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 September 30, 2010

 

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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). Yes  o  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 October 27, 2010, 22,661,739 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.

 

PART I

FINANCIAL INFORMATION

 

 

 

 

ITEM 1.

Financial Statements (Unaudited)

 

 

 

 

 

Consolidated Balance Sheets:
As of September 30, 2010 and December 31, 2009

2

 

 

 

 

Consolidated Statements of Operations and Comprehensive Income:
Three and nine months ended September 30, 2010 and 2009

3

 

 

 

 

Consolidated Statements of Common Shareholders’ Equity:
Nine months ended September 30, 2010 and 2009

4

 

 

 

 

Consolidated Statements of Cash Flows:
Nine months ended September 30, 2010 and 2009

5

 

 

 

 

Notes to Consolidated Financial Statements

6

 

 

 

ITEM 2.

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

35

 

 

 

 

Results of Operations —For the three and nine months ended September 30, 2010 and 2009

37

 

 

 

 

Summary of Investment Results

46

 

 

 

 

Liquidity and Capital Resources

51

 

 

 

 

Critical Accounting Estimates

55

 

 

 

 

Forward-Looking Statements

56

 

 

 

ITEM 3.

Quantitative and Qualitative Disclosures About Market Risk

57

 

 

 

ITEM 4.

Controls and Procedures

57

 

 

 

PART II

OTHER INFORMATION

 

 

 

 

ITEM 1.

Legal Proceedings

57

 

 

 

ITEM 1A.

Risk Factors

57

 

 

 

ITEM 2.

Unregistered Sales of Equity Securities and Use of Proceeds

57

 

 

 

ITEM 6.

Exhibits

58

 

 

 

SIGNATURES

 

59

 



Table of Contents

 

PART 1. FINANCIAL INFORMATION

 

ITEM 1. Financial Statements

 

ONEBEACON INSURANCE GROUP, LTD.

CONSOLIDATED BALANCE SHEETS

 

 

 

September 30,

 

December 31,

 

 

 

2010

 

2009

 

 

 

(Unaudited)

 

 

 

 

 

(in millions, except
share and per share
amounts)

 

Assets

 

 

 

 

 

Investment Securities:

 

 

 

 

 

Fixed maturity investments, at fair value (amortized cost $2,206.7 and $2,900.6)

 

$

2,304.4

 

$

2,994.3

 

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

 

465.6

 

544.4

 

Common equity securities, at fair value (cost $232.5 and $176.3)

 

262.7

 

187.6

 

Convertible bonds, at fair value (amortized cost $83.7 and $153.7)

 

93.8

 

170.2

 

Other investments (cost $157.0 and $122.8)

 

184.3

 

146.3

 

Total investments

 

3,310.8

 

4,042.8

 

Cash

 

34.6

 

44.8

 

Reinsurance recoverable on unpaid losses

 

641.1

 

664.1

 

Reinsurance recoverable on unpaid losses—Berkshire Hathaway, Inc.

 

1,298.2

 

1,528.8

 

Reinsurance recoverable on paid losses

 

14.9

 

15.9

 

Premiums receivable

 

341.1

 

469.1

 

Deferred acquisition costs

 

128.5

 

215.0

 

Net deferred tax asset

 

107.7

 

161.1

 

Investment income accrued

 

18.6

 

29.4

 

Ceded unearned premiums

 

162.9

 

49.9

 

Accounts receivable on unsettled investment sales

 

10.4

 

24.2

 

Other assets

 

338.7

 

286.9

 

Total assets

 

$

6,407.5

 

$

7,532.0

 

Liabilities

 

 

 

 

 

Loss and LAE reserves

 

$

3,390.2

 

$

3,934.8

 

Unearned premiums

 

731.5

 

1,018.3

 

Debt

 

419.5

 

620.5

 

Ceded reinsurance payable

 

188.6

 

24.7

 

Accounts payable on unsettled investment purchases

 

50.6

 

7.6

 

Other liabilities

 

388.2

 

478.0

 

Total liabilities

 

5,168.6

 

6,083.9

 

OneBeacon’s common shareholders’ equity and noncontrolling interests

 

 

 

 

 

OneBeacon’s common shareholders’ equity

 

 

 

 

 

Common shares and paid-in surplus (par value $0.01; authorized, 200,000,000 shares; issued and outstanding, 94,416,477 and 95,121,050 shares)

 

1,000.3

 

1,009.7

 

Retained earnings

 

225.1

 

425.5

 

Accumulated other comprehensive loss, after-tax:

 

 

 

 

 

Net unrealized foreign currency translation losses

 

(0.7

)

(0.7

)

Other comprehensive income and loss items

 

(5.6

)

(5.5

)

Total OneBeacon’s common shareholders’ equity

 

1,219.1

 

1,429.0

 

Total noncontrolling interests

 

19.8

 

19.1

 

Total OneBeacon’s common shareholders’ equity and noncontrolling interests

 

1,238.9

 

1,448.1

 

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

 

$

6,407.5

 

$

7,532.0

 

 

See Notes to Consolidated Financial Statements

 

2



Table of Contents

 

ONEBEACON INSURANCE GROUP, LTD.

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

(Unaudited)

 

 

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

($ in millions, except per share amounts)

 

Revenues

 

 

 

 

 

 

 

 

 

Earned premiums

 

$

317.9

 

$

492.8

 

$

1,199.4

 

$

1,470.8

 

Net investment income

 

21.6

 

34.4

 

74.9

 

92.4

 

Net realized and unrealized investment gains

 

51.6

 

117.6

 

79.6

 

239.1

 

Net other revenues

 

17.1

 

5.7

 

21.3

 

16.2

 

Total revenues

 

408.2

 

650.5

 

1,375.2

 

1,818.5

 

Expenses

 

 

 

 

 

 

 

 

 

Loss and LAE

 

179.9

 

298.2

 

775.5

 

861.9

 

Policy acquisition expenses

 

66.9

 

101.4

 

263.5

 

294.3

 

Other underwriting expenses

 

53.8

 

79.4

 

186.5

 

236.4

 

General and administrative expenses

 

6.0

 

6.9

 

20.5

 

18.9

 

Accretion of fair value adjustment to loss and LAE reserves

 

 

1.4

 

 

4.1

 

Interest expense on debt

 

6.4

 

9.1

 

23.4

 

30.1

 

Total expenses

 

313.0

 

496.4

 

1,269.4

 

1,445.7

 

Pre-tax income

 

95.2

 

154.1

 

105.8

 

372.8

 

Income tax expense

 

(7.6

)

(44.8

)

(8.8

)

(101.3

)

Net income including noncontrolling interests

 

87.6

 

109.3

 

97.0

 

271.5

 

Less: Net income attributable to noncontrolling interests

 

(0.8

)

(0.7

)

(1.6

)

(1.9

)

Net income attributable to OneBeacon’s common shareholders

 

86.8

 

108.6

 

95.4

 

269.6

 

Change in other comprehensive income and loss items

 

(0.3

)

0.2

 

(0.1

)

7.5

 

Comprehensive income attributable to OneBeacon’s common shareholders

 

$

86.5

 

$

108.8

 

$

95.3

 

$

277.1

 

 

 

 

 

 

 

 

 

 

 

Earnings per share attributable to OneBeacon’s common shareholders — basic and diluted

 

 

 

 

 

 

 

 

 

Net income attributable to OneBeacon’s common shareholders per share

 

$

0.92

 

$

1.14

 

$

1.01

 

$

2.83

 

 

 

 

 

 

 

 

 

 

 

Dividends declared and paid per OneBeacon’s common share

 

$

2.71

 

$

0.21

 

$

3.13

 

$

0.63

 

 

See Notes to Consolidated Financial Statements

 

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ONEBEACON INSURANCE GROUP, LTD.

CONSOLIDATED STATEMENTS OF COMMON SHAREHOLDERS’ EQUITY

(Unaudited)

 

 

 

OneBeacon’s Common 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, 2010

 

$

1,429.0

 

$

1,009.7

 

$

425.5

 

$

(6.2

)

$

19.1

 

Net income

 

95.4

 

 

95.4

 

 

1.6

 

Accrued option expense

 

0.7

 

0.7

 

 

 

 

Issuance of common shares

 

0.4

 

0.4

 

 

 

 

Repurchases and retirements of common shares

 

(10.5

)

(10.5

)

 

 

0.3

 

Dividends

 

(295.8

)

 

(295.8

)

 

(0.7

)

Contributions

 

 

 

 

 

0.5

 

Distributions

 

 

 

 

 

(1.0

)

Other comprehensive income, after tax

 

(0.1

)

 

 

(0.1

)

 

Balances at September 30, 2010

 

$

1,219.1

 

$

1,000.3

 

$

225.1

 

$

(6.3

)

$

19.8

 

 

 

 

OneBeacon’s Common 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

 

269.6

 

 

269.6

 

 

1.9

 

Accrued option expense

 

0.9

 

0.9

 

 

 

 

Issuance of common shares

 

0.3

 

0.3

 

 

 

 

Repurchases and retirements of common shares

 

 

 

 

 

0.3

 

Dividends

 

(59.9

)

 

(59.9

)

 

(0.6

)

Contributions

 

 

 

 

 

5.1

 

Distributions

 

 

 

 

 

(5.0

)

Other comprehensive income,
after tax

 

7.5

 

 

 

7.5

 

 

Balances at September 30, 2009

 

$

1,373.5

 

$

1,017.9

 

$

373.1

 

$

(17.5

)

$

18.9

 

 

See Notes to Consolidated Financial Statements

 

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ONEBEACON INSURANCE GROUP, LTD.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

 

 

Nine months ended
September 30,

 

 

 

2010

 

2009

 

 

 

($ in millions)

 

Cash flows from operations:

 

 

 

 

 

Net income including noncontrolling interests

 

$

97.0

 

$

271.5

 

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

 

 

 

 

 

Net realized and unrealized investment gains

 

(79.6

)

(239.1

)

Net realized loss on settlement of interest rate swap

 

 

7.4

 

Net realized gain on Personal Lines Transaction

 

(8.5

)

 

Net other realized losses (gains)

 

10.8

 

(5.4

)

Deferred income tax expense

 

53.4

 

147.0

 

Other operating items:

 

 

 

 

 

Net change in loss and LAE reserves

 

(295.3

)

(264.4

)

Net change in unearned premiums

 

(56.3

)

(7.0

)

Net change in ceded reinsurance payable

 

167.2

 

(34.2

)

Net change in ceded unearned premiums

 

(135.1

)

7.4

 

Net change in premiums receivable

 

40.3

 

21.8

 

Net change in reinsurance recoverable on paid and unpaid losses

 

308.9

 

263.4

 

Net change in other assets and liabilities

 

(93.1

)

(54.8

)

Net cash provided from operations

 

9.7

 

113.6

 

Cash flows from investing activities:

 

 

 

 

 

Net maturities, purchases and sales of short-term investments

 

(444.6

)

233.6

 

Maturities of fixed maturity investments

 

939.1

 

389.5

 

Sales of fixed maturity investments

 

794.6

 

528.9

 

Sales of common equity securities

 

42.7

 

214.3

 

Sales of convertible bonds

 

117.5

 

123.5

 

Distributions and redemptions of other investments

 

11.4

 

44.7

 

Purchases of fixed maturity investments

 

(1,007.1

)

(1,380.2

)

Purchases of common equity securities

 

(97.7

)

(37.8

)

Purchases of convertible bonds

 

(31.6

)

(89.9

)

Contributions for other investments

 

(45.8

)

(6.5

)

Proceeds from the Personal Lines Transaction

 

166.6

 

 

Net change in unsettled investment purchases and sales

 

56.8

 

41.4

 

Net acquisitions of property and equipment

 

(4.2

)

(1.8

)

Net cash provided from investing activities

 

497.7

 

59.7

 

Cash flows from financing activities:

 

 

 

 

 

Repayment of debt

 

(14.0

)

(42.8

)

Repurchases of debt

 

(197.3

)

(63.2

)

Cash dividends paid to common shareholders

 

(295.8

)

(59.9

)

Repurchases and retirements of Class A common shares

 

(10.5

)

 

Settlement of interest rate swap

 

 

(7.4

)

Net cash used for financing activities

 

(517.6

)

(173.3

)

Net change in cash during period

 

(10.2

)

 

Cash balance at beginning of period

 

44.8

 

53.0

 

Cash balance at end of period

 

$

34.6

 

$

53.0

 

 

 

 

 

 

 

Supplemental cash flows information:

 

 

 

 

 

Interest paid

 

$

18.1

 

$

21.6

 

Net tax payments to (refunds from) state and national governments

 

6.5

 

(1.9

)

 

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 Company is an exempted Bermuda limited liability company. 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 insurance products and services sold through independent agencies, brokers and managing general agencies. OneBeacon has historically offered a range of specialty, commercial and personal products and services, however, OneBeacon recently completed two transactions that represent significant steps in its transformation into a specialty lines company. On December 3, 2009, OneBeacon sold the renewal rights to approximately $490 million in premiums from its non-specialty commercial lines business to The Hanover Insurance Group (“The Hanover”). The transaction includes small commercial accounts and the non-specialty portion of the middle-market business, beginning with January 1, 2010 effective dates (the “Commercial Lines Transaction”). On July 1, 2010, OneBeacon completed the sale of its traditional personal lines business. See Note 2 for further discussion.

 

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. As of September 30, 2010, White Mountains owned 76.0% 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 principal executive office is located at 601 Carlson Parkway, Minnetonka, Minnesota 55305, its U.S. headquarters are located at 1 Beacon Lane, Canton, Massachusetts 02021 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. OneBeacon’s Insurance Operations segment includes the results of its insurance operations. OneBeacon has recently managed its Insurance Operations segment through a specialty lines underwriting unit and a personal lines underwriting unit, nearly all of which was subject to the personal lines transaction described in Note 2. The Insurance Operations segment also includes run-off business, which primarily consists of non-specialty commercial lines business which is being transferred to The Hanover, as described above, and other run-off business. OneBeacon’s Other Operations segment consists of the Company and its intermediate holding companies which include OneBeacon U.S. Enterprises Holdings, Inc. and OneBeacon U.S. Holdings, Inc. (“OBH”), both U.S.-domiciled companies, as well as various intermediate holding companies domiciled in the United States, Gibraltar, Luxembourg and Bermuda. As a result of the transactions described above, OneBeacon is currently evaluating its segments to determine the most effective management reporting structure.

 

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 state 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 2009 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 2009 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

 

Transfers of Financial Assets and Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities

 

On January 1, 2010, OneBeacon adopted Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) 2009-16 and ASU 2009-17, codified within Accounting Standards Codification (“ASC”) 860 and ASC 810, respectively. Under ASC 860, the concept of a qualifying special-purpose entity (“QSPE”) has been eliminated and accordingly, any existing QSPE must be evaluated for consolidation upon adoption. The appropriateness of derecognition is evaluated based on whether or not the transferor has surrendered control of the transferred assets. The evaluation must consider any continuing involvement by the transferor. OneBeacon does not have any entities that were considered a QSPE under guidance prior to ASC 860. ASC 810 clarifies the application of consolidation accounting for entities for which the controlling financial interest might not be solely identified through voting rights. The guidance under ASC 810 still requires a reporting entity to perform an analysis to determine if its variable interests give it a controlling financial interest in a variable interest entity (“VIE”). The analysis required identifies the primary beneficiary of a VIE as the entity having both of the following:

 

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·                  The power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance; and

 

·                  The obligation to absorb losses of the entity that could potentially be significant to the VIE or the right to receive benefits from the entity that could potentially be significant to the VIE.

 

In addition, a reporting entity must assess whether it has an implicit financial responsibility to ensure that a VIE operates as designed when determining if it has the power to direct the activities of the VIE that most significantly affect the entity’s economic performance. The concept of a reconsideration event is retained and an ongoing reassessment of whether a reporting entity is the primary beneficiary of a VIE is required. Specifically, the list of reconsideration events includes a change in facts and circumstances where the holders of an equity investment at risk as a group lose the power from voting or similar rights to direct the activities of the entity that most significantly affect the entity’s economic performance. In addition, a troubled debt-restructuring is now defined as a reconsideration event. Both statements expand required disclosures and are effective as of the beginning of the first annual reporting period that begins after November 15, 2009. The adoption of ASC 860 and ASC 810 had no material impact on OneBeacon’s financial position or results of operations.

 

Improving Disclosures about Fair Value Measurements

 

On January 1, 2010, OneBeacon adopted ASU 2010-06, Improving Disclosures about Fair Value Measurements, codified within ASC 820. ASU 2010-06 requires new disclosures and clarifies existing disclosure requirements for fair value measurements. ASU 2010-06 requires disclosure of the amounts and nature of the transfers in and out of Level 1 and Level 2 measurements. The ASU also requires a gross presentation of activity within the Level 3 rollforward, presenting separately information about purchases, sales, issuances and settlements. In addition, fair value measurements by Level will now be presented on a more disaggregated basis, by asset or liability class. The ASU also requires more detailed disclosures about inputs and valuation techniques for Level 2 and Level 3 measurements for interim and annual reporting periods. The ASU is effective for the first interim or annual reporting period beginning after December 15, 2009, except for the gross presentation of the Level 3 rollforward, which is required for annual reporting periods beginning after December 15, 2010 and for interim reporting periods within those years. The adoption of ASU 2010-06 had no material impact on OneBeacon’s financial position or results of operations. See Note 5 for required disclosures.

 

Recently Issued Accounting Pronouncements

 

Policy Acquisition Costs

 

On October 13, 2010, the FASB issued ASU 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts, codified within ASC 944. The new standard changes the types of policy acquisition costs that are eligible for deferral. Specifically, the new guidance limits deferrable costs to those that are incremental direct costs of contract acquisition and certain costs related to acquisition activities performed by the insurer, such as underwriting, policy issuance and processing, medical and inspection costs and sales force contract selling. ASU 2010-26 defines incremental direct costs as those costs that result directly from and were essential to the contract acquisition and would not have been incurred absent the acquisition. Accordingly, under the new guidance, deferrable acquisition costs are limited to costs related to successful contract acquisitions. Acquisition costs that are not eligible for deferral are to be charged to expense in the period incurred.

 

ASU 2010-26 is effective for interim periods and annual fiscal years beginning after December 15, 2011 and may be applied prospectively or retrospectively. OneBeacon is in the process of determining the expected effect on its financial position, results of operations and cash flows upon adoption.

 

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NOTE 2. Acquisitions and Dispositions

 

On July 1, 2010, OneBeacon completed the sale of its traditional personal lines business (the “Personal Lines Transaction”) to Tower Group, Inc. (“Tower”). The Personal Lines Transaction included two insurance companies through which the majority of the traditional personal lines business was written on a direct basis, two attorneys-in-fact managing the reciprocal insurance exchanges (“reciprocals”) that wrote the traditional personal lines business in New York and New Jersey, the surplus notes issued by the New York and New Jersey reciprocals and the remaining renewal rights to certain other traditional personal lines insurance policies. Net written premiums for the traditional personal lines business, which is included in the Personal Lines underwriting unit within OneBeacon’s Insurance Operations segment, totaled approximately $420 million for the year ended December 31, 2009. The Personal Lines Transaction required completion of the following:

 

·                  the termination of intercompany reinsurance agreements between York Insurance Company of Maine (“York”) and its affiliate, OneBeacon Insurance Company (“OBIC”), and Massachusetts Homeland Insurance Company (“MHIC”) and OBIC pursuant to which they ceded 100% of their respective direct business to OBIC;

·                  the sale to Tower of all of the issued and outstanding capital stock of York and MHIC through which the majority of the traditional personal lines business was written on a direct basis;

·                  the sale of all of the issued and outstanding units of two managing attorneys-in-fact, Adirondack AIF, LLC (“AAIF”) and New Jersey Skylands Management LLC (“NJSM”);

·                  the transfer to Tower of the surplus notes issued by each of Adirondack Insurance Exchange (“Adirondack Insurance”) and New Jersey Skylands Insurance Association (“NJSIA”), both reciprocals, which triggered deconsolidation of the reciprocals by OneBeacon (the surplus notes eliminated upon consolidation in OneBeacon’s financial statements);

·                  the execution of reinsurance agreements with certain subsidiaries of the Company pursuant to which OneBeacon cedes, on a 100% quota share basis, traditional personal lines business not directly written by York and MHIC; and

·                  the execution of a reinsurance agreement pursuant to which OneBeacon assumes, on a 100% quota share basis, non-traditional personal lines business written directly by York.

 

As consideration, based upon the carrying value of the traditional personal lines business as of July 1, 2010, OneBeacon received $166.6 million. The consideration represented the statutory surplus in the reciprocals (as consideration for surplus notes issued by the reciprocals), the combined GAAP equity in the insurance companies and attorneys-in-fact being sold, plus $32.5 million. For the nine months ended September 30, 2010, OneBeacon recorded a total after tax net gain on the sale of $24.6 million that is comprised of $8.5 million included in net other revenues and $16.1 million included in the tax provision. Included in OneBeacon’s second quarter financial statements was $5.6 million of the tax benefit related to the difference between the tax basis of the companies sold as part of the Personal Lines Transaction and the net asset value of those entities under GAAP. OneBeacon’s third quarter financial statements reflect the remaining $19.0 million of after tax net gain on the sale. The purchase price is subject to post-closing adjustments.

 

OneBeacon and Tower also entered into a Transition Services Agreement (“TSA”), pursuant to which OneBeacon is providing certain services to Tower during the three-year term of the TSA. The Personal Lines Transaction did not meet the criteria for discontinued operations accounting because of significant continuing cash flows between OneBeacon and the business sold relating to TSA services and reinsurance activities.

 

Except as described in Note 1 with respect to the Commercial Lines Transaction for renewals with January 1, 2010 effective dates and above with respect to the Personal Lines Transaction, during the first nine months of 2010, there were no acquisitions or dispositions. During the first nine months of 2009, there were no acquisitions or dispositions.

 

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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 and nine months ended September 30, 2010 and 2009:

 

 

 

Three months ended September 30,

 

Nine months ended September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

($ in millions)

 

Gross beginning balance

 

$

3,609.2

 

$

4,060.5

 

$

3,934.8

 

$

4,294.0

 

Less beginning reinsurance recoverable on unpaid losses

 

(2,100.7

)

(2,301.2

)

(2,192.9

)

(2,503.3

)

Net loss and LAE reserves

 

1,508.5

 

1,759.3

 

1,741.9

 

1,790.7

 

Loss and LAE incurred relating to:

 

 

 

 

 

 

 

 

 

Current year losses

 

191.7

 

318.9

 

811.6

 

915.2

 

Prior year losses

 

(11.8

)

(20.7

)

(36.1

)

(53.3

)

Total incurred loss and LAE

 

179.9

 

298.2

 

775.5

 

861.9

 

Accretion of fair value adjustment to net loss and LAE reserves

 

 

1.4

 

 

4.1

 

Loss and LAE paid relating to (1):

 

 

 

 

 

 

 

 

 

Current year losses

 

(102.3

)

(138.6

)

(308.2

)

(327.9

)

Prior year losses

 

(135.2

)

(135.0

)

(527.3

)

(543.5

)

Total loss and LAE payments

 

(237.5

)

(273.6

)

(835.5

)

(871.4

)

Net loss and LAE reserves

 

1,450.9

 

1,785.3

 

1,681.9

 

1,785.3

 

Net loss and LAE reserves reclassified from held for sale (2)

 

231.0

 

 

 

 

Net loss and LAE reserves sold as part of the Personal Lines Transaction

 

(231.0

)

 

(231.0

)

 

Net ending balance

 

1,450.9

 

1,785.3

 

1,450.9

 

1,785.3

 

Plus ending reinsurance recoverable on unpaid losses

 

1,939.3

 

2,244.3

 

1,939.3

 

2,244.3

 

Gross ending balance

 

$

3,390.2

 

$

4,029.6

 

$

3,390.2

 

$

4,029.6

 

 


(1)                  Loss and LAE paid for the three and nine months ended September 30, 2010 includes $78.2 million of traditional personal lines loss reserves not directly written by York or MHIC ($2.5 million relating to current year losses and $75.7 million relating to prior year losses) ceded to Tower pursuant to the Personal Lines Transaction which closed in July 2010.

 

(2)                  In the second quarter of 2010, $231.0 million of net loss and LAE reserves related to the Personal Lines Transaction were reclassified to held for sale. The Personal Lines Transaction closed in July 2010.

 

During the three months ended September 30, 2010, OneBeacon experienced $11.8 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 lines, commercial package business and other general liability lines. During the three months ended September 30, 2009, OneBeacon experienced $20.7 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 lines and commercial package business lines.

 

During the nine months ended September 30, 2010, OneBeacon experienced $36.1 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 lines, commercial package business and other general liability lines. The favorable development also included a one-time $6.5 million release of commercial and personal auto reserves associated with participation in an involuntary auto pool. During the nine months ended September 30, 2009, OneBeacon experienced $53.3 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 lines and commercial package business lines, partially offset by adverse loss reserve development primarily related to New York personal injury protection litigation at AutoOne Insurance (“AutoOne”).

 

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 was accreted through an income statement charge ratably with and over the period the claims are settled. Accordingly, OneBeacon recognized $1.4 million and $4.1 million of such charges for the three and nine months ended September 30, 2009, respectively. As of both September 30, 2010 and December 31, 2009, the outstanding pre-tax unaccreted adjustment was $0.

 

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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, 2010, OneBeacon renewed its property catastrophe reinsurance program through June 30, 2011. The program provides coverage for OneBeacon’s property business as well as certain acts of terrorism. Under the program, the first $80.0 million of losses resulting from any single catastrophe are retained and the next $195.0 million of losses resulting from the catastrophe are reinsured, with OneBeacon keeping a small co-participation. Any loss above $275.0 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 had entered into a 30% quota share agreement with a group of reinsurers that ran from January 1, 2009 through December 31, 2009, and had renewed the agreement effective January 1, 2010. Through June 30, 2010, OneBeacon ceded $25.6 million of written premiums from its Northeast homeowners business written through OBIC and its subsidiary companies, along with Adirondack Insurance and NJSIA in New York and New Jersey, respectively. Effective July 1, 2010, the closing date of the Personal Lines Transaction, the agreement was amended to remove OneBeacon as a signatory. During the three and nine months ended September 30, 2009, OneBeacon ceded $16.5 million and $46.5 million, respectively, of written premiums under the agreement.

 

At September 30, 2010, OneBeacon had $14.9 million of reinsurance recoverables on paid losses and $2,119.3 million (gross of $180.0 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.  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
September 30, 2010

 

% of total

 

A.M. Best
Rating (1)

 

National Indemnity Company and General Reinsurance Corporation (2)

 

$

1,618.4

 

76

%

A

++

Tower Insurance Company

 

70.6

 

3

%

A

-

Tokio Marine and Nichido Fire (3)

 

69.0

 

3

%

A

++

Hanover Insurance Company

 

41.9

 

2

%

A

 

Munich Reinsurance America

 

36.3

 

2

%

A

+

 


(1)

 

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

 

 

 

(2)

 

Includes $320.2 million of Third Party Recoverables (as defined below), which NICO (as defined below) would pay under the terms of the NICO Cover (as defined below) if they are unable to collect from third party reinsurers. OneBeacon also has an additional $8.6 million of Third Party Recoverables from various reinsurers, the majority of which are rated “A” or better by A.M. Best.

 

 

 

(3)

 

Includes $41.8 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.

 

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Table of Contents

 

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 under GAAP as a seller guarantee. NICO and GRC are wholly-owned subsidiaries of Berkshire Hathaway, Inc.

 

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 September 30, 2010. Since entering into the NICO Cover, approximately 5% of the $2.2 billion of utilized coverage relates to uncollectible Third Party Recoverables and settlements on Third Party Recoverables through September 30, 2010. Net losses paid totaled approximately $1.4 billion as of September 30, 2010. 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 at September 30, 2010.

 

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. During the three and nine months ended September 30, 2010, $61.3 million was billed to and collected from GRC under the GRC Cover.

 

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 2009 Annual Report on Form 10-K for a complete discussion.

 

In accordance with ASC 825, OneBeacon classifies its portfolio of fixed maturity investments and common equity securities, including convertible bonds, held for general investment purposes as trading securities. 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 September 30, 2010 and December 31, 2009.

 

Other investments primarily include hedge funds and private equity funds. OneBeacon measures its investments in hedge funds and private equity funds at fair value with changes therein reported in net realized and unrealized investment gains and losses in revenues on a pre-tax basis. Other investments also includes an investment in a community reinvestment vehicle which is accounted for at fair value and a tax advantaged federal affordable housing development fund which OneBeacon accounts for under the equity method.

 

OneBeacon had participated 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 were loaned to other institutions for short periods of time through a lending agent. OneBeacon maintained control over the securities it loaned, retained the earnings and cash flows associated with the loaned securities and received a fee from the borrower for the temporary use of the asset. Collateral, in the form of cash and United States government securities, was required at a rate of 102% of the fair value of the loaned securities. An indemnification agreement with the lending agent protected OneBeacon in the event a borrower became insolvent or failed 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 was obligated to make up any deficiency.

 

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

 

11



Table of Contents

 

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.

 

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 had 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. In May 2009, OneBeacon instructed the lending agent not to make any additional loans of securities and to recall all of the securities on loan and fund the return of collateral to the borrower. As a result of the actions described above, the securities lending assets are no longer segregated and are included within OneBeacon’s investment securities. As of September 30, 2010, $1.7 million in collateral had not been returned to the borrower.

 

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 and nine months ended September 30, 2010 and 2009 consisted of the following:

 

 

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

($ in millions)

 

Investment income:

 

 

 

 

 

 

 

 

 

Fixed maturity investments

 

$

21.3

 

$

34.8

 

$

73.3

 

$

91.5

 

Short-term investments

 

0.2

 

0.2

 

0.7

 

2.2

 

Common equity securities

 

1.1

 

0.2

 

3.0

 

1.1

 

Convertible bonds

 

1.2

 

2.0

 

4.2

 

5.1

 

Other investments

 

(0.1

)

0.2

 

0.5

 

1.3

 

Gross investment income

 

23.7

 

37.4

 

81.7

 

101.2

 

Less investment expenses

 

(2.1

)

(3.0

)

(6.8

)

(8.8

)

Net investment income, pre-tax

 

$

21.6

 

$

34.4

 

$

74.9

 

$

92.4

 

 

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

 

 

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

($ in millions)

 

Fixed maturity investments

 

$

16.1

 

$

13.4

 

$

46.1

 

$

(10.4

)

Short-term investments

 

 

 

 

0.1

 

Common equity securities

 

(0.3

)

1.4

 

1.3

 

(31.6

)

Convertible bonds

 

3.9

 

(0.1

)

14.4

 

1.8

 

Other investments (1)

 

2.6

 

14.9

 

(0.3

)

4.8

 

Net realized investment gains (losses), pre-tax

 

$

22.3

 

$

29.6

 

$

61.5

 

$

(35.3

)

 


(1)                  The nine months ended September 30, 2010 include $1.3 million of realized losses related to the impairment of a receivable related to an outstanding hedge fund redemption.

 

12


 


Table of Contents

 

The net changes in fair value for the three months ended September 30, 2010 and 2009 are as follows:

 

 

 

Three months ended September 30, 2010

 

 

 

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

 

$

5.2

 

$

(1.8

)

$

3.4

 

Short-term investments

 

 

0.1

 

0.1

 

Common equity securities

 

23.4

 

 

23.4

 

Convertible bonds

 

2.2

 

 

2.2

 

Other investments

 

0.2

 

 

0.2

 

Total

 

$

31.0

 

$

(1.7

)

$

29.3

 

 

 

 

Three months ended September 30, 2009

 

 

 

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

 

$

66.9

 

$

3.0

 

$

69.9

 

Short-term investments

 

 

0.3

 

0.3

 

Common equity securities

 

1.7

 

 

1.7

 

Convertible bonds

 

26.3

 

0.1

 

26.4

 

Other investments

 

(10.3

)

 

(10.3

)

Total

 

$

84.6

 

$

3.4

 

$

88.0

 

 


(1)

 

Includes changes in net deferred gains and losses on sales of investments between OneBeacon and entities under White Mountains’ common control of $(0.2) million and $0.2 million, pre-tax, for the three months ended September 30, 2010 and 2009, respectively.

 

The net changes in fair value for the nine months ended September 30, 2010 and 2009 are as follows:

 

 

 

Nine months ended September 30, 2010

 

 

 

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

 

$

4.3

 

$

(1.9

)

$

2.4

 

Short-term investments

 

 

(0.8

)

(0.8

)

Common equity securities

 

18.8

 

 

18.8

 

Convertible bonds

 

(6.2

)

 

(6.2

)

Other investments

 

3.9

 

 

3.9

 

Total

 

$

20.8

 

$

(2.7

)

$

18.1

 

 

 

 

Nine months ended September 30, 2009

 

 

 

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

 

$

198.4

 

$

18.5

 

$

216.9

 

Short-term investments

 

(0.2

)

1.3

 

1.1

 

Common equity securities

 

12.4

 

0.1

 

12.5

 

Convertible bonds

 

33.7

 

0.1

 

33.8

 

Other investments (2)

 

10.1

 

 

10.1

 

Total

 

$

254.4

 

$

20.0

 

$

274.4

 

 


(1)

 

Includes changes in net deferred gains and losses on sales of investments between OneBeacon and entities under White Mountains’ common control of $(1.4) million and $0.4 million, pre-tax, for the nine months ended September 30, 2010 and 2009, respectively.

 

 

 

(2)

 

Includes net unrealized gains related to OneBeacon’s securities lending program of $7.0 million, pre-tax, for the nine months ended September 30, 2009

 

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Table of Contents

 

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 September 30, 2010 and December 31, 2009 were as follows:

 

 

 

September 30,

 

December 31,

 

 

 

2010

 

2009

 

 

 

($ in millions)

 

Investment securities:

 

 

 

 

 

Gross unrealized investment gains

 

$

175.1

 

$

167.2

 

Gross unrealized investment losses

 

(9.2

)

(23.5

)

Net unrealized gains from investment securities

 

165.9

 

143.7

 

Income taxes

 

(58.1

)

(50.3

)

Total net unrealized investment gains, after tax

 

$

107.8

 

$

93.4

 

 

The cost or amortized cost, gross unrealized investment gains and losses, net foreign currency gains and losses and carrying values of OneBeacon’s fixed maturity investments as of September 30, 2010 and December 31, 2009 were as follows:

 

 

 

September 30, 2010

 

 

 

Cost or
amortized
cost

 

Gross
unrealized
gains

 

Gross
unrealized
losses

 

Net foreign
currency
losses

 

Carrying
value

 

 

 

($ in millions)

 

U.S. Government and agency obligations

 

$

251.8

 

$

9.3

 

$

 

$

 

$

261.1

 

Debt securities issued by corporations

 

824.5

 

63.5

 

(0.4

)

 

887.6

 

Municipal obligations

 

3.0

 

 

 

 

3.0

 

Asset-backed securities

 

1,036.2

 

20.5

 

(0.3

)

(0.5

)

1,055.9

 

Foreign government obligations

 

13.8

 

0.7

 

 

(0.1

)

14.4

 

Preferred stocks

 

77.4

 

5.0

 

 

 

82.4

 

Total fixed maturity investments

 

$

2,206.7

 

$

99.0

 

$

(0.7

)

$

(0.6

)

$

2,304.4

 

 

 

 

December 31, 2009

 

 

 

Cost or
amortized
cost

 

Gross
unrealized
gains

 

Gross
unrealized
losses

 

Net foreign
currency
gains

 

Carrying
value

 

 

 

($ in millions)

 

U.S. Government and agency obligations

 

$

519.4

 

$

12.4

 

$

(0.2

)

$

 

$

531.6

 

Debt securities issued by corporations

 

1,278.6

 

73.5

 

(6.4

)

1.3

 

1,347.0

 

Municipal obligations

 

2.5

 

0.1

 

 

 

2.6

 

Asset-backed securities

 

1,003.7

 

18.4

 

(7.2

)

 

1,014.9

 

Foreign government obligations

 

25.6

 

1.1

 

 

 

26.7

 

Preferred stocks

 

70.8

 

0.7

 

 

 

71.5

 

Total fixed maturity investments

 

$

2,900.6

 

$

106.2

 

$

(13.8

)

$

1.3

 

$

2,994.3

 

 

The cost or amortized cost, gross unrealized investment gains and losses, net foreign currency gains and losses and carrying values of OneBeacon’s common equity securities, convertible bonds and other investments as of September 30, 2010 and December 31, 2009 were as follows:

 

 

 

September 30, 2010

 

 

 

Cost or
amortized
cost

 

Gross
unrealized
gains

 

Gross
unrealized
losses

 

Net foreign
currency
losses

 

Carrying
value

 

 

 

($ in millions)

 

Common equity securities

 

$

232.5

 

$

32.9

 

$

(2.7

)

$

 

$

262.7

 

Convertible bonds

 

83.7

 

10.1

 

 

 

93.8

 

Other investments

 

157.0

 

33.1

 

(5.8

)

 

184.3

 

 

14



Table of Contents

 

 

 

December 31, 2009

 

 

 

Cost or
amortized
cost

 

Gross
unrealized
gains

 

Gross
unrealized
losses

 

Net foreign
currency
losses

 

Carrying
value

 

 

 

($ in millions)

 

Common equity securities

 

$

176.3

 

$

12.3

 

$

(1.0

)

$

 

$

187.6

 

Convertible bonds

 

153.7

 

16.6

 

(0.1

)

 

170.2

 

Other investments

 

122.8

 

32.1

 

(8.6

)

 

146.3

 

 

Fair value measurements at September 30, 2010

 

OneBeacon records its investments in accordance with ASC 820 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 ASC 820, 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”). ASC 820 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 ASC 820 prioritizes fair value measurements into three levels based on the nature of the inputs as follows:

 

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 September 30, 2010 and December 31, 2009, approximately 91% and 93%, respectively, 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 fair value hierarchy.

 

Other investments, which are primarily comprised of hedge funds and private equity funds for which the fair value option has been elected, are carried at fair value based upon OneBeacon’s proportionate interest in the underlying fund’s net asset value, which is deemed to approximate fair value. The fair value of OneBeacon’s investments in hedge funds and private equity funds has been estimated using net asset value because it reflects the fair value of the funds’ underlying investments in accordance with ASC 820. OneBeacon employs a number of procedures to assess the reasonableness of the fair value measurements, including obtaining and reviewing each fund’s audited financial statements and discussing each fund’s pricing with the fund’s manager. However, since the fund managers do not provide sufficient information to independently evaluate the pricing inputs and methods for each underlying investment, the inputs are considered to be unobservable. Accordingly, the fair values of OneBeacon’s investment in hedge funds and private equity funds have been classified as Level 3 under the fair value hierarchy.

 

In circumstances where the underlying investments are publicly traded, such as the investments made by hedge funds, the fair value of the underlying investments is determined using current market prices. In circumstances where the underlying investments are not publicly traded, such as the investments made by private equity funds, the private equity fund managers have considered the need for a liquidity discount on each of the underlying investments when determining the fund’s net asset value in accordance with ASC 820. In circumstances where OneBeacon’s portion of a fund’s net asset value is deemed to differ from fair value due to illiquidity or other factors associated with OneBeacon’s investment in the fund, including counterparty credit risk, the net asset value is adjusted accordingly. At September 30, 2010 and December 31, 2009, OneBeacon did not record a liquidity adjustment to the net asset value related to its investments in hedge funds or private equity funds.

 

As of September 30, 2010 and December 31, 2009, other investments reported at fair value represented approximately 5% and 4%, respectively, of the investment portfolio recorded at fair value. Other investments accounted for at fair value as of September 30, 2010 and December 31, 2009 were comprised of $73.7 million and $74.2 million, respectively, in hedge funds, $75.7 million and $58.0 million, respectively, in private equity funds and $14.1 million for both periods of an investment in a community reinvestment vehicle. At September 30, 2010 and December 31, 2009, we held investments in 14 and 15 hedge funds, respectively,

 

15



Table of Contents

 

and 16 private equity funds. The largest investment in a single fund was $24.0 million and $10.8 million, respectively, at September 30, 2010 and December 31, 2009.

 

As of September 30, 2010, other investments also included $20.8 million of an investment in a tax advantaged federal affordable housing development fund which is accounted for using the equity method.

 

The fair value measurements at September 30, 2010 and December 31, 2009 and their related inputs are as follows:

 

 

 

Fair value at
September 30, 2010

 

Level 1 Inputs

 

Level 2 Inputs

 

Level 3 Inputs

 

 

 

($ in millions)

 

Fixed maturity investments:

 

 

 

 

 

 

 

 

 

U.S. Government and agency obligations

 

$

261.1

 

$

258.6

 

$

2.5

 

$

 

Debt securities issued by corporations:

 

 

 

 

 

 

 

 

 

Consumer

 

299.8

 

 

299.8

 

 

Industrial

 

222.2

 

 

222.2

 

 

Financial

 

75.5

 

 

75.5

 

 

Communications

 

97.3

 

 

97.3

 

 

Energy

 

62.9

 

 

62.9

 

 

Basic materials

 

62.8

 

 

62.8

 

 

Utilities

 

52.3

 

 

52.3

 

 

Technology

 

14.8

 

 

14.8

 

 

Debt securities issued by corporations

 

887.6

 

 

887.6

 

 

Municipal obligations

 

3.0

 

 

3.0

 

 

Asset-backed securities

 

1,055.9

 

 

1,032.5

 

23.4

 

Foreign government obligations

 

14.4

 

13.6

 

0.8

 

 

Preferred stocks

 

82.4

 

 

11.7

 

70.7

 

Fixed maturity investments

 

2,304.4

 

272.2

 

1,938.1

 

94.1

 

 

 

 

 

 

 

 

 

 

 

Short-term investments

 

465.6

 

465.6

 

 

 

 

 

 

 

 

 

 

 

 

 

Common equity securities:

 

 

 

 

 

 

 

 

 

Financials

 

102.3

 

65.5

 

 

36.8

 

Basic Materials

 

57.6

 

57.6

 

 

 

Consumer

 

35.8

 

35.8

 

 

 

Energy

 

39.8

 

37.4

 

 

2.4

 

Utilities

 

12.7

 

12.6

 

 

0.1

 

Other

 

14.5

 

14.5

 

 

 

Common equity securities

 

262.7

 

223.4

 

 

39.3

 

 

 

 

 

 

 

 

 

 

 

Convertible bonds

 

93.8

 

 

93.8

 

 

 

 

 

 

 

 

 

 

 

 

Other investments (1)

 

163.5

 

 

 

163.5

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

3,290.0

 

$

961.2

 

$

2,031.9

 

$

296.9

 

 


(1)

 

Excludes the carrying value of $20.8 million associated with a tax advantaged federal affordable housing development fund accounted for using the equity method.

 

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Table of Contents

 

 

 

Fair value at
December 31, 2009

 

Level 1 Inputs

 

Level 2 Inputs

 

Level 3 Inputs

 

 

 

($ in millions)

 

Fixed maturity investments:

 

 

 

 

 

 

 

 

 

U.S. Government and agency obligations

 

$

531.6

 

$

529.0

 

$

2.6

 

$

 

Debt securities issued by corporations:

 

 

 

 

 

 

 

 

 

Consumer

 

516.9

 

 

516.9

 

 

Industrial

 

287.5

 

 

287.5

 

 

Financial

 

121.5

 

 

121.3

 

0.2

 

Communications

 

185.5

 

 

185.5

 

 

Energy

 

75.4

 

 

75.4

 

 

Basic materials

 

67.4

 

 

67.4

 

 

Utilities

 

76.6

 

 

76.6

 

 

Technology

 

16.2

 

 

16.2

 

 

Debt securities issued by corporations

 

1,347.0

 

 

1,346.8

 

0.2

 

Municipal obligations

 

2.6

 

 

2.6

 

 

Asset-backed securities

 

1,014.9

 

 

999.2

 

15.7

 

Foreign government obligations

 

26.7

 

21.4

 

5.3

 

 

Preferred stocks

 

71.5

 

 

1.5

 

70.0

 

Fixed maturity investments

 

2,994.3

 

550.4

 

2,358.0

 

85.9

 

 

 

 

 

 

 

 

 

 

 

Short-term investments

 

544.4

 

544.4

 

 

 

 

 

 

 

 

 

 

 

 

 

Common equity securities:

 

 

 

 

 

 

 

 

 

Financials

 

82.3

 

50.1

 

 

32.2

 

Basic Materials

 

32.3

 

32.3

 

 

 

Consumer

 

19.2

 

19.2

 

 

 

Energy

 

29.4

 

27.8

 

 

1.6

 

Utilities

 

7.2

 

7.2

 

 

 

Other

 

17.2

 

17.2

 

 

 

Common equity securities

 

187.6

 

153.8

 

 

33.8

 

 

 

 

 

 

 

 

 

 

 

Convertible bonds

 

170.2

 

 

170.2

 

 

 

 

 

 

 

 

 

 

 

 

Other investments

 

146.3

 

 

 

146.3

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

4,042.8

 

$

1,248.6

 

$

2,528.2

 

$

266.0

 

 

At September 30, 2010 and December 31, 2009, OneBeacon held one private preferred stock that represented approximately 86% and 98%, respectively, of its preferred stock portfolio. OneBeacon used quoted market prices for similar securities that were adjusted to reflect management’s best estimate of fair value; this security is classified as a Level 3 measurement.

 

The following table summarizes the ratings of OneBeacon’s corporate debt securities as of September 30, 2010 and December 31, 2009:

 

 

 

September 30,

 

December 31,

 

 

 

2010

 

2009

 

 

 

($ in millions)

 

AA

 

$

69.8

 

$

101.0

 

A

 

353.8

 

398.3

 

BBB

 

454.5

 

794.0

 

BB

 

9.5

 

31.6

 

Other

 

 

22.1

 

Debt securities issued by corporations

 

$

887.6

 

$

1,347.0

 

 

In addition to the investment portfolio described above, OneBeacon had $41.6 million and $27.2 million, respectively, of liabilities recorded at fair value and included in other liabilities as of September 30, 2010 and December 31, 2009. These liabilities relate to securities that have been sold short by a limited partnership in which OneBeacon invests and is required to consolidate in accordance with GAAP. All of the liabilities included in the $41.6 million and $27.2 million, respectively, have been deemed to have a Level 1 designation as of September 30, 2010 and December 31, 2009.

 

17


 


Table of Contents

 

Asset-backed Securities

 

OneBeacon purchases commercial and residential mortgage backed securities to maximize its fixed income portfolio’s risk adjusted returns in the context of a diversified portfolio. OneBeacon’s non-agency commercial mortgage-backed portfolio (“CMBS”) is generally short tenor, fixed rate and structurally senior, with more than 30 points of subordination on average for fixed rate CMBS and more than 55 points of subordination on average for floating rate CMBS as of September 30, 2010. In general, subordination represents the percentage of principal loss on the underlying collateral that would have to occur before the security incurs a loss.  These collateral losses, instead, are first absorbed by other securities lower in the capital structure. OneBeacon believes these levels of protection will mitigate the risk of loss tied to refinancing challenges facing the commercial real estate market. As of September 30, 2010, on average approximately 7% of the underlying loans were reported as non-performing for all CMBS held by OneBeacon. OneBeacon is not an originator of residential mortgage loans and held less than $0.1 million of residential mortgage-backed securities (“RMBS”) categorized as sub-prime as of September 30, 2010. In addition, OneBeacon’s investments in hedge funds and private equity funds contain negligible amounts of sub-prime mortgage backed securities as of September 30, 2010. OneBeacon considers sub-prime mortgage backed securities to be those that are issued from dedicated sub-prime shelves or have underlying loan pools that exhibit weak credit characteristics or dedicated second-lien shelf registrations (i.e., OneBeacon considers investments backed primarily by second-liens to be a sub-prime risk regardless of credit scores or other metrics).

 

There are also mortgage backed securities that OneBeacon categorizes as “non-prime” (also called “Alt A” or “A-”) that are backed by collateral that has overall credit quality between prime and sub-prime, as determined based on OneBeacon’s review of the characteristics of their underlying mortgage loan pools, such as credit scores and financial ratios. As of September 30, 2010, OneBeacon did not hold any mortgage backed securities that were classified as non-prime.  OneBeacon’s non-agency residential mortgage-backed portfolio is generally of moderate average life, fixed rate and structurally senior. OneBeacon does not own any collateralized debt obligations, including residential mortgage-backed collateralized debt obligations.

 

The following table summarizes the carrying value of OneBeacon’s asset-backed securities as of September 30, 2010 and December 31, 2009:

 

 

 

September 30, 2010

 

December 31, 2009

 

 

 

Fair Value

 

Level 2

 

Level 3

 

Fair Value

 

Level 2

 

Level 3

 

 

 

($ in millions)

 

Mortgage-backed securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Agency:

 

 

 

 

 

 

 

 

 

 

 

 

 

GNMA

 

$

699.4

 

$

682.5

 

$

16.9

 

$

483.0

 

$

483.0

 

$

 

FNMA

 

94.9

 

94.9

 

 

149.1

 

149.1

 

 

FHLMC

 

30.8

 

30.8

 

 

76.3

 

76.3

 

 

Total agency(1)

 

825.1

 

808.2

 

16.9

 

708.4

 

708.4

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-agency:

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential

 

6.5

 

 

6.5

 

30.7

 

30.7

 

 

Commercial

 

82.9

 

82.9

 

 

136.1

 

120.4

 

15.7

 

Total Non-agency

 

89.4

 

82.9

 

6.5

 

166.8

 

151.1

 

15.7

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total mortgage-backed securities

 

914.5

 

891.1

 

23.4

 

875.2

 

859.5

 

15.7

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other asset-backed securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Credit card receivables

 

38.7

 

38.7

 

 

27.7

 

27.7

 

 

Vehicle receivables

 

102.2

 

102.2

 

 

111.1

 

111.1

 

 

Other

 

0.5

 

0.5

 

 

0.9

 

0.9

 

 

Total other asset-backed securities

 

141.4

 

141.4

 

 

139.7

 

139.7

 

 

Total asset-backed securities

 

$

1,055.9

 

$

1,032.5

 

$

23.4

 

$

1,014.9

 

$

999.2

 

$

15.7

 

 


(1)          Represents publicly traded mortgage-backed securities which carry the full faith and credit guaranty of the U.S. government (i.e., GNMA) or are guaranteed by a government sponsored entity (i.e., FNMA, FHLMC).

 

18



Table of Contents

 

The security issuance years of OneBeacon’s investments in non-agency RMBS and non-agency CMBS securities as of September 30, 2010 are as follows:

 

 

 

 

 

Security Issuance Year

 

 

 

Fair Value

 

2001

 

2003

 

2005

 

2006

 

2007

 

2010

 

 

 

($ in millions)

 

Non-agency RMBS

 

$

6.5

 

$

 

$

 

$