UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the fiscal year ended December 31, 2016 | ||
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 (State or other jurisdiction of incorporation or organization) | 98-0503315 (I.R.S. Employer Identification No.) | |
605 North Highway 169 Plymouth, Minnesota (Address of principal executive offices) | 55441 (Zip Code) | |
Registrant's telephone number, including area code: (952) 852-2431
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Name of each exchange on which registered | |
Class A Common Shares, par value $0.01 per share | New York Stock Exchange | |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), 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 x No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§299.405) is not contained herein, and will not be contained, to the best of the Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
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 | |||
(Do not check if a smaller reporting company) | ||||||
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x
The aggregate market value of voting shares (based on the closing price of Class A common shares listed on the New York Stock Exchange and the consideration received for those shares not listed on a national or regional exchange) held by non-affiliates of the Registrant as of June 30, 2016, was $302,481,883.
As of February 22, 2017, 22,525,458 Class A common shares, par value $0.01 per share, and 71,754,738 Class B common shares, par value $0.01 per share, were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Definitive Proxy Statement to be filed with the Securities and Exchange Commission ("SEC") pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), relating to the Registrant's Annual General Meeting of Members scheduled to be held May 24, 2017 (the “2017 Definitive Proxy Statement”) are incorporated by reference into Part III of this Form 10-K. With the exception of the portions of the 2017 Definitive Proxy Statement specifically incorporated herein by reference, the 2017 Definitive Proxy Statement is not deemed to be filed as part of this Form 10-K.
ONEBEACON INSURANCE GROUP, LTD.
Annual Report on Form 10-K
For the Year Ended December 31, 2016
TABLE OF CONTENTS
Page | ||
PART I
ITEM 1. | BUSINESS |
Overview
OneBeacon Insurance Group, Ltd. (the Company or the Registrant), an exempted Bermuda limited liability company, through its subsidiaries (collectively, OneBeacon, we, us, or our) is a specialty property and casualty insurance provider that offers a wide range of insurance products in the U.S. primarily through independent agencies, regional and national brokers, wholesalers and managing general agencies. As a specialty underwriter, we believe that we will generate superior returns compared to an underwriter that takes a more "generalist" underwriting approach, and that our knowledge about specialized insurance products, targeted industries, classes of business, risk characteristics and limited number of specialized competitors provides us with a competitive edge when determining terms and conditions on individual accounts.
Historically, we offered a range of specialty, commercial and personal products and services. However, as a result of a series of transactions over the past several years, we are now focused exclusively on specialty businesses. The most recent of these transactions was the sale of certain of our run-off business consisting of assets, liabilities and capital related principally to our non-specialty business, including the vast majority of our asbestos and environmental reserves (Runoff Business), to an affiliate of Armour Group Holdings Limited (Armour Ltd), which closed on December 23, 2014 (Runoff Transaction). See Note 2—"Acquisitions and Dispositions" of the accompanying consolidated financial statements.
With the closing of the Runoff Transaction, we completed our transformation into a specialty insurance company and our balance sheet and risk profile have changed significantly. Our exposure to claims from policies related to the Runoff Business, such as commercial general liability, including asbestos and environmental exposures, and workers compensation policies, is now limited to the value of the surplus notes issued in conjunction with the transaction, which have a fair value of $71.9 million as of December 31, 2016. Our outstanding reserves as of December 31, 2016 for 2004 and prior accident years total $0.1 million and for accident years prior to 2007 total $6.9 million.
As of both December 31, 2016 and 2015, OneBeacon had $3.6 billion of total assets and $1.0 billion of common shareholders' equity. OneBeacon wrote $1.1 billion, $1.1 billion and $1.2 billion in net written premiums in 2016, 2015 and 2014, respectively.
Our reportable segments are Specialty Products, Specialty Industries, and Investing, Financing and Corporate. The Specialty Products segment is comprised of ten active underwriting operating segments representing an aggregation based on those that offer distinct products and tailored coverages and services to a broad customer base across the United States. The Specialty Products segment also includes the exited Crop underwriting operating segment. The Specialty Industries segment is comprised of six active underwriting operating segments representing an aggregation based on those that focus on solving the unique needs of a particular customer or industry group. The Investing, Financing and Corporate segment includes the investing and financing activities for OneBeacon on a consolidated basis, and certain other activities conducted through the Company and our intermediate subsidiaries. See Note 12—"Segment Information" of the accompanying consolidated financial statements.
Our parent company, White Mountains Insurance Group, Ltd. (White Mountains), is a holding company whose businesses provide property and casualty insurance, and certain other products. As of December 31, 2016, White Mountains owned 76.1% of our common shares.
Our headquarters are located at 26 Reid Street, Hamilton HM 11, Bermuda. Our U.S. corporate headquarters are located at 605 North Highway 169, Plymouth, Minnesota, 55441 and our registered office is located at Clarendon House, 2 Church Street, Hamilton HM 11, Bermuda.
The claims-paying (or financial strength) ratings assigned to our principal insurance operating subsidiaries as of February 27, 2017 ranged from "Good" to "Strong" or "Excellent." See "Item 1. Business—Ratings" for additional discussion of our ratings.
Our Operating Principles
We strive to operate within the spirit of four operating principles. These are:
Underwriting Comes First. An insurance enterprise must respect the fundamentals of insurance. There must be a realistic expectation of underwriting profit on all business written, and demonstrated fulfillment of that expectation over time, with focused attention to the loss ratio and to all the professional insurance disciplines of pricing, underwriting and claims management.
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Maintain a Disciplined Balance Sheet. The first concern here is that insurance liabilities must always be fully recognized. Loss reserves and expense reserves must be solid before any other aspect of the business can be solid. Pricing, marketing and underwriting all depend on informed judgment of ultimate loss costs and that can be managed effectively only with a disciplined balance sheet.
Invest for Total Return. Historically, accounting tends to hide unrealized gains and losses in the investment portfolio and over-reward reported investment income (interest and dividends). Regardless of the accounting, we must invest for the best growth in after tax value over time. In addition to investing our bond portfolios for total after tax return, that will also mean prudent investment in a balanced portfolio consistent with leverage and insurance risk considerations.
Think Like Owners. Thinking like owners has a value all its own. There are stakeholders in a business enterprise and doing good work requires more than this quarter's profit. But thinking like an owner embraces all that without losing the touchstone of a capitalist enterprise.
Business Overview
Generally, property and casualty insurance companies write insurance policies in exchange for premiums paid by their customers (the insureds). An insurance policy is a contract between the insurance company and the insured where the insurance company agrees to pay for losses suffered by the insured, or a third party claimant, that are covered under the contract. Such contracts are often subject to subsequent legal interpretation by courts, legislative action and arbitration.
We write both property insurance and casualty insurance in our Specialty Products and Specialty Industries segments. Property insurance generally covers the financial consequences of accidental losses to the insured's property, such as a business's building, inventory and equipment or personal property. Casualty insurance (often referred to as liability insurance) generally covers the financial consequences of a legal liability of an individual or an organization resulting from negligent acts or omissions causing bodily injury, property and/or economic damages to a third party. Premiums from ocean and inland marine, certain commercial multiple peril, and fire and allied lines generally represent our property (short-tail) lines of business, and claims from such business are typically reported and settled in a relatively short period of time. Premiums from general liability, workers compensation, commercial auto liability and certain commercial multiple peril policies generally represent our casualty (long-tail) lines of business, and claims from such business can take years, even decades, to settle. In addition, there are some coverages that do not fall into the “Property” or “Casualty” insurance definitions, including surety which typically has few losses but those can be very severe, as well as accident and credit insurance.
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Our various lines of business generally fall into three major categories, which reflect how we view the primary risk classification associated with each line: property lines, casualty lines, and other lines of business. Net written premiums by line of business for 2016, 2015 and 2014 consist of the following:
Year ended December 31, | ||||||||||||
Line of business | 2016 | 2015 | 2014 | |||||||||
($ in millions) | ||||||||||||
Property Lines: | ||||||||||||
Ocean and Inland Marine | $ | 176.0 | $ | 190.1 | $ | 201.9 | ||||||
Commercial Multiple Peril and Auto Physical Damage | 88.9 | 94.6 | 82.0 | |||||||||
Fire and Allied | 36.5 | 39.3 | 44.7 | |||||||||
Total Property Lines | 301.4 | 324.0 | 328.6 | |||||||||
Casualty Lines: | ||||||||||||
General Liability | 344.9 | 334.8 | 402.1 | |||||||||
Workers Compensation | 78.1 | 86.1 | 83.7 | |||||||||
Automobile Liability | 67.6 | 88.4 | 91.4 | |||||||||
Other Casualty | 59.9 | 51.8 | 40.3 | |||||||||
Total Casualty Lines | 550.5 | 561.1 | 617.5 | |||||||||
Other Lines: | ||||||||||||
Accident and Health | 131.4 | 151.1 | 149.8 | |||||||||
Credit and Other | 62.6 | 59.0 | 58.0 | |||||||||
Surety | 54.6 | 50.7 | 28.9 | |||||||||
Crop | 0.2 | (9.3 | ) | (1) | 34.1 | |||||||
Total Other | 248.8 | 251.5 | 270.8 | |||||||||
Total net written premiums | $ | 1,100.7 | $ | 1,136.6 | $ | 1,216.9 | ||||||
_______________________________________________________________________________
(1) | Amount primarily relates to the premiums ceded under a 100% quota share agreement to reinsure the remaining net Crop Business exposure for the 2015 reinsurance year. |
We derive substantially all of our revenues from earned premiums, investment income, and net realized and change in unrealized investment gains on investment securities. Written premiums are an operating metric and represent the amount we charge to an insured in order to provide coverage under an insurance contract, which are recognized as earned premiums within revenue over the period of time that insurance coverage is provided (i.e., ratably over the life of the policy). A significant period of time often elapses between receipt of insurance premiums and payment of insurance claims. During this time, we invest premiums, earn investment income, and generate net realized and change in unrealized investment gains on investment activities.
Insurance companies incur a significant amount of their total expenses from policy obligations, which are commonly referred to as claims or losses. In settling policyholder losses, various loss adjustment expenses (LAE) are incurred such as insurance adjusters' fees and litigation expenses. Loss and LAE are categorized by the year in which the claim is incurred, or “accident year.” In the following calendar years, as we increase or decrease our estimate for the ultimate loss and LAE for claims incurred in prior accident years, we will record favorable or adverse loss reserve development which is recorded in the current calendar year period. In addition, insurance companies incur policy acquisition expenses, such as commissions paid to agents and premium taxes, and other expenses related to the underwriting process, including employee compensation and benefits. The key measure of relative underwriting performance for an insurance company is the combined ratio. An insurance company's combined ratio is calculated by adding the ratio of incurred loss and LAE to earned premiums (the loss and LAE ratio) and the ratio of policy acquisition and other underwriting expenses to earned premiums (the expense ratio). A combined ratio under 100% indicates that an insurance company is generating an underwriting profit. However, when considering investment returns, insurance companies operating at a combined ratio of greater than 100% can be profitable.
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Insurance Business
Our net written premiums by segment for 2016, 2015 and 2014 consist of the following:
Year ended December 31, | ||||||||||||
2016 | 2015 | 2014 | ||||||||||
($ in millions) | ||||||||||||
Specialty Industries | $ | 559.8 | $ | 603.6 | $ | 610.0 | ||||||
Specialty Products | 540.9 | 533.0 | 606.9 | |||||||||
Total | $ | 1,100.7 | $ | 1,136.6 | $ | 1,216.9 | ||||||
Specialty Products
The Specialty Products segment is comprised of ten active underwriting operating segments, representing an aggregation based on those that offer distinct products and tailored coverages and services to a broad customer base across the United States. The Specialty Products segment includes Healthcare, Tuition Reimbursement, Programs, Surety, Other Professional Lines, Management Liability, Financial Services, Specialty Property, Environmental, and Financial Institutions, as well as the inactive Crop and Collector Cars and Boats underwriting operating segments which were exited in 2015 and 2013, respectively.
For 2016, 2015 and 2014, our Specialty Products segment's net written premiums by underwriting operating segment were as follows:
Year ended December 31, | ||||||||||||
2016 | 2015 | 2014 | ||||||||||
($ in millions) | ||||||||||||
Healthcare | $ | 132.4 | $ | 147.1 | $ | 180.4 | ||||||
Tuition Reimbursement | 76.8 | 72.1 | 70.5 | |||||||||
Programs | 66.8 | 99.1 | 50.8 | |||||||||
Other Professional Lines | 51.8 | 46.8 | 80.4 | |||||||||
Surety | 50.3 | 47.4 | 28.9 | |||||||||
Management Liability | 45.3 | 40.6 | 50.1 | |||||||||
Financial Services | 42.0 | 38.2 | 40.8 | |||||||||
Other Specialty Products | 75.5 | 41.7 | 105.0 | |||||||||
Total Specialty Products | $ | 540.9 | $ | 533.0 | $ | 606.9 | ||||||
A description of business written by each underwriting operating segment in the Specialty Products segment follows:
OneBeacon Healthcare Group (Healthcare)
Healthcare provides professional liability coverages and other specialized coverages including provider excess insurance and excess of loss or HMO reinsurance, targeting a variety of customer groups, including: hospitals and physicians; free-standing medical facilities; senior living organizations; and managed care organizations.
Tuition Reimbursement
A.W.G. Dewar, Inc. (Dewar) has been a leading provider of tuition reimbursement insurance since 1930. Dewar's product, generally classified as credit insurance for financial reporting purposes, protects both schools and parents from the financial consequences of a student's withdrawal or dismissal from school. We own approximately 81% of Dewar.
OneBeacon Program Group (Programs)
Programs provides a full range of multi-line package insurance for select specialty programs overseen by dedicated agencies that perform all policy administration functions. Products are available on an admitted and nonadmitted basis. Programs works primarily with managing general agents and managing general underwriters, commonly referred to as program administrators.
Other Professional Lines
Other Professional Lines includes primarily the results of OneBeacon Architects & Engineers and our Media business. Architects & Engineers offers professional liability coverages for various design customer groups including architects, civil
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engineers, construction managers and design/build contractors. Media offers professional liability coverages for various customer groups including publishers, broadcasters, advertising agencies, authors and producers, with coverage that is customizable for any company or individual that creates content. Other Professional Lines also includes the results of our exited lawyers professional liability business.
OneBeacon Surety Group (Surety)
Surety offers a broad range of commercial bonds targeting Fortune 2500 and large private companies written through a network of independent agencies, brokers and wholesalers. Business is serviced through eight regions throughout the United States.
OneBeacon Management Liability (Management Liability)
Management Liability offers directors and officers liability, employment practices liability, fiduciary liability and crime insurance for nonprofit organizations (all classes), private/nonprofit healthcare organizations and private for-profit companies of all sizes and types. Coverages are available on a modular form approach, allowing for tailored solutions.
OneBeacon Financial Services (Financial Services)
Financial Services offers property and casualty coverages for commercial banks, savings banks and savings and loan institutions, security broker-dealers, investment advisers, insurance companies and credit unions. Specialty coverages, including professional liability, trust errors & omissions, cyber liability and financial institution bond, are additionally available for institutions with less than $3 billion in assets.
Other Specialty Products
OneBeacon Specialty Property (Specialty Property)
Specialty Property provides excess property and inland marine solutions for layered insurance policies. Target classes of business include apartments and condominiums, commercial real estate, small-to-medium manufacturing, retail/wholesale, education and public entities. Specialty Property products are provided primarily through surplus lines wholesalers.
OneBeacon Environmental (Environmental)
Environmental specializes in environmental risk solutions designed to address a variety of exposures for a broad range of businesses, including multiline casualty placements for the environmental industry. The product suite includes commercial general liability, contractors' environmental liability, professional services liability, environmental premises liability, products pollution liability, follow-form excess, environmental excess and business auto.
OneBeacon Financial Institutions (Financial Institutions)
Financial Institutions provides a wide range of coverage solutions to address the insurance needs of financial institutions, including, but not limited to, professional and management liability. Target industries include banks (greater than $5 billion in corporate assets), security broker dealers and captive agents, insurance companies, insurance agents and brokers, investment advisers, mutual funds, hedge funds, real estate investment trusts, business development companies, private equity and venture capital firms. Products include directors and officers liability, professional liability, fiduciary liability, cyber liability, and financial institutions bonds.
OneBeacon Crop Insurance (Crop)
Prior to July 2015, we offered multiple peril crop insurance and the related crop-hail business (collectively, Crop). We exited the Crop business in 2015 because the managing general agency, through which the business was generated, was sold by a third party to a competitor.
Collector Cars and Boats
Prior to the termination of our relationship on January 1, 2013, we offered tailored coverages primarily for collector vehicles through an exclusive partnership with Hagerty Insurance Agency (Hagerty).
Specialty Industries
The Specialty Industries segment is comprised of six active underwriting operating segments, representing an aggregation based on those that focus on solving the unique needs of a particular customer or industry group. The Specialty Industries segment includes the Accident, Technology, Ocean Marine, Government Risks, Entertainment, and Inland Marine underwriting operating segments.
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For 2016, 2015 and 2014, our Specialty Industries segment's net written premiums by underwriting operating segment were as follows:
Year ended December 31, | ||||||||||||
2016 | 2015 | 2014 | ||||||||||
($ in millions) | ||||||||||||
Technology | $ | 124.1 | $ | 127.3 | $ | 133.1 | ||||||
Ocean Marine | 115.7 | 122.7 | 127.1 | |||||||||
Accident | 114.5 | 118.8 | 113.4 | |||||||||
Government Risks | 82.8 | 84.5 | 82.3 | |||||||||
Entertainment | 61.5 | 88.0 | 88.6 | |||||||||
Inland Marine | 61.2 | 62.3 | 65.5 | |||||||||
Total Specialty Industries | $ | 559.8 | $ | 603.6 | $ | 610.0 | ||||||
A description of business written by each underwriting operating segment in OneBeacon's Specialty Industries segment follows:
OneBeacon Technology Insurance (Technology)
Technology delivers all-lines underwriting solutions for the technology, life science and medical technology, and telecommunications industries. The specific capabilities offered include risk control, claims and third-party vendor solutions. Products span property, casualty, cyber, errors & omissions, international, products liability and professional coverages.
International Marine Underwriters (IMU)—Ocean Marine (Ocean Marine)
Ocean Marine traces its roots to the early 1900s, and offers a full range of ocean marine insurance solutions. Ocean Marine products include, but are not limited to, commercial hull and marine liabilities at both the primary and excess levels; ocean and air cargo with coverage extensions such as inland transit, warehousing and processing; yachts; and several marine package products with comprehensive property, auto and liability coverage.
OneBeacon Accident Group (Accident)
Accident focuses on analyzing and developing unique accident solutions for the transportation, non-subscription and corporate accident marketplace, while also developing specialized accident insurance programs. Accident's product suite includes accidental death and dismemberment, occupational accident, sports accident, non-truckers liability, vehicle physical damage and other accident coverages. Accident also provides employers and affinity groups with access to unique services including identity theft management services and travel assistance services.
OneBeacon Government Risks (Government Risks)
Government Risks provides solutions for mid-sized municipalities and counties, special districts including water, sanitation and fire, non-rail transit authorities and other publicly funded agencies. Government Risks products include property, casualty, and professional liability (comprised of law enforcement, public officials, and employment practices liability coverages) offered on a fully insured, deductible, self-insured retention or assumed reinsurance basis.
OneBeacon Entertainment (Entertainment)
Entertainment provides specialized commercial insurance, including professional liability protection, for the entertainment, sports and leisure industries. Coverages include film and television portfolio, producers portfolio, theatrical package, event cancellation, premises liability, event liability and participant liability.
IMU—Inland Marine (Inland Marine)
Inland Marine offers a full range of inland marine insurance solutions. Inland Marine solutions include builders risks, contractors equipment, installation floaters, fine arts, motor truck cargo, transportation, miscellaneous articles floaters, warehousemen’s legal liability and other inland marine opportunities.
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Geographic Concentration
Substantially all of our net written premiums are derived from business produced in the United States. We produced business in the following geographies during 2016, 2015 and 2014:
Year ended December 31, | |||||||||
2016 | 2015 | 2014 | |||||||
California | 18.2 | % | 17.6 | % | 16.4 | % | |||
New York | 11.5 | 10.4 | 10.0 | ||||||
Texas | 7.0 | 6.4 | 6.7 | ||||||
District of Columbia | 6.0 | 6.0 | 5.3 | ||||||
Florida | 4.7 | 5.1 | 5.7 | ||||||
Other(1) | 52.6 | 54.5 | 55.9 | ||||||
Total | 100.0 | % | 100.0 | % | 100.0 | % | |||
_______________________________________________________________________________
(1) | No other individual state accounts for more than 5% of net written premiums for 2016, 2015 or 2014. |
Marketing and Distribution
We offer our products and services through a network of approximately 2,300 independent agents, regional and national brokers, wholesalers and managing general agencies. We selectively enter these relationships with producers who demonstrate an understanding of our target markets, our capabilities and the specialized needs of their clients. We believe this selective distribution approach creates greater insight into the underwriting and management of the risks associated with our particular lines of business. Further, we believe agents and brokers will continue to represent a significant share of the business we desire going forward.
Underwriting and Pricing
We believe there must be a realistic expectation of attaining an underwriting profit on all the business we write, as well as a demonstrated fulfillment of that expectation over time. Consistent with our "Underwriting Comes First" operating principle, adequate pricing is a critical component for achieving an underwriting profit. We underwrite our book with a disciplined approach towards pricing our insurance products and are willing to forgo a business opportunity if we believe it is not priced appropriately.
We actively monitor pricing activity and measure our use of tiers, credits, debits and limits. In addition, we regularly update base rates to achieve targeted returns on capital and attempt to shift writings away from lines and classes where pricing is inadequate. To the extent changes in premium rates, policy forms or other matters are subject to regulatory approval (see "Item 1. Business—Regulatory Matters—General" and "Item 1A. Risk Factors—Risks Relating to our Business—Regulation may restrict our ability to operate"), we proactively monitor our pending regulatory filings to facilitate, to the extent possible, their prompt processing and approval. Lastly, we expend considerable effort to measure and verify exposures and insured values.
Competition
Property and casualty insurance is highly competitive. Our businesses each compete against a different subset of companies. In general, we compete in one or more of our businesses with most of the large multi-line insurance companies, such as Chubb, AIG, Beazley, CNA, Hartford, Liberty Mutual, Travelers and Zurich. We also compete with most specialty companies, such as Axis, Tokio Marine HCC, Navigators, Markel, RLI, and W.R. Berkley, as well as various local and regional insurance companies and niche carriers.
The more significant competitive factors for most of our insurance products are price, product terms and conditions, agency and broker relationships, claims service, company scale and financial stability. Our underwriting principles and dedication to independent distribution partners are unlikely to make us the low-cost provider in most markets. While it is often difficult for insurance companies to differentiate their products, we believe that providing superior specialty products to satisfy market needs and relying on agents and brokers who value our targeted expertise, superior claims service, and disciplined underwriting establishes a competitive advantage.
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Claims Management
Effective claims management is a critical factor in achieving satisfactory underwriting results. We maintain an experienced staff of claims handlers and managers located throughout our operating territories.
We have dedicated claims managers and adjusters for many of our specialty businesses. These individuals ensure that we have the appropriate level of expertise to handle claims often involving complex issues. Within the claims organization, we also use various shared services to both more efficiently manage costs and ensure we are delivering superior claims results. These services include: shared non-specialty property and casualty insurance claims adjusters, operational and information technology support, subrogation and recovery support, medical and legal bill review, a special investigation unit to detect insurance fraud, and dedicated legal support.
We have adopted a total claims cost management approach, which gives equal importance to appropriately controlling claims handling expenses, legal expenses and claims payments. This approach enables us to deliver effective and efficient claims results. We collect and review various metrics to analyze our claims handling results.
Our claims department utilizes an online claims system to record reserves, payments and adjuster activity. The workstation also helps claim handlers identify recovery potential, estimate property damage, evaluate claims and identify fraud. We maintain a paperless claim file system.
Catastrophe Risk Management and Reinsurance Protection
Catastrophes are severe losses resulting from a wide variety of events. Examples of catastrophes include losses caused by earthquakes, wildfires, hurricanes and other types of storms and terrorist acts. While our exposure to catastrophe losses has decreased meaningfully as a result of our repositioning in recent years as a specialty-only company, we are still exposed to catastrophe losses. The timing and size of catastrophe losses are unpredictable and the level of losses experienced in any year could be material to our operating results and financial condition. The extent of losses caused by a catastrophic event is a function of severity and the amount and type of insured exposure in the affected area. In the normal course of business, our insurance subsidiaries seek to limit losses that may arise from catastrophes or other events through individual risk selection, imposing deductibles and limits, limiting our concentration of insurance in catastrophe-prone areas such as coastal regions and reinsuring with third-party reinsurers.
We use models (primarily AIR Worldwide Touchstone version 4.1) to estimate potential losses from catastrophes. We use the model output in conjunction with other data to manage our exposure to catastrophe losses based on a probable maximum loss forecast to quantify our exposure to an extreme catastrophe event.
Our insurance subsidiaries enter into reinsurance contracts to protect their businesses from losses due to concentration of risk and to limit losses arising from catastrophic events. We utilize a general catastrophe reinsurance treaty with unaffiliated reinsurers to manage our exposure to large catastrophe losses. Effective May 1, 2016, we renewed our property catastrophe reinsurance program through April 30, 2017. The program provides coverage for our property business as well as certain acts of terrorism. Under the program, the first $20.0 million of losses resulting from any single catastrophe are retained, with 100% of the next $110.0 million of losses resulting from the catastrophe being reinsured. Any part of a catastrophe loss in excess of $130.0 million would be retained in full. In the event of a catastrophe, our 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. We anticipate that the $130.0 million limit is more than sufficient to cover the maximum hurricane and earthquake losses with a modeled 0.4% probability of occurrence (1-in-250-year). This $130.0 million limit is consistent with the limit that our previous catastrophe reinsurance program provided.
Our property catastrophe reinsurance program does not cover property losses resulting from any nuclear events or biological, chemical or radiological terrorist attacks. Also excluded are losses resulting from certified acts of terrorism committed by an individual or individuals acting on behalf of any foreign person or foreign interest as defined under the Terrorism Risk Insurance Program (the Terrorism Act).
We also purchase property-per-risk reinsurance coverage to reduce large loss volatility. The property-per-risk reinsurance program reinsures 100% of losses in excess of $3.0 million, up to $100.0 million. Individual risk facultative reinsurance is purchased above $100.0 million. The property-per-risk treaty provides one limit of reinsurance protection for losses in excess of $3.0 million up to $100.0 million on an individual risk basis for certified acts of foreign terrorism committed on behalf of any foreign person or foreign interest. However, any nuclear events, or biological, chemical or radiological terrorist attacks are not covered.
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In addition to the corporate catastrophe and property-per-risk reinsurance protection, we also purchase dedicated reinsurance protection for certain lines of business. Our specialty property business purchases a dedicated property catastrophe program providing 100% coverage for $34.0 million of loss in excess of $6.0 million of loss, which inures to the benefit of the broader property catastrophe reinsurance program described previously. This treaty limit cannot be reinstated.
In addition to the coverage provided under these treaties, we utilize a number of other catastrophe and general insurance treaties covering specific lines of business. See Note 4—"Reinsurance" of the accompanying consolidated financial statements for descriptions of the significant types of our reinsurance agreements.
As reinsurance contracts do not relieve us of our obligation to our policyholders, collectability of balances due from reinsurers is critical to our financial strength.
Our current third party reinsurance programs provide varying degrees of coverage for terrorism events. Our overall terrorism exposure is impacted by the Terrorism Act, which is a federal program administered by the Department of the Treasury that provides for a shared system of public and private compensation for commercial property and casualty losses resulting from events that reach the threshold for losses ($140 million in 2017 and increasing $20 million in subsequent years until the threshold becomes $200 million in 2020) and are certified as an act of terrorism by the U.S. Secretary of the Treasury, in concurrence with the Secretary of Homeland Security and the Attorney General of the United States. The current program was signed into law on January 12, 2015 and is authorized through December 31, 2020. See Note 4—“Reinsurance” of the accompanying consolidated financial statements for a further description of the Terrorism Act, including our estimated retention level.
We closely monitor and manage our concentration of risk for terrorism losses by geographic area. We control our exposures so that total maximum expected loss from a terrorism event within any half-mile radius in a metropolitan area or around a target risk will not exceed $450 million on a pre-tax basis before considering the federal government participation under the Terrorism Act. Reports monitoring our terrorism exposures are generated quarterly. In addition, our underwriting process evaluates all potential new business to determine if it would add exposure to an already existing concentration of risk or would individually add significant risk. As a result, we believe that we have appropriately limited our exposure to losses from terrorist attacks. Nonetheless, risks insured by us remain exposed to terrorist attacks and, even considering the coverage provided by the Terrorism Act, the possibility remains that losses resulting from future terrorist attacks could prove to be material.
Loss and LAE Reserves
We establish loss and LAE reserves that are estimates of amounts needed to pay claims and related expenses in the future for insured events that have already occurred. The process of estimating reserves involves a considerable degree of judgment by management and is always inherently uncertain. See Item 7—"Management's Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Estimates," as well as Note 1—"Nature of Operations and Summary of Significant Accounting Policies—Insurance Operations" and Note 3—"Unpaid Loss and LAE Reserves" in the accompanying consolidated financial statements for further discussion of our accounting for loss and LAE.
The following table reconciles loss and LAE reserves determined on a statutory basis to loss and LAE reserves determined in accordance with GAAP as of December 31, 2016 and 2015 as follows:
December 31, | ||||||||
2016 | 2015 | |||||||
($ in millions) | ||||||||
Statutory reserves | $ | 1,192.7 | $ | 1,203.8 | ||||
Reinsurance recoverable on unpaid losses and LAE(1) | 172.9 | 186.0 | ||||||
GAAP reserves | $ | 1,365.6 | $ | 1,389.8 | ||||
_______________________________________________________________________________
(1) | Represents adjustments made to add back reinsurance recoverables on unpaid losses and LAE included with the presentation of reserves under statutory accounting. |
Investing, Financing and Corporate
Investing, Financing and Corporate primarily consists of investing and financing activities, as well as other assets and liabilities, and general and administrative expenses and interest expense incurred at the holding company level.
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Investing
Our traditional investment philosophy is to maximize long-term total returns (after-tax) while taking prudent levels of risk and maintaining a diversified portfolio, subject to our investment guidelines and various regulatory restrictions. Under this approach, each dollar of after-tax investment income and realized and unrealized investment gains and losses is valued equally.
Invested assets are not allocated to our Specialty Products or Specialty Industries reportable underwriting segments since we do not manage our invested assets by segment. Invested assets, net investment income, and net realized and change in unrealized investment gains (losses) related to our Specialty Products and Specialty Industries segments are included in the Investing, Financing and Corporate segment since these assets are available for payment of losses and expenses for all segments.
Substantially all of our investment portfolio is managed under an agreement with White Mountains Advisors LLC (WM Advisors), a registered investment advisor and wholly owned subsidiary of White Mountains. See Note 15—"Related Party Disclosures" of the accompanying consolidated financial statements. Our investment portfolio mix as of December 31, 2016, consisted in large part of high quality, short duration fixed maturity investments and short-term investments. During the third quarter of 2016, we established a portfolio of high-yield fixed maturity investments. We also maintain a portfolio of common equity securities, and other investments, including surplus notes, hedge funds and private equity funds. Our management believes that prudent levels of investments in common equity securities, other investments and high yield fixed maturity investments are likely to enhance long-term after tax total returns.
WM Advisors' fixed maturity investment strategy is to purchase securities that are attractively priced in relation to their investment risks. WM Advisors manages the interest rate risk associated with holding fixed maturity investments by actively managing the average duration of the portfolio to achieve an adequate after tax total return without subjecting the portfolio to an unreasonable level of interest rate risk. WM Advisors has established relationships with third party registered investment advisers to invest in taxable and tax-exempt municipal securities and high-yield fixed maturity investments.
WM Advisors' looks to enhance long term after-tax total returns by investing a portion of the portfolio in common equity securities and other investments. A majority of our common equity securities represent passive exchange traded funds (ETFs) that seek to provide investment results that, before expenses, generally correspond to the performance of broad market indices. WM Advisors has established a relationship with a third party registered investment adviser to invest in publicly-traded common equity securities, excluding our ETFs.
Financing
Debt and the related interest expense on debt also are not allocated to or managed by segment and are included in the Investing, Financing and Corporate segment.
2012 Senior Notes
In November 2012, OneBeacon U.S. Holdings, Inc. (OBH), an intermediate holding company of OneBeacon, issued $275.0 million face value of 4.6% senior unsecured notes (the 2012 Senior Notes) through a public offering, with the proceeds used to repurchase OBH's then existing outstanding senior notes, and mature on November 9, 2022. The Company provides an irrevocable and unconditional guarantee as to the payment of principal and interest on the 2012 Senior Notes.
Credit Facility
On September 29, 2015, the Company and OBH, as co-borrowers and co-guarantors, entered into a revolving credit facility administered by U.S. Bank N.A. and also including BMO Harris Bank N.A., which has a total commitment of $65.0 million and has a maturity date of September 29, 2019 (the Credit Facility). As of December 31, 2016, the Credit Facility was undrawn.
See Item 7—"Management's Discussion and Analysis of Financial Condition and Results of Operations—Financing."
Corporate
Our corporate operations consist of the activities of the Company, and our intermediate subsidiaries which include OneBeacon U.S. Enterprises Holdings, Inc., OneBeacon U.S. Financial Services, Inc., and OBH, all U.S.-domiciled holding companies, as well as various other intermediate holding and financing companies domiciled in the United States, Barbados, Bermuda, Ireland and Luxembourg. The primary purpose of these entities is to efficiently manage the group's various capital and financing activities.
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Regulatory Matters
General
Our insurance operations are subject to regulation and supervision in each of the United States jurisdictions in which they are domiciled and licensed to conduct business. Generally, state regulatory authorities have broad supervisory and administrative powers over such matters as licenses, standards of solvency, premium rates, policy forms, investments, statutory deposits, methods of accounting, form and content of the consolidated financial statements, reserves for unpaid loss and LAE, reinsurance, minimum capital and surplus requirements, dividends and other distributions to shareholders, annual and other report filings, and other market conduct. In general, such regulation is for the protection of policyholders rather than shareholders. We are also subject to Bermuda insurance regulations, which are generally similar to insurance regulations imposed by U.S. states on U.S.-domiciled insurers, though there are important differences, as described below.
State Accreditation and Monitoring
All states have laws establishing standards that an insurer must meet to maintain its license to write business. In addition, all states have enacted laws substantially similar to the National Association of Insurance Commissioners’ (NAIC) risk-based capital (RBC) standards for property and casualty companies, which are designed to determine minimum capital requirements and to raise the level of protection that statutory surplus provides for policyholder obligations. The RBC formula for property and casualty insurance companies measures three major areas of risk: underwriting, which encompasses the risk of adverse loss developments and inadequate pricing; declines in asset values arising from market and/or credit risk; and off-balance sheet risk arising from adverse experience from non-controlled assets, guarantees for affiliates or other contingent liabilities, and excessive premium growth. Under laws adopted by individual states, insurers having less total adjusted capital than that required by the RBC calculation will be subject to varying degrees of regulatory action, depending on the level of capital inadequacy.
The NAIC has a set of financial relationships or tests known as the Insurance Regulatory Information System (IRIS) to assist state insurance regulators in monitoring the financial condition of insurance companies and identifying companies that require special regulatory attention. Insurance companies generally submit data annually to the NAIC, which in turn analyzes the data using prescribed financial data ratios (IRIS ratios), each with defined "usual ranges." Generally, regulators will begin to investigate or monitor an insurance company if its IRIS ratios fall outside the usual ranges for four or more of the ratios. If an insurance company has insufficient capital, regulators may act to reduce the amount of insurance it can issue or, in severe situations, assume control of the company. We currently believe that all of our insurance subsidiaries are within an acceptable IRIS range, and we are not aware of any IRIS-related regulatory investigation related to our insurance company subsidiaries.
Many states have laws and regulations that limit an insurer's ability to exit a market. For example, certain states prohibit an insurer from withdrawing from one or more lines of insurance business in the state without providing prior notice to or obtaining the state regulator's approval. State regulators may refuse to approve withdrawal plans on the grounds that they could lead to market disruption or for other reasons, including political and tax-related reasons. Some states also prohibit canceling or non-renewing certain policies for specific reasons.
State insurance laws and regulations include numerous provisions governing marketplace activities of insurers, including provisions governing marketing and sales practices, policyholder services, claims management and complaint handling. State regulatory authorities generally enforce these provisions through periodic market conduct examinations.
Guaranty Funds and Mandatory Shared Market Mechanisms
As a condition of our license to do business in certain states, we are required to participate in guaranty funds in which licensed insurers within the state bear a portion of the loss suffered by claimants due to the insolvency of other insurers. Certain states also impose mandatory shared market mechanisms, such as assigned risk plans, with each state dictating the types of insurance and the level of coverage that must be provided. Assigned risk plans require insurers licensed within the applicable state to accept applications for insurance policies from customers who are unable to obtain insurance in the voluntary market. The total number of such policies an insurer is required to accept is based on its market share of voluntary business in the state. Underwriting results related to assigned risk plans are typically adverse. Accordingly, we may be required to underwrite policies with a higher risk of loss than we would otherwise accept.
Reinsurance facilities are another type of shared market mechanism. Reinsurance facilities require an insurance company to accept all applications submitted by certain state designated agents. The reinsurance facility then allows the insurer to cede some of its business to the reinsurance facility and the facility will reimburse the insurer for claims paid on ceded business. Typically, however, reinsurance facilities operate at a deficit, which is funded through assessments against the same insurers. As a result, we could be required to underwrite policies with a higher risk of loss than we would otherwise voluntarily accept.
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Pricing, Investment and Dividends
Nearly all states have insurance laws requiring property and casualty insurance companies to file their rates, rules and policy or coverage forms with the state's regulatory authority. In most cases, such rates, rules and forms must be approved prior to use. While pricing laws vary from state to state, their objectives are generally to ensure that rates are not excessive, unfairly discriminatory or used to engage in unfair price competition. Our ability to increase rates and the timing of the process are dependent upon the regulatory requirements in each state.
We are subject to state laws and regulations that require investment portfolio diversification and dictate the quality and kind of investments we may hold. Non-compliance may cause non-conforming investments to be non-admitted when measuring statutory surplus and, in some instances, may require divestiture. Our investment portfolio as of December 31, 2016 complied with such laws and regulations in all material respects.
One of the primary sources of cash inflows for us and certain of our intermediary holding companies is dividends or distributions received from our operating subsidiaries. Under the insurance laws of the domiciliary states of our U.S. insurance subsidiaries, an insurer is restricted with respect to the timing or amount of dividends it may pay without prior approval by regulatory authorities. Atlantic Specialty Insurance Company (ASIC), a New York insurance company, is the lead insurance company for our specialty business. ASIC, regulated by the New York Department of Financial Services (NY DFS), has the ability to pay dividends to its immediate parent without the prior approval of regulatory authorities in an amount set by formula based on the lesser of (i) adjusted net investment income, as defined by statute, or (ii) 10% of statutory surplus, in both cases as most recently reported to regulatory authorities, subject to the availability of earned surplus. Additionally, upon ASIC’s request, the NY DFS has the discretion to approve a greater dividend, or allow for a special distribution of funds (including share repurchases).
Split Rock Insurance, Ltd. (Split Rock) our Bermuda-based reinsurance company has the ability to distribute statutory capital without the prior approval of the Bermuda Monetary Authority, provided it does not reduce its total statutory capital, as shown in its previous financial year's statutory financial statements, by 15% or more. In addition, Split Rock has the ability to pay dividends to its immediate parent without the prior notification of regulatory authorities of up to 25% of its previous financial years total statutory capital and surplus, subject to meeting all appropriate liquidity and solvency requirements as specified in the Bermuda Insurance Act of 1978 and related regulations (Insurance Act) and the Companies Act 1981 of Bermuda (Companies Act). See Item 7A—"Liquidity and Capital Resources" for further information regarding dividend capacity for ASIC and Split Rock.
Holding Company Structure
We are subject to regulation under certain state insurance holding company acts. These regulations contain reporting requirements relating to our capital structure, ownership, financial condition and general business operations. These regulations also contain special reporting and prior approval requirements with respect to certain transactions among affiliates. Since we are an insurance holding company, the domiciliary states of our U.S. insurance subsidiaries impose regulatory application and approval requirements on acquisitions of common shares which may be deemed to confer control over those subsidiaries, as that concept is defined under the applicable state laws. Acquisition of as little as 10% of our common shares may be deemed to confer control under the insurance laws of some jurisdictions, and the application process for approval can be extensive and time consuming.
Legislation
Although the federal government does not directly regulate the insurance business, federal legislation and administrative policies impact the industry. In addition, legislation has been introduced in recent years that, if enacted, could result in the federal government assuming a more direct role in the regulation of the insurance industry. Notably, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act) created the Federal Insurance Office (FIO) within the Treasury Department, which is responsible for gathering information and monitoring the insurance industry to identify gaps in the regulation of insurers that could contribute to a systemic crisis in the insurance industry or U.S. financial system. In addition to these recent financial regulations, we are impacted by other federal regulations targeted at the insurance industry, such as the Terrorism Act, which established a federal "backstop" for commercial property and casualty losses (see "—Catastrophe Risk Management and Reinsurance Protection" above). For example, the generally applicable levels of reinsurance support that the federal government provides to authorized carriers under the Terrorism Act could be reduced by future legislation. We will continue to monitor new and changing federal regulations and their potential impact, if any, on our insurance company subsidiaries.
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In addition to emerging federal regulation, many states are adopting laws that attempt to strengthen the ability of regulators to understand and regulate the risk management practices of insurers and insurance groups. For example, many states have adopted measures related to the NAIC’s Solvency Modernization Initiative (SMI), which have included model regulations that require insurers to summarize their key risks and risk management strategies to regulators. For example, the SMI resulted in a 2010 amendment to the NAIC’s Model Insurance Company Holding Company System Regulatory Act (the Model Holding Company Act), which requires the ultimate controlling person in an insurer’s holding company structure to identify and report material enterprise risks to the state insurance regulator. The SMI also produced the NAIC Risk Management and Own Risk Solvency Model Act (ORSA), which requires insurers meeting premium thresholds to: 1) maintain a risk management framework; and 2) annually submit a comprehensive report designed to assess the adequacy of an insurer’s risk management practices, including risks related to the insurer’s future solvency position. ORSA requirements became effective in 2015 in all of the domiciliary states of our U.S. insurance company subsidiaries.
Bermuda Law
We are an exempted company organized under the Companies Act. As a result, we are required to comply with the provisions of the Companies Act regulating the payment of dividends and making of distributions from contributed surplus. A company is prohibited from declaring or paying a dividend, or making a distribution out of contributed surplus, if there are reasonable grounds for believing that:
• | the company is, or would after the payment be, unable to pay its liabilities as they become due; or |
• | the realizable value of the company's assets would thereby be less than its liabilities. |
Under our bye-laws, each common share is entitled to dividends if, and when, dividends are declared by our board of directors (the Board), subject to any preferred dividend rights of the holders of any preference shares. Issued share capital is the aggregate par value of the company's issued shares, and the share premium account is the aggregate amount paid for issued shares over and above their par value. Share premium accounts may be reduced in certain limited circumstances. In addition, the Companies Act regulates return of capital, reduction of capital and any purchase or redemption of shares by OneBeacon.
Although we are incorporated in Bermuda, we have been designated as a non-resident of Bermuda for exchange control purposes by the Bermuda Monetary Authority (BMA). Pursuant to our non-resident status, we may hold any currency other than Bermuda dollars and convert that currency into any other currency, other than Bermuda dollars, without restriction.
Shares may be offered or sold in Bermuda only in compliance with the provisions of the Investment Business Act 2003 and the Exchange Control Act 1972, and related regulations of Bermuda which regulate the sale of securities in Bermuda. In addition, specific permission is required from the BMA pursuant to the provisions of the Exchange Control Act 1972 and related regulations, for all issuances and transfers of securities of Bermuda companies, other than in cases where the BMA has granted a general permission. The BMA, in its policy dated June 1, 2005, provides that, where any equity securities, including our common shares, of a Bermuda company are listed on an appointed stock exchange, general permission is given for the issue and subsequent transfer of any securities of a company from and/or to a non-resident for as long as any equity securities of such company remain so listed. The New York Stock Exchange is deemed to be an appointed stock exchange under Bermuda law. Notwithstanding the above general permission, the BMA has granted us permission to, subject to our common shares being listed on an appointed stock exchange, (a) issue and transfer our shares, up to the amount of our authorized capital from time to time, to persons resident and non-resident of Bermuda for exchange control purposes; (b) issue and transfer our options, warrants, depositary receipts, rights, and other securities; and (c) issue and transfer our loan notes and other debt instruments and options, warrants, receipts, rights over loan notes and other debt instruments to persons resident and non-resident of Bermuda for exchange control purposes.
Under Bermuda law, exempted companies are companies formed for the purpose of conducting business outside Bermuda from a principal place in Bermuda. As an exempted company, we may not, without the express authorization of the Bermuda legislature or under a license granted by the Bermuda Minister of Economic Development (Minister), participate in various specified business transactions, including:
• | the acquisition or holding of land in Bermuda, except land held by way of lease or tenancy agreement which is required for our business and held for a term not exceeding 50 years, or which is used to provide accommodation or recreational facilities for our officers and employees and held with the consent of the Minister, for a term not exceeding 21 years; |
• | the taking of mortgages on land in Bermuda in excess of $50,000; |
• | the acquisition of any bonds or debentures secured by any land in Bermuda, other than certain types of Bermuda government or public authority securities; or |
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• | subject to some exceptions, the carrying on of business of any kind in Bermuda for which we are not licensed in Bermuda. |
Under Bermuda law, non-Bermudians (other than spouses of Bermudians, holders of permanent resident certificates and holders of working resident certificates) may not engage in any gainful occupation in Bermuda without an appropriate governmental work permit. Work permits may be granted or extended by the Bermuda government upon showing that, after proper public advertisement in most cases, no Bermudian (or spouse of a Bermudian or a holder of a permanent resident’s certificate or holder of a working resident’s certificate) is available who meets the minimum standard requirements for the advertised position. A waiver from advertising is automatically granted in respect of any chief executive officer position and other chief officer positions.
The Company’s indirect, wholly owned subsidiary, Split Rock, is a Bermuda-based reinsurance company. Split Rock is subject to the Insurance Act. The Insurance Act requires Split Rock to be registered with the BMA. The Insurance Act imposes solvency and liquidity standards and auditing and reporting requirements on Bermuda insurance companies, including Split Rock, and grants the BMA powers to supervise, investigate, and intervene in the affairs of Bermuda insurance companies. While Bermuda insurance regulations are generally similar to insurance regulations imposed by U.S. states on U.S.-domiciled insurers, there are important differences. These differences must be accounted for in order for Split Rock to maintain its Bermuda insurance license. For example, instead of using the RBC formula to determine the minimum amount of capital needed to support an insurer’s overall business operations, under the Insurance Act, Split Rock is required to maintain available statutory capital and surplus at a level equal to or in excess of its enhanced capital requirement which is established by reference to either the BMA's Bermuda Solvency Capital Requirement (BSCR) model or an approved internal capital model in lieu thereof. Split Rock currently uses the BSCR model in calculating its capital and solvency requirements, which it files with the BMA annually along with its annual statutory return and which forms part of its overall capital and solvency return. Another difference relates to the regulation of insurer investments. Under the Insurance Act, Split Rock is required to maintain a minimum liquidity ratio to ensure that it has sufficient liquidity in its investment portfolio. See the Pricing, Investing and Dividends section above for Bermuda restrictions with respect to distributions and dividends and Item 7A—"Liquidity and Capital Resources" for further information regarding dividend capacity for ASIC and Split Rock. Split Rock also submits audited GAAP financial statements and audited statutory financial statements to the BMA, the former of which are published on the BMA’s website. In addition, Split Rock files a financial condition report with the BMA, which is available from the Company for public inspection on request. Finally, in addition to compliance under the Insurance Act, Split Rock must also comply with provisions of the Companies Act relating to exempted companies, including with respect to payment of dividends, as set out above.
Ratings
Insurance companies are evaluated by various rating agencies in order to measure each company's financial strength. Higher ratings generally indicate financial stability and a stronger ability to pay claims. We believe that strong ratings are an important factor in the marketing of insurance products and services to distribution partners and customers. These claims-paying (or financial strength) ratings do not refer to our ability to meet non-insurance obligations and are not a recommendation to purchase or discontinue any policy or contract issued by us or to buy, hold, or sell our securities.
The following table presents the financial strength ratings assigned to our principal insurance operating subsidiaries as of February 27, 2017:
A.M. Best(1) | Fitch(2) | Moody's(3) | Standard & Poor's(4) | |||||
Ratings | "A" (Excellent) | "A" (Strong) | "A3" (Good) | "A-" (Strong) | ||||
Outlook | Stable | Stable | Stable | Stable | ||||
_______________________________________________________________________________
(1) | "A" is the third highest of sixteen financial strength ratings assigned by A.M. Best. |
(2) | "A" is the sixth highest of nineteen international financial strength ratings assigned by Fitch. |
(3) | "A3" is the seventh highest of twenty-one financial strength ratings assigned by Moody's. |
(4) | "A-" is the seventh highest of twenty-one financial strength ratings assigned by Standard & Poor's. |
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Executive Officers
The section below provides information regarding our executive officers as of February 27, 2017:
Name | Age | Position(s) | |||
T. Michael Miller | 58 | Director, President and Chief Executive Officer | |||
Paul H. McDonough | 52 | Executive Vice President and Chief Financial Officer | |||
Paul J. Brehm | 56 | Executive Vice President, Chief Actuary, Chief Risk Officer | |||
Dennis A. Crosby | 58 | Executive Vice President | |||
Maureen A. Phillips | 62 | Senior Vice President and General Counsel | |||
John C. Treacy | 53 | Chief Accounting Officer and Treasurer | |||
T. Michael Miller has been President and Chief Executive Officer of the Company since October 2006. Mr. Miller joined OneBeacon in April 2005 to assume responsibility for OneBeacon's insurance operations. Throughout his tenure at OneBeacon, Mr. Miller has also held various chief executive positions with OneBeacon companies. Mr. Miller's experience prior to joining OneBeacon includes 10 years at St. Paul Travelers, most recently as Co-Chief Operating Officer, and 14 years with The Chubb Corporation.
Paul H. McDonough was named Executive Vice President and Chief Financial Officer of the Company in February 2016. Mr. McDonough was Senior Vice President and Chief Financial Officer of the Company since March 2009. Mr. McDonough was appointed Vice President and Chief Financial Officer of the Company in October 2006. Prior to joining OneBeacon in December 2005, Mr. McDonough served as Executive Vice President and Chief Financial Officer of BJ's Wholesale Club, and as Treasurer for St. Paul Travelers, where he worked from 1999-2004. Prior to joining St. Paul Travelers, Mr. McDonough served in various finance roles with Sears and Chevron.
Paul J. Brehm has been Executive Vice President of OneBeacon Services since February 2013. Mr. Brehm has served as Chief Actuary of OneBeacon since 2015 and Chief Risk Officer of OneBeacon since March 2010. Mr. Brehm joined OneBeacon in 2008 as the Chief Actuary for the Specialty Insurance operations and has held various positions with OneBeacon companies. Prior to joining OneBeacon, Mr. Brehm was a Managing Director at Guy Carpenter from 2005 to 2008. Prior to Guy Carpenter, he worked at St. Paul Travelers for 22 years, most recently as Chief Actuary.
Dennis A. Crosby has been Executive Vice President of OneBeacon Services since January 2012. Mr. Crosby joined OneBeacon in July 2010 and serves as the chief executive overseeing our businesses. Prior to joining OneBeacon, Mr. Crosby was with ACE from 2004 through 2010, serving as President and CEO of ACE Westchester and Chairman of ACE Commercial Risk Services. Prior to his 6 years at ACE, he spent 23 years with St. Paul Travelers in a variety of senior roles including commercial middle market, insurance operations and public sector services.
Maureen A. Phillips became Senior Vice President and General Counsel of the Company in February 2012. Prior to joining OneBeacon, Ms. Phillips was Senior Vice President and Chief Legal Officer of Allianz Life Insurance Company of North America since 2008. Ms. Phillips served as Senior Counsel at Fairview Health Services from 2006 to 2008. Her prior experience includes senior legal positions at St. Paul Travelers where she spent 17 years.
John C. Treacy became Chief Accounting Officer and Treasurer of the Company in February 2013 after joining OneBeacon in May of 2012. Prior to joining OneBeacon, Mr. Treacy served as Chief Financial Officer for Berkley Risk from 2009 to 2012 and for JB Collins from 2007 to 2009. Mr. Treacy also served as Senior Vice President and Corporate Controller at Zurich North America from 2005 to 2007 and, previously in the same role, at St. Paul Travelers where he worked for 16 years. Prior to joining St. Paul Travelers, he practiced public accounting with Ernst & Young.
Employees
As of December 31, 2016, we employed approximately 1,100 persons.
AVAILABLE INFORMATION
We are subject to the informational reporting requirements of the Securities Exchange Act of 1934. In accordance therewith, we file reports, proxy statements and other information with the Securities and Exchange Commission (SEC). These documents are available free of charge at www.onebeacon.com as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. In addition, our Code of Business Conduct and Corporate Governance
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Guidelines, as well as the charters of our Board Committees are available free of charge at www.onebeacon.com. Information contained on our website is expressly not incorporated by reference into this Form 10-K.
We will provide to any shareholder, upon request and without charge, copies of these documents (excluding any applicable exhibits unless specifically requested). Written or telephone requests should be directed to Investor Relations, OneBeacon Insurance Group, Ltd., 605 North Highway 169, Plymouth, Minnesota 55441, (877) 248-8765. Additionally, all such documents are physically available at our registered office at Clarendon House, 2 Church Street, Hamilton, HM 11 Bermuda.
ITEM 1A. | RISK FACTORS |
Our business is subject to various risks and uncertainties. Any of the risks described below could materially adversely affect our business, financial condition, and results of operations.
Risks Relating to Our Business
Our loss and loss adjustment expense (LAE) reserves may be inadequate to cover our ultimate liability for the cost of claims and as a result our financial condition and results of operations could be materially adversely affected.
We must maintain reserves adequate to cover our estimated ultimate liabilities for loss and LAE. They are typically comprised of (1) case reserves for claims reported and (2) IBNR reserves, which consist of reserves for losses that have occurred but for which claims have not yet been reported and for expected future development on case reserves.
Loss and LAE reserves are estimates of what we believe the settlement and administration of claims will cost based on facts and circumstances then known to us. These estimates involve actuarial and claims assessments and depend on a number of assumptions about future events that are subject to unexpected changes and are beyond our control, such as future trends in claim severity, emerging coverage issues, frequency of large claims, overall claim frequency, inflation, legislative and judicial changes, and other factors. Estimating loss and LAE reserves is particularly challenging for new businesses where we do not have sufficient claims experience to select the necessary assumptions and must rely on external data to establish loss and LAE reserves, increasing the likelihood that our estimates will differ from the ultimate cost of claims.
Because of the inherent uncertainties associated with estimating ultimate loss and LAE reserves, it is likely that the ultimate cost of paying claims will be different than our loss and LAE reserves. In the event that reserves become insufficient to cover our actual loss and LAE, we may need to strengthen our reserves, which could have a material adverse effect on our results of operations and financial condition.
For additional information relating to loss and LAE reserve requirements, see "Item 1. Business—Regulatory Matters." For further discussion of our loss and LAE reserves, see "Item 1. Business—Loss and LAE Reserves" and "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Estimates."
Our investment portfolio may suffer reduced returns or losses, which could adversely affect our results of operations and financial condition. Adverse changes in interest rates, equity markets, debt markets or market volatility could result in significant losses to the fair value of our investment portfolio.
Our investment portfolio, including the assets supporting our benefit plans, consists of fixed maturity investments, short-term investments, common equity securities and other investments such as surplus notes, hedge funds and private equity funds. We invest to maximize long-term total returns (after-tax) while taking prudent levels of risk and maintaining a diversified portfolio, subject to our investment guidelines and various regulatory restrictions. However, investing entails substantial risks. We may not achieve our investment objectives, and our investment performance may vary substantially over time. Investment returns are an important part of our strategy to grow book value, and fluctuations in the fixed income or equity markets could impair our results of operations and financial condition.
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Both the investment income we generate and the fair market value of our investment portfolio are affected by general economic and market conditions, including fluctuations in interest rates, debt market levels, equity market levels and market volatility. Interest rates are highly sensitive to many factors, including governmental monetary policies, domestic and international economic and political conditions and other factors beyond our control. In particular, a significant increase in interest rates could result in significant losses in the fair value of our investment portfolio and consequently could adversely affect our results of operations and financial condition. We are exposed to changes in equity markets. We are also exposed to changes in the volatility levels of various investment markets. The underlying conditions prompting such changes are outside of our control and could adversely affect the value of our investments and our results of operations and financial condition. We also hold investments, such as surplus notes, hedge funds and private equity funds, which are not regularly traded in active investment markets and may be illiquid. These investments may experience greater volatility in their returns or valuation, which could impair our financial performance.
Successful management of our investment portfolio is highly dependent on WM Advisors, which is owned by White Mountains. If we lose our investment relationship with WM Advisors, we may not be able to secure an investment adviser or advisers who will produce returns on our investments similar to those produced by WM Advisors in the past, or any positive returns at all.
The property and casualty insurance industry is highly competitive and cyclical, and we may not be able to compete effectively in the future.
The property and casualty insurance industry is highly competitive and has historically been cyclical, experiencing periods of severe price competition and less selective underwriting standards (soft markets) followed by periods of relatively high prices and more selective underwriting standards (hard markets). Cyclicality may adversely affect our results of operations and financial condition by reducing the rates we can charge for property and casualty insurance during soft markets. We expect to continue to experience the effects of cyclicality and may not be able to successfully manage the associated risks.
Insurance markets are highly competitive and our businesses each compete against different subsets of companies. In general terms, we compete in one or more of our businesses with most of the large multi-line insurance companies, most of the specialty companies, and various local and regional insurers. We also compete with new companies formed to enter insurance markets. Recent consolidation in the United States property and casualty insurance industry may increase the size and/or financial strength of some of our competitors. Increased competition could result in fewer submissions, lower premium rates and less favorable policy terms and conditions, which could adversely impact our results of operations and financial condition.
We could fail to build and sustain the kind of business relationships, including distribution relationships, that are necessary to compete. We offer our products through a select network of independent agents, regional and national brokers, wholesalers and managing general agencies, or MGAs. If our distribution partners find that our competitor insurers offer better priced coverage, we may be unable to maintain a competitive position, which in turn may adversely affect our results of operations and financial condition. Additionally, consolidation among brokers and agents may make it more difficult to distribute our products.
Catastrophic events could materially adversely affect our results of operations and financial condition
We write insurance policies that cover unpredictable catastrophic events. Covered unpredictable events include natural disasters, such as hurricanes, windstorms, earthquakes, floods, wildfires, and severe winter weather, and also include other disasters such as terrorist attacks, cyber-attacks, explosions, infrastructure failures, political instability, and wide-impact pandemics.
Our exposure to hurricanes and earthquakes is the largest natural catastrophe risk to our business. Key exposures include: (1) hurricane or windstorm damage in the United States Northeast Atlantic Coast and Gulf Coast regions; (2) major California earthquakes; (3) convective storms; and (4) losses from terrorist attacks in the United States, such as the attacks on September 11, 2001.
The extent of catastrophe losses is a function of the number of events, the severity of each event and total amount of insured exposure in the affected area. Increases in the value and concentrations of insured property or insured employees, the effects of inflation, and changes in weather patterns could increase the future frequency and severity of claims from catastrophic events. Claims from catastrophic events could reduce our earnings and cause substantial volatility in our results of operations for any fiscal quarter or year and adversely affect our financial condition. Our ability to write new insurance policies could also be impacted as a result of corresponding reductions in our surplus levels.
Changing climate conditions may add to the unpredictability and frequency of natural disasters and create additional uncertainty as to future trends and exposures. We cannot predict how changing climate conditions and the various governmental and other responses to such changes will impact our business. To the extent that climate change increases the unpredictability,
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frequency or severity of natural disasters, we may face increased claims, which could have a material adverse effect on our results of operations and financial condition. Such climate changes may also not be adequately considered in our catastrophe modeling, described below.
Our efforts to mitigate our exposure to catastrophes—which include analyzing possible catastrophe losses through a variety of tools, such as catastrophe modeling software, and purchasing reinsurance—may be unsuccessful. Loss estimates produced by catastrophe models depend on many variables, including assumptions about demand surge, storm surge, loss adjustment expenses, and event intensity. If the assumptions defining our modeling variables are incorrect, or the model itself is incorrect, the losses we might incur from an actual catastrophe could be materially higher than our expectation of losses generated from modeled catastrophe scenarios. To the extent these losses are not covered by reinsurance, our results of operations and financial condition could be materially adversely affected.
Terrorism risk presents unique challenges because of the unpredictability of targets, the frequency and severity of potential terrorist attacks, the limited availability of terrorism reinsurance, and the limited protection provided by government programs. Furthermore, we cannot predict the extent to which our future insurance contracts will be prohibited from excluding terrorism coverage from insurance offered to certain classes of business. Under the Terrorism Act, the U.S. federal government is required to provide assistance to insurers for certain terrorism events. However, the benefits to insurers are limited, the law is untested, and it is possible that Congress will terminate or modify the Terrorism Act, which could adversely affect our business by increasing our exposure to terrorism losses. There is a possibility that losses resulting from future terrorist attacks could prove to be material to our results of operations and financial condition.
We may need additional capital in the future, which may not be available to us or available to us on favorable terms. Raising additional capital could dilute your ownership in our company and may cause the market price of our common shares to fall.
We may need to raise additional funds through public or private debt or equity financings in order to:
• | fund liquidity needs; |
• | replace capital lost due to one of the other risks identified herein; |
• | repay the $275.0 million aggregate principal amount of our 2012 Senior Notes; |
• | satisfy letter of credit or guarantee bond requirements that may be imposed by our clients or by regulators; |
• | acquire new businesses or invest in existing businesses; |
• | expand our business into new regions or countries; or |
• | otherwise respond to competitive pressures. |
Any additional capital raised through the sale of equity will dilute an existing shareholders' ownership percentage in our company and may decrease the market price of our common shares. Furthermore, the securities may have rights, preferences and privileges that are senior or otherwise superior to those of our common shares. Any additional financing we may need may not be available on terms favorable to us, or at all, and could increase the company’s financial leverage and hence its overall risk levels.
We may not successfully alleviate risk through reinsurance arrangements. Additionally, we may be unable to collect all amounts due from reinsurers under our existing reinsurance arrangements.
We attempt to limit our risk of loss through reinsurance arrangements. The availability and cost of reinsurance protection is subject to market conditions which are outside of our control. In addition, the coverage provided by our reinsurance contracts may be inadequate to cover our future liabilities. As a result, we may not be able to successfully alleviate risk through these arrangements, which could have a material adverse effect on our results of operations and financial condition.
Purchasing reinsurance does not relieve us of our underlying obligations to policyholders, so any inability to collect amounts due from reinsurers could also adversely affect our results of operations and financial condition. Inability to collect amounts due from reinsurers can result from a number of scenarios, including: (1) reinsurers choosing to withhold payment due to a dispute or other factors beyond our control; and (2) reinsurers becoming unable to pay amounts owed to us as a result of a deterioration in financial condition. While we regularly review the financial condition of our reinsurers and currently believe their condition is strong, it is possible that one or more of our reinsurers will be significantly adversely affected by future significant loss or economic events, causing them to be unable or unwilling to pay amounts owed to us.
In addition, due to factors such as the price or availability of reinsurance coverage, we sometimes decide to increase the amount of risk we retain by purchasing less reinsurance. Such determinations have the effect of increasing our financial exposure to losses associated with such risks and, in the event of significant losses associated with a given risk, could have a material adverse effect on our results of operations and financial condition.
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We may be unable to adequately maintain our systems and safeguard the security of our data which may adversely impact our ability to operate our business and cause reputational harm and financial loss.
Because our business and operations rely on secure and efficient information technology systems, we depend on our ability, and the ability of certain third parties, including vendors and business partners, to access our computer systems to perform necessary functions such as providing quotes and product pricing, billing and processing premiums, administering claims, and reporting our financial results. The functioning of these systems may be impacted by any number of events, including power outages, natural and manmade catastrophes, and cyber-attacks. In the event we are unable to access any of our systems, or any third party system that we rely upon, our ability to operate our business effectively may be significantly impaired.
Our business also depends upon our ability to securely process, store, transmit and safeguard confidential and proprietary information that is in our possession. This information includes confidential information relating to our business, and personally identifiable information (PII) and protected health information (PHI) belonging to our employees, customers, claimants and business partners. Because our systems may be vulnerable to a variety of forms of unauthorized access that could result in a data breach, including hackers, computer viruses, and other cyber-attacks, as well as breaches that could result from dishonest employees, errors by employees or lost or stolen computer devices, we may not be able to protect the confidentiality of such information.
Third parties present an additional risk of cyber-related events. We outsource certain technological and business process functions to third-party providers. We rely on these third parties to maintain and store PII and PHI and other confidential information on their systems. We also routinely transmit such information by e-mail and other electronic means. Although we attempt to establish sufficient controls and secure capabilities to transmit such information and to prevent unauthorized disclosure, these controls may not be sufficient. Furthermore, third-party providers may not have appropriate controls in place to protect such information.
Like most insurance companies, our computer systems have been and will continue to be the target of cyber-attacks, although we are not aware that we have experienced a material cybersecurity breach. We are also not aware of any third-party vendor having experienced a material cybersecurity breach that impacted our data. The risk of cyber-attack may increase, and we may experience more significant attacks in the future.
The risks identified above could expose us to data breaches, disruptions of service, financial losses and significant increases in compliance costs and reputational harm to us, any of which could affect our business and results of operations. In addition, a data breach that involves the compromise of PII or PHI could subject us to legal liability or regulatory action under data protection and privacy laws and regulations enacted by federal, state and foreign governments, or other regulatory bodies. As a result, our ability to conduct our business and our results of operations might be materially and adversely affected.
We may suffer losses from unfavorable outcomes from litigation and other legal proceedings.
In the ordinary course of business, we are subject to litigation and other legal proceedings as part of the claims process, the outcomes of which are uncertain. We maintain reserves for claims-related legal proceedings as part of our loss and LAE reserves. Adverse outcomes are possible and could negatively impact our financial condition. Furthermore, as industry practices and legal, judicial, social and other conditions change, unexpected issues related to claims and coverage may emerge. These issues may adversely affect our results of operations and financial condition by either extending coverage beyond our underwriting intent or by increasing the number and size of claims. In some instances, these changes may not become apparent until sometime after we have issued the affected insurance contracts. Examples of emerging claims and coverage issues include, but are not limited to:
• | New theories of liability and disputes regarding medical causation with respect to certain diseases; |
• | Claims related to data security breaches, information system failures or cyber-attacks; and |
• | Claims caused by national and global political and social unrest. |
In addition, from time to time, we are subject to legal proceedings that are not related to the claims process. In the event of an unfavorable outcome in one or more non-claims legal matters, our ultimate liability may be in excess of amounts we have reserved and such additional amounts may be material to our results of operations and financial condition. Furthermore, it is possible that these non-claims legal proceedings could result in equitable remedies or other unexpected outcomes that may materially impact our business or operations.
Our debt and related service obligations could adversely affect our business.
As of December 31, 2016, we had $275.0 million face value of indebtedness. See "Item 1. Business—Investing, Financing and Corporate—Financing—2012 Senior Notes." Our ability to meet our debt and related service obligations will
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depend on our future performance, which will be affected by financial, business, economic, regulatory and other factors, many of which are beyond our control. If the Company or OBH defaults under a separate credit agreement, mortgage, or similar debt agreement with a principal amount greater than $75 million, and such default results in the acceleration of such debt, there will be a default under the 2012 Senior Notes which would permit the holders of 25% or more of the 2012 Senior Notes to declare an event of default under the indenture documents resulting in a required repayment of the 2012 Senior Notes. We cannot be certain that our earnings will be sufficient to allow us to pay the principal and interest on our debt and meet our other obligations, or to repay any accelerated indebtedness as a result of the trigger of the cross acceleration provisions in the indentures of the 2012 Senior Notes. If we do not have enough cash, we may be required to refinance all or part of our existing debt, sell assets, borrow more cash or issue equity. We cannot make assurances that we will be able to accomplish any of these alternatives on terms acceptable to us, if at all. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations—Financing."
We recently entered into a Credit Agreement with lenders providing an unsecured revolving credit facility of $65.0 million. To date, we have not incurred any indebtedness under the Credit Agreement.
We could incur additional indebtedness or issue preferred stock, or other hybrid instruments, in the future. To the extent new debt, preferred stock, hybrid instruments, or other obligations are added to our current debt levels, or we incur indebtedness under the revolving credit facility discussed above, the risks described in the previous paragraph would increase.
We may not be successful in developing our specialty businesses which could cause us to underprice our policies, underestimate reserves, incur additional expenses and fail to fully realize our investments in these businesses, which could materially affect our business and results of operations.
We recently entered into new specialty business lines, including financial institutions and programs. We intend to continue to look for appropriate opportunities to diversify our business portfolio by adding new specialty lines. We also intend to continue to grow our existing specialty lines. Due to our limited experience in new business lines, there could be limited expertise and financial information available to us to help estimate sufficient prices, estimate likely ultimate loss and LAE and expenses, and evaluate whether a given line can be managed and developed successfully. Also, these lines may not meet our performance expectations. Although we have a conservative approach to adding new lines, including stringent management oversight of underwriting, product and pricing development, and financial performance, there is no assurance that some or all of these new specialty businesses will be profitable, which could materially adversely affect our results of operations and financial condition.
Regulation may restrict our ability to operate.
The insurance industry is subject to extensive regulation under federal, state and Bermuda law. The primary goal of the regulation is protection of policyholders rather than shareholders. For example, in order to protect insurer solvency, state insurance regulations impose restrictions on the amount and type of investments, detail minimum capital standards, and require the maintenance of reserves. Also, laws that protect policyholders from premium rate increases may make it difficult for us to increase premiums to adequately reflect the cost of providing coverage. Our underwriting is heavily dependent on information gathered from third parties such as insurance rating bureaus, highly regulated credit report agencies and other data aggregators. Regulatory changes related to the availability or use of this information could materially affect how we underwrite and price premiums.
Changes in federal, state or Bermuda laws and regulations may restrict our ability to operate and/or have an adverse effect upon the profitability of our business within a given jurisdiction, and could have an effect on our business, results of operations and financial condition. For example, as a result of various state, federal and international regulatory efforts to modernize and harmonize insurer solvency regulations in the wake of the recent financial crisis, the states or Bermuda could further restrict allowable investments or increase our capital requirements, both of which could materially impact our results of operations.
We may not maintain favorable financial strength or creditworthiness ratings, which could adversely affect our ability to conduct business.
Third-party rating agencies assess and rate the financial strength, including claims-paying ability, of insurers and reinsurers. These ratings are based upon criteria established by the rating agencies and are subject to revision at any time at the sole discretion of the agencies. Some of the criteria relate to general economic conditions and other circumstances outside the rated company's control. These financial strength ratings are: (1) an important tool that policyholders, agents and brokers use to assess the suitability of insurers as business counterparties; and (2) an important factor in establishing the competitive position of insurance companies. A downgrade, withdrawal or negative watch/outlook of our financial strength ratings could severely limit or prevent our insurance subsidiaries from writing new insurance policies or renewing existing insurance policies, which could have a material adverse effect on our results of operations and financial condition.
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General creditworthiness ratings are used by existing and potential investors to assess the likelihood of repayment on a particular debt issue. Strong creditworthiness ratings also provide better financial flexibility when issuing new debt or restructuring existing debt. A downgrade, withdrawal or negative watch/outlook of our creditworthiness ratings could limit our ability to raise new debt or make new debt more costly and/or have more restrictive conditions.
We depend on our key personnel to manage our business effectively and they may be difficult to replace.
Our performance substantially depends on the efforts and abilities of our management team and other executive officers and key employees, including our experienced teams of specialty underwriters. Furthermore, much of our competitive advantage is based on the expertise, experience and know-how of our key management personnel and underwriting teams. We do not have fixed term employment agreements with any of our key employees or key man life insurance, and the loss of one or more of these key employees, or a substantial portion of an underwriting team, could adversely affect our business, results of operations and financial condition. Our success also depends on the ability to hire and retain additional key personnel, including underwriting and claims teams. Difficulty in hiring or retaining key personnel could adversely affect our results of operation.
Mandated market mechanisms may require us to underwrite policies with a higher risk of loss, and assessments and other surcharges for guaranty funds and second-injury funds may reduce our profitability.
We are often required to participate directly or indirectly in mandatory shared market mechanisms as a condition of writing insurance in certain states. These markets, which are commonly referred to as "residual" or "involuntary" markets, generally consist of risks considered to be undesirable from a standard underwriting perspective. Because underwriting performance related to assigned risk plans, which are a form of mandated market mechanism, is typically adverse, we are required to underwrite policies with a higher risk of loss than we would normally accept. Our participation in assigned risk plans may result in greater than expected liabilities and could materially adversely affect our results of operations and financial condition.
In addition, virtually all states require their licensed insurers to bear a portion of loss suffered by some insureds as the result of impaired or insolvent insurance companies. These guaranty funds are funded by assessments that follow insurer insolvencies, which are difficult to predict. Many states have also established second-injury funds that compensate injured employees for aggravation of a prior condition or injury. Because these second injury funds are funded by insurer assessment or premium surcharge mechanisms, they could reduce our profitability or limit our ability to grow.
We may not be able to maintain effective operating procedures and manage operational risk.
Our business operations depend on our ability to execute a large number of underwriting, claim processing, analytical, information technology and investment processes. If we are unable to do so, we may be unable to comply with regulatory requirements, accurately collect and analyze underwriting and claims data, or successfully develop new insurance products, among other things.
We implement procedures and internal controls designed to support our business processes and to mitigate these risks. However, a control system, no matter how well designed and operated, can provide only reasonable assurance that the control system’s objectives will be met. Failure of internal controls may result from, among other things, employee error or misconduct, failure to properly document transactions, failure to obtain necessary authorization, and failure to comply with regulatory requirements. Failure of controls may also result from failure to adequately supervise third party vendors we rely upon to support some of our business operations. If controls are not effective, it could lead to financial loss, unanticipated risk exposure, regulatory action or damage to our reputation. An example of ineffective controls leading to litigation can be seen in claims handling, where failure to properly handle a claim could increase our exposure by supporting policyholder theories that a claim was settled by us in bad faith.
There is no guaranty that the Board of Directors will maintain current dividend levels, which may reduce the return on an investment in our common shares.
Our current shareholder dividend practices are subject to change for reasons that may include decisions on whether, when and in what amounts to make any future distributions. These decisions remain at all times entirely at the discretion of our Board of Directors, which reserves the right to change or suspend our dividend practices at any time and for any reason. Our common shareholders should be aware that they have no contractual or other legal right to dividends. Our ability to pay dividends also depends on our future performance, which may be affected by factors beyond our control.
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The Company is a holding company with no direct operations, and our insurance subsidiaries' ability to pay dividends to us is restricted by law.
As a holding company with no direct operations, the Company relies in large part on dividends and other permitted payments, including distributions, from our subsidiaries to pay our expenses, interest on debt and dividends to shareholders, or otherwise distribute capital to shareholders. Our subsidiaries may not be able to generate cash flow sufficient to pay a dividend or distribute funds to us. In addition, under the insurance laws of the jurisdictions in which our insurance subsidiaries are domiciled, insurers are restricted with respect to the timing or the amount of dividends or distributions it may pay, and, in some cases, the prior approval of regulatory authorities may be required. ASIC, a New York insurance company, is our lead domestic insurance company. Dividends and distributions from ASIC may require prior approval by the NY DFS. Split Rock, our Bermuda reinsurance company, is regulated by the BMA and may require prior approval for dividends and other permitted payments.
If our insurance subsidiaries cannot pay dividends and other permitted payments in future periods, we may have difficulty servicing our debt, paying dividends on our common shares, continuing our current share repurchase program or repurchasing shares in the future, and paying our holding company expenses. For additional information relating to insurance regulations governing our operations, see "Item 1. Business—Regulatory Matters."
We are exposed to credit risk in certain of our business operations.
In addition to exposure to credit risk related to our investment portfolio and reinsurance recoverables, we are exposed to credit risk in other areas of our business operations.
In accordance with industry practice, when policyholders purchase insurance policies from us through independent agents and brokers, the premiums are often first received by the independent agents and brokers, who then route premiums to us. In most jurisdictions, the premiums are deemed paid to us whether or not we receive them. Consequently, we assume a degree of credit risk associated with due amounts from independent agents and brokers.
Under many of our policies, our customers are responsible to reimburse us for an agreed-upon amount per claim. Because we are typically required under these policies to pay covered claims first and then seek reimbursement from our customers, we are exposed to credit risk.
We are exposed to credit risk in our surety business, where we guarantee to a third party that our customer will satisfy certain performance obligations. We sometimes mitigate the surety customer credit risk by requiring customers to post collateral for some or all of their performance obligations, often in the form of pledged securities such as money market funds or letters of credit provided by banks. However, there is credit risk associated with any collateral — if we are holding collateral other than cash and our customer is unable to honor his or her obligations, we may be exposed to credit risks associated with pledged securities or the banks that issued the letter of credit.
Economic downturns generally increase these credit risks. If credit risks materialize and control mechanisms like underwriting guidelines and collateral requirements are unsuccessful, we could be left with collateral that has little or no value. As a result, our exposure to the above credit risks could materially and adversely affect our results of operations.
Bermuda law differs from the laws in effect in the United States and may afford less protection to shareholders.
We are organized under the laws of Bermuda, and a portion of our assets are located outside the United States. As a result, it may not be possible for our shareholders to enforce court judgments obtained in the United States against us based on the civil liability provisions of the federal or state securities laws of the United States, either in Bermuda or in countries other than the United States where we have assets. In addition, there is some doubt as to whether the courts of Bermuda and other countries would recognize or enforce judgments of U.S. courts obtained against us or our directors or officers based on the civil liabilities provisions of the federal or state securities laws of the United States or would hear actions against us or those persons based on those laws.
Our corporate affairs are governed by the Companies Act. The Companies Act differs in some material respects from laws generally applicable to U.S. corporations and shareholders, including the provisions relating to interested directors, amalgamations, mergers and acquisitions, takeovers, shareholder lawsuits and indemnification of directors. Generally, the duties of directors and officers of a Bermuda company are owed to the company only. Shareholders of Bermuda companies generally do not have rights to take action against directors or officers of the company and may only do so in limited circumstances. Class actions and derivative actions are generally not available to shareholders under Bermuda law. The Bermuda courts, however, would ordinarily be expected to permit a shareholder to commence an action in the name of a company to remedy a wrong to the company where the act complained of is alleged to be beyond the corporate power of the company or illegal, or would result in the violation of the company’s memorandum of association or bye-laws. Furthermore,
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consideration would be given by a Bermuda court to acts that are alleged to constitute a fraud against non-controlling shareholders or, for instance, where an act requires the approval of a greater percentage of the company’s shareholders than that which actually approved it.
When the affairs of a company are being conducted in a manner that is oppressive or prejudicial to the interests of some part of the shareholders, one or more shareholders may apply to the Supreme Court of Bermuda, which may make such order as it sees fit, including an order regulating the conduct of the company’s affairs in the future or ordering the purchase of the shares of any shareholders by other shareholders or by the company. Additionally, under our bye-laws and as permitted by Bermuda law, each shareholder has waived any claim or right of action against our directors or officers for any action taken by directors or officers in the performance of their duties, except for actions involving fraud or dishonesty. In addition, the rights of our shareholders and the fiduciary responsibilities of our directors under Bermuda law are not as clearly established as under statutes or judicial precedent in existence in jurisdictions in the United States, particularly the State of Delaware. Therefore, our shareholders may have more difficulty protecting their interests than would shareholders of a corporation incorporated in a jurisdiction within the United States.
Risks Relating to Our Relationship with White Mountains
Control of us by White Mountains, and the holding of White Mountains shares by some of our directors and officers, may result in conflicts of interest.
White Mountains beneficially owns all of our Class B common shares, representing 96.9% of the voting power of our voting securities and 76.1% of our total equity as of December 31, 2016. As long as White Mountains owns our common shares representing more than 50% of the voting power of our outstanding voting securities, White Mountains will generally be able to determine the outcome of all corporate actions requiring shareholder approval, including the election of directors. Furthermore, we are relying on the "controlled company" exemption under the rules of the New York Stock Exchange, and are therefore not required to have a majority of independent directors on our Board. Of the ten directors on our Board, five are current or former employees, directors or officers of White Mountains, or the Company. White Mountains also has control over the adoption or amendment of provisions in our memorandum of association or bye-laws and the approval of amalgamations, mergers, and other significant corporate transactions. Furthermore, White Mountains will continue to be able to exercise this control as long as its economic equity ownership in us is at least 20%. These factors also may delay or prevent a change in the management or voting control of us.
Also, at some time in the future, White Mountains may sell all or a portion of its ownership interest in us or may make a tax-free distribution to its shareholders of all or a portion of that interest. There is no guaranty that such a transaction would be in the best interests of our other shareholders.
Questions relating to conflicts of interest may arise between us and White Mountains in a number of areas relating to our past and ongoing relationships. Certain of our directors and executive officers may own substantial amounts of White Mountains stock and may also be directors or officers of White Mountains from time to time. Their ownership of White Mountains stock and these other relationships could create, or appear to create, potential conflicts of interest when these individuals are faced with decisions that could have different implications for us and White Mountains. These potential conflicts could arise, for example, over matters such as the desirability of an acquisition opportunity, employee retention or recruiting, or our dividend policy.
White Mountains may compete with us and the involvement of those individuals who are directors and officers of White Mountains and directors of ours in resolving matters relating to such competition will not constitute a breach of fiduciary duty to us.
Our bye-laws provide that White Mountains will have no obligation to refrain from:
• | engaging in the same or similar business activities or lines of business as we do; or |
• | doing business with any of our clients or customers. |
Because White Mountains may currently or in the future engage in the same activities in which we engage, we may be in direct competition with White Mountains. While White Mountains has indicated to us that its current expectation is to manage its activities such that opportunities to acquire specialty businesses will be pursued through OneBeacon, White Mountains is not legally obligated to do so and could in the future manage its activities in a different way. Under our bye-laws, it is not a breach of fiduciary duty on the part of any of our officers and directors by reason of their participation in any of the above described activities. Due to the resources of White Mountains, including financial resources, name recognition and knowledge of our strengths, weaknesses and business practices, White Mountains could have a competitive advantage over us should it decide to engage in the type of business we conduct, which may have a material adverse effect on our operations and financial condition.
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Agreements, or agreements we may enter into, with White Mountains may not be on arm's length terms.
In connection with the initial public offering, we entered into certain contractual arrangements with White Mountains and its affiliates. These agreements were made in the context of a parent-subsidiary relationship. For example, some of our investments are managed pursuant to an investment management agreement and on a discretionary basis by a registered investment advisor owned by White Mountains. While we are satisfied with the terms of such arrangement, we cannot confirm that such terms are as favorable to us as they might have been had we contracted with an independent advisor. On the other hand, if our investment management agreement should terminate, we may not be able to replace these investment services in a timely manner or on terms and conditions, including cost, that are comparable to those we receive from White Mountains, and we may have to pay higher prices for similar services from unaffiliated third parties. For more information on these and other arrangements with White Mountains, see Note 15—"Related Party Disclosures" of the accompanying consolidated financial statements.
Risks That Relate to Taxes
Changes in tax laws or tax treaties may adversely affect the Company.
The taxable income of our U.S. subsidiaries is subject to U.S. federal, state and local income tax and other taxes. Potential changes to these laws could adversely affect the company. For example, disallowing the deduction for reinsurance purchased from a reinsurer outside the U.S. or disallowing deductions for interest expense could adversely affect the Company.
The income of the non-U.S. companies in our group is generally subject to a rate of tax that is lower than the U.S. rate. Certain of our non-U.S. companies are eligible for the benefits of tax treaties between the United States and other countries. We believe our non-U.S. companies will continue to be eligible for treaty benefits. However, it is possible that factual changes or changes to U.S. tax laws or changes to tax treaties that presently apply to our non-U.S. companies could increase income, or the tax rate on income subject to tax in the United States. Similarly, changes to the applicable tax laws, treaties or regulations of other countries could subject the income of members of our group to higher rates of tax outside the United States. Additionally, the base erosion and profit shifting (“BEPS”) project currently being undertaken by the Organization for Economic Cooperation and Development (“OECD”) and the European Commission’s investigation into illegal state aid may result in changes to long-standing tax principles which could adversely affect the Company.
We have significant deferred tax assets, which we may be unable to utilize if we do not generate sufficient future taxable income.
We have a deferred tax asset related to net operating loss carryforwards and tax credit carryforwards at December 31, 2016 that are subject to carryforward limitations in the United States. Utilization of these assets and other assets included in our net deferred tax asset is dependent on generating sufficient future taxable income of the appropriate character (i.e. ordinary income or capital gains) in the appropriate jurisdiction. If it is determined that it is more likely than not that sufficient future taxable income will not be generated, we would be required to increase the valuation allowance (an offset to our deferred tax asset) in future periods, which could have an adverse effect on our results of operations. A reduction in the Federal income tax rate to between 15-20% would reduce the Company’s net deferred tax asset by $54 - $72 million.
OneBeacon Insurance Group, Ltd., our Bermuda-based parent company, and our non-U.S. subsidiaries may become subject to U.S. tax, which may have an adverse effect on our results of operations and our shareholders’ investments.
OneBeacon Insurance Group, Ltd. and our non-U.S. subsidiaries operate in a manner such that none of these companies should be subject to U.S. tax (other than U.S. excise tax on insurance and reinsurance premium income attributable to insuring or reinsuring U.S. risks and U.S. withholding tax on some types of U.S. source investment income), because none of these companies should be treated as engaged in a trade or business within the United States. However, because there is considerable uncertainty as to the activities that constitute being engaged in a trade or business within the United States, we cannot be certain that the Internal Revenue Service (IRS) will not contend successfully that the Company or its non-U.S. subsidiaries are engaged in a trade or business in the United States. If the Company or any of its non-U.S. subsidiaries were considered to be engaged in a trade or business in the United States, such entity could be subject to U.S. corporate income and branch profits taxes on the portion of its earnings effectively connected to such U.S. business, which could adversely affect our results of operations.
ITEM 1B. | UNRESOLVED STAFF COMMENTS |
None.
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ITEM 2. | PROPERTIES |
Our headquarters are located at 26 Reid Street, Hamilton HM 11, Bermuda. Our U.S. corporate headquarters are located at 605 Highway 169 North, Plymouth, Minnesota, 55441, and our registered office is located at Clarendon House, 2 Church Street, Hamilton HM 11, Bermuda. We also maintain branch offices in various cities throughout the United States. Our headquarters, U.S. corporate headquarters and branch offices are leased. Management believes that our office facilities will be suitable and adequate for our current level of operations.
ITEM 3. | LEGAL PROCEEDINGS |
OneBeacon, and the insurance and reinsurance industry in general, is routinely subject to claims-related litigation and arbitration in the normal course of business, as well as litigation and arbitration that do not arise from, or directly relate to, claims activity. We believe that the outcome of these proceedings, even if determined adversely, would not have a material adverse effect on our business, financial condition or results of operations.
Deutsche Bank Litigation
In June 2011, Deutsche Bank Trust Company Americas, Law Debenture Company of New York and Wilmington Trust Company (collectively referred to as “Plaintiffs”), in their capacity as trustees for certain senior notes issued by the Tribune Company (“Tribune”), filed lawsuits in various jurisdictions (the “Noteholder Actions”) against numerous defendants including OneBeacon, OneBeacon-sponsored benefit plans and other affiliates of White Mountains in their capacity as former shareholders of Tribune seeking recovery of the proceeds from the sale of common stock of Tribune in connection with Tribune's leveraged buyout in 2007 (the “LBO”). Tribune filed for bankruptcy in 2008 in the Delaware bankruptcy court (the “Bankruptcy Court”). The Bankruptcy Court granted Plaintiffs permission to commence these LBO-related actions, and in 2011, the Judicial Panel on Multidistrict Litigation granted a motion to consolidate the actions for pretrial matters and transferred all such proceedings to the United States District Court for the Southern District of New York (the SDNY). Plaintiffs seek recovery of the proceeds received by the former Tribune shareholders on a theory of constructive fraudulent transfer asserting that Tribune purchased or repurchased its common shares without receiving fair consideration at a time when it was, or as a result of the purchases of shares, was rendered, insolvent. OneBeacon has entered into a joint defense agreement with other affiliates of White Mountains that are defendants in the action. OneBeacon and OneBeacon-sponsored benefit plans received approximately $32 million for Tribune common stock tendered in connection with the LBO. The Court granted an omnibus motion to dismiss the Noteholders Action in September 2013 and plaintiffs appealed. On March 29, 2016, a three judge panel of the U.S Second Circuit Court of Appeals affirmed the dismissal of the Noteholders Action. On July 22, 2016, the Plaintiff's petition to the Second Circuit for reconsideration or for a rehearing en banc was denied in full. On September 9, 2016 the Plaintiffs filed for a writ of certiorari, seeking review in the United States Supreme Court.
In addition, OneBeacon, OneBeacon-sponsored benefit plans and other affiliates of White Mountains in their capacity as former shareholders of Tribune, along with thousands of former Tribune shareholders, have been named as defendants in an adversary proceeding brought by the Official Committee of Unsecured Creditors of the Tribune Company (the “Committee”), on behalf of the Tribune Company, which seeks to avoid the repurchase of shares by Tribune in the LBO on a theory of intentional fraudulent transfer (the “Committee Action”). Tribune emerged from bankruptcy in 2012, and a litigation trustee replaced the Committee as plaintiff in the Committee Action. This matter was consolidated for pretrial matters with the Noteholder Actions in the SDNY and was stayed pending the motion to dismiss in the Noteholder Action. An omnibus motion to dismiss the shareholder defendants in the Committee Action was filed in May 2014 and the motion was granted on January 6, 2017. The plaintiff has requested permission to move the SDNY to certify the decision as a final judgment capable of immediate appeal. No amount has been accrued in connection with this matter as of December 31, 2016, as the amount of loss, if any, cannot be reasonably estimated.
ITEM 4. | MINE SAFETY DISCLOSURES |
None.
25
PART II
ITEM 5. | MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |
The Class A common shares of OneBeacon are listed and traded on the New York Stock Exchange (Symbol: OB). Our Class A common shares began trading on November 9, 2006. Prior to such date, there was no established public trading market for our common shares. We also have Class B common shares that are not listed for trading, all of which are held by White Mountains. There is no public market for this class of securities. The closing price per share of the Class A common shares on the New York Stock Exchange on February 22, 2017 was $16.65. As of February 22, 2017, the 22,525,458 outstanding Class A common shares were held by 30 holders of record. During 2016, we paid a quarterly dividend of $0.21 per common share, or $79.2 million in total. See Item 7—"Management's Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Dividend Capacity" and Note 11—"Statutory Capital and Surplus" of the accompanying consolidated financial statements for a description of restrictions on our ability to pay dividends.
The following table presents the range of share prices for our Class A common shares for the periods indicated, and the quarterly dividends declared per share:
Three months ended | ||||||||||||||||
March 31 | June 30 | September 30 | December 31 | |||||||||||||
2016 | ||||||||||||||||
Common share price: | ||||||||||||||||
High | $ | 14.00 | $ | 13.83 | $ | 14.95 | $ | 16.25 | ||||||||
Low | $ | 11.68 | $ | 12.04 | $ | 13.56 | $ | 13.63 | ||||||||
Dividends declared | $ | 0.21 | $ | 0.21 | $ | 0.21 | $ | 0.21 | ||||||||
2015 | ||||||||||||||||
Common share price: | ||||||||||||||||
High | $ | 16.80 | $ | 16.29 | $ | 15.71 | $ | 14.74 | ||||||||
Low | $ | 14.49 | $ | 13.72 | $ | 13.78 | $ | 12.15 | ||||||||
Dividends declared | $ | 0.21 | $ | 0.21 | $ | 0.21 | $ | 0.21 | ||||||||
White Mountains is a holding company whose businesses provide property and casualty insurance and certain other products. During the fourth quarter of 2006, White Mountains sold 27.6 million, or 27.6%, of our Class A common shares in an initial public offering. Prior to the initial public offering, we were a wholly-owned subsidiary of White Mountains. As of December 31, 2016, White Mountains owned 76.1% of our common shares.
Purchases of Equity Securities by the Issuer
On August 22, 2007, the Board authorized us to repurchase up to $200.0 million of our Class A common shares from time to time, subject to market conditions. Shares may be repurchased on the open market or through privately negotiated transactions. This program does not have a stated expiration date. During the year ended December 31, 2016, 850,349 shares were repurchased under the share repurchase authorization for $10.6 million at an average share price of $12.42. During the year ended December 31, 2015, 166,368 shares were repurchased under the share repurchase authorization for $2.1 million at an average price of $12.62. No shares were repurchased under the share repurchase authorization in the fourth quarter of 2016 or during the year ended December 31, 2014. The amount of authorization remaining is $75.0 million as of December 31, 2016.
26
Stock Performance Graph
The following chart compares the total return on a cumulative basis of $100 invested in our Class A common shares on December 31, 2011 to the Standard & Poor's 500 Stock Index and the Standard & Poor's Property and Casualty Insurance Index. The following chart includes reinvestment of dividends.
Comparison of Five Year Cumulative Total Return
27
ITEM 6. | SELECTED FINANCIAL DATA |
The following tables set forth our selected consolidated financial information for the dates indicated. We have derived the selected consolidated financial information presented below as of and for the years ended December 31, 2016, 2015, 2014, 2013 and 2012 from our consolidated financial statements. See Note 2—"Acquisitions and Dispositions" and Note 18—"Discontinued Operations" of the accompanying consolidated financial statements.
Year ended December 31, | ||||||||||||||||||||
2016 | 2015 | 2014 | 2013 | 2012 | ||||||||||||||||
Summary Income Statement Data: | (in millions, except per share amounts) | |||||||||||||||||||
Net written premiums | $ | 1,100.7 | $ | 1,136.6 | $ | 1,216.9 | $ | 1,088.6 | $ | 1,179.2 | ||||||||||
Revenues | ||||||||||||||||||||
Earned premiums | $ | 1,100.6 | $ | 1,176.2 | $ | 1,177.1 | $ | 1,120.4 | $ | 1,132.0 | ||||||||||
Net investment income | 50.6 | 45.9 | 43.4 | 43.0 | 55.4 | |||||||||||||||
Net realized and change in unrealized investment gains | 37.7 | (35.1 | ) | 40.4 | 49.4 | 55.7 | ||||||||||||||
Net other revenues (expenses) | 5.5 | (0.6 | ) | 5.8 | 31.2 | (0.5 | ) | |||||||||||||
Total revenues | 1,194.4 | 1,186.4 | 1,266.7 | 1,244.0 | 1,242.6 | |||||||||||||||
Expenses | ||||||||||||||||||||
Loss and loss adjustment expenses | 656.0 | 700.7 | 815.1 | 622.1 | 650.0 | |||||||||||||||
Policy acquisition and other underwriting expenses | 415.0 | 432.0 | 382.5 | 413.7 | 454.6 | |||||||||||||||
General and administrative expenses | 14.2 | 15.4 | 13.8 | 12.0 | 13.4 | |||||||||||||||
Interest expense | 13.1 | 13.0 | 13.0 | 13.0 | 16.9 | |||||||||||||||
Total expenses | 1,098.3 | 1,161.1 | 1,224.4 | 1,060.8 | 1,134.9 | |||||||||||||||
Pre-tax income from continuing operations | 96.1 | 25.3 | 42.3 | 183.2 | 107.7 | |||||||||||||||
Income tax (expense) benefit | 12.5 | 12.9 | 12.3 | (36.5 | ) | (10.3 | ) | |||||||||||||
Net income from continuing operations | 108.6 | 38.2 | 54.6 | 146.7 | 97.4 | |||||||||||||||
Loss from discontinued operations, net of tax | — | (0.5 | ) | (1.8 | ) | (46.6 | ) | (24.3 | ) | |||||||||||
(Loss) gain from sale of discontinued operations, net of tax | — | 0.3 | (18.8 | ) | 46.6 | (91.0 | ) | |||||||||||||
Net income (loss) including noncontrolling interests | 108.6 | 38.0 | 34.0 | 146.7 | (17.9 | ) | ||||||||||||||
Less: Net income attributable to noncontrolling interests | (1.2 | ) | (1.2 | ) | (1.1 | ) | (1.0 | ) | (1.4 | ) | ||||||||||
Net income (loss) attributable to OneBeacon's common shareholders | 107.4 | 36.8 | 32.9 | 145.7 | (19.3 | ) | ||||||||||||||
Net change in benefit plan assets and obligations, net of tax | 1.0 | — | (12.0 | ) | 20.6 | (2.9 | ) | |||||||||||||
Comprehensive income (loss) attributable to OneBeacon's common shareholders | $ | 108.4 | $ | 36.8 | $ | 20.9 | $ | 166.3 | $ | (22.2 | ) | |||||||||
Basic and diluted earnings (loss) per share attributable to OneBeacon's common shareholders: | ||||||||||||||||||||
Net income from continuing operations per share | $ | 1.13 | $ | 0.38 | $ | 0.55 | $ | 1.52 | $ | 1.00 | ||||||||||
Loss from discontinued operations, net of tax, per share | — | — | (0.02 | ) | (0.49 | ) | (0.25 | ) | ||||||||||||
(Loss) gain from sale of discontinued operations, net of tax, per share | — | — | (0.19 | ) | 0.49 | (0.96 | ) | |||||||||||||
Net income (loss) attributable to OneBeacon's common shareholders per share | $ | 1.13 | $ | 0.38 | $ | 0.34 | $ | 1.52 | $ | (0.21 | ) | |||||||||
Weighted average number of common shares outstanding(1) | 94.0 | 94.8 | 94.7 | 94.5 | 94.5 | |||||||||||||||
Cash dividends declared per common share | $ | 0.84 | $ | 0.84 | $ | 0.84 | $ | 0.84 | $ | 0.84 | ||||||||||
_______________________________________________________________________________
(1) | Weighted average common shares outstanding includes the impact of unvested restricted shares as well as the impact of repurchases of Class A common shares made under the Company's share repurchase authorization. |
28
Year ended December 31, | ||||||||||||||||||||
2016 | 2015 | 2014 | 2013 | 2012 | ||||||||||||||||
(in millions) | ||||||||||||||||||||
Underwriting Ratios:(1)(2) | ||||||||||||||||||||
Consolidated Insurance Operations | ||||||||||||||||||||
Loss and LAE ratio | 59.6 | % | 59.6 | % | 69.2 | % | 55.5 | % | 57.4 | % | ||||||||||
Expense ratio | 37.7 | 36.7 | 32.5 | 36.9 | 40.1 | |||||||||||||||
Combined ratio | 97.3 | % | 96.3 | % | 101.7 | % | 92.4 | % | 97.5 | % | ||||||||||
Specialty Products | ||||||||||||||||||||
Loss and LAE ratio | 71.6 | % | 55.5 | % | 78.7 | % | 56.4 | % | 57.2 | % | ||||||||||
Expense ratio | 35.9 | 35.3 | 30.0 | 36.8 | 40.7 | |||||||||||||||
Combined ratio | 107.5 | % | 90.8 | % | 108.7 | % | 93.2 | % | 97.9 | % | ||||||||||
Specialty Industries | ||||||||||||||||||||
Loss and LAE ratio | 48.7 | % | 63.3 | % | 60.1 | % | 54.7 | % | 57.7 | % | ||||||||||
Expense ratio | 39.4 | 38.0 | 34.9 | 37.0 | 39.4 | |||||||||||||||
Combined ratio | 88.1 | % | 101.3 | % | 95.0 | % | 91.7 | % | 97.1 | % | ||||||||||
Summary Balance Sheet Data: | ||||||||||||||||||||
Total cash and investments | $ | 2,690.0 | $ | 2,686.6 | $ | 2,612.8 | $ | 2,532.4 | $ | 2,335.1 | ||||||||||
Total assets | 3,589.9 | 3,602.6 | 3,576.0 | 5,208.5 | 5,399.2 | |||||||||||||||
Loss and LAE reserves | 1,365.6 | 1,389.8 | 1,342.2 | 1,054.3 | 1,000.0 | |||||||||||||||
Unearned premiums | 575.1 | 560.3 | 588.3 | 544.9 | 573.8 | |||||||||||||||
Debt | 273.2 | 272.9 | 272.5 | 272.2 | 272.0 | |||||||||||||||
OneBeacon's common shareholders' equity | 1,021.3 | 1,000.9 | 1,045.8 | 1,103.7 | 1,014.2 | |||||||||||||||
OneBeacon's common shareholders' equity and noncontrolling interests | 1,025.2 | 1,004.5 | 1,049.3 | 1,106.8 | 1,017.0 | |||||||||||||||
_______________________________________________________________________________
(1) | Excludes the results of discontinued operations for all periods presented. |
(2) | Underwriting ratios are used to measure the components of underwriting profitability and include: The loss and LAE ratio, calculated by dividing loss and LAE by earned premiums; the expense ratio, calculated by dividing policy acquisition and other underwriting expenses by earned premiums; and the combined ratio, the sum of the loss and LAE ratio and the expense ratio. |
29
ITEM 7. | MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
The following discussion contains "forward-looking statements." Statements that are not historical in nature are forward-looking statements. OneBeacon cannot promise that its expectations as stated in such forward-looking statements will turn out to be correct. OneBeacon's actual results could be materially different from and worse than its expectations. See "Forward-Looking Statements" on page 63 for specific important factors that could cause actual results to differ materially from those contained in forward-looking statements.
Overview—Year ended December 31, 2016 versus year ended December 31, 2015
We ended 2016 with a book value per share of $10.82, reflecting an 11.1% increase, including quarterly dividends of $0.21 per share, on an internal rate of return basis, for the year ended December 31, 2016.
Net income attributable to OneBeacon's common shareholders was $107.4 million for 2016, compared to $36.8 million in 2015. Pre-tax underwriting income was $29.6 million for 2016, reflecting a combined ratio of 97.3%, compared to pre-tax underwriting income of $43.5 million for 2015, reflecting a combined ratio of 96.3%. The decrease in pre-tax underwriting results was driven by the unfavorable performance of our Healthcare business, discussed below, and to a lesser extent, from our Programs business. This unfavorable performance partially offset the strong underwriting results from many of our other businesses, including Accident, and also significant improvement in Entertainment and Ocean Marine, both of which were negatively impacted by elevated loss activity in 2015. Pre-tax net investment results were $88.3 million in 2016, representing a 3.6% total return on average invested assets, compared to $10.8 million in 2015, representing a 0.6% total return on average invested assets, with the significant increase being driven by higher returns in all asset classes. Our other investments portfolio return included a favorable impact from the surplus notes driven by changes in credit spreads, as well as lower adverse impacts from energy exposed private equity funds in 2016 than in 2015. In addition, a higher return in the fixed maturity investments portfolio was driven by interest rate movements in 2016 compared to 2015, while the higher return from our common equity securities portfolio was driven by improved market conditions.
Our net income for 2016 included a $16.3 million tax benefit resulting from the settlements of IRS examinations for tax years 2007 through 2012.
During the year ended December 31, 2016 we recorded $15.4 million of adverse prior accident year development driven by Healthcare but offset in part by other businesses. Healthcare recorded $40.7 million of adverse prior accident year development (Healthcare Development Impact), including $10.0 million in the first quarter, $20.0 million in the second quarter, $1.1 million in the third quarter, and $9.6 million in the fourth quarter. The full year development was driven by the extended care and complex risks sub-lines, and to a lesser extent, two large claims developments within the managed care errors and omissions sub-line related to unexpected outcomes from mediation and extended costs associated with claim defense. Extended care provides medical malpractice and general liability insurance for extended care facilities, including assisted living, memory care and continuing care facilities. Complex risks provides professional liability coverage to hospitals, physicians, and physician groups as well as physicians' extended reporting period coverage. The complex risks development was heavily influenced by large claim activity.
As a result of the elevated loss activity experienced in the extended care sub-line, in-depth claim file and actuarial reviews were performed in the middle of the year. The claim file review confirmed that the increased case incurred activity was driven by increased frequency, especially in the more recent prior accident years, as opposed to other potential considerations such as significant changes in claims-handling practices. The actuarial review included analysis related to the recent enhancements to the predictive model. Recent adverse financial results were primarily observed in high-risk categories of business and in difficult geographic venues identified by the predictive model data. As a result of these analyses, management increased its best estimate of prior accident year losses, and increased its loss provisions for the current accident year.
Despite the reserve actions taken through the first three quarters of 2016 case incurred loss activity continued to exceed expectations during the fourth quarter of 2016. The adverse development was driven by recent prior accident years spread across the complex risks, extended care, managed care errors and omissions, and medical excess sub-lines.
As a result of this loss activity, we have refocused our sales activity during 2016 to target more desirable risks. As a result primarily of these actions, as well as a large return premium on a single account, Healthcare premiums have decreased by $14.7 million in 2016. In addition, Programs net written premiums decreased by $32.3 million in 2016, as a result of exiting two larger Programs accounts which were experiencing higher than expected loss ratios.
30
Overview—Year ended December 31, 2015 versus year ended December 31, 2014
We ended 2015 with a book value per share of $10.53, reflecting a 3.8% increase, including quarterly dividends of $0.21 per share, on an internal rate of return basis for the year ended December 31, 2015.
Net income attributable to OneBeacon's common shareholders was $36.8 million for 2015, compared to $32.9 million in 2014. Pre-tax underwriting income was $43.5 million for 2015, reflecting a combined ratio of 96.3%, compared to a pre-tax underwriting loss of $20.5 million for 2014, reflecting a combined ratio of 101.7%. The increase in pre-tax underwriting results was driven by the significant impact of loss and LAE recorded in the fourth quarter of 2014 totaling $109.2 million, as noted below in "2014 Fourth Quarter Reserve Increase." The 2015 pre-tax underwriting results were driven by solid results in most of our underwriting operating segments, but were partially offset by unfavorable results in our Entertainment, Programs, Inland Marine and Ocean Marine businesses. Pre-tax net investment results were $10.8 million in 2015, representing a 0.6% total return on average invested assets, compared to $83.8 million in 2014, representing a 3.5% total return on average invested assets, with the decline from 2014 being driven by other investments generating significantly lower returns in energy exposed private equity funds in 2015 than in 2014 and negative valuation adjustments on surplus notes, lower equity returns, and decreased returns for the fixed maturity investment portfolio driven by interest rate movements. In addition, we had a tax benefit in 2015 of $12.9 million compared to a tax benefit of $12.3 million in 2014. The current year tax benefit was driven by the significant unfavorable change in unrealized investment gains in 2015.
2014 Fourth Quarter Reserve Increase
Through the first nine months of 2014, we recorded $14.3 million of unfavorable loss and LAE reserve development, driven by greater-than-expected large loss activity in several underwriting operating segments, primarily the Other Professional Lines and Management Liability underwriting operating segments. This large loss activity, which occurred mostly during the second and third quarters of 2014, also impacted the 2014 current accident year loss and LAE estimates. Additionally, we incurred higher-than-usual claim coverage determination costs, a component of LAE expenses, during the first nine months of 2014. Other underwriting operating segments also reported increased claim activity, including Entertainment, Government Risks, and Accident.
Since the increased level of loss and LAE activity continued into the early part of the fourth quarter of 2014, the high level of activity in the second and third quarters no longer seemed to be isolated occurrences. As such, during the fourth quarter of 2014, we enhanced our actuarial and claims review in several areas. We isolated the then-recent large loss activity in each of our underwriting operating segments and examined the emergence of large losses relative to the timing and amounts of expected large losses. We also conducted additional analyses in the lawyers' professional liability line within the Other Professional Lines underwriting operating segment. These new analyses included a claim level review and the application of additional actuarial methods and loss development assumptions. The results of these analyses indicated that the assumed tail risk included in the loss development patterns used to record IBNR reserves for this line were insufficient and needed to be increased for remaining long-tail exposures. Our claims and actuarial staff also conducted an in-depth review of coverage determination, litigation, and other claim-specific adjusting expenses as a result of an emerging trend of increased expenses in these areas over then-recent quarters, particularly coverage determination expenses. This review concluded that the ultimate costs of these loss adjustment expenses were larger than previously estimated, causing management to record an increase in estimated LAE, primarily in the Other Professional Lines, Management Liability and Financial Services underwriting operating units. Finally, we also recorded unfavorable prior year development in other underwriting units, including Entertainment and Government Risks. The unfavorable loss development in Entertainment and Government Risks resulted from heavier than expected claim activity during the fourth quarter of 2014, predominantly in the general liability and commercial auto liability lines.
31
As a result of these enhanced actuarial and claim reviews conducted during the fourth quarter of 2014 and in order to fully reflect these then-recent trends, we recorded a $109.2 million increase in loss and LAE reserves, which included a $75.5 million increase in prior accident year loss and LAE reserves and a $33.7 million increase in the current accident year loss and LAE reserves which were previously recorded at September 30, 2014. The components of the 2014 fourth quarter reserve increase and the net loss and LAE development for the full year are provided below:
2014 Fourth Quarter Reserve Increase | Full Year 2014 Net Prior Year Development | |||||||||||||||
Underwriting Operating Segment | Current Accident Year | Prior Accident Years | Total | |||||||||||||
($ in millions) | ||||||||||||||||
Other Professional Lines | $ | 11.1 | $ | 31.9 | $ | 43.0 | $ | 42.2 | ||||||||
Management Liability | 6.6 | 8.4 | 15.0 | 16.4 | ||||||||||||
Financial Services | 2.0 | 6.5 | 8.5 | 6.5 | ||||||||||||
Healthcare | 3.2 | (0.4 | ) | 2.8 | (6.0 | ) | ||||||||||
Specialty Property | (1.1 | ) | 5.7 | 4.6 | 1.1 | |||||||||||
Crop | 3.8 | — | 3.8 | — | ||||||||||||
Other | 2.8 | (0.4 | ) | 2.4 | 1.6 | |||||||||||
Specialty Products | 28.4 | 51.7 | 80.1 | 61.8 | ||||||||||||
Entertainment | 1.5 | 11.6 | 13.1 | 13.5 | ||||||||||||
Government Risks | 1.2 | 7.1 | 8.3 | 8.5 | ||||||||||||
Accident | — | 3.5 | 3.5 | 6.0 | ||||||||||||
Other | 2.6 | 1.6 | 4.2 | — | ||||||||||||
Specialty Industries | 5.3 | 23.8 | 29.1 | 28.0 | ||||||||||||
Total | $ | 33.7 | $ | 75.5 | $ | 109.2 | $ | 89.8 | ||||||||
As noted above, we increased our provision for 2014 current accident year losses and LAE by $33.7 million in the fourth quarter of 2014. In recording the change in estimate of our loss and LAE reserve provision for the 2014 accident year, we considered the results of the enhanced actuarial and claim review and the fact that reported large claims were approaching estimated ultimate large losses sooner than originally expected. Of the $33.7 million increase, $29.9 million reflects an increase in management's best estimate of current year loss and LAE as of December 31, 2014 from those amounts recorded in the first nine months of 2014. This increase primarily affected the Other Professional Lines and Management Liability underwriting operating segments, which represented $17.7 million of the total provision. The remaining increase was primarily related to a $3.8 million increase in estimated losses in the Crop underwriting operating segment from higher-than-expected reports of crop losses that emerged in the fourth quarter of 2014. We exited the Crop business in 2015.
Book Value Per Share
The following table presents our book value per share:
December 31, | ||||||||||||
2016 | 2015 | 2014 | ||||||||||
(in millions except per share amounts) | ||||||||||||
Numerator | ||||||||||||
OneBeacon's common shareholders' equity | $ | 1,021.3 | $ | 1,000.9 | $ | 1,045.8 | ||||||
Denominator | ||||||||||||
Common shares outstanding(1) | 94.3 | 95.1 | 95.3 | |||||||||
Book value per share | $ | 10.82 | $ | 10.53 | $ | 10.97 | ||||||
Dividends paid per share | $ | 0.84 | $ | 0.84 | $ | 0.84 | ||||||
_______________________________________________________________________________
(1) | Common shares outstanding includes unvested restricted shares. |
32
Results of Operations
Review of Consolidated Results
A summary of our consolidated financial results is as follows:
Year ended December 31, | ||||||||||||
2016 | 2015 | 2014 | ||||||||||
($ in millions) | ||||||||||||
Gross written premiums | $ | 1,221.3 | $ | 1,315.9 | $ | 1,323.4 | ||||||
Net written premiums | $ | 1,100.7 | $ | 1,136.6 | $ | 1,216.9 | ||||||
Revenues | ||||||||||||
Earned premiums | $ | 1,100.6 | $ | 1,176.2 | $ | 1,177.1 | ||||||
Net investment income | 50.6 | 45.9 | 43.4 | |||||||||
Net realized and change in unrealized investment gains | 37.7 | (35.1 | ) | 40.4 | ||||||||
Net other revenues (expenses) | 5.5 | (0.6 | ) | 5.8 | ||||||||
Total revenues | 1,194.4 | 1,186.4 | 1,266.7 | |||||||||
Expenses | ||||||||||||
Loss and LAE | 656.0 | 700.7 | 815.1 | |||||||||
Policy acquisition expenses | 206.0 | 213.8 | 203.3 | |||||||||
Other underwriting expenses | 209.0 | 218.2 | 179.2 | |||||||||
General and administrative expenses | 14.2 | 15.4 | 13.8 | |||||||||
Interest expense | 13.1 | 13.0 | 13.0 | |||||||||
Total expenses | 1,098.3 | 1,161.1 | 1,224.4 | |||||||||
Pre-tax income from continuing operations | 96.1 | 25.3 | 42.3 | |||||||||
Income tax benefit | 12.5 | 12.9 | 12.3 | |||||||||
Net income from continuing operations | 108.6 | 38.2 | 54.6 | |||||||||
Net loss from discontinued operations, net of tax | — | (0.2 | ) | (20.6 | ) | |||||||
Net income including noncontrolling interests | 108.6 | 38.0 | 34.0 | |||||||||
Less: Net income attributable to noncontrolling interests | (1.2 | ) | (1.2 | ) | (1.1 | ) | ||||||
Net income attributable to OneBeacon's common shareholders | 107.4 | 36.8 | 32.9 | |||||||||
Net change in benefit plan assets and obligations, net of tax | 1.0 | — | (12.0 | ) | ||||||||
Comprehensive income attributable to OneBeacon's common shareholders | $ | 108.4 | $ | 36.8 | $ | 20.9 | ||||||
33
A summary of our consolidated underwriting income and pre-tax income from continuing operations is as follows:
Year ended December 31, | ||||||||||||
2016 | 2015 | 2014 | ||||||||||
($ in millions) | ||||||||||||
Earned premiums | $ | 1,100.6 | $ | 1,176.2 | $ | 1,177.1 | ||||||
Loss and LAE | (656.0 | ) | (700.7 | ) | (815.1 | ) | ||||||
Policy acquisition expenses | (206.0 | ) | (213.8 | ) | (203.3 | ) | ||||||
Other underwriting expenses | (209.0 | ) | (218.2 | ) | (179.2 | ) | ||||||
Total underwriting income (loss) | 29.6 | 43.5 | (20.5 | ) | ||||||||
Net investment income | 50.6 | 45.9 | 43.4 | |||||||||
Net realized and change in unrealized investment gains | 37.7 | (35.1 | ) | 40.4 | ||||||||
Net other revenues (expenses) | 5.5 | (0.6 | ) | 5.8 | ||||||||
General and administrative expenses | (14.2 | ) | (15.4 | ) | (13.8 | ) | ||||||
Interest expense | (13.1 | ) | (13.0 | ) | (13.0 | ) | ||||||
Pre-tax income from continuing operations | $ | 96.1 | $ | 25.3 | $ | 42.3 | ||||||
The following table provides our consolidated underwriting ratios for our continuing operations:
Year ended December 31, | |||||||||
2016 | 2015 | 2014 | |||||||
Underwriting ratios: | |||||||||
Loss and LAE | 59.6 | % | 59.6 | % | 69.2 | % | |||
Expense | 37.7 | 36.7 | 32.5 | ||||||
Total combined ratio | 97.3 | % | 96.3 | % | 101.7 | % | |||
The impact of certain items to our underwriting ratios was as follows:
Unfavorable (favorable) impact | |||||||
2016 | 2015 | 2014 | |||||
Point impact on loss and LAE ratio and combined ratio: | |||||||
Catastrophe losses, net of reinsurance | 1.1 pts | 1.4 pts | 1.2 pts | ||||
Prior year loss reserve development | 1.4 pts | (0.2) pts | 7.6 pts | ||||
Consolidated Results—Year ended December 31, 2016 versus year ended December 31, 2015
Our 2016 comprehensive income attributable to OneBeacon's common shareholders was $108.4 million compared to $36.8 million for 2015, with the change driven primarily by a $77.5 million increase in pre-tax investment results due to higher returns in all asset classes as discussed below in "Investments," and to a lesser extent, a $16.3 million tax benefit resulting from the settlements of IRS examinations for tax years 2007 through 2012. Partially offsetting these increases was a $13.9 million decrease in pre-tax underwriting results driven by the factors discussed below in "Underwriting Results."
Our total revenues of $1,194.4 million for 2016 increased $8.0 million from $1,186.4 million for 2015, due to the $77.5 million increase in pre-tax investment results compared to 2015, which was mostly offset by a decrease in earned premiums of $75.6 million, or 6.4%, driven by decreases at Healthcare, and to a lesser extent, Entertainment and Other Professional Lines. Additionally, there was a $6.1 million favorable change in net other revenues (expenses), driven by the factors discussed below in "Net Other Revenues (Expenses)." Total expenses decreased to $1,098.3 million for 2016 from $1,161.1 million for 2015, resulting primarily from a decrease in loss and LAE of $44.7 million to $656.0 million in 2016, commensurate with the decline in earned premiums, which also resulted in a $9.2 million decrease in other underwriting expenses as well as a $7.8 million decrease of policy acquisition expenses.
Written Premiums
Consolidated net written premiums decreased $35.9 million, or 3.2%, to $1,100.7 million in 2016, resulting from decreases at Programs ($32.3 million), as we have exited two underperforming accounts, Entertainment ($26.5 million) due to a refinement of our underwriting appetite, and Healthcare ($14.7 million), reflecting the impact of refocusing our sales activity
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on more desirable risks, as well as a large return premium on a single account, and increased competition. These decreases were partially offset by increases at several other businesses, most notably our newer Financial Institutions business ($18.0 million).
Underwriting Results
Our pre-tax underwriting income was $29.6 million for 2016, reflecting a combined ratio of 97.3%, compared to pre-tax underwriting income of $43.5 million for 2015, reflecting a combined ratio of 96.3%.
Our combined ratio for 2016 of 97.3% reflected a 59.6% loss and LAE ratio and a 37.7% expense ratio, which compared to a combined ratio for 2015 of 96.3%, also reflecting a 59.6% loss and LAE ratio but a lower expense ratio of 36.7%.
The 2016 loss and LAE ratio of 59.6% was consistent with 2015 resulting from a 1.3 point decrease in current accident year non-catastrophe losses, a 1.6 point unfavorable change in prior year loss reserve development, and a 0.3 point decrease in catastrophe losses. Current accident year non-catastrophe losses for 2016 were $628.2 million, or 57.1 points, compared to $685.9 million, or 58.4 points for 2015, driven by the improved relative performance by many of our businesses in 2016, most notably Accident, Inland Marine and Ocean Marine which were partially offset by an increased current accident year provision within Healthcare, which was driven by heavy activity in the extended care subline, as well as the medical excess subline.
Net unfavorable prior year loss and LAE reserve development was $15.4 million, or 1.4 points for 2016 driven by Healthcare ($40.7 million), resulting from the Healthcare Development Impact, and to a lesser extent, unfavorable development in the architects and engineers sub-line within Other Professional Lines, and Programs, primarily as a result of two larger auto-related programs, in addition to smaller amounts of unfavorable development in several other businesses. This unfavorable development was partially offset by favorable development primarily in Accident, Entertainment, Technology and Financial Services. This compared with $1.8 million or 0.2 points for 2015, of net favorable loss reserve development primarily attributable to favorable development from several businesses, most notably Technology, and to a lesser extent, from the exited Collector Cars and Boats business, Specialty Property and Financial Services, along with certain other businesses. This favorable development was mostly offset by unfavorable development due to several large losses and an increase in small to mid-size claims in Entertainment, and to a lesser extent, unusually heavy loss activity of both large and small claims in Ocean Marine, as well as moderate unfavorable development from certain other businesses.
Catastrophe losses were $12.4 million, or 1.1 points, for 2016, primarily resulting from wind and thunderstorms in the southern United States impacting Inland Marine and Ocean Marine, compared to $16.6 million, or 1.4 points, for 2015, primarily resulting from wind and thunderstorms in the southern United States, particularly Texas, and winter storms in the northeastern United States.
The expense ratio increased 1.0 point to 37.7% for 2016, driven by the negative impact of lower earned premiums and increased commissions due to business mix in 2016 more than offsetting reduced salary and incentive compensation expense driven by headcount reductions and lower relative incentive compensation performance factors. Additionally, the 2015 ratio was negatively impacted by the exit of the Crop business, separation costs associated with senior management restructuring and severance costs.
Investments
Net investment income increased to $50.6 million in 2016, compared to $45.9 million in 2015 driven by a $2.4 million interest payment on the surplus notes, along with a higher asset allocation to fixed maturity investments. Net realized and change in unrealized investment gains increased significantly to positive $37.7 million in 2016, compared to negative $35.1 million in 2015, due to favorable 2016 results in the other investments portfolio driven by a valuation impact from the surplus notes of positive $20.4 million resulting primarily from changes in credit spreads compared to negative $13.6 million in 2015, and to a lesser extent, lower negative returns in energy sector exposed private equity funds in 2016 compared to 2015. The 2016 return was also significantly impacted by increased returns in the fixed maturity investments portfolio driven by interest rate movements in 2016 compared to 2015 and increased returns in the common equity securities portfolio due to improved market conditions.
Net Other Revenues (Expenses)
The $6.1 million favorable change in other revenues (expenses) compared to 2015, was driven by the prior year impact of a $3.7 million negative adjustment to the pre-tax gain on sale of Essentia and $3.0 million of income in 2016 from the excess invested assets remaining after the termination of the OneBeacon qualified pension plan. The prior year also included a $1.6 million pre-tax write-off of certain capitalized software and a $1.2 million loss on the sale of real estate, which were offset by a $3.0 million (pre-tax) payment received in connection with the early termination of our exclusive agreement with Climate Crop Insurance Agency (Crop Transaction Fee).
Income Taxes
Our income tax benefit related to pre-tax income from continuing operations for 2016 and 2015 represented net effective tax rates of (13.0)% and (51.0)%, respectively. The effective tax rate for 2016 and 2015 were lower than the U.S. statutory rate
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of 35% due to income generated in jurisdictions other than the United States, principally representing interest income and underwriting income taxed in a jurisdiction with a lower effective tax rate and, for the 2016 period, a $16.3 million favorable settlement of IRS examinations for the 2007 through 2012 tax years. The effective tax rate on non-U.S. income for 2016 and 2015 was 0.6% and 1.3%, respectively.
Net Change in Benefit Plan Assets and Liabilities
There was a $1.0 million net favorable after-tax change in benefit plan obligations impact to comprehensive income in 2016 compared to no net after-tax impact in 2015, which substantially relates to the amortization of the net periodic benefit cost for our defined benefit pension plan (Non-qualified Plan) as the previously sponsored OneBeacon qualified pension plan (Qualified Plan) was terminated during 2016. As of December 31, 2015, the projected benefit obligations of the terminated Qualified Plan were estimated using termination assumptions and the termination was completed in 2016 by purchasing a group annuity contract and making lump sum distributions to Qualified Plan participants electing such payments. We no longer have a benefit obligation related to the Qualified Plan after its settlement. See Note 8—"Retirement Plans."
Reinsurance Protection
We purchase reinsurance in order to minimize loss from large risks or catastrophic events. We also purchase individual property reinsurance coverage for certain risks to reduce large loss volatility through property-per-risk excess of loss reinsurance programs and individual risk facultative reinsurance. We also maintain excess of loss casualty reinsurance programs that provide protection for individual risk or catastrophe losses involving workers compensation, general liability, automobile liability, professional liability or umbrella liability. The availability and cost of reinsurance protection is subject to market conditions, which are outside of our control. Limiting our risk of loss through reinsurance arrangements serves to mitigate the impact of large losses; however, the cost of this protection in an individual period may exceed the benefit.
For 2016 and 2015, our net combined ratio was higher than our gross combined ratio by 3.6 points and 1.2 points, respectively, as a result of the cost of our reinsurance programs more than offsetting the benefits from ceded losses.
Consolidated Results—Year ended December 31, 2015 versus year ended December 31, 2014
Our 2015 comprehensive income attributable to OneBeacon's common shareholders of $36.8 million increased $15.9 million compared to 2014, with the change driven primarily by an increase of $64.0 million in pre-tax underwriting results and favorable changes of $20.4 million related to discontinued operations (see "Results of Operations—Discontinued Operations Results") and $12.0 million in other comprehensive income related to our pension plans, which were significantly offset by a $73.0 million decrease in pre-tax investment results.
Our total revenues of $1,186.4 million for 2015 decreased $80.3 million from $1,266.7 million for 2014, substantially due to a $73.0 million decrease of pre-tax investment results compared to 2014 and, to a lesser extent, an unfavorable change in net other revenues (expenses) of $6.4 million, driven by the factors discussed below in "Net Other Revenues (Expenses)." Total expenses decreased to $1,161.1 million for 2015 from $1,224.4 million for 2014, resulting primarily from a decrease in loss and LAE of $114.4 million to $700.7 million for 2015, as 2014 was significantly impacted by the 2014 fourth quarter reserve increase. The decrease in loss and LAE was partially offset by a $39.0 million increase in other underwriting expenses as well as a $10.5 million increase of policy acquisition expenses driven by the factors discussed below in "Underwriting Results."
Written Premiums
Consolidated net written premiums decreased $80.3 million, or 6.6%, to $1,136.6 million in 2015, resulting from our exit of the Crop business ($44.4 million), a decrease at Other Professional Lines ($33.6 million) primarily from the exit of our lawyers liability business, a decrease at our Healthcare business ($33.3 million) and the termination of an affiliated reinsurance treaty ($20.1 million). These decreases were partially offset by increases at our newer Programs and Surety businesses of $66.8 million, in total. Excluding the $93.1 million impact of our exit from the Crop and lawyers liability businesses, as well as the affiliated reinsurance treaty termination, consolidated net written premiums increased $12.8 million, or 1.1%.
Underwriting Results
Our pre-tax underwriting income was $43.5 million for 2015, reflecting a combined ratio of 96.3%, compared to a pre-tax underwriting loss of $20.5 million for 2014, reflecting a combined ratio of 101.7%.
Our combined ratio for 2015 of 96.3% reflected a 59.6% loss and LAE ratio and a 36.7% expense ratio, which compared to a combined ratio for 2014 of 101.7%, consisting of a 69.2% loss and LAE ratio and a 32.5% expense ratio.
The 9.6 point decrease in the loss and LAE ratio was substantially a result of the impact of the 2014 fourth quarter reserve increase, which had a 9.3 point impact on the 2014 combined ratio. The 9.6 point decrease in the loss and LAE ratio was comprised of a 2.0 point decrease in current accident year non-catastrophe losses, a 7.8 point favorable change in prior year loss reserve development, and partially offset by a 0.2 point increase in catastrophe losses. Current accident year non-catastrophe
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losses for 2015 were $685.9 million, or 58.4 points, compared to $711.5 million, or 60.4 points for 2014, as an increase in the provision for 2015 was more than offset by the 2014 impact of the 2014 fourth quarter reserve increase.
Net favorable prior year loss and LAE reserve development was $1.8 million, or 0.2 points for 2015 primarily attributable to favorable development from several businesses, most notably Technology, and to a lesser extent, from the exited Collector Cars and Boats business, Specialty Property and Financial Services, along with certain other businesses. This favorable development was mostly offset by unfavorable development due to several large losses and an increase in small to mid-size claims in Entertainment, and to a lesser extent, unusually heavy loss activity of both large and small claims in Ocean Marine, as well as moderate unfavorable development from certain other businesses. This compared with $89.8 million or 7.6 points, of net unfavorable loss reserve development of which $75.5 million, or 6.4 points, related to the 2014 fourth quarter reserve increase. Of the net unfavorable loss and LAE reserve development resulting from the 2014 fourth quarter reserve increase, $31.9 million related to Other Professional Lines driven primarily by lawyers professional liability and $11.6 million related to Entertainment resulting from several large losses. The remaining net unfavorable prior year loss and LAE reserve development for 2014 primarily related to unfavorable development recognized prior to the 2014 fourth quarter also in our Other Professional Lines (including lawyers professional liability) and Management Liability businesses, offset in part by favorable development in our Healthcare business.
Catastrophe losses were $16.6 million, or 1.4 points, for 2015, primarily resulting from wind and thunderstorms in the southern United States, particularly Texas, and winter storms in the northeastern United States, compared to $13.8 million, or 1.2 points, for 2014, primarily resulting from wind and thunderstorms in the southern, central and eastern United States, as well as ice and snow storms in the midwestern and northeastern United States.
The expense ratio increased 4.2 points to 36.7% for 2015, which was primarily driven by 2014 benefiting from a 2.4 point reduction in the incentive compensation accrual resulting from the 2014 fourth quarter reserve increase and from a transition services agreement with the buyer of our legacy personal lines business, which was terminated on June 30, 2014. Additionally, 2015 was negatively impacted by the exit of the Crop business, separation costs associated with senior management restructuring, and severance costs.
Investments
Net investment income increased to $45.9 million in 2015, compared to $43.4 million in 2014. Net realized and change in unrealized investment gains decreased significantly to negative $35.1 million in 2015, compared to positive $40.4 million in 2014, due to unfavorable results in the other investments portfolio driven by lower returns in energy exposed sector private equity funds and a valuation impact from the surplus notes of negative $13.6 million recorded in 2015 resulting from increased credit spreads. The 2015 return was also significantly impacted by decreased returns in the common equity securities portfolio due to lower equity market performance as well as decreased returns in the fixed maturity portfolio driven by interest rate movements.
Net Other Revenues (Expenses)
The $6.4 million unfavorable change in other revenues (expenses) compared to 2014, was driven by a $3.7 million negative adjustment to the pre-tax gain on sale of Essentia. In addition, 2015 net other revenues (expenses) included a $1.6 million pre-tax write-off of certain capitalized software associated with senior management restructuring, as well as an additional loss on the sale of real estate of $1.2 million in 2015. These other expenses were partially offset by the $3.0 million Crop Transaction Fee in 2015.
Income Taxes
Our income tax benefit related to pre-tax income from continuing operations for 2015 and 2014 represented net effective tax rates of (51.0)% and (29.1)%, respectively. The effective tax rates for 2015 and 2014, were lower than the U.S. statutory rate of 35% due to income generated in jurisdictions other than the United States, principally representing interest income and underwriting income taxed in a jurisdiction with a lower effective tax rate and, for the 2014 period, a $5.0 million favorable settlement of the 2005-2006 IRS exam. The effective tax rate on non-U.S. income for both 2015 and 2014 was 1.3%.
Net Change in Benefit Plan Assets and Liabilities
There was no net after-tax change in benefit plan assets and obligations impact to comprehensive income in 2015. As of December 31, 2015, the projected benefit obligations of the terminated Qualified Plan was estimated using termination assumptions as the settlement was imminent and the likelihood that the Qualified Plan would return from termination was remote. This compared to a decrease in comprehensive income in 2014 of $12.0 million, primarily reflecting the impact of a decrease in the discount rate, as well a change in the mortality assumptions used to estimate our pension plan projected benefit obligation.
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Reinsurance Protection
For 2015 and 2014, our net combined ratio was higher than our gross combined ratio by 1.2 points and 1.5 points, respectively, as a result of the cost of our reinsurance programs more than offsetting the benefits from ceded losses.
Summary of Operations By Segment
Our reportable segments are Specialty Products, Specialty Industries, and Investing, Financing and Corporate.
The Specialty Products segment is comprised of ten active underwriting operating segments, as well as the Crop and Collector Cars and Boats underwriting operating segments that were exited in 2015 and 2013, respectively, representing an aggregation based on those that offer distinct products and tailored coverages and services to a broad customer base across the United States. See "Item 1. Business—Insurance Business—Specialty Products" for further discussion of the Specialty Products segment, including descriptions of its underwriting operating segments.
The Specialty Industries segment is comprised of six active underwriting operating segments representing an aggregation based on those that focus on solving the unique needs of a particular customer or industry group. See "Item 1. Business—Insurance Business—Specialty Industries" for further discussion of the Specialty Industries segment, including descriptions of its underwriting operating segments.
The Investing, Financing and Corporate segment includes the investing and financing activities for OneBeacon on a consolidated basis, and certain other activities conducted through the Company and our intermediate subsidiaries.
Specialty Products
Financial results for our Specialty Products reportable segment were as follows:
Year ended December 31, | ||||||||||||
2016 | 2015 | 2014 | ||||||||||
($ in millions) | ||||||||||||
Gross written premiums | $ | 621.4 | $ | 669.4 | $ | 672.8 | ||||||
Net written premiums | $ | 540.9 | $ | 533.0 | $ | 606.9 | ||||||
Earned premiums | $ | 524.4 | $ | 560.3 | $ | 582.1 | ||||||
Loss and LAE | (375.4 | ) | (310.7 | ) | (457.9 | ) | ||||||
Policy acquisition expenses | (99.5 | ) | (100.1 | ) | (96.2 | ) | ||||||
Other underwriting expenses | (88.6 | ) | (97.9 | ) | (78.4 | ) | ||||||
Total underwriting income (loss) | (39.1 | ) | 51.6 | (50.4 | ) | |||||||
Net other revenues (expenses) | (0.1 | ) | (0.2 | ) | 0.9 | |||||||
General and administrative expenses | — | — | 0.2 | |||||||||
Pre-tax income (loss) from continuing operations | $ | (39.2 | ) | $ | 51.4 | $ | (49.3 | ) | ||||
The following table provides underwriting ratios for Specialty Products:
Year ended December 31, | |||||||||
2016 | 2015 | 2014 | |||||||
Underwriting ratios: | |||||||||
Loss and LAE | 71.6 | % | 55.5 | % | 78.7 | % | |||
Expense | 35.9 | 35.3 | 30.0 | ||||||
Total combined ratio | 107.5 | % | 90.8 | % | 108.7 | % | |||
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The impact of certain items to our underwriting ratios was as follows:
Unfavorable (favorable) impact | |||||||
Year ended December 31, | |||||||
2016 | 2015 | 2014 | |||||
Point impact on loss and LAE ratio and combined ratio: | |||||||
Catastrophe losses, net of reinsurance | 0.5 pts | 0.3 pts | 1.0 pts | ||||
Prior year loss reserve development | 8.9 pts | (4.2) pts | 10.6 pts | ||||
Specialty Products—Year ended December 31, 2016 versus year ended December 31, 2015
Net written premiums for Specialty Products increased $7.9 million, or 1.5%, to $540.9 million for 2016 from $533.0 million for 2015, reflecting strong growth at our newer Financial Institutions business ($18.0 million), and across most of our other businesses ($27.4 million), in addition to the adverse impact of the Crop exit on the prior period ($9.5 million). These increases were partially offset by decreases at Programs ($32.3 million), as we have exited two large accounts as a result of poor underwriting results, and Healthcare ($14.7 million), reflecting the impact of refocusing our sales activity on more desirable risks, as well as a large return premium on a single account, and increased competition.
The Specialty Products combined ratio for 2016 increased to 107.5% from 90.8% for 2015, as the loss and LAE ratio increased by 16.1 points to 71.6% and the expense ratio increased by 0.6 points to 35.9%.
The 16.1 point increase in the loss and LAE ratio was comprised of a 2.8 point increase in current accident year non-catastrophe losses, a 13.1 point unfavorable change in net prior year loss reserve development, and a 0.2 point increase in catastrophe losses.
The current accident year non-catastrophe loss ratio for 2016 was 62.2% compared to 59.4% for 2015, driven primarily by Healthcare related to the extended care, and to a lesser extent, medical excess sub-lines, as well as higher accident year provisions in Programs due to continued elevated losses across several programs, and Other Professional Lines, primarily due to higher than expected losses in the architects and engineers sub-line, and were modestly offset by the improved performance of several other business.
The 2016 results included $46.7 million, or 8.9 points, of net unfavorable prior year loss reserve development driven by the Healthcare Development Impact ($40.7 million), and to a lesser extent, in the architects and engineers sub-line ($14.8 million) within Other Professional Lines and Programs ($13.3 million) relating to continued adverse results in auto-related programs, which was partially offset by favorable development primarily in Financial Services ($8.2 million), the media sub-line ($4.8 million) within Other Professional Lines and Specialty Property ($4.8 million). The 2015 results included $23.6 million, or 4.2 points, of net favorable prior year loss reserve development, primarily attributable to favorable development from the exited Collector Cars and Boats business, Specialty Property, Financial Services, Surety, Environmental, and Crop businesses. This favorable development was partially offset by unfavorable development in the Programs business.
The 2016 results also reflected catastrophe losses of 0.5 points primarily resulting from wind and thunderstorms in Texas impacting Financial Services compared with fairly benign catastrophe losses of 0.3 points in 2015.
The 0.6 point increase in the expense ratio for 2016, compared to 2015, was primarily driven by the negative impact of lower earned premium volumes and increased commissions due to business mix in 2016 more than offsetting reduced salary and incentive compensation expense driven by headcount reductions in 2016 and lower relative incentive compensation performance factors. Additionally, the 2015 ratio was adversely impacted by the impact from the exit of the Crop business, separation costs associated with senior management restructuring, and severance costs.
Specialty Products—Year ended December 31, 2015 versus year ended December 31, 2014
Net written premiums for Specialty Products decreased $73.9 million, or 12.2%, to $533.0 million for 2015 from $606.9 million for 2014, primarily due to the negative $44.4 million impact of the Crop business, a $33.6 million decrease at our Other Professional Lines business, reflecting our exit from the lawyers liability business that was sold in December of 2014, a $33.3 million decrease at our Healthcare business largely due to increased competition and change in underwriting appetite and a $20.1 million negative impact due to the termination of an affiliated reinsurance treaty. These decreases were partially offset by increases of $48.3 million and $18.5 million in our newer Programs and Surety businesses, respectively.
The Specialty Products combined ratio for 2015 decreased to 90.8% from 108.7% for 2014, as the loss and LAE ratio decreased by 23.2 points to 55.5% and the expense ratio increased by 5.3 points to 35.3%.
The 23.2 point decrease in the loss and LAE ratio, was primarily due to the impact of the 2014 fourth quarter reserve increase which had a 13.8 point unfavorable impact on the 2014 combined ratio as well as the solid results at most of our
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underwriting operating segments in 2015. The 23.2 point decrease in the loss and LAE ratio was comprised of a 7.7 point decrease in current accident year non-catastrophe losses, a 14.8 point favorable change in net prior year loss reserve development, and a 0.7 point decrease in catastrophe losses.
The current accident year non-catastrophe loss ratio for 2015 was 59.4% compared to 67.1% for 2014 as higher current accident year provisions made in the 2015 period in certain underwriting operating segments, most notably for the Programs business, were more than offset by the impact of the 2014 fourth quarter reserve increase as well as a large 2014 loss in Specialty Property and an elevated Crop ratio due to lower commodity prices in the 2014 period.
The 2015 results included 4.2 points of net favorable prior year loss reserve development primarily attributable to favorable development from the Collector Cars and Boats, Specialty Property, Financial Services, Surety, Environmental, and Crop businesses. This favorable development was partially offset by unfavorable development in the Company's Programs business. The 2014 results included 10.6 points of net unfavorable prior year loss reserve development, of which 8.9 points related to the 2014 fourth quarter reserve increase, primarily driven by Other Professional Lines (including lawyers professional liability) as well as Management Liability and Specialty Property. The remaining amount of net unfavorable prior year loss reserve development for 2014 was primarily driven by unfavorable development recorded prior to the 2014 fourth quarter also in our Other Professional Lines and Management Liability businesses, offset in part by favorable development in our Healthcare business.
The 2015 results also reflected fairly benign catastrophe losses of 0.3 points compared with 1.0 point of catastrophe losses in 2014, primarily related to wind and thunderstorms in the midwestern and southern United States impacting Financial Services and Programs, as well as ice and snow storms in the midwestern and northeastern United States primarily impacting Financial Services.
The 5.3 point increase in the expense ratio for 2015, compared to 2014, was primarily driven by lower incentive compensation expense in 2014 resulting from the 2014 fourth quarter reserve increase, the adverse impact from the exit of the Crop business, and 2014 benefiting from a transition services agreement with the buyer of our legacy personal lines business, which was terminated on June 30, 2014. Additionally, the 2015 ratio was adversely impacted by separation costs associated with senior management restructuring and severance costs.
Specialty Industries
Financial results for our Specialty Industries reportable segment were as follows:
Year ended December 31, | ||||||||||||
2016 | 2015 | 2014 | ||||||||||
($ in millions) | ||||||||||||
Gross written premiums | $ | 599.9 | $ | 646.5 | $ | 650.6 | ||||||
Net written premiums | $ | 559.8 | $ | 603.6 | $ | 610.0 | ||||||
Earned premiums | $ | 576.2 | $ | 615.9 | $ | 595.0 | ||||||
Loss and LAE | (280.6 | ) | (390.0 | ) | (357.2 | ) | ||||||
Policy acquisition expenses | (106.5 | ) | (113.7 | ) | (107.1 | ) | ||||||
Other underwriting expenses | (120.4 | ) | (120.3 | ) | (100.8 | ) | ||||||
Total underwriting income (loss) | 68.7 | (8.1 | ) | 29.9 | ||||||||
Net other revenues | 1.5 | 1.4 | 1.1 | |||||||||
General and administrative expenses | (2.4 | ) | (2.7 | ) | (2.3 | ) | ||||||
Pre-tax income (loss) from continuing operations | $ | 67.8 | $ | (9.4 | ) | $ | 28.7 | |||||
The following table provides underwriting ratios for Specialty Industries:
Year ended December 31, | |||||||||
2016 | 2015 | 2014 | |||||||
Underwriting ratios: | |||||||||
Loss and LAE | 48.7 | % | 63.3 | % | 60.1 | % | |||
Expense | 39.4 | 38.0 | 34.9 | ||||||
Total combined ratio | 88.1 | % | 101.3 | % | 95.0 | % | |||
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The impact of certain items to our underwriting ratios was as follows:
(Favorable) unfavorable impact | |||||||
Year ended December 31, | |||||||
2016 | 2015 | 2014 | |||||
Point impact on loss and LAE ratio and combined ratio: | |||||||
Catastrophe losses, net of reinsurance | 1.7 pts | 2.4 pts | 1.3 pts | ||||
Prior year loss reserve development | (5.5) pts | 3.5 pts | 4.7 pts | ||||
Specialty Industries—Year ended December 31, 2016 versus year ended December 31, 2015
Net written premiums for Specialty Industries decreased $43.8 million, or 7.3%, to $559.8 million for 2016 from $603.6 million for 2015. The significant decrease in 2016 was driven by Entertainment ($26.5 million) due to a refinement of our underwriting appetite given recent loss experience, and to a lesser extent, decreases across all other underwriting operating segments, most notably Ocean Marine ($7.0 million) driven by market conditions and competition.
The Specialty Industries combined ratio for 2016 decreased to 88.1% compared to 101.3% for 2015, as the loss and LAE ratio decreased by 14.6 points to 48.7% and the expense ratio increased 1.4 points to 39.4%.
The 14.6 point decrease in the loss and LAE ratio was comprised of a 4.9 point decrease in current accident year non-catastrophe losses, a 9.0 point favorable change in prior year loss reserve development and a 0.7 point decrease in catastrophe losses.
The current accident year non-catastrophe loss ratio for 2016 was 52.5%, compared to 57.4% for 2015, driven by the strong performance of our Accident business and the improved performance of Inland Marine and Ocean Marine which were significantly impacted by heavy claim activity in 2015.
The 2016 results included $31.3 million, or 5.5 points, of net favorable prior year loss reserve development driven by Accident, Entertainment and Technology due to lower than expected loss activity. The 2015 results included $21.8 million, or 3.5 points, of net unfavorable prior year loss reserve development primarily driven by Entertainment due to several large losses and an increase in small to mid-size claims, and to a lesser extent, unusually heavy loss activity of both large and small claims in Ocean Marine which were partially offset by favorable prior year loss reserve development in Technology, and to a lesser extent Government Risks.
The 2016 results also included 1.7 points of catastrophe losses, primarily resulting from wind and thunderstorms in the southern United States impacting Inland Marine and Ocean Marine. This compared to 2.4 points of catastrophe losses in 2015, primarily related to winter storms in the northeastern United States impacting Ocean Marine, Entertainment and Inland Marine, as well as wind and thunderstorms in the midwestern, eastern and southern United States, particularly Texas, impacting Government Risks, Ocean Marine and Inland Marine.
The 1.4 point increase in the expense ratio was primarily driven by the negative impact of lower earned premiums and increased commissions due to business mix in 2016 more than offsetting reduced salary and incentive compensation expense driven by headcount reductions and lower relative incentive compensation performance factors. Additionally, the 2015 ratio was adversely impacted by separation costs associated with senior management restructuring and severance costs.
Specialty Industries—Year ended December 31, 2015 versus year ended December 31, 2014
Net written premiums for Specialty Industries decreased $6.4 million, or 1.0%, to $603.6 million for 2015 from $610.0 million for 2014. The decrease in 2015 was driven by modest decreases at most of the underwriting operating segments, most notably a $5.8 million decrease in our Technology business, but was partially offset by a $5.4 million increase in our Accident business.
The Specialty Industries combined ratio for 2015 increased to 101.3% compared to 95.0% for 2014, as the loss and LAE ratio increased by 3.2 points to 63.3% and the expense ratio increased 3.1 points to 38.0%.
The 3.2 point increase in the loss and LAE ratio was comprised of a 3.3 point increase in current accident year non-catastrophe losses, a 1.2 point favorable change in prior year loss reserve development and a 1.1 point increase in catastrophe losses.
The current accident year non-catastrophe loss ratio for 2015 was 57.4%, compared to 54.1% for 2014, reflecting an increase in that provision for each of the underwriting operating segments, most notably in Ocean Marine and Inland Marine due to heavy claim activity more than offsetting the impact of the 2014 fourth quarter reserve increase.
The 2015 results included 3.5 points of net unfavorable prior year loss reserve development primarily driven by Entertainment due to several large losses and an increase in small to mid-size claims, and to a lesser extent, unusually heavy
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loss activity of both large and small claims in Ocean Marine which were partially offset by favorable prior year loss reserve development in Technology, and to a lesser extent Government Risks. The 2014 results included 4.7 points of net unfavorable prior year loss reserve development primarily related to Entertainment, Government Risks, the transportation business within Accident and Inland Marine, all of which were driven by the 2014 fourth quarter reserve increase. This unfavorable prior year loss reserve development in 2014 was partially offset by favorable prior year loss reserve development in Ocean Marine.
The 2015 results also included 2.4 points of catastrophe losses, primarily related to winter storms in the northeastern United States impacting Ocean Marine, Entertainment and Inland Marine, as well as wind and thunderstorms in the midwestern, eastern and southern United States, particularly Texas, impacting Government Risks, Ocean Marine and Inland Marine. This compared to 1.3 points of catastrophe losses in 2014, primarily related to wind and thunderstorms in the southern, central and eastern United States impacting Ocean Marine and Inland Marine, as well as ice and snow storms in the midwestern United States impacting Technology, Ocean Marine and Inland Marine.
The 3.1 point increase in the expense ratio was primarily driven by lower incentive compensation expense in 2014 resulting from the 2014 fourth quarter reserve increase as well as 2014 benefiting from a transition services agreement with the buyer of our legacy personal lines business, which was terminated on June 30, 2014. Additionally, the 2015 ratio was adversely impacted by separation costs associated with senior management restructuring and severance costs.
Investing, Financing and Corporate
A summary of results from our Investing, Financing and Corporate reportable segment is as follows:
Year ended December 31, | ||||||||||||
2016 | 2015 | 2014 | ||||||||||
($ in millions) | ||||||||||||
Net investment income | $ | 50.6 | $ | 45.9 | $ | 43.4 | ||||||
Net realized and change in unrealized investment gains | 37.7 | (35.1 | ) | 40.4 | ||||||||
Pre-tax investment results | 88.3 | 10.8 | 83.8 | |||||||||
Net other revenues (expenses) | 4.1 | (1.8 | ) | 3.8 | ||||||||
General and administrative expenses | (11.8 | ) | (12.7 | ) | (11.7 | ) | ||||||
Interest expense | (13.1 | ) | (13.0 | ) | (13.0 | ) | ||||||
Pre-tax income (loss) from continuing operations | $ | 67.5 | $ | (16.7 | ) | $ | 62.9 | |||||
Investing, Financing and Corporate—Year ended December 31, 2016 versus year ended December 31, 2015
Investing, Financing and Corporate reported pre-tax income from continuing operations of $67.5 million in 2016, compared to a pre-tax loss of $16.7 million in 2015. The increase was primarily related to significantly higher investment returns in 2016. As described in greater detail in "Summary of Investment Results" below, net investment income increased to $50.6 million in 2016, compared to $45.9 million in 2015, while net realized and change in unrealized investment gains increased significantly to positive $37.7 million in 2016, compared to negative $35.1 million in 2015. In addition, there was a $5.9 million favorable change in other revenues (expenses) compared to 2015 driven by the prior year impact of a $3.7 million negative adjustment to the pre-tax gain on sale of Essentia, and $3.0 million of income in 2016 resulting from the excess invested assets that previously supported the Qualified Plan, which was terminated in 2016.
Investing, Financing and Corporate—Year ended December 31, 2015 versus year ended December 31, 2014
Investing, Financing and Corporate reported a pre-tax loss from continuing operations of $16.7 million in 2015, compared to pre-tax income of $62.9 million in 2014. The decrease was primarily related to substantially lower investment returns in 2015, and a $3.7 million negative adjustment to the pre-tax gain on sale of Essentia. In addition, net other revenues (expenses) included a $1.6 million pre-tax write-off of certain capitalized software associated with senior management restructuring, as well as an additional loss on the sale of real estate of $1.2 million in 2015. These other expenses were partially offset by the $3.0 million (pre-tax) of other revenues from the Crop Transaction Fee. As described in greater detail in "Summary of Investment Results" below, net investment income increased slightly to $45.9 million in 2015, compared to $43.4 million in 2014, while net realized and change in unrealized investment gains decreased significantly to negative $35.1 million in 2015, compared to positive $40.4 million in 2014.
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Runoff Business
As described in Note 1—"Nature of Operations and Summary of Significant Accounting Policies" and Note 2—"Acquisitions and Dispositions," on December 23, 2014, we completed the sale of our Runoff Business to Armour and the results of operations for the Runoff Business have been classified as discontinued operations and are presented as such, net of related income taxes, in the statements of operations and comprehensive income and cash flows for all periods. Our investing and financing activities are managed on a consolidated basis reported within the Investing, Financing and Corporate segment. Therefore, no investment or financing activity is included in discontinued operations.
In the fourth quarter of 2014, in conjunction with the Runoff Transaction, we provided financing in the form of surplus notes having a par value of $101.0 million, which had a fair value of $64.9 million on the date of sale. The surplus notes, issued by one of the transferred entities, Bedivere Insurance Company (Bedivere; the Issuer), were in the form of both seller priority and pari passu notes.
Under the contractual terms of both the seller priority and pari passu notes, scheduled interest payments accrue at 6% until the scheduled maturity date of March 15, 2020 and at a floating interest rate thereafter, should any principal remain outstanding. As required by the Pennsylvania Insurance Department (PID), interest on the notes is not compounding. The notes restrict the Issuer's ability to make distributions to the holders of its equity interest. All such distributions are prohibited while the seller priority note is outstanding, and while the pari passu note is outstanding, distributions are permitted only if the Issuer concurrently repays a pro rata amount of any outstanding principal on the pari passu note.
Pursuant to the notes, the Issuer shall seek to redeem the notes annually each March 15 at a requested redemption amount such that the Issuer’s total adjusted capital following the proposed redemption payment would equal 200% of the Issuer’s “authorized control level RBC,” as such term is defined by the insurance laws of the Commonwealth of Pennsylvania and as prescribed by the PID. All redemptions or repayments of principal and payments of interest on the notes are subject to approval by the PID.
Results of Discontinued Operations
Discontinued Operations Results—Year ended December 31, 2016
There was no gain or loss related to discontinued operations for the year ended December 31, 2016.
Discontinued Operations Results—Year ended December 31, 2015
The loss from discontinued operations, net of tax, of $0.2 million for the year ended December 31, 2015 included $0.5 million of post-closing expenses incurred in connection with the Runoff Business and a $0.3 million gain from sale of discontinued operations representing a positive adjustment to the estimated loss on sale taking into consideration the final settlement of certain post-closing items.
Discontinued Operations Results—Year ended December 31, 2014
During the year ended December 31, 2014, we reported $20.6 million, or $(0.21) per share, after-tax net loss in discontinued operations related to the Runoff Transaction, which included an $18.8 million after-tax loss from sale of the Runoff Business (further described below) and a $1.8 million after-tax loss from the underwriting results of the Runoff Business.
As part of the closing of the Runoff Transaction on December 23, 2014, the $101.0 million par value surplus notes issued had a fair value of $64.9 million at closing based on an internal discounted cash flow model, resulting in a valuation adjustment of $36.1 million, pre-tax, included in loss from sale of discontinued operations. Subsequent to the closing, the surplus notes became part of the our investment portfolio, categorized within other investments, and subsequent changes in the value thereon are reflected in continuing operations. See Note 5—"Investment Securities" for further disclosures regarding these surplus notes.
Also during 2014, our expectation of the treatment of a $7.4 million reserve charge recorded during the quarter ended June 30, 2013 changed. Previously, we had expected that the $7.4 million of assets to support this reserve charge would be transferred to Armour at the closing of the Runoff Transaction. However, OneBeacon and Armour agreed instead to increase the cap on seller financing. As a result, the $7.4 million reserve charge ($4.8 million after-tax) was recorded as a reduction to the estimated loss on sale of discontinued operations.
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Summary of Investment Results
OneBeacon invests to maximize long-term total returns (after-tax) while taking prudent levels of risk and maintaining a diversified portfolio, subject to OneBeacon's investment guidelines and various regulatory restrictions. Investments include fixed maturity investments, short-term investments, common equity securities and other investments.
During the third quarter of 2016, OneBeacon established a portfolio of high-yield fixed maturity investments. Given the risk profile of these investments, OneBeacon’s management believes that returns associated with the high-yield fixed maturity investments are more appropriately included with the returns from common equity securities and other investments instead of with returns associated with short-term investments and investment grade fixed maturity investments. See “NON—GAAP FINANCIAL MEASURES” on page 48.
For purposes of discussing rates of return, all percentages are presented gross of management fees and trading expenses in order to produce a better comparison to benchmark returns, while all dollar amounts are presented net of management fees and trading expenses.
Investment Returns
A summary of our consolidated pre-tax investment results is as follows:
Year ended December 31, | ||||||||||||
Components of Investment Results | 2016 | 2015 | 2014 | |||||||||
($ in millions) | ||||||||||||
Net investment income | $ | 50.6 | $ | 45.9 | $ | 43.4 | ||||||
Net realized investment gains | 10.3 | 47.2 | 69.7 | |||||||||
Change in net unrealized investment gains | 27.4 | (82.3 | ) | (29.3 | ) | |||||||
Total pre-tax investment results | $ | 88.3 | $ | 10.8 | $ | 83.8 | ||||||
Gross investment returns on average invested assets versus typical benchmarks are as follows:
Year ended December 31,(1) | |||||||||
2016 | 2015 | 2014 | |||||||
Short-term investments | 0.2 | % | — | % | (0.1 | )% | |||
Investment grade fixed maturity investments | 2.4 | % | 1.5 | % | 2.6 | % | |||
High-yield fixed maturity investments | 0.7 | % | N/A | N/A | |||||
Total fixed income investments(2) | 2.3 | % | 1.4 | % | 2.4 | % | |||
Bloomberg Barclays U.S. Intermediate Aggregate Index | 2.0 | % | 1.2 | % | 4.1 | % | |||
Common equity securities | 7.7 | % | 2.3 | % | 8.2 | % | |||
Other investments | 16.1 | % | (11.8 | )% | 7.6 | % | |||
Total common equity securities and other investments | 10.9 | % | (3.0 | )% | 8.0 | % | |||
Total common equity securities, other investments and high-yield fixed maturity investments | 10.1 | % | (3.0 | )% | 8.0 | % | |||
S&P 500 Index (total return) | 12.0 | % | 1.4 | % | 13.7 | % | |||
Total consolidated portfolio | 3.6 | % | 0.6 | % | 3.5 | % | |||
_______________________________________________________________________________
(1) | Gross investment returns exclude investment expenses of $4.8 million, $5.0 million and $7.0 million for the years ended December 31, 2016, 2015 and 2014, respectively. |
(2) | The impact of excluding high-yield fixed maturity investments from the GAAP fixed maturity investment returns was insignificant in 2016. |
Investment Returns—Year ended December 31, 2016 versus year ended December 31, 2015
Overview
Our total pre-tax investment results were $88.3 million, a return on average invested assets of 3.6% for 2016, compared to $10.8 million, a return of 0.6% for 2015. The significant increase was due in part to a higher return on our other investments
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portfolio, driven by changes in credit spreads, which contributed to a positive valuation impact on the surplus notes of $20.4 million in 2016 compared to a negative valuation impact of $13.6 million in 2015, and to a lesser extent, less negative returns in energy sector exposed private equity funds in 2016 compared to 2015. Our fixed maturity investments portfolio also generated a higher return in 2016, driven by narrowing credit spreads in the current period compared to widening credit spreads in the prior period. Finally, our common equity securities portfolio generated a higher return in 2016, benefiting from stronger market performance (as measured by the S&P 500 total return index) as compared to 2015.
Sales and maturities of investments, excluding short-term investments and other investments, increased to $1,681.3 million from $1,371.5 million for the years ended December 31, 2016 and 2015, respectively, due to increased maturities in the fixed maturity investments portfolio, and purchases of these investments decreased slightly to $1,655.9 million from $1,657.0 million for the years ended December 31, 2016 and 2015, respectively.
Fixed income
We maintain a high quality fixed income portfolio with a relatively short duration of approximately 2.5 years excluding short-term investments and approximately 2.4 years including short-term investments as of December 31, 2016. Our fixed income portfolio returned 2.3% in 2016, compared to 1.4% in 2015, outperforming the longer duration Bloomberg Barclays U.S. Intermediate Aggregate Index returns of 2.0% and 1.2% for 2016 and 2015, respectively. Modest increases in treasury rates during both periods contributed to our outperformance.
Excluding high-yield fixed maturity investments, our fixed income portfolio returned 2.3% in 2016, outperforming the longer duration Bloomberg Barclays U.S. Intermediate Aggregate Index return of 2.0% in 2016.
Common equity securities and other investments
We maintain a portfolio of common equity securities and other investments, including surplus notes hedge funds and private equity funds. We believe that prudent levels of these investments are likely to enhance long-term after-tax total returns. OneBeacon’s portfolio of common equity securities and other investments represented approximately 12.9% and 17.0% of total invested assets as of December 31, 2016 and 2015, respectively. Including high-yield fixed maturity investments OneBeacon’s portfolio of common equity securities, other investments and high-yield fixed maturity investments represented approximately 16.4% and 17.0% of total invested assets as of December 31, 2016 and 2015, respectively.
Our common equity securities and other investments portfolio returned 10.9% in 2016, compared to (3.0)% in 2015, underperforming the S&P 500 Index returns of 12.0% and 1.4% in 2016 and 2015, respectively.
Our common equity securities portfolio returned 7.7% in 2016, underperforming the S&P 500 Index return of 12.0%, compared to 2.3% in 2015, outperforming the S&P 500 Index return of 1.4%. Both variances to the S&P 500 Index return can largely be attributed to the results of our actively-managed publicly traded common equity securities portfolio.
Our other investments portfolio returned 16.1% in 2016, outperforming the S&P 500 Index return of 12.0%, compared to (11.8)% in 2015, underperforming the S&P 500 Index return of 1.4%. Both variances to the index returns are primarily due to the return on the surplus notes, for which a $20.4 million positive valuation adjustment was recorded in 2016 and a $13.6 million negative valuation adjustment was recorded in 2015. The surplus note valuation changes for both periods were driven primarily by changes in below investment grade credit spreads. Additionally, the return on other investments for 2015 was adversely impacted by lower returns in energy sector exposed private equity funds as compared to 2016.
The portfolio of common equity securities, other investments and high-yield fixed maturity investments returned 10.1% in 2016, which underperformed the S&P 500 Index return of 12.0%.
OneBeacon invests in ETFs that seek to provide investment results that, before expenses, generally correspond to the performance of broad market indices.
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The following summarizes OneBeacon's investments in ETFs by exposure to each index:
Index | Market Value December 31, 2016 | Market Value December 31, 2015 | ||||||
($ in millions) | ||||||||
S&P 500 | $ | 164.4 | $ | 153.1 | ||||
Russell 1000 Value | — | 20.6 | ||||||
Russell 1000 | — | 9.6 | ||||||
Total | $ | 164.4 | $ | 183.3 | ||||
In both 2016 and 2015, the ETF investments earned the effective market return, before expenses, over the period in which OneBeacon was invested in each respective fund.
OneBeacon has established relationships with third party registered investment advisers to actively manage a portion of its common equity securities portfolio. The largest of these relationships have been with Prospector Partners LLC (Prospector) and Lateef Investment Management (Lateef). During the second quarter of 2015, OneBeacon instructed Prospector to liquidate its separate account portfolios and redeemed its investments in hedge funds managed by Prospector. OneBeacon has since terminated its investment management agreements with Prospector. OneBeacon continues to have common equity securities actively managed by Lateef, though the allocation to Lateef was significantly reduced in the fourth quarter of 2016. Proceeds from both the 2015 Prospector liquidation and 2016 Lateef reduction were largely reinvested in ETFs.
During the third quarter of 2016, OneBeacon established a portfolio of high-yield fixed maturity investments. The high-yield portfolio had a fair value of $91.0 million as of December 31, 2016.
Investment Returns—Year ended December 31, 2015 versus year ended December 31, 2014
Overview
Our total pre-tax investment results were $10.8 million, a return on average invested assets of 0.6% for 2015, compared to $83.8 million, a return of 3.5% for 2014. The decrease was principally driven by other investments, which were impacted by significantly lower returns in energy exposed private equity funds relative to 2014 and negative valuation adjustments on the surplus notes, lower equity market performance, and decreased returns for the fixed maturity investment portfolio, driven by interest rate movements.
Sales and maturities of investments, excluding short-term investments and other investments, decreased to $1,371.5 million from $2,585.1 million for the years ended December 31, 2015 and 2014, respectively, and purchases of these investments decreased to $1,657.0 million from $2,409.2 million for the years ended December 31, 2015 and 2014, respectively. These decreases reflect increased transactional volume in 2014 related to the completion of the Runoff Transaction.
Fixed income
Our fixed income portfolio, which includes fixed maturity investments and short-term investments, returned 1.4% in 2015, outperforming the longer duration Bloomberg Barclays U.S. Intermediate Aggregate Index return of 1.2% compared to 2.4% in 2014, underperforming the longer duration Bloomberg Barclays U.S. Intermediate Aggregate Index return of 4.1%. Our fixed income portfolio was adversely impacted by an increase in interest rates in 2015.
Common equity securities and other investments
Our common equity securities and other investments portfolio returned (3.0)% in 2015, compared to 8.0% in 2014, underperforming the S&P 500 Index returns of 1.4% and 13.7% in 2015 and 2014, respectively.
Our common equity securities portfolio returned 2.3% in 2015, outperforming the S&P 500 Index return of 1.4% compared to 8.2% in 2014, underperforming the S&P 500 Index return of 13.7%. Both variances to the S&P 500 Index returns can largely be attributed to the results of our actively-managed publicly-traded common equity securities portfolio.
Our other investments portfolio returned (11.8)% for 2015, underperforming the S&P 500 Index return of 1.4%, compared to 7.6% for 2014, underperforming the S&P 500 Index return of 13.7%. The 2015 returns were heavily impacted by negative valuations from our energy exposed private equity funds and the surplus notes.
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The following table presents the composition of our reported investment portfolio balances:
As of December 31, | ||||||||||||||
2016 | 2015 | |||||||||||||
Type of Investment | $ in millions | % of total | $ in millions | % of total | ||||||||||
Fixed maturity investments | $ | 2,169.1 | 82.8 | % | $ | 2,080.5 | 80.3 | % | ||||||
Short-term investments | 112.1 | 4.3 | 69.2 | 2.7 | ||||||||||
Common equity securities | 188.7 | 7.2 | 298.7 | 11.5 | ||||||||||
Other investments(1) | 150.5 | 5.7 | 143.0 | 5.5 | ||||||||||
Total | $ | 2,620.4 | 100.0 | % | $ | 2,591.4 | 100.0 | % | ||||||
_______________________________________________________________________________
(1) Includes $71.9 million and $51.5 million of surplus notes as of December 31, 2016 and 2015, respectively, received in conjunction with the financing of the Runoff Transaction.
The breakdown of our fixed maturity portfolio as of December 31, 2016 by credit class, based upon issue credit ratings provided by Standard & Poor's, or if unrated by Standard & Poor's, long-term obligation ratings provided by Moody's, is as follows:
As of December 31, 2016 | ||||||||||||||
Ratings | Amortized Cost | % of Total | Carrying value | % of Total | ||||||||||
($ in millions) | ($ in millions) | |||||||||||||
U.S. government | $ | 169.6 | 7.8 | % | $ | 167.3 | 7.7 | % | ||||||
AAA/Aaa | 502.7 | 23.2 | 502.2 | 23.2 | ||||||||||
AA/Aa(1) | 621.7 | 28.7 | 621.3 | 28.6 | ||||||||||
A/A | 256.9 | 11.9 | 258.1 | 11.9 | ||||||||||
BBB/Baa | 484.7 | 22.4 | 491.8 | 22.7 | ||||||||||
BB/Ba | 74.4 | 3.5 | 73.5 | 3.4 | ||||||||||
B/B | 12.5 | 0.6 | 12.6 | 0.6 | ||||||||||
Other/not rated | 41.9 | 1.9 | 42.3 | 1.9 | ||||||||||
Total | $ | 2,164.4 | 100.0 | % | $ | 2,169.1 | 100.0 | % | ||||||
_______________________________________________________________________________
(1) Includes $288.0 million at amortized cost and $286.6 million at carrying value for U.S. government agency obligations.
The maturity distribution for fixed maturity investments held as of December 31, 2016 is as follows:
As of December 31, 2016 | ||||||||
Maturity | Amortized Cost | Carrying Value | ||||||
($ in millions) | ||||||||
Due within one year | $ | 91.0 | $ | 91.4 | ||||
Due after one through five years | 782.9 | 784.3 | ||||||
Due after five through ten years | 110.4 | 109.5 | ||||||
Due after ten years | 17.0 | 16.9 | ||||||
Asset-backed securities | 1,154.8 | 1,153.1 | ||||||
Preferred stocks | 8.3 | 13.9 | ||||||
Total | $ | 2,164.4 | $ | 2,169.1 | ||||
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INVESTMENT RETURN NON-GAAP FINANCIAL MEASURE
In 2016, OneBeacon purchased high-yield fixed maturity investments, which are U.S. dollar denominated publicly traded and 144A debt securities issued by corporations with generally at least one rating between "B-" and "BB+" inclusive by Standard & Poor's or similar ratings from other agencies. Given the risk profile of these investments, OneBeacon has included returns on high-yield fixed maturity investments with returns on common equity securities and other investments. A reconciliation of these returns follows:
December 31, 2016 | |||||||||
GAAP return | Include: Impact of return on high yield fixed maturity investments(1) | Non-GAAP return | |||||||
Common equity securities and other investment returns | 10.9 | % | (0.8 | )% | 10.1 | % | |||
_______________________________________________________________________________
(1) High-yield fixed maturity investments returned 0.7% for the year ended December 31, 2016.
Liquidity and Capital Resources
Operating Cash and Short-term Investments
Our sources and uses of cash are as follows:
Holding company level. The primary sources of cash for the Company and certain of our intermediate subsidiaries are expected to be distributions and tax sharing payments received from our insurance operating subsidiaries, capital raising activities, net investment income, and proceeds from sales and maturities of holding company investments. The primary uses of cash are expected to be interest payments on our debt obligations, repurchases and retirements of our debt obligations, dividend payments on our common shares, common share repurchases, purchases of investments, payments made to tax authorities, contributions to our operating subsidiaries, and holding company operating expenses.
Operating subsidiary level. The primary sources of cash for our operating subsidiaries are expected to be premium collections, net investment income, capital raising activities, contributions from our holding companies, and proceeds from sales and maturities of investments. The primary uses of cash are expected to be claim payments, policy acquisition and other underwriting expenses, interest payments on internal debt obligations, repurchases and retirements of internal debt obligations, purchases of investments, and distributions and tax sharing payments made to parent holding companies.
Insurance companies typically collect premiums on policies that they write prior to paying claims made under those policies. During periods of premium growth, insurance companies typically experience positive cash flow from operations, as premium receipts typically exceed claim payments and other operating expenses. When this happens, positive cash flow from operations is usually offset by negative cash flow from investing activities, as the positive operating cash flow is used to purchase investments. Conversely, during periods of premium decline, insurance companies typically experience negative cash flow from operations, even during periods in which they report net income, as the claims and other operating expenses that they pay exceed the premiums that they collect. When this happens, negative cash flow from operations is typically offset by positive cash flow from investing activities, as invested assets are sold to fund current claim payments.
Both internal and external forces influence our financial condition, results of operations and cash flows. Claim settlements, premium levels and investment returns may be impacted by changing rates of inflation and other economic conditions. In many cases, significant periods of time, sometimes several years or more, may lapse between the occurrence of an insured loss, the reporting of the loss to us and the settlement of the liability for that loss. The exact timing of the payment of claims and benefits cannot be predicted with certainty. Our operating subsidiaries maintain portfolios of invested assets with varying maturities and a substantial amount of cash and short-term investments to provide adequate liquidity for the payment of claims.
Management believes that our cash balances, cash flows from operations and cash flows from investments are adequate to meet expected cash requirements for the foreseeable future on both a holding company and operating subsidiary level.
Dividend Capacity
Under the insurance laws of the states and jurisdictions under which our insurance operating subsidiaries are domiciled, an insurer is restricted with respect to the timing and the amount of dividends it may pay without prior approval by regulatory authorities. Accordingly, there can be no assurance regarding the amount of such dividends that may be paid by such subsidiaries in the future.
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Our top tier regulated U.S. insurance operating subsidiary, ASIC, has the ability to pay dividends to its immediate parent without the prior approval of regulatory authorities in an amount set by formula based on the lesser of (i) adjusted net investment income, as defined by statute, or (ii) 10% of statutory surplus, in both cases as most recently reported to regulatory authorities, subject to the availability of earned surplus. Based upon the formula described above, as of December 31, 2016, ASIC has the ability to pay $11.4 million of dividends without prior approval of regulatory authorities. When taking into consideration the rolling 12-month portion of this statutorily-defined calculation, including adjusted net investment income and the timing of dividends paid, we anticipate that ASIC will have the ability to pay dividends of approximately $30.0 million during 2017. As of December 31, 2016, ASIC had $624.8 million of statutory surplus and $69.0 million of earned surplus. During the years ended December 31, 2016 and 2015, ASIC paid $26.5 million and $44.9 million, respectively, of dividends to its immediate parent. During the year ended December 31, 2015, ASIC also redeemed and retired common shares held by its immediate parent at an aggregate price of $66.0 million.
In 2017, Split Rock has the ability to distribute statutory capital without the prior approval of the Bermuda Monetary Authority, provided it does not reduce its total statutory capital, as shown in its previous financial year’s statutory financial statements, by 15% or more.
In addition, Split Rock has the ability to pay dividends without the prior notification of regulatory authorities of up to 25% of its previous financial year's total statutory capital and surplus, subject to meeting all appropriate liquidity and solvency requirements as specified in the Insurance Act and the Companies Act. As of December 31, 2016, Split Rock had $210.1 million of total statutory capital and $60.1 million of surplus for total statutory capital and surplus of $270.2 million.
Based upon the limitations described above, Split Rock currently has the ability to distribute up to $31.5 million of statutory capital and pay up to $60.1 million of dividends during 2017 without the prior approval of regulatory authorities. During 2016, Split Rock paid $25.0 million of dividends to its immediate parent and paid no such dividends during 2015. Also, during 2015, OneBeacon Ltd., through an intermediary holding company, contributed $85.0 million to Split Rock as statutory capital.
During the years ended December 31, 2016 and 2015, our unregulated insurance operating subsidiaries paid $5.7 million and $5.3 million, respectively, of dividends to their immediate parent. As of December 31, 2016, our unregulated insurance operating subsidiaries had $56.4 million of net unrestricted cash, short-term investments and fixed maturity investments and $71.9 million of other investments consisting of the surplus notes.
As described in Note 10—"Common Shareholders' Equity," during the years ended December 31, 2016, 2015 and 2014 OneBeacon Ltd. declared and paid regular quarterly dividends to its common shareholders totaling $79.2 million, $80.0 million and $80.0 million, respectively.
As of December 31, 2016, OneBeacon Ltd. and its intermediate subsidiaries held $64.5 million of net unrestricted cash, short-term investments and fixed maturity investments and $11.9 million of common equity securities outside of its regulated and unregulated insurance operating subsidiaries.
Insurance Float
Insurance float is an important aspect of our insurance operations. Insurance float represents funds that an insurance company holds for a limited time. In an insurance operation, float arises because premiums are collected before losses are paid. This interval can extend over many years. During that time, the insurer invests the funds. When the premiums that an insurer collects do not cover the losses and expenses it eventually must pay, the result is an underwriting loss, which can be considered as the cost of insurance float. One manner in which we calculate our insurance float is by taking our insurance liabilities and subtracting insurance assets. Although insurance float can be calculated using numbers determined under GAAP, insurance float is not a GAAP concept and, therefore, there is no comparable GAAP measure.
Insurance float can increase in a number of ways, including through acquisitions of insurance operations, organic growth in existing insurance operations and recognition of losses that do not immediately cause a corresponding reduction in investment assets. Conversely, insurance float can decrease in a number of other ways, including sales of insurance operations, shrinking or run-off of existing insurance operations, the acquisition of operations that do not have substantial investment assets (e.g., an agency) and the recognition of gains that do not cause a corresponding increase in investment assets. We intend to generate low-cost float over time through a combination of organic growth and acquisitions.
Certain operational leverage metrics can be measured with ratios that are calculated using insurance float. There are many activities that do not change the amount of insurance float at an insurance company but can have a significant impact on the company's operational leverage metrics. For example, investment gains and losses, debt issuances and repurchases/repayments,
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common share issuances and repurchases and dividends paid to shareholders are all activities that do not change insurance float but that can meaningfully impact operational leverage metrics that are calculated using insurance float.
The following table illustrates our consolidated insurance float position and two operational leverage ratios based on insurance float as of December 31, 2016 and 2015.
December 31, | ||||||||
2016 | 2015 | |||||||
($ in millions) | ||||||||
Loss and LAE reserves | $ | 1,365.6 | $ | 1,389.8 | ||||
Unearned premiums | 575.1 | 560.3 | ||||||
Reinsurance balances payable | 17.0 | 24.9 | ||||||
Funds held under insurance contracts | 153.0 | 137.7 | ||||||
Insurance liabilities | $ | 2,110.7 | $ | 2,112.7 | ||||
Cash in regulated insurance and reinsurance subsidiaries | $ | 13.6 | $ | 43.9 | ||||
Reinsurance recoverable on paid and unpaid losses | 179.5 | 193.5 | ||||||
Premiums receivable | 228.3 | 219.0 | ||||||
Deferred acquisition costs | 96.3 | 100.7 | ||||||
Ceded unearned premiums | 44.2 | 29.5 | ||||||
Insurance assets | $ | 561.9 | $ | 586.6 | ||||
Insurance float | $ | 1,548.8 | $ | 1,526.1 | ||||
Insurance float as a multiple of total capital | 1.2 | x | 1.2 | x | ||||
Insurance float as a multiple of OneBeacon's common shareholders' equity | 1.5 | x | 1.5 | x | ||||
During 2016, insurance float increased by $22.7 million, primarily from an increase of unrestricted collateral held relating to our Surety business.
Financing
Debt
The following table summarizes our debt to total capital ratio as of December 31, 2016 and 2015:
December 31, | ||||||||
2016 | 2015 | |||||||
($ in millions) | ||||||||
Senior Notes, carrying value | $ | 273.2 | $ | 272.9 | ||||
Non-controlling interest | 3.9 | 3.6 | ||||||
OneBeacon's common shareholders' equity | 1,021.3 | 1,000.9 | ||||||
Total capital | $ | 1,298.4 | $ | 1,277.4 | ||||
Ratio of debt to total capital | 21.0 | % | 21.4 | % | ||||
We believe that we have the flexibility and capacity to obtain funds externally as needed through debt or equity financing on both a short-term and long-term basis. However, we can provide no assurance that, if needed, we would be able to obtain additional debt or equity financing on satisfactory terms, if at all.
On September 29, 2015 the Company and OBH, as co-borrowers and co-guarantors, entered into a revolving credit facility administered by U.S. Bank N.A. and also including BMO Harris Bank N.A., which has a total commitment of $65.0 million and has a maturity date of September 29, 2019. As of December 31, 2016 the Credit Facility was undrawn.
The Credit Facility contains various affirmative, negative and financial covenants which OneBeacon considers to be customary for such borrowings, including certain minimum net worth and maximum debt to capitalization standards. These covenants can restrict the Company in several ways, including its ability to incur additional indebtedness. An uncured breach of
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these covenants could result in an event of default under the Credit Facility, which would allow lenders to declare any amounts owed under the Credit Facility to be immediately due and payable.
In November 2012, OBH issued $275.0 million face value of senior unsecured notes (2012 Senior Notes) through a public offering, at an issue price of 99.9% and received $272.9 million of proceeds. The 2012 Senior Notes bear an annual interest rate of 4.6% payable semi-annually in arrears on May 9 and November 9, until maturity on November 9, 2022, and are fully and unconditionally guaranteed as to the payment of principal and interest by the Company.
The 2012 Senior Notes were issued under indentures that contain restrictive covenants which, among other things, limit the ability of the Company, OBH, and their respective subsidiaries to create liens and enter into sale and leaseback transactions and limits the ability of OneBeacon to consolidate, merge or transfer their properties and assets. The indentures do not contain any financial ratios or specified levels of net worth or liquidity to which the Company or OBH must adhere. In addition, a failure by the Company or its subsidiaries to pay principal and interest on covered debt, where such failure results in the acceleration of at least $75 million of the principal amount of covered debt, could trigger the acceleration of the 2012 Senior Notes.
During each of the years ended December 31, 2016, 2015 and 2014, we paid $12.7 million of interest on the 2012 Senior Notes.
As of December 31, 2016, the Company and OBH were in compliance with all of the covenants under the 2012 Senior Notes and the Credit Facility, and anticipate they will continue to remain in compliance with these covenants for the foreseeable future.
Capital Lease
In December 2011, the Company sold the majority of its then owned fixed assets and capitalized software. The Company entered into lease financing arrangements with US Bancorp Equipment Finance, Inc. (US Bancorp) and Fifth Third Equipment Finance Company (Fifth Third) whereby it sold furniture and equipment and capitalized software, respectively, at a cost equal to net book value. The Company then leased the fixed assets back from US Bancorp for a lease term of five years and leased the capitalized software back from Fifth Third for a lease term of four years which expired in December 2015. The Company received cash proceeds of $23.1 million as a result of entering into the sale-leaseback transactions.
Upon expiration of the lease agreement with US Bancorp in December 2016, the leased assets under the agreement with a remaining book value of $1.3 million reverted ownership back to the Company, and there is no longer a capital lease asset or obligation. As of December 31, 2015, the Company had a capital lease obligation of $1.7 million included within other liabilities and a capital lease asset of $2.4 million included within other assets.
Contractual Obligations and Commitments
Below is a schedule of our material contractual obligations and commitments due by period as of December 31, 2016:
Total | Due in Less Than One Year | Due in One to Three Years | Due in Three to Five Years | Due After Five Years | ||||||||||||||||
($ in millions) | ||||||||||||||||||||
Debt | $ | 275.0 | $ | — | $ | — | $ | — | $ | 275.0 | ||||||||||
Interest on debt | 75.9 | 12.7 | 25.3 | 25.3 | 12.6 | |||||||||||||||
Loss and LAE reserves(1) | 1,365.6 | 499.8 | 508.0 | 187.1 | 170.7 | |||||||||||||||
Long-term incentive compensation | 48.3 | 11.7 | 32.2 | 1.8 | 2.6 | |||||||||||||||
Pension and other benefit plan obligations(2) | 49.3 | 10.7 | 6.5 | 6.2 | 25.9 | |||||||||||||||
Operating leases | 58.2 | 10.1 | 15.8 | 10.4 | 21.9 | |||||||||||||||
Total contractual obligations and commitments | $ | 1,872.3 | $ | 545.0 | $ | 587.8 | $ | 230.8 | $ | 508.7 | ||||||||||
_______________________________________________________________________________
(1) | Represents expected future cash outflows resulting from loss and LAE payments. The amounts presented are gross of reinsurance recoverables on unpaid losses of $172.9 million and net of the discount on our workers compensation loss and LAE reserves of $1.6 million as of December 31, 2016. |
(2) | Includes expected future cash outflows under our Non-qualified, non-contributory, defined benefit pension plan and our 401(k) savings and employee stock ownership plan. Our pension plans were curtailed in 2002. See Note 8—"Retirement Plans" of the accompanying consolidated financial statements. |
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Our loss and LAE reserves do not have contractual maturity dates. However, based on historical payment patterns, the preceding table includes an estimate of when management expects our loss and LAE reserves to be paid. The timing of claim payments is subject to significant uncertainty. We maintain a portfolio of marketable investments with varying maturities and a substantial amount of short-term investments to provide adequate cash flows for the payment of claims.
The balances included in the table above regarding our long-term incentive compensation plans include amounts payable for performance shares and units, as well as deferred compensation balances. Exact amounts to be paid cannot be predicted with certainty as the ultimate amounts of these liabilities are based on future performance. The estimated payments reflected in the table are based on current accrual factors (common share price and pay-out percentage) and assume that all outstanding balances were 100% vested as of December 31, 2016.
There are no provisions within our material operating lease agreements that would trigger acceleration of future lease payments. We do not finance our operations through the securitization of trade receivables, special purpose entities or synthetic leases. Further, we have not entered into any material arrangement requiring us to guarantee payment of third-party debt, lease payments or to fund losses of an unconsolidated special purpose entity.
We also have future binding commitments to fund certain limited partnership investments. These commitments, which total $15.0 million as of December 31, 2016, do not have fixed funding dates and are therefore excluded from the table above.
Share Repurchase Authorization
On August 22, 2007, our Board authorized us to repurchase up to $200.0 million of OneBeacon's Class A common shares from time to time, subject to market conditions. Shares may be repurchased on the open market or through privately negotiated transactions. This authorization does not have a stated expiration date. Since the inception of this authorization, the Company has repurchased and retired 6.7 million of its Class A common shares. During the year ended December 31, 2016, 850,349 shares were repurchased under the share repurchase authorization for $10.6 million at an average share price of $12.42. During the year ended December 31, 2015, 166,368 shares were repurchased under the share repurchase authorization for $2.1 million at an average price of $12.62. No shares were repurchased under the share repurchase authorization during the year ended December 31, 2014. The amount of authorization remaining is $75.0 million as of December 31, 2016.
During 2016, 2015, and 2014, we repurchased 64,981, 112,051, and 106,366 common shares, respectively, to satisfy employee income tax withholding, pursuant to employee benefit plans. Shares repurchased pursuant to employee benefit plans do not fall under the board authorizations referred to above.
Cash Flows
Detailed information concerning our cash flows during the years ended December 31, 2016, 2015 and 2014 follows:
Cash flows from operations for the years ended December 31, 2016, 2015 and 2014
For 2016, net cash flows provided from operations were $47.3 million. For 2015, net cash flows provided from operations were $191.9 million. For 2014, net cash flows provided from operations was $97.5 million, consisting of $152.0 million provided from continuing operations and $54.5 million used for discontinued operations. Net cash flows provided from operations in 2014 were reduced by the run-off of reserves related to the Runoff Business, which are included in discontinued operations.
Net cash flows provided from operations in 2016 decreased by $144.6 million relative to 2015, primarily due to lower collateral received related to our Surety business and amounts received in conjunction with our exited Crop business, as well as resulting from lower premium collections, higher payments related to various incentive programs, and a large claim payment at the end of 2016. We expect to recover most of the large claim payment in 2017 by a recovery under our reinsurance and corporate insurance policies that had not been received by OneBeacon as of December 31, 2016. Net cash flows provided from continuing operations in 2015 increased $40.4 million relative to 2014, primarily due to increased cash collateral received related to our Surety business and lower incentive payments which more than offset increased loss and LAE payments relative to the prior year.
Other Liquidity and Capital Resource Activities
During 2016, we made payments with respect to our long-term incentive compensation plans totaling $9.3 million, in cash or by deferral into certain of our non-qualified compensation plans. These payments were made primarily with respect to 126,900 performance units, 3,825,000 long-term cash awards, and 167,300 performance shares for the 2013-2015 performance cycle.
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During 2015, we made payments with respect to our long-term incentive compensation plans totaling $8.6 million, in cash or by deferral into certain of our non-qualified compensation plans. These payments were made primarily with respect to 129,100 performance units, 3,965,000 long-term cash awards, and 181,290 performance shares for the 2012-2014 performance cycle.
During 2014, we made payments with respect to our long-term incentive compensation plans totaling $10.8 million, in cash or by deferral into certain of our non-qualified compensation plans. These payments were made primarily with respect to 106,225 performance units and 142,138 performance shares for the 2011-2013 performance cycle.
Cash flows from investing and financing activities for the year ended December 31, 2016
Financing and Other Capital Activities
During 2016, we declared and paid $79.2 million of regular quarterly cash dividends to holders of OneBeacon's common shares.
During 2016, we repurchased and retired 850,349 shares of our Class A common stock for $10.6 million at an average share price of $12.42 under the board authorization referred to above, as well as 64,981 common shares for $0.9 million to satisfy employee income tax withholding, pursuant to employee benefit plans that do not fall under the board authorization.
Cash flows from investing and financing activities for the year ended December 31, 2015
Financing and Other Capital Activities
During 2015, we declared and paid 80.0 million of regular quarterly cash dividends to holders of OneBeacon's common shares.
During 2015, we repurchased and retired 166,368 shares of our Class A common stock for $2.1 million at an average share price of $12.62 under the board authorization referred to above, as well as 112,051 common shares for $1.6 million to satisfy employee income tax withholding, pursuant to employee benefit plans that do not fall under the board authorization.
Cash flows from investing and financing activities for the year ended December 31, 2014
Financing and Other Capital Activities
During 2014, we declared and paid $80.0 million of regular quarterly cash dividends to holders of OneBeacon's common shares.
During 2014, we repurchased and retired 106,366 common shares for $1.8 million to satisfy employee income tax withholding, pursuant to employee benefit plans that do not fall under the board authorization.
Acquisitions and Dispositions
During 2014, we transferred $50.8 million of cash in connection with the sale of the Runoff Business which was completed on December 23, 2014.
Recently Issued Accounting Pronouncements
Refer to Note 1—"Nature of Operations and Summary of Significant Accounting Policies" of the accompanying consolidated financial statements for a discussion of recently issued accounting pronouncements.
Fair Value of Financial Instruments
Refer to Note 5—"Investment Securities" for discussion regarding assets measured at fair value using unobservable inputs.
Critical Accounting Estimates
Management's Discussion and Analysis of Financial Condition and Results of Operations discusses our consolidated financial statements. The consolidated financial statements presented herein include all adjustments considered necessary by management to fairly present our financial position, results of operations and cash flows.
The preparation of financial statements in conformity with GAAP requires management to make significant estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the historical consolidated financial statements and the reported amounts of revenues and expenses during the reporting period.
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On an ongoing basis, management evaluates its estimates, including those related to fair value measurements and loss and LAE reserves. Management bases its estimates on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.
Management believes that certain of these estimates are considered critical in that they involve a higher degree of judgment and are subject to a significant degree of variability. The descriptions below summarize the more significant estimates used in the preparation of our consolidated financial statements.
1. Fair Value Measurements
We measure certain assets at estimated fair value in our consolidated financial statements, with changes therein recognized in current period earnings. In addition, we disclose estimated fair value for certain assets and liabilities measured at historical or amortized cost. 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). Fair value measurements are categorized into a 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). Quoted prices in active markets for identical assets or liabilities have the highest priority (Level 1), followed by observable inputs other than quoted prices, including prices for similar but not identical assets or liabilities (Level 2) with unobservable inputs, including the reporting entity's estimates of the assumptions that market participants would use, having the lowest priority (Level 3).
Assets carried at fair value include fixed maturity investments, common equity securities, surplus notes, and interests in hedge funds and private equity funds. Valuation of assets measured at fair value requires us to make estimates and apply judgment to matters that may carry a significant degree of uncertainty. In determining our estimates of fair value, we use a variety of valuation approaches and inputs. Whenever possible, we estimate fair value using valuation methods that maximize the use of observable prices and other inputs.
For investments in active markets, we use quoted market prices to determine fair value. In circumstances where quoted market prices are unavailable, we utilize fair value estimates based upon reference to other observable inputs other than quoted prices, including matrix pricing, benchmark interest rates, market comparables, broker quotes and other relevant observable inputs. Where observable inputs are not available, the estimated fair value is based upon internal pricing models using assumptions that include inputs that may not be observable in the marketplace but which reflect our best judgment given the circumstances and are consistent with what other market participants would use when pricing such instruments.
As of December 31, 2016 and 2015, approximately 95% and 92%, respectively, of the investment portfolio recorded at fair value was priced based upon quoted market prices or other observable inputs. Investments valued using Level 1 inputs include fixed maturity investments, primarily investments in U.S. Treasuries, common equity securities and short-term investments, which include U.S. Treasury Bills. Investments valued using Level 2 inputs are comprised primarily of fixed maturity investments, which have been disaggregated into classes, including debt securities issued by corporations, municipal obligations, mortgage and asset-backed securities, foreign government obligations and preferred stocks. Certain ETFs that track U.S. stock indices such as the S&P 500 but are traded on foreign exchanges are also considered Level 2 measurements, as management values such investments using the fund’s published net asset value (NAV) to account for the difference in market close times. Fair value estimates for investments that trade infrequently and have few or no observable market prices are classified as Level 3 measurements. Level 3 fair value estimates based upon unobservable inputs include our investments in surplus notes, as well as certain investments in fixed maturity investments and common equity securities where quoted market prices are unavailable or not considered reasonable. We determine when transfers between levels have occurred as of the beginning of the period.
We use brokers and outside pricing services to assist in determining fair values. For investments in active markets, we use the quoted market prices provided by outside pricing services to determine fair value. The outside pricing services we use have indicated that if no observable inputs are available for the security, they will not provide a price. In such circumstances, where quoted market prices are unavailable or are not considered reasonable, we estimate fair value using industry standard pricing methodologies and observable inputs such as benchmark yields, reported trades, broker-dealer quotes, issuer spreads, benchmark securities, bids, offers, credit spreads, prepayment speeds reference data including research publications and other relevant inputs. Given that many fixed maturity investments do not trade on a daily basis, the outside pricing services evaluate a wide range of fixed maturity investments by regularly drawing parallels from recent trades and quotes of comparable securities with similar features. The characteristics used to identify comparable fixed maturity investments vary by asset type and take into account market convention.
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Our process to assess the reasonableness of the market prices obtained from the outside pricing sources covers substantially all of our fixed maturity investments and includes, but is not limited to, the evaluation of pricing methodologies and a review of the pricing services' quality control processes and procedures on at least an annual basis, a comparison of our invested asset market prices to prices obtained from different independent pricing vendors on at least a semi-annual basis, monthly analytical reviews of certain prices and a review of the underlying assumptions utilized by our pricing services for selected measurements on an ad hoc basis throughout the year. We also perform back-testing of selected sales activity to determine whether there are any significant differences between the market price used to value the security prior to sale and the actual sale price on an ad-hoc basis throughout the year. Prices provided by the pricing services that vary by more than 5% and $1.0 million from the expected price based on these assessment procedures are considered outliers. Also considered outliers are prices that have not changed from period to period and prices that have trended unusually compared to market conditions. In circumstances where the results of our review process do not appear to support the market price provided by the pricing services, we challenge the pricing services' price. If we cannot gain satisfactory evidence to support the challenged price, we rely upon our own pricing methodologies to estimate the fair value of the security in question.
The valuation process above is generally applicable to all of OneBeacon’s fixed maturity investments. The techniques and inputs specific to asset classes within OneBeacon's fixed maturity investments for Level 2 securities that use observable inputs are as follows:
Debt securities issued by corporations: The fair value of debt securities issued by corporations is determined from a pricing evaluation technique that uses information from market sources and integrates relative credit information, observed market movements, and sector news. Key inputs include benchmark yields, reported trades, broker-dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data including sector, coupon, quality ratings, duration, credit enhancements, early redemption features and market research publications.
Municipal obligations: The fair value of municipal obligations is determined from a pricing evaluation technique that uses information from market makers, broker-dealers, buy-side firms, and analysts along with general market information. Key inputs include benchmark yields, reported trades, issuer financial statements, material event notices and new issue data, as well as broker-dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data including type, coupon, credit quality ratings, duration, credit enhancements, geographic location and market research publications.
Mortgage and asset-backed securities: The fair value of mortgage and asset-backed securities is determined from a pricing evaluation technique that uses information from market sources and leveraging similar securities. Key inputs include benchmark yields, reported trades, underlying tranche cash flow data, collateral performance, plus new issue data, as well as broker-dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data including issuer, vintage, loan type, collateral attributes, prepayment speeds, default rates, recovery rates, cash flow stress testing, credit quality ratings and market research publications.
Foreign government obligations: The fair value of foreign government obligations is determined from a pricing evaluation technique that uses feeds from data sources in each respective country, including active market makers and inter-dealer brokers. Key inputs include benchmark yields, reported trades, broker-dealer quotes, two-sided markets, benchmark securities, bids, offers, local exchange prices, foreign exchange rates and reference data including coupon, credit quality ratings, duration and market research publications.
Preferred stocks: The fair value of preferred stocks is determined from a pricing evaluation technique that calculates the appropriate spread over a comparable security for each issue. Key inputs include exchange prices (underlying and common stock of same issuer), benchmark yields, reported trades, broker-dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data including sector, coupon, credit quality ratings, duration, credit enhancements, early redemption features and market research publications.
Level 3 valuations are generated from techniques that use assumptions not observable in the market. These unobservable assumptions reflect OneBeacon's assumptions that market participants would use in valuing the investment. Generally, certain securities may start out as Level 3 when they are originally issued but as observable inputs become available in the market, they may be reclassified to Level 2.
The fair value of the surplus notes provided in conjunction with the financing of the Runoff Transaction is determined based on a discounted expected cash flow model using information as of the measurement date, and is classified as a Level 3 measurement. OneBeacon’s other investments also include an investment in a community reinvestment vehicle, which is accounted for at fair value, and a tax advantaged federal affordable housing development fund, which is accounted for under the proportional amortization method.
Hedge funds and private equity funds are measured at fair value for which NAV is generally the practical expedient and are no longer classified within the fair value hierarchy. We employ a number of procedures to assess the reasonableness of the NAV reported by the fund, including obtaining and reviewing periodic and audited financial statements and discussing each
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fund’s pricing with the fund manager throughout the year. In the event we believe that our estimate of NAV differs from that reported by the fund due to illiquidity or other factors, we will adjust the fund's reported NAV to more appropriately represent the fair value of our interest in the investment. As of December 31, 2016 and 2015, we recorded negative adjustments of $5.0 million and $2.4 million, respectively, to the reported NAV of certain investments in private equity funds.
See Note 5—"Investment Securities" of the accompanying consolidated financial statements for tables that summarize the changes in OneBeacon's fair value instruments by level for the years ended December 31, 2016 and 2015 and for the amount of total gains (losses) included in earnings attributable to net change in unrealized investment gains for Level 3 investments for the years ended December 31, 2016, 2015 and 2014.
In the fourth quarter of 2014, in conjunction with the Runoff Transaction, OneBeacon provided financing in the form of surplus notes having a par value of $101.0 million, which had a fair value of $64.9 million on the date of sale and $71.9 million and $51.5 million as of December 31, 2016 and 2015, respectively. The surplus notes, issued by one of the transferred entities, Bedivere (Issuer), were in the form of both seller priority and pari passu notes.
Under the contractual terms of both the seller priority and pari passu notes, scheduled interest payments accrue at 6% until the scheduled maturity date of March 15, 2020 and at a floating interest rate thereafter, should any principal remain outstanding. As required by the PID, interest on the notes is not compounding. The notes restrict the Issuer's ability to make distributions to the holders of its equity interest. All such distributions are prohibited while the seller priority note is outstanding, and while the pari passu note is outstanding, distributions are permitted only if the Issuer concurrently repays a pro rata amount of any outstanding principal on the pari passu note.
Pursuant to the notes, the Issuer shall seek to redeem the notes annually each March 15 at a requested redemption amount such that the Issuer’s total adjusted capital following the proposed redemption payment would equal 200% of the Issuer’s “authorized control level RBC,” as such term is defined by the insurance laws of the Commonwealth of Pennsylvania and as prescribed by the PID. All redemptions or repayments of principal and payments of interest on the notes are subject to approval by the PID. Below is a table illustrating the valuation adjustments taken to arrive at estimated fair value as of December 31, 2016 and 2015:
Type of Surplus Note | Total as of December 31, 2016 | Total as of December 31, 2015 | ||||||||||||||
Seller Priority | Pari Passu | |||||||||||||||
(in millions) | ||||||||||||||||
Par value | $ | 57.9 | $ | 43.1 | $ | 101.0 | $ | 101.0 | ||||||||
Fair value adjustments to reflect: | ||||||||||||||||
Current market rates on public debt and contract-based repayments(1) | 6.2 | (1.1 | ) | 5.1 | (15.1 | ) | ||||||||||
Regulatory approval(2) | (0.2 | ) | (15.4 | ) | (15.6 | ) | (24.2 | ) | ||||||||
Liquidity adjustment(3) | (12.8 | ) | (5.8 | ) | (18.6 | ) | (10.2 | ) | ||||||||
Total | (6.8 | ) | (22.3 | ) | (29.1 | ) | (49.5 | ) | ||||||||
Fair value(4) | $ | 51.1 | $ | 20.8 | $ | 71.9 | $ | 51.5 | ||||||||
_______________________________________________________________________________
(1) | Represents the value of the surplus notes, at current market yields on comparable publicly traded debt, and assuming issuer is allowed to make principal and interest payments when its financial capacity is available, as measured by statutory capital in excess of a 250% RBC score under the NAIC's risk-based capital standards for property and casualty companies. The favorable year-over-year change in impact is due principally to the narrowing of non-investment grade credit spreads as well as the time value of money benefit from moving one year closer to modeled cash receipts. |
(2) | Represents anticipated delay in securing regulatory approvals of interest and principal payments to reflect graduated changes in Issuer's statutory surplus. The monetary impact of the anticipated delay is measured based on credit spreads of public securities with roughly equivalent percentages of discounted payments missed. The favorable year-over-year change in impact is driven primarily by the narrowing of non-investment grade credit spreads, which causes the anticipated delay in securing regulatory approval to be less punitive, partially offset by the change in estimates and assumptions regarding the timeline, amounts, and process necessary to obtain regulatory approval for principal and interest payments described below. |
(3) | Represents impact of liquidity spread to account for OneBeacon's sole ownership of the notes, lack of a trading market, and unique nature of the ongoing regulatory approval process. The unfavorable year-over-year change in impact is due largely to the increased fair value of the notes as well as a higher effective duration resulting from a lower overall yield to maturity; there was no change in the magnitude of the liquidity spread in 2016. |
(4) | The increase in the fair value of the surplus notes during the year ended December 31, 2016 was driven primarily by the narrowing of non-investment grade credit spreads, partially offset by the impact of a change in estimates and assumptions regarding the timing of regulatory approval of principal and interest payments on the notes. |
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The internal valuation model used to estimate the fair value of the surplus notes is based on a discounted expected cash flow model using information as of the measurement date. The estimated fair value of the surplus notes is sensitive to changes in public debt credit spreads, as well as changes in estimates with respect to other variables, including a discount to reflect the private nature of the notes (and the related lack of liquidity), the credit quality of the notes, based on the financial performance of the Issuer relative to expectations, and the timing, amount, and likelihood of interest and principal payments on the notes, which are subject to regulatory approval and therefore may vary from the contractual terms. Anticipating a change in the assumed timeline, amounts, and process necessary to obtain regulatory approval, the Company made a change in its estimate as of December 31, 2016 with regard to the timing of regulatory approval of principal and interest payments on the notes. For the purpose of estimating fair value, the Company has currently assumed that all accrued unpaid interest on the seller priority note since the date of issuance is paid in 2020, with regular annual interest payments on both the seller priority note and pari passu note beginning thereafter, all accrued but unpaid interest on the pari passu note since the date of issuance is paid in 2025, and principal repayments begin on a graduated basis in 2030 for the seller priority note and 2035 for the pari passu note. Previously, including as of December 31, 2015, the Company had assumed for the purpose of estimating fair value that interest payouts, including all accrued but unpaid amounts, began in 2020 for both notes and that principal repayments began on a graduated basis in 2025 for the seller priority note and 2030 for the pari passu note.
Although these variables involve considerable judgment, the Company does not currently expect any resulting changes in the estimated value of the surplus notes to be material to its financial position. Given these significant unobservable inputs, the surplus notes have been classified as Level 3 under the fair value hierarchy. See "Significant Unobservable Inputs" in Note 5—"Investment Securities" of the accompanying consolidated financial statements.
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As a means to provide the degree of variability for each of the key assumptions that affect the fair value of the surplus notes, below is a table of sensitivities which measure hypothetical changes in such variables and the resulting pre-tax increase (or decrease) impact on the valuation of the surplus notes:
Estimates affecting fair value | Pre-tax increase (decrease) in fair value | |||||||||||||||
Liquidity Spread(1) | -100 bp | -50 bp | +50 bp | +100 bp | ||||||||||||
Seller priority note | $ | 4.6 | $ | 2.3 | $ | (2.1 | ) | $ | (4.1 | ) | ||||||
Pari passu note | 2.1 | 1.0 | (1.0 | ) | (1.9 | ) | ||||||||||
Total surplus notes | $ | 6.7 | $ | 3.3 | $ | (3.1 | ) | $ | (6.0 | ) | ||||||
Credit Spread(2) | + 2 Notches | + 1 Notch | -1 Notch | -2 Notches | ||||||||||||
Seller priority note | $ | 9.1 | $ | 4.3 | $ | (3.9 | ) | $ | (7.3 | ) | ||||||
Pari passu note | 4.2 | 1.9 | (1.7 | ) | (3.3 | ) | ||||||||||
Total surplus notes | $ | 13.3 | $ | 6.2 | $ | (5.6 | ) | $ | (10.6 | ) | ||||||
Principal Repayment Delay(3) | -3 Years | -1 Year | + 1 Year | +3 Years | ||||||||||||
Seller priority note | $ | 0.6 | $ | 0.2 | $ | (0.2 | ) | $ | (0.6 | ) | ||||||
Pari passu note | 0.7 | 0.2 | (0.2 | ) | (0.4 | ) | ||||||||||
Total surplus notes | $ | 1.3 | $ | 0.4 | $ | (0.4 | ) | $ | (1.0 | ) | ||||||
Interest Repayment Delay(4) | -3 Years | -1 Year | + 1 Year | +3 Years | ||||||||||||
Seller priority note | $ | 1.9 | $ | 0.9 | $ | (1.1 | ) | $ | (3.8 | ) | ||||||
Pari passu note | 4.4 | 1.4 | (1.5 | ) | (4.5 | ) | ||||||||||
Total surplus notes | $ | 6.3 | $ | 2.3 | $ | (2.6 | ) | $ | (8.3 | ) | ||||||
_______________________________________________________________________________
Description of fair value assumptions and related sensitivities:
(1) | Represents the sensitivity to changes in the estimate of the liquidity spread added to account for OneBeacon's sole ownership of the notes, lack of a liquid trading market, and unique nature of the ongoing regulatory approval process. |
(2) | Represents the sensitivity to changes in the estimate of the underlying equivalent credit quality of the notes. Such credit quality is approximated by comparing the expected percentage of discounted payments missed, as calculated in a proprietary stochastic simulation, to a series of benchmarks derived from data published by Standard & Poor's. Note that a 'notch' is defined as the difference between, for example, a 'B' and 'B+' rated instrument. |
(3) | Represents the sensitivity to changes in the estimate of the timing of the first principal payment received by OneBeacon. The fair value model assumes a delay in the receipt of principal cash flows as a result of the regulatory approval required before such payments may occur; and assuming repayments are made with a graduated impact on statutory surplus. |
(4) | Represents the sensitivity to changes in the estimate of the timing of the first interest payment received by OneBeacon. The fair value model assumes a delay in the receipt of interest cash flows as a result of the regulatory approval required before such payments may occur; and assuming repayments are made with a graduated impact on statutory surplus. |
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As of December 31, 2016 and 2015, other investments reported at fair value represented approximately 6% and 5%, respectively, of the total investment portfolio and consisted of the following:
($ in millions) | December 31, 2016 | December 31, 2015 | ||||||
Hedge funds(1) | $ | 18.4 | $ | 16.4 | ||||
Private equity funds(2) | 33.6 | 46.1 | ||||||
Total hedge funds and private equity funds | 52.0 | 62.5 | ||||||
Surplus notes (par value $101.0)(3) | 71.9 | 51.5 | ||||||
Investment in community reinvestment vehicle | 14.3 | 14.3 | ||||||
Total other investments(4) | $ | 138.2 | $ | 128.3 | ||||
_______________________________________________________________________________
(1) | Consists of 4 hedge funds as of both December 31, 2016 and 2015. |
(2) | Consists of 17 private equity funds as of both December 31, 2016 and 2015. |
(3) | The increase in the fair value of the surplus notes during the year ended December 31, 2016 was driven primarily by the narrowing of non-investment grade credit spreads, partially offset by the impact of a change in estimates and assumptions regarding the timing of regulatory approval of principal and amount of interest payments on the notes. |
(4) | Excludes the carrying value of $12.3 million and $14.7 million as of December 31, 2016 and 2015, respectively, associated with a tax advantaged federal affordable housing development fund accounted for using the proportional amortization method. |
The fair values as of December 31, 2016 for assets measured using Level 3 inputs are as follows:
Fair value at December 31, 2016 | Level 3 Value | Level 3 Percentage | |||||||||
($ in millions) | |||||||||||
Fixed maturity investments: | |||||||||||
U.S. Government | $ | 167.3 | $ | — | — | % | |||||
Debt securities issued by corporations | 763.1 | — | — | ||||||||
Municipal obligations | 70.5 | — | — | ||||||||
Asset-backed securities | 1,153.1 | — | — | ||||||||
Foreign government obligations | 1.2 | — | — | ||||||||
Preferred stocks | 13.9 | — | — | ||||||||
Fixed maturity investments | 2,169.1 | — | — | ||||||||
Short-term investments | 112.1 | — | — | ||||||||
Common equity securities | 188.7 | — | — | ||||||||
Other investments(1)(2) | 138.2 | 86.2 | 62.4 | ||||||||
Total investments(1)(2) | $ | 2,608.1 | $ | 86.2 | 3.3 | % | |||||
_______________________________________________________________________________
(1) | Excludes the carrying value of $12.3 million as of December 31, 2016 associated with a tax advantaged federal affordable housing development fund accounted for using the proportional amortization method. |
(2) | As described in Note 1—"Nature of Operations and Summary of Significant Accounting Policies" investments in hedge funds and private equity funds with a measured fair value of $52.0 million for which NAV is generally the practical expedient are no longer classified within the fair value hierarchy. |
2. Loss and LAE
We establish loss and LAE reserves that are estimates of amounts needed to pay claims and related expenses in the future for insured events that have already occurred. The process of estimating reserves involves a considerable degree of judgment by management and, as of any given date, is inherently uncertain. See Note 3—"Unpaid Loss and Loss Adjustment Expense ("LAE") Reserves" for a description of our loss and LAE reserves and actuarial methods.
We perform an actuarial review of our recorded reserves each quarter. As part of that review, our actuaries compare the previous quarter's projections of paid and case reserve activity to amounts experienced in the quarter. Differences between previous estimates and actual experience are evaluated. While some variance is expected each quarter due to the inherent
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uncertainty in loss and LAE, persistent or large variances would indicate that prior assumptions and/or reliance on certain reserving methods may need to be revised going forward.
Upon completion of each quarterly review, our actuaries select indicated reserve levels based on the results of the actuarial methods described in Note 3—"Unpaid Loss and Loss Adjustment Expense ("LAE") Reserves," which are the primary consideration in determining management's best estimate of required reserves. However, in making its best estimate, management also considers other qualitative factors that may lead to a difference between held reserves and the actuarial central estimate of reserves. Typically, these factors exist when management and our actuaries conclude that there is insufficient historical incurred and paid loss information or that there is particular uncertainty about whether trends included in the historical incurred and paid loss information are likely to repeat in the future. Such factors include, among others, recent entry into new markets or new products, improvements in the claims department that are expected to lessen future ultimate loss costs, legal and regulatory developments, or other volatilities that may arise.
Reserve Estimation by Line of Business
The process of establishing loss reserves, including amounts incurred but not reported, is complex and imprecise as it must consider many variables that are subject to the outcome of future events. As a result, informed subjective estimates and judgments as to the ultimate exposure to losses are an integral component of the loss reserving process. OneBeacon categorizes and tracks insurance reserves by "line of business", as either property (short-tailed) lines, casualty (long-tailed) lines, or other (accident, surety, and credit) lines. These distinctions follow the characteristics of the underlying reserves such that property lines typically are short-tailed as they payout relatively quickly, while casualty reserves are long-tailed as they pay out over a longer period of time. The other lines category reflects the unique characteristics of the sub-lines within that grouping, which includes credit, accident and surety. These categories are also consistent with considerations by OneBeacon's management with respect to decision making as pertains to capital needs. For example, short-tail lines require less deployed capital than longer-tail lines.
OneBeacon regularly reviews the appropriateness of reserve levels at the line of business level, considering the variety of trends that impact the ultimate settlement of claims for the subsets of claims in each particular line of business.
For loss and allocated LAE reserves, the key assumption as of December 31, 2016 was that the impact of the various reserving factors, as described in Note 3—"Unpaid Loss and Loss Adjustment Expense ("LAE") Reserves," on future paid losses would be similar to the impact of those factors on the historical loss data with the exception of severity trends. Severity trends have been relatively stable over the relevant historical period. The actuarial methods used would project losses assuming continued stability in severity trends. Management has considered a range of assumptions regarding future increases in loss severity trends, including the impact of inflation, in making its reserve selections.
The major causes of material uncertainty (reserving factors) generally will vary for each line, as well as for each separately analyzed component of the line. Also, reserving factors can have offsetting or compounding effects on estimated reserves. For example, in workers compensation, the use of expensive medical procedures that result in medical cost inflation may enable workers to return to work faster, thereby lowering indemnity costs. Thus, in almost all cases, it is impossible to discretely measure the effect of a single reserving factor and construct a meaningful sensitivity expectation. Actual results will likely vary from expectations for each of these assumptions, resulting in an ultimate claim liability that is different from that being estimated currently.
Additional causes of material uncertainty exist in most product lines and may impact the types of claims that could occur within a particular operating segment or book of business. Examples where reserving factors, within an operating segment or book of business, are subject to change include changing types of insured (e.g. type of insured vehicle, size of account, industry insured, jurisdiction, etc.), changing underwriting standards, or changing policy provisions (e.g. deductibles, policy limits, or endorsements).
See Note 3—"Unpaid Loss and Loss Adjustment Expense ("LAE") Reserves" for a detailed description of the reserve factors and consideration for each of the major lines.
Prior Loss and LAE Development Discussions by Year
See Note 3—"Unpaid Loss and Loss Adjustment Expense ("LAE") Reserves" of the accompanying consolidated financial statements for prior loss and LAE development discussions for the years ending December 31, 2016, 2015 and 2014.
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Unpaid Loss and LAE Reserves by Line of Business
Unpaid loss and LAE reserves, net of reinsurance recoverable on unpaid losses, by line of business as of December 31, 2016 and 2015 were as follows:
December 31, 2016 | December 31, 2015 | |||||||||||||||||||||||
Case | IBNR | Total | Case | IBNR | Total | |||||||||||||||||||
($ in millions) | ||||||||||||||||||||||||
Property Lines: | ||||||||||||||||||||||||
Property | $ | 42.4 | $ | 22.6 | $ | 65.0 | $ | 33.9 | $ | 37.6 | $ | 71.5 | ||||||||||||
Ocean marine | 39.5 | 39.0 | 78.5 | 52.8 | 38.7 | 91.5 | ||||||||||||||||||
Total Property Lines | 81.9 | 61.6 | 143.5 | 86.7 | 76.3 | 163.0 | ||||||||||||||||||
Casualty Lines: | ||||||||||||||||||||||||
Automobile liability | 52.0 | 65.7 | 117.7 | 49.8 | 57.7 | 107.5 | ||||||||||||||||||
General liability – occurrence | 72.9 | 208.8 | 281.7 | 69.7 | 201.1 | 270.8 | ||||||||||||||||||
General liability – claims made | 79.8 | 150.1 | 229.9 | 86.8 | 179.2 | 266.0 | ||||||||||||||||||
Medical malpractice | 102.6 | 101.0 | 203.6 | 84.4 | 94.5 | 178.9 | ||||||||||||||||||
Workers compensation | 57.7 | 65.1 | 122.8 | 54.1 | 62.2 | 116.3 | ||||||||||||||||||
Other | 0.4 | 4.8 | 5.2 | 0.2 | 4.6 | 4.8 | ||||||||||||||||||
Total Casualty Lines | 365.4 | 595.5 | 960.9 | 345.0 | 599.3 | 944.3 | ||||||||||||||||||
Other Lines | 22.4 | 65.9 | 88.3 | 23.6 | 72.9 | 96.5 | ||||||||||||||||||
Total | $ | 469.7 | $ | 723.0 | $ | 1,192.7 | $ | 455.3 | $ | 748.5 | $ | 1,203.8 | ||||||||||||
Range of Reserve Estimates
Our range of loss and LAE reserve estimates was evaluated to consider the strengths and weaknesses of the various actuarial methods applied against our historical claims experience data. The following table shows the recorded reserves and the high and low ends of our range of reasonable loss and LAE reserves estimates, net of reinsurance recoverable on unpaid losses, as of December 31, 2016 and 2015. The high and low ends of our range of reserve estimates in the table below are based on the results of various actuarial methods described in Note 3—"Unpaid Loss and Loss Adjustment Expense ("LAE") Reserves."
December 31, 2016 | December 31, 2015 | |||||||||||||||||||||||
Low | Recorded | High | Low | Recorded | High | |||||||||||||||||||
($ in millions) | ||||||||||||||||||||||||
Unpaid loss and LAE reserves, net of reinsurance recoverable on unpaid losses | $ | 1,011.6 | $ | 1,192.7 | $ | 1,363.4 | $ | 1,009.1 | $ | 1,203.8 | $ | 1,356.1 | ||||||||||||
The recorded reserves represent management's best estimate of unpaid loss and LAE reserves. We use the results of several different actuarial methods to develop our estimate of ultimate reserves. While we have not determined the statistical probability of actual ultimate paid losses falling within the range, management believes that it is reasonably likely that actual ultimate paid losses will fall within the ranges noted above because the ranges were developed by using several different generally accepted actuarial methods.
Although management believes our reserves are reasonably stated, ultimate losses may deviate, perhaps materially, from the recorded reserve amounts and could be above the high end of the range of actuarial projections. This is because ranges are developed based on known events as of the valuation date, whereas the ultimate disposition of losses is subject to the outcome of events and circumstances that may be unknown as of the valuation date.
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Sensitivity Analysis
The following discussion includes disclosure of possible variations from current estimates of loss reserves due to changes in a few of the many key assumptions. Each of the impacts described below is estimated individually, without consideration for any correlation among key assumptions. Further, there is uncertainty around other assumptions not explicitly quantified in the discussion below. Therefore, it would be inappropriate to take each of the amounts described below and add them together in an attempt to estimate volatility for our reserves in total. It is important to note that the volatilities and variations discussed below are not meant to be worst-case scenarios or an all-inclusive list, and therefore it is possible that future volatilities and variations may be more than amounts discussed below.
• | Various sources of inflation volatility impact all of our reserves in different ways. Using our internal economic capital model we have derived a distribution of future loss payments under the range of inflation scenarios and related claim cost trends in our economic scenario set, holding all other sources of reserve volatility constant. At the 75th percentile of modeled outcomes, the estimated impact of claim cost inflation above our actuarially indicated reserves is $34 million, net of reinsurance. The following are intended to provide additional insight into the impact of inflation on key lines of business: |
◦ | Professional liability: Recorded loss and allocated LAE reserves, net of reinsurance recoverables, for professional liability were $438 million as of December 31, 2016. A key assumption for professional liability is the implicit loss cost trend, particularly the severity inflation trend component of loss costs. Across the entire reserve base, a 5.0 point change in assumed annual severity trend would have changed the estimated net reserve by approximately $84 million as of December 31, 2016, in either direction. |
◦ | Workers compensation: Recorded workers compensation loss and LAE reserves, net of reinsurance recoverables, were $123 million as of December 31, 2016. The two most important assumptions for workers compensation reserves are loss development factors and loss cost trends, particularly medical cost inflation. Loss development patterns are dependent on medical cost inflation. Approximately half of the workers compensation net reserves are related to future medical costs. Across the entire reserve base, a 1.0 point change in calendar year medical inflation would have changed the estimated net reserve by approximately $3 million as of December 31, 2016, in either direction. |
• | The volatility associated with the frequency and severity of large losses, defined as claims greater than or equal to $2.5 million, can have a material impact on our results. The frequency and severity of large claims is driven primarily by the random nature of the insurance process but also by claim cost inflation and parameter risk. These large losses often emerge over a long time period potentially leading to a material impact on our reserves. One way we consider this sensitivity is by examining the volatility of large losses in the current accident year using our economic capital model. At the 75th percentile of modeled outcomes we estimate that large losses could exceed the mean by $18 million gross of reinsurance and $8 million net of the current reinsurance structure. |
• | As we start up new businesses, our initial loss estimates and development patterns are often based on industry data. As actual losses develop, we will revise our initial expectations with our actual experience. However, depending on the tail for the specific business it can be a few years before we have sufficient internal data to rely on. As of December 31, 2016, we have $311 million of inception-to-date premium from our newer businesses (Programs, Environmental and Financial Institutions). A 10% error in our initial loss ratio estimates could result in approximately $31 million of adverse net variance in loss reserves. |
• | Expansion of coverage definitions on existing policies, new theories of liability and emerging risks all could cause adverse development in our loss reserves. One example of an emerging risk is cyber claims, for which courts have yet to fully address the potential liaility and coverage issues presented. As of December 31, 2015 we had provided aggregate limit of $7 billion on in force policies that offer cyber coverage. If our incurred-but-not-reported cyber losses had been 1% of the exposed limits on those policies, our gross liability would be $70 million. |
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FORWARD-LOOKING STATEMENTS
The information contained in this report may contain "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements, other than statements of historical facts, included or referenced in this report that address activities, events or developments which we expect will or may occur in the future are forward-looking statements. The words "will," "believe," "intend," "expect," "anticipate," "project," "estimate," "predict," "may," "anticipate" and similar expressions are also intended to identify forward-looking statements. These forward-looking statements include, among others, statements with respect to our:
• | change in book value per share or return on equity; |
• | business strategy; |
• | financial and operating targets or plans; |
• | incurred loss and LAE and the adequacy of our loss and LAE reserves and related reinsurance; |
• | projections of revenues, income (or loss), earnings (or loss) per share, dividends, market share or other financial forecasts; |
• | expansion and growth of our business and operations; |
• | future capital expenditures; and |
• | pending legal proceedings. |
These statements are based on certain assumptions and analyses made by us in light of our experience and judgments about historical trends, current conditions and expected future developments, as well as other factors believed to be appropriate in the circumstances. However, whether actual results and developments will conform to our expectations is subject to a number of risks, uncertainties or other factors which are described in more detail beginning on page 16 of this Form 10-K, that could cause actual results to differ materially from expectations, including:
• | changes in interest rates, debt or equity markets or other market volatility that negatively impact our investment portfolio; |
• | competitive forces and the cyclicality of the property and casualty insurance industry; |
• | recorded loss and LAE reserves subsequently proving to have been inadequate; |
• | claims arising from catastrophic events, such as hurricanes, windstorms, earthquakes, floods or terrorist attacks; |
• | the continued availability of capital and financing; |
• | the continued availability and cost of reinsurance coverage and our ability to collect reinsurance recoverables; |
• | the outcome of litigation and other legal or regulatory proceedings; |
• | our ability to continue meeting our debt and related service obligations or to pay dividends; |
• | the ability of our technology resources to prevent a data breach and the ability of our internal controls to ensure compliance with legal and regulatory policies; |
• | our ability to successfully develop new specialty businesses; |
• | actions taken by rating agencies from time to time with respect to us, such as financial strength or credit rating downgrades or placing our ratings on negative watch; |
• | changes in laws or regulations, or their interpretations, which are applicable to us, our competitors, our agents or our customers; |
• | participation in guaranty funds and mandatory market mechanisms; |
• | changes to current shareholder dividend practice and regulatory restrictions on dividends; |
• | credit risk exposure in certain of our business operations; |
• | our ability to retain key personnel; |
• | our status as a subsidiary of White Mountains, including potential conflicts of interest; |
• | changes in tax laws or tax treaties; and |
• | other factors, most of which are beyond our control. |
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Consequently, all of the forward-looking statements made in this report are qualified by these cautionary statements, and there can be no assurance that the anticipated results or developments will be realized or, even if substantially realized, that they will have the expected consequences. The forward-looking statements in this report speak only as of the date on which they are made. We assume no obligation to update publicly any such forward-looking statements, whether as a result of new information, future events or otherwise.
ITEM 7A. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
Our consolidated balance sheet includes a substantial amount of assets and liabilities whose fair values are subject to market risk. The term market risk refers to the risk of loss arising from adverse changes in interest rates, credit spreads, equity market prices and other relevant market rates and prices. Due to our sizable investment portfolio, market risk can have a significant effect on OneBeacon's consolidated financial position.
Interest Rate Risk
Fixed Maturity Investments. In connection with our consolidated insurance subsidiaries, we invest in interest rate sensitive securities. Our portfolio of fixed maturity investments held for general investment purposes are classified as trading securities which 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 in revenues.
We generally manage the interest rate risk associated with our portfolio of fixed maturity investments by monitoring the average duration of the portfolio. Our fixed maturity portfolio is comprised primarily of investment and non-investment grade debt securities issued by corporations, U.S. government and agency obligations, municipal obligations, preferred stocks, and mortgage and asset-backed securities.
Increases and decreases in prevailing interest rates generally translate into decreases and increases in fair values of fixed maturity investments, respectively. Additionally, fair values of interest rate sensitive instruments may be affected by the creditworthiness of the issuer, prepayment options, relative values of alternative investments, the liquidity of the instrument and other market factors.
The table below summarizes the estimated effects of hypothetical increases and decreases in market interest rates on our fixed maturity investments:
Fair value at December 31, 2016 | Assumed change in relevant interest rate | Estimated fair value after change in interest rate | After tax increase (decrease) in carrying value | |||||||||||
($ in millions) | ||||||||||||||
Fixed maturity investments | $ | 2,169.1 | 100 bp decrease | $ | 2,217.9 | $ | 36.1 | |||||||
50 bp decrease | 2,195.5 | 19.5 | ||||||||||||
50 bp increase | 2,141.9 | (20.3 | ) | |||||||||||
100 bp increase | 2,114.0 | (41.2 | ) | |||||||||||
The magnitude of the fair value decrease in rising rates scenarios may be more significant than the fair value increase in comparable falling rates scenarios. This can occur because (a) the analysis floors interest rates at a de-minimis level in falling rate scenarios, muting price increases, (b) portions of the fixed maturity investment portfolio may be callable, muting price increases in falling rate scenarios and (c) portions of the fixed maturity investment portfolio may experience cash flow extension in higher rate environments, which generally results in lower prices.
Surplus notes. See "Item 7—Management's Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Estimates—1. Fair Value Measurements" for sensitivity analysis with respect to the interest rate risk related to our surplus notes.
Long-term obligations. As of December 31, 2016, our interest and dividend bearing long-term obligations consisted of the 2012 Senior Notes which have a fixed interest rate. As a result, our exposure to interest rate risk resulting from variable interest rate obligations is insignificant.
The 2012 Senior Notes were issued in 2012 and mature on November 9, 2022. As of December 31, 2016, the fair value of the 2012 Senior Notes was $274.2 million, which compared to a carrying value of $273.2 million. The fair value of this obligation was estimated by using quoted market prices.
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Credit Spread Risk
Sensitivity analysis of spread risk. Widening and tightening of spreads generally translate into decreases and increases in fair values of fixed maturity investments, respectively.
The table below summarizes the estimated pre-tax effects of hypothetical widening and tightening of credit spreads for different classes of our fixed maturity investments.
December 31, 2016 Fair Value | Tighten 50 | Tighten 25 | Widen 25 | Widen 50 | ||||||||||||||||
($ in millions) | ||||||||||||||||||||
U.S. Government | $ | 167.3 | $ | — | $ | — | $ | — | $ | — | ||||||||||
Foreign government obligations | 1.2 | — | — | — | — | |||||||||||||||
December 31, 2016 Fair Value | Tighten 100 | Tighten 50 | Widen 50 | Widen 100 | ||||||||||||||||
($ in millions) | ||||||||||||||||||||
Agency mortgage-backed securities | $ | 286.6 | $ | 7.0 | $ | 4.0 | $ | (4.3 | ) | $ | (8.5 | ) | ||||||||
Other asset-backed securities | 607.9 | 3.7 | 2.8 | (4.2 | ) | (8.3 | ) | |||||||||||||
December 31, 2016 Fair Value | Tighten 200 | Tighten 100 | Widen 100 | Widen 200 | ||||||||||||||||
($ in millions) | ||||||||||||||||||||
Debt securities issued by corporations | $ | 763.1 | $ | 27.8 | $ | 19.6 | $ | (22.1 | ) | $ | (43.8 | ) | ||||||||
Municipal obligations | 70.5 | 3.9 | 2.5 | (2.6 | ) | (5.1 | ) | |||||||||||||
December 31, 2016 Fair Value | Tighten 400 | Tighten 200 | Widen 200 | Widen 400 | ||||||||||||||||
($ in millions) | ||||||||||||||||||||
Non-agency commercial mortgage-backed securities | $ | 123.6 | $ | 10.3 | $ | 6.8 | $ | (7.5 | ) | $ | (14.5 | ) | ||||||||
December 31, 2016 Fair Value | Tighten 600 | Tighten 300 | Widen 300 | Widen 600 | ||||||||||||||||
($ in millions) | ||||||||||||||||||||
Preferred stocks | $ | 13.9 | $ | 2.0 | $ | 2.0 | $ | (5.3 | ) | $ | (7.8 | ) | ||||||||
Non-agency residential mortgage-backed securities | 135.0 | 9.0 | 9.0 | (12.2 | ) | (22.3 | ) | |||||||||||||
The magnitude of the fair value decrease in wider credit spread scenarios may be more significant than the fair value increase in comparable tighter credit spread scenarios. This can occur because the analysis limits the credit spread tightening in order to floor yields of non-government bonds above yields of short government bonds, muting price increases.
Surplus notes. See "Item 7—Management's Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Estimates—1. Fair Value Measurements" for sensitivity analysis with respect to the credit spread risk related to our surplus notes.
Equity Price Risk
The carrying values of our common equity securities and other investments are based on quoted market prices or management's estimates of fair value as of the balance sheet date. Market prices of common equity securities, in general, are subject to fluctuations. These fluctuations could cause the amount realized upon sale or exercise of these instruments to differ significantly from the current reported value. The fluctuations may result from perceived changes in the underlying economic characteristics of the investment, the relative price of alternative investments, supply and demand imbalances for a particular security or other market factors.
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Sensitivity analysis of likely changes in fair values of common equity securities, hedge funds and private equity funds
Our investment portfolio includes investments in common equity securities and other investments, including hedge funds and private equity funds. The underlying investments of the hedge funds and private equity funds consists of publicly traded and private common equity investments, and, as such, are subject to market risks that are similar to those in our common equity securities portfolio.
The table below summarizes the estimated pre-tax effects from hypothetical changes in market value as of December 31, 2016:
Change in fair value | ||||||||||||||||
10% decline | 10% increase | 30% decline | 30% increase | |||||||||||||
($ in millions) | ||||||||||||||||
Common equity securities | $ | (18.9 | ) | $ | 18.9 | $ | (56.6 | ) | $ | 56.6 | ||||||
Hedge funds | (1.8 | ) | 1.8 | (5.5 | ) | 5.5 | ||||||||||
Private equity funds | (3.4 | ) | 3.4 | (10.1 | ) | 10.1 | ||||||||||
Foreign Exposure Risk
Our investment portfolio consists of investments issued in 10 countries worldwide. The United States represents the country of issue for approximately 94% of our investment portfolio and we have zero sovereign risk exposure to European peripheral countries such as Greece, Portugal, Spain and Italy as of December 31, 2016. We could have indirect exposure to European peripheral countries through securities issued from non-peripheral countries as issuers of those securities could have exposure to European peripheral countries.
ITEM 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA |
The financial statements and supplementary data have been filed as a part of this Annual Report on Form 10-K as indicated in the Index to Consolidated Financial Statements and Financial Statement Schedules appearing on page F-1 of this report.
ITEM 9. | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE |
None.
ITEM 9A. | CONTROLS AND PROCEDURES |
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer (CEO) and Chief Financial Officer (CFO), as appropriate, to allow timely decisions regarding required financial disclosure.
The CEO and the CFO of OneBeacon (the principal executive officer and principal financial officer, respectively) have evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended) as of December 31, 2016. Based on this evaluation, the CEO and CFO have concluded that as of December 31, 2016, our disclosure controls and procedures are adequate and effective to provide reasonable assurance that material information required to be included in our periodic SEC reports is recorded, processed, summarized and reported within the time periods specified in rules and forms.
The CEO and the CFO have evaluated the effectiveness of our internal control over financial reporting as of December 31, 2016. Based on that evaluation, the CEO and CFO have concluded that our internal control over financial reporting is effective. Management's annual report on internal control over financial reporting is included on page F-85 of this report. The attestation report on the effectiveness of our internal control over financial reporting by PricewaterhouseCoopers LLP is included on page F-86 of this report.
There were no significant changes with respect to our internal control over financial reporting or in other factors that materially affected, or are reasonably likely to materially affect, internal control over financial reporting during the quarter ended December 31, 2016.
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ITEM 9B. | OTHER INFORMATION |
None.
PART III
ITEM 10. | DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE |
a. Directors
Reported under the caption "The Board of Directors" in the Company's 2017 Definitive Proxy Statement, and incorporated herein by reference.
b. Executive Officers
See “Item 1. Business—Executive Officers."
c. Audit Committee and Audit Committee Financial Expert
Reported under the caption "Corporate Governance—Committees of the Board—Audit Committee" of the Company's 2017 Definitive Proxy Statement, and incorporated herein by reference.
d. Compliance with Section 16(a) of the Exchange Act
Reported under the caption "Section 16(a) Beneficial Ownership Reporting Compliance" of the Company's 2017 Definitive Proxy Statement, and incorporated herein by reference.
e. Code of Ethics
The Company's Code of Business Conduct, which applies to all directors, officers and employees in carrying out their responsibilities to and on behalf of the Company, is posted on the Company's website at www.onebeacon.com. Any changes to the Company’s Code of Business Conduct will also be posted on the Company’s website, along with any waivers of such code granted to the principal executive officer, principal financial officer or principal accounting officer.
f. Nominating Committee
There have been no material changes to the procedures by which shareholders may recommend nominees to the Company's Board of Directors. The procedures for shareholders to nominate directors may be found in the Company's 2017 Definitive Proxy Statement under the caption "Corporate Governance-Nominating and Governance Committee-Procedures for Nominating Director Candidates" and incorporated herein by reference.
ITEM 11. | EXECUTIVE COMPENSATION |
Reported under the captions "Executive Compensation" (including "Compensation Committee Report"), "Compensation of Directors," and "Corporate Governance—Committees of the Board—Compensation Committee Interlocks and Insider Participation" of the Company's 2017 Definitive Proxy Statement, and incorporated herein by reference.
ITEM 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS |
Reported under the captions "Voting Securities and Principal Holders Thereof" and "Equity Compensation Plan Information" of the Company's 2017 Definitive Proxy Statement, and incorporated herein by reference.
ITEM 13. | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE |
Reported under the caption "Transactions with Related Persons, Promoters and Certain Control Persons" and "Corporate Governance" of the Company's 2017 Definitive Proxy Statement, and incorporated herein by reference.
ITEM 14. | PRINCIPAL ACCOUNTANT FEES AND SERVICES |
Reported under the caption "Independent Registered Public Accountant Fees and Services" of the Company's 2017 Definitive Proxy Statement, and incorporated herein by reference.
67
PART IV
ITEM 15. | EXHIBITS AND FINANCIAL STATEMENT SCHEDULES |
a. Documents Filed as Part of the Report
The financial statements and financial statement schedules and reports of independent auditors have been filed as part of this Annual Report on Form 10-K as indicated in the Index to Consolidated Financial Statements and Financial Statement Schedules appearing on page F-1 of this report. A listing of exhibits filed as part of the report appears below.
b. Exhibits
EXHIBIT INDEX
Exhibit No. | Description | |
2.1 | ** | Separation Agreement between White Mountains Insurance Group, Ltd. and OneBeacon Insurance Group, Ltd incorporated by reference to Exhibit 2.1 to the Company's Registration Statement on Form S-1 Amendment No. 3 filed on October 20, 2006 (Commission File No. 333-136287). |
3.2 | ** | Memorandum of Association of OneBeacon Insurance Group, Ltd incorporated by reference to Exhibit 3.1 to the Company's Registration Statement on Form S-1 Amendment No. 2 filed on October 10, 2006 (Commission File No. 333-136287). |
3.3 | ** | Certificate of Deposit of Memorandum of Increase of Share Capital dated October 31, 2006 incorporated by reference to Exhibit 3.1.1 to the Company's Registration Statement on Form S-1 Amendment No. 4 filed on November 3, 2006 (Commission File No. 333-136287). |
3.4 | ** | Amended and Restated Bye-laws of OneBeacon Insurance Group, Ltd. incorporated by reference to Exhibit 3.2 to the Company Registration Statement on Form S-1 Amendment No. 3 filed on October 20, 2006 (Commission File No. 333-136287). |
4.1 | ** | Specimen Class A common share certificate incorporated by reference to Exhibit 4.1 to the Company Registration Statement on Form S-1 Amendment No. 3 filed on October 20, 2006 (Commission File No. 333-136287). |
4.2 | ** | Indenture, dated as of November 9, 2012, among OneBeacon U.S. Holdings, Inc., the Company, and The Bank of New York Mellon Trust Company, N.A., as trustee incorporated by reference to Exhibit 4.1 to the Company's Current Report on Form 8-K filed on November 9, 2012. |
4.3 | ** | First Supplemental Indenture, dated as of November 9, 2012, among OneBeacon U.S. Holdings, Inc., the Company and The Bank of New York Mellon Trust Company, N.A., as trustee incorporated by reference to Exhibit 4.2 to the Company's Current Report on Form 8-K filed on November 9, 2012. |
4.4.1 | ** | Registration Rights Agreement between OneBeacon Insurance Group, Ltd. and White Mountains Insurance Group, Ltd. incorporated by reference to Exhibit 4.3 to the Company's Registration Statement on Form S-1 Amendment No. 2 filed on October 10, 2006 (Commission File No. 333-136287). |
4.4.2 | ** | Form of Joinder to Registration Rights Agreement between OneBeacon Insurance Group, Ltd. and White Mountains Insurance Group, Ltd. which was executed by each of Lone Tree Holdings, Ltd. and Bridge Holdings (Bermuda), Ltd. incorporated by reference to Exhibit 4.4.2 to the Company’s Annual Report on Form 10-K filed on February 27, 2015. |
10.1 | ** | Separation Agreement between White Mountains Insurance Group, Ltd. and OneBeacon Insurance Group, Ltd. (See 2.1.1 of this index) |
10.2.1 | ** | Amended and Restated Investment Management Agreement dated as of December 23, 2014 by and between White Mountains Advisors LLC and OneBeacon Insurance Group, Ltd. incorporated by reference to Exhibit 10.3.1 to the Company’s Annual Report on Form 10-K filed on February 27, 2015. |
10.2.2 | ** | First Amendment dated as of May 1, 2015 to the Amended and Restated Investment Management Agreement dated as of December 23, 2014 by and between White Mountains Advisors LLC and OneBeacon Insurance Group, Ltd. incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q filed on August 3, 2015. |
68
Exhibit No. | Description | |
10.2.3 | ** | Second Amendment dated as of June 1, 2015 to the Amended and Restated Investment Management Agreement dated as of December 23, 2014 by and between White Mountains Advisors LLC and OneBeacon Insurance Group, Ltd. incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q filed on May 2, 2016. |
10.2.4 | ** | Third Amendment dated as of February 10, 2016 to the Amended and Restated Investment Management Agreement dated as of December 23, 2014 by and between White Mountains Advisors LLC and OneBeacon Insurance Group, Ltd. incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q filed on May 2, 2016. |
10.3.1 | * | $57,900,000 Seller Priority Surplus Note, dated as of December 23, 2014, of Bedivere Insurance Company (formerly OneBeacon Insurance Company) |
10.3.2 | * | $43,100,000 Seller Pari Passu Surplus Note, dated as of December 23, 2014, of Bedivere Insurance Company (formerly OneBeacon Insurance Company) |
10.4.1 | ** | OneBeacon 2007 Long-Term Incentive Plan incorporated by reference to Appendix A of the Registrant's Definitive Proxy Statement for the Annual General Meeting of Members filed with the Securities and Exchange Commission on April 13, 2012. |
10.4.2 | ** | OneBeacon's 2016 Management Incentive Plan incorporated by reference to Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q filed on May 2, 2016. |
10.4.3 | ** | OneBeacon Deferred Compensation Plan incorporated by reference to Exhibit 10.4.6 to the Company's Registration Statement on Form S-1 Amendment No. 2 filed on November 8, 2006 (Commission File No. 333-136287). |
10.4.4 | ** | Form of OneBeacon Insurance Group, Ltd. Long-Term Incentive Plan 2014-2016 Performance Share Grant incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed on March 3, 2014. |
10.4.5 | ** | Form of OneBeacon Insurance Group, Ltd. Long-Term Incentive Plan 2015-2017 Performance Share Grant incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed on March 2, 2015. |
10.4.6 | ** | Form of OneBeacon Insurance Group, Ltd. Long-Term Incentive Plan 2015-2017 Performance Unit Grant incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on March 2, 2015. |
10.4.7 | ** | Form of OneBeacon Insurance Group, Ltd. Long-Term Incentive Plan 2015-2016 Performance Unit Grant incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K filed on March 2, 2015. |
10.4.8 | ** | Form of OneBeacon Insurance Group, Ltd. Long-Term Incentive Plan Restricted Share Award Agreement incorporated by reference to Exhibit 10.4 to the Company’s Current Report on Form 8-K filed on March 2, 2015. |
10.4.9 | ** | Form of OneBeacon Insurance Group, Ltd. Long-Term Incentive Plan 2016-2018 Performance Share Grant incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on February 29, 2016. |
10.4.10 | ** | Form of OneBeacon Insurance Group, Ltd. Long-Term Incentive Plan 2016-2018 Performance Unit Grant incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on February 29, 2016. |
10.4.11 | ** | Form of OneBeacon Insurance Group, Ltd. 2016 Special Restricted Share Award Agreement incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K filed on February 29, 2016. |
10.4.12 | ** | Form of OneBeacon Insurance Group, Ltd. 2016-2018 Restricted Share Award Agreement incorporated by reference to Exhibit 10.4 to the Company’s Current Report on Form 8-K filed on February 29, 2016. |
10.4.13 | ** | Restricted Share Award Agreement by and between OneBeacon Insurance Group, Ltd. and T. Michael Miller dated as of May 25, 2011 incorporated by reference to Exhibit 10.42 to the Company’s Current Report on Form 8-K filed on May 31, 2011. |
10.4.14 | ** | Form of Company's Confidentiality and Non-Solicitation Agreement incorporated by reference to Exhibit 10.3 to the Company's Current Report on Form 8-K filed on May 31, 2011. |
10.4.15 | ** | Form of Company’s Confidentiality and Non-Solicitation Agreement incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q filed on May 4, 2015. |
69
Exhibit No. | Description | |
10.5 | ** | Employment Offer Letter for Paul McDonough, dated as of December 5, 2005 incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q filed on April 29, 2013. |
10.6 | ** | Employment Offer Letter for Dennis Crosby, dated as of July 15, 2010 incorporated by reference to Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q filed on April 29, 2013. |
10.7 | ** | Employment Offer Letter for Maureen Phillips, dated as of February 1, 2012 incorporated by reference to Exhibit 10.4 to the Company’s Quarterly Report on Form 10-Q filed on April 29, 2013. |
10.8 | * | Employment Offer Letter for Paul Brehm, dated as of March 31, 2008. |
10.9 | ** | $65,000,000 Credit Agreement, dated as of September 29, 2015 among the Company and OneBeacon U.S. Holdings, Inc., as the Borrowers, U.S. Bank National Association, as the Administrative Agent, an Issuing Lender and the Issuing Agent, and the other Lenders party to the agreement incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q filed on November 2, 2015. |
12.1 | * | Statement of Computation of Ratio of Earnings (Loss) to Fixed Charges. |
21.1 | * | List of Subsidiaries of OneBeacon Insurance Group, Ltd. |
23.1 | * | Consent of PricewaterhouseCoopers LLP. |
24.1 | * | Power of Attorney. |
31.1 | * | Certification of T. Michael Miller pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
31.2 | * | Certification of Paul H. McDonough pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
32.1 | *** | Certification of T. Michael Miller pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
32.2 | *** | Certification of Paul H. McDonough pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
101.1 | *** | The following financial information from OneBeacon Insurance Group, Ltd.'s Annual Report on Form 10-K for the years ended December 31, 2016 and 2015 formatted in XBRL: (i) Consolidated Balance Sheets at December 31, 2016 and 2015; (ii) Consolidated Statements of Operations and Comprehensive Income (Loss) for each of the years ended December 31, 2016, 2015 and 2014; (iii) Consolidated Statements of Common Shareholders' Equity for each of the years ended December 31, 2016, 2015 and 2014; (iv) Consolidated Statements of Cash Flows for each of the years ended December 31, 2016, 2015 and 2014; and (v) Notes to Consolidated Financial Statements. |
_______________________________________________________________________________
* Filed herewith
** Previously filed
*** Furnished herewith
c. Financial Statement Schedules
The financial statement schedules and report of independent registered public accounting firm have been filed as part of this Annual Report on Form 10-K as indicated in the Index to Consolidated Financial Statements and Financial Statement Schedules appearing on page F-1 of this report.
70
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
OneBeacon Insurance Group, Ltd. | |||
By: | /s/ T. MICHAEL MILLER | ||
T. Michael Miller President and Chief Executive Officer | |||
Date: February 27, 2017 | |||
71
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature | Title | Date | ||||
/s/ T. MICHAEL MILLER | President and Chief Executive Officer (Principal Executive Officer) and Director | February 27, 2017 | ||||
T. Michael Miller | ||||||
/s/ PAUL H. MCDONOUGH | Executive Vice President and Chief Financial Officer (Principal Financial Officer) | February 27, 2017 | ||||
Paul H. McDonough | ||||||
/s/ JOHN C. TREACY | Chief Accounting Officer (Principal Accounting Officer) | February 27, 2017 | ||||
John C. Treacy | ||||||
* | Director | February 27, 2017 | ||||
Lowndes A. Smith | ||||||
* | Director | February 27, 2017 | ||||
Raymond Barrette | ||||||
* | Director | February 27, 2017 | ||||
Reid T. Campbell | ||||||
* | Director | February 27, 2017 | ||||
Morgan W. Davis | ||||||
* | Director | February 27, 2017 | ||||
David T. Foy | ||||||
* | Director | February 27, 2017 | ||||
Lois W. Grady | ||||||
* | Director | February 27, 2017 | ||||
Ira H. Malis | ||||||
* | Director | February 27, 2017 | ||||
Patrick A. Thiele | ||||||
* | Director | February 27, 2017 | ||||
Kent D. Urness | ||||||
* By | /s/ PAUL H. MCDONOUGH | |||||
Paul H. McDonough, As Attorney-in-Fact | ||||||
72
ONEBEACON INSURANCE GROUP, LTD.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND
FINANCIAL STATEMENT SCHEDULES
Form 10-K Page(s) | ||
Audited Consolidated Financial Statements | ||
Other Financial Information | ||
Financial Statement Schedules | ||
F-1
ONEBEACON INSURANCE GROUP, LTD.
CONSOLIDATED BALANCE SHEETS
December 31, | ||||||||
2016 | 2015 | |||||||
(in millions, except share and per share amounts) | ||||||||
Assets | ||||||||
Investment Securities: | ||||||||
Fixed maturity investments, at fair value (amortized cost: $2,164.4 in 2016 and $2,078.3 in 2015) | $ | 2,169.1 | $ | 2,080.5 | ||||
Short-term investments, at amortized cost (which approximates fair value) | 112.1 | 69.2 | ||||||
Common equity securities, at fair value (amortized cost - $182.3 in 2016 and $295.0 in 2015) | 188.7 | 298.7 | ||||||
Other investments, at fair value (amortized cost - $120.9 in 2016 and $135.6 in 2015) | 150.5 | 143.0 | ||||||
Total investment securities | 2,620.4 | 2,591.4 | ||||||
Cash | 69.6 | 95.2 | ||||||
Reinsurance recoverables | 179.5 | 193.5 | ||||||
Premiums receivable | 228.3 | 219.0 | ||||||
Deferred acquisition costs | 96.3 | 100.7 | ||||||
Ceded unearned premiums | 44.2 | 29.5 | ||||||
Net deferred tax asset | 126.7 | 140.2 | ||||||
Investment income accrued | 11.3 | 10.1 | ||||||
Accounts receivable on unsettled investment sales | 1.4 | 30.5 | ||||||
Other assets | 212.2 | 192.5 | ||||||
Total assets | $ | 3,589.9 | $ | 3,602.6 | ||||
Liabilities | ||||||||
Unpaid loss and loss adjustment expense reserves | $ | 1,365.6 | $ | 1,389.8 | ||||
Unearned premiums | 575.1 | 560.3 | ||||||
Funds held under insurance contracts | 153.0 | 137.7 | ||||||
Debt | 273.2 | 272.9 | ||||||
Other liabilities | 197.8 | 237.4 | ||||||
Total liabilities | 2,564.7 | 2,598.1 | ||||||
OneBeacon's common shareholders' equity and noncontrolling interests | ||||||||
OneBeacon's common shareholders' equity | ||||||||
Preference shares (Par value $0.01; 80,000,000 authorized shares; none issued or outstanding) | — | — | ||||||
Common shares and paid-in surplus (Class A: par value $0.01; 200,000,000 authorized shares; 22,592,731 and 23,334,502 issued and outstanding)(Class B: par value $0.01; 200,000,000 authorized shares; 71,754,738 issued and outstanding for both periods) | 1,013.2 | 1,022.0 | ||||||
Retained earnings (deficit) | 12.3 | (15.9 | ) | |||||
Accumulated other comprehensive loss, after tax | (4.2 | ) | (5.2 | ) | ||||
Total OneBeacon's common shareholders' equity | 1,021.3 | 1,000.9 | ||||||
Noncontrolling interests | 3.9 | 3.6 | ||||||
Total OneBeacon's common shareholders' equity and noncontrolling interests | 1,025.2 | 1,004.5 | ||||||
Total liabilities, OneBeacon's common shareholders' equity and noncontrolling interests | $ | 3,589.9 | $ | 3,602.6 | ||||
See Notes to Consolidated Financial Statements, including Note 16—"Commitments and Contingencies."
F-2
ONEBEACON INSURANCE GROUP, LTD.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
Year ended December 31, | ||||||||||||
2016 | 2015 | 2014 | ||||||||||
($ in millions, except per share amounts) | ||||||||||||
Revenues | ||||||||||||
Earned premiums | $ | 1,100.6 | $ | 1,176.2 | $ | 1,177.1 | ||||||
Net investment income | 50.6 | 45.9 | 43.4 | |||||||||
Net realized and change in unrealized investment gains | 37.7 | (35.1 | ) | 40.4 | ||||||||
Net other revenues (expenses) | 5.5 | (0.6 | ) | 5.8 | ||||||||
Total revenues | 1,194.4 | 1,186.4 | 1,266.7 | |||||||||
Expenses | ||||||||||||
Loss and loss adjustment expenses | 656.0 | 700.7 | 815.1 | |||||||||
Policy acquisition expenses | 206.0 | 213.8 | 203.3 | |||||||||
Other underwriting expenses | 209.0 | 218.2 | 179.2 | |||||||||
General and administrative expenses | 14.2 | 15.4 | 13.8 | |||||||||
Interest expense | 13.1 | 13.0 | 13.0 | |||||||||
Total expenses | 1,098.3 | 1,161.1 | 1,224.4 | |||||||||
Pre-tax income from continuing operations | 96.1 | 25.3 | 42.3 | |||||||||
Income tax benefit | 12.5 | 12.9 | 12.3 | |||||||||
Net income from continuing operations | 108.6 | 38.2 | 54.6 | |||||||||
Net loss from discontinued operations, net of tax | — | (0.2 | ) | (20.6 | ) | |||||||
Net income, including noncontrolling interests | 108.6 | 38.0 | 34.0 | |||||||||
Less: Net income attributable to noncontrolling interests | (1.2 | ) | (1.2 | ) | (1.1 | ) | ||||||
Net income attributable to OneBeacon's common shareholders | 107.4 | 36.8 | 32.9 | |||||||||
Net change in benefit plan assets and obligations, net of tax | 1.0 | — | (12.0 | ) | ||||||||
Comprehensive income attributable to OneBeacon's common shareholders | $ | 108.4 | $ | 36.8 | $ | 20.9 | ||||||
Earnings per share attributable to OneBeacon's common shareholders—basic and diluted | ||||||||||||
Net income from continuing operations, per share | $ | 1.13 | $ | 0.38 | $ | 0.55 | ||||||
Net loss from discontinued operations, net of tax, per share | — | — | (0.21 | ) | ||||||||
Net income attributable to OneBeacon's common shareholders per share | $ | 1.13 | $ | 0.38 | $ | 0.34 | ||||||
Dividends declared and paid per OneBeacon's common share | $ | 0.84 | $ | 0.84 | $ | 0.84 | ||||||
See Notes to Consolidated Financial Statements.
F-3
ONEBEACON INSURANCE GROUP, LTD.
CONSOLIDATED STATEMENTS OF COMMON SHAREHOLDERS' EQUITY
OneBeacon's Common Shareholders' Equity | Total OneBeacon's common shareholders' equity and noncontrolling interests | |||||||||||||||||||||||||
Common shares outstanding | Common shares and paid-in surplus | Retained earnings (deficit) | AOCI | Common shareholders' equity | Noncontrolling interests, after tax | |||||||||||||||||||||
($ in millions) | ||||||||||||||||||||||||||
Balances at January 1, 2014 | 95,404,138 | $ | 1,022.5 | $ | 74.4 | $ | 6.8 | $ | 1,103.7 | $ | 3.1 | $ | 1,106.8 | |||||||||||||
Comprehensive income (loss): | ||||||||||||||||||||||||||
Net income | — | — | 32.9 | — | 32.9 | 1.1 | 34.0 | |||||||||||||||||||
Other comprehensive loss, net of tax | — | — | — | (12.0 | ) | (12.0 | ) | — | (12.0 | ) | ||||||||||||||||
Total comprehensive income (loss) | — | — | 32.9 | (12.0 | ) | 20.9 | 1.1 | 22.0 | ||||||||||||||||||
Amortization of restricted share awards | — | 3.0 | — | — | 3.0 | — | 3.0 | |||||||||||||||||||
Issuance of common shares | 1,115 | — | — | — | — | 0.2 | 0.2 | |||||||||||||||||||
Repurchase and retirement of common shares | (108,866 | ) | (1.8 | ) | — | — | (1.8 | ) | — | (1.8 | ) | |||||||||||||||
Dividends | — | — | (80.0 | ) | — | (80.0 | ) | (0.9 | ) | (80.9 | ) | |||||||||||||||
Balances at December 31, 2014 | 95,296,387 | $ | 1,023.7 | $ | 27.3 | $ | (5.2 | ) | $ | 1,045.8 | $ | 3.5 | $ | 1,049.3 | ||||||||||||
Comprehensive income: | ||||||||||||||||||||||||||
Net income | — | — | 36.8 | — | 36.8 | 1.2 | 38.0 | |||||||||||||||||||
Other comprehensive income, net of tax | — | — | — | — | — | — | — | |||||||||||||||||||
Total comprehensive income | — | — | 36.8 | — | 36.8 | 1.2 | 38.0 | |||||||||||||||||||
Amortization of restricted share awards | — | 2.0 | — | — | 2.0 | — | 2.0 | |||||||||||||||||||
Issuance of common shares | 81,000 | — | — | — | — | 0.1 | 0.1 | |||||||||||||||||||
Repurchase and retirement of common shares | (288,147 | ) | (3.7 | ) | — | — | (3.7 | ) | — | (3.7 | ) | |||||||||||||||
Dividends | — | — | (80.0 | ) | — | (80.0 | ) | (1.2 | ) | (81.2 | ) | |||||||||||||||
Balances at December 31, 2015 | 95,089,240 | $ | 1,022.0 | $ | (15.9 | ) | $ | (5.2 | ) | $ | 1,000.9 | $ | 3.6 | $ | 1,004.5 | |||||||||||
Comprehensive income: | ||||||||||||||||||||||||||
Net income | — | — | 107.4 | — | 107.4 | 1.2 | 108.6 | |||||||||||||||||||
Other comprehensive income, net of tax | — | — | — | 1.0 | 1.0 | — | 1.0 | |||||||||||||||||||
Total comprehensive income | — | — | 107.4 | 1.0 | 108.4 | 1.2 | 109.6 | |||||||||||||||||||
Amortization of restricted share awards | — | 2.7 | — | — | 2.7 | — | 2.7 | |||||||||||||||||||
Issuance of common shares | 173,559 | — | — | — | — | 0.1 | 0.1 | |||||||||||||||||||
Repurchase and retirement of common shares | (915,330 | ) | (11.5 | ) | — | — | (11.5 | ) | — | (11.5 | ) | |||||||||||||||
Dividends | — | — | (79.2 | ) | — | (79.2 | ) | (1.0 | ) | (80.2 | ) | |||||||||||||||
Balances at December 31, 2016 | 94,347,469 | $ | 1,013.2 | $ | 12.3 | $ | (4.2 | ) | $ | 1,021.3 | $ | 3.9 | $ | 1,025.2 | ||||||||||||
See Notes to Consolidated Financial Statements.
F-4
ONEBEACON INSURANCE GROUP, LTD.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31, | ||||||||||||
2016 | 2015 | 2014 | ||||||||||
($ in millions) | ||||||||||||
Cash flows from operations: | ||||||||||||
Net income including noncontrolling interests | $ | 108.6 | $ | 38.0 | $ | 34.0 | ||||||
Charges (credits) to reconcile net income to cash flows provided from operations: | ||||||||||||
Net loss from discontinued operations | — | 0.2 | 20.6 | |||||||||
Net realized and change in unrealized investment gains | (37.7 | ) | 35.1 | (40.4 | ) | |||||||
Net adjustment to gain on sale of business | (0.5 | ) | 3.7 | — | ||||||||
Deferred income tax expense (benefit) | 15.4 | (5.8 | ) | (19.0 | ) | |||||||
Other operating items: | ||||||||||||
Net change in loss and LAE reserves | (24.2 | ) | 47.6 | 287.9 | ||||||||
Net change in unearned premiums | 14.8 | (28.0 | ) | 43.4 | ||||||||
Net change in ceded unearned premium | (14.7 | ) | (11.6 | ) | (3.6 | ) | ||||||
Net change in premiums receivable | (9.3 | ) | 22.5 | (13.3 | ) | |||||||
Net change in reinsurance recoverable on paid and unpaid losses | 14.0 | (19.7 | ) | (83.9 | ) | |||||||
Net change in funds held under reinsurance contracts | — | 37.1 | (35.3 | ) | ||||||||
Net change in funds held under insurance contracts | 15.3 | 56.7 | 17.7 | |||||||||
Net change in other assets and liabilities | (34.4 | ) | 16.6 | (56.1 | ) | |||||||
Net cash provided from operations—continuing operations | 47.3 | 192.4 | 152.0 | |||||||||
Net cash used for operations—discontinued operations | — | (0.5 | ) | (54.5 | ) | |||||||
Net cash provided from operations | 47.3 | 191.9 | 97.5 | |||||||||
Cash flows from investing activities: | ||||||||||||
Net maturities, purchases and sales of short-term investments | (42.9 | ) | 133.1 | (65.5 | ) | |||||||
Maturities of fixed maturity investments | 543.5 | 262.4 | 396.4 | |||||||||
Sales of fixed maturity investments | 752.9 | 763.5 | 1,843.1 | |||||||||
Sales of common equity securities | 384.9 | 345.6 | 240.2 | |||||||||
Return of capital and distributions of other investments | 11.6 | 40.5 | 53.4 | |||||||||
Purchases of fixed maturity investments | (1,395.9 | ) | (1,333.5 | ) | (2,206.8 | ) | ||||||
Purchases of common equity securities | (260.0 | ) | (323.5 | ) | (202.4 | ) | ||||||
Contributions for other investments | (1.0 | ) | (4.2 | ) | (81.9 | ) | ||||||
Net change in unsettled investment purchases and sales | 29.1 | (23.8 | ) | (15.0 | ) | |||||||
Proceeds from sale of property and equipment | — | 56.8 | — | |||||||||
Net acquisitions of property and equipment | (2.7 | ) | (11.5 | ) | (2.2 | ) | ||||||
Net cash provided from (used for) investing activities—continuing operations | 19.5 | (94.6 | ) | (40.7 | ) | |||||||
Net cash provided from investing activities—discontinued operations | — | — | — | |||||||||
Net cash provided from (used for) investing activities | 19.5 | (94.6 | ) | (40.7 | ) | |||||||
Cash flows from financing activities: | ||||||||||||
Cash dividends paid to common shareholders | (79.2 | ) | (80.0 | ) | (80.0 | ) | ||||||
Repurchases and retirements of common stock | (11.5 | ) | (3.7 | ) | (1.8 | ) | ||||||
Payments on capital lease obligation | (1.7 | ) | (5.4 | ) | (5.3 | ) | ||||||
Net cash used for financing activities—continuing operations | (92.4 | ) | (89.1 | ) | (87.1 | ) | ||||||
Net cash used for financing activities—discontinued operations | — | — | — | |||||||||
Net cash used for financing activities | (92.4 | ) | (89.1 | ) | (87.1 | ) | ||||||
Net (decrease) increase in cash during period | (25.6 | ) | 8.2 | (30.3 | ) | |||||||
Cash transferred with sale of business | — | — | (50.8 | ) | ||||||||
Net (decrease) increase after cash transferred with sale of business | (25.6 | ) | 8.2 | (81.1 | ) | |||||||
Cash balance at beginning of period | 95.2 | 87.0 | 168.1 | |||||||||
Cash balance at end of period | $ | 69.6 | $ | 95.2 | $ | 87.0 | ||||||
See Notes to Consolidated Financial Statements.
F-5
NOTE 1. Nature of Operations and Summary of Significant Accounting Policies
Basis of presentation
The accompanying 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 with U.S.-based underwriting operating companies that are property and casualty insurance writers and a Bermuda-based reinsurance company, Split Rock Insurance, Ltd. ("Split Rock"). OneBeacon offers a wide range of specialty insurance products and services primarily through independent agencies, regional and national brokers, wholesalers and managing general agencies.
OneBeacon is 76.1% owned by White Mountains Insurance Group, Ltd. ("White Mountains"), a holding company whose businesses provide property and casualty insurance, and certain other products. The Company's headquarters are located at 26 Reid Street, Hamilton HM 11, Bermuda. The Company's U.S. corporate headquarters are located at 605 North Highway 169, Plymouth, Minnesota, 55441 and its registered office is located at Clarendon House, 2 Church Street, Hamilton HM 11, Bermuda.
On December 23, 2014, OneBeacon completed the sale of its run-off business to a subsidiary of Armour Group Holdings Limited (“Armour”). See Note 2—"Acquisitions and Dispositions" and Note 18—"Discontinued Operations." The run-off business generally included the results of OneBeacon's non-specialty business, including the vast majority of asbestos and environmental reserves (the “Runoff Business,” the sale of which is referred to as the “Runoff Transaction”). The Runoff Business has been presented as discontinued operations in the consolidated statements of operations and cash flows.
OneBeacon's reportable segments are Specialty Products, Specialty Industries and Investing, Financing and Corporate. The Specialty Products segment is comprised of ten active underwriting operating segments, representing an aggregation based on those that offer distinct products and tailored coverages and services to a broad customer base across the United States. The Specialty Industries segment is comprised of six active underwriting operating segments, representing an aggregation based on those that focus on solving the unique needs of a particular customer or industry group. The Investing, Financing and Corporate segment includes the investing and financing activities for OneBeacon on a consolidated basis, and certain other activities conducted through the Company and its intermediate subsidiaries. Certain amounts in the prior period financial statements have been reclassified to conform to the current presentation.
The preparation of financial statements 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.
Significant Accounting Policies
Investment Securities
OneBeacon classifies its portfolio of fixed maturity investments, common equity securities, including exchange traded funds ("ETFs"), and other investments 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 changes in unrealized investment gains on trading securities are reported, on a pre-tax basis, in revenues as net realized and change in unrealized investment gains.
Short-term investments consist of interest-bearing money market funds 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 approximates fair value.
Other investments consist primarily of surplus notes, hedge funds and private equity funds. Surplus notes provided in conjunction with the financing of the Runoff Transaction are measured at estimated fair value based on a discounted expected cash flow model, with changes in fair value reported in total revenues as net realized and change in unrealized investment gains. OneBeacon measures its investments in hedge funds and private equity funds at fair value with changes therein reported in total revenues as net realized and change in unrealized investment gains. Other investments also include an investment in a community reinvestment vehicle which is accounted for at fair value, with changes in fair value reported in total revenues as net realized and change in unrealized investment gains, and a tax advantaged federal affordable housing development fund, which is accounted for under the proportional amortization method.
F-6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 1. Nature of Operations and Summary of Significant Accounting Policies
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"). Fair value measurements are categorized into a 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"). Quoted prices in active markets for identical assets or liabilities have the highest priority ("Level 1"), followed by observable inputs other than quoted prices, including prices for similar but not identical assets or liabilities ("Level 2") and unobservable inputs, including the reporting entity's estimates of the assumptions that market participants would use, having the lowest priority ("Level 3").
As of both December 31, 2016 and 2015, approximately 95% and 92%, respectively, of the investment portfolio recorded at fair value was priced based upon quoted market prices or other observable inputs. Investments valued using Level 1 inputs include fixed maturity investments, primarily investments in U.S. Treasuries, common equity securities and short-term investments, which include U.S. Treasury Bills. Investments valued using Level 2 inputs are comprised primarily of fixed maturity investments, which have been disaggregated into classes, including debt securities issued by corporations, municipal obligations, mortgage and asset-backed securities, foreign government obligations and preferred stocks. Certain ETFs that track U.S. stock indices such as the S&P 500 but are traded on foreign exchanges are also considered Level 2 measurements, as management values such investments using the fund manager's published net asset value ("NAV") to account for the difference in market close times. Fair value estimates for investments that trade infrequently and have few or no observable market prices are classified as Level 3 measurements. Level 3 fair value estimates based upon unobservable inputs include OneBeacon's investments in surplus notes and certain investments in debt and equity securities where quoted market prices are unavailable or are not considered reasonable. OneBeacon determines when transfers between levels have occurred as of the beginning of the period.
OneBeacon uses brokers and outside pricing services to assist in determining fair values. For investments in active markets, OneBeacon uses the quoted market prices provided by outside pricing services to determine fair value. The outside pricing services used by OneBeacon have indicated that if no observable inputs are available for the security, they will not provide a price. In such circumstances, where quoted market prices are unavailable or are not considered reasonable, OneBeacon estimates fair value using industry standard pricing methodologies and observable inputs, such as benchmark yields, reported trades, broker-dealer quotes, issuer spreads, benchmark securities, bids, offers, credit ratings, prepayment speeds, reference data including research publications and other relevant inputs. Given that many fixed maturity investments do not trade on a daily basis, the outside pricing services used by OneBeacon evaluate a wide range of fixed maturity investments by regularly drawing parallels from recent trades and quotes of comparable securities with similar features. The characteristics used to identify comparable fixed maturity investments vary by asset type and take into account market convention.
OneBeacon's process to assess the reasonableness of the market prices obtained from the outside pricing sources covers substantially all of its fixed maturity investments and includes, but is not limited to, the evaluation of pricing methodologies and a review of the pricing services' quality control processes and procedures on at least an annual basis, comparison of our invested asset market prices to prices obtained from different independent pricing vendors on at least a semi-annual basis, monthly analytical reviews of certain prices and a review of the underlying assumptions utilized by our pricing services for selected measurements on an ad hoc basis throughout the year. OneBeacon also performs back-testing of selected sales activity to determine whether there are any significant differences between the market price used to value the security prior to sale and the actual sale price on an ad-hoc basis throughout the year. Prices provided by the pricing services that vary by more than 5% and $1.0 million from the expected price based on these procedures are considered outliers. Also considered outliers are prices that have not changed from period to period and prices that have trended unusually compared to market conditions. In circumstances where the results of OneBeacon's review process do not appear to support the market price provided by the pricing services, OneBeacon challenges the price. During the past year, nine securities fell outside OneBeacon's expected results, thereby triggering a challenge with the pricing service. If OneBeacon cannot gain satisfactory evidence to support the challenged price, it relies upon its own pricing methodologies to estimate the fair value of the security in question. The fair values of such securities are considered Level 3 measurements.
OneBeacon's investments in debt securities, including mortgage and asset-backed securities, are generally valued utilizing an evaluated pricing process. Key inputs include benchmark yields, benchmark securities, reported trades, issuer spreads, bids, offers, credit ratings and prepayment speeds. Income on mortgage and asset-backed securities is recognized using an effective yield based on anticipated prepayments and the estimated economic life of the securities. When actual prepayments differ significantly from anticipated prepayments, the estimated economic life is recalculated and the remaining unamortized premium or discount is amortized prospectively over the remaining economic life.
F-7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 1. Nature of Operations and Summary of Significant Accounting Policies
OneBeacon's other investments include surplus notes, the fair value of which are estimated using a discounted estimated cash flow method, as described in Note 5—"Investment Securities." Also included in other investments are hedge funds and private equity funds, which are generally carried at fair value based upon OneBeacon's proportionate interest in the underlying fund's NAV, which is deemed to approximate fair value, given that the NAV of the fund reflects the fair value of the fund's underlying investments. 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.
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 NAV. In circumstances where OneBeacon's portion of a fund's NAV 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 NAV is adjusted accordingly. See Note 5—"Investment Securities."
Cash
Cash includes amounts on hand and demand deposits with banks and other financial institutions. Amounts presented in the statements of cash flows are shown net of balances acquired and sold in the purchase or sale of the Company's consolidated subsidiaries.
Insurance Operations
Premiums written are recognized as revenues and are earned ratably over the term of the related policy. Unearned premiums represent the portion of premiums written that are applicable to future insurance coverage provided by policies.
Policy acquisition costs represent commissions, premium taxes, brokerage expenses and other costs which are directly attributable to and vary with the production of business. These costs are deferred and amortized to the extent they relate to successful contract acquisitions over the applicable premium recognition period. Policy acquisition costs deferred were $229.0 million, $237.3 million and $237.6 million for the years ended December 31, 2016, 2015 and 2014, respectively, all of which were included in policy acquisition expenses, with the exception of $20.4 million, $21.3 million and $22.9 million for each respective period that were deferred relating to other underwriting expenses. Policy acquisition costs amortized were $232.7 million, $239.7 million and $227.6 million for the years ended December 31, 2016, 2015 and 2014, respectively, all of which were included in policy acquisition expenses, with the exception of $20.7 million, $22.2 million and $23.0 million for each respective period that were amortized relating to other underwriting expenses.
Deferred acquisition costs are limited to the amount expected to be recovered from future earned premiums and anticipated investment income. This limitation is referred to as a premium deficiency. A premium deficiency is recognized if the sum of expected loss and loss adjustment expenses ("LAE"), unamortized acquisition costs, and maintenance costs exceeds related unearned premiums and anticipated investment income. A premium deficiency is recognized by charging any unamortized acquisition costs to expense to the extent required in order to eliminate the deficiency. If the premium deficiency exceeds unamortized acquisition costs then a liability is accrued for the excess deficiency. There were no premium deficiencies recognized for any years presented.
Loss and LAE are charged against income as incurred. Unpaid loss and LAE reserves are based on estimates (generally determined by claims adjusters, legal counsel and actuarial staff) of the ultimate costs of settling claims, including the effects of inflation and other societal and economic factors. Unpaid loss and LAE reserves represent management's best estimate of ultimate loss and LAE, net of reinsurance and estimated salvage and subrogation recoveries, if applicable. Such estimates are regularly reviewed and updated and any resulting adjustments are reflected in the current period. The process of estimating unpaid loss and LAE reserves involves a considerable degree of judgment by management and the ultimate amount of expense to be incurred could be considerably greater than or less than the amounts currently reflected in the financial statements.
OneBeacon discounts certain of its long-term workers compensation loss and LAE reserves when such liabilities constitute unpaid but settled claims under which the payment pattern and ultimate costs are fixed and determinable on an individual claim basis. OneBeacon discounts these reserves using the statutory rate (2.5% at December 31, 2016 and 2015). As of December 31, 2016 and 2015, the discount on OneBeacon's workers compensation loss and LAE reserves amounted to $1.6 million and $1.1 million, respectively.
F-8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 1. Nature of Operations and Summary of Significant Accounting Policies
OneBeacon's insurance subsidiaries enter into reinsurance contracts to protect their businesses from losses due to concentration of risk, to manage their operating leverage ratios and to limit losses arising from catastrophic events. The majority of such reinsurance contracts are executed through excess of loss treaties and catastrophe contracts under which the reinsurer indemnifies for a specified part or all of certain types of losses over stipulated amounts arising from any one occurrence or event. OneBeacon has also entered into quota share treaties with reinsurers under which all risks meeting prescribed criteria are covered on a pro rata basis. The amount of each risk ceded by OneBeacon is subject to maximum limits which vary by line of business and type of coverage. See Note 4—"Reinsurance."
Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policies. The collectibility of reinsurance recoverables is subject to the solvency of the reinsurers. OneBeacon is selective in regard to its reinsurers, principally placing reinsurance with those reinsurers with strong financial condition, reputation, industry ratings and underwriting ability. Management monitors the financial condition and ratings of its reinsurers on an ongoing basis.
Reinsurance premiums, commissions, expense reimbursements and reserves related to reinsured business are accounted for on a basis consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. Premiums ceded to other companies are reported as a reduction of premiums written. Expense allowances received in connection with reinsurance ceded have been accounted for as a reduction of the related policy acquisition costs and are deferred and amortized accordingly.
Funds Held
Funds held under insurance contracts represent unrestricted collateral held by the Company primarily relating to the Surety business.
Mandatory Shared Market Mechanisms
As a condition of its licenses to do business in certain states, OneBeacon's insurance operations are required to participate in various mandatory shared market mechanisms commonly referred to as "residual" or "involuntary" markets. These markets generally consist of risks considered to be undesirable from a standard or routine underwriting perspective. Each state dictates the levels of insurance coverage that are mandatorily assigned to participating insurers within these markets. The total amount of such business an insurer must accept in a particular state is generally based on that insurer's market share of voluntary business written within that state. In certain cases, OneBeacon is obligated to write business from shared market mechanisms at a future date based on its historical market share of all voluntary policies written within that state. Involuntary business generated from mandatory shared market mechanisms may be treated as assumed reinsurance depending on the structure of the mechanism.
OneBeacon's market assignments are typically required to be written in the current period, although, in certain cases OneBeacon is required to accept policy assignments at a future date. Anticipated losses associated with future market assignments are recognized when the amount of such anticipated losses is determined to be probable and can be reasonably estimated.
Insurance Related Assessments
Under existing guaranty fund laws in all states, insurers licensed to do business in those states can be assessed for certain obligations of insolvent insurance companies to policyholders and claimants. OneBeacon's insurance subsidiaries record guaranty fund assessments when such assessments are billed by the respective guaranty funds. In addition, OneBeacon will monitor other insurance company insolvencies and will accrue a liability when such losses are determined to be probable and the assessment amounts can be reasonably estimated. The actual amount of such assessments will depend upon the final outcome of rehabilitation proceedings and will be paid over several years.
Capital Lease
In December 2011, the Company entered into lease financing arrangements with US Bancorp Equipment Finance, Inc. ("US Bancorp") and Fifth Third Equipment Finance Company ("Fifth Third") whereby it sold furniture and equipment and capitalized software, respectively, at a cost equal to net book value. The Company then leased the fixed assets back from US Bancorp for a lease term of five years and leased the capitalized software back from Fifth Third for a lease term of four years both of which have now ended. See Note 16—"Commitments and Contingencies."
F-9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 1. Nature of Operations and Summary of Significant Accounting Policies
Deferred Software Costs
OneBeacon capitalizes costs related to computer software developed for internal use during the application development stage of software development projects. These costs generally consist of certain external, payroll and payroll related costs. OneBeacon begins amortization of these costs once the project or the respective phase of the project is completed and ready for its intended use. Amortization is on a straight line basis over the useful life which generally ranges from three to five years. No impairments were recognized during the year ended December 31, 2016, while the Company recognized a $1.6 million pre-tax impairment of certain capitalized software associated with senior management restructuring during the year ended December 31, 2015. OneBeacon had unamortized deferred software costs of $13.4 million and $12.7 million as of December 31, 2016 and 2015, respectively.
Federal and Foreign Income Taxes
The majority of the Company's subsidiaries file consolidated tax returns in the United States. Income earned or losses generated by companies outside the United States are generally subject to an overall effective tax rate lower than that imposed by the United States.
Deferred tax assets and liabilities are recorded when a difference between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts for tax purposes exists, and for other temporary differences. The deferred tax asset or liability is recorded based on tax rates expected to be in effect when the difference reverses. The deferred tax asset is recognized when it is more likely than not that it will be realized.
Foreign Currency Exchange
The U.S. dollar is the functional currency for all of OneBeacon's businesses. OneBeacon is subject to foreign currency fluctuations associated with foreign investment securities. Assets and liabilities recorded in foreign currencies are translated into U.S. dollars at exchange rates in effect at the balance sheet date, and revenues and expenses are converted using the average exchange rates for the period. Net foreign exchange gains and losses arising from the translation are reported as a component of net income in the period in which they arise.
Variable Interest Entities
OneBeacon consolidates a reciprocal insurance exchange ("reciprocal") as a variable interest entity ("VIE"), when it has both the power to direct the activities of the VIE that most significantly impact its economic performance and either the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE. See Note 13—"Variable Interest Entities ("VIE")."
Defined Benefit Plans
OneBeacon sponsors defined benefit plans and recognizes the funded status of the difference between plan assets at fair value and the projected benefit obligation (for defined benefit pension plans) or the accumulated benefit obligation (for other postretirement benefit plans) in its statement of financial position. The Company recognizes amounts previously deferred and amortized in other comprehensive income in the period in which they occur and measure plan assets and obligations as of the fiscal year end. The projected benefit obligation of the OneBeacon qualified pension plan ("Qualified Plan") was calculated using termination assumptions as of December 31, 2015 and finalized its termination by purchasing a group annuity contract and making lump sum distributions to plan participants electing such payments during the year ended December 31, 2016, and as a result of these transactions, no longer has a projected benefit obligation with respect to the Qualified Plan. See Note 8—"Retirement Plans."
Recently Adopted Changes in Accounting Principles
Short Duration Contracts
Effective December 31, 2016, OneBeacon adopted ASU 2015-09, Disclosures about Short Duration Contracts (ASC 944) which requires expanded footnote disclosures about loss and LAE reserves. Upon adoption, OneBeacon modified its footnote disclosures to include loss development tables on a disaggregated basis by accident year and a reconciliation of loss development data to the loss and LAE reserves reflected on the balance sheet. The footnote disclosures have also been expanded to include information about claim frequency data, including a description of how the claims frequency data is measured. Prior year disclosures have been modified to conform to the new disclosures.
F-10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 1. Nature of Operations and Summary of Significant Accounting Policies
Business Combinations - Measurement Period Adjustments
Effective January 1, 2016, OneBeacon adopted ASU 2015-16, Simplifying the Accounting for Measurement-Period Adjustments, which requires adjustments to provisional amounts recorded in connection with a business combination that are identified during the measurement period to be recorded in the reporting period in which the adjustment amounts are determined, rather than as retroactive adjustments to prior periods. OneBeacon has not recognized any adjustments to estimated purchase accounting amounts for the year ended December 31, 2016 and accordingly, there was no effect to OneBeacon's financial statements upon adoption.
Fair Value Measurements
Effective January 1, 2016, OneBeacon adopted ASU 2015-07, Fair Value Measurement - Disclosures for Investments in Certain Entities that Calculate Net Asset Value per Share (or Its Equivalent) (ASC 820) which eliminates the requirement to disclose the fair value hierarchy level for investments for which fair value is measured at NAV using the practical expedient in ASC 820. OneBeacon measures the fair value of its investments in hedge funds and private equity funds using this practical expedient. Upon adoption, these fair value measurements are no longer classified within the fair value hierarchy. Prior year amounts have been modified to conform to the current year's disclosures.
Amendments to Consolidation Analysis
On January 1, 2016, OneBeacon adopted ASU 2015-02, Amendments to the Consolidation Analysis (ASC 810) which amends the guidance for determining whether an entity is a VIE. ASU 2015-02 eliminates the separate consolidation guidance for limited partnerships and with it, the presumption that a general partner should consolidate a limited partnership. In addition, ASU 2015-02 changes the guidance for determining if fee arrangements qualify as variable interests and the effect fee arrangements have on the determination of the primary beneficiary. Adoption of ASU 2015-02 did not affect the consolidation analysis for any of OneBeacon's investments.
Share-Based Compensation Awards
On January 1, 2016, OneBeacon adopted ASU 2014-12, Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period (ASC 718). The new guidance requires that a performance target that affects vesting and that can be achieved after the requisite service period be treated as a performance condition. Compensation cost is to be recognized in the period when it becomes probable the performance target will be achieved in an amount equal to the compensation cost attributable to the periods for which service has been rendered. Adoption did not have a significant effect on OneBeacon's financial position, results of operations, cash flows, presentation or disclosures.
Debt Issuance Costs
Effective January 1, 2016, OneBeacon adopted ASU 2015-03, Imputation of Interest (ASC 835) which requires debt issuance costs to be presented as a deduction from the carrying amount of the related debt, consistent with the treatment required for debt discounts. The new guidance requires amortization of debt issuance costs to be classified within interest expense and also requires disclosure of the debt's effective interest rate. OneBeacon has applied the guidance retrospectively and as a result has reclassified $1.9 million of unamortized debt issuance costs from other assets, reflecting these amounts as a reduction from the related debt and has modified its disclosures to include the required effective interest rate on its debt. As of December 31, 2016, the unamortized debt issuance costs included in debt is $1.6 million. In addition, effective January 1, 2016, OneBeacon adopted ASU 2015-15, Imputation of Interest (ASC 835), which addresses the presentation and subsequent measurement of debt issuance costs related to line-of-credit arrangements. Adoption of ASU 2015-15 did not have a significant effect on OneBeacon's financial position, results of operations, cash flows, presentation or disclosures.
F-11
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 1. Nature of Operations and Summary of Significant Accounting Policies
Recently Issued Accounting Pronouncements
Cash Flow Statement
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments (ASC 230), which addresses the classification and presentation of certain items, including debt prepayment and extinguishment costs, contingent consideration payments made after a business combination and distributions received from equity method investees, for which there was diversity in practice. In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows: Restricted Cash (ASC 230). Under current guidance, restricted amounts of cash or cash equivalents are excluded from the cash flow statement. The new guidance requires restricted cash and restricted cash equivalents to be included in the reconciliation of beginning and end-of-period amounts presented on the statement of cash flows. In addition, the new guidance requires a description of the nature of the changes in restricted cash and cash equivalents during the periods presented. The updated guidance in ASU 2016-15 and ASU 2016-18 are both effective for interim and annual reporting periods beginning after December 15, 2017, with early adoption permitted. OneBeacon is evaluating the expected impact of this new guidance.
Credit Losses
In June 2016, the FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments (ASC 326), which establishes new guidance for the recognition of credit losses for financial assets measured at amortized cost. The new ASU, which applies to financial assets that have the contractual right to receive cash, including reinsurance receivables, requires reporting entities to estimate the credit losses expected over the life of a credit exposure using historical information, current information and reasonable and supportable forecasts that affect the collectability of the financial asset. ASU 2016-13 is effective for annual periods beginning after January 1, 2020, including interim periods. OneBeacon measures financial assets at fair value with changes therein recognized in current period earnings and accordingly, does not expect adoption to have a significant impact on its financial statements.
Stock Compensation
In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting (ASC 718) which is intended to simplify certain aspects of the accounting for share-based compensation, including forfeiture assumptions,
net settlement of equity awards for withholding taxes and accounting for excess tax benefits. The new guidance provides an
accounting policy election to account for forfeitures by either applying an assumption, as required under existing guidance, or
by recognizing forfeitures when they actually occur. The new ASU also permits net settlement of equity awards for
withholding taxes up to the maximum statutory rate and requires such amounts to be classified as a financing activities in
the statement of cash flows. In addition, the new guidance changes the accounting for excess tax benefits and deficiencies by
requiring recognition in the income statement, with treatment of the tax effects as discrete items in determining a reporting
entity’s effective rate in the period in which exercise or vesting of awards occurs. The new guidance became effective on
January 1, 2017 for OneBeacon and did not have a significant effect upon adoption.
Leases
In February 2016, the FASB issued ASU 2016-02, Leases (ASC 842). The new guidance requires lessees to recognize lease assets and liabilities on the balance sheet for both operating and financing leases, with the exception of leases with an original term of 12 months or less. Under existing guidance recognition of lease assets and liabilities is not required for operating leases. The lease assets and liabilities to be recognized are both measured initially based on the present value of the lease payments. Under the new guidance, a sale-leaseback transaction must meet the recognition criteria under ASC 606, Revenues in order to be accounted for as a sale. The new guidance is effective for OneBeacon for years beginning after December 15, 2018, including interim periods therein. OneBeacon is evaluating the expected impact of this new guidance and available adoption methods.
Financial Instruments - Recognition and Measurement
In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities (ASC 825-10). The new ASU modifies the guidance for financial instruments, including investments in equity securities. Under the new guidance, all equity securities with readily determinable fair values are required to be measured at fair value with changes therein recognized through current period earnings. In addition, the new ASU requires a qualitative assessment for equity investments without readily determinable fair values to identify an impairment, and for impaired equity security investments to be measured at fair value. ASU 2016-01 is effective for fiscal years beginning after December 15, 2017, with early adoption permitted. OneBeacon measures its portfolio of investment securities at fair value with changes therein
F-12
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 1. Nature of Operations and Summary of Significant Accounting Policies
recognized through current period earnings and accordingly, does not expect the adoption of ASU 2016-01 to have a significant impact on its financial statements.
Revenue Recognition
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (ASC 606), which modifies the guidance for revenue recognition. Under ASU 2014-09, revenue is to be recognized at an amount that reflects the consideration to which an entity expects to be entitled in exchange for goods or services transferred to customers. The new guidance sets forth the steps to be followed to recognize revenue: (i) identify the contract(s) with a customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract and (v) recognize revenue when (or as) the entity satisfies a performance obligation. Subsequently, the FASB issued additional ASUs clarifying the guidance in and providing implementation guidance for ASU 2014-09. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers, which delays the effective date of ASU 2014-09 and all related ASUs to annual and interim reporting periods beginning after December 15, 2017. Most of OneBeacon’s revenue from customers relates to insurance contracts, which are excluded from the scope of ASU 2014-09, as are investment income and investments gains and losses. However, the new guidance is applicable to some of OneBeacon’s revenue streams, including certain fee arrangements as well as commissions and other non-insurance revenues. OneBeacon is evaluating the new guidance, but does not expect ASU 2014-09 to have a significant effect on recognition of OneBeacon’s non-insurance revenues from customers.
NOTE 2. Acquisitions and Dispositions
Crop Business
On July 31, 2015, Monsanto Company sold Climate Crop Insurance Agency ("CCIA"), the third party agency with which OneBeacon previously had an exclusive managing general agency agreement, to an affiliate of AmTrust Financial Services, Inc. ("AmTrust"). As a result of the sale, the Company has exited the multiple peril crop insurance ("MPCI") business and its related crop-hail business (collectively, "Crop Business"). As a result of the transaction, OneBeacon and CCIA agreed to an early termination of the existing five year agreement. In connection with the termination of the agreement, OneBeacon received a payment of $3.0 million (pre-tax) recorded in net other revenues (expenses) during the year ended December 31, 2015. Also related to the transaction, OneBeacon withdrew its 2016 Plan of Operations, which previously authorized it to write MPCI for the 2016 Reinsurance Year, and affiliates of AmTrust agreed to reinsure the Company’s remaining net Crop Business exposure for the 2015 Reinsurance Year under a related 100% quota share reinsurance agreement which, coupled with other transfer and assignment agreements as well as communications with policyholders and agents, had the effect of assumption reinsurance. As a result of this transaction, the Company has no material net exposure related to the Crop Business.
Runoff Business
As described in Note 1—"Nature of Operations and Summary of Significant Accounting Policies," on December 23, 2014, OneBeacon completed the sale of its Runoff Business to Armour. OneBeacon provided financing in the form of surplus notes issued by Bedivere Insurance Company ("Bedivere"), one of the legal entities transferred as part of the transaction, having a par value of $101.0 million, which had a fair value of $64.9 million on the date of sale. See Note 18—"Discontinued Operations" for further information.
Essentia Insurance Company
Effective January 1, 2013, OneBeacon completed the sale of Essentia Insurance Company ("Essentia"), which wrote the collector cars and boats business, to Markel Corporation ("Markel"). Concurrently therewith, OneBeacon and Hagerty Insurance Agency ("Hagerty") terminated their underwriting arrangement with respect to the collector cars and boats business. In 2015, the Company recognized in net other revenues (expenses) a $3.7 million negative adjustment to the pre-tax gain on sale of Essentia in connection with an assessment from the Michigan Catastrophic Claims Association ("MCCA") payable to Markel pursuant to the indemnification provisions in the stock purchase agreement governing the sale of Essentia. In 2016, the Company recognized in net other revenues (expenses) a $0.5 million positive adjustment to the pre-tax gain on sale of Essentia resulting from recoveries upon the resolution of a matter relating to the MCCA.
Except as described above, during the years ended December 31, 2016, 2015 and 2014, there were no significant acquisitions or dispositions.
F-13
NOTE 3. Unpaid Loss and Loss Adjustment Expense ("LAE") Reserves
Methodology for Estimating Incurred But Not Reported ("IBNR") Reserves
OneBeacon's insurance subsidiaries establish loss and LAE reserves that are estimates of amounts needed to pay claims and related expenses in the future for insured events that have already occurred. The process of estimating reserves involves a considerable degree of judgment by management and, as of any given date, is inherently uncertain.
Loss and LAE reserves are typically comprised of (1) case reserves for claims reported and (2) IBNR reserves, which include a provision for expected future development on case reserves and for losses that have occurred but for which claims have not yet been reported. Case reserves are estimated based on the experience and knowledge of claims staff regarding the nature and potential cost of each claim and are adjusted as additional information becomes known or payments are made. IBNR reserves are derived by subtracting paid loss and LAE and case reserves from estimates of ultimate loss and LAE. Actuaries estimate ultimate loss and LAE using various generally accepted actuarial methods, as described below, applied to known losses and other relevant information. Like case reserves, IBNR reserves are adjusted as additional information becomes known or payments are made.
Ultimate loss and LAE are generally determined by extrapolation of claim emergence and settlement patterns observed in the past that can reasonably be expected to persist into the future. In forecasting ultimate loss and LAE with respect to any line of business, past experience with respect to that line of business is the primary resource, but cannot be relied upon in isolation. OneBeacon's own experience, particularly claims development experience, such as trends in case reserves, payments on and closings of claims, as well as changes in business mix and coverage limits, is the most important information for estimating its reserves. External data, available from organizations such as statistical bureaus, consulting firms and reinsurance companies, is sometimes used to supplement or corroborate OneBeacon's own experience. External data can be especially useful for estimating costs on newer lines of business (e.g. Surety) or newer business segments (e.g. Programs).
For some lines of business, such as "long-tail" coverages discussed below, claims data reported in the most recent accident or report year or years is often too limited to provide a meaningful basis for analysis due to the typical delay in reporting and settling of claims. For this type of business, OneBeacon uses an expected loss ratio method for the initial accident year or years. This is a standard and accepted actuarial reserve estimation method in these circumstances in which the loss ratio is selected based upon information used in pricing policies for that line of business, as well as any publicly available industry data, such as industry pricing, experience and trends, for that line of business.
Uncertainties in estimating ultimate loss and LAE are magnified by the time lag between when a claim actually occurs and when it is reported and eventually settled. This time lag is sometimes referred to as the "claim-tail." The claim-tail for most property coverages is typically short (usually a few days up to a few months). The claim-tail for casualty coverages, such as automobile liability, general liability including the liability portion of multiple peril coverage, workers compensation, and professional liability can be especially long as claims are often reported and ultimately paid or settled years, even decades, after the related loss events occur. During the long claims reporting and settlement period, additional facts regarding coverages written in prior accident years, as well as about actual claims and trends may become known that cause OneBeacon to adjust its reserves. If management determines that an adjustment is appropriate, the adjustment is booked in the accounting period in which such determination is made. Accordingly, should reserves need to be increased or decreased in the future from amounts currently established, future results of operations would be negatively or positively impacted, respectively.
In determining ultimate loss and LAE, the cost to indemnify claimants, provide needed legal defense and other services for insureds and administer the investigation and adjustment of claims are considered. These claim costs are influenced by many factors that change over time, such as expanded coverage definitions as a result of new court decisions, inflation in costs to repair or replace damaged property, inflation in the cost of medical services, and legislated changes in statutory benefits, as well as by the particular, unique facts that pertain to each claim. As a result, the rate at which claims arose in the past and the costs to settle them may not always be representative of what will occur in the future. The factors influencing changes in claim costs are often difficult to isolate or quantify and developments in paid and incurred losses from historical trends are frequently subject to multiple and conflicting interpretations. Changes in coverage terms or claims handling practices may also cause future experience and/or development patterns to vary from the past. A key objective of actuaries in developing estimates of ultimate loss and LAE and resulting IBNR reserves is to identify aberrations and systemic changes occurring within historical experience and accurately adjust for them so that the future can be projected more reliably. Because of the factors previously discussed, this process requires the use of informed judgment and is inherently uncertain.
F-14
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 3. Unpaid Loss and LAE Reserves
OneBeacon's actuaries use several generally accepted actuarial methods to evaluate its loss and LAE reserves, each of which has its own strengths and weaknesses. OneBeacon places more or less reliance on a particular method based on the facts and circumstances at the time the reserve estimates are made. These methods generally fall into one of the following categories or are hybrids of one or more of the following categories:
• | Historical paid loss development methods: These methods use historical loss payments over discrete periods of time to estimate future losses. Historical paid loss development methods assume that the ratio of losses paid in one period to losses paid in an earlier period will remain constant. These methods necessarily assume that factors that have affected paid losses in the past, such as inflation or the effects of litigation, will remain constant in the future. Because historical paid loss development methods do not use case reserves to estimate ultimate losses, they can be more reliable than the other methods discussed below that look to case reserves (such as actuarial methods that use incurred losses) in situations in which there are significant changes in how case reserves are established by a company's claims adjusters. However, historical paid loss development methods are more leveraged, meaning that small changes in payments have a larger impact on estimates of ultimate losses, than actuarial methods that use incurred losses because cumulative loss payments take much longer to approach the expected ultimate losses than cumulative incurred amounts. In addition, and for similar reasons, historical paid loss development methods are often slow to react to situations when new or different factors arise than those that have affected paid losses in the past. |
• | Historical incurred loss development methods: These methods, like historical paid loss development methods, assume that the ratio of losses in one period to losses in an earlier period will remain constant in the future. However, instead of using paid losses, these methods use incurred losses (i.e., the sum of cumulative historical loss payments plus outstanding case reserves) over discrete periods of time to estimate future losses. Historical incurred loss development methods can be preferable to historical paid loss development methods because they explicitly take into account open cases and the claims adjusters' evaluations of the cost to settle all known claims. However, historical incurred loss development methods necessarily assume that case reserving practices are consistently applied over time. Therefore, when there have been significant changes in how case reserves are established, using incurred loss data to project ultimate losses can be less reliable than other methods. |
• | Expected loss ratio methods: These methods are based on the assumption that ultimate losses vary proportionately with premiums. Expected loss ratios are typically developed based upon the information used in pricing, and are multiplied by the total amount of premiums earned to calculate ultimate losses. Expected loss ratio methods are useful for estimating ultimate losses in the early years of long-tailed lines of business, when little or no paid or incurred loss information is available. |
• | Bornhuetter-Ferguson methods: These methods are a blend of the expected loss ratio and loss development methods. The percent of incurred (or paid) loss to ultimate loss implied by the selected development pattern from the incurred (or paid) loss development method is used to determine the percentage of ultimate loss yet to be developed. Inception to date losses are added to losses yet to be developed, yielding an estimate of ultimate for each accident year. |
• | Adjusted historical paid and incurred loss development methods: These methods take traditional historical paid and incurred loss development methods and adjust them for the estimated impact of changes from the past in factors such as inflation, the speed of claim payments or the adequacy of case reserves. Adjusted historical paid and incurred loss development methods are often more reliable methods of predicting ultimate losses in periods of significant change, provided the actuaries can develop methods to reasonably quantify the impact of changes. |
We perform an actuarial review of our recorded reserves each quarter. As part of that review, our actuaries compare the previous quarter's projections of paid and case reserve activity to amounts experienced in the quarter. Differences between previous estimates and actual experience are evaluated. While some variance is expected each quarter due to the inherent uncertainty in loss and LAE, persistent or large variances would indicate that prior assumptions and/or reliance on certain reserving methods may need to be revised going forward.
Upon completion of each quarterly review, the Company's actuaries select indicated reserve levels based on the results of the actuarial methods described previously, which are the primary consideration in determining management's best estimate of required reserves. However, in making its best estimate, management also considers other qualitative factors that may lead to a difference between held reserves and the actuarial central estimate of reserves. Typically, these factors exist when management and our actuaries conclude that there is insufficient historical incurred and paid loss information or that trends included in the historical incurred and paid loss information are unlikely to repeat in the future. Such factors include, among others, recent
F-15
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 3. Unpaid Loss and LAE Reserves
entry into new markets or new products, improvements in the claims department that are expected to lessen future ultimate loss costs, legal and regulatory developments, or other volatilities that may arise.
Reserve Estimation by Line of Business
The process of establishing loss reserves, including amounts incurred but not reported, is complex and imprecise as it must consider many variables that are subject to the outcome of future events. As a result, informed subjective estimates and judgments as to the ultimate exposure to losses are an integral component of the loss reserving process. OneBeacon categorizes and tracks insurance reserves by "line of business", which are summarized herein as either property (short-tailed) lines, casualty (long-tailed) lines, or other (accident, surety, and credit) lines.
OneBeacon regularly reviews the appropriateness of reserve levels at the line of business level, considering the variety of trends that impact the ultimate settlement of claims for the subsets of claims in each particular line of business.
For loss and allocated LAE reserves, the key assumption as of December 31, 2016 was that the impact of the various reserving factors, as described below, on future paid losses would be similar to the impact of those factors on the historical loss data with the exception of severity trends. Severity trends have been relatively stable over the relevant historical period. The actuarial methods used would project losses assuming continued stability in severity trends. Management has considered a range of assumptions regarding future increases in loss severity trends, including the impact of inflation, in making its reserve selections.
The major causes of material uncertainty (reserving factors) generally will vary for each line, as well as for each separately analyzed component of the line. The following section details reserving factors by major product line. Also, reserving factors can have offsetting or compounding effects on estimated reserves. For example, in workers compensation, the use of expensive medical procedures that result in medical cost inflation may enable workers to return to work faster, thereby lowering indemnity costs. Thus, in almost all cases, it is impossible to discretely measure the effect of a single reserving factor and construct a meaningful sensitivity expectation. Actual results will likely vary from expectations for each of these assumptions, resulting in an ultimate claim liability that is different from that being estimated currently.
Additional causes of material uncertainty exist in most product lines and may impact the types of claims that could occur within a particular operating segment or book of business. Examples where reserving factors, within an operating segment or book of business, are subject to change include changing types of insured (e.g. type of insured vehicle, size of account, industry insured, jurisdiction, etc.), changing underwriting standards, or changing policy provisions (e.g. deductibles, policy limits, or endorsements).
Following is a detailed description of the reserve factors and consideration for each of the major lines of business.
Property Lines
The property (short-tailed) lines represent lines for which the payout of the claim liability occurs shortly after the occurrence of the loss. Reserving for property lines generally involves less uncertainty given the short-tailed nature of these lines.
Property lines, including the property portion of the multiple peril coverage and including Inland Marine coverage, cover losses to a business' premises, inventory and equipment as a result of weather, fire, theft and other causes. Claims associated with property coverage generally take a relatively short period of time to close. The reserve risk is driven by occasional catastrophic events or large single losses. The relatively high attachment points and insured values of the property policies underwritten in the Specialty Property underwriting operating segment present a potentially longer tail and greater uncertainty than our standard property business.
Property also includes the comprehensive and collision coverages of automobile policies characterized by low severity payments that are made quickly. Additionally, Property includes all of the Ocean Marine products. Ocean Marine has property and liability exposure related to commercial hull, marine, and cargo products. The exposure is generally low severity and short to medium tailed.
Casualty Lines
The casualty (long-tailed) lines represent lines for which the loss may not be paid, or even reported, until well after the loss occurred. As a result, the amount of liability may not be known at the date of the loss. Reserving for casualty lines generally involves more uncertainty given these factors.
F-16
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 3. Unpaid Loss and LAE Reserves
Casualty lines cover a variety of losses associated with policies that cover general liability, the liability portion of commercial multiple peril, professional liability, workers compensation, and commercial automobile liability lines. Losses associated with casualty coverage generally take a longer period of time to close claims. Most of the general reserving factors for casualty are applicable across these sub-lines, while certain sub-lines have additional reserving factors.
Casualty lines policies can generally be written on either a claims made or occurrence form. Most professional liability, management liability, and medical professional policies are written on a claims made basis, under which the trigger of loss is based on the date the loss is discovered or the loss is reported to OneBeacon. Professional liability policies cover the defense expenses and damages related to negligence claims brought against the insured professional services firm or government entity. The coverage focuses on damages resulting from an alleged failure to perform, error or omission in the product or service provided by the policyholder. Management liability policies cover the defense expenses and damages related to alleged wrongful acts committed by the directors and officers of the insured organization. Medical professional liability policies cover the defense expenses and damages related to negligence claims brought against the insured health care institution or provider. The coverage focuses on damages resulting from an alleged failure to perform, error or omission in the service provided by the policyholder.
Most general liability policies are written on an occurrence basis under which the trigger of losses are based on the date the loss happened. They cover businesses for any liability resulting from bodily injury and property damage arising from general business operations, accidents on business premises and the products manufactured or sold. Reserves for these policies generally include two components: bodily injury and property damage. Bodily injury payments reimburse the claimant for damages pertaining to physical injury as a result of the policyholder's legal obligation arising from non-intentional acts such as negligence, subject to the insurance policy provisions. In some cases the damages can include future wage loss (which is a function of future earnings power and wage inflation) and future medical treatment costs. Property damage payments result from damages to the claimant's private property arising from the policyholder's legal obligation for non-intentional acts. In most cases, property damage losses are a function of costs as of the loss date or soon thereafter. Defense costs are also a part of the insured costs covered by liability policies and can be significant, sometimes greater than the cost of the actual paid claims, though for some products this risk is mitigated by policy language such that the insured portion of defense costs erodes the amount of policy limit available to pay the claim.
Casualty coverages are generally considered long-tail line business, as it takes a relatively long period of time to finalize and settle claims from a given accident year. The speed of claim reporting and claim settlement is a function of the specific coverage provided and the jurisdiction, among other factors. There are numerous components underlying these product lines. Some of these have relatively moderate payment patterns (with most of the claims for a given accident year closed within 5 to 7 years), while others can have extreme lags in both reporting and payment of claims (e.g., a reporting lag of a decade for "construction defect" claims).
Examples of common reserving factors across casualty lines that can change and, thus, affect estimated casualty reserves include:
• | Changes in claim handling philosophies (e.g., case reserving standards), including the use of third party claims administrators |
• | Changes in the pattern of underlying claims, including frequency and severity |
• | Changes in policy provisions or court interpretations of such provisions |
• | New theories of liability (e.g., cyber related claims) |
• | Trends in litigation or jury awards, including the propensity to sue |
• | Changes in statutes of limitations |
• | Shifts in lawsuit mix between federal and state courts |
• | Changes in tort or case law |
• | Distortions from losses resulting from large single accounts or single issues |
• | Subrogation opportunities |
While these reserving factors are applicable to most casualty reserving lines, there are certain sub-lines within the casualty major line that have unique reserving factors in addition to these. These include commercial automobile liability and workers compensation.
Commercial automobile liability coverage insure relatively short tailed property damage liability claims and longer tailed, more difficult to estimate bodily injury claims. In general, claim reporting lags are minor, claim complexity is not a major issue,
F-17
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 3. Unpaid Loss and LAE Reserves
and the line is viewed as high frequency, low to moderate severity. In addition to the examples of common reserving factors related to casualty described above, other examples that affect estimated commercial automobile liability reserves include:
• | Frequency of claims with payment capped by policy limits |
• | Change in average severity of accidents, or proportion of severe accidents |
• | Frequency of visits to health providers |
• | Number of medical procedures given during visits to health providers |
• | Types of health providers used |
• | Types of medical treatments received |
• | Changes in cost of medical treatments |
• | Degree of patient responsiveness to treatment |
Workers compensation covers an employer's liability for injuries, disability or death of employees, without regard to fault, as prescribed by state workers compensation law and other statutes. Workers compensation is a long-tail coverage as it takes a relatively long period of time to finalize claims from a given accident year. While certain payments such as initial medical treatment or temporary wage replacement for the injured worker are made quickly, some other payments are made over the course of several years, such as awards for permanent partial injuries. In addition, some payments can run as long as the injured worker's life, such as permanent disability benefits and ongoing medical care. Despite the possibility of long payment tails, the reporting lags are generally short, settlements are generally not complex, and most of the claims can be considered high frequency with moderate severity. The largest reserve risk generally comes from the low frequency, high severity claims providing lifetime coverage for medical expenses arising from a worker's injury. Examples of common reserving factors that can change and, thus, affect the estimated workers compensation reserves include:
• | Changes in the type, frequency of utilization or cost of medical treatments (e.g. changes in the use of pharmaceutical drugs, types of health providers used, use of preferred provider networks and other medical cost containment practices) |
• | Availability of new medical processes and equipment |
• | Degree of patient responsiveness to treatment |
• | Mortality trends of injured workers with lifetime indemnity and medical treatment benefits |
• | Degree of cost shifting between workers compensation and health insurance |
• | Time required to recover from the injury and return to regular or transitional work |
• | Future wage inflation for states that index benefits |
Other Lines
Other lines represent lines that do not fall into either the property or casualty definition. These lines have unique characteristics that are taken into consideration during the reserving process. Other lines include the accident line, which is included within the Specialty Industries reporting segment, as well as the credit and surety lines, which are included within the Specialty Products segment.
Accident lines includes accidental death and dismemberment, occupational accident, sports accident, non-truckers liability, and other accident coverages. It has a short to medium tailed development pattern and moderate severity profile.
Credit lines represents primarily the Tuition Reimbursement underwriting operating segment which provides insurance protection for schools and parents from the financial consequences of a student's withdrawal or dismissal. The reserve risk for this line is relatively low given the extremely short-tailed and low severity nature.
Surety, which also has a significant credit risk component, is a short-tailed but high severity coverage. As a newer business, lack of historical data means external data is heavily relied upon where available and applicable. Surety reserving factors that can change and, thus, affect estimated surety reserves include size of payment (severity) which is impacted by the bond limit, the ability of the principal (insured) or OneBeacon to mitigate the loss or amount and collectability of assets or other collateral available to mitigate loss.
F-18
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 3. Unpaid Loss and LAE Reserves
Cumulative Number of Reported Claims
The Company counts a claim for each unique combination of individual claimant and major coverage (e.g. auto liability - bodily injury, auto liability - property damage, auto physical damage, etc.). The claim is counted only if, net of any applicable deductibles, a payment has been made or a case reserve has been recorded. As a point of clarification, it is counted if a case reserve is established and the claim is later closed with no payment. For a relatively small amount of bulk-coded assumed reinsurance and pools & association losses there are no claim counts available.
Discount
OneBeacon discounts its long-term workers compensation loss and LAE reserves, as such liabilities constitute unpaid but settled claims under which the payment pattern and ultimate costs are fixed and determinable on an individual basis. OneBeacon discounts these reserves using the statutory rate (2.5% at December 31, 2016 and 2015). For the years ended December 31, 2016 and 2015, reserves for unpaid claims and claims adjustment expenses were reduced by $1.6 million and $1.1 million, respectively. Changes in loss and LAE reserves resulting from a change in the average long-term workers compensation discount rate is recorded within incurred loss and LAE expense.
F-19
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 3. Unpaid Loss and LAE Reserves
Loss and LAE reserve summary
The following table summarizes the loss and LAE reserve activities of OneBeacon's insurance subsidiaries for the years ended December 31, 2016, 2015, and 2014:
Year ended December 31, | |||||||||||||
2016 | 2015 | 2014 | |||||||||||
($ in millions) | |||||||||||||
Gross beginning loss and LAE reserves | $ | 1,389.8 | $ | 1,342.2 | $ | 1,054.3 | |||||||
Less beginning reinsurance recoverable on unpaid losses | (186.0 | ) | (161.6 | ) | (80.2 | ) | |||||||
Net beginning loss and LAE reserves | 1,203.8 | 1,180.6 | 974.1 | ||||||||||
Loss and LAE incurred from continuing operations relating to: | |||||||||||||
Current year losses | 640.6 | 702.5 | 725.3 | ||||||||||
Prior year losses | 15.4 | (1.8 | ) | 89.8 | |||||||||
Total incurred loss and LAE from continuing operations | 656.0 | 700.7 | 815.1 | ||||||||||
Loss and LAE paid from continuing operations relating to: | |||||||||||||
Current year losses | (188.0 | ) | (202.4 | ) | (199.6 | ) | |||||||
Prior year losses | (479.1 | ) | (475.1 | ) | (409.0 | ) | |||||||
Total loss and LAE payments from continuing operations | (667.1 | ) | (677.5 | ) | (608.6 | ) | |||||||
Net loss and LAE reserves | 1,192.7 | 1,203.8 | 1,180.6 | ||||||||||
Total incurred loss and LAE from discontinued operations | — | — | (0.7 | ) | |||||||||
Total loss and LAE payments from discontinued operations | — | — | (55.1 | ) | |||||||||
Net loss and LAE reserves | 1,192.7 | 1,203.8 | 1,124.8 | ||||||||||
Net change in loss and LAE reserves reported in liabilities held for sale | — | — | 188.4 | (1) | |||||||||
Net loss and LAE reserves sold | — | — | (132.6 | ) | (2) | ||||||||
Net ending loss and LAE reserves | 1,192.7 | 1,203.8 | 1,180.6 | ||||||||||
Plus ending reinsurance recoverable on unpaid losses | 172.9 | 186.0 | 161.6 | ||||||||||
Gross ending loss and LAE reserves | $ | 1,365.6 | $ | 1,389.8 | $ | 1,342.2 | |||||||
_______________________________________________________________________________
(1) | Consists of the change in net loss and LAE reserves of $188.4 million, representing the balances classified as held for sale as December 31, 2013, in connection with the Runoff Transaction. |
(2) Relates to the Runoff Transaction, which closed on December 23, 2014.
Loss and LAE development
Loss and LAE development—2016
Net unfavorable prior year loss and LAE reserve development was $15.4 million during the year ended December 31, 2016 driven by Healthcare ($40.7 million), as discussed below, and to a lesser extent, unfavorable development in the architects and engineers sub-line within Other Professional Lines, and Programs, primarily as a result of two larger auto-related programs, in addition to smaller amounts of unfavorable development in several other businesses. This unfavorable development was partially offset by favorable development primarily in Accident, Entertainment, Technology and Financial Services.
During the year ended December 31, 2016, Healthcare recorded $40.7 million of adverse prior accident year development, including $10.0 million in the first quarter, $20.0 million in the second quarter, $1.1 million in the third quarter, and $9.6 million in the fourth quarter. The full year development was driven by the extended care and complex risks sub-lines, and to a lesser extent, two large claim developments within the managed care errors and omissions sub-line related to unexpected outcomes from mediation and extended costs associated with claim defense. Extended care provides medical malpractice and general liability insurance for extended care facilities, including assisted living, memory care and continuing care facilities. Complex risks provides professional liability coverage to hospitals, physicians, and physician groups as well as physicians' extended reporting period coverage. The complex risks development was heavily influenced by large claim activity.
F-20
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 3. Unpaid Loss and LAE Reserves
As a result of the elevated loss activity experienced in the extended care sub-line, in-depth claim file and actuarial reviews were performed in the middle of the year. The claim file review confirmed that the increased case incurred activity was driven by increased frequency, especially in the more recent prior accident years, as opposed to other potential considerations such as significant changes in claims-handling practices. The actuarial review included analysis related to the recent enhancements to the predictive model. Recent adverse financial results were primarily observed in high-risk categories of business and in difficult geographic venues identified by the predictive model data. As a result of these analyses, management increased its best estimate of prior accident year losses, and increased its loss provisions for the current accident year.
Despite the reserve actions taken through the first three quarters of 2016 case incurred loss activity continued to exceed expectations during the fourth quarter of 2016. The adverse development was driven by recent prior accident years spread across the complex risks, extended care, managed care errors and omissions, and medical excess sub-lines.
Loss and LAE development—2015
Net favorable prior year loss and LAE reserve development was $1.8 million during the year ended December 31, 2015, primarily attributable to favorable development from several businesses, most notably Technology, and to a lesser extent, from Collector Cars and Boats, Specialty Property and Financial Services, along with certain other businesses. This favorable development was mostly offset by unfavorable development due to several large losses and an increase in small to mid-size claims in Entertainment, and to a lesser extent, unusually heavy loss activity of both large and small claims in Ocean Marine, as well as moderate unfavorable development from certain other businesses.
Loss and LAE development—2014
Net unfavorable prior year loss and LAE reserve development was $89.8 million during the year ended December 31, 2014, of which $75.5 million related to the 2014 fourth quarter reserve increase described below. Of the net unfavorable loss and LAE reserve development resulting from the 2014 fourth quarter reserve increase, $31.9 million related to the Other Professional Lines driven primarily by lawyers professional liability, and $11.6 million related to Entertainment resulting from several large losses. The remaining net unfavorable prior year loss and LAE reserve development for 2014 primarily related to unfavorable development recognized prior to the 2014 fourth quarter also in our Other Professional Lines (including lawyers professional liability) and Management Liability businesses, offset in part by favorable development in our Healthcare business. See the table below for a breakout of development by underwriting operating segment.
2014 Fourth Quarter Reserve Increase
Through the first nine months of 2014, the Company recorded $14.3 million of unfavorable loss and LAE reserve development, driven by greater-than-expected large loss activity in several underwriting operating segments, primarily in the Other Professional Lines and Management Liability underwriting operating segments. This large loss activity, which occurred mostly during the second and third quarters of 2014, also impacted the 2014 current accident year loss and LAE estimates. Additionally, the Company incurred higher-than-usual claim coverage determination costs, a component of LAE expenses, during the first nine months of 2014. Other underwriting operating segments also reported increased claim activity, including Entertainment, Government Risks and Accident.
Since the increased level of loss and LAE activity continued into the early part of the fourth quarter of 2014, the high level of activity in the second and third quarters no longer seemed to be isolated occurrences. As such, during the fourth quarter of 2014, the Company enhanced its actuarial and claims review in several areas. The Company isolated the recent large loss activity in each of its underwriting operating segments and examined the emergence of large losses relative to the timing and amounts of expected large losses. The Company also conducted additional analyses in the lawyers' professional liability Line within the Other Professional Lines underwriting operating segment. These new analyses included a claim level review and the application of additional actuarial methods and loss development assumptions. The results of these analyses indicated that the assumed tail risk included in the loss development patterns used to record IBNR reserves for this line were insufficient and needed to be increased for remaining long-tail exposures. The Company's claims and actuarial staff also conducted an in-depth review of coverage determination, litigation, and other claim-specific adjusting expenses as a result of an emerging trend of increased expenses in these areas over then-recent quarters, particularly coverage determination expenses. This review concluded that the ultimate costs of these loss adjustment expenses were larger than previously estimated, causing management to record an increase in estimated LAE expenses, primarily in the Other Professional Lines, Management Liability and Financial Services underwriting operating segments. Finally, the Company also recorded unfavorable prior year development in other underwriting units, including Entertainment and Government Risks. The unfavorable loss development in Entertainment
F-21
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 3. Unpaid Loss and LAE Reserves
and Government Risks resulted from heavier than expected claim activity during the fourth quarter of 2014, predominantly in the general liability and commercial auto liability lines.
As a result of these enhanced actuarial and claim reviews conducted during the fourth quarter of 2014 and in order to fully reflect these recent trends, the Company recorded a $109.2 million increase in loss and LAE reserves, which included a $75.5 million increase in prior accident year loss and LAE reserves and a $33.7 million increase in the current accident year loss and LAE reserves which were previously recorded at September 30, 2014. The components of the 2014 fourth quarter reserve increase and the net loss and LAE development for the full year are provided below:
2014 Fourth Quarter Reserve Increase | Full Year 2014 Net Prior Year Development | |||||||||||||||
Underwriting Operating Segment | Current Accident Year | Prior Accident Years | Total | |||||||||||||
($ in millions) | ||||||||||||||||
Other Professional Lines | $ | 11.1 | $ | 31.9 | $ | 43.0 | $ | 42.2 | ||||||||
Management Liability | 6.6 | 8.4 | 15.0 | 16.4 | ||||||||||||
Financial Services | 2.0 | 6.5 | 8.5 | 6.5 | ||||||||||||
Healthcare | 3.2 | (0.4 | ) | 2.8 | (6.0 | ) | ||||||||||
Specialty Property | (1.1 | ) | 5.7 | 4.6 | 1.1 | |||||||||||
Crop | 3.8 | — | 3.8 | — | ||||||||||||
Other | 2.8 | (0.4 | ) | 2.4 | 1.6 | |||||||||||
Specialty Products | 28.4 | 51.7 | 80.1 | 61.8 | ||||||||||||
Entertainment | 1.5 | 11.6 | 13.1 | 13.5 | ||||||||||||
Government Risks | 1.2 | 7.1 | 8.3 | 8.5 | ||||||||||||
Accident | — | 3.5 | 3.5 | 6.0 | ||||||||||||
Other | 2.6 | 1.6 | 4.2 | — | ||||||||||||
Specialty Industries | 5.3 | 23.8 | 29.1 | 28.0 | ||||||||||||
Total | $ | 33.7 | $ | 75.5 | $ | 109.2 | $ | 89.8 | ||||||||
As noted above, the Company increased its provision for 2014 current accident year losses and LAE by $33.7 million in the fourth quarter of 2014. In recording the change in estimate of its loss and LAE reserve provision for the 2014 accident year, the Company considered the results of the enhanced actuarial and claim review and the fact that reported large claims were approaching estimated ultimate large losses sooner than originally expected. Of the $33.7 million increase, $29.9 million reflects an increase in management's best estimate of current year loss and LAE as of December 31, 2014 from those amounts recorded in the first nine months of 2014. This increase primarily affected the Other Professional Lines and Management Liability underwriting operating segments, which represented $17.7 million of the total provision. The remaining increase was primarily related to a $3.8 million increase in estimated losses in the Crop underwriting operating segment from higher-than-expected reports of crop losses that emerged in the fourth quarter of 2014.
F-22
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 3. Unpaid Loss and LAE Reserves
Reconciliation of liabilities for unpaid loss and LAE
The following table summarizes the ending liabilities for unpaid loss and LAE, net of reinsurance for each of OneBeacon's major lines of business by reportable segment as of December 31, 2016:
Liabilities for unpaid loss and LAE, net of reinsurance | As of December 31, 2016 | |||
($ in millions) | ||||
Specialty Products - Property | $ | 30.2 | ||
Specialty Industries - Property | 108.5 | |||
Specialty Products - Casualty | 568.7 | |||
Specialty Industries - Casualty | 360.0 | |||
Specialty Products - Other | 38.2 | |||
Specialty Industries - Other | 47.4 | |||
Total unpaid and undiscounted loss and allocated LAE reserves, net of reinsurance | $ | 1,153.0 | ||
Less: Discount on workers compensation reserves | (1.6 | ) | ||
Total unpaid loss and allocated LAE reserves, net of reinsurance | $ | 1,151.4 | ||
Plus: Unallocated LAE | 41.3 | |||
Plus: Other items | — | |||
Total unpaid loss and LAE reserves, net of reinsurance | $ | 1,192.7 | ||
Plus: Reinsurance recoverables on unpaid losses | ||||
Specialty Products - Property | 40.9 | |||
Specialty Industries - Property | 13.2 | |||
Specialty Products - Casualty | 64.0 | |||
Specialty Industries - Casualty | 19.9 | |||
Specialty Products - Other | 16.0 | |||
Specialty Industries - Other | 0.6 | |||
Investing, Financing and Corporate(1) | 18.3 | |||
Plus: Total Reinsurance recoverables on unpaid losses | 172.9 | |||
Total unpaid loss and LAE reserves | $ | 1,365.6 | ||
(1) As described in Note 18—"Discontinued Operations," ASIC has entered into a 100% quota share reinsurance agreement whereby ASIC is ceding to Bedivere 100% of the legacy Runoff Business that was written by ASIC or one of the ongoing entities. As of December 31, 2016, $18.3 million is included in reinsurance recoverables on unpaid losses within Investing, Financing, and Corporate resulting from that agreement.
The following six table groupings, reflecting one table each for the Property, Casualty and Other major lines of business for each of the Specialty Products and Specialty Industries external reportable segments, and include three sections. The first table (top section) presents, for each of the previous 10 accident years (1) cumulative total undiscounted incurred loss and allocated LAE, net of reinsurance, as of each of the previous 10 year-end evaluations, (2) total IBNR plus expected development on reported claims as of December 31, 2016, and (3) the cumulative number of reported claims as of December 31, 2016.
The second table (middle section) presents cumulative paid loss and allocated LAE, net of reinsurance for each of the previous 10 accident years, as of each of the previous 10 year-end evaluations. Also included in this table is a calculation of the liability for loss and allocated LAE as of December 31, 2016 which is then included the reconciliation to the consolidated balance sheet presented above. The liability as of December 31, 2016 is calculated as the cumulative incurred loss and allocated LAE from the first table less the cumulative paid loss and allocated from the second table, plus any outstanding liabilities from accident years prior to 2007.
The third table (bottom section) is supplementary information about the average historical claims duration as of December 31, 2016. It shows the weighted average annual percentage payout of incurred loss and allocated LAE by accident year as of each age. For example, the first column is calculated as the incremental paid loss and allocated LAE in the first calendar year for each given accident year (e.g. calendar year 2008 for accident year 2008, calendar year 2009 for accident year 2009) divided by the cumulative incurred loss and allocated LAE as of December 31, 2016 for that accident year. The resulting ratios are weighted together using cumulative incurred loss and allocated LAE as of December 31, 2016.
F-23
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 3. Unpaid Loss and LAE Reserves
Specialty Products - Property ($ in millions) | |||||||||||||||||||||||||||||||||||||||||||||
Incurred Loss and Allocated LAE, Net of Reinsurance | As of December 31, 2016 | ||||||||||||||||||||||||||||||||||||||||||||
For the Years Ended December 31, | |||||||||||||||||||||||||||||||||||||||||||||
Unaudited | Total IBNR plus expected development on reported claims | Cumulative number of reported claims | |||||||||||||||||||||||||||||||||||||||||||
Accident Year | 2007 | 2008 | 2009 | 2010 | 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | |||||||||||||||||||||||||||||||||||
2007 | $ | 12.0 | $ | 11.1 | $ | 9.1 | $ | 7.6 | $ | 7.6 | $ | 7.7 | $ | 8.7 | $ | 8.6 | $ | 8.6 | $ | 8.6 | $ | — | 250 | ||||||||||||||||||||||
2008 | 31.3 | 29.2 | 25.4 | 25.6 | 26.6 | 26.8 | 26.8 | 26.8 | 26.8 | — | 3,466 | ||||||||||||||||||||||||||||||||||
2009 | 55.2 | 52.1 | 52.9 | 53.3 | 52.9 | 52.6 | 52.5 | 51.6 | — | 8,768 | |||||||||||||||||||||||||||||||||||
2010 | 51.0 | 49.5 | 55.6 | 56.7 | 55.9 | 55.8 | 55.8 | — | 10,170 | ||||||||||||||||||||||||||||||||||||
2011 | 58.7 | 59.8 | 60.2 | 60.6 | 60.8 | 60.7 | 0.2 | 11,121 | |||||||||||||||||||||||||||||||||||||
2012 | 79.9 | 86.7 | 92.9 | 92.2 | 92.2 | 0.2 | 12,405 | ||||||||||||||||||||||||||||||||||||||
2013 | 36.4 | 27.6 | 27.6 | 27.7 | 0.3 | 5,267 | |||||||||||||||||||||||||||||||||||||||
2014 | 37.5 | 32.1 | 31.6 | 0.4 | 1,227 | ||||||||||||||||||||||||||||||||||||||||
2015 | 28.3 | 25.7 | 1.1 | 2,186 | |||||||||||||||||||||||||||||||||||||||||
2016 | 24.5 | 5.2 | 1,825 | ||||||||||||||||||||||||||||||||||||||||||
Total | $ | 405.2 | |||||||||||||||||||||||||||||||||||||||||||
Specialty Products - Property ($ in millions) | |||||||||||||||||||||||||||||||||||||||
Cumulative Paid Loss and Allocated LAE, Net of Reinsurance | |||||||||||||||||||||||||||||||||||||||
For the Years Ended December 31, | |||||||||||||||||||||||||||||||||||||||
Unaudited | |||||||||||||||||||||||||||||||||||||||
Accident Year | 2007 | 2008 | 2009 | 2010 | 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | |||||||||||||||||||||||||||||
2007 | $ | 1.8 | $ | 3.7 | $ | 6.8 | $ | 7.0 | $ | 7.0 | $ | 7.0 | $ | 8.7 | $ | 8.6 | $ | 8.6 | $ | 8.6 | |||||||||||||||||||
2008 | 15.5 | 23.5 | 25.2 | 25.5 | 26.0 | 26.8 | 26.8 | 26.8 | 26.8 | ||||||||||||||||||||||||||||||
2009 | 41.5 | 47.3 | 51.2 | 51.9 | 51.9 | 51.6 | 51.6 | 51.6 | |||||||||||||||||||||||||||||||
2010 | 43.1 | 47.9 | 53.3 | 55.2 | 55.7 | 55.7 | 55.7 | ||||||||||||||||||||||||||||||||
2011 | 51.8 | 59.0 | 59.7 | 60.1 | 60.4 | 60.5 | |||||||||||||||||||||||||||||||||
2012 | 58.8 | 72.5 | 78.3 | 79.0 | 78.8 | ||||||||||||||||||||||||||||||||||
2013 | 24.3 | 26.9 | 27.1 | 27.4 | |||||||||||||||||||||||||||||||||||
2014 | 19.8 | 28.2 | 31.2 | ||||||||||||||||||||||||||||||||||||
2015 | 15.0 | 22.1 | |||||||||||||||||||||||||||||||||||||
2016 | 12.3 | ||||||||||||||||||||||||||||||||||||||
Total | $ | 375.0 | |||||||||||||||||||||||||||||||||||||
All outstanding liabilities before 2007, net of reinsurance | — | ||||||||||||||||||||||||||||||||||||||
Liabilities for loss and allocated LAE, net of reinsurance | $ | 30.2 | |||||||||||||||||||||||||||||||||||||
Specialty Products - Property | ||||||||||||||||||||
Average Annual Percentage Payout of Incurred Losses and Allocated LAE by Age, Net of Reinsurance | ||||||||||||||||||||
Unaudited | ||||||||||||||||||||
Years | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 | ||||||||||
70.1 | % | 14.6 | % | 5.9 | % | 1.1 | % | 0.3 | % | 0.2 | % | 0.4 | % | — | % | — | % | — | % | |
F-24
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 3. Unpaid Loss and LAE Reserves
Specialty Industries - Property ($ in millions) | |||||||||||||||||||||||||||||||||||||||||||||
Incurred Loss and Allocated LAE, Net of Reinsurance | As of December 31, 2016 | ||||||||||||||||||||||||||||||||||||||||||||
For the Years Ended December 31, | |||||||||||||||||||||||||||||||||||||||||||||
Unaudited | Total IBNR plus expected development on reported claims | Cumulative number of reported claims | |||||||||||||||||||||||||||||||||||||||||||
Accident Year | 2007 | 2008 | 2009 | 2010 | 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | |||||||||||||||||||||||||||||||||||
2007 | $ | 110.0 | $ | 104.8 | $ | 101.3 | $ | 94.9 | $ | 95.1 | $ | 95.3 | $ | 95.1 | $ | 95.1 | $ | 95.1 | $ | 94.9 | $ | — | 4,828 | ||||||||||||||||||||||
2008 | 147.3 | 137.6 | 129.6 | 129.3 | 132.0 | 132.7 | 130.0 | 129.8 | 129.7 | 0.1 | 6,603 | ||||||||||||||||||||||||||||||||||
2009 | 124.5 | 118.6 | 118.2 | 117.9 | 118.8 | 118.6 | 118.7 | 118.6 | 0.1 | 6,718 | |||||||||||||||||||||||||||||||||||
2010 | 131.4 | 131.5 | 127.2 | 130.0 | 129.7 | 131.4 | 131.2 | — | 8,617 | ||||||||||||||||||||||||||||||||||||
2011 | 138.5 | 141.5 | 141.1 | 143.5 | 143.2 | 142.5 | 0.3 | 9,704 | |||||||||||||||||||||||||||||||||||||
2012 | 126.9 | 123.8 | 126.7 | 130.4 | 130.1 | 0.8 | 9,697 | ||||||||||||||||||||||||||||||||||||||
2013 | 125.1 | 127.0 | 142.9 | 143.6 | 1.9 | 8,085 | |||||||||||||||||||||||||||||||||||||||
2014 | 123.9 | 123.5 | 130.1 | 3.9 | 8,352 | ||||||||||||||||||||||||||||||||||||||||
2015 | 142.3 | 138.9 | 10.2 | 8,607 | |||||||||||||||||||||||||||||||||||||||||
2016 | 120.3 | 32.8 | 7,429 | ||||||||||||||||||||||||||||||||||||||||||
Total | $ | 1,279.9 | |||||||||||||||||||||||||||||||||||||||||||
Specialty Industries - Property ($ in millions) | |||||||||||||||||||||||||||||||||||||||
Cumulative Paid Loss and Allocated LAE, Net of Reinsurance | |||||||||||||||||||||||||||||||||||||||
For the Years Ended December 31, | |||||||||||||||||||||||||||||||||||||||
Unaudited | |||||||||||||||||||||||||||||||||||||||
Accident Year | 2007 | 2008 | 2009 | 2010 | 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | |||||||||||||||||||||||||||||
2007 | $ | 42.2 | $ | 70.9 | $ | 82.7 | $ | 87.6 | $ | 91.7 | $ | 93.4 | $ | 94.2 | $ | 94.5 | $ | 94.5 | $ | 94.6 | |||||||||||||||||||
2008 | 62.5 | 101.4 | 116.8 | 123.4 | 129.5 | 129.1 | 129.2 | 129.3 | 129.3 | ||||||||||||||||||||||||||||||
2009 | 50.4 | 85.9 | 105.4 | 111.0 | 115.5 | 117.2 | 118.0 | 118.4 | |||||||||||||||||||||||||||||||
2010 | 69.0 | 106.2 | 118.2 | 122.8 | 125.9 | 129.3 | 130.8 | ||||||||||||||||||||||||||||||||
2011 | 72.5 | 117.4 | 130.7 | 138.0 | 139.5 | 141.4 | |||||||||||||||||||||||||||||||||
2012 | 64.2 | 103.1 | 116.4 | 128.5 | 131.9 | ||||||||||||||||||||||||||||||||||
2013 | 59.8 | 101.5 | 126.1 | 137.7 | |||||||||||||||||||||||||||||||||||
2014 | 56.5 | 94.6 | 111.6 | ||||||||||||||||||||||||||||||||||||
2015 | 68.6 | 114.4 | |||||||||||||||||||||||||||||||||||||
2016 | 61.3 | ||||||||||||||||||||||||||||||||||||||
Total | $ | 1,171.4 | |||||||||||||||||||||||||||||||||||||
All outstanding liabilities before 2007, net of reinsurance | — | ||||||||||||||||||||||||||||||||||||||
Liabilities for loss and allocated LAE, net of reinsurance | $ | 108.5 | |||||||||||||||||||||||||||||||||||||
Specialty Industries - Property | ||||||||||||||||||||
Average Annual Percentage Payout of Incurred Losses by Age and Allocated LAE, Net of Reinsurance | ||||||||||||||||||||
Unaudited | ||||||||||||||||||||
Years | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 | ||||||||||
47.4 | % | 27.3 | % | 9.9 | % | 4.1 | % | 1.8 | % | 0.7 | % | 0.2 | % | 0.1 | % | — | % | — | % | |
F-25
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 3. Unpaid Loss and LAE Reserves
Specialty Products - Casualty ($ in millions) | |||||||||||||||||||||||||||||||||||||||||||||
Incurred Loss and Allocated LAE, Net of Reinsurance | As of December 31, 2016 | ||||||||||||||||||||||||||||||||||||||||||||
For the Years Ended December 31, | |||||||||||||||||||||||||||||||||||||||||||||
Unaudited | Total IBNR plus expected development on reported claims | Cumulative number of reported claims | |||||||||||||||||||||||||||||||||||||||||||
Accident Year | 2007 | 2008 | 2009 | 2010 | 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | |||||||||||||||||||||||||||||||||||
2007 | $ | 138.3 | $ | 120.2 | $ | 97.3 | $ | 90.7 | $ | 70.5 | $ | 70.1 | $ | 61.8 | $ | 58.3 | $ | 57.1 | $ | 56.5 | $ | 2.5 | 1,236 | ||||||||||||||||||||||
2008 | 145.6 | 128.6 | 118.2 | 100.8 | 98.3 | 95.5 | 95.3 | 97.3 | 96.8 | 3.3 | 2,199 | ||||||||||||||||||||||||||||||||||
2009 | 169.5 | 186.2 | 194.9 | 193.2 | 192.0 | 194.9 | 195.0 | 195.5 | 4.9 | 4,002 | |||||||||||||||||||||||||||||||||||
2010 | 211.5 | 225.4 | 226.2 | 225.0 | 232.3 | 234.9 | 240.0 | 7.8 | 6,029 | ||||||||||||||||||||||||||||||||||||
2011 | 194.9 | 189.8 | 205.4 | 214.2 | 214.8 | 214.9 | 9.4 | 6,661 | |||||||||||||||||||||||||||||||||||||
2012 | 213.5 | 220.1 | 246.1 | 248.8 | 249.4 | 14.4 | 6,794 | ||||||||||||||||||||||||||||||||||||||
2013 | 205.2 | 233.1 | 229.6 | 247.9 | 20.3 | 5,866 | |||||||||||||||||||||||||||||||||||||||
2014 | 240.5 | 235.9 | 258.9 | 44.4 | 6,504 | ||||||||||||||||||||||||||||||||||||||||
2015 | 206.9 | 213.4 | 78.5 | 9,710 | |||||||||||||||||||||||||||||||||||||||||
2016 | 202.8 | 142.8 | 9,093 | ||||||||||||||||||||||||||||||||||||||||||
Total | $ | 1,976.1 | |||||||||||||||||||||||||||||||||||||||||||
Specialty Products - Casualty ($ in millions) | |||||||||||||||||||||||||||||||||||||||
Cumulative Paid Loss and Allocated LAE, Net of Reinsurance | |||||||||||||||||||||||||||||||||||||||
For the Years Ended December 31, | |||||||||||||||||||||||||||||||||||||||
Unaudited | |||||||||||||||||||||||||||||||||||||||
Accident Year | 2007 | 2008 | 2009 | 2010 | 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | |||||||||||||||||||||||||||||
2007 | $ | 6.8 | $ | 24.8 | $ | 32.4 | $ | 41.7 | $ | 44.4 | $ | 50.7 | $ | 51.9 | $ | 53.6 | $ | 54.0 | $ | 54.0 | |||||||||||||||||||
2008 | 8.8 | 32.3 | 50.8 | 65.4 | 77.6 | 83.1 | 85.3 | 88.1 | 91.5 | ||||||||||||||||||||||||||||||
2009 | 26.5 | 81.8 | 124.0 | 147.8 | 161.4 | 169.9 | 178.3 | 187.8 | |||||||||||||||||||||||||||||||
2010 | 32.0 | 107.0 | 157.8 | 180.5 | 196.3 | 213.6 | 220.3 | ||||||||||||||||||||||||||||||||
2011 | 25.8 | 88.9 | 131.3 | 163.7 | 186.2 | 192.5 | |||||||||||||||||||||||||||||||||
2012 | 25.8 | 86.7 | 157.7 | 193.6 | 219.8 | ||||||||||||||||||||||||||||||||||
2013 | 26.4 | 86.3 | 143.1 | 194.2 | |||||||||||||||||||||||||||||||||||
2014 | 34.3 | 95.2 | 156.7 | ||||||||||||||||||||||||||||||||||||
2015 | 19.9 | 78.4 | |||||||||||||||||||||||||||||||||||||
2016 | 16.5 | ||||||||||||||||||||||||||||||||||||||
Total | $ | 1,411.7 | |||||||||||||||||||||||||||||||||||||
All outstanding liabilities before 2007, net of reinsurance | 4.3 | ||||||||||||||||||||||||||||||||||||||
Liabilities for loss and allocated LAE, net of reinsurance | $ | 568.7 | |||||||||||||||||||||||||||||||||||||
Specialty Products - Casualty | ||||||||||||||||||||
Average Annual Percentage Payout of Incurred Losses by Age and Allocated LAE, Net of Reinsurance | ||||||||||||||||||||
Unaudited | ||||||||||||||||||||
Years | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 | ||||||||||
11.3 | % | 24.0 | % | 17.8 | % | 9.6 | % | 4.7 | % | 2.2 | % | 0.9 | % | 0.7 | % | 0.2 | % | — | % | |
F-26
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 3. Unpaid Loss and LAE Reserves
Specialty Industries - Casualty ($ in millions) | |||||||||||||||||||||||||||||||||||||||||||||
Incurred Loss and Allocated LAE, Net of Reinsurance | As of December 31, 2016 | ||||||||||||||||||||||||||||||||||||||||||||
For the Years Ended December 31, | |||||||||||||||||||||||||||||||||||||||||||||
Unaudited | Total IBNR plus expected development on reported claims | Cumulative number of reported claims | |||||||||||||||||||||||||||||||||||||||||||
Accident Year | 2007 | 2008 | 2009 | 2010 | 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | |||||||||||||||||||||||||||||||||||
2007 | $ | 24.9 | $ | 24.3 | $ | 21.7 | $ | 34.0 | $ | 34.9 | $ | 35.1 | $ | 35.1 | $ | 36.0 | $ | 37.1 | $ | 36.9 | $ | 0.3 | 1,770 | ||||||||||||||||||||||
2008 | 26.3 | 26.2 | 30.4 | 26.4 | 25.8 | 25.2 | 23.7 | 22.2 | 22.1 | 0.5 | 1,835 | ||||||||||||||||||||||||||||||||||
2009 | 51.0 | 51.1 | 51.5 | 49.6 | 54.8 | 53.6 | 51.6 | 51.0 | 1.0 | 2,982 | |||||||||||||||||||||||||||||||||||
2010 | 80.8 | 72.4 | 69.3 | 69.4 | 73.3 | 75.5 | 77.2 | 3.5 | 4,791 | ||||||||||||||||||||||||||||||||||||
2011 | 88.1 | 87.5 | 90.2 | 100.5 | 111.8 | 112.2 | 3.8 | 5,254 | |||||||||||||||||||||||||||||||||||||
2012 | 118.8 | 103.4 | 102.0 | 101.8 | 98.8 | 7.9 | 6,298 | ||||||||||||||||||||||||||||||||||||||
2013 | 121.9 | 131.5 | 133.6 | 138.2 | 18.0 | 7,107 | |||||||||||||||||||||||||||||||||||||||
2014 | 135.6 | 127.4 | 124.2 | 35.7 | 7,633 | ||||||||||||||||||||||||||||||||||||||||
2015 | 146.3 | 127.7 | 61.8 | 7,315 | |||||||||||||||||||||||||||||||||||||||||
2016 | 129.9 | 98.4 | 5,701 | ||||||||||||||||||||||||||||||||||||||||||
Total | $ | 918.2 | |||||||||||||||||||||||||||||||||||||||||||
Specialty Industries - Casualty ($ in millions) | |||||||||||||||||||||||||||||||||||||||
Cumulative Paid Loss and Allocated LAE, Net of Reinsurance | |||||||||||||||||||||||||||||||||||||||
For the Years Ended December 31, | |||||||||||||||||||||||||||||||||||||||
Unaudited | |||||||||||||||||||||||||||||||||||||||
Accident Year | 2007 | 2008 | 2009 | 2010 | 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | |||||||||||||||||||||||||||||
2007 | $ | 2.8 | $ | 5.5 | $ | 7.9 | $ | 13.8 | $ | 27.9 | $ | 29.9 | $ | 32.4 | $ | 32.9 | $ | 34.3 | $ | 35.9 | |||||||||||||||||||
2008 | 3.2 | 6.9 | 11.5 | 14.2 | 17.3 | 19.9 | 21.2 | 20.8 | 20.9 | ||||||||||||||||||||||||||||||
2009 | 5.1 | 16.6 | 25.0 | 34.5 | 42.9 | 46.3 | 46.3 | 47.4 | |||||||||||||||||||||||||||||||
2010 | 8.7 | 21.1 | 37.3 | 51.4 | 57.5 | 65.3 | 68.9 | ||||||||||||||||||||||||||||||||
2011 | 11.1 | 34.2 | 53.7 | 69.8 | 88.9 | 96.4 | |||||||||||||||||||||||||||||||||
2012 | 12.9 | 31.9 | 50.6 | 67.8 | 79.7 | ||||||||||||||||||||||||||||||||||
2013 | 18.6 | 45.5 | 72.7 | 96.6 | |||||||||||||||||||||||||||||||||||
2014 | 16.6 | 40.2 | 61.4 | ||||||||||||||||||||||||||||||||||||
2015 | 13.6 | 39.3 | |||||||||||||||||||||||||||||||||||||
2016 | 11.8 | ||||||||||||||||||||||||||||||||||||||
Total | $ | 558.3 | |||||||||||||||||||||||||||||||||||||
All outstanding liabilities before 2007, net of reinsurance | 0.1 | ||||||||||||||||||||||||||||||||||||||
Liabilities for loss and allocated LAE, net of reinsurance | $ | 360.0 | |||||||||||||||||||||||||||||||||||||
Specialty Industries - Casualty | ||||||||||||||||||||
Average Annual Percentage Payout of Incurred Losses by Age and Allocated LAE, Net of Reinsurance | ||||||||||||||||||||
Unaudited | ||||||||||||||||||||
Years | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 | ||||||||||
11.4 | % | 16.2 | % | 12.9 | % | 9.7 | % | 6.8 | % | 2.5 | % | 0.8 | % | 0.1 | % | 0.2 | % | 0.2 | % | |
F-27
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 3. Unpaid Loss and LAE Reserves
Specialty Products - Other ($ in millions) | |||||||||||||||||||||||||||||||||||||||||||||
Incurred Loss and Allocated LAE, Net of Reinsurance | As of December 31, 2016 | ||||||||||||||||||||||||||||||||||||||||||||
For the Years Ended December 31, | |||||||||||||||||||||||||||||||||||||||||||||
Unaudited | Total IBNR plus expected development on reported claims | Cumulative number of reported claims | |||||||||||||||||||||||||||||||||||||||||||
Accident Year | 2007 | 2008 | 2009 | 2010 | 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | |||||||||||||||||||||||||||||||||||
2007 | $ | 26.8 | $ | 26.7 | $ | 26.8 | $ | 28.6 | $ | 28.6 | $ | 28.6 | $ | 28.6 | $ | 28.6 | $ | 28.6 | $ | 28.6 | $ | — | 5,073 | ||||||||||||||||||||||
2008 | 31.7 | 31.5 | 31.2 | 31.2 | 31.2 | 31.2 | 31.2 | 31.2 | 31.2 | — | 5,192 | ||||||||||||||||||||||||||||||||||
2009 | 33.8 | 31.4 | 31.3 | 30.8 | 30.9 | 30.9 | 30.9 | 30.9 | — | 5,138 | |||||||||||||||||||||||||||||||||||
2010 | 34.7 | 34.3 | 32.5 | 32.6 | 32.5 | 32.5 | 32.5 | — | 5,182 | ||||||||||||||||||||||||||||||||||||
2011 | 33.2 | 35.5 | 35.4 | 35.4 | 35.4 | 35.4 | — | 5,306 | |||||||||||||||||||||||||||||||||||||
2012 | 36.6 | 36.9 | 36.9 | 36.9 | 37.0 | — | 5,324 | ||||||||||||||||||||||||||||||||||||||
2013 | 39.6 | 40.6 | 39.2 | 39.2 | — | 5,510 | |||||||||||||||||||||||||||||||||||||||
2014 | 96.6 | 90.8 | 92.9 | — | 9,971 | ||||||||||||||||||||||||||||||||||||||||
2015 | 75.5 | 73.2 | 1.8 | 10,704 | |||||||||||||||||||||||||||||||||||||||||
2016 | 77.1 | 33.8 | 4,306 | ||||||||||||||||||||||||||||||||||||||||||
Total | $ | 478.0 | |||||||||||||||||||||||||||||||||||||||||||
Specialty Products - Other ($ in millions) | |||||||||||||||||||||||||||||||||||||||
Cumulative Paid Loss and Allocated LAE, Net of Reinsurance | |||||||||||||||||||||||||||||||||||||||
For the Years Ended December 31, | |||||||||||||||||||||||||||||||||||||||
Unaudited | |||||||||||||||||||||||||||||||||||||||
Accident Year | 2007 | 2008 | 2009 | 2010 | 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | |||||||||||||||||||||||||||||
2007 | $ | 19.8 | $ | 28.4 | $ | 28.6 | $ | 28.6 | $ | 28.6 | $ | 28.6 | $ | 28.6 | $ | 28.6 | $ | 28.6 | $ | 28.6 | |||||||||||||||||||
2008 | 21.3 | 31.1 | 31.2 | 31.2 | 31.2 | 31.2 | 31.2 | 31.2 | 31.2 | ||||||||||||||||||||||||||||||
2009 | 21.6 | 30.8 | 30.8 | 30.9 | 30.9 | 30.9 | 30.9 | 30.9 | |||||||||||||||||||||||||||||||
2010 | 22.4 | 32.4 | 32.5 | 32.5 | 32.5 | 32.5 | 32.5 | ||||||||||||||||||||||||||||||||
2011 | 25.2 | 35.2 | 35.4 | 35.4 | 35.4 | 35.4 | |||||||||||||||||||||||||||||||||
2012 | 26.1 | 36.8 | 36.9 | 36.9 | 37.0 | ||||||||||||||||||||||||||||||||||
2013 | 27.4 | 39.0 | 39.2 | 39.2 | |||||||||||||||||||||||||||||||||||
2014 | 46.2 | 88.5 | 90.3 | ||||||||||||||||||||||||||||||||||||
2015 | 41.7 | 70.6 | |||||||||||||||||||||||||||||||||||||
2016 | 44.2 | ||||||||||||||||||||||||||||||||||||||
Total | $ | 439.9 | |||||||||||||||||||||||||||||||||||||
All outstanding liabilities before 2007, net of reinsurance | 0.1 | ||||||||||||||||||||||||||||||||||||||
Liabilities for loss and allocated LAE, net of reinsurance | $ | 38.2 | |||||||||||||||||||||||||||||||||||||
Specialty Products - Other | ||||||||||||||||||||
Average Annual Percentage Payout of Incurred Losses by Age and Allocated LAE, Net of Reinsurance | ||||||||||||||||||||
Unaudited | ||||||||||||||||||||
Years | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 | ||||||||||
61.9 | % | 29.5 | % | 0.6 | % | — | % | — | % | — | % | — | % | — | % | — | % | — | % | |
F-28
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 3. Unpaid Loss and LAE Reserves
Specialty Industries - Other ($ in millions) | |||||||||||||||||||||||||||||||||||||||||||||
Incurred Loss and Allocated LAE, Net of Reinsurance | As of December 31, 2016 | ||||||||||||||||||||||||||||||||||||||||||||
For the Years Ended December 31, | |||||||||||||||||||||||||||||||||||||||||||||
Unaudited | Total IBNR plus expected development on reported claims | Cumulative number of Reported Claims | |||||||||||||||||||||||||||||||||||||||||||
Accident Year | 2007 | 2008 | 2009 | 2010 | 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | |||||||||||||||||||||||||||||||||||
2007 | $ | 4.3 | $ | 4.6 | $ | 4.5 | $ | 4.4 | $ | 4.4 | $ | 4.4 | $ | 4.4 | $ | 4.4 | $ | 4.4 | $ | 4.4 | $ | — | 291 | ||||||||||||||||||||||
2008 | 10.4 | 10.8 | 12.2 | 11.9 | 11.9 | 11.8 | 12.1 | 12.1 | 12.3 | — | 975 | ||||||||||||||||||||||||||||||||||
2009 | 19.1 | 19.2 | 19.0 | 19.3 | 20.9 | 21.4 | 21.5 | 21.7 | 0.2 | 1,763 | |||||||||||||||||||||||||||||||||||
2010 | 25.6 | 26.6 | 27.1 | 27.9 | 28.2 | 28.4 | 28.4 | — | 2,449 | ||||||||||||||||||||||||||||||||||||
2011 | 35.1 | 36.0 | 37.7 | 38.5 | 38.2 | 38.2 | 0.2 | 3,638 | |||||||||||||||||||||||||||||||||||||
2012 | 42.0 | 39.6 | 40.1 | 41.1 | 41.6 | 0.3 | 3,861 | ||||||||||||||||||||||||||||||||||||||
2013 | 41.1 | 41.2 | 42.2 | 42.5 | 0.7 | 4,245 | |||||||||||||||||||||||||||||||||||||||
2014 | 42.6 | 40.4 | 40.6 | 1.9 | 3,497 | ||||||||||||||||||||||||||||||||||||||||
2015 | 46.6 | 31.9 | 4.9 | 3,301 | |||||||||||||||||||||||||||||||||||||||||
2016 | 33.2 | 19.4 | 2,222 | ||||||||||||||||||||||||||||||||||||||||||
Total | $ | 294.8 | |||||||||||||||||||||||||||||||||||||||||||
Specialty Industries - Other ($ in millions) | |||||||||||||||||||||||||||||||||||||||
Cumulative Paid Loss and Allocated LAE, Net of Reinsurance | |||||||||||||||||||||||||||||||||||||||
For the Years Ended December 31, | |||||||||||||||||||||||||||||||||||||||
Unaudited | |||||||||||||||||||||||||||||||||||||||
Accident Year | 2007 | 2008 | 2009 | 2010 | 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | |||||||||||||||||||||||||||||
2007 | $ | 1.2 | $ | 4.0 | $ | 4.3 | $ | 4.3 | $ | 4.3 | $ | 4.3 | $ | 4.3 | $ | 4.4 | $ | 4.4 | $ | 4.4 | |||||||||||||||||||
2008 | 3.8 | 9.0 | 11.1 | 11.7 | 11.8 | 11.7 | 12.0 | 12.0 | 12.2 | ||||||||||||||||||||||||||||||
2009 | 6.3 | 14.6 | 17.7 | 18.3 | 19.2 | 21.2 | 21.4 | 21.4 | |||||||||||||||||||||||||||||||
2010 | 8.3 | 22.9 | 25.1 | 26.9 | 27.6 | 28.0 | 28.1 | ||||||||||||||||||||||||||||||||
2011 | 13.5 | 29.4 | 34.6 | 36.5 | 37.2 | 37.3 | |||||||||||||||||||||||||||||||||
2012 | 13.2 | 30.7 | 35.8 | 38.3 | 39.1 | ||||||||||||||||||||||||||||||||||
2013 | 13.0 | 29.3 | 37.2 | 39.6 | |||||||||||||||||||||||||||||||||||
2014 | 12.6 | 28.9 | 34.8 | ||||||||||||||||||||||||||||||||||||
2015 | 9.8 | 22.2 | |||||||||||||||||||||||||||||||||||||
2016 | 8.0 | ||||||||||||||||||||||||||||||||||||||
Total | $ | 247.1 | |||||||||||||||||||||||||||||||||||||
All outstanding liabilities before 2007, net of reinsurance | (0.3 | ) | |||||||||||||||||||||||||||||||||||||
Liabilities for loss and allocated LAE, net of reinsurance | $ | 47.4 | |||||||||||||||||||||||||||||||||||||
Specialty Industries - Other | ||||||||||||||||||||
Average Annual Percentage Payout of Incurred Losses by Age and Allocated LAE, Net of Reinsurance | ||||||||||||||||||||
Unaudited | ||||||||||||||||||||
Years | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 | ||||||||||
30.4 | % | 37.0 | % | 10.8 | % | 3.3 | % | 1.1 | % | 0.9 | % | 0.2 | % | — | % | 0.1 | % | — | % | |
F-29
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 if the reinsurer does not honor its obligations under reinsurance contracts.
The effects of reinsurance on OneBeacon's insurance subsidiaries' written and earned premiums and on loss and LAE were as follows:
Year ended December 31, | ||||||||||||
2016 | 2015 | 2014 | ||||||||||
($ in millions) | ||||||||||||
Written premiums: | ||||||||||||
Direct | $ | 1,193.3 | $ | 1,279.9 | $ | 1,257.5 | ||||||
Assumed | 28.0 | 36.0 | 65.9 | |||||||||
Gross written premiums | 1,221.3 | 1,315.9 | 1,323.4 | |||||||||
Ceded | (120.6 | ) | (179.3 | ) | (1) | (106.5 | ) | |||||
Net written premiums | $ | 1,100.7 | $ | 1,136.6 | $ | 1,216.9 | ||||||
Earned premiums: | ||||||||||||
Direct | $ | 1,177.0 | $ | 1,298.0 | $ | 1,209.1 | ||||||
Assumed | 29.4 | 45.9 | 70.9 | |||||||||
Gross earned premiums | 1,206.4 | 1,343.9 | 1,280.0 | |||||||||
Ceded | (105.8 | ) | (167.7 | ) | (1) | (102.9 | ) | |||||
Net earned premiums | $ | 1,100.6 | $ | 1,176.2 | $ | 1,177.1 | ||||||
Loss and LAE: | ||||||||||||
Direct | $ | 679.5 | $ | 783.0 | $ | 778.7 | ||||||
Assumed | 21.2 | 55.7 | 115.7 | |||||||||
Gross loss and LAE | 700.7 | 838.7 | 894.4 | |||||||||
Ceded | (44.7 | ) | (138.0 | ) | (1) | (79.3 | ) | |||||
Net loss and LAE | $ | 656.0 | $ | 700.7 | $ | 815.1 | ||||||
_______________________________________________________________________________
(1) | During the year ended December 31, 2015, the Company recorded ceded written premiums of $33.3 million, ceded earned premiums of $33.3 million and ceded loss and LAE of $33.4 million as a result of the exit of the Crop Business due to the 100% quota share reinsurance agreement with AmTrust. |
Reinsurance Treaties
The timing and size of catastrophe losses are unpredictable and the level of losses experienced in any year could be material to the Company's operating results and financial condition. Examples of catastrophes include losses caused by earthquakes, wildfires, hurricanes and other types of storms and terrorist acts. The extent of losses caused by a catastrophic event is a function of severity and the amount and type of insured exposure in the affected area. In the normal course of business, OneBeacon's insurance subsidiaries seek to limit losses that may arise from catastrophes or other events through individual risk selection, imposing deductibles and limits, limiting its concentration of insurance in catastrophe-prone areas such as coastal regions and reinsuring with third-party reinsurers.
The Company uses models (primarily AIR Worldwide Touchstone version 4.1) to estimate potential losses from catastrophes. The Company uses the model output in conjunction with other data to manage its exposure to catastrophe losses based on a probable maximum loss forecast to quantify its exposure to an extreme catastrophe event.
OneBeacon utilizes a general catastrophe reinsurance treaty with unaffiliated reinsurers to manage its exposure to large catastrophe losses. Effective May 1, 2016, OneBeacon renewed its property catastrophe reinsurance program through April 30, 2017. The program provides coverage for OneBeacon's property business as well as certain acts of terrorism. Under the program, the first $20.0 million of losses resulting from any single catastrophe are retained with 100% of the next $110.0 million of losses resulting from the catastrophe being reinsured. Any part of the catastrophe loss from a single event in excess of $130.0 million would be retained in full. In the event of a catastrophe, OneBeacon's property catastrophe reinsurance
F-30
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's current third party reinsurance programs provide varying degrees of coverage for terrorism events. The Company's overall terrorism exposure is impacted by the Terrorism Risk Insurance Program (the “Terrorism Act”), which is a federal program administered by the Department of the Treasury that provides for a shared system of public and private compensation for commercial property and casualty losses resulting from events that reach the threshold for losses ($140 million in 2017 and increasing $20 million in subsequent years until the threshold becomes $200 million in 2020) and are certified as an act of terrorism by the U.S. Secretary of the Treasury, in concurrence with the Secretary of Homeland Security and the Attorney General of the United States. The Terrorism Act limits the industry's aggregate liability for losses from certified terrorist acts by requiring the federal government to share a set amount of losses (83% in 2017 and decreasing 1% annually in subsequent years until it reaches a floor of 80% in 2020) once a company meets a specific retention or deductible as determined by its prior year's direct written premiums. It also limits the aggregate liability to be paid by the government and industry without further action by Congress to $100 billion. In exchange for this backstop, primary insurers are required to make coverage available to commercial insureds for losses from acts of terrorism as defined in the Terrorism Act. The following types of coverage are excluded from the program: commercial automobile, burglary and theft, surety, farmowners multi-peril and all professional liability coverage except directors and officers coverage.
All losses that result from a nuclear, biological, chemical or radiological terrorist attack are excluded from the Company's current third party reinsurance program. OneBeacon's property catastrophe treaty also excludes acts of terrorism certified pursuant to the Terrorism Act and committed by an individual or individuals acting on behalf of any foreign person or foreign interest. OneBeacon's casualty clash treaty provides coverage for losses that result from certified and non-certified acts of terrorism, on an aggregated basis, subject to a maximum of one full treaty limit. OneBeacon's property per risk, casualty and workers compensation treaties each provide full coverage for certified acts of terrorism on behalf of a non-foreign person or interest, but are sublimited to one full treaty limit for certified acts of terrorism committed on behalf of any foreign person or foreign interest. OneBeacon's healthcare treaty is sublimited to one full treaty limit of coverage for all acts of terrorism.
OneBeacon estimates its individual retention level for commercial policies subject to the Terrorism Act to be approximately $140 million in 2017. The federal government will pay 83% of covered terrorism losses that exceed the Company's or the industry's retention levels in 2017, up to a total of $100 billion. As indicated above, the Company's 17% copay will increase annually by 1% until it reaches a limit of 20% in 2020.
F-31
In addition to the corporate catastrophe reinsurance protection, the Company also purchases dedicated reinsurance protection for certain lines of business. The following table summarizes the reinsurance coverage currently in effect as of December 31, 2016:
$ in millions | ||||||||||||||||
Coverage | Contract Type | Renewal Date | First-Dollar Retention | Per Risk Limit Purchased | Maximum Retention | |||||||||||
Corporate Property Catastrophe - Property and Inland Marine | Excess of Loss | 5/1 | $ | 20.0 | $ | 110.0 | $ | 20.0 | ||||||||
Property Per Risk - Property and Inland Marine | Excess of Loss | 5/1 | 3.0 | 100.0 | 3.0 | |||||||||||
Specialty Property - Excess and Surplus Property Catastrophe | Excess of Loss | 5/1 | 6.0 | 34.0 | 6.0 | |||||||||||
Medical Excess - HMO/Provider Excess | Excess of Loss | 1/1 | 5.0 | Unlimited | 5.0 | |||||||||||
Ocean and Inland Marine | Excess of Loss | 4/1 | 2.5 | 57.5 | 7.0 | |||||||||||
Surety | Excess of Loss | 10/1 | 5.0 | 45.0 | 5.0 | |||||||||||
Film Completion Bonds | Excess of Loss | 6/1 | 2.0 | 38.0 | 2.0 | |||||||||||
Casualty Clash/Workers Compensation Catastrophe | Excess of Loss | 6/1 | 6.0 | 34.0 | 6.0 | |||||||||||
Workers Compensation Catastrophe | Excess of Loss | 6/1 | 40.0 | 20.0 | 6.0 | |||||||||||
Financial Institutions - Professional Liability | Quota Share | 6/1 | N/A | 10.0 | 5.0 | |||||||||||
Combined Healthcare/Casualty 2nd Layer - Various lines | Excess of Loss | 6/1 | 10.0 / 11.0 | 10.0 | 3.0 | |||||||||||
Casualty Per Policy - Various lines | Excess of Loss | 6/1 | 3.0 | 8.0 | 3.0 | |||||||||||
Workers Compensation Per Occurrence | Excess of Loss | 6/1 | 2.0 | 8.0 | 2.0 | |||||||||||
Healthcare Professional Liability | Excess of Loss | 6/1 | 3.0 | 7.0 | 3.0 | |||||||||||
Reinsurance Recoverables
As of December 31, 2016, OneBeacon had reinsurance recoverable on paid losses of $6.6 million and reinsurance recoverables on unpaid losses of $172.9 million. As reinsurance contracts do not relieve OneBeacon of its obligations, collectibility of balances due from reinsurers is important to OneBeacon's financial strength. OneBeacon is selective with its reinsurers, placing reinsurance with only those reinsurers having a strong financial condition. OneBeacon monitors the financial strength of its reinsurers on an ongoing basis. Uncollectible amounts historically have not been significant. The following table summarizes A.M. Best Company, Inc. ("A.M. Best") ratings for OneBeacon's reinsurers for its continuing insurance operations, excluding industry pools and associations, based upon reinsurance recoverable amounts on paid and unpaid losses and LAE:
December 31, 2016 | % of total | ||||||
A.M Best's Rating (1): | ($ in millions) | ||||||
A+ or better | $ | 73.9 | 41 | % | |||
A- to A | 79.7 | 44 | % | ||||
B, Not Rated and Other | 25.9 | (2) | 15 | % | |||
Total reinsurance recoverables | $ | 179.5 | 100 | % | |||
_______________________________________________________________________________
(1) | A.M Best's ratings as detailed above are "A+ or better" (Superior), "A- to A" (Excellent) and "B" (Fair). |
(2) | Includes reinsurance recoverable on unpaid losses from Bedivere of $18.3 million. |
F-32
NOTE 5. Investment Securities
OneBeacon's net investment income is comprised primarily of interest income associated with OneBeacon's fixed maturity investments and short-term investments and dividend income from its common equity securities and other investments. Net investment income for the years ended December 31, 2016, 2015, and 2014 consisted of the following:
Year ended December 31, | ||||||||||||
2016 | 2015 | 2014 | ||||||||||
($ in millions) | ||||||||||||
Fixed maturity investments | $ | 48.7 | $ | 43.8 | $ | 41.8 | ||||||
Short-term investments | 0.2 | — | — | |||||||||
Common equity securities | 3.5 | 6.1 | 6.5 | |||||||||
Other investments | 3.0 | 1.0 | 2.1 | |||||||||
Gross investment income | 55.4 | 50.9 | 50.4 | |||||||||
Less investment expenses | (4.8 | ) | (5.0 | ) | (7.0 | ) | ||||||
Net investment income, pre-tax | $ | 50.6 | $ | 45.9 | $ | 43.4 | ||||||
The composition of net realized investment gains consisted of the following:
Year ended December 31, | ||||||||||||
2016 | 2015 | 2014 | ||||||||||
($ in millions) | ||||||||||||
Fixed maturity investments | $ | (0.1 | ) | $ | 2.0 | $ | 6.6 | |||||
Short-term investments | — | — | — | |||||||||
Common equity securities | 12.2 | 33.8 | 53.9 | |||||||||
Other investments | (1.8 | ) | 11.4 | 9.2 | ||||||||
Net realized investment gains, pre-tax | 10.3 | 47.2 | 69.7 | |||||||||
Income taxes | (4.1 | ) | (9.1 | ) | (21.0 | ) | ||||||
Net realized investment gains, after tax | $ | 6.2 | $ | 38.1 | $ | 48.7 | ||||||
OneBeacon recognized gross realized investment gains of $31.7 million, $64.2 million and $75.0 million and gross realized investment losses of $21.4 million, $17.0 million and $5.3 million on sales and other-than-temporary impairment charges on investment securities during the years ended December 31, 2016, 2015 and 2014, respectively.
The net changes in fair value for the years ended December 31, 2016, 2015, and 2014 are as follows:
Year ended December 31, 2016 | ||||||||||||
Changes in net unrealized investment gains | Changes in net foreign currency translation gains (losses) | Total net changes in fair value reflected in revenues | ||||||||||
($ in millions) | ||||||||||||
Fixed maturity investments | $ | 2.5 | $ | — | $ | 2.5 | ||||||
Short-term investments | — | — | — | |||||||||
Common equity securities | 2.7 | — | 2.7 | |||||||||
Other investments | 22.2 | — | 22.2 | |||||||||
Net change, pre-tax | $ | 27.4 | $ | — | $ | 27.4 | ||||||
F-33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 5. Investment Securities
Year ended December 31, 2015 | ||||||||||||
Changes in net unrealized investment gains | Changes in net foreign currency translation gains (losses) | Total net changes in fair value reflected in revenues | ||||||||||
($ in millions) | ||||||||||||
Fixed maturity investments | $ | (15.7 | ) | $ | — | $ | (15.7 | ) | ||||
Short-term investments | — | — | — | |||||||||
Common equity securities | (33.2 | ) | 0.2 | (33.0 | ) | |||||||
Other investments | (33.6 | ) | — | (33.6 | ) | |||||||
Net change, pre-tax | $ | (82.5 | ) | $ | 0.2 | $ | (82.3 | ) | ||||
Year ended December 31, 2014 | ||||||||||||
Changes in net unrealized investment gains | Changes in net foreign currency translation gains (losses) | Total net changes in fair value reflected in revenues | ||||||||||
($ in millions) | ||||||||||||
Fixed maturity investments | $ | 1.9 | $ | — | $ | 1.9 | ||||||
Short-term investments | — | (0.1 | ) | (0.1 | ) | |||||||
Common equity securities | (32.6 | ) | (0.3 | ) | (32.9 | ) | ||||||
Other investments | 1.8 | — | 1.8 | |||||||||
Net change, pre-tax | $ | (28.9 | ) | $ | (0.4 | ) | $ | (29.3 | ) | |||
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 investment portfolio as of December 31, 2016 and 2015 were as follows:
December 31, | ||||||||
2016 | 2015 | |||||||
Investment securities: | ($ in millions) | |||||||
Gross unrealized investment gains | $ | 52.7 | $ | 46.5 | ||||
Gross unrealized investment losses | (12.0 | ) | (33.2 | ) | ||||
Total net unrealized investment gains, pre-tax | 40.7 | 13.3 | ||||||
Income taxes | (14.0 | ) | (6.5 | ) | ||||
Total net unrealized investment gains, after tax | $ | 26.7 | $ | 6.8 | ||||
F-34
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 5. Investment Securities
The cost or amortized cost, gross unrealized pre-tax investment gains and losses, net foreign currency gain and losses and carrying values of OneBeacon's fixed maturity investments as of December 31, 2016 and 2015 were as follows:
December 31, 2016 | ||||||||||||||||||||
Cost or amortized cost | Gross unrealized gains | Gross unrealized losses | Net unrealized foreign currency gain (losses) | Carrying value | ||||||||||||||||
($ in millions) | ||||||||||||||||||||
U.S. Government | $ | 169.6 | $ | — | $ | (2.3 | ) | $ | — | $ | 167.3 | |||||||||
Debt securities issued by corporations | 760.6 | 6.2 | (3.7 | ) | — | 763.1 | ||||||||||||||
Municipal obligations | 70.1 | 0.8 | (0.4 | ) | — | 70.5 | ||||||||||||||
Mortgage and asset-backed securities | 1,154.8 | 1.8 | (3.5 | ) | — | 1,153.1 | ||||||||||||||
Foreign government obligations | 1.0 | 0.2 | — | — | 1.2 | |||||||||||||||
Preferred stocks | 8.3 | 5.6 | — | — | 13.9 | |||||||||||||||
Total fixed maturity investments | $ | 2,164.4 | $ | 14.6 | $ | (9.9 | ) | $ | — | $ | 2,169.1 | |||||||||
December 31, 2015 | ||||||||||||||||||||
Cost or amortized cost | Gross unrealized gains | Gross unrealized losses | Net unrealized foreign currency gains (losses) | Carrying value | ||||||||||||||||
($ in millions) | ||||||||||||||||||||
U.S. Government | $ | 85.4 | $ | — | $ | (0.1 | ) | $ | — | $ | 85.3 | |||||||||
Debt securities issued by corporations | 810.8 | 4.1 | (4.5 | ) | — | 810.4 | ||||||||||||||
Municipal obligations | 67.7 | 1.5 | (0.2 | ) | — | 69.0 | ||||||||||||||
Mortgage and asset-backed securities | 1,035.1 | 1.3 | (4.5 | ) | — | 1,031.9 | ||||||||||||||
Foreign government obligations | 1.0 | 0.2 | — | — | 1.2 | |||||||||||||||
Preferred stocks | 78.3 | 4.4 | — | — | 82.7 | |||||||||||||||
Total fixed maturity investments | $ | 2,078.3 | $ | 11.5 | $ | (9.3 | ) | $ | — | $ | 2,080.5 | |||||||||
The cost or amortized cost and carrying value of OneBeacon's fixed maturity investments as of December 31, 2016 is presented below by contractual maturity. Actual maturities could differ from contractual maturities because borrowers may have the right to call or prepay certain obligations with or without call or prepayment penalties.
December 31, 2016 | ||||||||
Cost or amortized cost | Carrying value | |||||||
($ in millions) | ||||||||
Due in one year or less | $ | 91.0 | $ | 91.4 | ||||
Due after one year through five years | 782.9 | 784.3 | ||||||
Due after five years through ten years | 110.4 | 109.5 | ||||||
Due after ten years | 17.0 | 16.9 | ||||||
Asset-backed securities | 1,154.8 | 1,153.1 | ||||||
Preferred stocks | 8.3 | 13.9 | ||||||
Total | $ | 2,164.4 | $ | 2,169.1 | ||||
F-35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 5. Investment Securities
The following table summarizes the ratings of OneBeacon's debt securities issued by corporations as of December 31, 2016 and 2015:
December 31, | ||||||||
2016 | 2015 | |||||||
($ in millions) | ||||||||
AA(1) | $ | 63.7 | $ | 42.7 | ||||
A(1) | 169.1 | 265.4 | ||||||
BBB(1) | 450.8 | 502.3 | ||||||
BB(1) | 70.8 | — | ||||||
B(1) | 8.7 | — | ||||||
Debt securities issued by corporations | $ | 763.1 | $ | 810.4 | ||||
(1) | Credit ratings are assigned based on the following hierarchy: 1) Standard and Poor’s and 2) Moody’s Investor Service (“Moody’s”). |
The cost or amortized cost, gross unrealized pre-tax investment gains and losses, net foreign currency gains and losses and carrying values of OneBeacon's common equity securities and other investments as of December 31, 2016 and 2015 were as follows:
December 31, 2016 | ||||||||||||||||||||
Cost or amortized cost | Gross unrealized gains | Gross unrealized losses | Net unrealized foreign currency gains (losses) | Carrying value | ||||||||||||||||
($ in millions) | ||||||||||||||||||||
Common equity securities | $ | 182.3 | $ | 6.9 | $ | (0.5 | ) | $ | — | $ | 188.7 | |||||||||
Other investments | 120.9 | 31.2 | (1.6 | ) | — | 150.5 | ||||||||||||||
Total common equity securities and other investments | $ | 303.2 | $ | 38.1 | $ | (2.1 | ) | $ | — | $ | 339.2 | |||||||||
December 31, 2015 | ||||||||||||||||||||
Cost or amortized cost | Gross unrealized gains | Gross unrealized losses | Net unrealized foreign currency gains (losses) | Carrying value | ||||||||||||||||
($ in millions) | ||||||||||||||||||||
Common equity securities | $ | 295.0 | $ | 12.7 | $ | (9.0 | ) | $ | — | $ | 298.7 | |||||||||
Other investments | 135.6 | 22.3 | (14.9 | ) | — | 143.0 | ||||||||||||||
Total common equity securities and other investments | $ | 430.6 | $ | 35.0 | $ | (23.9 | ) | $ | — | $ | 441.7 | |||||||||
Sales and maturities of investments, excluding short-term investments and other investments, totaled $1,681.3 million, $1,371.5 million and $2,585.1 million for the years ended December 31, 2016, 2015 and 2014, respectively. There were no non-cash exchanges or involuntary sales of investment securities during the years ended December 31, 2016, 2015 and 2014.
OneBeacon's consolidated insurance operations are required to maintain deposits with certain insurance regulatory agencies in order to maintain their insurance licenses. The fair value of such deposits totaled $87.5 million and $82.1 million, respectively, as of December 31, 2016 and 2015.
As of December 31, 2016 and 2015, investments of $2.7 million and $2.2 million, respectively, were held in a trust required to be maintained to comply with New York surplus lines regulations and investments of $1.5 million and $5.4 million,
F-36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 5. Investment Securities
respectively, were held in a trust required to be maintained in relation to a reinsurance agreement with Star & Shield Insurance Exchange.
As of December 31, 2016 and 2015, the Company held unrestricted collateral from its customers, which is included in cash and invested assets, relating to its Surety business of $153.0 million and $137.7 million, respectively.
Fair value measurements
Fair value measurements are categorized into a 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"). Quoted prices in active markets for identical assets or liabilities have the highest priority ("Level 1"), followed by observable inputs other than quoted prices, including prices for similar but not identical assets or liabilities ("Level 2") with unobservable inputs, including the reporting entity's estimates of the assumptions that market participants would use, having the lowest priority ("Level 3"). As of December 31, 2016 and 2015, approximately 95% and 92%, respectively, of the investment portfolio recorded at fair value was priced based upon observable inputs.
Investments valued using Level 1 inputs include fixed maturity investments, primarily investments in U.S. Treasuries, common equity securities and short-term investments, which include U.S. Treasury Bills. Investments valued using Level 2 inputs are comprised primarily of fixed maturity investments, which have been disaggregated into classes, including debt securities issued by corporations, municipal obligations, mortgage and asset-backed securities, foreign government obligations and preferred stocks. Certain ETFs that track U.S. stock indices such as the S&P 500 but are traded on foreign exchanges are also considered Level 2 measurements, as management values such investments using the fund's published NAV to account for the difference in market close times. Fair value estimates for investments that trade infrequently and have few or no observable market prices are classified as Level 3 measurements. Level 3 fair value estimates based upon unobservable inputs include OneBeacon's investments in surplus notes, and certain fixed maturity investments and common equity securities where quoted market prices are unavailable or are not considered reasonable. OneBeacon determines when transfers between levels have occurred as of the beginning of the period.
OneBeacon uses brokers and outside pricing services to assist in determining fair values. For investments in active markets, OneBeacon uses the quoted market prices provided by outside pricing services to determine fair value. The outside pricing services used by OneBeacon have indicated that if no observable inputs are available for the security, they will not provide a price. In such circumstances, where quoted market prices are unavailable or are not considered reasonable, OneBeacon estimates the fair value using industry standard pricing methodologies and observable inputs such as benchmark yields, reported trades, broker-dealer quotes, issuer spreads, benchmark securities, bids, offers, prepayment speeds, reference data including research publications and other relevant inputs. Given that many fixed maturity investments do not trade on a daily basis, the outside pricing services evaluate a wide range of fixed maturity investments by regularly drawing parallels from recent trades and quotes of comparable securities with similar features. The characteristics used to identify comparable fixed maturity investments vary by asset type and take into account market convention.
OneBeacon's process to assess the reasonableness of the market prices obtained from the outside pricing sources covers substantially all of its fixed maturity investments and includes, but is not limited to, the evaluation of pricing methodologies and a review of the pricing services' quality control processes and procedures on at least an annual basis, comparison of our invested asset market prices to prices obtained from different independent pricing vendors on at least a semi-annual basis, monthly analytical reviews of certain prices and review of the underlying assumptions utilized by our pricing services for selected measurements on an ad hoc basis throughout the year. OneBeacon also performs back-testing of selected sales activity to determine whether there are any significant differences between the market price used to value the security prior to sale and the actual sale price on an ad-hoc basis throughout the year. Prices provided by the pricing services that vary by more than 5% and $1.0 million from the expected price based on these procedures are considered outliers. Also considered outliers are prices that have not changed from period to period and prices that have trended unusually compared to market conditions. In circumstances where the results of OneBeacon's review process do not appear to support the market price provided by the pricing services, OneBeacon challenges the price. If OneBeacon cannot gain satisfactory evidence to support the challenged price, it relies upon its own pricing methodologies to estimate the fair value of the security in question.
The valuation process above is generally applicable to all of OneBeacon’s fixed maturity investments. The techniques and inputs specific to asset classes within OneBeacon's fixed maturity investments for Level 2 securities that use observable inputs are as follows:
F-37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 5. Investment Securities
Debt securities issued by corporations: The fair value of debt securities issued by corporations is determined from a pricing evaluation technique that uses information from market sources and integrates relative credit information, observed market movements, and sector news. Key inputs include benchmark yields, reported trades, broker-dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data including sector, coupon, credit quality ratings, duration, credit enhancements, early redemption features and market research publications.
Municipal obligations: The fair value of municipal obligations is determined from a pricing evaluation technique that uses information from market makers, broker-dealers, buy-side firms, and analysts along with general market information. Key inputs include benchmark yields, reported trades, issuer financial statements, material event notices and new issue data, as well as broker-dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data including type, coupon, credit quality ratings, duration, credit enhancements, geographic location and market research publications.
Mortgage and asset-backed securities: The fair value of mortgage and asset-backed securities is determined from a pricing evaluation technique that uses information from market sources and leveraging similar securities. Key inputs include benchmark yields, reported trades, underlying tranche cash flow data, collateral performance, plus new issue data, as well as broker-dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data including issuer, vintage, loan type, collateral attributes, prepayment speeds, default rates, recovery rates, cash flow stress testing, credit quality ratings and market research publications.
Foreign government obligations: The fair value of foreign government obligations is determined from a pricing evaluation technique that uses feeds from data sources in each respective country, including active market makers and inter-dealer brokers. Key inputs include benchmark yields, reported trades, broker-dealer quotes, two-sided markets, benchmark securities, bids, offers, local exchange prices, foreign exchange rates and reference data including coupon, credit quality ratings, duration and market research publications.
Preferred stocks: The fair value of preferred stocks is determined from a pricing evaluation technique that calculates the appropriate spread over a comparable security for each issue. Key inputs include exchange prices (underlying and common stock of same issuer), benchmark yields, reported trades, broker-dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data including sector, coupon, credit quality ratings, duration, credit enhancements, early redemption features and market research publications.
Level 3 valuations are generated from techniques that use assumptions not observable in the market. These unobservable assumptions reflect OneBeacon's assumptions that market participants would use in valuing the investment. Generally, certain securities may start out as Level 3 when they are originally issued but as observable inputs become available in the market, they may be reclassified to Level 2.
The fair value of the surplus notes provided in conjunction with the financing of the Runoff Transaction is determined based on a discounted expected cash flow model using information as of the measurement date, and is classified as a Level 3 measurement. OneBeacon’s other investments also include an investment in a community reinvestment vehicle, which is accounted for at fair value, and a tax advantaged federal affordable housing development fund, which is accounted for under the proportional amortization method.
The fair values of OneBeacon's investments in hedge funds and private equity funds have been classified as NAV as prescribed by ASU 2015-07. OneBeacon employs a number of procedures to assess the reasonableness of the NAV reported by the fund's manager, including obtaining and reviewing periodic and audited financial statements and discussing each fund’s pricing with the fund manager throughout the year. In the event OneBeacon believes that its estimate of NAV differs from that reported by the fund due to illiquidity or other factors, OneBeacon will adjust the fund's reported NAV to more appropriately represent the fair value of its interest in the investment. As of December 31, 2016 and 2015, OneBeacon recorded negative adjustments of $5.0 million and $2.4 million, respectively, to the reported NAV of certain investments in private equity funds.
As of December 31, 2015, OneBeacon held one private preferred stock that represented approximately 85% of its preferred stock portfolio. That security, which was generally valued using quoted market prices for similar securities that were adjusted to reflect management's best estimate of fair value and was classified as a Level 3 measurement, was called during the year ended December 31, 2016.
Fair value measurements by level
The following tables summarize the Company's fair value measurements for investments as of December 31, 2016 and 2015 by level. The major security types were based on the legal form of the securities. OneBeacon has disaggregated its fixed maturity investments based on the issuing entity type, which impacts credit quality, with debt securities issued by U.S.
F-38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 5. Investment Securities
government entities carrying minimal credit risk, while the credit and other risks associated with other issuers, such as corporations, foreign governments, municipalities or entities issuing asset-backed securities vary depending on the nature of the issuing entity type. OneBeacon further disaggregates debt securities issued by corporations and equity securities by industry sector because investors often reference commonly used benchmarks and their subsectors to monitor risk and performance. Accordingly, OneBeacon has further disaggregated these asset classes into subclasses based on the similar sectors and industry classifications the Company uses to evaluate investment risk and performance against commonly used benchmarks, such as the Bloomberg Barclays U.S. Intermediate Aggregate and S&P 500 indices.
Fair value at December 31, 2016 | Level 1 | Level 2 | Level 3 | |||||||||||||
($ in millions) | ||||||||||||||||
Fixed maturity investments: | ||||||||||||||||
U.S. Government | $ | 167.3 | $ | 167.3 | $ | — | $ | — | ||||||||
Debt securities issued by corporations: | ||||||||||||||||
Consumer | 194.8 | — | 194.8 | — | ||||||||||||
Healthcare | 129.2 | — | 129.2 | — | ||||||||||||
Industrial | 118.2 | — | 118.2 | — | ||||||||||||
Financial | 96.3 | — | 96.3 | — | ||||||||||||
Communications | 59.4 | — | 59.4 | — | ||||||||||||
Energy | 47.4 | — | 47.4 | — | ||||||||||||
Technology | 40.7 | — | 40.7 | — | ||||||||||||
Utilities | 39.5 | — | 39.5 | — | ||||||||||||
Basic materials | 37.6 | — | 37.6 | — | ||||||||||||
Debt securities issued by corporations | 763.1 | — | 763.1 | — | ||||||||||||
Municipal obligations | 70.5 | — | 70.5 | — | ||||||||||||
Mortgage and asset-backed securities | 1,153.1 | — | 1,153.1 | — | ||||||||||||
Foreign government obligations | 1.2 | 0.6 | 0.6 | — | ||||||||||||
Preferred stocks | 13.9 | — | 13.9 | — | ||||||||||||
Fixed maturity investments | 2,169.1 | 167.9 | 2,001.2 | — | ||||||||||||
Short-term investments | 112.1 | 112.1 | — | — | ||||||||||||
Common equity securities: | ||||||||||||||||
Exchange Traded Funds(1) | 164.4 | 140.9 | 23.5 | — | ||||||||||||
Healthcare | 7.0 | 7.0 | — | — | ||||||||||||
Consumer | 4.3 | 4.3 | — | — | ||||||||||||
Financials | 3.9 | 3.9 | — | — | ||||||||||||
Technology | 3.7 | 3.7 | — | — | ||||||||||||
Communications | 3.5 | 3.5 | — | — | ||||||||||||
Energy | 1.2 | 1.2 | — | — | ||||||||||||
Industrial | 0.7 | 0.7 | — | — | ||||||||||||
Common equity securities | 188.7 | 165.2 | 23.5 | — | ||||||||||||
Other investments(2)(3) | 86.2 | — | — | 86.2 | ||||||||||||
Total(1)(2)(3) | $ | 2,556.1 | $ | 445.2 | $ | 2,024.7 | $ | 86.2 | ||||||||
_______________________________________________________________________________
(1) | ETFs traded on foreign exchanges are priced using the fund’s published NAV to account for the difference in market close times and are therefore designated as level 2 measurements. |
(2) | Excludes the carrying value of $12.3 million associated with a tax advantaged federal affordable housing development fund accounted for using the proportional amortization method as of December 31, 2016. |
(3) | As described in Note 1—"Nature of Operations and Summary of Significant Accounting Policies" investments in hedge funds and private equity funds with a measured fair value of $52.0 million for which NAV is generally the practical expedient are no longer classified within the fair value hierarchy. |
F-39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 5. Investment Securities
Fair value at December 31, 2015 | Level 1 | Level 2 | Level 3 | |||||||||||||
($ in millions) | ||||||||||||||||
Fixed maturity investments: | ||||||||||||||||
U.S. Government | $ | 85.3 | $ | 85.3 | $ | — | $ | — | ||||||||
Debt securities issued by corporations: | ||||||||||||||||
Consumer | 218.3 | — | 218.3 | — | ||||||||||||
Healthcare | 136.2 | — | 136.2 | — | ||||||||||||
Industrial | 121.8 | — | 121.8 | — | ||||||||||||
Financial | 116.0 | — | 116.0 | — | ||||||||||||
Energy | 75.2 | — | 75.2 | — | ||||||||||||
Communications | 46.0 | — | 46.0 | — | ||||||||||||
Utilities | 42.2 | — | 42.2 | — | ||||||||||||
Technology | 28.9 | — | 28.9 | — | ||||||||||||
Basic materials | 25.8 | — | 25.8 | — | ||||||||||||
Debt securities issued by corporations | 810.4 | — | 810.4 | — | ||||||||||||
Municipal obligations | 69.0 | — | 69.0 | — | ||||||||||||
Mortgage and asset-backed securities | 1,031.9 | — | 1,031.9 | — | ||||||||||||
Foreign government obligations | 1.2 | 0.6 | 0.6 | — | ||||||||||||
Preferred stocks | 82.7 | — | 12.7 | 70.0 | ||||||||||||
Fixed maturity investments | 2,080.5 | 85.9 | 1,924.6 | 70.0 | ||||||||||||
Short-term investments | 69.2 | 69.2 | — | — | ||||||||||||
Common equity securities: | ||||||||||||||||
Exchange Traded Funds(1) | 183.3 | 162.0 | 21.3 | — | ||||||||||||
Consumer | 38.2 | 38.2 | — | — | ||||||||||||
Communications | 23.9 | 23.9 | — | — | ||||||||||||
Healthcare | 19.6 | 19.6 | — | — | ||||||||||||
Technology | 14.7 | 14.7 | — | — | ||||||||||||
Industrial | 14.5 | 14.5 | — | — | ||||||||||||
Financials | 4.5 | 4.5 | — | — | ||||||||||||
Common equity securities | 298.7 | 277.4 | 21.3 | — | ||||||||||||
Other investments(2)(3) | 65.8 | — | — | 65.8 | ||||||||||||
Total(1)(2)(3) | $ | 2,514.2 | $ | 432.5 | $ | 1,945.9 | $ | 135.8 | ||||||||
_______________________________________________________________________________
(1) | ETFs traded on foreign exchanges are priced using the fund's published NAV to account for the difference in market close times and are therefore designated as level 2 measurements. |
(2) | Excludes the carrying value of $14.7 million associated with a tax advantaged federal affordable housing development fund accounted for using the proportional amortization method as of December 31, 2015. |
(3) | As described in Note 1—"Nature of Operations and Summary of Significant Accounting Policies" investments in hedge funds and private equity funds with a measured fair value of $62.5 million for which NAV is generally the practical expedient are no longer classified within the fair value hierarchy. |
F-40
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 5. Investment Securities
Rollforwards of Fair Value Measurements by Level
The following tables summarize the changes in OneBeacon’s fair value measurements by level for the year ended December 31, 2016 and 2015:
Level 3 Investments | ||||||||||||||||||||||||
($ in millions) | Level 1 Investments | Level 2 Investments | Fixed maturity investments | Other investments(1) | NAV Investments(2) | Total(1)(2)(3) | ||||||||||||||||||
Balance at January 1, 2016 | $ | 363.3 | $ | 1,945.9 | $ | 70.0 | $ | 65.8 | 62.5 | $ | 2,507.5 | |||||||||||||
Amortization/accretion | — | (13.3 | ) | — | — | — | (13.3 | ) | ||||||||||||||||
Net realized and change in unrealized gains | 9.2 | 8.2 | (0.1 | ) | 20.4 | — | 37.7 | |||||||||||||||||
Purchases | 496.9 | 1,111.0 | 48.0 | — | 1.0 | 1,656.9 | ||||||||||||||||||
Sales | (536.3 | ) | (1,075.0 | ) | (70.0 | ) | — | (11.5 | ) | (1,692.8 | ) | |||||||||||||
Transfers in | — | 47.9 | — | — | — | 47.9 | ||||||||||||||||||
Transfers out | — | — | (47.9 | ) | — | — | (47.9 | ) | ||||||||||||||||
Balance at December 31, 2016 | $ | 333.1 | $ | 2,024.7 | $ | — | $ | 86.2 | $ | 52.0 | $ | 2,496.0 | ||||||||||||
_______________________________________________________________________________
(1) | Excludes the carrying value of $12.3 million associated with a tax advantaged federal affordable housing development fund accounted for using the proportional amortization method as of December 31, 2016. |
(2) | As described in Note 1—"Nature of Operations and Summary of Significant Accounting Policies" investments in hedge funds and private equity funds generally measured using the NAV practical expedient are no longer classified within the fair value hierarchy. |
(3) | Excludes short-term investments. |
Level 3 Investments | ||||||||||||||||||||||||
($ in millions) | Level 1 Investments | Level 2 Investments | Fixed maturity investments | Other investments(1) | NAV Investments(2) | Total(1)(2)(3) | ||||||||||||||||||
Balance at January 1, 2015 | $ | 358.7 | $ | 1,692.1 | $ | 74.0 | $ | 79.6 | 102.4 | $ | 2,306.8 | |||||||||||||
Amortization/accretion | — | (13.2 | ) | — | — | — | (13.2 | ) | ||||||||||||||||
Net realized and change in unrealized gains | 1.3 | (12.7 | ) | (1.1 | ) | (13.9 | ) | (8.7 | ) | (35.1 | ) | |||||||||||||
Purchases | 638.0 | 985.7 | 34.0 | 0.7 | 2.7 | 1,661.1 | ||||||||||||||||||
Sales | (634.7 | ) | (742.9 | ) | — | (0.6 | ) | (33.9 | ) | (1,412.1 | ) | |||||||||||||
Transfers in | — | 36.9 | — | — | — | 36.9 | ||||||||||||||||||
Transfers out | — | — | (36.9 | ) | — | — | (36.9 | ) | ||||||||||||||||
Balance at December 31, 2015 | $ | 363.3 | $ | 1,945.9 | $ | 70.0 | $ | 65.8 | $ | 62.5 | $ | 2,507.5 | ||||||||||||
_______________________________________________________________________________
(1) | Excludes the carrying value of $14.7 million associated with a tax advantaged federal affordable housing development fund accounted for using the proportional amortization method as of December 31, 2015. |
(2) | As described in Note 1—"Nature of Operations and Summary of Significant Accounting Policies" investments in hedge funds and private equity funds generally measured using the NAV practical expedient are no longer classified within the fair value hierarchy. |
(3) | Excludes short-term investments. |
There were no “Transfers in” to Level 3 fixed maturity investments for the years ended December 31, 2016 and 2015.
“Transfers out” of Level 3 fixed maturity investments for the year ended December 31, 2016 were comprised of $44.2 million of residential mortgage-backed securities and $3.7 million of other asset-backed securities, all of which were recategorized as Level 2 measurements when quoted market prices for similar securities that were considered reliable and could be validated against an alternative source became available.
“Transfers out” of Level 3 fixed maturity investments for the year ended December 31, 2015 were comprised of $18.1 million in residential mortgage-backed securities ("RMBS"), $10.3 million in commercial mortgage-backed securities, $5.6 million in asset backed securities and $2.9 million of debt securities issued by corporations, all of which were recategorized as
F-41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 5. Investment Securities
Level 2 measurements when quoted market prices that were considered reliable and could be validated against alternative sources became available.
The following table summarizes the change in net unrealized investment gains and losses for assets designated as Level 3 for the year ended December 31, 2016, 2015, and 2014:
Year ended December 31, | ||||||||||||
2016 | 2015 | 2014 | ||||||||||
($ in millions) | ||||||||||||
Fixed maturity investments | $ | — | $ | (1.1 | ) | $ | 1.1 | |||||
Other investments(1) | 20.4 | (14.0 | ) | 6.3 | ||||||||
Total | $ | 20.4 | $ | (15.1 | ) | $ | 7.4 | |||||
_______________________________________________________________________________
(1) As described in Note 1—"Nature of Operations and Summary of Significant Accounting Policies" investments in hedge funds and private equity funds generally measured using the NAV practical expedient are no longer classified within the fair value hierarchy.
F-42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 5. Investment Securities
Significant Unobservable Inputs
The following summarizes significant unobservable inputs used in estimating the fair value of investment securities other than hedge funds and private equity funds, classified within Level 3 as of December 31, 2016 and 2015. The fair value of investments in hedge funds and private equity funds, which are classified with Level 3, are generally estimated using the NAV of the funds.
($ in millions) | As of December 31, 2016 | |||||||||||||
Description | Fair Value | Rating(1) | Valuation Technique | Unobservable Inputs | Input | |||||||||
Surplus notes: | 11.7% | |||||||||||||
- Seller priority note | $ | 51.1 | N/R | Discounted cash flow | Discount rate(2) | 9.6% | ||||||||
Timing of interest payments(3) | 2020 | |||||||||||||
Timing of principal payments(3) | 2030 | |||||||||||||
- Pari passu note | $ | 20.8 | N/R | Discounted cash flow | Discount rate(4) | 15.0% | ||||||||
Timing of interest payments(5) | 2021 | |||||||||||||
Timing of principal payments(5) | 2035 | |||||||||||||
Community reinvestment vehicle | $ | 14.3 | N/R | Member share of GAAP net equity | GAAP net equity | $ | 14.3 | |||||||
($ in millions) | As of December 31, 2015 | |||||||||||||
Description | Fair Value | Rating(1) | Valuation Technique | Unobservable Inputs | Input | |||||||||
Preferred stock | $ | 70.0 | N/R | Par value(6) | Issuer's intent to call | $ | 70.0 | |||||||
Surplus notes: | 16.1% | |||||||||||||
- Seller priority note | $ | 38.0 | N/R | Discounted cash flow | Discount rate(2) | 13.0% | ||||||||
Timing of interest payments(3) | 2020 | |||||||||||||
Timing of principal payments(3) | 2025 | |||||||||||||
- Pari passu note | $ | 13.5 | N/R | Discounted cash flow | Discount rate(4) | 22.4% | ||||||||
Timing of interest payments(5) | 2020 | |||||||||||||
Timing of principal payments(5) | 2030 | |||||||||||||
Community reinvestment vehicle | $ | 14.3 | N/R | Member share of GAAP net equity | GAAP net equity | $ | 14.3 | |||||||
_________________________________________________________________________
(1) | Credit ratings, if rated, are assigned based on the following hierarchy: 1) Standard & Poor's and 2) Moody's |
(2) | Stochastic modeling supporting the fair value estimation indicates that the average percentage of discounted payments missed on the seller priority note is roughly equivalent to that of a conventional debt security with a credit rating of ‘B’. The corresponding credit spread, increased by an additional 250 bps to reflect both a liquidity discount for a private debt instrument and regulatory payment approval uncertainty, was added to the treasury rate to determine the discount rate for the seller priority note. |
(3) | As of December 31, 2016, the Company has assumed for the purpose of estimating fair value that all accrued but unpaid interest on the seller priority note since the date of issuance is paid in 2020, with regular annual interest payments beginning thereafter. Principal repayments are assumed to begin on a graduated basis in 2030. As of December 31, 2015, the company assumed for the purpose of estimating fair value that all accrued but unpaid interest on the seller priority note since the date of issuance was paid in 2020, with regular annual payments beginning thereafter. Principal repayments were assumed to begin on a graduated basis in 2025. |
(4) | Stochastic modeling supporting the fair value estimation indicates that the average percentage of discounted payments missed on the pari passu note is roughly equivalent to that of a conventional debt security with a credit rating of ‘CCC’. The corresponding credit spread, increased by an additional 250 bps to reflect both a liquidity discount for a private debt instrument and regulatory payment approval uncertainty, was added to the treasury rate to determine the discount rate for the seller priority note. |
(5) | As of December 31, 2016, the company has assumed for the purpose of estimating fair value that regular annual interest payments on the pari passu note begin in 2021. All accrued but unpaid interest since the date of issuance is assumed to be paid in 2025. Principal repayments are assumed to begin on a graduated basis in 2035. As of December 31, 2015, the company assumed for the purpose of estimating fair value that all accrued but unpaid interest on the pari passu note since the date of issuance was paid in 2020, with regular annual payments beginning thereafter. Principal repayments were assumed to begin on a graduated basis in 2030. |
(6) | Valuation based on issuer's intent as of December 31, 2015 to call the security in the near term. |
F-43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 5. Investment Securities
Mortgage and Asset-backed Securities
OneBeacon purchases commercial mortgage-backed securities ("CMBS") and RMBS to maximize its risk adjusted returns in the context of a diversified portfolio. OneBeacon's non-agency CMBS are generally short tenor and structurally senior, with approximately 30 points of subordination on average for fixed rate and floating rate CMBS as of December 31, 2016. 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 this structural protection mitigates the risk of loss tied to refinancing challenges facing the commercial real estate market. As of December 31, 2016, none of the loans underlying the agency and non-agency CMBS portfolio were reported as non-performing.
OneBeacon's non-agency RMBS portfolio is generally of moderate average life, fixed rate and structurally senior. OneBeacon considers sub-prime mortgage-backed securities to be those that have underlying loan pools that exhibit weak credit characteristics or are issued from dedicated sub-prime shelf registrations or dedicated second-lien shelf registrations (i.e., investments backed primarily by second-liens are considered to be sub-prime risks regardless of credit scores or other metrics). OneBeacon did not hold any RMBS categorized as sub-prime as of December 31, 2016.
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 December 31, 2016, OneBeacon did not hold any mortgage-backed securities that were classified as non-prime. OneBeacon does not own any collateralized debt obligations, with the exception of $29.0 million of non-agency RMBS resecuritization tranches, each a senior tranche in its own right and each collateralized by a single earlier vintage Super Senior or Senior non-agency RMBS security.
The following table summarizes the carrying value of OneBeacon's asset-backed securities as of December 31, 2016 and 2015:
December 31, | ||||||||||||||||||||||||
2016 | 2015 | |||||||||||||||||||||||
Fair Value | Level 2 | Level 3 | Fair Value | Level 2 | Level 3 | |||||||||||||||||||
($ in millions) | ||||||||||||||||||||||||
Mortgage-backed securities: | ||||||||||||||||||||||||
Agency: | ||||||||||||||||||||||||
GNMA | $ | 213.5 | $ | 213.5 | $ | — | $ | 220.5 | $ | 220.5 | $ | — | ||||||||||||
FNMA | 42.8 | 42.8 | — | 1.4 | 1.4 | — | ||||||||||||||||||
FHLMC | 30.3 | 30.3 | — | 3.1 | 3.1 | — | ||||||||||||||||||
Total agency(1) | 286.6 | 286.6 | — | 225.0 | 225.0 | — | ||||||||||||||||||
Non-agency: | ||||||||||||||||||||||||
Residential (RMBS) | 135.0 | 135.0 | — | 132.7 | 132.7 | — | ||||||||||||||||||
Commercial (CMBS) | 123.6 | 123.6 | — | 140.4 | 140.4 | — | ||||||||||||||||||
Total non-agency | 258.6 | 258.6 | — | 273.1 | 273.1 | — | ||||||||||||||||||
Total mortgage-backed securities | 545.2 | 545.2 | — | 498.1 | 498.1 | — | ||||||||||||||||||
Other asset-backed securities: | ||||||||||||||||||||||||
Vehicle receivables | 273.6 | 273.6 | — | 255.6 | 255.6 | — | ||||||||||||||||||
Credit card receivables | 224.3 | 224.3 | — | 202.7 | 202.7 | — | ||||||||||||||||||
Other | 110.0 | 110.0 | — | 75.5 | 75.5 | — | ||||||||||||||||||
Total other asset-backed securities | 607.9 | 607.9 | — | 533.8 | 533.8 | — | ||||||||||||||||||
Total mortgage and asset-backed securities | $ | 1,153.1 | $ | 1,153.1 | $ | — | $ | 1,031.9 | $ | 1,031.9 | $ | — | ||||||||||||
_______________________________________________________________________________
(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). |
F-44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 5. Investment Securities
Non-agency Mortgage-backed Securities
The security issuance years of OneBeacon's investments in non-agency RMBS and non-agency CMBS securities as of December 31, 2016 are as follows:
Fair Value | Security Issuance Year | |||||||||||||||||||||||||||||||||||||||||||||||
2004 | 2005 | 2006 | 2008 | 2010 | 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | ||||||||||||||||||||||||||||||||||||||
($ in millions) | ||||||||||||||||||||||||||||||||||||||||||||||||
Total non-agency RMBS | $ | 135.0 | $ | 19.1 | $ | 5.7 | $ | 3.0 | $ | 2.7 | $ | 7.4 | $ | 9.9 | $ | 5.0 | $ | 13.9 | $ | 30.5 | $ | 5.0 | $ | 32.8 | ||||||||||||||||||||||||
Total non-agency CMBS | 123.6 | — | — | — | — | 4.3 | — | 18.1 | 11.5 | 23.4 | 44.4 | 21.9 | ||||||||||||||||||||||||||||||||||||
Total non-agency | $ | 258.6 | $ | 19.1 | $ | 5.7 | $ | 3.0 | $ | 2.7 | $ | 11.7 | $ | 9.9 | $ | 23.1 | $ | 25.4 | $ | 53.9 | $ | 49.4 | $ | 54.7 | ||||||||||||||||||||||||
Non-agency Residential Mortgage-backed Securities
The classification of the underlying collateral quality and the tranche levels of OneBeacon's non-agency RMBS securities are as follows as of December 31, 2016:
Fair Value | Super Senior(1) | Senior(2) | Subordinate(3) | |||||||||||||
($ in millions) | ||||||||||||||||
Prime | $ | 135.0 | $ | 82.1 | $ | 52.9 | $ | — | ||||||||
Non-prime | — | — | — | — | ||||||||||||
Total non-agency RMBS | $ | 135.0 | $ | 82.1 | $ | 52.9 | $ | — | ||||||||
_______________________________________________________________________________
(1) | At issuance, Super Senior, or in the case of resecuritization, the underlying securities, were rated AAA by Standard & Poor's, Aaa by Moody's, or AAA by Fitch Ratings ("Fitch") and were senior to other AAA or Aaa securities. |
(2) | At issuance, Senior, or in the case of resecuritization, the underlying securities, were rated AAA by Standard & Poor's, Aaa by Moody's, or AAA by Fitch and were senior to non-AAA or non-Aaa securities. |
(3) | At issuance, Subordinate were not rated AAA by Standard & Poor's, Aaa by Moody's, or AAA by Fitch and were junior to other securities. |
Non-agency Commercial Mortgage-backed Securities
The amount of fixed and floating rate securities and their tranche levels are as follows as of December 31, 2016:
Fair Value | Super Senior(1) | Senior(2) | Subordinate(3) | |||||||||||||
($ in millions) | ||||||||||||||||
Fixed rate CMBS | $ | 112.1 | $ | 8.7 | $ | 56.9 | $ | 46.5 | ||||||||
Floating rate CMBS | 11.5 | — | — | 11.5 | ||||||||||||
Total non-agency CMBS | $ | 123.6 | $ | 8.7 | $ | 56.9 | $ | 58.0 | ||||||||
_______________________________________________________________________________
(1) | At issuance, Super Senior, or in the case of resecuritization, the underlying securities, were rated AAA by Standard & Poor's, Aaa by Moody's or AAA by Fitch and were senior to other AAA or Aaa securities. |
(2) | At issuance, Senior, or in the case of resecuritization, the underlying securities, were rated AAA by Standard & Poor's, Aaa by Moody's, or AAA by Fitch and were senior to non-AAA or non-Aaa securities. |
(3) | At issuance, Subordinate were not rated AAA by Standard & Poor's, Aaa by Moody's, or AAA by Fitch and were junior to other securities. |
F-45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 5. Investment Securities
Other Investments
As of December 31, 2016 and 2015, other investments reported at fair value represented approximately 6% and 5%, respectively, of the total investment portfolio and consisted of the following:
($ in millions) | December 31, 2016 | December 31, 2015 | ||||||
Hedge funds(1) | $ | 18.4 | $ | 16.4 | ||||
Private equity funds(2) | 33.6 | 46.1 | ||||||
Total hedge funds and private equity funds | 52.0 | 62.5 | ||||||
Surplus notes (par value $101.0)(3) | 71.9 | 51.5 | ||||||
Investment in community reinvestment vehicle | 14.3 | 14.3 | ||||||
Total other investments(4) | $ | 138.2 | $ | 128.3 | ||||
_______________________________________________________________________________
(1) | Consists of 4 hedge funds as of both December 31, 2016 and 2015. |
(2) | Consists of 17 private equity funds as of both December 31, 2016 and 2015. |
(3) | The increase in the fair value of the surplus notes during the year ended December 31, 2016 was driven primarily by the narrowing of non-investment grade credit spreads, partially offset by the impact of a change in estimates and assumptions regarding the timing of regulatory approval of principal and interest payments on the notes. |
(4) | Excludes the carrying value of $12.3 million and $14.7 million as of December 31, 2016 and 2015, respectively, associated with a tax advantaged federal affordable housing development fund accounted for using the proportional amortization method. |
The largest investment in a single hedge fund or private equity fund was $15.0 million and $12.9 million as of December 31, 2016 and 2015, respectively.
Surplus Notes
In the fourth quarter of 2014, in conjunction with the Runoff Transaction, OneBeacon provided financing in the form of surplus notes having a par value of $101.0 million, which had a fair value of $71.9 million and $51.5 million as of December 31, 2016 and 2015, respectively. The surplus notes, issued by one of the transferred entities, Bedivere (“Issuer”), were in the form of both seller priority and pari passu notes.
The internal valuation model used to estimate the fair value is based on a discounted expected cash flow model using information as of the measurement date. The estimated fair value of the surplus notes is sensitive to changes in public debt credit spreads, as well as changes in estimates with respect to other variables including a discount to reflect the private nature of the notes (and the related lack of liquidity), the credit quality of the notes, based on the financial performance of the Issuer relative to expectations, and the timing, amount, and likelihood of interest and principal payments on the notes, which are subject to regulatory approval and therefore may vary from the contractual terms. Anticipating a change in the assumed timeline, amounts, and process necessary to obtain regulatory approval, the Company made a change in estimate as of December 31, 2016 with regard to the timing of regulatory approval of principal and interest payments on the notes. For the purpose of estimating fair value, the Company has currently assumed that all accrued by unpaid interest on the seller priority note since the date of issuance is paid in 2020, with regular annual interest payments on both the seller priority note and pari passu note beginning thereafter, all accrued but unpaid interest on the pari passu note since the date of issuance is paid in 2025, and principal repayments begin on a graduated basis in 2030 for the seller priority note and 2035 for the pari passu note. Previously, including as of December 31, 2015, the Company had assumed for the purpose of estimating fair value that interest payouts, including all accrued but unpaid amounts, began in 2020 for both notes and that principal repayments began on a graduated basis in 2025 for the seller priority note and 2030 for the pari passu note. Although these variables involve considerable judgment, the Company does not currently expect any resulting changes in the estimated value of the surplus notes to be material to its financial position. An interest payment of $2.4 million was received in the year ended December 31, 2016.
F-46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 5. Investment Securities
Below is a table illustrating the valuation adjustments taken to arrive at estimated fair value of the surplus notes as of December 31, 2016 and 2015:
Type of Surplus Note | Total as of December 31, 2016 | |||||||||||
Seller Priority | Pari Passu | |||||||||||
(in millions) | ||||||||||||
Par value | $ | 57.9 | $ | 43.1 | $ | 101.0 | ||||||
Fair value adjustments to reflect: | ||||||||||||
Current market rates on public debt and contract-based repayments(1) | 6.2 | (1.1 | ) | 5.1 | ||||||||
Regulatory approval(2) | (0.2 | ) | (15.4 | ) | (15.6 | ) | ||||||
Liquidity adjustment(3) | (12.8 | ) | (5.8 | ) | (18.6 | ) | ||||||
Total | (6.8 | ) | (22.3 | ) | (29.1 | ) | ||||||
Fair value(4) | $ | 51.1 | $ | 20.8 | $ | 71.9 | ||||||
Type of Surplus Note | Total as of December 31, 2015 | |||||||||||
Seller Priority | Pari Passu | |||||||||||
(in millions) | ||||||||||||
Par value | $ | 57.9 | $ | 43.1 | $ | 101.0 | ||||||
Fair value adjustments to reflect: | ||||||||||||
Current market rates on public debt and contract-based repayments(1) | (0.4 | ) | (14.7 | ) | (15.1 | ) | ||||||
Regulatory approval(2) | (11.7 | ) | (12.5 | ) | (24.2 | ) | ||||||
Liquidity adjustment(3) | (7.8 | ) | (2.4 | ) | (10.2 | ) | ||||||
Total | (19.9 | ) | (29.6 | ) | (49.5 | ) | ||||||
Fair value | $ | 38.0 | $ | 13.5 | $ | 51.5 | ||||||
_______________________________________________________________________________
(1) | Represents the value of the surplus notes, at current market yields on comparable publicly traded debt, and assuming issuer is allowed to make principal and interest payments when its financial capacity is available, as measured by statutory capital in excess of a 250% RBC score under the National Association of Insurance Commissioners’ risk-based capital standards for property and casualty companies. The favorable year-over-year change in impact is due principally to the narrowing of non-investment grade credit spreads as well as the time value of money benefit from moving on year closer to modeled cash receipts. |
(2) | Represents anticipated delay in securing regulatory approvals of interest and principal payments to reflect graduated changes in Issuer's statutory surplus. The monetary impact of the anticipated delay is measured based on credit spreads of public securities with roughly equivalent percentages of discounted payments missed. The favorable year-over-year change in impact is driven primarily by the narrowing of non-investment grade credit spreads, which causes the anticipated delay in securing regulatory approval to be less punitive, partially offset by the change in estimates and assumptions regarding the timeline, amounts, and process necessary to obtain regulatory approval for principal and interest payments described below. |
(3) | Represents impact of liquidity spread to account for OneBeacon's sole ownership of the notes, lack of a trading market, and unique nature of the ongoing regulatory approval process. The unfavorable year-over-year change in impact is due largely to the increased fair value of the notes as well as a higher effective duration resulting from a lower overall yield to maturity; there was no change in the magnitude of the liquidity spread in 2016. |
(4) | The increase in the fair value of the surplus notes during the year ended December 31, 2016 was driven primarily by the narrowing of non-investment grade credit spreads, partially offset by the impact of a change in estimates and assumptions regarding the timing of regulatory approval of principal and interest payments on the notes. |
F-47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 5. Investment Securities
Hedge Funds and Private Equity Funds
OneBeacon holds investments in hedge funds and private equity funds which are included in other investments. The fair value of these investments has generally been estimated using the NAV of the fund. The following table summarizes investments in hedge funds and private equity funds as of December 31, 2016 and 2015:
December 31, | ||||||||||||||||
2016 | 2015 | |||||||||||||||
Fair Value | Unfunded Commitments | Fair Value | Unfunded Commitments | |||||||||||||
($ in millions) | ||||||||||||||||
Hedge funds | ||||||||||||||||
Long/short equity banks and financial | $ | 15.0 | $ | — | $ | 12.8 | $ | — | ||||||||
Other | 3.4 | — | 3.6 | — | ||||||||||||
Total hedge funds | 18.4 | — | 16.4 | — | ||||||||||||
Private equity funds | ||||||||||||||||
Energy infrastructure and services | 14.1 | 3.2 | 20.7 | 3.4 | ||||||||||||
Multi-sector | 11.5 | 2.0 | 14.8 | 2.1 | ||||||||||||
Healthcare | 3.5 | 0.4 | 3.8 | 0.4 | ||||||||||||
Private equity secondaries | 3.0 | 2.1 | 4.4 | 2.1 | ||||||||||||
Insurance | 0.8 | 0.1 | 2.0 | 0.1 | ||||||||||||
Direct lending / mezzanine debt | 0.4 | 7.1 | — | — | ||||||||||||
Real estate | 0.3 | 0.1 | 0.4 | 0.1 | ||||||||||||
Total private equity funds | 33.6 | 15.0 | 46.1 | 8.2 | ||||||||||||
Total hedge funds and private equity funds | $ | 52.0 | $ | 15.0 | $ | 62.5 | $ | 8.2 | ||||||||
Redemptions of investments in certain hedge funds are subject to restrictions including lock-up periods where no redemptions or withdrawals are allowed, restrictions on redemption frequency and advance notice periods for redemptions. Amounts requested for redemptions remain subject to market fluctuations until the redemption effective date, which generally falls at the end of the defined redemption period. As of December 31, 2016, none of OneBeacon's active hedge funds were subject to lock-up. The following summarizes the December 31, 2016 fair value of hedge funds subject to restrictions on redemption frequency and advance notice period requirements:
Hedge Fund Notice Period | ||||||||||||||||||||
30 - 59 days notice | 60 - 89 days notice | 90 - 119 days notice | 120+ days notice | Total | ||||||||||||||||
($ in millions) | ||||||||||||||||||||
Redemption frequency | ||||||||||||||||||||
Monthly | $ | — | $ | — | $ | — | $ | — | $ | — | ||||||||||
Quarterly | 16.0 | — | — | — | 16.0 | |||||||||||||||
Annual | — | — | 2.4 | — | 2.4 | |||||||||||||||
Total hedge funds | $ | 16.0 | $ | — | $ | 2.4 | $ | — | $ | 18.4 | ||||||||||
Certain hedge fund investments are no longer active and are in the process of disposing of their underlying investments. Distributions from such funds are remitted to investors as the fund's underlying investments are liquidated. As of December 31, 2016, $1.0 million of OneBeacon's hedge funds were in liquidation. The actual amount of the final distribution is subject to market fluctuations. The date at which such distributions will be received is not determinable as of December 31, 2016.
F-48
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 5. Investment Securities
OneBeacon has also submitted redemption requests for certain of its investments in active hedge funds. As of December 31, 2016, redemptions of $2.4 million were outstanding and remain subject to market fluctuations. The date at which such redemptions will be received is not determinable at December 31, 2016. Redemptions are recorded as receivables when the investment is no longer subject to market fluctuations.
Investments in private equity funds are generally subject to lock-up periods during which investors may not request a redemption. Distributions prior to the expected termination date of the fund may be limited to dividends or proceeds arising from the liquidation of the fund's underlying investments. In addition, certain private equity funds provide an option to extend the lock-up period at either the sole discretion of the fund manager or upon agreement between the fund and its investors. As of December 31, 2016, investments in private equity funds were subject to lock-up periods as follows:
1 - 3 years | 3 - 5 years | 5 - 10 years | >10 years | Total | ||||||||||||||||
($ in millions) | ||||||||||||||||||||
Private Equity Funds—expected lock-up period remaining | $ | 14.8 | $ | 3.5 | $ | 14.9 | $ | 0.4 | $ | 33.6 | ||||||||||
NOTE 6. Debt
OneBeacon's debt outstanding as of December 31, 2016 and 2015 consisted of the following:
December 31, | ||||||||
2016 | 2015 | |||||||
($ in millions) | ||||||||
Senior unsecured notes, at face value | $ | 275.0 | $ | 275.0 | ||||
Unamortized original issue discount | (0.2 | ) | (0.2 | ) | ||||
Unamortized issuance costs(1) | (1.6 | ) | (1.9 | ) | ||||
Senior unsecured notes, carrying value | $ | 273.2 | $ | 272.9 | ||||
(1) Unamortized issuance costs have been reclassified from other assets to a decrease of the debt liability in accordance with ASU 2015-03, as described in Note 1—"Nature of Operations and Summary of Significant Accounting Policies."
Contractual repayments of $275.0 million for OneBeacon's outstanding debt are due more than five years after December 31, 2016.
2012 Senior Notes
In November 2012, OneBeacon U.S. Holdings, Inc. ("OBH") issued $275.0 million face value of senior unsecured notes ("2012 Senior Notes") through a public offering, at an issue price of 99.9% and received $272.9 million of proceeds. The 2012 Senior Notes bear an annual interest rate of 4.6% payable semi-annually in arrears on May 9 and November 9, until maturity on November 9, 2022, and are fully and unconditionally guaranteed as to the payment of principal and interest by the Company. Taking into effect the amortization of the original issue discount and all underwriting and issuance expenses, the 2012 Senior Notes have an effective yield to maturity of approximately 4.7% per annum.
Credit Facility
On September 29, 2015 the Company and OBH, as co-borrowers and co-guarantors, entered into a revolving credit facility administered by U.S. Bank N.A. and also including BMO Harris Bank N.A., which has a total commitment of $65.0 million and has a maturity date of September 29, 2019 (the "Credit Facility"). As of December 31, 2016 the credit facility was undrawn.
Debt Covenants
The 2012 Senior Notes were issued under indentures that contain restrictive covenants which, among other things, limit the ability of the Company, OBH, and their respective subsidiaries to create liens and enter into sale and leaseback transactions and limits the ability of OneBeacon to consolidate, merge or transfer their properties and assets. The indentures do not contain any financial ratios or specified levels of net worth or liquidity to which the Company or OBH must adhere. In addition, a failure by the Company or its subsidiaries to pay principal and interest on covered debt, where such failure results in the
F-49
acceleration of at least $75 million of the principal amount of covered debt, could trigger the acceleration of the 2012 Senior Notes.
The Credit Facility contains various affirmative, negative and financial covenants which OneBeacon considers to be customary for such borrowings, including certain minimum net worth and maximum debt to capitalization standards. These covenants can restrict the Company in several ways, including its ability to incur additional indebtedness. An uncured breach of these covenants could result in an event of default under the Credit Facility, which would allow lenders to declare any amounts owed under the Credit Facility to be immediately due and payable.
As of December 31, 2016, OneBeacon was in compliance with all of the covenants under the 2012 Senior Notes and the Credit Facility.
Interest
Total interest expense incurred by OneBeacon for its indebtedness was $13.1 million, $13.0 million and $13.0 million for the years ended December 31, 2016, 2015 and 2014, respectively. Total cash interest paid by OneBeacon for its indebtedness was $12.7 million during each of the years ended December 31, 2016, 2015 and 2014.
NOTE 7. Income Taxes
OneBeacon and its Bermuda-domiciled subsidiaries are not subject to Bermuda income tax under current Bermuda law. In the event that there is a change in the current law such that taxes are imposed, OneBeacon and its Bermuda-domiciled subsidiaries would be exempt from such tax until March 31, 2035, pursuant to the Bermuda Exempted Undertakings Tax Protection Act of 1966. OneBeacon also has subsidiaries that operate in Gibraltar, Barbados, Luxembourg, Ireland and the United States. U.S. operations are financed with a combination of debt and equity and the financing income and underwriting income currently account for the majority of non-U.S. earnings.
OneBeacon's U.S. subsidiaries join in the filing of a federal consolidated tax return. The consolidated U.S. parent is OneBeacon U.S. Financial Services, Inc. ("OBFS"). For all years, the companies included within the U.S. consolidated tax return are parties to a tax sharing agreement which provides that each company pays the amount of income taxes or estimated tax or receives refunds that it would have to make or be entitled to if it filed its own separate tax return. As a result, certain companies have made payments, and received refunds from the consolidated U.S. parent that are different than amounts payable to the Internal Revenue Service ("IRS"). The companies that are domiciled outside of the U.S. file separate returns for the appropriate jurisdictions.
The total income tax expense from continuing operations for the years ended December 31, 2016, 2015 and 2014 consisted of the following:
Year ended December 31, | ||||||||||||
2016 | 2015 | 2014 | ||||||||||
($ in millions) | ||||||||||||
Current tax (expense) benefit: | ||||||||||||
Federal | $ | 29.3 | $ | 9.1 | $ | (4.3 | ) | |||||
State | (1.0 | ) | (1.2 | ) | (1.6 | ) | ||||||
Non-U.S. | (0.4 | ) | (0.8 | ) | (0.8 | ) | ||||||
Total current tax (expense) benefit | 27.9 | 7.1 | (6.7 | ) | ||||||||
Deferred tax (expense) benefit: | ||||||||||||
Federal | (15.4 | ) | 5.8 | 19.0 | ||||||||
State | — | — | — | |||||||||
Non-U.S. | — | — | — | |||||||||
Total deferred tax (expense) benefit | (15.4 | ) | 5.8 | 19.0 | ||||||||
Total income tax benefit | $ | 12.5 | $ | 12.9 | $ | 12.3 | ||||||
F-50
A reconciliation of taxes calculated using the 35% U.S. statutory rate (the tax rate at which the majority of OneBeacon's worldwide operations are taxed) to the income tax expense on pre-tax income from continuing operations follows:
Year ended December 31, | ||||||||||||
2016 | 2015 | 2014 | ||||||||||
($ in millions) | ||||||||||||
Tax expense at the U.S. statutory rate | $ | (33.6 | ) | $ | (8.9 | ) | $ | (14.8 | ) | |||
Differences in taxes resulting from: | ||||||||||||
Non-U.S. earnings, net of foreign taxes | 24.7 | 19.3 | 19.6 | |||||||||
Tax reserve adjustments and IRS exam settlements | 16.2 | (1.7 | ) | 4.1 | ||||||||
Tax exempt interest and dividends | 2.3 | 2.6 | 2.5 | |||||||||
Change in valuation allowance | (0.1 | ) | 0.5 | (0.2 | ) | |||||||
Other, net | 3.0 | 1.1 | 1.1 | |||||||||
Total income tax benefit on pre-tax income from continuing operations | $ | 12.5 | $ | 12.9 | $ | 12.3 | ||||||
The non-U.S. component of pre-tax income from continuing operations, which relates to interest and underwriting income, was $71.7 million, $57.2 million and $58.0 million, respectively, for the years ended December 31, 2016, 2015 and 2014.
The income tax benefit related to pre-tax income from continuing operations for the years ended December 31, 2016, 2015 and 2014 represented net effective tax rates of (13.0)%, (51.0)% and (29.1)%, respectively. For the years ended December 31, 2016, 2015 and 2014, the effective tax rate on non-U.S. income was 0.6%, 1.3% and 1.3%, respectively, and the effective tax rate on U.S. income or loss was (53.0)%, 42.6% and 83.7%, respectively.
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Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts for tax purposes. An outline of the significant components of OneBeacon's deferred tax assets and liabilities follows:
December 31, | ||||||||
2016 | 2015 | |||||||
($ in millions) | ||||||||
Deferred income tax assets related to: | ||||||||
U.S. net operating loss carryforwards | $ | 74.5 | $ | 63.7 | ||||
Unearned premiums | 37.5 | 37.2 | ||||||
Tax credit carryforwards | 19.2 | 16.9 | ||||||
Discounting of loss and LAE reserves | 18.0 | 26.7 | ||||||
Compensation and bonus accruals | 16.0 | 15.3 | ||||||
Sale of Runoff Business | 12.6 | 12.6 | ||||||
Deferred compensation plans | 5.5 | 6.0 | ||||||
Fixed assets | 3.1 | 4.2 | ||||||
Allowance for doubtful accounts | 0.5 | 0.7 | ||||||
Non-U.S. net operating loss carryforwards | 0.4 | 0.4 | ||||||
Other accrued compensation | 0.1 | 0.1 | ||||||
Accrued rent | — | 3.9 | ||||||
Investment basis differences | — | 3.2 | ||||||
Other items | 1.3 | 0.2 | ||||||
Total gross deferred income tax assets | 188.7 | 191.1 | ||||||
Less valuation allowance | (1.4 | ) | (1.3 | ) | ||||
Total net deferred income tax assets | 187.3 | 189.8 | ||||||
Deferred income tax liabilities related to: | ||||||||
Deferred acquisition costs | 33.7 | 35.2 | ||||||
Net unrealized investment gains | 14.0 | 6.5 | ||||||
Prepaid pension | 6.3 | 3.5 | ||||||
Capitalized software | 4.7 | 4.4 | ||||||
Investment basis differences | 1.7 | — | ||||||
Other items | 0.2 | — | ||||||
Total gross deferred income tax liabilities | 60.6 | 49.6 | ||||||
Net deferred tax asset | $ | 126.7 | $ | 140.2 | ||||
OneBeacon's deferred tax assets are net of federal and non-U.S. valuation allowances and, to the extent they relate to non-U.S. jurisdictions, they are shown at year-end exchange rates. Of the $1.4 million valuation allowance as of December 31, 2016, $0.4 million relates to deferred tax assets on net operating losses (“NOLs”) in Luxembourg subsidiaries that are not expected to have significant income in the future, and $1.0 million relates to deferred tax assets of Houston General Insurance Exchange ("HGIE"), which files its own tax return.
OneBeacon records a valuation allowance against deferred tax assets if it becomes more likely than not that all or a portion of a deferred tax asset will not be realized. Changes in the valuation allowance are included in income tax expense in the period of the change in estimate is made. In determining whether or not to record a valuation allowance, or subsequent changes in estimate, OneBeacon considers factors such as prior earnings history, expected future earnings, carryback and carryforward periods as well as prudent and economically feasible strategies that, if executed, would result in the realization of a deferred tax asset. It is possible that certain planning strategies or projected earnings in certain subsidiaries may not be
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feasible to utilize the entire deferred tax asset, which could result in material changes to OneBeacon’s net deferred tax assets and related tax expense.
OneBeacon believes that, based upon its prior earnings history, expected future earnings, reversing temporary differences and capacity for carry-back of losses, and available planning strategies it is more likely than not that the net deferred tax asset balances (net of valuation allowance) carried as of December 31, 2016 and 2015 will be realized.
NOL carryforwards as of December 31, 2016 and the expiration dates are as follows:
December 31, 2016 | ||||||||||||
United States | Luxembourg | Total | ||||||||||
($ in millions) | ||||||||||||
NOL carryforwards by year: | ||||||||||||
2017 | $ | — | $ | — | $ | — | ||||||
From years 2018 to 2025 | 2.0 | — | 2.0 | |||||||||
From years 2026 to 2036 | 225.6 | — | 225.6 | |||||||||
No expiration date | — | 1.5 | 1.5 | |||||||||
Total NOL carryforwards | $ | 227.6 | $ | 1.5 | $ | 229.1 | ||||||
December 31, 2016 | ||||||||||||
United States | Luxembourg | Total | ||||||||||
($ in millions) | ||||||||||||
Gross deferred tax asset for NOL carryforwards | $ | 74.5 | $ | 0.4 | $ | 74.9 | ||||||
Valuation allowance for NOL carryforwards | (0.6 | ) | (0.4 | ) | (1.0 | ) | ||||||
Net deferred tax asset for NOL carryforwards | $ | 73.9 | $ | — | $ | 73.9 | ||||||
OneBeacon does not anticipate future taxable income in Luxembourg. Therefore, OneBeacon does not believe that it is more likely than not that these losses will be realized and has recorded a full valuation allowance against the tax benefits associated with these NOLs. Effective January 1, 2013, the Luxembourg statutory tax rate increased from 28.80% to 29.22%.
As of December 31, 2016, there were U.S. net operating loss carryforwards of approximately $227.6 million, which begin to expire in 2021. Included in these tax losses are losses of $0.5 million subject to an annual limitation on utilization under Internal Revenue Code Section 382. In addition, the losses include NOLs of $1.8 million related to HGIE, a reciprocal, which files its own tax return. As of December 31, 2016, OBFS also had low income housing tax credits of $18.0 million which begin to expire in 2031 and alternative minimum tax credit carryovers of $0.8 million which do not expire.
Recognition of the benefit of a given tax position is based upon whether or not a company determines that it is more likely than not that a tax position will be sustained upon examination based upon the technical merits of the position. In evaluating the more-likely-than-not recognition threshold, OneBeacon must presume that the tax position will be subject to examination by a taxing authority with full knowledge of all relevant information. If the recognition threshold is met, then the tax position is measured at the largest amount of benefit that is more than 50% likely of being realized upon ultimate settlement.
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A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:
Permanent differences(1) | Temporary differences(2) | Interest and penalties(3) | Total | |||||||||||||
($ in millions) | ||||||||||||||||
January 1, 2014 | $ | 7.6 | $ | 16.6 | $ | 8.4 | $ | 32.6 | ||||||||
Changes in prior year tax positions | (2.2 | ) | (0.8 | ) | (1.9 | ) | (4.9 | ) | ||||||||
Tax positions taken during the current year | — | 7.3 | — | 7.3 | ||||||||||||
Lapse in statute of limitations | — | — | — | — | ||||||||||||
Settlements with tax authorities | — | — | — | — | ||||||||||||
December 31, 2014 | $ | 5.4 | $ | 23.1 | $ | 6.5 | $ | 35.0 | ||||||||
Changes in prior year tax positions | — | (12.4 | ) | 1.7 | (10.7 | ) | ||||||||||
Tax positions taken during the current year | — | — | — | — | ||||||||||||
Lapse in statute of limitations | — | — | — | — | ||||||||||||
Settlements with tax authorities | — | — | — | — | ||||||||||||
December 31, 2015 | $ | 5.4 | $ | 10.7 | $ | 8.2 | $ | 24.3 | ||||||||
Changes in prior year tax positions | — | (5.5 | ) | 0.1 | (5.4 | ) | ||||||||||
Tax positions taken during the current year | — | — | — | — | ||||||||||||
Lapse in statute of limitations | — | — | — | — | ||||||||||||
Settlements with tax authorities | (5.4 | ) | — | (8.3 | ) | (13.7 | ) | |||||||||
December 31, 2016 | $ | — | $ | 5.2 | $ | — | $ | 5.2 | ||||||||
_______________________________________________________________________________
(1) | Represents the amount of unrecognized tax benefits that, if recognized, would impact the effective tax rate. |
(2) | Represents the amount of unrecognized tax benefits that, if recognized, would create a temporary difference between the reported amount of an item in OneBeacon's Consolidated Balance Sheet and its tax basis. |
(3) | Net of tax benefit. |
The balance as of December 31, 2016 includes $5.2 million of tax positions for which ultimate deductibility is highly certain but the timing of deductibility is uncertain. Because of the impact of deferred tax accounting, other than interest and penalties, the disallowance of the shorter deductibility period would not affect the effective tax rate but would accelerate the payment of cash to the taxing authority to an earlier period.
OneBeacon classifies all interest and penalties on unrecognized tax benefits as part of income tax expense. During the years ended December 31, 2016, 2015 and 2014, OneBeacon recognized $(8.2) million, $1.7 million and $(1.9) million, respectively, of net interest (income) expense. The balance of accrued interest as of December 31, 2016 and 2015 is $0.0 million and $8.2 million, respectively, net of any tax benefit.
With few exceptions, OneBeacon is no longer subject to U.S. federal, state or non-U.S. income tax examinations by tax authorities for years before 2013. On May 27, 2016, OneBeacon received the Closing Letter (Letter 1156) from the IRS Revenue Agents relating to the examination of tax years 2010, 2011 and 2012. All disputed items have now been agreed to and resolved. As the receipt of the Closing Letter described above represents formal settlement, OneBeacon recorded a tax benefit of $3.5 million in the second quarter of 2016 related to tax years 2010, 2011 and 2012.
On January 19, 2016, OneBeacon received Form 870-AD (Offer to Waive Restrictions on Assessment and Collection Tax Deficiency and to Accept Overassessment) from the IRS Appeals Office relating to the examination of tax years 2007, 2008 and 2009. All disputed items have now been agreed to and resolved with the Joint Committee on Taxation. As the receipt of the Form 870-AD described above represents formal settlement, OneBeacon recorded a tax benefit of $12.8 million in the first quarter of 2016 related to tax years 2007, 2008 and 2009.
OneBeacon recorded a tax benefit of $5.0 million in the first quarter of 2014 relating to the settlement of the IRS examination for tax years 2005 and 2006.
Net cash (refunds) payments for federal, state and non-U.S. income taxes, totaled $(12.8) million, $(6.2) million and $2.1 million for the years ended December 31, 2016, 2015 and 2014, respectively.
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NOTE 8. Retirement Plans
OneBeacon previously sponsored the Qualified Plan. During the year ended December 31, 2016, the Qualified Plan finalized its termination by purchasing a group annuity contract from the Principal Financial Group ("Principal"), and making lump sum distributions to Qualified Plan participants electing such payments, which eliminated the remaining Qualified Plan liability, and also ceased administratively paying benefits. As a result of these transactions, the Company recognized an estimated pre-tax pension settlement gain of $3.0 million during the year ended December 31, 2016, primarily resulting from a refund from Principal related to the final settlement of the Qualified Plan, and no longer has a projected benefit obligation with respect to the Qualified Plan. The Company transferred $47.1 million of excess invested assets from the Qualified Plan into the trust supporting the OneBeacon 401(k) Savings and Employee Stock Ownership Plan ("KSOP"), which is the Qualified Replacement Plan ("QRP"), during the year ended December 31, 2016 (see Note 9—"Employee Share-Based Incentive Compensation Plans"), with $13.0 million of excess invested assets remaining in the Qualified Plan trust as of December 31, 2016 in order to wind-down potential post-termination obligations of that plan, as approved by way of a March 2016 private letter ruling from the IRS. The invested assets related to both the legacy Qualified Plan and the QRP are included in other assets and are accounted for at fair value with related income recognized in net other revenues (expenses).
OneBeacon continues to sponsor a non-qualified, non-contributory, defined benefit pension plan ("Non-qualified Plan") covering certain employees who were employed as of December 31, 2001 and former employees who had met the eligibility requirements, as well as retirees. The Non-qualified Plan was frozen and curtailed in 2002, resulting in the pension benefit obligation being equal to the accumulated benefit obligation. The benefits are based primarily on years of service and employees’ compensation through December 31, 2002. OneBeacon’s funding policy is generally to contribute amounts equal to actual benefit payments during the year. There are no regulatory funding requirements that apply to the Non-qualified Plan.
F-55
The following tables set forth the obligations and funded status, assumptions, plan assets and cash flows associated with the Non-qualified and Qualified Plan as of December 31, 2016 and 2015:
December 31, | ||||||||
2016 | 2015 | |||||||
($ in millions) | ||||||||
Change in projected benefit obligation: | ||||||||
Projected benefit obligation at beginning of year | $ | 109.5 | $ | 119.7 | ||||
Service cost | 0.2 | 0.9 | ||||||
Interest cost | 1.5 | 4.6 | ||||||
Settlement loss (gain) on projected benefit obligation(1)(2) | 1.2 | (1.8 | ) | |||||
Assumption changes | (0.9 | ) | (3.5 | ) | ||||
Actuarial loss | 0.4 | 0.9 | ||||||
Annuity contract purchases related to termination of Qualified Plan(3) | (69.0 | ) | — | |||||
Benefits, including lump sum payments, and expenses paid with plan assets(3) | (17.0 | ) | (13.7 | ) | ||||
Benefits paid directly by OneBeacon | (2.1 | ) | (2.2 | ) | ||||
Remeasurement due to plan termination(4) | — | 4.6 | ||||||
Projected benefit obligation at end of year | $ | 23.8 | $ | 109.5 | ||||
Change in plan assets: | ||||||||
Fair value of plan assets at beginning of year | $ | 139.8 | $ | 146.0 | ||||
Actual return on plan assets | 6.3 | 7.5 | ||||||
Annuity contract purchases related to termination of Qualified Plan(3) | (69.0 | ) | — | |||||
Transfer of assets to the QRP(5) | (47.1 | ) | — | |||||
Benefits, including lump sum payments, and expenses paid with plan assets(3) | (17.0 | ) | (13.7 | ) | ||||
Fair value of plan assets at end of year | $ | 13.0 | $ | 139.8 | ||||
(Unfunded) over funded status at end of year | $ | (10.8 | ) | $ | 30.3 | |||
___________________________________________________________________________
(1) | During the year ended December 31, 2016, OneBeacon recognized a $1.2 million settlement loss primarily resulting from final settlement of the Qualified Plan. |
(2) | During the fourth quarter of 2015, OneBeacon triggered settlement accounting for the Qualified Plan as the total lump sum payments exceeded the service plus interest costs, resulting in a $1.8 million adverse effect on accumulated other comprehensive income. |
(3) | During the year ended December 31, 2016, the Qualified Plan finalized its termination by purchasing group annuity contracts for $69.0 million from Principal and making lump sum distributions, included in the $17.0 million above, to Qualified Plan participants electing such payments. |
(4) | As of December 31, 2015, the projected benefit obligation was valued on a plan termination basis. |
(5) | During the year ended December 31, 2016, OneBeacon transferred excess invested assets from the Qualified Plan after its termination into the trust supporting the QRP. |
The unfunded status of the consolidated pension plans as of December 31, 2016 was $10.8 million, which includes $13.0 million of excess invested assets remaining in the Qualified Plan trust in order to wind-down potential post-termination obligations of that plan and an under-funding of $23.8 million related to the Non-qualified Plan. The Non-qualified Plan, which is unfunded, does not hold any assets. OneBeacon has set aside $20.6 million in an irrevocable rabbi trust for the benefit of Non-qualified Plan participants. Assets held in the rabbi trust are not reflected in the funded status of the consolidated pension plans as presented but are included in other assets in the consolidated balance sheet.
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The Company transferred $47.1 million of excess invested assets from the Qualified Plan into the QRP during the year ended December 31, 2016. Amounts recognized in the financial statements as of December 31, 2016 and 2015 consist of:
December 31, | ||||||||
2016 | 2015 | |||||||
($ in millions) | ||||||||
Net balance sheet asset recorded in other assets | $ | 13.0 | $ | 55.8 | ||||
Net balance sheet liability recorded in other liabilities | (23.8 | ) | (25.5 | ) | ||||
Net amount recognized in the financial statements | $ | (10.8 | ) | $ | 30.3 | |||
Information for the Non-qualified Plan, which had accumulated benefit obligations in excess of plan assets, was as follows:
December 31, | ||||||||
2016 | 2015 | |||||||
($ in millions) | ||||||||
Projected benefit obligation | $ | 23.8 | $ | 25.5 | ||||
Accumulated benefit obligation | $ | 23.8 | $ | 25.5 | ||||
Fair value of plan assets | $ | — | $ | — | ||||
Information for the Qualified Plan, which had accumulated benefit obligations less than plan assets until its termination, was finalized during the year ended December 31, 2016, was as follows:
December 31, | |||||||||
2016 | 2015 | ||||||||
($ in millions) | |||||||||
Projected benefit obligation | $ | — | $ | 84.0 | (1) | ||||
Accumulated benefit obligation | $ | — | $ | 84.0 | (1) | ||||
Fair value of plan net assets | $ | 13.0 | $ | 139.8 | |||||
___________________________________________________________________________
(1) | Measured on a plan termination basis |
The amounts recognized in accumulated other comprehensive loss on a pre-tax basis for the years ended December 31, 2016 and 2015 were as follows:
December 31, | ||||||||
2016 | 2015 | |||||||
($ in millions) | ||||||||
Accumulated other comprehensive loss at beginning of year | $ | (8.0 | ) | $ | (8.0 | ) | ||
Increase (decrease) in accumulated other comprehensive loss: | ||||||||
Amortization of net actuarial gains recognized during the year | 1.3 | 1.3 | ||||||
Net actuarial gains (losses) occurring during the year(1) | 3.2 | (1.3 | ) | |||||
Qualified Plan termination impact(2) | (3.0 | ) | — | |||||
Accumulated other comprehensive loss at end of year | $ | (6.5 | ) | $ | (8.0 | ) | ||
_______________________________________________________________________________
(1) | Net actuarial gains in 2016 resulted from changes in assumptions in estimating the projected benefit obligation as well as changes in investment returns and demographic experience different than those assumed. The 2015 net actuarial losses reflect the valuation of the Qualified Plan on a termination basis. |
(2) | During the year ended December 31, 2016, OneBeacon recognized a $3.0 million gain resulting from the final settlement of the Qualified Plan. |
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The amount in accumulated other comprehensive loss, on a pre-tax basis, that has not yet been recognized as a component of net periodic benefit cost for the year ended December 31, 2016, is attributable to net losses. During the year ending December 31, 2017, OneBeacon expects $0.9 million will be amortized from accumulated other comprehensive loss into net periodic benefit cost.
The components of net periodic benefit cost (income) for the years ended December 31, 2016, 2015 and 2014 were as follows:
December 31, | ||||||||||||
2016 | 2015 | 2014 | ||||||||||
($ in millions) | ||||||||||||
Service cost | $ | 0.2 | $ | 0.9 | $ | 0.6 | ||||||
Interest cost | 1.5 | 4.6 | 4.7 | |||||||||
Expected return on plan assets | (1.0 | ) | (8.7 | ) | (8.5 | ) | ||||||
Amortization of net actuarial losses recognized during the year | 1.3 | 1.3 | 0.3 | |||||||||
Net periodic pension cost (income) before special termination benefits | 2.0 | (1.9 | ) | (2.9 | ) | |||||||
Settlement gain(1) | (3.0 | ) | — | — | ||||||||
Special termination benefits expense(2) | — | — | 0.3 | |||||||||
Total net periodic benefit income | $ | (1.0 | ) | $ | (1.9 | ) | $ | (2.6 | ) | |||
_______________________________________________________________________________
(1) | Represents the impact of the termination of the Qualified Plan during the year ended December 31, 2016. |
(2) | Special termination benefits represent additional payments made from the Qualified Plan to certain vested participants when their employment was terminated due to a reduction in force. |
Assumptions
The weighted average assumptions for the Non-qualified Plan used to determine benefit obligations as of December 31, 2016 and for the Plans as of December 31, 2015 were as follows:
December 31, | ||||||
2016 | 2015 | |||||
Discount rate | 3.78 | % | 3.22 | % | ||
The weighted average assumptions used to determine net periodic benefit cost for the Plans for the years ended December 31, 2016 and 2015 were as follows:
December 31, | ||||||
2016 | 2015 | |||||
Discount rate | 3.88 | % | 3.91 | % | ||
Expected long-term rate of return on plan assets | 3.00 | % | (1) | 6.00 | % | |
_______________________________________________________________________________
(1) Represents the rate for the Qualified Plan prior to its termination in March 2016. The Non-qualified Plan is unfunded and, as such the expected long-term rate of return on plan assets is not applicable.
OneBeacon's discount rate assumptions used to account for the Plans reflect the rates at which the benefit obligations could be effectively settled. In addition to consideration of published yields for high quality long-term corporate bonds, U.S. Treasuries and insurance company annuity contract pricings, consideration was given to cash flow matching analyses.
OneBeacon performed an analysis of expected long-term rate of return based on the allocation of it Qualified Plan assets as of December 31, 2015 and 2014 to develop expected rates of return for 2016 and 2015, respectively, for each significant asset class or economic indicator. A range of returns was developed based both on forecasts and on broad-market historical benchmarks for expected return, correlation, and volatility for each asset class. During 2015, OneBeacon changed the asset allocation to more fixed income and shorter duration in anticipation of the plan termination, which resulted in a decrease in this assumption as compared to the prior year.
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Plan Assets
The remaining assets of the Qualified Plan are managed internally by OneBeacon and consist substantially of common equity funds tracking the S&P 500 and Russell 1000 indices, held to wind-down potential post-termination obligations of the plan, as approved by way of a March 2016 private letter ruling from the IRS. The Qualified Plan's investments are stated at fair value. A description of key fair value inputs by asset category and the categorization of such inputs into the fair value level hierarchy is provided in Note 1—"Nature of Operations and Summary of Significant Accounting Policies."
The fair value of the Qualified Plan's invested assets and their related inputs as of December 31, 2016 and 2015 by asset category were as follows:
Fair value at December 31, 2016 (1) | Level 1 | Level 2 | Level 3 | |||||||||||||
Common equity securities | $ | 12.8 | $ | 12.8 | $ | — | $ | — | ||||||||
_______________________________________________________________________________
(1) Excludes cash and short-term investments
Fair value at December 31, 2015 | Level 1 | Level 2 | Level 3 | |||||||||||||
Fixed maturity investments | $ | 132.4 | $ | 132.4 | $ | — | $ | — | ||||||||
Short-term investments | 7.0 | 7.0 | — | — | ||||||||||||
Total | $ | 139.4 | $ | 139.4 | $ | — | $ | — | ||||||||
There were no transfers between Levels 1, 2 or 3 during the years ended December 31, 2016 and 2015.
The Qualified Plan's asset allocations as of December 31, 2016 and 2015 by asset category were as follows:
Plan Assets at December 31, | ||||||
2016 | 2015 | |||||
Common equity securities | 98.5 | % | — | % | ||
Fixed maturity investments | — | 95.0 | ||||
Cash and short-term investments | 1.5 | 5.0 | ||||
Total | 100.0 | % | 100.0 | % | ||
Cash Flows
OneBeacon anticipates contributing $2.1 million to the Non-qualified Plan in 2017, for which OneBeacon has assets held in a rabbi trust.
The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid:
Expected Benefit Payments | |||
($ in millions) | |||
2017 | $ | 2.1 | |
2018 | 2.1 | ||
2019 | 2.0 | ||
2020 | 2.0 | ||
2021 | 1.9 | ||
2022 – 2026 | 8.4 | ||
F-59
Other Benefit Plans
OneBeacon sponsors an employee savings plan (defined contribution plan) covering the majority of employees. The contributory plan historically provided qualifying employees with matching contributions of 50% of the first 6% of salary (subject to federal limits on allowable contributions in a given year). During 2016, the matching contribution of the contributory plan was replaced with a fixed 3% of salary employer contribution (subject to federal limits on allowable contributions in a given year). Total expense for the contribution was $3.2 million, $3.0 million and $2.7 million in the years ended December 31, 2016, 2015 and 2014, respectively. The employee savings plan also includes an employee stock ownership component. See Note 9—"Employee Share-Based Incentive Compensation Plans."
OneBeacon had a post-employment benefit liability related to disability and health benefits available to former employees that are no longer employed by the Company of $3.1 million and $4.1 million as of December 31, 2016 and 2015, respectively.
OneBeacon also had a post-employment benefit liability related to death benefits to beneficiaries of former executives that are no longer employed by the Company of $12.8 million and $12.5 million as of December 31, 2016 and 2015, respectively. OneBeacon has set aside funds to satisfy its obligation in a rabbi trust of $29.3 million and $33.9 million as of December 31, 2016 and 2015, respectively. During 2016, the Company withdrew $5.5 million from the rabbi trust in accordance with the trust agreement, which remains overfunded.
NOTE 9. Employee Share-Based Incentive Compensation Plans
The OneBeacon Long-Term Incentive Plan (the "Incentive Plan") provides for the granting of various types of share-based incentive awards to certain key employees of OneBeacon.
OneBeacon's share-based compensation plans include performance shares, restricted shares, and restricted stock units ("RSUs"), which are designed to maximize shareholder value over long periods of time by aligning the financial interests of its management with those of its owners. OneBeacon expenses the full cost of all its share-based compensation over the requisite service period. The Company recognized expense related to its share-based compensation plans of $10.8 million, $7.7 million and $7.5 million for the years ended December 31, 2016, 2015 and 2014, respectively.
Performance Shares
Performance shares are conditional awards that can be settled in a specified number of common shares or an equivalent amount of cash. In general, grants are earned, subject to the attainment of pre-specified performance goals, at the end of a three-year period or as otherwise determined by the Compensation Committee of the Board and are valued based on the market price of an underlying OneBeacon common share at the time awards are paid plus cumulative dividends for the period beginning at grant date and ending at the time awards are paid. Results that significantly exceed pre-specified targets can result in a performance share payout of up to 200% of granted shares whereas results significantly below target could result in no payout. Performance shares are typically settled by payment of cash, though, in some instances, they may be settled in common shares or may be deferred in accordance with the terms of OneBeacon's deferred compensation plan. Compensation expense, based on the estimated performance share payout, is recognized ratably over the performance period.
For awards granted during the year ended December 31, 2014, the targeted performance goal for full payment of the outstanding performance shares is the attainment of a growth in book value per share ("GBVPS") of 14% for the 2014-2016 performance cycle. At a GBVPS of 7% or less, no performance shares would be earned and at a GBVPS of 21% or more, 200% of performance shares would be earned.
For awards granted during the year ended December 31, 2015, the targeted performance goal for full payment of the outstanding performance shares is the attainment of a GBVPS of 13% for the performance cycle 2015-2017. At a GBVPS of 6% or less, no performance shares would be earned and at a GBVPS of 20% or more, 200% of performance shares would be earned.
For awards granted during the year ended December 31, 2016, the targeted performance goal for full payment of the outstanding performance shares is the attainment of a GBVPS of 12% for the performance cycle 2016-2018. At a GBVPS of 5% or less, no performance shares would be earned and at a GBVPS of 19% or more, 200% of performance shares would be earned.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 9. Employee Share-Based Incentive Compensation Plans
The following summarizes performance share activity for performance shares for the years ended December 31, 2016, 2015 and 2014:
Year ended December 31, | |||||||||||||||||||||
2016 | 2015 | 2014 | |||||||||||||||||||
Target Performance Shares outstanding | Accrued expense | Target Performance Shares outstanding | Accrued expense | Target Performance Shares outstanding | Accrued expense | ||||||||||||||||
($ in millions) | |||||||||||||||||||||
Beginning of period | 449,435 | $ | 1.4 | 517,470 | $ | 3.4 | 493,421 | $ | 4.0 | ||||||||||||
Payments and deferrals(1) | (167,300 | ) | (0.6 | ) | (181,290 | ) | (1.5 | ) | (142,138 | ) | (1.0 | ) | |||||||||
New awards | 163,150 | — | 154,887 | — | 165,800 | — | |||||||||||||||
Forfeitures and net change in assumed forfeitures | 7,234 | — | (41,632 | ) | (0.1 | ) | 387 | — | |||||||||||||
Expense (income) recognized | — | 0.8 | — | (0.4 | ) | — | 0.4 | ||||||||||||||
End of period | 452,519 | $ | 1.6 | 449,435 | $ | 1.4 | 517,470 | $ | 3.4 | ||||||||||||
_______________________________________________________________________________
(1) | Performance share payments in 2016 for the 2013-2015 performance cycle were based upon a performance factor of 24.3%. Performance share payments in 2015 for the 2012-2014 performance cycle were based upon a performance factor of 45.7%. Performance share payments in 2014 for the 2011-2013 performance cycle were based upon a performance factor of 37.1%. |
The following summarizes performance shares outstanding and accrued performance share expense as of December 31, 2016 for each performance cycle:
Target Performance Shares outstanding | Accrued expense | ||||||
($ in millions) | |||||||
Performance cycle: | |||||||
2014 – 2016 | 142,710 | $ | — | ||||
2015 – 2017 | 146,659 | 0.7 | |||||
2016 – 2018 | 163,150 | 0.9 | |||||
Total as of December 31, 2016 | 452,519 | 1.6 | |||||
If 100% of the outstanding performance shares had been vested on December 31, 2016, the total additional compensation cost to be recognized would have been $2.1 million, based on current accrual factors (common share price, accumulated dividends and performance assumptions) as of December 31, 2016. The Company has assumed no forfeitures as of December 31, 2016 based on recent experience.
All performance shares earned and paid were settled in cash or by deferral into OneBeacon's deferred compensation plan.
Restricted Shares
On February 24, 2016, OneBeacon issued to certain employees 170,650, shares of restricted stock having a grant date fair value of $2.3 million, of which 92,500 are scheduled to cliff vest on February 24, 2018 and the remaining 78,150 on January 1, 2019.
On February 24, 2015, OneBeacon issued to certain employees 75,950 shares of restricted stock having a grant date fair value of $1.1 million, of which 67,722 were outstanding as of December 31, 2016 and are scheduled to cliff vest in full on January 1, 2018.
On March 1, 2012, OneBeacon issued shares of restricted stock to certain employees. Of these restricted shares, 142,500 shares vested on February 28, 2014 and the remaining 138,500 restricted shares vested on February 28, 2015.
F-61
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 9. Employee Share-Based Incentive Compensation Plans
On May 25, 2011, OneBeacon issued to its CEO 630,000 shares of stock, of which 157,500 restricted shares vested on each of February 22, 2014, 2015 and 2016, and the remaining 157,500 restricted shares are scheduled to vest on February 22, 2017.
The restricted shares contain dividend participation features and therefore are considered participating securities.
The following summarizes restricted shares activity for the years ended December 31, 2016, 2015 and 2014:
Year ended December 31, | |||||||||||||||||||||
2016 | 2015 | 2014 | |||||||||||||||||||
Restricted Shares | Unamortized Issue Date Fair Value | Restricted Shares | Unamortized Issue Date Fair Value | Restricted Shares | Unamortized Issue Date Fair Value | ||||||||||||||||
($ in millions) | |||||||||||||||||||||
Beginning of period | 382,722 | $ | 2.5 | 612,500 | $ | 3.5 | 915,000 | $ | 6.5 | ||||||||||||
New awards | 170,650 | 2.3 | 75,950 | 1.1 | — | — | |||||||||||||||
Forfeitures | — | — | (9,728 | ) | (0.1 | ) | (2,500 | ) | — | ||||||||||||
Vested | (157,500 | ) | — | (296,000 | ) | — | (300,000 | ) | — | ||||||||||||
Expense recognized | — | (2.7 | ) | — | (2.0 | ) | — | (3.0 | ) | ||||||||||||
End of period | 395,872 | $ | 2.1 | 382,722 | $ | 2.5 | 612,500 | $ | 3.5 | ||||||||||||
Restricted shares that vested during the years ended December 31, 2016, 2015 and 2014 had a grant date fair value of $2.1 million, $4.3 million and $4.3 million, respectively. As of December 31, 2016, unrecognized compensation expense of $2.1 million related to restricted stock awards is expected to be recognized over a weighted-average period of 0.7 years.
Restricted Stock Units
During the year ended December 31, 2016, 233,461 RSUs were issued, of which 214,506 were outstanding as of December 31, 2016. The RSUs are scheduled to cliff vest in full on December 31, 2018, at which time the RSUs will be paid out in cash or shares at the discretion of the Compensation Committee. During the year ended December 31, 2015, 226,778 RSUs were issued, of which 173,042 were outstanding as of December 31, 2016. The RSUs are scheduled to cliff vest in full on December 31, 2017, at which time they will be paid out in cash or common shares at the discretion of the Compensation Committee. Compensation expense associated with the RSUs, which is recognized ratably over the three year vesting period, was $2.1 million and $0.8 million for the year ended December 31, 2016 and 2015, respectively.
If 100% of the outstanding RSUs had been vested on December 31, 2016, the total additional compensation cost to be recognized would have been $3.9 million, based on current accrual factors (common share price and accumulated dividends) as of December 31, 2016.
Share-Based Compensation under Qualified Retirement Plans
OneBeacon sponsors a defined contribution plan, the KSOP. Under the KSOP, participants have the ability to invest their balances in several different investment options, including the common shares of White Mountains and the common shares of the Company.
The employee stock ownership component of the KSOP provides all participants with an annual base contribution in common shares of the Company equal to 3% of their salary, up to the applicable Social Security wage base (or $118,500 with respect to 2016). Additionally, those participants not otherwise eligible to receive certain other Company benefits can earn a variable contribution up to an additional 6% of their salary, capped at the annual covered compensation limits ($265,000 for 2016), contingent upon OneBeacon's performance. The variable contribution amounts for eligible participants constituted approximately 3%, 3% and 2%, respectively, of salary for the years ended December 31, 2016, 2015 and 2014. OneBeacon has recorded $5.2 million, $5.4 million and $4.1 million, respectively, in compensation expense to pay benefits and allocate common shares to participants' accounts for the years ended December 31, 2016, 2015 and 2014. As discussed in Note 8—"Retirement Plans," $47.1 million was transferred to the KSOP plan trust during the year ended December 31, 2016 and will be used to fund future contributions.
F-62
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 9. Employee Share-Based Incentive Compensation Plans
As of December 31, 2016 and 2015, the KSOP owned less than 3% of either of the total White Mountains common shares outstanding or the total Company common shares outstanding. All OneBeacon common shares held by the KSOP are considered outstanding for earnings (loss) per share computations.
NOTE 10. Common Shareholders' Equity
Common Shares Repurchased and Retired
On August 22, 2007, the Company's Board authorized the repurchase of up to $200.0 million of its Class A common shares from time to time, subject to market conditions. Shares may be repurchased on the open market or through privately negotiated transactions. This authorization does not have a stated expiration date. During the year ended December 31, 2016, 850,349 shares were repurchased under the share repurchase authorization for $10.6 million at an average share price of $12.42. During the year ended December 31, 2015, 166,368 shares were repurchased under the share repurchase authorization for $2.1 million at an average price of $12.62. No shares were repurchased under the share repurchase authorization during the year ended December 31, 2014. The amount of authorization remaining is $75.0 million as of December 31, 2016.
During the years ended December 31, 2016, 2015, and 2014 the Company repurchased 64,981, 112,051, and 106,366 common shares, respectively, for $0.9 million, $1.6 million and $1.8 million during the years ended December 31, 2016, 2015, and 2014, respectively, to satisfy employee income tax withholding, pursuant to employee benefit plans. Shares repurchased pursuant to employee benefit plans do not fall under the board authorizations referred to above.
Dividends on Common Shares
During the year ended December 31, 2016 the Company declared and paid cash dividends totaling $79.2 million and during the years ended December 31, 2015 and 2014 the Company declared and paid cash dividends totaling $80.0 million, or $0.84 per common share of regular quarterly cash dividends for each year.
Change in Accumulated Other Comprehensive Income (Loss)
The pre-tax components of the Company's change in other comprehensive income (loss) and the related income tax benefit (expense) are as follows:
Year ended December 31, | ||||||||||||
2016 | 2015 | 2014 | ||||||||||
($ in millions) | ||||||||||||
Net change in benefit plan assets and obligations | $ | 1.5 | $ | — | $ | (18.5 | ) | |||||
Income tax (expense) benefit | (0.5 | ) | — | 6.5 | ||||||||
Net change in benefit plan assets and obligations, net of tax | $ | 1.0 | $ | — | $ | (12.0 | ) | |||||
NOTE 11. Statutory Capital and Surplus
OneBeacon's U.S. insurance operations are subject to regulation and supervision in each of the states where they are domiciled and licensed to conduct business. Generally, state regulatory authorities have broad supervisory and administrative powers over such matters as licenses, standards of solvency, premium rates, policy forms, investments, security deposits, methods of accounting, form and content of financial statements, reserves for unpaid loss and LAE, reinsurance, minimum capital and surplus requirements, dividends and other distributions to shareholders, periodic examinations, and annual and other report filings. In general, such regulation is for the protection of policyholders rather than shareholders.
State insurance departments have established the insurer solvency laws and regulatory infrastructure to maintain accredited status with the National Association of Insurance Commissioners ("NAIC"). A key solvency-driven NAIC accreditation requirement is a state's adoption of risk-based capital ("RBC") requirements. As of December 31, 2016, OneBeacon's U.S. insurance operating subsidiaries exceeded their respective RBC requirements.
The Insurance Act 1978 of Bermuda and related regulations, as amended (the “Insurance Act”), regulates the insurance businesses of Bermuda domiciled insurers. Under the Insurance Act, insurers are required to maintain available statutory capital and surplus at a level equal to or in excess of its enhanced capital requirement which is established by reference to either a Bermuda Solvency Capital Requirement ("BSCR") model or an approved internal capital model. Generally, the Bermuda Monetary Authority (“BMA”) has broad supervisory and administrative powers over such matters as licenses, standards of
F-63
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 11. Statutory Capital and Surplus
solvency, investments, methods of accounting, form and content of financial statements, minimum capital and surplus requirements, and annual and other report filings.
OneBeacon’s U.S. combined statutory surplus was $624.8 million and $622.3 million as of December 31, 2016 and 2015, respectively. OneBeacon's combined U.S. statutory net income (loss) for the years ended December 31, 2016, 2015 and 2014 was $36.7 million, $44.5 million and $(14.2) million, respectively. The minimum policyholders' surplus necessary to satisfy OneBeacon's top tier regulated U.S. insurance operating subsidiary, ASIC, regulatory requirements was $107.5 million as of December 31, 2016, which equals the authorized control level of the NAIC risk-based capital of OneBeacon’s primary top tier regulated operating subsidiary.
OneBeacon’s statutory capital and surplus for Split Rock was $270.2 million and $249.5 million as of December 31, 2016 and 2015, respectively, which met Bermuda's statutory capital and surplus requirements. Split Rock reported $42.4 million, $45.5 million and $46.2 million of statutory net income (loss) for the years ended December 31, 2016, 2015 and 2014, respectively.
The principal differences between OneBeacon's combined U.S. and Split Rock's statutory reported amounts, and the amounts reported in accordance with GAAP, include deferred acquisition costs, deferred taxes and market value adjustments for debt securities. OneBeacon's insurance subsidiaries' statutory policyholders' surplus as of December 31, 2016 was in excess of the minimum requirements of relevant state and Bermuda insurance regulations.
Dividend Capacity
Under the insurance laws of the states and jurisdictions under which OneBeacon's insurance operating subsidiaries are domiciled, an insurer is restricted with respect to the timing and the amount of dividends it may pay without prior approval by regulatory authorities. Accordingly, there can be no assurance regarding the amount of such dividends that may be paid by such subsidiaries in the future.
Our top tier regulated U.S. insurance operating subsidiary, Atlantic Specialty Insurance Company ("ASIC"), has the ability to pay dividends to its immediate parent without the prior approval of regulatory authorities in an amount set by formula based on the lesser of (i) adjusted net investment income, as defined by statute, or (ii) 10% of statutory surplus, in both cases as most recently reported to regulatory authorities, subject to availability of earned surplus. Based upon the formula described above, as of December 31, 2016, ASIC has the ability to pay $11.4 million of dividends without prior approval of regulatory authorities. As of December 31, 2016, ASIC had $624.8 million of statutory surplus and $69.0 million of earned surplus. During the years ended December 31, 2016 and 2015, ASIC paid dividends to its immediate parent of $26.5 million and $44.9 million, respectively, to its immediate parent. During the year ended December 31, 2015, ASIC also redeemed and retired common shares held by its immediate parent at an aggregate price of $66.0 million.
In 2017, Split Rock has the ability to distribute statutory capital without the prior approval of the Bermuda Monetary Authority, provided it does not reduce its total statutory capital, as shown in its previous financial year’s statutory financial statements, by 15% or more.
In addition, Split Rock has the ability to pay dividends without the prior notification of regulatory authorities of up to 25% of its previous financial year's total statutory capital and surplus, subject to meeting all appropriate liquidity and solvency requirements as specified in the Insurance Act 1978 and the Companies Act 1981. As of December 31, 2016, Split Rock had $210.1 million of total statutory capital and $60.1 million of surplus for total statutory capital and surplus of $270.2 million.
Based upon the limitations described above, Split Rock currently has the ability to distribute up to $31.5 million of statutory capital and pay up to $60.1 million of dividends during 2017 without the prior approval of regulatory authorities. During 2016, Split Rock paid $25.0 million of dividends to its immediate parent and paid no such dividends during 2015. Also, during 2015, OneBeacon Ltd., through an intermediary holding company, contributed $85.0 million to Split Rock as statutory capital.
During the years ended December 31, 2016 and 2015, the Company's unregulated insurance operating subsidiaries paid $5.7 million and $5.3 million, respectively, of dividends to their immediate parent. As of December 31, 2016, OneBeacon's unregulated insurance operating subsidiaries had $56.4 million of net unrestricted cash, short-term investments and fixed maturity investments and $71.9 million of other investments consisting of the surplus notes.
F-64
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 11. Statutory Capital and Surplus
As described in Note 10—"Common Shareholders' Equity," during the years ended December 31, 2016, 2015 and 2014 OneBeacon Ltd. declared and paid regular quarterly dividends to its common shareholders totaling $79.2 million, $80.0 million and $80.0 million, respectively.
As of December 31, 2016, OneBeacon Ltd. and its intermediate subsidiaries held $64.5 million of net unrestricted cash, short-term investments and fixed maturity investments and $11.9 million of common equity securities outside of its regulated and unregulated insurance operating subsidiaries.
NOTE 12. Segment Information
The Company has sixteen active underwriting operating segments, which are managed by the chief operating decision maker and are aggregated into two underwriting reportable segments. The two underwriting reportable segments were determined based on the nature of products or services, the production process, method of distribution and the nature of the regulatory environment. The principal difference between the reportable segments is the type or class of customer.
The Specialty Products segment is comprised of ten active underwriting operating segments, representing an aggregation based on those that offer distinct products and tailored coverages and services to a broad customer base across the United States. The Specialty Products segment includes Healthcare, Tuition Reimbursement, Programs, Surety, Other Professional Lines, Management Liability, Financial Services, Specialty Property, Environmental, and Financial Institutions, as well as the inactive Crop and Collector Cars and Boats underwriting operating segments which were exited in 2015 and 2013, respectively.
The Specialty Industries segment is comprised of six active underwriting operating segments, representing an aggregation based on those that focus on solving the unique needs of a particular customer or industry group. The Specialty Industries segment includes the Accident, Technology, Ocean Marine, Government Risks, Entertainment, and Inland Marine underwriting operating segments.
The Investing, Financing and Corporate segment includes the investing and financing activities for OneBeacon on a consolidated basis, and certain other activities conducted through the Company and its intermediate subsidiaries, including the 100% quota share reinsurance agreement with Bedivere, which cedes the losses associated with the legacy Runoff Business to Bedivere, one of the transferred entities that was sold as part of the Runoff Transaction and has been an indirect wholly-owned subsidiary of Armour since December 23, 2014. There is no net retention of the legacy Runoff Business to OneBeacon.
Invested assets are not allocated to the Specialty Products and Specialty Industries segments since OneBeacon does not manage them by segment. Invested assets, net investment income and net realized and change in unrealized investment gains related to OneBeacon's Specialty Products and Specialty Industries segments are included in the Investing, Financing and Corporate segment since these assets are available for payment of losses and expenses for all segments. Debt and the related interest expense on debt also are not allocated to or managed by segment and are also included in the Investing, Financing and Corporate segment.
Substantially all of the Company's revenue is generated from customers located in the United States.
F-65
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 12. Segment Information
Financial information for OneBeacon's reportable segments is as follows:
Insurance Operations | Investing, Financing and Corporate | |||||||||||||||
Specialty Products | Specialty Industries | Consolidated | ||||||||||||||
($ in millions) | ||||||||||||||||
Year ended December 31, 2016 | ||||||||||||||||
Earned premiums | $ | 524.4 | $ | 576.2 | $ | — | $ | 1,100.6 | ||||||||
Loss and loss adjustment expense | (375.4 | ) | (280.6 | ) | — | (656.0 | ) | |||||||||
Policy acquisition expenses | (99.5 | ) | (106.5 | ) | — | (206.0 | ) | |||||||||
Other underwriting expenses | (88.6 | ) | (120.4 | ) | — | (209.0 | ) | |||||||||
Total underwriting income (loss) | (39.1 | ) | 68.7 | — | 29.6 | |||||||||||
Net investment income | — | — | 50.6 | 50.6 | ||||||||||||
Net realized and change in unrealized investment gains | — | — | 37.7 | 37.7 | ||||||||||||
Net other revenues (expenses) | (0.1 | ) | 1.5 | 4.1 | 5.5 | |||||||||||
General and administrative expenses | — | (2.4 | ) | (11.8 | ) | (14.2 | ) | |||||||||
Interest expense | — | — | (13.1 | ) | (13.1 | ) | ||||||||||
Pre-tax income (loss) from continuing operations | $ | (39.2 | ) | $ | 67.8 | $ | 67.5 | $ | 96.1 | |||||||
Year ended December 31, 2015 | ||||||||||||||||
Earned premiums | $ | 560.3 | $ | 615.9 | $ | — | $ | 1,176.2 | ||||||||
Loss and loss adjustment expense | (310.7 | ) | (390.0 | ) | — | (700.7 | ) | |||||||||
Policy acquisition expenses | (100.1 | ) | (113.7 | ) | — | (213.8 | ) | |||||||||
Other underwriting expenses | (97.9 | ) | (120.3 | ) | — | (218.2 | ) | |||||||||
Total underwriting income (loss) | 51.6 | (8.1 | ) | — | 43.5 | |||||||||||
Net investment income | — | — | 45.9 | 45.9 | ||||||||||||
Net realized and change in unrealized investment gains | — | — | (35.1 | ) | (35.1 | ) | ||||||||||
Net other revenues (expenses) | (0.2 | ) | 1.4 | (1.8 | ) | (0.6 | ) | |||||||||
General and administrative expenses | — | (2.7 | ) | (12.7 | ) | (15.4 | ) | |||||||||
Interest expense | — | — | (13.0 | ) | (13.0 | ) | ||||||||||
Pre-tax income (loss) from continuing operations | $ | 51.4 | $ | (9.4 | ) | $ | (16.7 | ) | $ | 25.3 | ||||||
Year ended December 31, 2014 | ||||||||||||||||
Earned premiums | $ | 582.1 | $ | 595.0 | $ | — | $ | 1,177.1 | ||||||||
Loss and loss adjustment expense | (457.9 | ) | (357.2 | ) | — | (815.1 | ) | |||||||||
Policy acquisition expenses | (96.2 | ) | (107.1 | ) | — | (203.3 | ) | |||||||||
Other underwriting expenses | (78.4 | ) | (100.8 | ) | — | (179.2 | ) | |||||||||
Total underwriting income (loss) | (50.4 | ) | 29.9 | — | (20.5 | ) | ||||||||||
Net investment income | — | — | 43.4 | 43.4 | ||||||||||||
Net realized and change in unrealized investment gains | — | — | 40.4 | 40.4 | ||||||||||||
Net other revenues | 0.9 | 1.1 | 3.8 | 5.8 | ||||||||||||
General and administrative expenses | 0.2 | (2.3 | ) | (11.7 | ) | (13.8 | ) | |||||||||
Interest expense | — | — | (13.0 | ) | (13.0 | ) | ||||||||||
Pre-tax income (loss) from continuing operations | $ | (49.3 | ) | $ | 28.7 | $ | 62.9 | $ | 42.3 | |||||||
F-66
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 12. Segment Information
Insurance Operations | Investing, Financing and Corporate | |||||||||||||||
Specialty Products | Specialty Industries | Consolidated | ||||||||||||||
($ in millions) | ||||||||||||||||
December 31, 2016 | ||||||||||||||||
Assets | ||||||||||||||||
Total investment securities | $ | — | $ | — | $ | 2,620.4 | $ | 2,620.4 | ||||||||
Premiums receivable | 81.4 | 146.9 | — | 228.3 | ||||||||||||
Reinsurance recoverables(1) | 125.4 | 35.8 | 18.3 | 179.5 | ||||||||||||
Deferred acquisition costs | 48.3 | 48.0 | — | 96.3 | ||||||||||||
Ceded unearned premiums | 34.4 | 9.8 | — | 44.2 | ||||||||||||
Other assets(2) | 1.1 | 0.1 | 420.0 | 421.2 | ||||||||||||
Total Assets | $ | 290.6 | $ | 240.6 | $ | 3,058.7 | $ | 3,589.9 | ||||||||
Liabilities | ||||||||||||||||
Unpaid loss and loss adjustment expense reserves(1) | $ | 776.6 | $ | 570.7 | $ | 18.3 | $ | 1,365.6 | ||||||||
Unearned premiums | 319.8 | 255.3 | — | 575.1 | ||||||||||||
Funds held under insurance contracts | 153.0 | — | — | 153.0 | ||||||||||||
Debt | — | — | 273.2 | 273.2 | ||||||||||||
Other liabilities(2) | — | — | 197.8 | 197.8 | ||||||||||||
Total Liabilities | $ | 1,249.4 | $ | 826.0 | $ | 489.3 | $ | 2,564.7 | ||||||||
December 31, 2015 | ||||||||||||||||
Assets | ||||||||||||||||
Total investment securities | $ | — | $ | — | $ | 2,591.4 | $ | 2,591.4 | ||||||||
Premiums receivable | 63.0 | 156.0 | — | 219.0 | ||||||||||||
Reinsurance recoverables(1) | 139.5 | 33.6 | 20.4 | 193.5 | ||||||||||||
Deferred acquisition costs | 49.6 | 51.1 | — | 100.7 | ||||||||||||
Ceded unearned premiums | 19.2 | 10.3 | — | 29.5 | ||||||||||||
Other assets(2) | 0.9 | 0.1 | 467.5 | 468.5 | ||||||||||||
Total Assets | $ | 272.2 | $ | 251.1 | $ | 3,079.3 | $ | 3,602.6 | ||||||||
Liabilities | ||||||||||||||||
Unpaid loss and loss adjustment expense reserves(1) | $ | 772.2 | $ | 597.2 | $ | 20.4 | $ | 1,389.8 | ||||||||
Unearned premiums | 288.1 | 272.2 | — | 560.3 | ||||||||||||
Funds held under insurance contracts | 137.7 | — | — | 137.7 | ||||||||||||
Debt | — | — | 272.9 | 272.9 | ||||||||||||
Other liabilities(2) | — | — | 237.4 | 237.4 | ||||||||||||
Total Liabilities | $ | 1,198.0 | $ | 869.4 | $ | 530.7 | $ | 2,598.1 | ||||||||
_______________________________________________________________________________
(1) | ASIC entered into a 100% quota share reinsurance agreement in conjunction with the Runoff Transaction whereby ASIC is ceding to Bedivere 100% of the legacy Runoff Business that was written by ASIC or one of the ongoing entities. As of December 31, 2016 and 2015, $18.3 million and $20.4 million, respectively, are included in both unpaid loss and LAE reserves and reinsurance recoverables included within Investing, Financing, and Corporate resulting from that agreement. |
(2) The majority of other assets and other liabilities are not separately identifiable at the segment level and have therefore been included within Investing, Financing, and Corporate.
F-67
NOTE 13. Variable Interest Entities ("VIE")
Reciprocals
Reciprocals are policyholder-owned insurance carriers organized as unincorporated associations. Each policyholder insured by the reciprocal shares risk with the other policyholders. Policyholders share profits and losses in the same proportion as the amount of insurance purchased but are not subject to assessment for net losses of the reciprocal.
OneBeacon has one reciprocal that was capitalized by loaning funds in exchange for a surplus note. Houston General Insurance Management Company ("HGMC"), a wholly-owned indirect subsidiary of the Company, provides management services for a fee to the reciprocal, HGIE. The surplus note, as amended, has a remaining balance of $5.0 million. The principal and interest on the remaining surplus note is repayable to HGMC only with regulatory approval. The obligation to repay principal on the note is subordinated to all other liabilities including obligations to policyholders and claimants for benefits under insurance policies. OneBeacon has no ownership interest in the reciprocal.
OneBeacon has determined that HGIE qualifies as a VIE. Furthermore, OneBeacon has determined that it is the primary beneficiary as it has both the power to direct the activities of the VIE that most significantly impact the entity's economic performance and the obligation to absorb losses or receive benefits of the entity that could potentially be significant to the VIE as a result of the management services provided to the reciprocal and the funds loaned to it. Accordingly, OneBeacon consolidates HGIE.
As of December 31, 2016, consolidated amounts related to HGIE included total assets of $5.1 million and total liabilities of $5.0 million. As of December 31, 2016, the net amount of capital at risk is equal to the surplus note of $5.0 million less the accumulated losses of $0.5 million which includes accrued interest on the surplus note of $0.6 million which eliminates in consolidation.
NOTE 14. Fair Value of Financial Instruments
OneBeacon carries its financial instruments on its balance sheet at fair value with the exception of its investment in qualified affordable housing projects, which is accounted for using the proportional amortization method, and fixed-rate, long-term indebtedness. For certain financial instruments where quoted market prices are not available, other independent valuation techniques and assumptions are used. Because considerable judgment is used, these estimates are not necessarily indicative of amounts that could be realized in a current market exchange. Certain financial instruments are excluded from disclosure, including insurance contracts.
As of December 31, 2016 and 2015, the fair value of OneBeacon's 2012 Senior Notes (its fixed-rate, long-term indebtedness) was $274.2 million and $276.4 million, respectively. As described in Note 6—"Debt," the net carrying value of the 2012 Senior Notes was $273.2 million and $272.9 million as of December 31, 2016 and 2015, respectively. The fair value measurement of the 2012 Senior Notes is classified as Level 2 in the valuation hierarchy and determined based on the closing market price at the end of the quarter.
NOTE 15. Related Party Disclosures
White Mountains
In 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 December 31, 2016, White Mountains owned 76.1% of the Company's outstanding common shares.
Separation Agreement & Other Servicing Arrangements
In connection with the initial public offering, the Company entered into a separation agreement dated November 14, 2006 with White Mountains (the "Separation Agreement") to address a number of operational, administrative and financial matters relating to the fact that OneBeacon would no longer be a wholly-owned subsidiary of White Mountains. These matters included, among others, the administration of payroll, employee benefits programs, deferred compensation and 401(k) plans, OneBeacon's travel and logistics office, certain information technology assets and functions and certain agreements with respect to finance and tax arrangements. Pursuant to the Separation Agreement, White Mountains has agreed to indemnify the Company and its subsidiaries, as well as their current and former officers, directors and employees to the extent permitted by
F-68
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 15. Related Party Disclosures
law, for any and all claims or actions resulting in losses, expenses or damages relating to or arising out of the business, operation or ownership of any subsidiary company or business owned by the Company or its subsidiaries that, subsequent to OneBeacon's ownership, was a subsidiary or business of White Mountains (but no longer a subsidiary or business of OneBeacon).
For the years ended December 31, 2016, 2015 and 2014, OneBeacon recorded expenses of $0.2 million, $0.3 million and $0.3 million, respectively, and received amounts of $1.4 million for the year ended December 31, 2016 and $2.0 million for each of the years ended December 31, 2015 and 2014, for services under the Separation Agreement.
Effective October 19, 2016, the Company and its Bermuda subsidiaries entered into services agreements with Bridge Holdings (Bermuda), Ltd. ("Bridge Holdings"), a wholly owned subsidiary of White Mountains, pursuant to which Bridge Holdings provides office space and various management and administrative services for the Company’s Bermuda companies, including Split Rock. For the year ended December 31, 2016, the Company and its subsidiaries paid an aggregate of less than $0.1 million in fees pursuant to these services agreements.
Registration Rights Agreement
In connection with the initial public offering, the Company entered into a registration rights agreement dated November 14, 2006 with White Mountains that provides that White Mountains can demand that the Company register the distribution of its common shares owned by White Mountains ("demand" registration rights). In addition, White Mountains has "piggyback" registration rights, which means that White Mountains may include its shares in any future registrations of the Company's common equity securities, whether or not that registration relates to a primary offering by the Company or a secondary offering by or on behalf of any of the Company's shareholders. These registration rights are transferable by White Mountains. The Company will pay all costs and expenses in connection with each such registration, except underwriting discounts and commissions applicable to the common shares sold by White Mountains. The registration rights agreement contains customary terms and provisions with respect to, among other things, registration procedures and rights to indemnification in connection with the registration of the common shares on behalf of White Mountains. The Company will register sales of its common shares owned by employees and directors of White Mountains pursuant to employee share or option plans, but only to the extent such registration is required for the shares to be freely tradable.
Investment Management Agreements with White Mountains Advisors LLC ("WM Advisors")
Pursuant to an Amended and Restated Investment Management Agreement dated December 23, 2014 (the "Investment Management Agreement"), WM Advisors supervises and directs OneBeacon's managed investment portfolio in accordance with the investment objectives, policies and restrictions described in OneBeacon's investment guidelines (the "Investment Guidelines").
Under the Investment Management Agreement, WM Advisors has full discretion and authority to make all investment decisions in respect to OneBeacon's managed investment portfolio, and to do anything which WM Advisors deems is required, appropriate or advisable in connection with the foregoing, subject to and in accordance with Investment Guidelines. The assets of OneBeacon's portfolio are held in one or more separately identifiable accounts in the custody of a bank or similar entity designated by OneBeacon and acceptable to WM Advisors. The agreement is terminable by WM Advisors or OneBeacon upon 60 days prior written notice.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 15. Related Party Disclosures
OneBeacon is responsible for custodial arrangements and the payment of all custodial charges and fees. OneBeacon has agreed to pay annual investment management fees generally based on the quarter-end market values held under custody as set forth in the table below:
Assets Under Management | Annual Fee | |
Investment Grade Fixed Income: | ||
—Up to $1 billion | 10.0 basis points | |
—Next $1 billion | 8.5 basis points | |
—Next $3 billion | 7.5 basis points | |
—Greater than $5 billion | 2.5 basis points | |
High Yield Fixed Income | 25.0 basis points | |
ETFs | 10.0 basis points | |
Equities | 100.0 basis points | |
Hedge Funds | 100.0 basis points | |
Private Equities & Deferreds: | ||
First 2 years of fund's life (committed) | 100.0 basis points | |
Thereafter (fair value) | 100.0 basis points | |
Affordable housing credit funds: | ||
First year of fund's life (committed) | 100.0 basis points | |
Thereafter (fair value) | 10.0 basis points | |
OneBeacon incurred $3.7 million, $3.6 million and $3.4 million in total fees for investment management services provided by WM Advisors under the Investment Management Agreements during the years ended December 31, 2016, 2015 and 2014, respectively. WM Advisors is also paid a quarterly fee for treasury management services computed at the annual rate of 1.75 basis points (0.0175%) of the aggregate value of net assets on an annual basis. OneBeacon incurred $0.5 million in treasury management fees during the year ended December 31, 2016 and $0.4 million in treasury management fees during each of the years ended December 31, 2015 and 2014.
Effective as of December 15, 2016, the Company’s indirect subsidiary, OB Portfolio Solutions ICAV (“OB ICAV”) entered into a tri-party Investment Management Agreement (the “ICAV Investment Management Agreement”) in which WM Advisors provides investment advisory and management services to the OB ICAV in accordance with the fund’s stated investment objectives, policies and restrictions. Under the ICAV Investment Management Agreement, WM Advisors is paid a quarterly fee computed at an annual rate of 1.75 basis points (0.0175%) of the net asset value of the OB ICAV. For the year ended December 31, 2016, OB ICAV incurred a fee of less than $0.1 million for the investment advisory and management services provided by WM Advisors under this arrangement.
Star & Shield Insurance Exchange
ASIC and Split Rock each entered into a quota share agreement effective as of November 1, 2013, to reinsure certain risks of Star & Shield Insurance Exchange (“Star & Shield”), a reciprocal insurance exchange consolidated in White Mountains, which provides private passenger auto insurance. ASIC and Split Rock recorded combined written premiums of negative $2.8 million and positive $17.3 million in 2015 and 2014, respectively, related to Star & Shield which are included in the Specialty Products reporting segment. The quota share agreement was terminated on December 31, 2014 and the negative $2.8 million net written premiums in 2015 reflects the transfer of the remaining net unearned premium balance.
Prospector
Investment Management Agreement with Prospector
Until June 30, 2015, Prospector Partners LLC (“Prospector”) supervised and directed the publicly-traded common equity securities and convertible fixed maturity investments portions of OneBeacon's investment portfolio and managed assets for each of the Qualified Plan, the Non-Qualified Plan, and two proprietary funds under the KSOP pursuant to separate investment
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 15. Related Party Disclosures
management agreements with OneBeacon and each of the plans. Under the agreements, OneBeacon and the plans paid annual management fees to Prospector based on aggregate net assets under management according to the following schedule: 1.00% on the first $200 million; 0.50% on the next $200 million; and 0.25% on amounts over $400 million.
For the years ended December 31, 2015 and 2014, OneBeacon incurred $0.4 million and $2.0 million, respectively, in fees for investment management services provided by Prospector. For the years ended December 31, 2015 and 2014, the employee benefit plans incurred $0.9 million and $1.3 million, respectively, in fees for investment management services provided by Prospector.
Richard P. Howard was a portfolio manager of Prospector and a director of the Company until his retirement from Prospector and his resignation from the Company’s Board of Directors effective December 31, 2014. John D. Gillespie was a director of White Mountains and the founder and managing member of Prospector. In conjunction with Mr. Gillespie’s retirement from the White Mountains Board of Directors, the investment management agreement between OneBeacon and Prospector and the OneBeacon benefit plans and Prospector was terminated in June 2015.
Prospector Managed Limited Partnerships
Prior to fully redeeming its interests in 2015, OneBeacon held investments in limited partnerships managed by Prospector. Under the limited partnership agreements, Prospector served as general partner and general manager of the funds and was paid a management fee by OneBeacon. In addition, OneBeacon allocated a portion of its earnings from OneBeacon's limited partnership interests to Prospector as an incentive fee. For the years ended December 31, 2015 and 2014, OneBeacon incurred $0.1 million and $0.2 million, respectively, in management fees. For the year ended December 31, 2014, OneBeacon incurred $0.2 million in incentive fees and less than $0.1 million for the year ended December 31, 2015.
NOTE 16. Commitments and Contingencies
Leases
OneBeacon leases certain office space under noncancellable operating leases expiring at various dates through 2030. Net rental expense for all of OneBeacon's locations was approximately $10.7 million, $12.0 million and $11.1 million, respectively, for the years ended December 31, 2016, 2015 and 2014. OneBeacon's future annual minimum rental payments required under noncancellable leases primarily for office space are $10.1 million, $8.4 million, $7.4 million, $5.9 million and $26.4 million for 2017, 2018, 2019, 2020 and 2021 and thereafter, respectively.
As described in Note 1—"Nature of Operations and Summary of Significant Accounting Policies," in December 2011, the Company sold the majority of its then owned fixed assets and capitalized software. The Company entered into lease financing arrangements with US Bancorp and Fifth Third whereby it sold furniture and equipment and capitalized software, respectively, at a cost equal to net book value. The Company then leased the fixed assets back from US Bancorp for a lease term of five years and leased the capitalized software back from Fifth Third for a lease term of four years which expired in December 2015. The Company received cash proceeds of $23.1 million as a result of entering into the sale-leaseback transactions.
In December 2016 the lease agreement with US Bancorp expired and the leased assets under the agreement with a remaining book value of $1.3 million reverted ownership back to the Company, and there is no longer a capital lease asset or obligation. As of December 31, 2015, the Company had a capital lease obligation of $1.7 million included within other liabilities and a capital lease asset of $2.4 million included within other assets.
Other Investments
OneBeacon has future binding commitments to fund certain limited partnership investments which do not have fixed funding dates and totaled $15.0 million as of December 31, 2016.
Assigned Risks
As a condition of license to do business in certain states, OneBeacon's insurance operations are required to participate in mandatory shared market mechanisms. Each state dictates the types of insurance and the level of coverage that must be provided. The total amount of such business an insurer is required to accept is based on its market share of voluntary business in the state. In certain cases, OneBeacon is obligated to write business from mandatory shared market mechanisms at some time in the future based on the market share of voluntary policies it is currently writing. Underwriting results related to assigned risk plans are typically adverse and are not subject to the predictability associated with OneBeacon's voluntarily written business.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 16. Commitments and Contingencies
Guaranty Funds
Under existing guaranty fund laws in all states, insurers licensed to do business in those states can be assessed for certain obligations of insolvent insurance companies to policyholders and claimants. OneBeacon's insurance subsidiaries record guaranty fund assessments when such assessments are billed by the respective guaranty funds. In addition, OneBeacon will monitor other insurance company insolvencies and will accrue a liability when such losses are determined to be probable and the assessment amounts can be reasonably estimated. The actual amount of such assessments will depend upon the final outcome of rehabilitation proceedings and will be paid over several years. As of December 31, 2016, the reserve for such assessments at OneBeacon's insurance subsidiaries totaled $8.0 million.
Legal Contingencies
OneBeacon, and the insurance and reinsurance industry in general, is routinely subject to claims-related litigation and arbitration in the normal course of business, as well as litigation and arbitration that do not arise from, or directly relate to, claims activity. OneBeacon's estimates of the costs of settling matters routinely encountered in claims activity are reflected in the reserves for unpaid loss and LAE. See Note 3—"Unpaid Loss and Loss Adjustment Expense ("LAE") Reserves."
OneBeacon evaluates its exposure to non-claims related litigation and arbitration and establishes accruals for litigation and arbitration if it is probable that a loss has been incurred and it can be reasonably estimated. Disclosure of litigation and arbitration is made if it is probable that a loss has been incurred or if there is a reasonable possibility that a loss may have been incurred. Although the ultimate outcome of claims and non-claims related litigation and arbitration, and the amount or range of potential loss at any particular time, is often inherently uncertain, management does not believe that the ultimate outcome of such claims and non-claims related litigation and arbitration will have a material adverse effect on OneBeacon's financial condition, full year results of operations, or cash flows.
The following summarizes significant ongoing non-claims related litigation or arbitration as of December 31, 2016:
Deutsche Bank Litigation
In June 2011, Deutsche Bank Trust Company Americas, Law Debenture Company of New York and Wilmington Trust Company (collectively referred to as “Plaintiffs”), in their capacity as trustees for certain senior notes issued by the Tribune Company (“Tribune”), filed lawsuits in various jurisdictions (the “Noteholder Actions”) against numerous defendants including OneBeacon, OneBeacon-sponsored benefit plans and other affiliates of White Mountains in their capacity as former shareholders of Tribune seeking recovery of the proceeds from the sale of common stock of Tribune in connection with Tribune's leveraged buyout in 2007 (the “LBO”). Tribune filed for bankruptcy in 2008 in the Delaware bankruptcy court (the “Bankruptcy Court”). The Bankruptcy Court granted Plaintiffs permission to commence these LBO-related actions, and in 2011, the Judicial Panel on Multidistrict Litigation granted a motion to consolidate the actions for pretrial matters and transferred all such proceedings to the United States District Court for the Southern District of New York (the "SDNY"). Plaintiffs seek recovery of the proceeds received by the former Tribune shareholders on a theory of constructive fraudulent transfer asserting that Tribune purchased or repurchased its common shares without receiving fair consideration at a time when it was, or as a result of the purchases of shares, was rendered, insolvent. OneBeacon has entered into a joint defense agreement with other affiliates of White Mountains that are defendants in the action. OneBeacon and OneBeacon-sponsored benefit plans received approximately $32 million for Tribune common stock tendered in connection with the LBO. The Court granted an omnibus motion to dismiss the Noteholders Action in September 2013 and plaintiffs appealed. On March 29, 2016, a three judge panel of the U.S Second Circuit Court of Appeals affirmed the dismissal of the Noteholders Action. On July 22, 2016, the Plaintiff's petition to the Second Circuit for reconsideration or for a rehearing en banc was denied in full. On September 9, 2016 the Plaintiffs filed for a writ of certiorari, seeking review in the United States Supreme Court.
In addition, OneBeacon, OneBeacon-sponsored benefit plans and other affiliates of White Mountains in their capacity as former shareholders of Tribune, along with thousands of former Tribune shareholders, have been named as defendants in an adversary proceeding brought by the Official Committee of Unsecured Creditors of the Tribune Company (the “Committee”), on behalf of the Tribune Company, which seeks to avoid the repurchase of shares by Tribune in the LBO on a theory of intentional fraudulent transfer (the “Committee Action”). Tribune emerged from bankruptcy in 2012, and a litigation trustee replaced the Committee as plaintiff in the Committee Action. This matter was consolidated for pretrial matters with the Noteholder Actions in the SDNY and was stayed pending the motion to dismiss in the Noteholder Action. An omnibus motion to dismiss the shareholder defendants in the Committee Action was filed in May 2014 and the motion was granted on January 6, 2017. The plaintiff has requested permission to move the SDNY to certify the decision as a final judgment capable of immediate appeal. No amount has been accrued in connection with this matter as of December 31, 2016, as the amount of loss, if any, cannot be reasonably estimated.
F-72
NOTE 17. Earnings per Share
Basic and diluted earnings per share amounts are based on the weighted average number of common shares outstanding, including unvested restricted shares that are considered participating securities. Diluted earnings per share amounts are based on the weighted average number of common shares including unvested restricted shares and the net effect of potentially dilutive common shares outstanding.
The following table outlines the Company's computation of earnings per share for net income from continuing operations attributable to OneBeacon's common shareholders for the years ended December 31, 2016, 2015 and 2014:
Year ended December 31, | ||||||||||||
2016 | 2015 | 2014 | ||||||||||
Earnings attributable to OneBeacon's common shareholders—basic and diluted (in millions): | ||||||||||||
Net income from continuing operations attributable to OneBeacon's common shareholders | $ | 107.4 | $ | 37.0 | $ | 53.5 | ||||||
Allocation of income for participating unvested restricted common shares | (0.5 | ) | (0.2 | ) | (0.4 | ) | ||||||
Dividends paid on participating restricted common shares | (0.3 | ) | (0.3 | ) | (0.5 | ) | ||||||
Total allocation to restricted common shares | (0.8 | ) | (0.5 | ) | (0.9 | ) | ||||||
Net income from continuing operations attributable to OneBeacon's common shareholders, net of restricted common share amounts | $ | 106.6 | $ | 36.5 | $ | 52.6 | ||||||
Undistributed (over-distributed) net earnings (in millions): | ||||||||||||
Net income from continuing operations attributable to OneBeacon's common shareholders, net of restricted common share amounts | $ | 106.6 | $ | 36.5 | $ | 52.6 | ||||||
Dividends paid, net of restricted common share amounts | (78.9 | ) | (79.7 | ) | (79.5 | ) | ||||||
Total undistributed (over-distributed) net earnings, net of restricted common share amounts | $ | 27.7 | $ | (43.2 | ) | $ | (26.9 | ) | ||||
Earnings per share denominator—basic and diluted (in millions): | ||||||||||||
Total weighted average common shares outstanding | 94.4 | 95.3 | 95.3 | |||||||||
Weighted average unvested restricted common shares(1) | (0.4 | ) | (0.5 | ) | (0.6 | ) | ||||||
Basic and diluted earnings per share denominator | 94.0 | 94.8 | 94.7 | |||||||||
Earnings per share attributable to OneBeacon's common shareholders—basic and diluted (in dollars): | ||||||||||||
Net income from continuing operations attributable to OneBeacon's common shareholders | $ | 1.13 | $ | 0.38 | $ | 0.55 | ||||||
Dividends declared and paid | (0.84 | ) | (0.84 | ) | (0.84 | ) | ||||||
Undistributed (over-distributed) earnings | $ | 0.29 | $ | (0.46 | ) | $ | (0.29 | ) | ||||
_______________________________________________________________________________
(1) | Restricted shares outstanding vest in equal installments upon a stated date or upon the occurrence of a specified event. |
Basic and diluted income (loss) per share amounts for discontinued operations are included in Note 18—"Discontinued Operations."
F-73
NOTE 18. Discontinued Operations
Runoff Business
As described in Note 1—"Nature of Operations and Summary of Significant Accounting Policies" and Note 2—"Acquisitions and Dispositions," on December 23, 2014, OneBeacon completed the sale of its Runoff Business to Armour and the results of operations for the Runoff Business have been classified as discontinued operations and are presented as such, net of related income taxes, in the statements of operations and comprehensive income and cash flows for all periods. Investing and financing activities for OneBeacon are managed on a consolidated basis reported within the Investing, Financing and Corporate segment. Therefore, no investment or financing activity is included in discontinued operations. The vast majority of the gross and net run-off unpaid loss and LAE reserves were included in the entities that were transferred to Armour. As of December 31, 2016 and 2015, gross loss and LAE reserves of $18.3 million and $20.4 million, respectively, related to the Runoff business were ceded to Bedivere, an indirect wholly-owned subsidiary of Armour, beginning December 23, 2014, by way of a 100% quota share agreement with ASIC.
In the fourth quarter of 2014, in conjunction with the Runoff Transaction, OneBeacon provided financing in the form of surplus notes having a par value of $101.0 million, which had a fair value of $64.9 million on the date of sale. The surplus notes, issued by one of the transferred entities, Bedivere (“Issuer”), were in the form of both seller priority and pari passu notes.
Under the contractual terms of both the seller priority and pari passu notes, scheduled interest payments accrue at 6% until the scheduled maturity date of March 15, 2020 and at a floating interest rate thereafter, should any principal remain outstanding. As required by the Pennsylvania Insurance Department ("PID"), interest on the notes is not compounding. The notes restrict the Issuer's ability to make distributions to the holders of its equity interest. All such distributions are prohibited while the seller priority note is outstanding, and while the pari passu note is outstanding, distributions are permitted only if the Issuer concurrently repays a pro rata amount of any outstanding principal on the pari passu note.
Pursuant to the notes, the Issuer shall seek to redeem the notes annually each March 15 at a requested redemption amount such that the Issuer’s total adjusted capital following the proposed redemption payment would equal 200% of the Issuer’s “authorized control level RBC,” as such term is defined by the insurance laws of the Commonwealth of Pennsylvania and as prescribed by the PID. All redemptions or repayments of principal and payments of interest on the notes are subject to approval by the PID.
Results of Discontinued Operations
Discontinued Operations Results—Year ended December 31, 2016
There was no gain or loss related to discontinued operations for the year ended December 31, 2016.
Discontinued Operations Results—Year ended December 31, 2015
The loss from discontinued operations, net of tax, of $0.2 million for the year ended December 31, 2015 included $0.5 million of post-closing expenses incurred in connection with the Runoff Business and a $0.3 million gain from sale of discontinued operations representing a positive adjustment to the estimated loss on sale taking into consideration the final settlement of certain post-closing items.
Discontinued Operations Results—Year ended December 31, 2014
During the year ended December 31, 2014, the Company reported $20.6 million, or $(0.21) per share, after-tax net loss in discontinued operations related to the Runoff Transaction, which included an $18.8 million after-tax loss from sale of the Runoff Business (further described below) and a $1.8 million after-tax loss from the underwriting results of the Runoff Business.
As part of the closing of the Runoff Transaction on December 23, 2014, the $101.0 million par value surplus notes issued had a fair value of $64.9 million at closing based on an internal discounted cash flow model, resulting in a valuation adjustment of $36.1 million, pre-tax, included in loss from sale of discontinued operations. Subsequent to the closing, the surplus notes became part of the Company's investment portfolio, categorized within other investments, and subsequent changes in the value thereon are reflected in continuing operations. See Note 5—"Investment Securities" for further disclosures regarding these surplus notes.
F-74
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 18. Discontinued Operations
Also during 2014, the Company's expectation of the treatment of a $7.4 million reserve charge recorded during the quarter ended June 30, 2013 changed. Previously, the Company had expected that the $7.4 million of assets to support this reserve charge would be transferred to Armour at the closing of the Runoff Transaction. However, OneBeacon and Armour agreed instead to increase the cap on seller financing. As a result, the $7.4 million reserve charge ($4.8 million after-tax) was recorded as a reduction to the estimated loss on sale of discontinued operations.
These changes, along with certain other adjustments, resulted in a net increase in the estimated loss on sale of $28.9 million ($18.8 million after-tax) for the full year 2014, resulting in a pre-tax loss on sale at closing of $97.9 million ($63.7 million after-tax) recognized since the Runoff Transaction was announced in October of 2012.
Below is a table illustrating the valuation adjustments taken to arrive at estimated fair value of the surplus notes as of December 23, 2014:
Type of Surplus Note | Total | |||||||||||
Seller Priority | Pari Passu | |||||||||||
(in millions) | ||||||||||||
Par value | $ | 57.9 | $ | 43.1 | $ | 101.0 | ||||||
Fair value adjustments to reflect: | ||||||||||||
Current market rates on public debt and contract-based repayments(1) | 1.6 | (8.4 | ) | (6.8 | ) | |||||||
Regulatory approval(2) | (4.6 | ) | (8.0 | ) | (12.6 | ) | ||||||
Liquidity adjustment(3) | (11.0 | ) | (5.7 | ) | (16.7 | ) | ||||||
Total | (14.0 | ) | (22.1 | ) | (36.1 | ) | ||||||
Fair value | $ | 43.9 | $ | 21.0 | $ | 64.9 | ||||||
_______________________________________________________________________________
(1) | Represents the value of the surplus notes, at current market yields on comparable publicly traded debt, and assuming issuer is allowed to make principal and interest payments when its financial capacity is available, as measured by statutory capital in excess of a 250% RBC score. |
(2) | Represents anticipated delay in securing regulatory approvals of interest and principal payments to reflect graduated changes in Issuer's statutory surplus. The monetary impact of the anticipated delay is measured based on credit spreads of public securities with roughly equivalent percentages of discounted payments missed. |
(3) | Represents impact of liquidity spread to account for OneBeacon's sole ownership of the notes, lack of a trading market, and ongoing regulatory approval risk. |
F-75
NOTE 19. Consolidating Financial Information
The Company has fully and unconditionally guaranteed the 2012 Senior Notes issued by its 100% owned subsidiary, OBH. The following tables present OneBeacon's consolidating balance sheets as of December 31, 2016 and 2015, and statements of operations and comprehensive income and cash flows for the years ended December 31, 2016, 2015 and 2014. These financial statements reflect the Company's ("guarantor") financial position, results of operations and cash flows on a stand-alone basis, that of OBH ("the issuer") and of the Company's other entities ("non-guarantor subsidiaries") as well as the necessary consolidating adjustments to eliminate intercompany balances and transactions.
Consolidating Balance Sheet | The Company (guarantor) | Non-guarantor subsidiaries | OBH (issuer) | Consolidating adjustments | Consolidated | |||||||||||||||
as of December 31, 2016 | (in millions) | |||||||||||||||||||
Assets | ||||||||||||||||||||
Investment Securities: | ||||||||||||||||||||
Fixed maturity investments, at fair value | $ | — | $ | 2,169.1 | $ | — | $ | — | $ | 2,169.1 | ||||||||||
Short-term investments, at amortized cost (which approximates fair value) | 2.5 | 108.1 | 1.5 | — | 112.1 | |||||||||||||||
Common equity securities, at fair value | — | 188.7 | — | — | 188.7 | |||||||||||||||
Other investments | — | 150.5 | — | — | 150.5 | |||||||||||||||
Total investment securities | 2.5 | 2,616.4 | 1.5 | — | 2,620.4 | |||||||||||||||
Cash | — | 69.5 | 0.1 | — | 69.6 | |||||||||||||||
Reinsurance recoverables | — | 179.5 | — | — | 179.5 | |||||||||||||||
Premiums receivable | — | 228.3 | — | — | 228.3 | |||||||||||||||
Deferred acquisition costs | — | 96.3 | — | — | 96.3 | |||||||||||||||
Ceded unearned premiums | — | 44.2 | — | — | 44.2 | |||||||||||||||
Net deferred tax asset | — | 126.6 | — | 0.1 | 126.7 | |||||||||||||||
Investment income accrued | — | 11.3 | — | — | 11.3 | |||||||||||||||
Accounts receivable on unsettled investment sales | — | 1.4 | — | — | 1.4 | |||||||||||||||
Investments in subsidiaries | 1,018.8 | — | 989.4 | (2,008.2 | ) | — | ||||||||||||||
Other assets | 0.4 | 211.4 | 0.4 | — | 212.2 | |||||||||||||||
Total assets | $ | 1,021.7 | $ | 3,584.9 | $ | 991.4 | $ | (2,008.1 | ) | $ | 3,589.9 | |||||||||
Liabilities | ||||||||||||||||||||
Unpaid loss and loss adjustment expense reserves | $ | — | $ | 1,365.6 | $ | — | $ | — | $ | 1,365.6 | ||||||||||
Unearned premiums | — | 575.1 | — | — | 575.1 | |||||||||||||||
Funds held under insurance contracts | — | 153.0 | — | — | 153.0 | |||||||||||||||
Debt | — | — | 273.2 | — | 273.2 | |||||||||||||||
Other liabilities | 0.4 | 190.6 | 6.8 | — | 197.8 | |||||||||||||||
Total liabilities | 0.4 | 2,284.3 | 280.0 | — | 2,564.7 | |||||||||||||||
OneBeacon's common shareholders' equity and noncontrolling interests | ||||||||||||||||||||
Total OneBeacon's common shareholders' equity | 1,021.3 | 1,296.7 | 711.4 | (2,008.1 | ) | 1,021.3 | ||||||||||||||
Noncontrolling interests | — | 3.9 | — | — | 3.9 | |||||||||||||||
Total OneBeacon's common shareholders' equity and noncontrolling interests | 1,021.3 | 1,300.6 | 711.4 | (2,008.1 | ) | 1,025.2 | ||||||||||||||
Total liabilities, OneBeacon's common shareholders' equity and noncontrolling interests | $ | 1,021.7 | $ | 3,584.9 | $ | 991.4 | $ | (2,008.1 | ) | $ | 3,589.9 | |||||||||
F-76
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 19. Consolidating Financial Information
Consolidating Balance Sheet | The Company (guarantor) | Non-guarantor subsidiaries | OBH (issuer) | Consolidating adjustments | Consolidated | |||||||||||||||
as of December 31, 2015 | (in millions) | |||||||||||||||||||
Assets | ||||||||||||||||||||
Investment Securities: | ||||||||||||||||||||
Fixed maturity investments, at fair value | $ | — | $ | 2,074.6 | $ | 5.9 | $ | — | $ | 2,080.5 | ||||||||||
Short-term investments, at amortized cost (which approximates fair value) | 4.4 | 64.1 | 0.7 | — | 69.2 | |||||||||||||||
Common equity securities, at fair value | — | 298.7 | — | — | 298.7 | |||||||||||||||
Other investments | — | 143.0 | — | — | 143.0 | |||||||||||||||
Total investment securities | 4.4 | 2,580.4 | 6.6 | — | 2,591.4 | |||||||||||||||
Cash | — | 94.6 | 0.6 | — | 95.2 | |||||||||||||||
Reinsurance recoverables | — | 193.5 | — | — | 193.5 | |||||||||||||||
Premiums receivable | — | 219.0 | — | — | 219.0 | |||||||||||||||
Deferred acquisition costs | — | 100.7 | — | — | 100.7 | |||||||||||||||
Ceded unearned premiums | — | 29.5 | — | — | 29.5 | |||||||||||||||
Net deferred tax asset | — | 140.1 | — | 0.1 | 140.2 | |||||||||||||||
Investment income accrued | — | 10.1 | — | — | 10.1 | |||||||||||||||
Accounts receivable on unsettled investment sales | — | 30.5 | — | — | 30.5 | |||||||||||||||
Investments in subsidiaries | 996.9 | — | 951.3 | (1,948.2 | ) | — | ||||||||||||||
Other assets | 0.5 | 190.6 | 1.4 | — | 192.5 | |||||||||||||||
Total assets | $ | 1,001.8 | $ | 3,589.0 | $ | 959.9 | $ | (1,948.1 | ) | $ | 3,602.6 | |||||||||
Liabilities | ||||||||||||||||||||
Unpaid loss and loss adjustment expense reserves | $ | — | $ | 1,389.8 | $ | — | $ | — | $ | 1,389.8 | ||||||||||
Unearned premiums | — | 560.3 | — | — | 560.3 | |||||||||||||||
Funds held under insurance contracts | — | 137.7 | — | — | 137.7 | |||||||||||||||
Debt | — | — | 272.9 | — | 272.9 | |||||||||||||||
Other liabilities | 0.9 | 230.4 | 6.1 | — | 237.4 | |||||||||||||||
Total liabilities | 0.9 | 2,318.2 | 279.0 | — | 2,598.1 | |||||||||||||||
OneBeacon's common shareholders' equity and noncontrolling interests | ||||||||||||||||||||
Total OneBeacon's common shareholders' equity | 1,000.9 | 1,267.2 | 680.9 | (1,948.1 | ) | 1,000.9 | ||||||||||||||
Noncontrolling interests | — | 3.6 | — | — | 3.6 | |||||||||||||||
Total OneBeacon's common shareholders' equity and noncontrolling interests | 1,000.9 | 1,270.8 | 680.9 | (1,948.1 | ) | 1,004.5 | ||||||||||||||
Total liabilities, OneBeacon's common shareholders' equity and noncontrolling interests | $ | 1,001.8 | $ | 3,589.0 | $ | 959.9 | $ | (1,948.1 | ) | $ | 3,602.6 | |||||||||
F-77
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 19. Consolidating Financial Information
Consolidating Statement of Operations and Comprehensive Income | The Company (guarantor) | Non-guarantor subsidiaries | OBH (issuer) | Consolidating adjustments | Consolidated | |||||||||||||||
Year ended December 31, 2016 | (in millions) | |||||||||||||||||||
Revenues | ||||||||||||||||||||
Earned premiums | $ | — | $ | 1,100.6 | $ | — | $ | — | $ | 1,100.6 | ||||||||||
Net investment income | — | 50.6 | — | — | 50.6 | |||||||||||||||
Net realized and change in unrealized investment gains | — | 37.7 | — | — | 37.7 | |||||||||||||||
Net other revenues | — | 5.5 | — | — | 5.5 | |||||||||||||||
Total revenues | — | 1,194.4 | — | — | 1,194.4 | |||||||||||||||
Expenses | ||||||||||||||||||||
Loss and loss adjustment expenses | — | 656.0 | — | — | 656.0 | |||||||||||||||
Policy acquisition expenses | — | 206.0 | — | — | 206.0 | |||||||||||||||
Other underwriting expenses | — | 209.0 | — | — | 209.0 | |||||||||||||||
General and administrative expenses | 4.5 | 9.3 | 0.4 | — | 14.2 | |||||||||||||||
Interest expense | — | — | 13.1 | — | 13.1 | |||||||||||||||
Total expenses | 4.5 | 1,080.3 | 13.5 | — | 1,098.3 | |||||||||||||||
Pre-tax income (loss) from continuing operations | (4.5 | ) | 114.1 | (13.5 | ) | — | 96.1 | |||||||||||||
Income tax benefit | — | 7.7 | 4.8 | — | 12.5 | |||||||||||||||
Net income (loss) from continuing operations | (4.5 | ) | 121.8 | (8.7 | ) | — | 108.6 | |||||||||||||
Net loss from discontinued operations, net of tax | — | — | — | — | — | |||||||||||||||
Income (loss) before equity in earnings of unconsolidated affiliates | (4.5 | ) | 121.8 | (8.7 | ) | — | 108.6 | |||||||||||||
Equity in earnings of subsidiaries, net of tax | 111.9 | — | 59.2 | (171.1 | ) | — | ||||||||||||||
Net income including noncontrolling interests | 107.4 | 121.8 | 50.5 | (171.1 | ) | 108.6 | ||||||||||||||
Less: Net income attributable to noncontrolling interests | — | (1.2 | ) | — | — | (1.2 | ) | |||||||||||||
Net income attributable to OneBeacon's common shareholders | 107.4 | 120.6 | 50.5 | (171.1 | ) | 107.4 | ||||||||||||||
Net change in benefit plan assets and obligations, net of tax | 1.0 | — | 1.0 | (1.0 | ) | 1.0 | ||||||||||||||
Comprehensive income attributable to OneBeacon's common shareholders | $ | 108.4 | $ | 120.6 | $ | 51.5 | $ | (172.1 | ) | $ | 108.4 | |||||||||
F-78
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 19. Consolidating Financial Information
Consolidating Statement of Operations and Comprehensive Income (Loss) | The Company (guarantor) | Non-guarantor subsidiaries | OBH (issuer) | Consolidating adjustments | Consolidated | |||||||||||||||
Year ended December 31, 2015 | (in millions) | |||||||||||||||||||
Revenues | ||||||||||||||||||||
Earned premiums | $ | — | $ | 1,176.2 | $ | — | $ | — | $ | 1,176.2 | ||||||||||
Net investment income | — | 45.9 | — | — | 45.9 | |||||||||||||||
Net realized and change in unrealized investment gains | — | (35.1 | ) | — | — | (35.1 | ) | |||||||||||||
Net other revenues (expenses) | — | (0.6 | ) | — | — | (0.6 | ) | |||||||||||||
Total revenues | — | 1,186.4 | — | — | 1,186.4 | |||||||||||||||
Expenses | ||||||||||||||||||||
Loss and loss adjustment expenses | — | 700.7 | — | — | 700.7 | |||||||||||||||
Policy acquisition expenses | — | 213.8 | — | — | 213.8 | |||||||||||||||
Other underwriting expenses | — | 218.2 | — | — | 218.2 | |||||||||||||||
General and administrative expenses | 4.8 | 10.3 | 0.3 | — | 15.4 | |||||||||||||||
Interest expense | — | — | 13.0 | — | 13.0 | |||||||||||||||
Total expenses | 4.8 | 1,143.0 | 13.3 | — | 1,161.1 | |||||||||||||||
Pre-tax income (loss) from continuing operations | (4.8 | ) | 43.4 | (13.3 | ) | — | 25.3 | |||||||||||||
Income tax benefit | — | 8.2 | 4.7 | — | 12.9 | |||||||||||||||
Net income (loss) from continuing operations | (4.8 | ) | 51.6 | (8.6 | ) | — | 38.2 | |||||||||||||
Net loss from discontinued operations, net of tax | — | (0.2 | ) | — | — | (0.2 | ) | |||||||||||||
Net income (loss) before equity in earnings of unconsolidated affiliates | (4.8 | ) | 51.4 | (8.6 | ) | — | 38.0 | |||||||||||||
Equity in earnings of subsidiaries, net of tax | 41.6 | — | 8.3 | (49.9 | ) | — | ||||||||||||||
Net income (loss) including noncontrolling interests | 36.8 | 51.4 | (0.3 | ) | (49.9 | ) | 38.0 | |||||||||||||
Less: Net income attributable to noncontrolling interests | — | (1.2 | ) | — | — | (1.2 | ) | |||||||||||||
Net income (loss) attributable to OneBeacon's common shareholders | 36.8 | 50.2 | (0.3 | ) | (49.9 | ) | 36.8 | |||||||||||||
Net change in benefit plan assets and obligations, net of tax | — | — | — | — | — | |||||||||||||||
Comprehensive income (loss) attributable to OneBeacon's common shareholders | $ | 36.8 | $ | 50.2 | $ | (0.3 | ) | $ | (49.9 | ) | $ | 36.8 | ||||||||
F-79
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 19. Consolidating Financial Information
Consolidating Statement of Operations and Comprehensive Income (Loss) | The Company (guarantor) | Non-guarantor subsidiaries | OBH (issuer) | Consolidating adjustments | Consolidated | |||||||||||||||
Year ended December 31, 2014 | (in millions) | |||||||||||||||||||
Revenues | ||||||||||||||||||||
Earned premiums | $ | — | $ | 1,177.1 | $ | — | $ | — | $ | 1,177.1 | ||||||||||
Net investment income | — | 44.4 | 0.1 | (1.1 | ) | 43.4 | ||||||||||||||
Net realized and change in unrealized investment gains | — | 44.6 | — | (4.2 | ) | 40.4 | ||||||||||||||
Net other revenues (expenses) | — | 5.8 | (3.7 | ) | 3.7 | 5.8 | ||||||||||||||
Total revenues | — | 1,271.9 | (3.6 | ) | (1.6 | ) | 1,266.7 | |||||||||||||
Expenses | ||||||||||||||||||||
Loss and loss adjustment expenses | — | 815.1 | — | — | 815.1 | |||||||||||||||
Policy acquisition expenses | — | 203.3 | — | — | 203.3 | |||||||||||||||
Other underwriting expenses | — | 179.2 | — | — | 179.2 | |||||||||||||||
General and administrative expenses | 5.1 | 8.4 | 0.3 | — | 13.8 | |||||||||||||||
Interest expense | — | — | 14.1 | (1.1 | ) | 13.0 | ||||||||||||||
Total expenses | 5.1 | 1,206.0 | 14.4 | (1.1 | ) | 1,224.4 | ||||||||||||||
Pre-tax income (loss) from continuing operations | (5.1 | ) | 65.9 | (18.0 | ) | (0.5 | ) | 42.3 | ||||||||||||
Income tax benefit | — | 5.8 | 6.3 | 0.2 | 12.3 | |||||||||||||||
Net income (loss) from continuing operations | (5.1 | ) | 71.7 | (11.7 | ) | (0.3 | ) | 54.6 | ||||||||||||
Net loss from discontinued operations, net of tax | — | (20.6 | ) | — | — | (20.6 | ) | |||||||||||||
Income (loss) before equity in earnings of unconsolidated affiliates | (5.1 | ) | 51.1 | (11.7 | ) | (0.3 | ) | 34.0 | ||||||||||||
Equity in earnings of subsidiaries, net of tax | 38.0 | — | 9.5 | (47.5 | ) | — | ||||||||||||||
Net income (loss) including noncontrolling interests | 32.9 | 51.1 | (2.2 | ) | (47.8 | ) | 34.0 | |||||||||||||
Less: Net income attributable to noncontrolling interests | — | (1.1 | ) | — | — | (1.1 | ) | |||||||||||||
Net income (loss) attributable to OneBeacon's common shareholders | 32.9 | 50.0 | (2.2 | ) | (47.8 | ) | 32.9 | |||||||||||||
Net change in benefit plan assets and obligations, net of tax | (12.0 | ) | — | (12.0 | ) | 12.0 | (12.0 | ) | ||||||||||||
Comprehensive income (loss) attributable to OneBeacon's common shareholders | $ | 20.9 | $ | 50.0 | $ | (14.2 | ) | $ | (35.8 | ) | $ | 20.9 | ||||||||
F-80
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 19. Consolidating Financial Information
Consolidating Statement of Cash Flows | The Company (guarantor) | Non-guarantor subsidiaries | OBH (issuer) | Consolidating adjustments | Consolidated | |||||||||||||||
Year ended December 31, 2016 | ($ in millions) | |||||||||||||||||||
Cash flows from operations: | ||||||||||||||||||||
Net income including noncontrolling interests | $ | 107.4 | $ | 121.8 | $ | 50.5 | $ | (171.1 | ) | $ | 108.6 | |||||||||
Charges (credits) to reconcile net income to cash flows provided from (used for) operations: | ||||||||||||||||||||
Undistributed earnings from subsidiaries | (111.9 | ) | — | (59.2 | ) | 171.1 | — | |||||||||||||
Net realized and change in unrealized investment gains | — | (37.7 | ) | — | — | (37.7 | ) | |||||||||||||
Net adjustment to gain on sale of business | — | (0.5 | ) | — | — | (0.5 | ) | |||||||||||||
Deferred income tax expense | — | 15.4 | — | — | 15.4 | |||||||||||||||
Dividends received from subsidiaries | 91.0 | 4.5 | 4.5 | (100.0 | ) | — | ||||||||||||||
Other operating items: | ||||||||||||||||||||
Net change in loss and LAE reserves | — | (24.2 | ) | — | — | (24.2 | ) | |||||||||||||
Net change in unearned premiums | — | 14.8 | — | — | 14.8 | |||||||||||||||
Net change in ceded unearned premium | — | (14.7 | ) | — | — | (14.7 | ) | |||||||||||||
Net change in premiums receivable | — | (9.3 | ) | — | — | (9.3 | ) | |||||||||||||
Net change in reinsurance recoverable on paid and unpaid losses | — | 14.0 | — | — | 14.0 | |||||||||||||||
Net change in funds held under insurance contracts. | — | 15.3 | — | — | 15.3 | |||||||||||||||
Net change in other assets and liabilities | 2.3 | (38.6 | ) | 1.9 | — | (34.4 | ) | |||||||||||||
Net cash provided from (used for) operations—continuing operations | 88.8 | 60.8 | (2.3 | ) | (100.0 | ) | 47.3 | |||||||||||||
Net cash used for operations—discontinued operations | — | — | — | — | — | |||||||||||||||
Net cash provided from (used for) operations | 88.8 | 60.8 | (2.3 | ) | (100.0 | ) | 47.3 | |||||||||||||
Cash flows from investing activities: | ||||||||||||||||||||
Net maturities, purchases and sales of short-term investments | 1.9 | (44.0 | ) | (0.8 | ) | — | (42.9 | ) | ||||||||||||
Maturities of fixed maturity investments | — | 543.5 | — | — | 543.5 | |||||||||||||||
Sales of fixed maturity investments | — | 771.2 | 24.2 | (42.5 | ) | 752.9 | ||||||||||||||
Sales of common equity securities | — | 384.9 | — | — | 384.9 | |||||||||||||||
Return of capital and distributions of other investments | — | 11.6 | — | — | 11.6 | |||||||||||||||
Purchases of fixed maturity investments | — | (1,420.1 | ) | (18.3 | ) | 42.5 | (1,395.9 | ) | ||||||||||||
Purchases of common equity securities | — | (260.0 | ) | — | — | (260.0 | ) | |||||||||||||
Contributions for other investments | — | (1.0 | ) | — | — | (1.0 | ) | |||||||||||||
Net change in unsettled investment purchases and sales | — | 29.1 | — | — | 29.1 | |||||||||||||||
Net acquisitions of property and equipment | — | (2.7 | ) | — | — | (2.7 | ) | |||||||||||||
Capital contribution from parent | — | 27.3 | 28.5 | (55.8 | ) | — | ||||||||||||||
Net cash provided from investing activities—continuing operations | 1.9 | 39.8 | 33.6 | (55.8 | ) | 19.5 | ||||||||||||||
Net cash provided from investing activities—discontinued operations | — | — | — | — | — | |||||||||||||||
Net cash provided from investing activities | 1.9 | 39.8 | 33.6 | (55.8 | ) | 19.5 | ||||||||||||||
Cash flows from financing activities: | ||||||||||||||||||||
Cash dividends paid to common shareholders | (79.2 | ) | — | — | — | (79.2 | ) | |||||||||||||
Cash dividends paid to parent | — | (95.5 | ) | (4.5 | ) | 100.0 | — | |||||||||||||
Capital contribution to subsidiary | — | (28.5 | ) | (27.3 | ) | 55.8 | — | |||||||||||||
Repurchases and retirements of common stock | (11.5 | ) | — | — | — | (11.5 | ) | |||||||||||||
Payments on capital lease obligation | — | (1.7 | ) | — | — | (1.7 | ) | |||||||||||||
Net cash used for financing activities—continuing operations | (90.7 | ) | (125.7 | ) | (31.8 | ) | 155.8 | (92.4 | ) | |||||||||||
Net cash used for financing activities—discontinued operations | — | — | — | — | — | |||||||||||||||
Net cash used for financing activities | (90.7 | ) | (125.7 | ) | (31.8 | ) | 155.8 | (92.4 | ) | |||||||||||
Net decrease in cash during period | — | (25.1 | ) | (0.5 | ) | — | (25.6 | ) | ||||||||||||
Cash balance at beginning of period | — | 94.6 | 0.6 | — | 95.2 | |||||||||||||||
Cash balance at end of period | $ | — | $ | 69.5 | $ | 0.1 | $ | — | $ | 69.6 | ||||||||||
F-81
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 19. Consolidating Financial Information
Consolidating Statement of Cash Flows | The Company (guarantor) | Non-guarantor subsidiaries | OBH (issuer) | Consolidating adjustments | Consolidated | |||||||||||||||
Year ended December 31, 2015 | ($ in millions) | |||||||||||||||||||
Cash flows from operations: | ||||||||||||||||||||
Net income (loss) including noncontrolling interests | $ | 36.8 | $ | 51.4 | $ | (0.3 | ) | $ | (49.9 | ) | $ | 38.0 | ||||||||
Charges (credits) to reconcile net income to cash flows provided from operations: | ||||||||||||||||||||
Undistributed earnings from subsidiaries | (41.6 | ) | — | (8.3 | ) | 49.9 | — | |||||||||||||
Net loss from discontinued operations | — | 0.2 | — | — | 0.2 | |||||||||||||||
Net realized and change in unrealized investment gains | — | 35.1 | — | — | 35.1 | |||||||||||||||
Net adjustment to gain on sale of business | — | 3.7 | — | — | 3.7 | |||||||||||||||
Deferred income tax benefit | — | (5.8 | ) | — | — | (5.8 | ) | |||||||||||||
Dividends received from subsidiaries | 72.0 | 99.9 | 110.9 | (282.8 | ) | — | ||||||||||||||
Other operating items: | ||||||||||||||||||||
Net change in loss and LAE reserves | — | 47.6 | — | — | 47.6 | |||||||||||||||
Net change in unearned premiums | — | (28.0 | ) | — | — | (28.0 | ) | |||||||||||||
Net change in ceded unearned premiums | — | (11.6 | ) | — | — | (11.6 | ) | |||||||||||||
Net change in premiums receivable | — | 22.5 | — | — | 22.5 | |||||||||||||||
Net change in reinsurance recoverable on paid and unpaid losses | — | (19.7 | ) | — | — | (19.7 | ) | |||||||||||||
Net change in funds held under reinsurance contracts | — | 37.1 | — | — | 37.1 | |||||||||||||||
Net change in funds held under insurance contracts | — | 56.7 | — | — | 56.7 | |||||||||||||||
Net change in other assets and liabilities | 2.5 | 13.6 | 0.5 | — | 16.6 | |||||||||||||||
Net cash provided from operations—continuing operations | 69.7 | 302.7 | 102.8 | (282.8 | ) | 192.4 | ||||||||||||||
Net cash used for operations—discontinued operations | — | (0.5 | ) | — | — | (0.5 | ) | |||||||||||||
Net cash provided from operations | 69.7 | 302.2 | 102.8 | (282.8 | ) | 191.9 | ||||||||||||||
Cash flows from investing activities: | ||||||||||||||||||||
Net maturities, purchases and sales of short-term investments | 14.0 | 118.5 | 0.6 | — | 133.1 | |||||||||||||||
Maturities of fixed maturity investments | — | 262.4 | — | — | 262.4 | |||||||||||||||
Sales of fixed maturity investments | — | 491.5 | 88.7 | 183.3 | 763.5 | |||||||||||||||
Sales of common equity securities | — | 345.6 | — | — | 345.6 | |||||||||||||||
Return of capital and distributions of other investments | — | 40.5 | — | — | 40.5 | |||||||||||||||
Purchases of fixed maturity investments | — | (1,055.3 | ) | (94.9 | ) | (183.3 | ) | (1,333.5 | ) | |||||||||||
Purchases of common equity securities | — | (323.5 | ) | — | — | (323.5 | ) | |||||||||||||
Contributions for other investments | — | (4.2 | ) | — | — | (4.2 | ) | |||||||||||||
Net change in unsettled investment purchases and sales | — | (23.8 | ) | — | — | (23.8 | ) | |||||||||||||
Proceeds from sale of property and equipment | — | 56.8 | — | — | 56.8 | |||||||||||||||
Net acquisitions of property and equipment | — | (11.5 | ) | — | — | (11.5 | ) | |||||||||||||
Capital contribution from parent | — | 2.2 | 5.5 | (7.7 | ) | — | ||||||||||||||
Net cash provided from (used for) investing activities—continuing operations | 14.0 | (100.8 | ) | (0.1 | ) | (7.7 | ) | (94.6 | ) | |||||||||||
Net cash provided from investing activities—discontinued operations | — | — | — | — | — | |||||||||||||||
Net cash provided from (used for) investing activities | 14.0 | (100.8 | ) | (0.1 | ) | (7.7 | ) | (94.6 | ) | |||||||||||
Cash flows from financing activities: | ||||||||||||||||||||
Cash dividends paid to common shareholders | (80.0 | ) | — | — | — | (80.0 | ) | |||||||||||||
Cash dividends paid to parent | — | (182.9 | ) | (99.9 | ) | 282.8 | — | |||||||||||||
Capital contribution to subsidiary | — | (5.5 | ) | (2.2 | ) | 7.7 | — | |||||||||||||
Repurchases and retirements of common stock | (3.7 | ) | — | — | — | (3.7 | ) | |||||||||||||
Payments on capital lease obligation | — | (5.4 | ) | — | — | (5.4 | ) | |||||||||||||
Net cash used for financing activities—continuing operations | (83.7 | ) | (193.8 | ) | (102.1 | ) | 290.5 | (89.1 | ) | |||||||||||
Net cash used for financing activities—discontinued operations | — | — | — | — | — | |||||||||||||||
Net cash used for financing activities | (83.7 | ) | (193.8 | ) | (102.1 | ) | 290.5 | (89.1 | ) | |||||||||||
Net increase in cash during period | — | 7.6 | 0.6 | — | 8.2 | |||||||||||||||
Cash balance at beginning of period | — | 87.0 | — | — | 87.0 | |||||||||||||||
Cash balance at end of period | $ | — | $ | 94.6 | $ | 0.6 | $ | — | $ | 95.2 | ||||||||||
F-82
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 19. Consolidating Financial Information
Consolidating Statement of Cash Flows | The Company (guarantor) | Non-guarantor subsidiaries | OBH (issuer) | Consolidating adjustments | Consolidated | |||||||||||||||
Year ended December 31, 2014 | ($ in millions) | |||||||||||||||||||
Cash flows from operations: | ||||||||||||||||||||
Net income (loss) including noncontrolling interests | $ | 32.9 | $ | 51.1 | $ | (2.2 | ) | $ | (47.8 | ) | $ | 34.0 | ||||||||
Charges (credits) to reconcile net income to cash flows provided from operations: | ||||||||||||||||||||
Undistributed earnings from subsidiaries | (38.0 | ) | — | (9.5 | ) | 47.5 | — | |||||||||||||
Net loss from discontinued operations | — | 20.6 | — | — | 20.6 | |||||||||||||||
Net realized and change in unrealized investment gains | — | (44.6 | ) | — | 4.2 | (40.4 | ) | |||||||||||||
Net other realized losses | — | (3.7 | ) | 3.7 | — | — | ||||||||||||||
Deferred income tax expense (benefit) | — | (18.8 | ) | — | (0.2 | ) | (19.0 | ) | ||||||||||||
Dividends received from subsidiaries | 90.4 | 15.0 | 50.0 | (155.4 | ) | — | ||||||||||||||
Other operating items: | ||||||||||||||||||||
Net change in loss and LAE reserves | — | 287.9 | — | — | 287.9 | |||||||||||||||
Net change in unearned premiums | — | 43.4 | — | — | 43.4 | |||||||||||||||
Net change in ceded unearned premiums | — | (3.6 | ) | — | — | (3.6 | ) | |||||||||||||
Net change in premiums receivable | — | (13.3 | ) | — | — | (13.3 | ) | |||||||||||||
Net change in reinsurance recoverable on paid and unpaid losses | — | (83.9 | ) | — | — | (83.9 | ) | |||||||||||||
Net change in funds held under reinsurance contracts | — | (35.3 | ) | — | — | (35.3 | ) | |||||||||||||
Net change in funds held under insurance contracts | — | 17.7 | — | — | 17.7 | |||||||||||||||
Net change in other assets and liabilities | 1.9 | (49.6 | ) | (1.9 | ) | (6.5 | ) | (56.1 | ) | |||||||||||
Net cash provided from operations—continuing operations | 87.2 | 182.9 | 40.1 | (158.2 | ) | 152.0 | ||||||||||||||
Net cash used for operations—discontinued operations | — | (54.5 | ) | — | — | (54.5 | ) | |||||||||||||
Net cash provided from operations | 87.2 | 128.4 | 40.1 | (158.2 | ) | 97.5 | ||||||||||||||
Cash flows from investing activities: | ||||||||||||||||||||
Net maturities, purchases and sales of short-term investments | (5.4 | ) | (62.8 | ) | 2.7 | — | (65.5 | ) | ||||||||||||
Maturities of fixed maturity investments | — | 396.4 | — | — | 396.4 | |||||||||||||||
Sales of fixed maturity investments | — | 1,927.9 | 80.3 | (165.1 | ) | 1,843.1 | ||||||||||||||
Sales of common equity securities | — | 240.2 | — | — | 240.2 | |||||||||||||||
Return of capital and distributions of other investments | — | 53.4 | — | — | 53.4 | |||||||||||||||
Purchases of fixed maturity investments | — | (2,265.1 | ) | (80.9 | ) | 139.2 | (2,206.8 | ) | ||||||||||||
Purchases of common equity securities | — | (202.4 | ) | — | — | (202.4 | ) | |||||||||||||
Contributions for other investments | — | (81.9 | ) | — | — | (81.9 | ) | |||||||||||||
Net change in unsettled investment purchases and sales | — | (15.0 | ) | — | — | (15.0 | ) | |||||||||||||
Net acquisitions of property and equipment | — | (2.2 | ) | — | — | (2.2 | ) | |||||||||||||
Capital contribution from parent | — | 70.0 | 70.0 | (140.0 | ) | — | ||||||||||||||
Net cash (used for) provided from investing activities—continuing operations | (5.4 | ) | 58.5 | 72.1 | (165.9 | ) | (40.7 | ) | ||||||||||||
Net cash provided from investing activities—discontinued operations | — | — | — | — | — | |||||||||||||||
Net cash (used for) provided from investing activities | (5.4 | ) | 58.5 | 72.1 | (165.9 | ) | (40.7 | ) | ||||||||||||
Cash flows from financing activities: | ||||||||||||||||||||
Repurchases of debt | — | — | (28.7 | ) | 28.7 | — | ||||||||||||||
Cash dividends paid to common shareholders | (80.0 | ) | — | — | — | (80.0 | ) | |||||||||||||
Cash dividends paid to parent | — | (140.4 | ) | (15.0 | ) | 155.4 | — | |||||||||||||
Capital contribution to subsidiary | — | (70.0 | ) | (70.0 | ) | 140.0 | — | |||||||||||||
Repurchases and retirements of common stock | (1.8 | ) | — | — | — | (1.8 | ) | |||||||||||||
Payments on capital lease obligation | — | (5.3 | ) | — | — | (5.3 | ) | |||||||||||||
Net cash used for financing activities—continuing operations | (81.8 | ) | (215.7 | ) | (113.7 | ) | 324.1 | (87.1 | ) | |||||||||||
Net cash used for financing activities—discontinued operations | — | — | — | — | — | |||||||||||||||
Net cash used for financing activities | (81.8 | ) | (215.7 | ) | (113.7 | ) | 324.1 | (87.1 | ) | |||||||||||
Net decrease in cash during period | — | (28.8 | ) | (1.5 | ) | — | (30.3 | ) | ||||||||||||
Cash transferred with sale of business | — | (50.8 | ) | — | — | (50.8 | ) | |||||||||||||
Net decrease after cash transferred with sale of business | — | (79.6 | ) | (1.5 | ) | — | (81.1 | ) | ||||||||||||
Cash balance at beginning of period | — | 166.6 | 1.5 | — | 168.1 | |||||||||||||||
Cash balance at end of period | $ | — | $ | 87.0 | $ | — | $ | — | $ | 87.0 | ||||||||||
F-83
NOTE 20. Selected Quarterly Financial Data (Unaudited)
Selected quarterly financial data for 2016 and 2015 is shown in the following table. The quarterly financial data includes, in the opinion of management, all recurring adjustments necessary for a fair presentation of the results of operations for the interim periods.
2016 Three months ended | 2015 Three months ended | |||||||||||||||||||||||||||||||
($ in millions, except per share amounts) | Mar 31 | Jun 30 | Sep 30 | Dec 31 | Mar 31 | Jun 30 | Sep 30 | Dec 31 | ||||||||||||||||||||||||
Revenues | $ | 310.5 | $ | 309.0 | $ | 307.0 | $ | 267.9 | $ | 308.2 | $ | 314.2 | $ | 267.8 | $ | 296.2 | ||||||||||||||||
Expenses | 272.3 | 286.0 | 274.1 | 265.9 | 280.1 | 311.3 | 284.6 | 285.1 | ||||||||||||||||||||||||
Pre-tax income (loss) from continuing operations | 38.2 | 23.0 | 32.9 | 2.0 | 28.1 | 2.9 | (16.8 | ) | 11.1 | |||||||||||||||||||||||
Tax (expense) benefit | 8.7 | 2.0 | (4.6 | ) | 6.4 | (3.4 | ) | 0.9 | 3.5 | 11.9 | ||||||||||||||||||||||
Net income (loss) from continuing operations | 46.9 | 25.0 | 28.3 | 8.4 | 24.7 | 3.8 | (13.3 | ) | 23.0 | |||||||||||||||||||||||
Net (loss) gain from discontinued operations, net of tax | — | — | — | — | (0.1 | ) | 0.1 | (0.1 | ) | (0.1 | ) | |||||||||||||||||||||
Net income (loss) including noncontrolling interests | 46.9 | 25.0 | 28.3 | 8.4 | 24.6 | 3.9 | (13.4 | ) | 22.9 | |||||||||||||||||||||||
Less: Net income attributable to noncontrolling interests | (0.5 | ) | (0.5 | ) | — | (0.2 | ) | (0.5 | ) | (0.5 | ) | — | (0.2 | ) | ||||||||||||||||||
Net income (loss) attributable to OneBeacon's common shareholders | $ | 46.4 | $ | 24.5 | $ | 28.3 | $ | 8.2 | $ | 24.1 | $ | 3.4 | $ | (13.4 | ) | $ | 22.7 | |||||||||||||||
Earnings (loss) per share attributable to OneBeacon's common shareholders—basic and diluted:(1) | ||||||||||||||||||||||||||||||||
Net income (loss) from continuing operations per share | $ | 0.49 | $ | 0.26 | $ | 0.30 | $ | 0.09 | $ | 0.25 | $ | 0.03 | $ | (0.14 | ) | $ | 0.24 | |||||||||||||||
Net income (loss) attributable to OneBeacon's common shareholders per share | $ | 0.49 | $ | 0.26 | $ | 0.30 | $ | 0.09 | $ | 0.25 | $ | 0.03 | $ | (0.14 | ) | $ | 0.24 | |||||||||||||||
(1) Due to the averaging of shares, quarterly earnings per share may not add to the total for the full year.
F-84
MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS
Management is responsible for the preparation and fair presentation of the financial statements included in this report. The financial statements have been prepared in conformity with GAAP in the United States. 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.
The Audit Committee of the Board, which is comprised entirely of independent, qualified directors, is responsible for the oversight of our accounting policies, financial reporting and internal control including the appointment and compensation of our independent registered public accounting firm. The Audit Committee meets periodically with management, our independent registered public accounting firm and our internal auditors to ensure they are carrying out their responsibilities. The Audit Committee is also responsible for performing an oversight role by reviewing our financial reports. Our independent registered public accounting firm and internal auditors have full and unlimited access to the Audit Committee, with or without management present, to discuss the adequacy of internal control over financial reporting and any other matters which they believe should be brought to their attention.
MANAGEMENT'S ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. Because of its inherent limitations, internal control over financial reporting may not prevent or detect a material misstatement. Accordingly, even effective internal control over financial reporting can provide only reasonable assurance with respect to financial statement preparation. Further, an effective internal control environment as of a point in time may become inadequate in the future because of changes in conditions, or deterioration in the degree of compliance with the policies and procedures.
We assessed the effectiveness of OneBeacon's internal control over financial reporting as of December 31, 2016. In making our assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control—Integrated Framework (2013). Based on this assessment, we have concluded that OneBeacon maintained effective internal control over financial reporting as of December 31, 2016.
PricewaterhouseCoopers LLP, the Company's independent registered public accounting firm, has audited the effectiveness of OneBeacon's internal control over financial reporting as of December 31, 2016 as stated in their report which appears on page F-86.
February 27, 2017 | ||
/s/ T. MICHAEL MILLER | /s/ PAUL H. MCDONOUGH | |
T. Michael Miller President and Chief Executive Officer (Principal Executive Officer) | Paul H. McDonough Executive Vice President and Chief Financial Officer (Principal Financial Officer) | |
F-85
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of OneBeacon Insurance Group, Ltd.:
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of OneBeacon Insurance Group, Ltd. and its subsidiaries at December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the accompanying index present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial statements and financial statement schedules, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Annual Report on Internal Control over Financial Reporting. Our responsibility is to express opinions on these financial statements, on the financial statement schedules, and on the Company's internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ PricewaterhouseCoopers LLP
Minneapolis, Minnesota
February 27, 2017
F-86
SCHEDULE I
ONEBEACON INSURANCE GROUP, LTD.
SUMMARY OF INVESTMENTS—OTHER THAN
INVESTMENTS IN RELATED PARTIES
As of December 31, 2016
Amortized Cost | Fair Value | Carrying Value | ||||||||||
($ in millions) | ||||||||||||
Investments: | ||||||||||||
Fixed maturity investments: | ||||||||||||
Bonds: | ||||||||||||
U.S. Government | $ | 169.6 | $ | 167.3 | $ | 167.3 | ||||||
Corporate bonds and asset-backed securities | 1,915.4 | 1,916.2 | 1,916.2 | |||||||||
States, municipalities and political subdivisions | 70.1 | 70.5 | 70.5 | |||||||||
Foreign governments | 1.0 | 1.2 | 1.2 | |||||||||
Preferred stocks | 8.3 | 13.9 | 13.9 | |||||||||
Total fixed maturity investments | 2,164.4 | 2,169.1 | 2,169.1 | |||||||||
Short-term investments | 112.1 | 112.1 | 112.1 | |||||||||
Common equity securities: | ||||||||||||
ETFs | 159.6 | 164.4 | 164.4 | |||||||||
Banks, trust and insurance companies | 3.7 | 3.9 | 3.9 | |||||||||
Industrial, miscellaneous and other | 178.6 | 184.8 | 184.8 | |||||||||
Total common equity securities | 182.3 | 188.7 | 188.7 | |||||||||
Other investments | 120.9 | 150.5 | 150.5 | |||||||||
Total investments | $ | 2,579.7 | $ | 2,620.4 | $ | 2,620.4 | ||||||
S-1
SCHEDULE II
ONEBEACON INSURANCE GROUP, LTD.
(Registrant Only)
CONDENSED BALANCE SHEETS
December 31, | ||||||||
2016 | 2015 | |||||||
($ in millions) | ||||||||
Assets: | ||||||||
Short-term investments, at amortized cost (which approximates fair value) | $ | 2.5 | $ | 4.4 | ||||
Investments in subsidiaries | 1,018.8 | 996.9 | ||||||
Other assets | 0.4 | 0.5 | ||||||
Total assets | $ | 1,021.7 | $ | 1,001.8 | ||||
Liabilities | $ | 0.4 | $ | 0.9 | ||||
OneBeacon's common shareholders' equity | 1,021.3 | 1,000.9 | ||||||
Total liabilities and OneBeacon's common shareholders' equity | $ | 1,021.7 | $ | 1,001.8 | ||||
CONDENSED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
Year ended December 31, | ||||||||||||
2016 | 2015 | 2014 | ||||||||||
($ in millions) | ||||||||||||
Revenues | $ | — | $ | — | $ | — | ||||||
Expenses | 4.5 | 4.8 | 5.1 | |||||||||
Pre-tax loss from continuing operations | (4.5 | ) | (4.8 | ) | (5.1 | ) | ||||||
Income tax benefit | — | — | — | |||||||||
Net loss from continuing operations | (4.5 | ) | (4.8 | ) | (5.1 | ) | ||||||
Equity in earnings from subsidiaries, net of tax | 111.9 | 41.6 | 38.0 | |||||||||
Net income attributable to OneBeacon's common shareholders | 107.4 | 36.8 | 32.9 | |||||||||
Other comprehensive income (loss) items, after tax | 1.0 | — | (12.0 | ) | ||||||||
Comprehensive income attributable to OneBeacon's common shareholders | $ | 108.4 | $ | 36.8 | $ | 20.9 | ||||||
See Notes to Financial Statements.
S-2
SCHEDULE II (continued)
ONEBEACON INSURANCE GROUP, LTD.
(Registrant Only)
CONDENSED STATEMENTS OF CASH FLOWS
Year ended December 31, | ||||||||||||
2016 | 2015 | 2014 | ||||||||||
($ in millions) | ||||||||||||
Net income | $ | 107.4 | $ | 36.8 | $ | 32.9 | ||||||
Charges (credits) to reconcile net income to net cash from operations: | ||||||||||||
Undistributed earnings from subsidiaries | (111.9 | ) | (41.6 | ) | (38.0 | ) | ||||||
Dividends received from subsidiaries | 91.0 | 72.0 | 90.4 | |||||||||
Net change in other assets and liabilities | 2.3 | 2.5 | 1.9 | |||||||||
Net cash provided from operations | 88.8 | 69.7 | 87.2 | |||||||||
Cash flows from investing activities: | ||||||||||||
Net maturities, purchases and sales of short-term investments | 1.9 | 14.0 | (5.4 | ) | ||||||||
Net cash provided from (used for) investing activities | 1.9 | 14.0 | (5.4 | ) | ||||||||
Cash flows from financing activities: | ||||||||||||
Cash dividends paid to common shareholders | (79.2 | ) | (80.0 | ) | (80.0 | ) | ||||||
Repurchases and retirements of common stock | (11.5 | ) | (3.7 | ) | (1.8 | ) | ||||||
Net cash used for financing activities | (90.7 | ) | (83.7 | ) | (81.8 | ) | ||||||
Net change in cash during the year | — | — | — | |||||||||
Cash balance at beginning of year | — | — | — | |||||||||
Cash balance at end of year | $ | — | $ | — | $ | — | ||||||
ONEBEACON INSURANCE GROUP, LTD.
(Registrant Only)
NOTES TO CONDENSED FINANCIAL INFORMATION
1. General
The financial statements of the Registrant should be read in conjunction with the consolidated financial statements and notes thereto included in Item 8.
2. Long-term Obligations and Guarantees
The Company has fully and unconditionally guaranteed the 2012 Senior Notes maturing on November 9, 2022 presented in Note 6—"Debt" that were issued by its 100% owned subsidiary, OBH.
3. Supplemental Cash Flow Information
Dividends received from subsidiaries were $91.0 million, $72.0 million and $90.4 million for the years ended December 31, 2016, 2015, and 2014, respectively.
S-3
SCHEDULE III
ONEBEACON INSURANCE GROUP, LTD.
SUPPLEMENTARY INSURANCE INFORMATION
Column A | Column B | Column C | Column D | Column E | Column F | Column G | Column H | Column I | Column J | Column K | ||||||||||||||||||||||||||||||
Segment | Deferred acquisition costs | Future policy benefits, losses, claims and loss expenses | Unearned premiums | Other policy claims and benefits payable | Premiums earned | Net investment income(1) | Benefits, claims, losses, and settlement expenses | Amortization of policy acquisition expenses | Other operating expenses | Premiums written | ||||||||||||||||||||||||||||||
($ in millions) | ||||||||||||||||||||||||||||||||||||||||
Years ended: | ||||||||||||||||||||||||||||||||||||||||
December 31, 2016: | ||||||||||||||||||||||||||||||||||||||||
Specialty Industries | $ | 48.0 | $ | 570.7 | $ | 255.3 | $ | — | $ | 576.2 | $ | — | $ | (280.6 | ) | $ | (106.5 | ) | $ | (120.4 | ) | $ | 559.8 | |||||||||||||||||
Specialty Products | 48.3 | 776.6 | 319.8 | — | 524.4 | — | (375.4 | ) | (99.5 | ) | (88.6 | ) | 540.9 | |||||||||||||||||||||||||||
Investing, Financing and Corporate(2) | — | 18.3 | — | — | — | 50.6 | — | — | — | — | ||||||||||||||||||||||||||||||
December 31, 2015: | ||||||||||||||||||||||||||||||||||||||||
Specialty Industries | $ | 51.1 | $ | 597.2 | $ | 272.2 | $ | — | $ | 615.9 | $ | — | $ | (390.0 | ) | $ | (113.7 | ) | $ | (120.3 | ) | $ | 603.6 | |||||||||||||||||
Specialty Products | 49.6 | 772.2 | 288.1 | — | 560.3 | — | (310.7 | ) | (100.1 | ) | (97.9 | ) | 533.0 | |||||||||||||||||||||||||||
Investing, Financing and Corporate(2) | — | 20.4 | — | — | — | 45.9 | — | — | — | — | ||||||||||||||||||||||||||||||
December 31, 2014: | ||||||||||||||||||||||||||||||||||||||||
Specialty Industries | $ | 53.5 | $ | 519.6 | $ | 284.7 | $ | — | $ | 595.0 | $ | — | $ | (357.2 | ) | $ | (107.1 | ) | $ | (100.8 | ) | $ | 610.0 | |||||||||||||||||
Specialty Products | 49.7 | 798.8 | 303.6 | — | 582.1 | — | (457.9 | ) | (96.2 | ) | (78.4 | ) | 606.9 | |||||||||||||||||||||||||||
Investing, Financing and Corporate(2) | — | 23.8 | — | — | — | 43.4 | — | — | — | — | ||||||||||||||||||||||||||||||
__________________________________________________________
(1) | Invested assets are not allocated to Specialty Industries or Specialty Products since OneBeacon does not manage its assets by segment. Net investment income related to OneBeacon's Specialty Industries and Specialty Products segments are included in the Investing, Financing and Corporate segment since these assets are available for payment of losses and expenses for all segments. |
(2) | As described in Note 18—"Discontinued Operations", ASIC is ceding to Bedivere 100% of the legacy Runoff Business that was written on ASIC or one of the ongoing entities. The balance of $18.3 million, $20.4 million and $23.8 million as of December 31, 2016, 2015 and 2014, respectively, is included in both unpaid loss and LAE reserves and reinsurance recoverable included within Investing, Financing, and Corporate. |
S-4
SCHEDULE IV
ONEBEACON INSURANCE GROUP, LTD.
REINSURANCE
Column A | Column B | Column C | Column D | Column E | Column F | ||||||||||||||
Premiums earned | Gross amount | Ceded to other companies | Assumed from other companies | Net amount | Percentage of amount assumed to net | ||||||||||||||
($ in millions) | |||||||||||||||||||
Year ended December 31, 2016 | |||||||||||||||||||
Specialty Products | $ | 568.0 | $ | (65.2 | ) | $ | 21.6 | $ | 524.4 | 4.1 | % | ||||||||
Specialty Industries | 609.0 | (40.6 | ) | 7.8 | 576.2 | 1.4 | % | ||||||||||||
Total Insurance Operations | $ | 1,177.0 | $ | (105.8 | ) | $ | 29.4 | $ | 1,100.6 | 2.7 | % | ||||||||
Year ended December 31, 2015 | |||||||||||||||||||
Specialty Products | $ | 647.8 | $ | (124.7 | ) | $ | 37.2 | $ | 560.3 | 6.6 | % | ||||||||
Specialty Industries | 650.2 | (43.0 | ) | 8.7 | 615.9 | 1.4 | % | ||||||||||||
Total Insurance Operations | $ | 1,298.0 | $ | (167.7 | ) | $ | 45.9 | $ | 1,176.2 | 3.9 | % | ||||||||
Year ended December 31, 2014 | |||||||||||||||||||
Specialty Products | $ | 582.5 | $ | (62.2 | ) | $ | 61.8 | $ | 582.1 | 10.6 | % | ||||||||
Specialty Industries | 626.6 | (40.7 | ) | 9.1 | 595.0 | 1.5 | % | ||||||||||||
Total Insurance Operations | $ | 1,209.1 | $ | (102.9 | ) | $ | 70.9 | $ | 1,177.1 | 6.0 | % | ||||||||
S-5
SCHEDULE V
ONEBEACON INSURANCE GROUP, LTD.
VALUATION AND QUALIFYING ACCOUNTS
Column A | Column B | Column C | Column D | Column E | ||||||||||||||||
Additions (subtractions) | ||||||||||||||||||||
Description | Balance at beginning of period | Charged (credited) to costs and expenses | Charged (credited) to other accounts(1) | Other additions (deductions) described(2) | Balance at end of period | |||||||||||||||
($ in millions) | ||||||||||||||||||||
Years ended: | ||||||||||||||||||||
December 31, 2016 | ||||||||||||||||||||
Reinsurance recoverable on paid and unpaid losses: | ||||||||||||||||||||
Allowance for reinsurance balances | $ | 0.7 | $ | 0.2 | $ | — | $ | — | $ | 0.9 | ||||||||||
Premiums receivable: | ||||||||||||||||||||
Allowance for uncollectible accounts | 2.0 | (0.3 | ) | (0.4 | ) | — | 1.3 | |||||||||||||
December 31, 2015 | ||||||||||||||||||||
Reinsurance recoverable on paid and unpaid losses: | ||||||||||||||||||||
Allowance for reinsurance balances | $ | 2.2 | $ | (0.1 | ) | $ | — | $ | (1.4 | ) | $ | 0.7 | ||||||||
Premiums receivable: | ||||||||||||||||||||
Allowance for uncollectible accounts | 1.9 | 0.8 | (0.7 | ) | — | 2.0 | ||||||||||||||
December 31, 2014 | ||||||||||||||||||||
Reinsurance recoverable on paid and unpaid losses: | ||||||||||||||||||||
Allowance for reinsurance balances | $ | 14.3 | $ | (0.5 | ) | $ | — | $ | (11.6 | ) | $ | 2.2 | ||||||||
Premiums receivable: | ||||||||||||||||||||
Allowance for uncollectible accounts | 3.1 | (0.2 | ) | (1.0 | ) | — | 1.9 | |||||||||||||
_______________________________________________________________________________
(1) | Amount credited to other accounts represents a reduction in the Allowance for uncollectible premiums receivable which was offset by a corresponding reduction in Gross premiums receivable. There was no impact to Premiums receivable as presented in the consolidated balance sheet. |
(2) | Represents net collections (charge offs) of balances receivable. |
S-6
SCHEDULE VI
ONEBEACON INSURANCE GROUP, LTD.
SUPPLEMENTAL INFORMATION FOR PROPERTY AND CASUALTY INSURANCE UNDERWRITERS
Column A | Column B | Column C | Column D | Column E | Column F | Column G | Column H | Column I | Column J | Column K | |||||||||||||||||||||||||||||||||||
Deferred acquisition costs | Reserves for Unpaid Claims and Claims Adjustment Expenses | Discount, if any, deducted in Column C(1) | Unearned Premiums | Earned Premiums | Net investment income(2) | Claims and Claims Adjustment Expenses Incurred Related to | Amortization of deferred policy acquisition costs | Paid Claims and Claims Adjustment Expenses | Premiums written | ||||||||||||||||||||||||||||||||||||
Affiliation with registrant | Current Year | Prior Year | |||||||||||||||||||||||||||||||||||||||||||
($ in millions) | |||||||||||||||||||||||||||||||||||||||||||||
Specialty Industries: | |||||||||||||||||||||||||||||||||||||||||||||
2016 | $ | 48.0 | $ | 570.7 | $ | 1.6 | $ | 255.3 | $ | 576.2 | $ | — | $ | 311.9 | $ | (31.3 | ) | $ | (106.5 | ) | $ | 307.9 | $ | 559.8 | |||||||||||||||||||||
2015 | 51.1 | 597.2 | 1.1 | 272.2 | 615.9 | — | 368.2 | 21.8 | (113.7 | ) | 322.7 | 603.6 | |||||||||||||||||||||||||||||||||
2014 | 53.5 | 519.6 | 1.0 | 284.7 | 595.0 | — | 329.2 | 28.0 | (107.1 | ) | 277.3 | 610.0 | |||||||||||||||||||||||||||||||||
Specialty Products: | |||||||||||||||||||||||||||||||||||||||||||||
2016 | $ | 48.3 | $ | 776.6 | $ | — | $ | 319.8 | $ | 524.4 | $ | — | $ | 328.7 | $ | 46.7 | $ | (99.5 | ) | $ | 359.2 | $ | 540.9 | ||||||||||||||||||||||
2015 | 49.6 | 772.2 | — | 288.1 | 560.3 | — | 334.3 | (23.6 | ) | (100.1 | ) | 354.8 | 533.0 | ||||||||||||||||||||||||||||||||
2014 | 49.7 | 798.8 | — | 303.6 | 582.1 | — | 396.1 | 61.8 | (96.2 | ) | 331.3 | 606.9 | |||||||||||||||||||||||||||||||||
Investing, Financing and Corporate:(4) | |||||||||||||||||||||||||||||||||||||||||||||
2016 | $ | — | $ | 18.3 | (3) | $ | — | $ | — | $ | — | $ | 50.6 | $ | — | $ | — | $ | — | $ | — | $ | — | ||||||||||||||||||||||
2015 | — | 20.4 | (3) | — | — | — | 45.9 | — | — | — | — | — | |||||||||||||||||||||||||||||||||
2014 | — | 23.8 | (3) | — | — | — | 43.4 | — | — | — | — | — | |||||||||||||||||||||||||||||||||
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(1) | The amounts shown represent discount on long-term workers compensation loss and LAE reserves, as such liabilities constitute unpaid but settled claims under which the payment pattern and ultimate costs are fixed and determinable on an individual basis. OneBeacon discounts these reserves at the statutory rate (2.5% as of December 31, 2016, 2015 and 2014). |
(2) | Invested assets are not allocated to Specialty Industries or Specialty Products since OneBeacon does not manage its assets by segment and these assets are available for payment of losses and expenses for all segments and, as such, the related net investment income is included in the Investing, Financing and Corporate segment. |
(3) | As described in Note 18—"Discontinued Operations", ASIC is ceding to Bedivere 100% of the legacy Runoff Business that was written on ASIC or one of the ongoing entities. The balances of $18.3 million, $20.4 million, and $23.8 million as of December 31, 2016, 2015 and 2014, respectively, are included in unpaid loss and loss adjustment expense reserves within Investing, Financing, and Corporate. |
S-7