagrees with the adjustments proposed by the IRS and intends to vigorously defend its position. The timing of the resolution of these items is uncertain, however, it is reasonably possible that the resolution could occur within the next 12 months. OneBeacon’s overall liability for tax assessments for 2003 and 2004 is limited due to the Tax Make Whole Agreement with White Mountains, which fixes the liability for these items at the amount recorded on OneBeacon’s books. Refer to “Note 18. Related Party Disclosures” of the Company’s 2008 Annual Report on Form 10-K. OneBeacon does not expect the resolution of this examination to result in a material change to its financial position. In October 2008, the IRS commenced examination of OneBeacon’s U.S. income tax returns for 2005 through 2006. As of March 31, 2009, the IRS has not proposed any significant adjustments to taxable income as a result of the 2005 through 2006 audit. Due to the uncertainty of the outcome of the ongoing IRS examination, OneBeacon cannot estimate the range of reasonably possible changes to its unrecognized tax benefits at this time. However, OneBeacon does not expect to receive any adjustments that would result in a material change to its financial position.

 

NOTE 11. Earnings per Share

 

Basic and diluted earnings (loss) per share amounts have been determined in accordance with SFAS No. 128, “Earnings per Share.” During the second quarter of 2008, 4,103 shares of the Company’s Class A common shares were awarded to certain non-employee members of the Company’s Board, in lieu of their 2008 annual cash retainer. During the third quarter of 2007, the Company began a share repurchase program. Since the inception of this program, the Company has repurchased and retired 5.0 million of its class A common shares. During the three months ended March 31, 2009, no shares were repurchased. During the three months ended March 31, 2008, the Company repurchased and retired 2.5 million of its Class A common shares for $52.8 million.

 

 

 

Three months ended
March 31,

 

 

 

2009

 

2008

 

Basic earnings (loss) per share attributable to OneBeacon’s shareholders (in millions):

 

 

 

 

 

Net income (loss) attributable to OneBeacon’s shareholders

 

$

32.8

 

$

(24.3

)

Weighted average shares outstanding

 

95.1

 

97.6

 

Diluted earnings (loss) per share attributable to OneBeacon’s shareholders (in millions):

 

 

 

 

 

Net income (loss) attributable to OneBeacon’s shareholders

 

$

32.8

 

$

(24.3

)

Weighted average shares outstanding (1)

 

95.1

 

97.6

 

 

 

 

 

 

 

Basic earnings (loss) per share attributable to OneBeacon’s shareholders (in dollars):

 

 

 

 

 

Net income (loss) attributable to OneBeacon’s shareholders

 

$

0.34

 

$

(0.25

)

Diluted earnings (loss) per share attributable to OneBeacon’s shareholders (in dollars):