UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

x		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the period ended March 31, 2007
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)

 

 

 

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

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer  o

Accelerated Filer  o

Non-accelerated filer  x

 

 

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

 

As of May 1, 2007, 28,258,554 Class A common shares, par value of $0.01 per share, and 71,754,738 Class B common shares, par value $0.01 per share, were outstanding.

 

 

ONEBEACON INSURANCE GROUP, LTD.

TABLE OF CONTENTS

 

PART I		FINANCIAL INFORMATION
ITEM 1.		Financial Statements (Unaudited)
		Consolidated Balance Sheets:
		December 31, 2006 and March 31, 2007		2
		Consolidated Statements of Income and Comprehensive Income:
		Three months ended March 31, 2006 and 2007		3
		Consolidated Statements of Common Shareholders’ Equity:
		Three months ended March 31, 2006 and 2007		4
		Consolidated Statements of Cash Flows:
		Three months ended March 31, 2006 and 2007		5
		Notes to Consolidated Financial Statements		6
ITEM 2.		Managements’ Discussion and Analysis of Financial Condition and Results of Operations
		Results of Operations — For the three months ended March 31, 2006 and 2007		22
		Liquidity and Capital Resources		29
		Critical Accounting Estimates		33
		Forward Looking Statements		34
ITEM 3.		Quantitative and Qualitative Disclosures About Market Risk		35
ITEM 4.		Controls and Procedures		35
PART II		OTHER INFORMATION
ITEM 1.		Legal Proceedings		35
ITEM 1A.		Risk Factors		35
ITEM 6.		Exhibits		35
SIGNATURES				36

 

 

PART 1. FINANCIAL INFORMATION

 

 

ITEM 1. Financial Statements

 

 

ONEBEACON INSURANCE GROUP, LTD.

CONSOLIDATED BALANCE SHEETS

 

		December 31,			March 31,
		2006			2007
					(Unaudited)
		($ in millions, except share and per share amounts)
Assets
Available-for-sale investments:
Fixed maturity investments, at fair value (amortized cost $3,501.5 and $3,386.3)		$	3,539.7		$	3,437.2
Common equity securities, at fair value (cost $568.9 and $575.5)		737.1			739.3
Short-term investments, at amortized cost (which approximates fair value)		319.0			327.0
Held-to-maturity investments (assets held in trust):
Fixed maturity investments, at amortized cost (estimated fair value $304.0 and $307.9)		305.0			308.4
Short-term investments, at amortized cost (which approximates fair value)		33.8			26.9
Other investments (cost $229.5 and $232.2)		278.1			287.3
Total investments		5,212.7			5,126.1
Cash		41.5			36.3
Reinsurance recoverable on unpaid losses		1,032.6			1,041.4
Reinsurance recoverable on unpaid losses—Berkshire Hathaway, Inc.		1,810.0			1,779.1
Reinsurance recoverable on paid losses		32.4			20.5
Premiums receivable		517.1			490.5
Securities lending collateral		528.8			431.4
Deferred acquisition costs		183.8			181.8
Deferred tax asset		61.2			36.6
Investment income accrued		34.8			33.8
Ceded unearned premiums		38.2			53.6
Accounts receivable on unsettled investment sales		6.7			29.3
Other assets		369.6			358.6
Total assets		$	9,869.4		$	9,619.0
Liabilities
Loss and LAE reserves		$	4,837.7		4,773.9
Unearned premiums		985.2			971.6
Debt		759.5			757.6
Securities lending payable		528.8			431.4
Preferred stock subject to mandatory redemption:
Held by Berkshire Hathaway Inc. (redemption value $300.0)		242.3			250.5
Held by others (redemption value $20.0)		20.0			20.0
Ceded reinsurance payable		71.9			84.9
Accounts payable on unsettled investment purchases		11.5			6.4
Other liabilities		635.3			497.0
Total liabilities		8,092.2			7,793.3
Common shareholders’ equity
Common shares and paid-in surplus (par value $0.01; authorized, 200,000,000 shares; issued and outstanding, 100,013,292 shares)		1,115.9			1,116.2
Retained earnings		474.4			513.6
Accumulated other comprehensive income, after-tax:
Net unrealized gains on investments		173.1			180.4
Net unrealized foreign currency translation gains		11.8			13.3
Other comprehensive income items		2.0			2.2
Total common shareholders’ equity		1,777.2			1,825.7
Total liabilities and common shareholders’ equity		$	9,869.4		$	9,619.0

 

See Notes to Consolidated Financial Statements

2

 

ONEBEACON INSURANCE GROUP, LTD.

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

(Unaudited)

 

		Three months ended March 31,
		2006			2007
		($ in millions, except per  share amounts)
Revenues
Earned premiums		$	506.8		$	468.9
Net investment income		46.2			50.6
Net realized investment gains		28.0			54.9
Net other revenues		5.5			3.1
Total revenues		586.5			577.5
Expenses
Loss and LAE		337.7			288.2
Policy acquisition expenses		87.5			78.3
Other underwriting expenses		83.9			90.9
General and administrative expenses		4.6			2.4
Accretion of fair value adjustment to loss and LAE reserves		5.7			4.0
Interest expense on debt		11.3			11.4
Interest expense—dividends on preferred stock subject to mandatory redemption		7.6			7.6
Interest expense—accretion on preferred stock subject to mandatory redemption		6.4			8.2
Total expenses		544.7			491.0
Pre-tax income		41.8			86.5
Income tax provision		(11.7		)	(26.0		)
Income from continuing operations before equity in earnings of unconsolidated affiliate		30.1			60.5
Equity in earnings of unconsolidated affiliate		2.2			—
Income from continuing operations		32.3			60.5
Loss from discontinued operations		(1.2		)	—
Net income		31.1			60.5
Change in net unrealized gains and losses for investments held		12.4			43.6
Recognition of net unrealized gains and losses for investments sold		(11.2		)	(36.3		)
Change in foreign currency translation		(0.8		)	1.5
Change in other comprehensive income items		1.1			0.2
Comprehensive net income		$	32.6		$	69.5
Basic and diluted earnings per share
Basic:
Income from continuing operations		$	0.32		$	0.61
Loss from discontinued operations		(0.01		)	—
Net income available to common shareholders		$	0.31		$	0.61
Diluted:
Income from continuing operations		$	0.32		$	0.61
Loss from discontinued operations		(0.01		)	—
Net income available to common shareholders		$	0.31		$	0.61
Dividends declared and paid per common share		$	—		$	0.21

 

See Notes to Consolidated Financial Statements

3

 

ONEBEACON INSURANCE GROUP, LTD.

CONSOLIDATED STATEMENTS OF COMMON SHAREHOLDERS’ EQUITY

(Unaudited)

 

		Common shareholders’ equity			Common shares and paid-in surplus			Retained earnings			Accum. other comprehensive income, after-tax
		($ in millions)
Balances at January 1, 2006		$	1,560.0		$	1,169.8		$	232.6		$	157.6
Adjustment to adopt SFAS No. 155, after-tax		—			—			7.1			(7.1		)
Net income		31.1			—			31.1			—
Other comprehensive income, after-tax		1.5			—			—			1.5
Balances at March 31, 2006		$	1,592.6		$	1,169.8		$	270.8		$	152.0

 

 

		Common shareholders’ equity			Common shares and paid-in surplus			Retained earnings			Accum. other comprehensive income, after-tax
		($ in millions)
Balances at January 1, 2007		$	1,777.2		$	1,115.9		$	474.4		$	186.9
Adjustment to adopt FIN 48		(0.3		)	—			(0.3		)	—
Net income		60.5			—			60.5			—
Dividends		(21.0		)	—			(21.0		)	—
Other comprehensive income, after-tax		9.0			—			—			9.0
Accrued stock option expense		0.3			0.3			—			—
Balances at March 31, 2007		$	1,825.7		$	1,116.2		$	513.6		$	195.9

 

See Notes to Consolidated Financial Statements

4

 

ONEBEACON INSURANCE GROUP, LTD.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

		Three months ended March 31,
		2006			2007
		($ in millions)
Cash flows from operations:
Net income		$	31.1		$	60.5
Charges (credits) to reconcile net income to cash flows used for operations:
Loss from discontinued operations		1.2			—
Net realized investment gains		(28.0		)	(54.9		)
Dividends paid on mandatorily redeemable preferred stock of subsidiaries		7.6			7.6
Other operating items:
Net change in loss and LAE reserves		(168.1		)	(63.8		)
Net change in unearned premiums		19.7			(13.6		)
Net change in ceded reinsurance		(11.6		)	13.0
Net change in premiums receivable		7.1			26.6
Net change in reinsurance recoverable on paid and unpaid losses		88.2			34.0
Net change in other assets and liabilities		(150.7		)	(115.2		)
Net cash used for operating activities of continuing operations		(203.5		)	(105.8		)
Net cash used for operating activities of discontinued operations		(1.5		)	—
Net cash used for operations		(205.0		)	(105.8		)
Cash flows from investing activities:
Net change in short-term investments available-for-sale		(106.4		)	(8.0		)
Maturities of investments held-to-maturity		—			6.9
Sales of fixed maturity investments		423.5			485.7
Maturities of fixed maturity investments		150.9			161.3
Sales of common equity securities		47.2			99.4
Sales of other investments		0.9			16.0
Purchases of fixed maturity investments available-for-sale		(221.5		)	(529.7		)
Purchases of common equity securities		(113.5		)	(65.8		)
Purchases of other investments		(7.7		)	(5.7		)
Net change in unsettled investment purchases and sales		44.8			(27.7		)
Net acquisitions of property and equipment		(6.2		)	(1.2		)
Net cash provided from investing activities of continuing operations		212.0			131.2
Net cash used for investing activities of discontinued operations		(3.9		)	—
Net cash provided from investing activities		208.1			131.2
Cash flows from financing activities:
Repayment of debt		—			(2.0		)
Cash dividends paid to common shareholders		—			(21.0		)
Dividends paid on mandatorily redeemable preferred stock of subsidiaries		(7.6		)	(7.6		)
Net cash used for financing activities of continuing operations		(7.6		)	(30.6		)
Net decrease in cash during period		(4.5		)	(5.2		)
Cash balance at beginning of period		44.1			41.5
Cash balance at end of period		$	39.6		$	36.3
Supplemental cash flows information:
Interest paid		$	0.7		$	0.9
Net Federal income taxes (received) paid		(13.0		)	42.3

 

See Notes to Consolidated Financial Statements

5

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

Basis of presentation

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

OneBeacon was acquired by White Mountains Group, Ltd. (“White Mountains”) from Aviva plc (“Aviva”, formerly CGNU) in 2001 (the “OneBeacon Acquisition”). White Mountains is a holding company whose businesses provide property and casualty insurance, reinsurance and certain other products. During the fourth quarter of 2006, White Mountains sold 27.6 million or 27.6% of the Company’s common shares in an initial public offering. Prior to the initial public offering, OneBeacon was a wholly-owned subsidiary of White Mountains. Within this report, the term “OneBeacon” is used to refer to one or more entities within the consolidated organization, as the context requires. The Company is a Bermuda exempted limited company with its headquarters located at the Bank of Butterfield Building, 42 Reid Street, 6th Floor, Hamilton HM 12, Bermuda. The Company’s U.S. headquarters are located at 1 Beacon Lane, Canton, Massachusetts 02021, its principal executive office is located at 601 Carlson Parkway, Minnetonka, Minnesota 55305 and its registered office is located at Clarendon House, 2 Church Street, Hamilton HM 11, Bermuda. OneBeacon’s reportable segments are Primary Insurance Operations, Affiliate Quota Shares, and Other Operations, as defined below.

OneBeacon’s Primary Insurance Operations segment includes the results of substantially all of its insurance operations, with the exception of certain quota share arrangements with affiliates of White Mountains as described below.

During 2004 and 2005, OneBeacon entered into two quota share reinsurance arrangements with other subsidiaries of White Mountains. Under the Sirius Quota Share, OneBeacon ceded between 6% and 12% of business written, effective April 1, 2004, to Sirius International Insurance Corporation. Under the Esurance Quota Share, which was effective on January 1, 2005, OneBeacon assumed approximately 85% of business written by Esurance Insurance Company, which includes business written by its wholly-owned subsidiary, Esurance Property and Casualty Insurance Company. These quota share agreements were commuted during the fourth quarter of 2006 in connection with the Company’s initial public offering.

OneBeacon’s Other Operations segment consists of the Company and its intermediate holding companies.

All significant intercompany transactions have been eliminated in consolidation. These interim financial statements include all adjustments considered necessary by management to fairly present the financial position, results of operations and cash flows of OneBeacon.  These interim financial statements may not be indicative of financial results for the full year and should be read in conjunction with the Company’s 2006 Annual Report on Form 10-K. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Refer to the Company’s 2006 Annual Report on Form 10-K for a complete discussion regarding OneBeacon’s significant accounting policies.

As part of a reorganization immediately preceding the initial public offering, OneBeacon sold certain consolidated subsidiaries to White Mountains on August 3, 2006 at GAAP book value. These subsidiaries have been classified as discontinued operations. Accordingly, the results of operations for these subsidiaries are presented net of tax, as loss from discontinued operations in the consolidated statements of income and comprehensive income. Cash flows associated with the operating and investing activities of discontinued operations are aggregated and presented under separate captions in the consolidated statements of cash flows. There were no cash flows associated with financing activities for the discontinued operations.

6

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Recently Adopted Changes in Accounting Principles

Federal, State and Foreign Income Taxes

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

On January 1, 2007 (“Date of Adoption”) OneBeacon adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”). FIN 48 prescribes when the benefit of a given tax position should be recognized and how it should be measured.  Under the new guidance, recognition 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.

FIN 48 also addresses how interest and penalties should be accrued for uncertain tax positions, requiring that interest expense should be recognized in the first period interest would be accrued under the tax law. OneBeacon classifies all interest and penalties on unrecognized tax benefits as part of income tax expense.  At the Date of Adoption, the Company had accrued interest and penalties of $3.3 million, net of federal benefit. In connection with the adoption of FIN 48, OneBeacon has recognized a $0.3 million increase in the liability for unrecognized tax benefits, primarily as a result of increases in its estimates of accrued interest. The effect of adoption has been recorded as an adjustment to opening retained earnings.

At the Date of Adoption the Company had $56.0 million of unrecognized tax benefits.  If recognized, $51.8 million would increase net income. Because of the impact of deferred tax accounting, exposure for certain temporary differences would not affect the effective tax rate but would accelerate the payment of cash to the taxing authority to an earlier period.  There have been no material changes to the above balances since the Date of Adoption.

7

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With few exceptions, the Company is no longer subject to U.S. federal, state or non-U.S. income tax examinations by tax authorities for years before 2003.  The Internal Revenue Service (IRS) commenced an examination of the Company’s U.S. income tax returns for 2003 through 2004 in the second quarter of 2006 that is anticipated to be completed by the end of 2008.  As of March 31, 2007 the IRS has not proposed any significant adjustments to taxable income.  The Company does not expect to receive any adjustments that would result in a material change to its financial position.

The Company does not anticipate any significant changes to its total unrecognized tax benefits within the next twelve months.

Recent Accounting Pronouncements

Fair Value Measurements

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). The Statement provides a revised definition of fair value and guidance on the methods used to measure fair value. The Statement also expands financial statement disclosure requirements for fair value information. The Statement establishes a fair value hierarchy that distinguishes between assumptions based on market data from independent sources (“observable inputs”) and a reporting entity’s internal assumptions based upon the best information available when external market data is limited or unavailable (“unobservable inputs”). The fair value hierarchy in SFAS 157 prioritizes inputs within three levels. Quoted prices in active markets have the highest priority (Level 1) followed by observable inputs other than quoted prices (Level 2) and unobservable inputs having the lowest priority (Level 3). The Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, with earlier application allowed for entities that have not issued financial statements in the fiscal year of adoption. OneBeacon has not yet determined the effect of adoption on its financial condition, results of operations or cash flows.

Fair Value Option

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). The Statement allows companies to make an election, on an individual instrument basis, to report financial assets and liabilities at fair value. The election must be made at the inception of a transaction and may not be reversed. The election may also be made for existing financial assets and liabilities at the time of adoption. Unrealized gains and losses on assets or liabilities for which the fair value option has been elected are to be reported in earnings. The Statement requires additional disclosures for instruments for which the election has been made, including a description of management’s reasons for making the election. The Statement is effective as of fiscal years beginning after November 15, 2007 and is to be adopted prospectively and concurrent with the adoption of SFAS 157. OneBeacon has not yet determined the effect of adoption on its financial condition, results of operations or cash flows.

NOTE 2. Discontinued Operations

In 2006 OneBeacon sold certain consolidated subsidiaries at GAAP book value to White Mountains. These subsidiaries are included in discontinued operations and comprise the following entities:

·       White Mountains Advisors LLC—an investment management subsidiary;

·       White Mountains Management Company, Inc. and White Mountains Capital, Inc.—both service companies;

8

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·       White Mountains Services Holdings and White Mountains Services, LLC—these companies contain the remainder of mortgage banking run-off assets from the sale of substantially all the mortgage banking assets of White Mountains Services Corporation (formerly Source One Mortgage Services Corporation) to Citibank Mortgage, Inc. in 1999;

·       Tuckerman Capital, L.P. and Tuckerman Capital II, L.P.—both private equity fund investments;

·       International American Group—primarily consists of American Centennial Insurance Company and British Insurance Company of Cayman, two run-off insurance companies.

OneBeacon’s net income from continuing operations excludes the results of operations for the above entities for all periods presented. Loss from discontinued operations has been presented separately and is shown net of related income taxes.

NOTE 3. Acquisitions and Dispositions

On September 29, 2006, OneBeacon sold certain assets and the right to renew existing policies of Agri, a division of OneBeacon that provided commercial farm and ranch and commercial agricultural insurance products, for $32.0 million in cash to QBE and recorded a pre-tax gain of $30.4 million through net other revenues. In connection with this sale, OneBeacon entered into agreements under which, at the option of QBE, it will write the policies of Agri on a direct basis and cede 100% of this business to QBE.

On October 31, 2006, OneBeacon restructured its investment in Main Street America Holdings, Inc. (“MSA”). OneBeacon received a $70 million cash dividend from MSA following which OneBeacon sold its 50% common stock investment in MSA to Main Street America Group, Inc. (“the MSA Group”) for (i) $70.0 million in 9.0% non-voting cumulative perpetual preferred stock of the MSA Group and (ii) 4.9% of the common stock of the MSA Group. Effective October 31, 2006, OneBeacon accounts for its remaining investment in the MSA Group in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” Refer to the Company’s 2006 Annual Report on Form 10-K. Prior to the sale, OneBeacon owned 50% of the total common shares outstanding of MSA and accounted for this investment using the equity method of accounting. These transactions resulted in a net after-tax realized gain of $8.5 million.

9

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NOTE 4. Reserves for Unpaid Loss and LAE

The following table summarizes the loss and LAE reserve activities of OneBeacon’s insurance subsidiaries for the three months ended March 31, 2006 and 2007:

		Three months ended March 31,
		2006			2007
Gross beginning balance		$	5,354.3		$	4,837.7
Less beginning reinsurance recoverable on unpaid losses		(3,120.9		)	(2,842.6		)
Net loss and LAE reserves		2,233.4			1,995.1
Loss and LAE incurred relating to:
Current year losses		330.5			300.2
Prior year losses		(7.2		)	(12.0		)
Total incurred loss and LAE		337.7			288.2
Accretion of fair value adjustment to net loss and LAE reserves		5.7			4.0
Loss and LAE paid relating to:
Current year losses		(93.9		)	(76.0		)
Prior year losses		(330.5		)	(257.9		)
Total loss and LAE payments		(424.4		)	(333.9		)
Net ending balance		2,152.4			1,953.4
Plus ending reinsurance recoverable on unpaid losses		3,033.8			2,820.5
Gross ending balance		$	5,186.2		$	4,773.9

 

In connection with purchase accounting for the OneBeacon Acquisition, loss and LAE reserves and the related reinsurance recoverables were adjusted to fair value on the balance sheets. The net reduction to loss and LAE reserves is being recognized through an income statement charge ratably with and over the period the claims are settled. Accordingly, OneBeacon recognized $5.7 million and $4.0 million of such charges for the three months ended March 31, 2006 and 2007, respectively.

NOTE 5. Reinsurance

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

At March 31, 2007, OneBeacon had $20.5 million of reinsurance recoverables on paid losses and $3,053.6 million (gross of $233.1 million in purchase accounting adjustments, as described in Note 4) that will become recoverable if claims are paid in accordance with current reserve estimates. The collectibility of balances due from OneBeacon’s reinsurers is critical to OneBeacon’s financial strength because reinsurance contracts do not relieve OneBeacon of its primary obligation to its policyholders. 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. As a result, uncollectible amounts have historically not been significant. The following table provides a listing of OneBeacon’s top reinsurers based upon recoverable amounts, the percentage of total reinsurance recoverables and the reinsurers’ A.M. Best ratings.

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($ in millions)		Balance at March 31, 2007			% of total		A.M. Best Rating(1)
Subsidiaries of Berkshire (NICO and GRC)(2)		$	2,185.6		71	%	A	++
Tokio Marine and Nichido Fire		58.3			2	%	A	++
Munich Reinsurance America (formerly America Reinsurance Company)		56.2			2	%	A
Liberty Mutual and subsidiaries(3)		37.7			1	%	A
Swiss Re		22.5			1	%	A	+

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

(2)             Includes $404.0 million of Third Party Recoverables, which NICO would pay under the terms of the NICO Cover if they are unable to collect from third party reinsurers. OneBeacon also has an additional $377.0 million of Third Party Recoverables from various reinsurers, the majority of which are rated “A” or better by A.M. Best.

(3)             At March 31, 2007, OneBeacon had assumed balances receivable and expenses receivable of approximately $34.0 million under its renewal rights agreement with Liberty Mutual, which expired on October 31, 2003.

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

Under the terms of the NICO Cover, NICO receives the economic benefit of reinsurance recoverables from certain of OneBeacon’s third party reinsurers (“Third Party Reinsurers”) in existence at the time the NICO Cover was executed (“Third Party Recoverables”). As a result, the Third Party Recoverables serve to protect the $2.5 billion limit of NICO coverage for the benefit of OneBeacon. OneBeacon estimates that on an incurred basis, net of Third Party Recoverables, as of March 31, 2007 it has used approximately $2.1 billion of the coverage provided by NICO. Approximately $878 million of these incurred losses have been paid by NICO through March 31, 2007. Since entering into the NICO Cover, $29.7 million of the $2.1 billion of utilized coverage from NICO related to uncollectible Third Party Recoverables. To the extent that actual experience differs from OneBeacon’s estimate of ultimate A&E losses and Third Party Recoverables, future losses could utilize some or all of the protection remaining under the NICO Cover.

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

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NOTE 6. Investment Securities

OneBeacon’s net investment income is comprised primarily of interest income associated with OneBeacon’s fixed maturity investments, dividend income from its equity investments and interest income from its short-term investments. Net investment income for the three months ended March 31, 2006 and 2007 consisted of the following:

 

The composition of net realized investment gains consisted of the following:

 

The components of OneBeacon’s ending net unrealized investment gains and losses on its investment portfolio were as follows:

 

(1)             Does not include deferred gains and losses on sales of investments between OneBeacon and entities under White Mountains’ common control of $18.7 million and $18.0 million, after-tax, as of December 31, 2006 and March 31, 2007, respectively.

In connection with the initial public offering, two irrevocable grantor trusts were established to economically defease the Company’s mandatorily redeemable preferred stock.  The assets of each trust are soley dedicated to payments of dividends and redemption amounts on the mandatorily redeemable preferred stock.  The assets held in the trusts include fixed maturity and short-term investments which are classified and accounted for as held-to-maturity.  Refer to the Company’s 2006 Annual Report on Form 10-K for a complete discussion of the economic defeasance of the

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Company’s mandatorily redeemable preferred stock. The carrying value, gross unrealized investment gains and losses, and estimated market values of OneBeacon’s fixed maturity held-to-maturity investments, carried at amortized cost, as of December 31, 2006 and March 31, 2007 were as follows:

		December 31, 2006
		Carrying Value			Gross unrealized gains			Gross unrealized losses			Net foreign currency gains			Estimated Market Value
		($ in millions)
U.S. Government obligations		$	305.0		$	—		$	(1.0	)	$	—		$	304.0
Total fixed maturity investments		$	305.0		$	—		$	(1.0	)	$	—		$	304.0

 

		March 31, 2007
		Carrying Value			Gross unrealized gains			Gross unrealized losses			Net foreign currency gains			Estimated Market Value
		($ in millions)
U.S. Government obligations		$	308.4		$	—		$	(0.5	)	$	—		$	307.9
Total fixed maturity investments		$	308.4		$	—		$	(0.5	)	$	—		$	307.9

 

The cost or amortized cost, gross unrealized investment gains and losses, and carrying values of OneBeacon’s fixed maturity available-for-sale investments as of December 31, 2006 and March 31, 2007, were as follows:

		December 31, 2006
		Cost or amortized cost			Gross unrealized gains			Gross unrealized losses			Net foreign currency gains			Carrying value
		($ in millions)
U.S. Government obligations		$	806.7		$	1.8		$	(4.2	)	$	—		$	804.3
Debt securities issued by industrial corporations		1,429.6			8.2			(8.4		)	10.7			1,440.1
Municipal obligations		8.2			0.4			—			—			8.6
Asset-backed securities		1,091.4			9.4			(3.7		)	—			1,097.1
Foreign government obligations		54.7			—			(0.6		)	—			54.1
Preferred stocks		110.9			17.1			(0.4		)	7.9			135.5
Total fixed maturity investments		$	3,501.5		$	36.9		$	(17.3	)	$	18.6		$	3,539.7

 

		March 31, 2007
		Cost or amortized cost			Gross unrealized gains			Gross unrealized losses			Net foreign currency gains			Carrying value
		($ in millions)
U.S. Government obligations		$	588.4		$	6.5		$	(1.6	)	$	—		$	593.3
Debt securities issued by industrial corporations		1,482.3			7.9			(5.9		)	12.7			1,497.0
Municipal obligations		8.2			0.4			—			—			8.6
Asset-backed securities		1,154.9			12.3			(1.7		)	—			1,165.5
Foreign government obligations		41.6			0.2			(0.4		)	—			41.4
Preferred stocks		110.9			13.0			(0.4		)	7.9			131.4
Total fixed maturity investments		$	3,386.3		$	40.3		$	(10.0	)	$	20.6		$	3,437.2

 

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The cost or amortized cost, gross unrealized investment gains and losses, and carrying values of OneBeacon’s common equity securities and other investments as of December 31, 2006 and March 31, 2007, were as follows:

		December 31, 2006
		Cost or amortized cost			Gross unrealized gains			Gross unrealized losses			Net foreign currency losses			Carrying value
		($ in millions)
Common equity securities		$	568.9		$	169.2		$	(0.9	)	$	(0.1	)	$	737.1
Other investments		$	229.5		$	49.2		$	(0.6	)	$	—		$	278.1

 

		March 31, 2007
		Cost or amortized cost			Gross unrealized gains			Gross unrealized losses			Net foreign currency gains			Carrying value
		($ in millions)
Common equity securities		$	575.5		$	166.7		$	(2.9	)	$	—		$	739.3
Other investments		$	232.2		$	55.7		$	(0.6	)	$	—		$	287.3

 

Impairment

Temporary losses on investment securities are recorded as unrealized losses. Temporary losses do not impact net income and earnings per share but serve to reduce comprehensive net income and common shareholders’ equity. Unrealized losses subsequently identified as other-than-temporary impairments are recorded as realized losses. Other-than-temporary impairments previously recorded as unrealized losses do not impact comprehensive net income and common shareholders’ equity but serve to reduce net income and earnings per share.

OneBeacon’s methodology of assessing other-than-temporary impairments is based on security-specific facts and circumstances as of the balance sheet date. As a result, subsequent adverse changes in an issuers’ credit quality or subsequent weakening of market conditions that differ from expectations could result in additional other-than-temporary impairments. In addition, the sale of a fixed maturity security with a previously recorded unrealized loss would result in a realized loss. Either of these situations would adversely impact net income and earnings per share but would not impact comprehensive net income and common shareholders’ equity.

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The following table presents an analysis of the continuous periods during which OneBeacon has held investment positions which were carried at an unrealized loss as of March 31, 2007 (excluding short-term investments):

		March 31, 2007
		0-6 Months			6-12 Months			> 12 Months			Total
		(in millions)
Fixed maturity investments:
Number of positions		44			4			113			161
Market value		$	463.3		$	23.1		$	612.6		$	1,099.0
Amortized cost		$	464.8		$	23.2		$	621.0		$	1,109.0
Unrealized loss		$	(1.5	)	$	(0.1	)	$	(8.4	)	$	(10.0	)
Common equity securities:
Number of positions		13			—			—			13
Market value		$	66.0		$	—		$	—		$	66.0
Amortized cost		$	68.9		$	—		$	—		$	68.9
Unrealized loss		$	(2.9	)	$	—		$	—		$	(2.9	)
Other investments:
Number of positions		2			—			2			4
Market value		$	6.8		$	—		$	3.9		$	10.7
Amortized cost		$	7.0		$	—		$	4.3		$	11.3
Unrealized loss		$	(0.2	)	$	—		$	(0.4	)	$	(0.6	)
Total:
Number of positions		59			4			115			178
Market value		$	536.1		$	23.1		$	616.5		$	1,175.7
Amortized cost		$	540.7		$	23.2		$	625.3		$	1,189.2
Unrealized loss		$	(4.6	)	$	(0.1	)	$	(8.8	)	$	(13.5	)
% of total gross unrealized losses		34		%	1		%	65		%	100		%

 

During the three months ended March 31, 2006 and 2007, OneBeacon did not recognize any material pre-tax other-than-temporary impairment charges. OneBeacon believes that the gross unrealized losses relating to its fixed maturity investments at March 31, 2007 resulted primarily from increases in market interest rates from the dates that certain investments within that portfolio were acquired as opposed to fundamental changes in the credit quality of the issuers of such securities. OneBeacon views these decreases in value as being temporary because it has the intent and ability to retain such investments until recovery. However, should OneBeacon determine that it no longer has the intent and ability to hold a fixed maturity investment that has an existing unrealized loss resulting from an increase in market interest rates until it recovers, this loss would be realized through the income statement at the time such determination is made. OneBeacon also believes that the gross unrealized losses recorded on its common equity securities and its other investments at March 31, 2007 resulted primarily from decreases in quoted market values from the dates that certain investments securities within that portfolio were acquired as opposed to fundamental changes in the issuer’s financial performance and near term financial prospects. Therefore, these decreases are also viewed as being temporary. However, due to the inherent risk involved in investing in the equity markets, it is possible that the decrease in market value of these investments may ultimately prove to be other than temporary. At March 31, 2007, OneBeacon’s investment portfolio did not include any individual investment securities with an after-tax unrealized loss of more than $2.0 million for more than a six-month period.

NOTE 7. Segment Information

OneBeacon’s segments consist of the following: (1) Primary Insurance Operations, (2) Affiliate Quota Shares and (3) Other Operations. OneBeacon has made its segment determination based on consideration of the following criteria: (i) the nature of the business activities of each of the Company’s subsidiaries and affiliates; (ii) the manner in which the Company’s subsidiaries and affiliates are organized; (iii) the existence of primary

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managers responsible for specific subsidiaries and affiliates; and (iv) the organization of information provided to the Board of Directors. Significant intercompany transactions among OneBeacon’s segments have been eliminated herein. Financial information for OneBeacon’s segments follows:

		Primary Insurance Operations			Affiliate Quota Shares(1)			Other Operations			Total
		($ in millions)
Three months ended March 31, 2006
Earned premiums		$	480.1		$	26.7		$	—		$	506.8
Net investment income		43.3			—			2.9			46.2
Net realized investment gains (losses)		28.2			—			(0.2		)	28.0
Net other revenues		2.3			—			3.2			5.5
Total revenues		553.9			26.7			5.9			586.5
Loss and LAE		303.7			34.0			—			337.7
Policy acquisition expenses		86.4			1.1			—			87.5
Other underwriting expenses		83.9			—			—			83.9
General and administrative expenses		0.7			—			3.9			4.6
Accretion of fair value adjustment to loss and LAE reserves		—			—			5.7			5.7
Interest expense on debt		0.6			—			10.7			11.3
Interest expense-on preferred stock subject to mandatory redemption		—			—			14.0			14.0
Total expenses		475.3			35.1			34.3			544.7
Pre-tax income (loss)		$	78.6		$	(8.4	)	$	(28.4	)	$	41.8
Three months ended March 31, 2007
Earned premiums		468.9			$	—		$	—		$	468.9
Net investment income		45.7			—			4.9			50.6
Net realized investment gains (losses)		54.9			—			—			54.9
Net other revenues		3.3			—			(0.2		)	3.1
Total revenues		572.8			—			4.7			577.5
Loss and LAE		288.2			—			—			$	288.2
Policy acquisition expenses		78.3			—			—			78.3
Other underwriting expenses		90.9			—			—			90.9
General and administrative expenses		—			—			2.4			2.4
Accretion of fair value adjustment to loss and LAE reserves		—			—			4.0			4.0
Interest expense on debt		0.9			—			10.5			11.4
Interest expense-on preferred stock subject to mandatory redemption		—			—			15.8			15.8
Total expenses		458.3			—			32.7			491.0
Pre-tax income (loss)		$	114.5		$	—		$	(28.0	)	$	86.5
December 31, 2006
Total investments		$	4,806.9		$	—		$	405.8		$	5,212.7
Reinsurance recoverable on paid and unpaid losses		3,112.1			—			(237.1		)	2,875.0
Total assets		9,729.2			—			140.2			9,869.4
Loss and LAE reserves		5,108.2			—			(270.5		)	4,837.7
Total liabilities		7,382.3			—			709.9			8,092.2
Total equity		2,346.9			—			(569.7		)	1,777.2
March 31, 2007
Total investments		$	4,657.9		$	—		$	468.2		$	5,126.1
Reinsurance recoverable on paid and unpaid losses		3,074.1			—			(233.1		)	2,841.0
Total assets		9,390.7			—			228.3			9,619.0
Loss and LAE reserves		5,036.4			—			(262.5		)	4,773.9
Total liabilities		7,012.9			—			780.4			7,793.3
Total equity		2,377.8			—			(552.1		)	1,825.7

(1)             The affiliate quota share agreements were commuted during the fourth quarter of 2006.

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The following tables provide net written premiums and earned insurance premiums for OneBeacon’s Primary Insurance Operations by major underwriting unit and in total for the three months ended March 31, 2006 and 2007:

				Specialty			Commercial					Personal					Total(1)
		($ in millions)
Three months ended March 31, 2006
Net written premiums		$	102.0				$	166.8		$	202.4				$	474.4
Earned premiums		102.0					165.3			209.5					480.1
Three months ended March 31, 2007
Net written premiums		$	96.8				$	170.6		$	172.8				$	440.3
Earned premiums		107.0					172.0			189.8					468.9

(1)       Includes results from run-off.

 

NOTE 8. Investment in Unconsolidated Affiliate

OneBeacon’s investments in unconsolidated affiliate represent operating investments in other companies in which OneBeacon has a significant voting and economic interest but does not control the entity.

On October 31, 2006, OneBeacon’s investment in MSA was restructured. OneBeacon received a $70 million cash dividend from MSA following which OneBeacon sold its 50% common stock investment in MSA to Main Street America Group, Inc. (“the MSA Group”) for (i) $70.0 million in 9.0% non-voting cumulative perpetual preferred stock of the MSA Group and (ii) 4.9% of the common stock of the MSA Group. (See “Note 3—Acquisitions and Dispositions”). Effective October 31, 2006, OneBeacon accounts for its remaining investment in the MSA Group in accordance with SFAS 115. Prior to the sale, OneBeacon owned 50% of the total common shares outstanding of MSA and accounted for this investment using the equity method of accounting. These transactions resulted in a net after-tax realized gain of $8.5 million.

Prior to the exchange of our common stock investment in MSA, we accounted for this investment using the equity method of accounting. For the three months ended March 31, 2006, the after-tax equity in earnings from MSA common stock and unrealized investment losses was $2.2 million and $(1.2) million, respectively.

NOTE 9. Retirement and Postretirement Plans

The components of net periodic benefit costs for the three months ended March 31, 2006 and 2007 were as follows:

		Three months ended March 31,
		2006			2007
		($ in millions)
Service cost		$	0.3		$	0.5
Interest cost		6.9			6.6
Expected return on plan assets		(7.6		)	(6.8		)
Amortization of unrecognized loss		—			0.1
Net periodic pension cost before settlements, curtailments and special termination benefits		(0.4		)	0.4
Special termination benefits expense(1)		1.2			—
Net periodic benefit cost		$	0.8		$	0.4

(1)             Special termination benefits are payments made from the pension plan when a vested participant terminates employment due to a reduction in force.

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The Company anticipates contributing $2.9 million to the pension plans for 2007. As of March 31, 2007, $1.0 million in contributions have been made. All of OneBeacon’s year to date and expected pension contributions in 2007 relate to non-qualified pension plans, for which OneBeacon has established assets held in rabbi trusts.

NOTE 10.  Employee Share-Based Incentive Compensation Plans

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

In December 2004, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-Based Payment” (“SFAS 123R”), which is a revision to SFAS No. 123, “Accounting for Stock Based Compensation” (“SFAS 123”) and supersedes Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees” (“APB 25”). Effective January 1, 2006, OneBeacon adopted SFAS 123R to account for its share-based compensation under the modified prospective method of adoption. Under this method of adoption, SFAS 123R applies to new grants of share-based awards, awards modified after the effective date and the remaining portion of the fair value of the unvested awards at the adoption date. The unvested portion of OneBeacon performance share awards, as well as new awards, such as the stock options granted in connection with the initial public offering, are subject to the fair value measurement and recognition requirements of SFAS 123R.

Prior to adoption of SFAS 123R, OneBeacon accounted for its share-based compensation plans under the recognition and measurement principles of APB 25, and related interpretations, and the disclosure provisions of SFAS 123. The accounting treatment for OneBeacon’s performance share awards under APB 25 was identical to the method prescribed by SFAS 123, whereby the liability for performance share awards was measured each period based upon the current market price of the underlying common shares. Under APB 25, the liability for the compensation cost for performance share awards was measured each period based upon the current market price of the underlying common shares. Forfeitures were recognized as they occurred. Upon adoption of SFAS 123R an estimate of future forfeitures was incorporated into the determination of the compensation cost for performance shares. The effect of this change was immaterial.

Performance Shares

Prior to February 2007, the value of OneBeacon’s performance shares was based upon the market price of an underlying White Mountains common share (“WTM Performance Shares”).  In February 2007, all of OneBeacon’s WTM Performance Shares outstanding were replaced with performance shares whose value is based upon the market price of an underlying OneBeacon common share (“OB Performance Shares”).

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