The following discussion contains "forward-looking statements." Statements that
are not historical in nature are forward-looking statements. OB Holdings cannot
promise that its expectations in such forward-looking statements will turn out
to be correct. OB Holdings' actual results could be materially different from
and worse than its expectations. See "Forward-Looking Statements" on page 56 for
specific important factors that could cause actual results to differ materially
from those contained in forward-looking statements.
Significant Transactions
AutoOne. On February 22, 2012, OBIG and certain of its subsidiaries completed
the sale of AutoOne Insurance business (AutoOne) to Interboro Holdings, Inc.
(Interboro) (the AutoOne Transaction). AutoOne offered products and services to
assigned risk markets primarily in New York and New Jersey. AutoOne had been
included within the Other Insurance Operations segment, however, as a result of
the AutoOne Transaction, AutoOne has been presented as discontinued operations
in the statements of operations through closing with the prior periods
reclassified to conform to the current presentation. Pursuant to the terms of
the AutoOne Transaction, at closing we transferred to Interboro all of the
issued and outstanding shares of common stock of AutoOne Insurance Company
(AOIC) and AutoOne Select Insurance Company (AOSIC), through which substantially
all of the AutoOne business was written on a direct basis. At closing, we also
transferred the assets, liabilities (including loss reserves and unearned
premiums) and capital of the business as well as substantially all of the
AutoOne infrastructure including systems and office space as well as certain
staff. The closing balance sheet is subject to post-closing adjustments. The
AutoOne Transaction also included the execution of a reinsurance agreement with
certain subsidiaries of the Company pursuant to which OneBeacon cedes, on a 100%
quota share basis, AutoOne business not directly written by AOIC and AOSIC.
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Results of Operations
Review of Consolidated Results
A summary of our consolidated financial results for the three and six months
ended June 30, 2012 and 2011 is as follows:
Three months ended Six months ended
June 30, June 30,
2012 2011 2012 2011
($ in millions)
Net written premiums $ 293.4 $ 265.6 $ 597.0 $ 525.5
Revenues
Earned premiums $ 282.0 $ 247.5 $ 554.8 $ 492.6
Net investment income 12.9 17.8 26.5 37.5
Net realized and unrealized
investment (losses) gains (10.6 ) 9.9 17.5 31.8
Net other revenues (expenses) 0.2 (11.4 ) 0.3 (10.6 )
Total revenues 284.5 263.8 599.1 551.3
Expenses
Loss and LAE 152.5 137.9 301.8 268.3
Policy acquisition expenses 60.1 53.5 117.5 102.5
Other underwriting expenses 52.0 44.1 100.8 93.4
General and administrative
expenses 1.2 0.8 2.2 2.0
Interest expense on debt 4.0 6.2 8.1 12.5
Total expenses 269.8 242.5 530.4 478.7
Pre-tax income from continuing
operations 14.7 21.3 68.7 72.6
Income tax expense (5.3 ) (7.8 ) (23.6 ) (25.5 )
Net income from continuing
operations 9.4 13.5 45.1 47.1
Loss from discontinued
operations, net of tax - (1.2 ) (0.1 ) (1.9 )
Net income including
noncontrolling interests 9.4 12.3 45.0 45.2
Less: Net income attributable to
noncontrolling interests (0.2 ) (0.5 ) (0.8 ) (0.9 )
Net income attributable to OB
Holdings' common shareholder 9.2 11.8 44.2 44.3
Change in other comprehensive
income and loss items 0.1 - 0.3 0.1
Comprehensive income
attributable to OB Holdings'
common shareholder $ 9.3 $ 11.8 $ 44.5 $ 44.4
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The following table provides ratios of our consolidated underwriting results for
the three and six months ended
June 30, 2012 and 2011:
Three months ended Six months ended
June 30, June 30,
2012 2011 2012 2011
Ratios:(1)(2)(3)(4)
Loss and LAE 54.1 % 55.7 % 54.4 % 54.5 %
Expense 39.8 39.4 39.3 39.8
GAAP combined 93.9 % 95.1 % 93.7 % 94.3 %
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(1) Certain amounts in the prior period financial statements have been
reclassified to conform to the current presentation.
(2) Includes our long-term incentive compensation expense. For the
three months ended June 30, 2012 and 2011, long-term incentive compensation
expense increased our total combined ratio by 1.1 points and 1.9 points,
respectively. For the six months ended June 30, 2012 and 2011, long-term
incentive compensation expense increased our total combined ratio by 1.5 points
and 1.8 points, respectively.
(3) Includes loss and LAE relating to catastrophes. For the three
months ended June 30, 2012 and 2011, total calendar year incurred loss and LAE
relating to catastrophes increased our loss and LAE and total combined ratios by
2.0 points and 5.5 points, respectively. Development on prior accident year
catastrophes had no impact on our loss and LAE and total combined ratios. For
the six months ended June 30, 2012 and 2011, total calendar year incurred loss
and LAE relating to catastrophes increased our loss and LAE and total combined
ratios by 1.7 points and 4.9 points, respectively, including development on
prior accident year catastrophes which increased our loss and LAE and total
combined ratios by 0.2 points and 0.6 points, respectively.
(4) Prior accident year development, including development on
catastrophes, for the three months ended June 30, 2012 and 2011 decreased our
loss and LAE and total combined ratios by 1.1 points and 4.1 points,
respectively. Prior accident year development, including development on
catastrophes, for the six months ended June 30, 2012 and 2011 increased
(decreased) our loss and LAE and total combined ratios by 1.3 points and (3.1)
points, respectively.
Consolidated Results-Three months ended June 30, 2012 versus three months ended
June 30, 2011
Our comprehensive income attributable to OB Holdings' common shareholder was
$9.3 million in the three months ended June 30, 2012, compared to $11.8 million
in the three months ended June 30, 2011. Net income attributable to OB Holdings'
common shareholder was $9.2 million in the three months ended June 30, 2012,
compared to $11.8 million in the three months ended June 30, 2011.
Our total revenues increased 7.8% to $284.5 million in the three months ended
June 30, 2012, compared to $263.8 million in the three months ended June 30,
2011. The increase included a 13.9% increase in earned premiums related to
several of our specialty businesses as described below. Net realized and
unrealized investment (losses) gains decreased $20.5 million to $(10.6) million,
compared to $9.9 million in the three months ended June 30, 2011. Net investment
income decreased 27.5% to $12.9 million in the three months ended June 30, 2012
due to an 11.6% decline in average invested assets. The decline in average
invested assets since June 30, 2011 was driven by the AutoOne Transaction,
repurchases of debt and the run-off of reserves related to the commercial lines
business which was exited via a renewal rights sale. Net other revenues
(expenses) increased to $0.2 million in the three months ended June 30, 2012,
compared to $(11.4) million in the three months ended June 30, 2011. During the
three months ended June 30, 2011, we repurchased and retired $150.0 million
aggregate principal of senior notes as a result of a cash tender offer,
resulting in a $12.0 million loss.
Our total expenses increased 11.3% in the three months ended June 30, 2012 to
$269.8 million, compared to $242.5 million in the three months ended June 30,
2011. Loss and LAE increased 10.6% to $152.5 million in the three months ended
June 30, 2012, in line with the growth in our specialty businesses and also due
to lower favorable loss reserve development. Policy acquisition expenses
increased 12.3% to $60.1 million related to higher commission expense on
increased premium volumes as well as lower deferrals under revised accounting
guidance and amortization of previously deferred costs. Other underwriting
expenses increased 17.9% to $52.0 million in the three months ended June 30,
2012 primarily reflective of costs to support the growth in our specialty
businesses. Interest expense decreased 35.5% to $4.0 million in the three months
ended June 30, 2012 reflective of actions taken to reduce outstanding debt.
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Our income tax expense related to pre-tax income from continuing operations for
the three months ended June 30, 2012 and 2011 represented net effective tax
rates of 36.1% and 36.6%, respectively. The effective tax rates for the three
months ended June 30, 2012 and 2011 were higher than the U.S. statutory rate of
35% due to state income taxes and an increase in the valuation allowance for an
insurance reciprocal, partially offset by tax exempt income, dividends received
deduction and a low income housing tax credit. In arriving at the effective tax
rate for the three months ended June 30, 2012 and 2011, we forecasted changes in
realized and unrealized investment gains or losses for the years ending
December 31, 2012 and 2011, respectively, and included these gains or losses in
the effective tax rate calculation pursuant to ASC 740-270.
Our GAAP combined ratio for the three months ended June 30, 2012 improved to
93.9% from 95.1% for the three months ended June 30, 2011. The loss and LAE
ratio decreased by 1.6 points to 54.1% while the expense ratio increased by 0.4
points to 39.8%. The decrease in the loss and LAE ratio was primarily due to
lower current accident year catastrophe and non-catastrophe losses, partially
offset by lower favorable loss reserve development. The three months ended
June 30, 2012 included $5.7 million or 2.0 points of current accident year
catastrophe losses, as compared to $13.7 million or 5.5 points of current
accident year catastrophe losses in the three months ended June 30, 2011. The
three months ended June 30, 2012 included $3.3 million or 1.1 points of
favorable loss reserve development, as compared to $10.1 million or 4.1 points
of favorable loss reserve development in the three months ended June 30, 2011.
The favorable loss reserve development was primarily due to lower than expected
severity on non-catastrophe losses related to professional liability lines,
multiple peril liability lines and other general liability lines. The expense
ratio increased primarily due to other underwriting expenses related to higher
employee costs resulting from actions taken to migrate corporate functions to
corporate headquarters in Minnesota, partially offset by a slight decrease in
policy acquisition expenses.
Consolidated Results-Six months ended June 30, 2012 versus six months ended
June 30, 2011
Our comprehensive income attributable to OB Holdings' common shareholder was
$44.5 million in the six months ended June 30, 2012, compared to $44.4 million
in the six months ended June 30, 2011. Net income attributable to OB Holdings'
common shareholder was $44.2 million in the six months ended June 30, 2012,
compared to $44.3 million in the six months ended June 30, 2011.
Our total revenues increased 8.7% to $599.1 million in the six months ended
June 30, 2012, compared to $551.3 million in the six months ended June 30, 2011.
The increase was mainly due to a 12.6% increase in earned premiums related to
several of our specialty businesses as described below. Net realized and
unrealized investment gains decreased $14.3 million to $17.5 million, compared
to $31.8 million in the six months ended June 30, 2011. Net investment income
decreased 29.3% to $26.5 million in the six months ended June 30, 2011 due to an
11.1% decline in average invested assets. The decline in average invested assets
since June 30, 2012 was driven by the AutoOne Transaction, repurchases of debt
and the run-off of reserves related to the commercial lines business that was
exited via a renewal rights sale. Net other revenues (expenses) increased $10.9
million to $0.3 million in the six months ended June 30, 2012, compared to
$(10.6) million in the six months ended June 30, 2011. The six months ended
June 30, 2011 included a $12.0 million loss related to the purchase of a portion
of our senior notes, partially offset by $0.8 million in additional
consideration for aggregate premium renewals exceeding $200 million related to
the renewal rights agreement for our commercial lines business.
Our total expenses increased 10.8% in the six months ended June 30, 2012 to
$530.4 million, compared to $478.7 million in the six months ended June 30,
2011. Loss and LAE increased 12.5% to $301.8 million in the six months ended
June 30, 2012 in line with the growth in our specialty businesses and also due
to unfavorable loss reserve development. The unfavorable loss reserve
development was driven by case incurred development on a small number of run-off
claims related to multiple peril liability lines and general liability lines and
also the impact of an adverse court ruling in Mississippi regarding a disputed
assessment from an involuntary pool for hurricane Katrina claims. Policy
acquisition expenses increased 14.6% to $117.5 million related to higher
commission expense on increased premium volumes as well as lower deferrals under
revised accounting guidance and amortization of previously deferred costs. Other
underwriting expenses increased 7.9% to $100.8 million in the six months ended
June 30, 2012 primarily reflective of costs to support the growth in our
specialty businesses. Interest expense decreased 35.2% to $8.1 million in the
six months ended June 30, 2012 reflective of actions taken to reduce outstanding
debt.
Our income tax expense related to pre-tax income from continuing operations for
the six months ended June 30, 2012 and 2011 represented net effective tax rates
of 34.4% and 35.1%, respectively. The effective tax rate for the six months
ended June 30, 2012 was lower than the U.S. statutory rate of 35% due to tax
exempt interest, dividends received deduction and a low income housing tax
credit, partially offset by an increase in the valuation allowance for an
insurance reciprocal. The effective tax rate for the six months ended June 30,
2011 was higher than the U.S. statutory rate of 35% due to state income taxes
and an increase in the valuation allowance for an insurance reciprocal,
partially offset by tax exempt income, dividends received deduction and a low
income housing tax credit. In arriving at the effective tax rate for the six
months ended June 30, 2012 and 2011, we forecasted changes in realized and
unrealized investment gains or losses for the years ending December 31, 2012 and
2011, respectively, and included these gains or losses in the effective tax rate
calculation pursuant to ASC 740-270.
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Our GAAP combined ratio for the six months ended June 30, 2012 improved to 93.7%
from 94.3% for the six months ended June 30, 2011. The loss and LAE ratio
decreased by 0.1 point to 54.4% while the expense ratio decreased by 0.5 points
to 39.3%. The decrease in the loss and LAE ratio was primarily due to a decrease
in current accident year catastrophe and non-catastrophe losses, almost entirely
offset by unfavorable loss reserve development. The six months ended June 30,
2012 included $8.2 million or 1.5 points of current accident year catastrophe
losses, as compared to $21.0 million or 4.3 points of current accident year
catastrophe losses in the six months ended June 30, 2011. The six months ended
June 30, 2012 included $7.2 million or 1.3 points of unfavorable loss reserve
development primarily driven by case incurred development on a small number of
run-off claims related to multiple peril liability lines and general liability
lines and also the impact of an adverse court ruling in Mississippi regarding a
disputed assessment from an involuntary pool for hurricane Katrina claims,
partially offset by favorable loss reserve development within Specialty
Insurance Operations. The six months ended June 30, 2011 included $15.2 million
or 3.1 points of favorable loss reserve development primarily due to lower than
expected severity on non-catastrophe losses related to professional liability
lines, multiple peril liability lines and other general liability lines. The
expense ratio decreased primarily due to higher other underwriting expenses on a
higher earned premium base, partially offset by a slight increase in policy
acquisition expenses.
Summary of Operations By Segment
Specialty Insurance Operations is comprised of a number of underwriting units
that are aggregated into three major underwriting units: MGA Business, Specialty
Industries and Specialty Products. Other Insurance Operations includes the
non-specialty commercial lines business and traditional personal lines business,
other run-off business and certain purchase accounting adjustments relating to
our acquisition by White Mountains in 2001. Investing, Financing and Corporate
Operations includes the investing and financing activities for OB Holdings on a
consolidated basis, and certain other activities conducted through the Company.
The prior periods have been reclassified to conform to the current presentation.
Our segment information is presented in Note 7-"Segment Information" of the
accompanying consolidated financial statements.
Specialty Insurance Operations
Financial results for our Specialty Insurance Operations segment for the three
and six months ended June 30, 2012
and 2011 are as follows:
Three months ended Six months ended
June 30, June 30,
2012 2011 2012 2011
($ in millions)
Net written premiums $ 292.1 $ 266.0 $ 595.2 $ 524.3
Earned premiums $ 280.3 $ 246.9 $ 552.1 $ 488.8
Loss and LAE (151.4 ) (139.0 ) (287.9 ) (271.6 )
Policy acquisition expenses (60.8 ) (53.5 ) (119.0 ) (102.7 )
Other underwriting expenses (51.3 ) (42.0 ) (98.7 ) (88.4 )
Total underwriting income 16.8 12.4 46.5 26.1
Net other revenues 0.1 0.1 0.2 0.2
General and administrative expenses (0.5 ) (0.4 ) (0.8 ) (0.9 )
Pre-tax income from continuing operations $ 16.4$ 12.1$ 45.9$ 25.4
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The following table provides net written premiums, earned premiums and
underwriting ratios by major underwriting unit and Specialty Insurance
Operations in total for the three and six months ended June 30, 2012 and 2011:
Specialty
MGA Specialty Specialty Insurance
($ in millions) Business Industries Products Operations
Three months ended June 30, 2012
Net written premiums $ 79.0 $ 120.9 $ 92.2 $ 292.1
Earned premiums 76.2 103.6 100.5 280.3
Ratios:(1)(2)(3)
Loss and LAE 51.3 % 49.4 % 60.8 % 54.0 %
Expense 44.4 38.4 38.3 40.0
GAAP combined 95.7 % 87.8 % 99.1 % 94.0 %
Three months ended June 30, 2011
Net written premiums $ 71.7 $ 102.9 $ 91.4 $ 266.0
Earned premiums 68.3 83.7 94.9 246.9
Ratios:(1)(2)(3)
Loss and LAE 53.3 % 50.9 % 63.2 % 56.3 %
Expense 41.6 40.4 35.1 38.7
GAAP combined 94.9 % 91.3 % 98.3 % 95.0 %
Six months ended June 30, 2012
Net written premiums $ 134.7 $ 231.2 $ 229.3 $ 595.2
Earned premiums 149.1 202.3 200.7 552.1
Ratios:(1)(2)(3)
Loss and LAE 47.0 % 49.8 % 58.3 % 52.1 %
Expense 44.3 38.3 36.9 39.4
GAAP combined 91.3 % 88.1 % 95.2 % 91.5 %
Six months ended June 30, 2011
Net written premiums $ 120.2 $ 188.5 $ 215.6 $ 524.3
Earned premiums 134.3 164.6 189.9 488.8
Ratios:(1)(2)(3)
Loss and LAE 49.4 % 53.9 % 61.4 % 55.6 %
Expense 41.8 41.4 35.2 39.1
GAAP combined 91.2 % 95.3 % 96.6 % 94.7 %
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(1) Includes our long-term incentive compensation expense.
For
the three months ended June 30, 2012 and 2011, long-term incentive compensation
expense increased our Specialty Insurance Operations combined ratio by 1.1
points and 1.9 points, respectively. For the six months ended June 30, 2012 and
2011, long-term incentive compensation expense increased our Specialty Insurance
Operations combined ratio by 1.5 points and 1.7 points, respectively.
(2) Includes loss and LAE relating to catastrophes. For
the
three months ended June 30, 2012 and 2011, total calendar year incurred loss and
LAE relating to catastrophes increased our Specialty Insurance Operations loss
and LAE and total combined ratios by 1.8 points and 5.5 points, respectively,
including development on prior accident year catastrophes which decreased our
Specialty Insurance Operations loss and LAE and total combined ratios by 0.2
points and 0, respectively. For the six months ended June 30, 2012 and 2011,
total calendar year incurred loss and LAE relating to catastrophes increased our
Specialty Insurance Operations loss and LAE and total combined ratios by 1.6
points and 4.6 points, respectively, including development on prior accident
year catastrophes which increased our Specialty Insurance Operations loss and
LAE and total combined ratios by 0.1 points and 0.3 points, respectively.
(3) Prior accident year development, including development
on
catastrophes, for the three months ended June 30, 2012 and 2011 decreased our
Specialty Insurance Operations loss and LAE and total combined ratios by 1.2
points and 2.8 points, respectively. Prior accident year development, including
development on catastrophes, for the six months ended June 30, 2012 and 2011
decreased our Specialty Insurance Operations loss and LAE and total combined
ratios by 1.0 points and 1.7 points, respectively.
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Specialty Insurance Operations-Three months ended June 30, 2012 versus three
months ended June 30, 2011
Overview. We reported a GAAP combined ratio of 94.0% for the three months ended
June 30, 2012, compared to 95.0% for the three months ended June 30, 2011. The
decrease in our combined ratio reflects lower current accident year catastrophe
losses, partially offset by lower favorable loss reserve development and higher
other underwriting expenses.
MGA Business. Net written premiums for MGA Business increased 10.2% to
$79.0 million in the three months ended June 30, 2012 from $71.7 million in the
three months ended June 30, 2011. The increase compared to the prior year period
was primarily due to a $4.7 million increase in net written premiums from our
collector cars and boats business driven by growth in new business, a $1.6
million increase in net written premiums from OneBeacon Entertainment (OBE)
related to growth in new business and a $1.0 million increase in net written
premiums from A.W.G. Dewar (Dewar) as compared to the prior year period.
The MGA Business combined ratio for the three months ended June 30, 2012
increased to 95.7% from 94.9% for the three months ended June 30, 2011. The loss
and LAE ratio decreased by 2.0 points to 51.3%, while the expense ratio
increased by 2.8 points to 44.4%. The decrease in the loss and LAE ratio
reflects a 2.3 point decrease in current accident year catastrophe and
non-catastrophe losses as compared to the prior year period. The three months
ended June 30, 2012 includes 0.4 points of current accident year catastrophe
losses, primarily related to spring windstorms which impacted our collector cars
and boats business, as compared to 2.0 points in the three months ended June 30,
2011, primarily related to tornados in the southeastern and midwestern United
States which impacted our collector cars and boats business. The three months
ended June 30, 2012 included 1.3 points of unfavorable loss reserve development
primarily related to our collector cars and boats business, compared to 1.0
point of unfavorable loss reserve development primarily related to OBE. The
increase in the expense ratio was driven by higher other underwriting expenses
relating to employee costs associated with the newly formed OneBeacon Program
Group, partially offset by lower policy acquisition expenses despite higher
policy acquisition expenses related to lower deferrals under revised accounting
guidance and amortization of $2.0 million of previously deferred costs that are
no longer eligible for deferral, principally within our collector cars and boats
business.
Specialty Industries. Net written premiums for Specialty Industries increased
17.5% to $120.9 million in the three months ended June 30, 2012 from $102.9
million in the three months ended June 30, 2011. The increase compared to the
prior year period was due to an $8.3 million increase in net written premiums
from OneBeacon Technology Insurance (OBTI), a $4.2 million increase in net
written premiums from OneBeacon Energy Group (OBEG), a $2.8 million increase in
net written premiums from OneBeacon Accident Group (OBA) and a $1.8 million
increase in net written premiums from OneBeacon Government Risks (OBGR),
partially offset by a $0.9 million decrease in net written premiums from
International Marine Underwriters (IMU). The increase was primarily due to new
business as well as solid retention levels despite competition in the
marketplace.
The Specialty Industries combined ratio for the three months ended June 30, 2012
decreased to 87.8% from 91.3% for the three months ended June 30, 2011. The loss
and LAE ratio decreased by 1.5 points to 49.4% while the expense ratio decreased
by 2.0 points to 38.4%. The decrease in the expense ratio reflects the impact of
higher policy acquisition expenses and other underwriting expenses over a higher
earned premium base. The decrease in the loss and LAE ratio was due to a 1.5
point decrease in current accident year losses, compared with the three months
ended June 30, 2011. The three months ended June 30, 2012 included 1.8 points of
current accident year catastrophes, primarily related to spring windstorms
impacting OBGR, as compared to 2.7 points of current accident year catastrophe
losses primarily related to tornados in southeastern and midwestern United
States which impacted OBTI and OBGR in the prior year period.
Specialty Products. Net written premiums for Specialty Products increased 0.9%
to $92.2 million in the three months ended June 30, 2012 from $91.4 million in
the three months ended June 30, 2011. The increase was primarily due to a $4.1
million increase in net written premiums from OneBeacon Specialty Property
(OBSP) driven by growth in new business and retention and $1.1 million increase
in net written premiums from OneBeacon Excess and Surplus (OBES) which we began
writing in 2011, partially offset by a $4.0 million decrease in net written
premiums from OneBeacon Property and Inland Marine (PIM) reflecting a revised
underwriting strategy. Net written premiums from OneBeacon Professional
Insurance (OBPI) were essentially flat.
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The Specialty Products combined ratio for the three months ended June 30, 2012
increased to 99.1% from 98.3% for the three months ended June 30, 2011. The loss
and LAE ratio decreased by 2.4 points to 60.8% while the expense ratio increased
by 3.2 points to 38.3%. The increase in the expense ratio was primarily due to
an increase in policy acquisition expenses mainly due to an assumed reinsurance
program and an increase in contingent commissions at OBPI, as well as other
underwriting expenses. The decrease in the loss and LAE ratio was primarily due
to a 6.7 point decrease in current accident year losses, compared with the three
months ended June 30, 2011. The three months ended June 30, 2012 included 3.5
points of current accident year catastrophe losses, primarily related to spring
windstorms impacting PIM and OBPI, compared to 10.3 points of current accident
year catastrophe losses primarily related to tornados in the southeastern and
midwestern United States impacting PIM and OBPI in the prior year period. This
was partially offset by lower favorable loss reserve development. The three
months ended June 30, 2012 included 0.2 points of favorable loss reserve
development, compared to 4.5 points of favorable loss reserve development
primarily related to professional liability in the prior year period.
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 the three months ended June 30, 2012, our net combined ratio was higher than
our gross combined ratio by 7.5 points, primarily due to the impact of favorable
development on a large loss that had been ceded under the marine reinsurance
treaty, and to a lesser extent the cost of facultative reinsurance, property
reinsurance and catastrophe reinsurance. For the three months ended June 30,
2011, our net combined ratio was higher than our gross combined ratio by 4.1
points, primarily due to the impact of the cost of property reinsurance and
catastrophe reinsurance, and to a lesser extent the cost of facultative
reinsurance and marine reinsurance.
Specialty Insurance Operations-Six months ended June 30, 2012 versus six months
ended June 30, 2011
Overview. We reported a GAAP combined ratio of 91.5% for the six months ended
June 30, 2012, compared to 94.7% for the six months ended June 30, 2011. The
decrease in our combined ratio was primarily due to lower current accident year
catastrophe and non-catastrophe losses and slightly lower other underwriting
expenses, partially offset by lower favorable loss reserve development and
higher policy acquisition expenses.
MGA Business. Net written premiums for MGA Business increased 12.1% to
$134.7 million in the six months ended June 30, 2012 from $120.2 million in the
six months ended June 30, 2011. The increase compared to the prior year period
was primarily due to an $8.3 million increase in net written premiums from our
collector cars and boats business driven by growth in new business as well as
retention, a $5.1 million increase in net written premiums from OBE related to
growth in new business and a $1.1 million increase in net written premiums from
Dewar.
The MGA Business combined ratio for the six months ended June 30, 2012 was
essentially flat at 91.3% compared to 91.2% for the six months ended June 30,
2011. The loss and LAE ratio decreased by 2.4 points to 47.0%, while the expense
ratio increased by 2.5 points to 44.3%. The decrease in the loss and LAE ratio
was primarily due to a decrease in unfavorable loss reserve development. The six
months ended June 30, 2012 included 1.1 point of unfavorable loss reserve
development related to our collector cars and boats business and OBE, compared
to 3.7 points of unfavorable loss reserve development related to OBE. The
increase in the expense ratio was driven primarily by employee costs associated
with the newly formed OneBeacon Program Group, as well as slightly higher policy
acquisition expenses which includes the impact of lower deferrals under revised
accounting guidance and amortization of $4.4 million of previously deferred
costs that are no longer eligible for deferral, principally within our collector
cars and boats business.
Specialty Industries. Net written premiums for Specialty Industries increased
22.7% to $231.2 million in the six months ended June 30, 2012 from
$188.5 million in the six months ended June 30, 2011. The increase compared to
the prior year period was due to a $17.1 million increase in net written
premiums from OBTI, a $9.8 million increase in net written premiums from OBA, a
$7.8 million increase in net written premiums from OBEG, a $6.0 million increase
in net written premiums from OBGR and a $2.0 million increase in net written
premiums from IMU. The increase was primarily due to new business as well as
solid retention levels across the businesses despite competition in the
marketplace.
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The Specialty Industries combined ratio for the six months ended June 30, 2012
decreased to 88.1% from 95.3% for the six months ended June 30, 2011. The loss
and LAE ratio decreased by 4.1 points to 49.8% while the expense ratio decreased
by 3.1 points to 38.3%. The decrease in the loss and LAE ratio was primarily due
to a decrease in current accident year catastrophe and non-catastrophe losses.
The six months ended June 30, 2012 included 1.6 points of current accident year
catastrophe losses primarily related to spring windstorms impacting OBGR, as
compared to 4.2 points of current accident year catastrophe losses, primarily
related to storms and freezing weather in the northeastern and southwestern
United States impacting IMU and tornados in the southeastern and midwestern
United States impacting OBTI as well as OBGR and IMU in the six months ended
June 30, 2011. This was partially offset by a decrease in favorable loss reserve
development. The six months ended June 30, 2012 included 2.1 points of favorable
loss reserve development primarily related to OBTI and OBGR, compared to 4.1
points of favorable loss reserve development primarily related to OBTI, as well
as IMU and OBGR in the prior year period. The decrease in the expense ratio was
due to a decrease in other underwriting expenses primarily related to lower
compensation and IT costs at IMU, as well as a small decrease in policy
acquisition expenses.
Specialty Products. Net written premiums for Specialty Products increased 6.4%
to $229.3 million in the six months ended June 30, 2012 from $215.6 million in
the six months ended June 30, 2011. The increase was primarily due to a
$10.7 million increase in net written premiums from OBPI primarily related to
the medical excess line, a $4.9 million increase in net written premiums from
OBSP related to strong new business and retention and a $2.0 million increase in
net written premiums from OBES which we began writing in 2011, partially offset
by a $3.9 million decrease in net written premiums from PIM, reflecting a
revised underwriting strategy.
The Specialty Products combined ratio for the six months ended June 30, 2012
decreased to 95.2% from 96.6% for the six months ended June 30, 2011. The loss
and LAE ratio decreased by 3.1 points to 58.3% while the expense ratio increased
by 1.7 points to 36.9%. The decrease in the loss and LAE ratio was primarily due
to lower current accident year catastrophe losses, partially offset by lower
favorable loss reserve development. The six months ended June 30, 2012 included
2.0 points of current accident year catastrophe losses, primarily related to
spring windstorms impacting PIM and OBPI, compared to 6.4 points of current
accident year catastrophe losses, primarily related to tornados in the
southeastern and midwestern United States as well as storms and freezing weather
in the northeastern and southwestern United States impacting PIM and to a lesser
extent within the financial services business of OBPI. The six months ended
June 30, 2012 included 1.3 points of favorable loss reserve development
primarily related to professional liability, compared to 3.6 points of favorable
loss reserve development primarily related to professional liability in the six
months ended June 30, 2011. The increase in the expense ratio was due to an
increase in policy acquisition expenses mainly due to an assumed reinsurance
program at OBPI, partially offset by a slight decrease in other underwriting
expenses primarily related to OBPI.
Reinsurance protection. For the six months ended June 30, 2012, our net combined
ratio was higher than our gross combined ratio by 6.3 points, primarily due to
favorable development on a large loss that had been ceded under the marine
reinsurance treaty and also the cost of property reinsurance, facultative
reinsurance and catastrophe reinsurance. For the six months ended June 30, 2011,
our net combined ratio was higher than our gross combined ratio by 4.5 points,
primarily due to the impact of the cost of property reinsurance and facultative
reinsurance, and also the cost of catastrophe reinsurance and marine
reinsurance.
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Other Insurance Operations
Financial results for our Other Insurance Operations segment for the three and
six months ended June 30, 2012 and 2011 are as follows:
Three months ended Six months ended
June 30, June 30,
2012 2011 2012 2011
($ in millions)
Net written premiums $ 1.3 $ (0.4 ) $ 1.8 $ 1.2
Earned premiums $ 1.7 $ 0.6 $ 2.7 $ 3.8
Loss and LAE (1.1 ) 1.1 (13.9 ) 3.3
Policy acquisition expenses 0.7 - 1.5 0.2
Other underwriting expenses (0.7 ) (2.1 ) (2.1 ) (5.0 )
Total underwriting income (loss) 0.6 (0.4 ) (11.8 ) 2.3
Net other revenues - 0.6 0.2 1.5
General and administrative
expenses - - - -
Pre-tax income (loss) from
continuing operations $ 0.6 $ 0.2 $ (11.6 ) $ 3.8
Other Insurance Operations-Three months ended June 30, 2012 versus three months
ended June 30, 2011
Net written premiums for Other Insurance Operations were $1.3 million in the
three months ended June 30, 2012, as compared to $(0.4) million in the three
months ended June 30, 2011. Other Insurance Operations generated underwriting
income of $0.6 million in the three months ended June 30, 2012, compared to an
underwriting loss of $0.4 million in the three months ended June 30, 2011. For
the three months ended June 30, 2012, we recognized $0.1 million of unfavorable
loss reserve development, as compared to the three months ended June 30, 2011
which included $3.0 million of favorable loss reserve development primarily
related to multiple peril liability lines and general liability lines. In
furtherance of our strategy to focus on our core specialty lines businesses, we
are exploring various strategic alternatives with respect to the business within
our Other Insurance Operations segment.
Other Insurance Operations-Six months ended June 30, 2012 versus six months
ended June 30, 2011
Net written premiums for Other Insurance Operations were $1.8 million in the six
months ended June 30, 2012, as compared to $1.2 million in the six months ended
June 30, 2011. Other Insurance Operations generated an underwriting loss of
$11.8 million in the six months ended June 30, 2012, compared to underwriting
income of $2.3 million in the six months ended June 30, 2011. For the six months
ended June 30, 2012, we recognized $12.5 million of unfavorable loss reserve
development primarily driven by case incurred development on a small number of
claims related to multiple peril liability lines and general liability lines and
also the impact of an adverse court ruling in Mississippi regarding a disputed
assessment from an involuntary pool for hurricane Katrina claims. For the six
months ended June 30, 2011, we recognized $6.9 million in favorable loss reserve
development primarily related to multiple peril liability lines and general
liability lines. The six months ended June 30, 2011 included $0.8 million in
additional consideration for aggregate premium renewals exceeding $200 million
related to the transfer of our commercial lines business. As described above, in
furtherance of our strategy to focus on our core specialty lines businesses, we
are exploring various strategic alternatives with respect to the business within
our Other Insurance Operations segment.
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Investing, Financing and Corporate Operations
Financial results for our Investing, Financing and Corporate Operations segment
for the three and six months ended June 30, 2012 and 2011 is as follows:
Three months ended Six months ended
June 30, June 30,
2012 2011 2012 2011
($ in millions)
Net investment income $ 12.9 $ 17.8 $ 26.5 $ 37.5
Net realized and unrealized
investment (losses) gains (10.6 ) 9.9 17.5 31.8
Net other revenues (expenses) 0.1 (12.1 ) (0.1 ) (12.3 )
General and administrative
expenses (0.7 ) (0.4 ) (1.4 ) (1.1 )
Interest expense on debt (4.0 ) (6.2 ) (8.1 ) (12.5 )
Pre-tax (loss) income from
continuing operations $ (2.3 ) $ 9.0 $ 34.4 $ 43.4
Investing, Financing and Corporate Operations-Three months ended June 30, 2012
versus three months ended June 30, 2011
Investing, Financing and Corporate Operations reported a pre-tax loss of
$2.3 million in the three months ended June 30, 2012, compared to pre-tax income
of $9.0 million in the three months ended June 30, 2011. The decrease was
primarily due to net realized and unrealized investment losses and a decrease in
net investment income. As further described below, the three months ended
June 30, 2012 included $10.6 million of net realized and unrealized investment
losses as compared to $9.9 million of net realized and unrealized investment
gains in the prior year period. Net investment income decreased to $12.9 million
in the three months ended June 30, 2012, compared to $17.8 million in the three
months ended June 30, 2011, as further described below. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations-Summary
of Investment Results". Net other expenses for the three months ended June 30,
2011 included a $12.0 million loss related to the purchase of a portion of our
senior notes. The decrease in interest expense reflects actions taken to reduce
outstanding debt. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations-Financing".
Investing, Financing and Corporate Operations-Six months ended June 30, 2012
versus six months ended June 30, 2011
Investing, Financing and Corporate Operations reported pre-tax income of
$34.4 million in the six months ended June 30, 2012, compared to pre-tax income
of $43.4 million in the six months ended June 30, 2011. The decrease was
primarily due to decreases in net realized and unrealized investment gains and
in net investment income. As further described below, the six months ended
June 30, 2012 included $17.5 million of net realized and unrealized investment
gains as compared to $31.8 million in the prior year period. Net investment
income decreased to $26.5 million in the six months ended June 30, 2012,
compared to $37.5 million in the six months ended June 30, 2011, as further
described below. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations-Summary of Investment Results". These were
partially offset by decreases in net other expenses and interest expense. Net
other expenses for the six months ended June 30, 2011 included a $12.0 million
loss related to the purchase of a portion of our senior notes. The decrease in
interest expense reflects actions taken to reduce outstanding debt. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations-Financing".
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Summary of Investment Results
Investment Philosophy
Our long-term investment philosophy has historically been to maximize our after
tax risk-adjusted return while taking prudent levels of risk and maintaining a
diversified portfolio. Under this approach, each dollar of after tax investment
income and realized and unrealized gains and losses is valued equally.
Our investment portfolio mix as of June 30, 2012 consisted in large part of high
quality, fixed maturity investments and short-term investments, as well as a
smaller allocation to equity investments which are comprised of common equity
securities, convertible fixed maturity investments and other investments such as
hedge funds and private equity funds. Our management believes that prudent
levels of investments in common equity securities, convertible bonds and other
investments within our investment portfolio are likely to enhance long-term
after tax total returns without significantly increasing the risk profile of the
portfolio.
Our overall fixed maturity investment strategy is to purchase securities that
are attractively priced in relation to their investment risks. We also generally
manage the interest rate risk associated with holding fixed maturity investments
by actively maintaining 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.
Our equity investment strategy is to maximize absolute risk-adjusted return
through investments in a variety of common equity, equity-related and
convertible fixed maturity instruments as well as other investments, primarily
hedge funds and private equity funds. We invest in relatively concentrated
positions in the United States and other developed markets. Our philosophy is to
invest for risk-adjusted return using a bottom-up, value investing approach.
Preservation of capital is of the utmost importance.
Investment Returns
A summary of our consolidated pre-tax investment results for the three and six
months ended June 30, 2012 and 2011 is as follows:
Three months ended Six months ended
June 30, June 30,
2012 2011 2012 2011
($ in millions)
Net investment income $ 12.9 $ 17.8 $ 26.5 $ 37.5
Net realized investment (losses)
gains (3.7 ) 16.5 16.1 37.7
Change in net unrealized
investment gains and losses (6.9 ) (6.6 ) 1.4 (5.9 )Total pre-tax investment results $ 2.3 $ 27.7 $ 44.0 $ 69.3
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Gross investment returns versus typical benchmarks for the three and six months
ended June 30, 2012 and 2011 are as follows:
Three months ended Six months ended
June 30, (1) June 30, (1)
2012 2011 2012 2011
Fixed maturity investments 1.0 % 1.4 % 2.4 % 2.6 %
Short-term investments 0.1 0.1 - 0.1
Total fixed income 0.9 1.4 2.1 2.5
Barclays U.S. Intermediate
Aggregate Index 1.3 2.2 2.0 2.7
Common equity securities (4.2 ) (1.0 ) (0.5 ) 2.3
Convertible fixed maturity
investments (2.8 ) (2.5 ) 3.0 (0.6 )
Total common equity securities
and convertible fixed maturity
investments (3.9 ) (1.3 ) 0.3 1.6
Other investments (0.7 ) 2.3 2.4
6.2
Total common equity securities,
convertible fixed maturity and
other investments (2.9 ) (0.2 ) 0.9 3.0
S&P 500 Index (total return) (2.8 ) 0.1 9.5 6.0
Total consolidated portfolio 0.2 % 1.1 % 1.9 % 2.6 %
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(1) Gross investment income returns exclude investment
expenses
of $1.6 million and $1.7 million, respectively, for the three months ended
June 30, 2012 and 2011, and $3.2 million and $3.4 million, respectively, for the
six months ended June 30, 2012 and 2011.
Investment Returns-Three months ended June 30, 2012 versus three months ended
June 30, 2011
Overview
Our total pre-tax investment results were $2.3 million, a return of 0.2% for the
three months ended June 30, 2012, compared to $27.7 million, a return of 1.1%
for the three months ended June 30, 2011. Net investment income in the three
months ended June 30, 2012 was $12.9 million, a decrease of $4.9 million,
compared to $17.8 million in the three months ended June 30, 2011 primarily due
to lower fixed maturity yields and a reduction in invested assets as a result of
the AutoOne Transaction and repurchases of debt. Net realized investment losses
were $3.7 million in the three months ended June 30, 2012, a decrease of $20.2
million compared to net realized gains of $16.5 million in the three months
ended June 30, 2011. The change in net unrealized investment gains and losses
was a decrease of $6.9 million in the three months ended June 30, 2012, compared
to a decrease of $6.6 million in the three months ended June 30, 2011.
Fixed income
Our fixed income portfolio, which includes fixed maturity and short-term
investments, returned 0.9% for the three months ended June 30, 2012, compared to
1.4% for the three months ended June 30, 2011. We maintained a high quality
fixed maturity portfolio with a relatively short duration of approximately 3.1
years excluding short-term investments and approximately 3.0 years including
short-term investments at June 30, 2012. Our fixed income portfolio trailed the
longer-duration Barclays U.S. Intermediate Aggregate Index benchmark for the
three months ended June 30, 2012 as rates fell during the second quarter of
2012.
Common equity securities, convertible fixed maturity investments and other
investments
Our total common equity securities, convertible fixed maturity investments and
other investments portfolio returned (2.9)% for the three months ended June 30,
2012, compared to (0.2)% for the three months ended June 30, 2011. Our total
common equity securities and convertible fixed maturity investments portfolio
returned (3.9)% and (1.3)% for the three months ended June 30, 2012 and 2011,
respectively, or 110 basis points and 140 basis points worse, respectively, than
the S&P 500 benchmark. Our total common equity securities and convertible fixed
maturity investments portfolio has overweight positions in the gold mining
sector and underweight positions in technology, consumer products and bank
stocks compared to the stocks that compose the S&P 500 Index. In addition, other
investments, which are composed principally of hedge funds and private equities,
outperformed the S&P 500 Index by 210 basis points and 220 basis points for the
three months ended June 30, 2012 and 2011, respectively.
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Investment Returns-Six months ended June 30, 2012 versus six months ended
June 30, 2011
Overview
Our total pre-tax investment results were $44.0 million, a return of 1.9% for
the six months ended June 30, 2012, compared to $69.3 million, a return of 2.6%
for the six months ended June 30, 2011. Net investment income in the six months
ended June 30, 2012 was $26.5 million, a decrease of $11.0 million, compared to
$37.5 million in the six months ended June 30, 2011. The decrease was primarily
due to lower fixed maturity yields and a reduction in invested assets as a
result of the AutoOne Transaction and repurchases of debt. Net realized
investment gains were $16.1 million in the six months ended June 30, 2012, a
decrease of $21.6 million compared to $37.7 million in the six months ended
June 30, 2011. The change in net unrealized investment gains and losses was an
increase of $1.4 million in the six months ended June 30, 2012, compared to a
decrease of $(5.9) million in the six months ended June 30, 2011.
Fixed income
Our fixed income portfolio, which includes fixed maturity and short-term
investments, returned 2.1% for the six months ended June 30, 2012, compared to
2.5% for the six months ended June 30, 2011. We maintained a high quality fixed
maturity portfolio with a relatively short duration of approximately 3.1 years
excluding short-term investments and approximately 3.0 years including
short-term investments at June 30, 2012. Our fixed income portfolio performed
consistent with the longer-duration Barclays U.S. Intermediate Aggregate Index
benchmark for the six months ended June 30, 2012.
Common equity securities, convertible fixed maturity investments and other
investments
Our total common equity securities, convertible fixed maturity investments and
other investments portfolio returned 0.9% for the six months ended June 30,
2012, compared to 3.0% for the six months ended June 30, 2011. Our total common
equity securities and convertible fixed maturity investments portfolio returned
0.3% and 1.6% for the six months ended June 30, 2012 and 2011, respectively, or
920 basis points and 440 basis points, respectively, worse than the S&P 500
benchmark. Our total common equity securities and convertible fixed maturity
investments portfolio has overweight positions in the gold mining sector and
underweight positions in technology, consumer products and bank stocks compared
to the stocks that compose the S&P 500 Index. In addition, other investments,
which are composed principally of hedge funds and private equities,
underperformed the S&P 500 Index by 710 basis points and outperformed the S&P
500 Index by 20 basis points for the six months ended June 30, 2012 and 2011,
respectively.
Fair Value Considerations
We record our investments in accordance with ASC 820 which provides a revised
definition of fair value, establishes a framework for measuring fair value and
expands financial statement disclosure requirements for fair value information.
Under ASC 820, fair value is defined as the price that would be received to sell
an asset or paid to transfer a liability in an orderly transaction between
market participants (an exit price). ASC 820 establishes a fair value hierarchy
that distinguishes between inputs based on market data from independent sources
(observable inputs) and a reporting entity's internal assumptions based upon the
best information available when external market data is limited or unavailable
(unobservable inputs). The fair value hierarchy in ASC 820 prioritizes fair
value measurements into three levels based on the nature of the inputs. 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).
Assets carried at fair value include fixed maturity investments, common equity
securities, convertible fixed maturity investments 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 or are not
considered reasonable, 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
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 consistent with what other market participants would
use when pricing such instruments.
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As of June 30, 2012 and December 31, 2011, approximately 91% 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 equities and short-term investments, which include
U.S. Treasury Bills. Investments valued using Level 2 inputs comprise fixed
maturity investments including corporate debt, state and other governmental
debt, convertible fixed maturity investments and mortgage and asset-backed
securities. 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 hedge funds and private equity funds, as well as certain
investments in debt and equity securities, including asset-backed securities,
where quoted market prices are unavailable or are not considered reasonable.
We use brokers and outside pricing services to assist in determining fair
values. The outside pricing services we use have indicated that they will only
provide prices where observable inputs are available. If no observable inputs
are available for a security, the pricing services will not provide a price. In
circumstances where quoted market prices are unavailable or are not considered
reasonable, we estimate the fair value using industry standard pricing models
and observable inputs such as benchmark interest rates, matrix pricing, market
comparables, broker quotes, issuer spreads, bids, offers, credit rating
prepayment speeds and other relevant inputs.
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, evaluation of model pricing
methodologies, review of the pricing services' quality control processes and
procedures on at least an annual basis, comparison of market prices to prices
obtained from different independent pricing vendors on at least an annual basis,
monthly analytical reviews of certain prices and review of assumptions utilized
by the pricing service for selected measurements on an ad hoc basis throughout
the year. We also perform back-testing of selected purchases and sales activity
to determine whether there are any significant differences between the market
price used to value the security prior to purchase or sale and the actual
purchase or sale price on at least an annual basis. Prices provided by the
pricing services that vary by more than 5% and $1.0 million from the expected
price based on the procedures are considered outliers. In circumstances where
the results of our review process does not appear to support the market price
provided by the pricing services, we challenge the 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.
Other investments, which are primarily comprised of hedge funds and private
equity funds for which the fair value option has been elected, are carried at
fair value based upon our proportionate interest in the underlying fund's net
asset value, which is deemed to approximate fair value. The fair value of our
investments in hedge funds and private equity funds has been estimated using net
asset value because it reflects the fair value of the funds' underlying
investments in accordance with ASC 820. We employ 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. The fair values of our investments in
hedge funds and private equity funds have been classified as Level 3 under the
fair value hierarchy since the fund managers do not provide sufficient
information to independently evaluate the pricing inputs and methods for each
underlying investment, and therefore the inputs are considered to be
unobservable.
In circumstances where the underlying investments are publicly traded, such as
the investments made by hedge funds, the fair value of the underlying
investments is determined using current market prices. In circumstances where
the underlying investments are not publicly traded, such as the investments made
by private equity funds, the private equity fund managers have considered the
need for a liquidity discount on each of the underlying investments when
determining the fund's net asset value in accordance with ASC 820. In
circumstances where our portion of a fund's net asset value is deemed to differ
from fair value due to illiquidity or other factors associated with our
investment in the fund, including counterparty credit risk, the net asset value
is adjusted accordingly. At June 30, 2012 and December 31, 2011, we did not
record a liquidity adjustment to the net asset value related to our investments
in hedge funds or private equity funds.
As of June 30, 2012 and December 31, 2011, other investments reported at fair
value represented approximately 6% and 5% of the investment portfolio recorded
at fair value, respectively. Other investments accounted for at fair value as of
June 30, 2012 and December 31, 2011 were comprised of $53.2 million and
$53.5 million, respectively, in hedge funds, $66.5 million and $65.7 million,
respectively, in private equity funds, $14.1 million for both periods of an
investment in a community reinvestment vehicle. At June 30, 2012 and
December 31, 2011, OneBeacon held investments in 9 hedge funds and 15 and 14
private equity funds, respectively. The largest investment in a single fund was
$12.4 million and $13.7 million, respectively, at June 30, 2012 and December 31,
2011. As of June 30, 2012 and December 31, 2011, other investments also included
$21.5 million and $21.8 million, respectively, of an investment in a tax
advantaged federal affordable housing development fund which is accounted for
using the equity method.
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The fair value measurements at June 30, 2012 and December 31, 2011 for assets
recorded in accordance with ASC 825 and any related Level 3 inputs are as
follows:
Fair value at Level 3 Level 3
June 30, 2012 Inputs Percentage
($ in millions)
Fixed maturity investments:
U.S. Government and agency obligations $ 197.4 $ - - %
Debt securities issued by corporations 679.7 - -
Municipal obligations 3.4 - -
Asset-backed securities 884.7 14.5 1.6
Foreign government obligations 8.0 - -
Preferred stocks 82.7 70.1 84.8
Fixed maturity investments 1,855.9 84.6 4.6
Short-term investments 118.4 - -
Common equity securities 243.4 0.8 0.3
Convertible fixed maturity investments 68.3 - -
Other investments(1) 133.8 133.8 100.0
Total(1) $ 2,419.8 $ 219.2 9.1 %
Fair value at Level 3 Level 3
December 31, 2011 (2) Inputs Percentage
($ in millions)
Fixed maturity investments:
U.S. Government and agency obligations $ 215.4 $ - - %
Debt securities issued by corporations 685.5 - -
Municipal obligations 2.2 - -
Asset-backed securities 871.1 2.3 0.3
Foreign government obligations 8.1 - -
Preferred stocks 75.3 63.8 84.7
Fixed maturity investments 1,857.6 66.1 3.6
Short-term investments 291.8 - -
Common equity securities 243.5 0.8 0.3
Convertible fixed maturity investments 72.5 - -
Other investments(1) 133.3 133.3 100.0
Total(1) $ 2,598.7 $ 200.2 7.7 %
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(1) Excludes the carrying value of $21.5 million and $21.8
million, respectively, associated with a tax advantaged federal affordable
housing development fund accounted for using the equity method as of June 30,
2012 and December 31, 2011.
(2) Fair value includes $111.8 million of fixed maturity
investments reclassified to assets held for sale in the December 31, 2011
consolidated balance sheet as part of the AutoOne Transaction.
At both June 30, 2012 and December 31, 2011, we held one private preferred stock
that represented approximately 85% of our preferred stock portfolio. We used
quoted market prices for similar securities that were adjusted to reflect
management's best estimate of fair value; this security is classified as a
Level 3 measurement.
In addition to the investment portfolio described above, we had $38.1 million
and $36.9 million, respectively, of liabilities recorded at fair value and
included in other liabilities as of June 30, 2012 and December 31, 2011. These
liabilities relate to securities that have been sold short by a limited
partnership in which we invest and are required to consolidate in accordance
with GAAP. As of June 30, 2012 and December 31, 2011, all of the liabilities
included in the $38.1 million and $36.9 million, respectively, have been
classified as Level 1 measurements.
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The changes in Level 3 fair value measurements for the three and six months
ended June 30, 2012 are as follows:
Fixed Common Convertible
maturity equity fixed maturity Other
investments securities investments investments(1) Total(1)
($ in millions)Balance at January 1, 2012 $ 66.1 $ 0.8 $
- $ 133.3 $ 200.2
Amortization/accretion 0.1 - - - 0.1
Total net realized and
unrealized gains (losses) 5.8 - - 4.9 10.7
Purchases 34.1 - - 1.2 35.3
Sales (0.4 ) - - (5.0 ) (5.4 )
Transfers in - - - - -
Transfers out - - - - -
Balance at March 31, 2012 $ 105.7 $ 0.8 $ - $ 134.4 $ 240.9
Amortization/accretion 0.1 - - - 0.1
Total net realized and
unrealized gains (losses) 0.3 - - (0.9 ) (0.6 )
Purchases 18.1 - - 11.6 29.7
Sales (39.6 ) - - (11.3 ) (50.9 )
Transfers in - - - - -
Transfers out - - - - -
Balance at June 30, 2012 $ 84.6 $ 0.8 $ - $ 133.8 $ 219.2
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(1) Excludes the carrying value of $21.5 million associated with a tax
advantaged federal affordable housing development fund accounted for using the
equity method.
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 OBH are expected to be
distributions and tax sharing payments received from our insurance operating
subsidiaries, financing activities and 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, purchases of investments, tax payments,
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, financing activities, net
investment income, 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 costs, interest payments on our debt
obligations, repurchases and retirements of our debt obligations, operating
expenses, 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. 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 GAAP net income, as the claims 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. Negative cash flows from operations also
occur as invested assets are used to fund current claim payments associated with
run-off operations, such as those related to the commercial lines business that
was exited via a renewal rights agreement.
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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, ranging up to 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
operating subsidiaries are domiciled, an insurer is restricted with respect to
the timing or 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.
Generally, our regulated insurance operating subsidiaries have the ability to
pay dividends during any 12-month period without the prior approval of
regulatory authorities in an amount set by formula based on the greater of prior
year statutory net income or 10% of prior year end statutory surplus, subject to
the availability of unassigned funds. Our top tier regulated insurance operating
subsidiaries have the ability to pay $103 million of dividends during 2012
without the prior approval of regulatory authorities, subject to the
availability of unassigned funds. At March 31, 2012, OB Holdings' top tier
regulated insurance operating subsidiaries had $0.8 billion of unassigned funds
and at December 31, 2011, had statutory surplus of $1.0 billion. At June 30,
2012, we had approximately $30 million of net unrestricted cash, short-term
investments and fixed maturity investments outside of our regulated insurance
operating subsidiaries.
During the six months ended June 30, 2012 and 2011, our top tier regulated
operating subsidiaries distributed $79.0 million of ordinary dividends and
$150.0 million of extraordinary dividends, respectively, to OneBeacon Insurance
Group LLC. Dividends during the six months ended June 30, 2012 included the
distribution by one of our top tier regulated operating subsidiaries of its
investment in another regulated insurance subsidiary at a value of $34.0
million. During the six months ended June 30, 2012 and 2011, our unregulated
operating subsidiaries paid $4.2 million and $4.1 million, respectively, of
dividends to their immediate parent.
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 is considered to be the cost of insurance float. We
calculate our insurance float by taking our net invested assets and subtracting
our total capital. 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 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 have historically
obtained our insurance float through both acquisitions and organic growth. We
intend to generate low-cost float over time through a combination of
acquisitions and organic growth in our ongoing insurance operations. However, we
will seek to increase our insurance float organically only when market
conditions allow for an expectation of generating underwriting profits.
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, foreign currency gains and losses, debt issuances and
repurchases/repayments, 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.
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The following table illustrates our consolidated insurance float position and
four operational leverage ratios based on insurance float and net invested
assets as of June 30, 2012 and December 31, 2011.
June 30, December 31,
2012 2011
($ in millions)
Total investments $ 2,441.3 $ 2,508.7
Cash 26.9 49.0Cash and investments classified within assets held for
sale
-
117.3
Accounts receivable on unsettled investment sales 7.0
0.4
Accounts payable on unsettled investment purchases (37.8 ) (22.7 )
Net invested assets $ 2,437.4 $
2,652.7
OB Holdings' common shareholder's equity $ 947.0 $ 932.5
Debt 269.8 269.7
Total capital $ 1,216.8 $ 1,202.2
Insurance float $ 1,220.6 $ 1,450.5
Insurance float as a multiple of total capital 1.0 x 1.2 x
Net invested assets as a multiple of total capital 2.0 x
2.2 x
Insurance float as a multiple of OB Holdings' common
shareholder's equity
1.3 x
1.6 x
Net invested assets as a multiple of OB Holdings' common
shareholder's equity
2.6 x 2.8 x
Insurance float decreased by approximately $230 million, primarily due to the
AutoOne Transaction and the continued run-off of reserves related to the
commercial lines business that was exited through a renewal rights sale.
Financing
Debt
The following table summarizes our debt to capital ratio at June 30, 2012 and
December 31, 2011:
June 30, December 31,
2012 2011
($ in millions)
Senior Notes, carrying value $ 269.8 $ 269.7
OB Holdings' common shareholder's equity 947.0 932.5
Total capital $ 1,216.8 $ 1,202.2
Ratio of debt to total capital 22.2 % 22.4 %
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 March 24, 2011, we commenced a cash tender offer for up to $150.0 million in
aggregate principal amount of the 5.875% Senior Notes due 2013, which we refer
to as the Senior Notes, at a price of $1,045 per $1,000 principal amount. The
cash tender offer, which was not subject to the tender of any minimum principal
amount of Senior Notes, expired on April 20, 2011. Holders of Senior Notes who
tendered on or before April 6, 2011 received an early tender payment of $30 for
every $1,000 principal amount of Senior Notes validly tendered. Payment for the
Senior Notes included accrued and unpaid interest up to the settlement date. On
April 21, 2011, we accepted and retired $150.0 million aggregate principal
amount of its Senior Notes for $161.6 million, which resulted in a $12.0 million
pre-tax loss, including transaction fees.
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White Mountains provides an irrevocable and unconditional guarantee as to the
payment of principal and interest on the Senior Notes. In consideration of this
Guarantee, we have agreed to pay a specified fee to White Mountains in the
amount of 25 basis points per annum on the outstanding principal amount of the
Senior Notes. We have further agreed that if White Mountains' voting interest in
OBIG ceases to represent more than 50% of all our voting securities, we are
obligated to seek to redeem, exchange or otherwise modify the Senior Notes in
order to fully and permanently eliminate White Mountains' obligations under the
Guarantee (the Guarantee Elimination). White Mountains has agreed to provide
written notice to us when its voting interest in OBIG has been reduced below
50%. We will have 180 days from the receipt of such notification to complete the
Guarantee Elimination. If the Guarantee Elimination is not completed within the
initial 180-day period, the Guarantee fee shall increase by 200 basis points.
The Guarantee fee shall further increase by 100 basis points for each subsequent
90-day period thereafter, up to a maximum Guarantee fee of 425 basis points,
until the Guarantee Elimination has been completed.
The Senior Notes were issued under an indenture which contains restrictive
covenants. These covenants, among other things, place certain limitations on the
ability of White Mountains, OBH and their respective subsidiaries, which
includes us, as a subsidiary of White Mountains, to create liens and enter into
sale and leaseback transactions and substantially limit the ability of White
Mountains, OBH and their respective subsidiaries, which includes us, to
consolidate, merge or transfer their properties and assets. The indenture does
not contain any financial ratios or specified levels of net worth or liquidity
to which White Mountains or OBH must adhere. At June 30, 2012, White Mountains
and OBH were in compliance with all of the covenants under the Senior Notes.
The indenture documents provide that, if OBH or White Mountains as guarantor of
the Senior Notes defaults under a credit agreement, mortgage or similar debt
agreement with a principal amount greater than $25 million, and such default
results in the acceleration of such debt, there is a default under the Senior
Notes. Such a default would permit the trustees or holders of 25% or more of the
Senior Notes to declare an event of default under the indenture documents
resulting in a required repayment of the Senior Notes. See "Note 15. Related
Party Disclosures" of the Company's 2011 Annual Report on Form 10-K.
Capital Lease
In December 2011, OneBeacon Insurance Company (OBIC), an indirect wholly-owned
subsidiary of the Company, sold the majority of its fixed assets and capitalized
software to OneBeacon Services LLC (OB Services), another indirect wholly-owned
subsidiary of the Company. The fixed assets and capitalized software were sold
at a cost equal to book value with no gain or loss recorded on the sale.
Subsequent to purchasing the fixed assets and capitalized software from OBIC, OB
Services entered into lease financing arrangements with US Bancorp Equipment
Finance, Inc. (US Bancorp) and Fifth Third Equipment Finance Company (Fifth
Third) whereby OB Services sold its furniture and equipment and its capitalized
software, respectively, to US Bancorp and Fifth Third. The assets were sold at a
cost equal to net book value. OB Services 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. OB Services received cash
proceeds of $23.1 million as a result of entering into the sale-leaseback
transactions. At the end of the lease terms, OB Services will have the
obligation to purchase the leased assets for a nominal fee, after which all
rights, title and interest would transfer to OB Services. In accordance with ASC
840, OBIC recorded the sale of the assets with no gain or loss recognized while
OB Services recorded a capital lease obligation and a capital lease asset. As of
June 30, 2012 and December 31, 2011, OB Services had a capital lease obligation
of $20.7 million and $23.1 million, respectively, included within other
liabilities and a capital lease asset of $19.4 million and $22.9 million,
respectively, included within other assets.
Cash Flows
Detailed information concerning our cash flows for the six months ended June 30,
2012 and 2011 follows:
Cash flows from operations for the six months ended June 30, 2012 and 2011
Net cash flows used for operations were $89.3 million and $134.0 million,
respectively, for the six months ended June 30, 2012 and 2011. Net cash flows
for operations for the six months ended June 30, 2012 and 2011 were reduced by
the run-off of reserves related to the commercial lines business that was exited
via a renewal rights sale. Net cash flows for operations for the six months
ended June 30, 2012 and 2011 were also reduced by declining net investment
income, primarily due to lower overall portfolio yields, shifts in portfolio mix
to lower risk, lower yield investments and a decrease in the overall invested
asset base.
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Cash flows from investing and financing activities for the six months ended
June 30, 2012
Financing and Other Capital Activities
During the six months ended June 30, 2012, we declared and paid $30.0 million of
cash distributions to OneBeacon U.S. Enterprises Holdings, Inc. (OBEH),
including $15.5 million of dividends and $14.5 million representing return of
capital.
During the six months ended June 30, 2012, we paid $8.1 million of interest
including $7.9 million on the Senior Notes and $0.2 million related to our
capital lease obligation.
Other Liquidity and Capital Resource Activities
During the first quarter of 2012, we made payments with respect to our long-term
incentive compensation plans totaling $14.8 million, in cash or by deferral into
certain of our non-qualified compensation plans. These payments were made
primarily with respect to 247,583 performance shares and 151,475 performance
units for the 2009-2011 performance cycle.
Cash flows from investing and financing activities for the six months ended
June 30, 2011
Financing and Other Capital Activities
During the six months ended June 30, 2011, we declared and paid $30.0 million of
cash distributions to OBEH, including $19.4 million of dividends and $10.6
million representing return of capital.
During the six months ended June 30, 2011, we paid $10.8 million of interest on
our debt obligations, including $10.6 million of interest on the Senior Notes.
During the three months ended June 30, 2011, OBH repurchased and retired a
portion of the Senior Notes for $161.6 million in a cash tender offer, including
transaction fees.
Other Liquidity and Capital Resource Activities
During the first quarter of 2011, we made payments with respect to our long-term
incentive compensation plans totaling $16.8 million, in cash or by deferral into
certain of our non-qualified compensation plans. These payments were made
primarily with respect to 929,849 performance shares for the 2008-2010
performance cycle.
Critical Accounting Estimates
Refer to the Company's 2011 Annual Report on Form 10-K for a complete discussion
regarding our critical accounting estimates. As of June 30, 2012, there were no
material changes to our critical accounting estimates.
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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 or anticipate will or
may occur in the future are forward-looking statements. The words "will,"
"believe," "intend," "expect," "anticipate," "project," "estimate," "predict"
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 loss adjustment expenses and the adequacy of our
loss and loss adjustment expense 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; and
† future capital expenditures.
These statements are based on certain assumptions and analyses made by us in
light of our experience and perception of 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 and predictions is subject to a
number of risks and uncertainties that could cause actual results to differ
materially from expectations, including:
† the risks associated with Item 1A of the Company's 2011 Annual Report
on Form 10-K and in Item 1A of this Form 10-Q;
† claims arising from catastrophic events, such as hurricanes,
windstorms, earthquakes, floods or terrorist attacks;
† recorded loss and loss adjustment expense reserves subsequently
proving to have been inadequate;
† the continued availability and cost of reinsurance coverage;
† the continued availability of capital and financing;
† general economic, market or business conditions;
† business opportunities (or lack thereof) that may be presented to us
and pursued;
† competitive forces, including the conduct of other property and
casualty insurers and agents;
† changes in domestic or foreign laws or regulations, or their
interpretation, applicable to us, our competitors, our agents or our customers;
† an economic downturn or other economic conditions adversely affecting
our financial position including stock market volatility;
† actions taken by rating agencies from time to time, such as financial
strength or credit rating downgrades or placing ratings on negative watch; 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
actual results or developments anticipated by us will be realized or, even if
substantially realized, that they will have the expected consequences to, or
effects on, us or our business or operations. We assume no obligation to update
publicly any such forward-looking statements, whether as a result of new
information, future events or otherwise.
