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 June 30, 2006

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 1-8993

WHITE MOUNTAINS INSURANCE GROUP, LTD.

(Exact name of registrant as specified in its charter)

 

Harborside Financial Center, Plaza 5, Jersey City, New Jersey 07311-1114
(Address of principal executive offices including zip code)

(201) 631-3300
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x   No o

Indicate by check mark whether the Registrant 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.

 

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 July 28, 2006, 10,780,053 common shares with a par value of $1.00 per share were outstanding (which includes 10,000 restricted common shares that were not vested at such date).

 

WHITE MOUNTAINS INSURANCE GROUP, LTD.

Table of Contents

				Page No.
PART I.		FINANCIAL INFORMATION
Item 1.		Financial Statements (Unaudited)		3
		Consolidated Balance Sheets, June 30, 2006 and December 31, 2005		3
		Consolidated Statements of Income and Comprehensive Income, Three and Six Months Ended June 30, 2006 and 2005		4
		Consolidated Statements of Common Shareholders’ Equity, Six Months Ended June 30, 2006 and 2005		5
		Consolidated Statements of Cash Flows, Six Months Ended June 30, 2006 and 2005		6
		Notes to Consolidated Financial Statements		7
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		31
		Results of Operations — Three and Six Months Ended June 30, 2006 and 2005		31
		Non-GAAP Financial Measures		44
		Liquidity and Capital Resources		45
		Critical Accounting Estimates		49
		Forward-Looking Statements		50
Item 3.		Quantitative and Qualitative Disclosures About Market Risk		51
Item 4.		Controls and Procedures		51
PART II.		OTHER INFORMATION
Items 1 through 6				52
SIGNATURES				55

 

2

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PART I. FINANCIAL INFORMATION.

Item 1. Financial Statements

WHITE MOUNTAINS INSURANCE GROUP, LTD.

CONSOLIDATED BALANCE SHEETS

		June 30,		December 31,
($ in millions, except share and per share amounts)		2006		2005
		Unaudited
Assets
Fixed maturity investments, at fair value (amortized cost: $7,323.2 and $7,548.4)		$7,303.6		$7,582.7
Common equity securities, at fair value (cost: $950.9 and $796.5)		1,147.0		967.8
Short-term investments, at amortized cost (which approximates fair value)		873.5		727.8
Other investments (cost: $435.9 and $510.8)		469.6		588.1
Total investments		9,793.7		9,866.4
Cash		191.6		187.7
Reinsurance recoverable on unpaid losses		2,725.3		3,003.6
Reinsurance recoverable on unpaid losses — Berkshire Hathaway Inc.		1,935.6		2,022.1
Reinsurance recoverable on paid losses		116.0		77.0
Insurance and reinsurance premiums receivable		1,062.4		1,014.3
Securities lending collateral		453.1		674.9
Funds held by ceding companies		554.7		620.4
Investments in unconsolidated insurance affiliates		412.0		479.7
Deferred tax asset		324.2		341.2
Deferred acquisition costs		324.9		288.4
Ceded unearned premiums		167.1		200.7
Investment income accrued		89.4		93.5
Accounts receivable on unsettled investment sales		23.6		21.7
Other assets		554.4		526.5
Total assets		$18,728.0		$19,418.1
Liabilities
Loss and loss adjustment expense reserves		$9,775.3		$10,231.2
Reserves for structured contracts		214.2		224.6
Unearned insurance and reinsurance premiums		1,730.7		1,582.0
Debt		838.2		779.1
Securities lending payable		453.1		674.9
Deferred tax liability		241.0		274.3
Ceded reinsurance payable		166.9		204.5
Funds held under reinsurance treaties		130.1		171.4
Accounts payable on unsettled investment purchases		63.7		43.4
Other liabilities		1,003.2		1,165.5
Preferred stock subject to mandatory redemption:
Held by Berkshire Hathaway Inc. (redemption value $300.0)		227.3		214.0
Held by others (redemption value $20.0)		20.0		20.0
Total liabilities		14,863.7		15,584.9
Common shareholders’ equity
Common shares at $1 par value per share — authorized 50,000,000 share issued and outstanding 10,780,053 and 10,779,223 shares		10.8		10.8
Paid-in surplus		1,715.6		1,716.4
Retained earnings		2,077.7		1,899.8
Accumulated other comprehensive income, after-tax
Net unrealized gains on investments		53.1		233.9
Net unrealized foreign currency translation losses		9.3		(21.8	)
Minimum pension liability and other		(2.2	)	(4.0	)
Unearned compensation - restricted common share awards		—		(1.9	)
Total common shareholders’ equity		3,864.3		3,833.2
Total liabilities and common shareholders’ equity		$18,728.0		$19,418.1

 

See Notes to Consolidated Financial Statements

3

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WHITE MOUNTAINS INSURANCE GROUP, LTD.

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

Unaudited

		Three Months Ended						Six Months Ended
		June 30,						June 30,
(Millions, except per share amounts)		2006			2005			2006			2005
Revenues:
Earned insurance and reinsurance premiums		$	953.5		$	943.4		$	1,854.5		$	1,898.4
Net investment income		104.4			104.6			202.9			278.5
Net realized investment gains		106.5			63.3			135.0			100.4
Other revenue		36.5			59.6			66.3			118.9
Total revenues		1,200.9			1,170.9			2,258.7			2,396.2
Expenses:
Loss and loss adjustment expenses		763.8			570.2			1,327.8			1,189.5
Insurance and reinsurance acquisition expenses		187.7			184.1			373.3			373.2
Other underwriting expenses		122.8			128.3			238.7			250.5
General and administrative expenses		22.2			61.5			69.7			99.2
Accretion of fair value adjustment to loss and loss adjustment expense reserves		6.4			9.1			11.6			19.0
Interest expense on debt		11.9			11.7			23.6			23.3
Interest expense - dividends on preferred stock subject to mandatory redemption		7.5			7.5			15.1			15.1
Interest expense - accretion on preferred stock subject to mandatory redemption		6.9			5.4			13.3			10.4
Total expenses		1,129.2			977.8			2,073.1			1,980.2
Pre-tax income		71.7			193.1			185.6			416.0
Income tax benefit (provision)		29.3			(55.4		)	2.4			(111.7		)
Income before equity in earnings of unconsolidated affiliates		101.0			137.7			188.0			304.3
Equity in earnings of unconsolidated insurance affiliates		14.8			9.1			23.8			18.8
Net income		115.8			146.8			211.8			323.1
Change in net unrealized gains and losses for investments held		(63.0		)	128.6			(96.2		)	67.2
Change in foreign currency translation and other		11.9			(44.0		)	32.9			(68.6		)
Recognition of net unrealized gains and losses for investments sold		(51.5		)	(32.1		)	(75.4		)	(72.1		)
Comprehensive net income		$	13.2		$	199.3		$	73.1		$	249.6
Basic earnings per share		$	10.75		$	13.64		$	19.67		$	30.03
Diluted earnings per share		10.72			13.64			19.61			29.94
Dividends declared and paid per common share		$	2.00		$	2.00		$	4.00		$	4.00

 

See Notes to Consolidated Financial Statements

4

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WHITE MOUNTAINS INSURANCE GROUP, LTD.

CONSOLIDATED STATEMENTS OF COMMON SHAREHOLDERS’ EQUITY

Unaudited

					Common						Accum. other
		Common			shares and						comprehensive
		shareholders’			paid-in			Retained			income,			Unearned
(Millions)		equity			surplus			earnings			after-tax			compensation
Balances at January 1, 2006		$	3,833.2		$	1,727.2		$	1,899.8		$	208.1		$	(1.9	)
Net income		211.8			—			211.8			—-			—
Other comprehensive income, after-tax		(138.7		)	—			—			(138.7		)	—
Cumulative effect adjustment — hybrid instruments		—			—			9.2			(9.2		)	—
Cumulative effect adjustment — share-based compensation		—			(1.9		)	—			—			1.9
Dividends declared on common shares		(43.1		)	—			(43.1		)	—			—
Issuances of common shares		.2			.2			—			—			—
Amortization of restricted common share awards		.9			.9			—			—			—
Balances at June 30, 2006		$	3,864.3		$	1,726.4		$	2,077.7		$	60.2		$	—

 

					Common						Accum. other
		Common			shares and						comprehensive
		shareholders’			paid-in			Retained			income,			Unearned
(Millions)		equity			surplus			earnings			after-tax			compensation
Balances at January 1, 2005		$	3,883.9		$	1,730.0		$	1,695.9		$	462.2		$	(4.2	)
Net income		323.1			—			323.1			—			—
Other comprehensive income, after-tax		(73.5		)	—			—			(73.5		)	—
Dividends declared on common shares		(43.1		)	—			(43.1		)	—			—
Changes to accrued option expense		.1			.1			—			—			—
Issuances of common shares		.3			.3			—			—			—
Repurchases and retirements of common shares		(.1		)	(.1		)	—			—			—
Amortization of restricted common share awards		1.1			—			—			—			1.1
Balances at June 30, 2005		$	4,091.8		$	1,730.3		$	1,975.9		$	388.7		$	(3.1	)

 

See Notes to Consolidated Financial Statements

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WHITE MOUNTAINS INSURANCE GROUP, LTD.

CONSOLIDATED STATEMENTS OF CASH FLOWS

Unaudited

		Six Months Ended
		June 30,
(Millions)		2006			2005
Cash flows from operations:
Net income		$	211.8		$	323.1
Charges (credits) to reconcile net income to net cash used for operations:
Net realized investment gains		(135.0		)	(100.4		)
Other operating items:
Net change in loss and loss adjustment expense reserves		(532.0		)	203.5
Net change in reinsurance recoverable on paid and unpaid losses		340.7			(668.4		)
Net change in unearned insurance and reinsurance premiums		130.4			14.2
Net change in funds held by ceding companies		62.8			154.2
Net change in deferred acquisition costs		(33.8		)	(1.7		)
Net change in funds held under reinsurance treaties		(34.8		)	8.6
Net change in insurance and reinsurance premiums receivable		(34.4		)	53.4
Net change in other assets and liabilities, net		(125.4		)	(243.5		)
Net cash used for operations		(149.7		)	(257.0		)
Cash flows from investing activities:
Net change in short-term investments		(109.8		)	300.4
Sales of fixed maturity investments		2,344.7			2,457.9
Maturities, calls and paydowns of fixed maturity investments		445.3			450.8
Sales of common equity securities		252.3			251.4
Sales of other investments		23.3			94.8
Purchases of other investments		(40.4		)	(108.4		)
Purchases of common equity securities		(280.0		)	(212.9		)
Purchases of fixed maturity investments		(2,488.8		)	(2,970.9		)
Net change in unsettled investment purchases and sales		18.4			65.2
Net acquisitions of property and equipment		(8.5		)	(31.9		)
Net cash provided from investing activities		156.5			296.4
Cash flows from financing activities:
Issuance of debt		50.0			—
Cash dividends paid to common shareholders		(43.1		)	(43.1		)
Cash dividends paid to preferred shareholders		(15.1		)	(15.1		)
Proceeds from issuances of common shares		.1			.3
Net cash used for financing activities		(8.1		)	(57.9		)
Effect of exchange rate changes on cash		5.2			(20.6		)
Net increase (decrease) in cash during the period		3.9			(39.1		)
Cash balances at beginning of period		187.7			243.1
Cash balances at end of period		$	191.6		$	204.0
Supplemental cash flows information:
Interest paid		$	(22.5	)	$	(21.5	)
Net Federal income taxes received (paid)		17.5			(36.4		)

 

See Notes to Consolidated Financial Statements

6

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

Note 1.   Summary of Significant Accounting Policies

Basis of Presentation

These interim consolidated financial statements include the accounts of White Mountains Insurance Group, Ltd. (the “Company” or the “Registrant”) and its subsidiaries (collectively, “White Mountains”) and have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”). The Company is an exempted Bermuda limited liability company with its headquarters located at the Bank of Butterfield Building, 42 Reid Street, 6th Floor, Hamilton HM 12, Bermuda. The Company’s principal executive office is located at Harborside Financial Center, Plaza 5, Jersey City, New Jersey 07311-1114 and its registered office is located at Clarendon House, 2 Church Street, Hamilton HM 11, Bermuda. White Mountains’ reportable segments are OneBeacon, White Mountains Re, Esurance and Other Operations, as defined below.

The OneBeacon segment consists of the OneBeacon Insurance Group LLC family of companies (collectively “OneBeacon”), which 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, personal and commercial products and services sold primarily through select independent agents. OneBeacon was acquired by White Mountains in 2001 (the “OneBeacon Acquisition”).

The White Mountains Re segment consists of White Mountains Re Group, Ltd. and its subsidiaries (collectively “White Mountains Re”). White Mountains Re offers lead reinsurance capacity for property, liability, accident & health, aviation and certain marine exposures on a worldwide basis through its reinsurance subsidiaries, Folksamerica Reinsurance Company (“Folksamerica Re”, together with its parent, Folksamerica Holding Company, “Folksamerica”), which has been a wholly-owned subsidiary of White Mountains since 1998, and Sirius International Insurance Corporation (“Sirius International”), which has been a wholly-owned subsidiary of White Mountains since 2004. White Mountains’ reinsurance operations also include its wholly-owned subsidiaries Scandinavian Reinsurance Company Ltd. (“Scandinavian Re”), a reinsurance company that has been in run-off since 2002, as well as White Mountains Underwriting Limited (domiciled in Ireland) and White Mountains Underwriting (Bermuda) Limited (collectively, “WMU”). WMU is an underwriting advisory company specializing in international property and marine excess reinsurance.  In April of 2006, White Mountains Re entered into an agreement to sell its wholly-owned subsidiary, Sirius America Insurance Company (“Sirius America”), which provides primary insurance programs in the United States, to an investor group led by Lightyear Capital for approximately $139 million. As part of the transaction, White Mountains will acquire an equity interest of approximately 18% in the acquiring entity.  The sale is expected to close during the third quarter of 2006.

The Esurance segment consists of Esurance Holdings, Inc. and its subsidiaries (collectively, “Esurance”). Esurance, which has been a unit of White Mountains since 2000, markets personal auto insurance directly to consumers online and through select online agents.

White Mountains’ Other Operations segment consists of the Company and its intermediate holding companies, its wholly-owned investment management subsidiary, White Mountains Advisors LLC (“WM Advisors”), as well as the International American Group, Inc. (the “International American Group”). The International American Group, which was acquired by White Mountains in 1999, consists of American Centennial Insurance Company (“American Centennial”) and British Insurance Company of Cayman (“British Insurance Company”), both of which are in run-off. The Other Operations segment also includes White Mountains’ investments in warrants to purchase common shares of both Montpelier Re Holdings, Ltd. (“Montpelier Re”) and Symetra Financial Corporation (“Symetra”).

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 White Mountains and are of a normal recurring nature. 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 2005 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 2005 Annual Report on Form 10-K for a complete discussion regarding White Mountains’ significant accounting policies.

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Weather Derivative Contracts

During 2006, White Mountains entered into the weather risk management business through its new subsidiary, Galileo Weather Risk Management, Ltd. (“Galileo”). Galileo offers weather risk management products, which currently are all in the form of derivative financial instruments. All weather derivatives are recognized as either assets or liabilities in the balance sheet at fair value.  Galileo’s weather derivatives do not meet the GAAP criteria for hedge accounting.  Accordingly, changes in fair value of exchange traded contracts are recognized currently as gains or losses within the income statement. At June 30, 2006, White Mountains recognized a net asset of $.7 million for the fair value of exchange traded weather derivative contracts. The gain (loss) at the inception date for contracts valued based upon internal pricing models are deferred, with changes in fair value subsequent to inception recognized currently as gains or losses within the income statement.  At June 30, 2006, White Mountains had a net liability of $9.7 million for weather derivative contracts valued based on internal pricing models.  The net liability includes $5.1 million of inception date deferred gains which upon ultimate recognition will reduce the liability balance.  Galileo has also received consideration of $8.9 million on its derivative contracts.

Fair values for exchange traded contracts are based upon quoted market prices, where available. Where quoted market prices are not available, management uses available market data and internal pricing models based upon consistent statistical methodologies to estimate fair values. Fair values are subject to change in the near-term and reflect management’s best estimate based on various factors including, but not limited to, realized and forecasted weather conditions, changes in interest or foreign currency exchange rates and other market factors. Estimating the fair value of derivative instruments that do not have quoted market prices requires management’s judgment in determining amounts that could reasonably be expected to be received from or paid to a third party to settle the contracts. Such amounts could be materially different from the amounts that might be realized in an actual transaction to settle the contract with a third party.

As of June 30, 2006, all of Galileo’s weather derivative contracts mature in less than one year.

Recently Adopted Accounting Pronouncements

Share-Based Compensation

In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard (“FAS”) No. 123 (Revised), “Share-Based Payment” (“FAS 123R”), which is a revision to FAS 123 and supersedes Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”), and related interpretations, including FASB Interpretation No. 28, “Accounting for Stock Appreciation Rights and Other Variable Stock Options or Award Plans” (“FIN 28”). Effective January 1, 2006, White Mountains adopted FAS 123R to account for its share-based compensation under the modified prospective method of adoption. Under this method of adoption, FAS 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 White Mountains incentive stock options (“Options”), restricted common share awards (“Restricted Shares”) and performance share awards, as well as new awards will be subject to the fair value measurement and recognition requirements of FAS 123R.

        White Mountains’ share-based compensation plans consist primarily of performance shares with limited use of Restricted Shares and a one-time grant of Options in 2000.  Prior to adoption of FAS 123R, White Mountains accounted for these plans under the recognition and measurement principles of APB 25 and FIN 28, and adopted the disclosure provisions of FAS 123.

Under APB 25 and FIN 28, 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. The compensation cost recognized for White Mountains’ Restricted Shares under APB 25 was based upon fair value of the award at the date of issuance and was charged to compensation expense ratably over the service period. Forfeitures were recognized as they occurred. Upon adoption of FAS 123R an estimate of future forfeitures was incorporated into the determination of the compensation cost for performance shares and Restricted Shares.  The effect of this change was immaterial.

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White Mountains’ Options have an escalating exercise price and vest on a pro rata basis over the service period. As a result, the Company’s outstanding Options were accounted for as variable awards under FIN 28, with compensation expense charged to earnings over the service period based on the intrinsic value of the underlying common shares and forfeitures recognized as they occurred.  Upon adoption of FAS 123R, the grant date fair value of the awards as originally disclosed for FAS 123, adjusted for estimated future forfeitures, became the basis for recognition of compensation expense for the Options.

The following table illustrates the pro forma effect on net income and earnings per share for the three and six months ended June 30, 2005 as if the Company had applied the fair value recognition provisions of FAS 123 to its Options at those times. The fair value of each option award at the grant date (February 28, 2000) was estimated using a closed-form option model using an expected volatility assumption of 18.5%, a risk-free interest rate assumption of 6.4% and an expected term of ten years.

Millions, except per share amounts		Three Months Ended June 30, 2005			Six Months Ended June 30, 2005
Net income, as reported		$	146.8		$	323.1
Add: Option expense included in reported net income under APB 25 and FIN 28		1.1			.1
Less: Option expense determined under FAS 123		—			—
Net income, pro forma		$	147.9		$	323.2
Earnings per share:
Basic—as reported		$	13.64		$	30.03
Basic—pro forma		13.74			30.03
Diluted—as reported		$	13.64		$	29.94
Diluted—pro forma		13.74			29.94

 

Performance Shares

For purposes of this presentation, performance shares include both performance shares granted under White Mountains’ Long-Term Incentive Plan and performance shares and phantom performance shares granted under subsidiary performance plans.

The following summarizes performance share activity for the three and six months ended June 30, 2006 and 2005:

		Three Months Ended June 30,										Six Months Ended June 30,
		2006					2005					2006					2005
Millions, except share amounts		Target Performance Shares Outstanding		Accrued Expense			Target Performance Shares Outstanding		Accrued Expense			Target Performance Shares Outstanding		Accrued Expense			Target Performance Shares Outstanding		Accrued Expense
Beginning of period		185,363		$	58.9		221,940		$	113.8		183,317		$	100.5		368,646		$	340.0
Payments and deferrals(1)(2)		—		—			—		—			(64,100	)	(57.0		)	(212,611	)	(234.5		)
Forfeitures and cancellations		—		—			(250	)	(.1		)	(5,039	)	(1.4		)	(1,435	)	(1.5		)
New awards		—		—			1,000		—			71,185		—			68,090		—
Expense recognized		—		(1.3		)	—		24.6			—		15.5			—		34.3
Ending June 30,		185,363		$	57.6		222,690		$	138.3		185,363		$	57.6		222,690		$	138.3

(1)             Performance share payments in 2006 for the 2003-2005 performance cycle ranged from 142% to 181% of target.

(2)             Performance share payments in 2005 for the 2002-2004 performance cycle ranged from 160% to 180% of target.

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The following summarizes performance shares outstanding and accrued performance share expense at June 30, 2006 for each performance cycle:

 

If 100% of the outstanding performance shares had been vested on June 30, 2006, the total additional compensation cost to be recognized would have been $56.2 million, based on current accrual factors (common share price and payout assumptions).

All performance shares earned for the 2003-2005 and the 2002-2004 performance cycles were settled in cash or by deferral into certain non-qualified deferred compensation plans of the Company or its subsidiaries.

Restricted Shares

The following outlines the unrecognized compensation cost associated with the outstanding Restricted Share awards for the three and six months ended June 30, 2006 and 2005:

		Three Months Ended June 30,										Six Months Ended June 30,
		2006					2005					2006					2005
Millions, except share amounts		Restricted Shares		Unamortized Grant Date Fair Value			Restricted Shares		Unamortized Grant Date Fair Value			Restricted Shares		Unamortized Grant Date Fair Value			Restricted Shares		Unamortized Grant Date Fair Value
Non-vested, beginning of period,		13,000		$	1.4		15,000		$	3.7		13,000		$	1.9		15,000		$	4.2
Granted		—		—			—		—			—		—			—		—
Vested		(3,000	)	—			(1,000	)	—			(3,000	)	—			(1,000	)	—
Forfeited		—		—			—		—			—		—			—		—
Expense recognized		—		(.4		)	—		(.6		)	—		(.9		)	—		(1.1		)
Non-vested at June 30,		10,000		$	1.0		14,000		$	3.1		10,000		$	1.0		14,000		$	3.1

 

The 10,000 Restricted Shares outstanding at June 30, 2006 are scheduled to cliff vest on February 23, 2007.  The unrecognized compensation cost of $1.0 million at June 30, 2006 is expected to be recognized over the remaining vesting period.  Vesting is dependent on continuous service by the employee throughout the award period.  Upon vesting, all restrictions initially placed upon the common shares lapse.

Upon adopting FAS 123R, on January 1, 2006 White Mountains recorded an adjustment of $1.9 million to reclassify unearned compensation in common shareholders’ equity relating to its outstanding Restricted Shares to opening paid-in surplus to reflect the cumulative effect of adoption.

Options

The Company issued 81,000 Options to certain key employees on February 28, 2000 (the grant date).  There have been no further Option issuances. The Options were issued at an exercise price equal to the market price of the underlying common shares on February 27, 2000.  The exercise price escalates by 6% per annum, compounded daily over the life of the Options. The Options vest ratably over a ten-year service period.

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The following summarizes the Company’s Option activity for the three and six months ended June 30, 2006 and 2005:

		Three Months Ended June 30,						Six Months Ended June 30,
Millions, except share and per share amounts		2006			2005			2006			2005
Opening balance—outstanding Options		33,450			44,730			34,280			46,530
Vested during period		—			—			—			—
Forfeited		—			—			—			—
Exercised		—			—			(830		)	(1,800		)
Ending balance—outstanding Options		33,450			44,730			33,450			44,730
Outstanding Options—exercisable		8,250			8,730			8,250			8,730
Exercise price—outstanding Options at beginning of period		$	151.40		$	142.83		$	149.25		$	140.80
Intrinsic value of Options exercised		$	—		$	—		$	.3		$	.9
Exercise price—outstanding Options at June 30,		$	153.65		$	144.95		$	153.65		$	144.95
Compensation expense		$	—		$	1.1		$	—		$	.1

 

The total in-the-money value of all outstanding Options and those Options currently exercisable at June 30, 2006 was $11.2 million and $2.8 million, respectively. The remaining term of all outstanding Options is 44 months.  White Mountains expects approximately 6,300 Options to become exercisable in 2006 and will issue common shares when the Options are exercised.

Hybrid Financial Instruments

On February 16, 2006, the FASB issued FAS No. 155, “Accounting for Certain Hybrid Instruments, an amendment to Statement Nos. 133 and 140” (“FAS 155”). The Statement eliminates the requirement to bifurcate financial instruments with embedded derivatives if the holder of the instrument elects to account for the entire instrument on a fair value basis. Changes in fair value are recorded as realized gains. The fair value election may be applied upon adoption of the statement for hybrid instruments that had been bifurcated under FAS 133 prior to adoption. The Statement is effective for fiscal years commencing after September 15, 2006 with early adoption permitted as of the beginning of an entity’s fiscal year.

White Mountains has adopted FAS 155 effective January 1, 2006.  Prior to adopting this statement, White Mountains had bifurcated the equity conversion option in its investment in convertible bonds. Changes in the fair value of the host instrument, the convertible bonds, were recorded as unrealized gains (losses) on investments while changes in the fair value of the equity conversion option were recorded as realized investment gains (losses).  At December 31, 2005, White Mountains had recorded $283.5 million related to the host instrument in fixed maturity investments and $99.8 million for the equity conversion option in other investments.  Upon adopting FAS 155, White Mountains recorded an adjustment of $9.2 million to reclassify net unrealized gains on investments (gross gains of $9.8 million and gross losses of $.6 million) to opening retained earnings to reflect the cumulative effect of adoption.  At June 30, 2006, White Mountains had $353.8 million of convertible bonds recorded in fixed maturity investments.

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Recent Accounting Pronouncements

Income Taxes

In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”). FIN 48 is an interpretation of FAS Statement No. 109, “Accounting for Income Taxes.” The Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.  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, a company should presume 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 provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The Interpretation is effective for fiscal years beginning after December 15, 2006. White Mountains expects to adopt FIN 48 on January 1, 2007 and does not expect the adoption to have a material effect on its financial condition, results of operations or cash flows.

Note 2.   Loss and Loss Adjustment Expense Reserves

The following table summarizes the loss and loss adjustment expense (“LAE”) reserve activities of White Mountains’ insurance and reinsurance subsidiaries for the three and six months ended June 30, 2006 and 2005:

		Three Months Ended June 30,						Six Months Ended June 30,
Millions		2006			2005			2006			2005
Gross beginning balance		$	9,987.0		$	9,199.8		$	10,231.2		$	9,398.5
Less beginning reinsurance recoverable on unpaid losses		(4,860.0		)	(3,672.8		)	(5,025.7		)	(3,797.4		)
Net loss and LAE reserves		5,127.0			5,527.0			5,205.5			5,601.1
Loss and LAE incurred relating to:
Current year losses		569.1			570.5			1,122.9			1,190.8
Prior year losses(1)		194.7			(.3		)	204.9			(1.3		)
Total incurred losses and LAE		763.8			570.2			1,327.8			1,189.5
Accretion of fair value adjustment to loss and LAE reserves		6.4			9.1			11.6			19.0
Foreign currency translation adjustment to loss and LAE reserves		11.9			(33.7		)	19.9			(28.2		)
Loss and LAE paid relating to:
Current year losses		(213.7		)	(183.6		)	(371.0		)	(292.1		)
Prior year losses		(584.3		)	(756.7		)	(1,082.7		)	(1,357.0		)
Total loss and LAE payments		(798.0		)	(940.3		)	(1,453.7		)	(1,649.1		)
Net ending balance		5,111.1			5,132.3			5,111.1			5,132.3
Plus ending reinsurance recoverable on unpaid losses		4,664.2			4,403.5			4,664.2			4,403.5
Gross ending balance		$	9,775.3		$	9,535.8		$	9,775.3		$	9,535.8

(1)             During the six months ended June 30, 2005, White Mountains Re recorded $6 million of unfavorable development on its workers compensation reserves relating to its Sierra Insurance Group acquisition, which was offset dollar-for-dollar by a reduction in the principal amount of the adjustable note that White Mountains Re issued as part of the financing of that acquisition.

White Mountains experienced $194.7 million and $204.9 million of net unfavorable development on prior accident year loss reserves during the three and six months ended June 30, 2006, respectively, which was primarily related to adverse development on loss and LAE reserves previously established for hurricanes Katrina, Rita and Wilma.

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In June 2006, following the receipt of new claims information reported from several ceding companies and subsequent reassessment of the ultimate loss exposures, White Mountains Re increased its gross loss estimates for hurricanes Katrina, Rita and Wilma by $201 million.

White Mountains Re believes that several factors influenced the timing and amount of the increase in White Mountains Re’s gross loss estimates.  As a result of newly reported claims on off-shore energy and marine exposures, Folksamerica Re set its gross loss and LAE reserves as of June 30, 2006 on off-shore energy and marine exposures for hurricanes Katrina and Rita at full contract limits and also increased reserves on other exposures affected by hurricanes Katrina, Rita and Wilma.

Under the terms of Folksamerica Re’s 2005 quota share reinsurance treaty with Olympus Reinsurance Company (“Olympus”), $139 million of these losses, net of reinstatement premiums, from hurricanes Katrina, Rita and Wilma recorded in the second quarter of 2006 were ceded to Olympus.  However, Folksamerica entered into an indemnity agreement on June 16, 2006 with Olympus (the “Indemnity Agreement”) under which Folksamerica agreed to reimburse Olympus for up to $137 million of these losses, which has been recorded as loss and LAE expense during the second quarter of 2006.

During the three and six months ended June 30, 2005, White Mountains did not experience any material favorable or unfavorable development on prior accident year loss reserves.

In connection with purchase accounting for the acquisitions of OneBeacon and Sirius, White Mountains was required to adjust loss and LAE reserves and the related reinsurance recoverables to fair value on OneBeacon’s and Sirius’ acquired 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, White Mountains recognized $6.4 million and $11.6 million of such charges for the three and six months ended June 30, 2006, respectively, and $9.1 million and $19.0 million of such charges for the three and six months ended June 30, 2005, respectively.

As a result of a re-evaluation during the first quarter of 2006 of the remaining run-off contracts at Scandinavian Re, White Mountains Re reduced its unallocated loss adjustment expense reserve by approximately $6.5 million and has modified the accretion of its net fair value adjustment established in purchase accounting. The change in accretion, which will be made prospectively over the remaining amortization period, resulted in approximately $.1 million of expense for the first six months of 2006 compared to an expense of $6.0 million for the comparable period in the prior year.

Note 3.   Third Party Reinsurance

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

Reinsurance Protection

Effective July 1, 2006, OneBeacon renewed its property catastrophe reinsurance program through June 30, 2007.  Under that program, which provides substantially the same coverage as the prior year, the first $200 million of losses resulting from any single catastrophe are retained by OneBeacon and losses from a single event in excess of $200 million and up to $850 million are reinsured for 100% of the loss.  In the event of a catastrophe, OneBeacon’s property catastrophe reinsurance program is reinstated for the remainder of the original contract term by paying a reinstatement premium that is based on the percentage of coverage reinstated and the original property catastrophe coverage premium.

During the first quarter of 2006, Folksamerica Re purchased a series of Second Event Industry Loss Warranty Covers (“ILW”) for a total annual cost of $19 million.  This reinsurance protection has a total limit of $150 million from multiple retrocessionaires. The ILW was purchased to protect Folksamerica Re’s balance sheet from the adverse impact of the occurrence of two significant natural peril catastrophic events in the United States during 2006 (“Loss Events”).  Coverage is not dependent on the order in which the Loss Events occur, and Folksamerica Re can only recover losses that it actually incurs as a result of the Loss Events.

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OneBeacon

At June 30, 2006, OneBeacon had $33.4 million of reinsurance recoverables on paid losses and $3,216.6 million (gross of $249.1 million in purchase accounting adjustments, as described in Note 2) 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.

Top Reinsurers ($ in millions)		Balance at June 30, 2006			% of Total		A.M. Best Rating (1)
Subsidiaries of Berkshire (NICO and GRC)(2)		$	2,270.0		82	%	A++
Liberty Mutual Insurance Group and subsidiaries(3)		77.2			2		A
American Re-Insurance Company		58.4			2		A
Nichido (formerly Tokio Fire and Marine Insurance Company)		52.2			2		A++
Swiss Re		24.4			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 (as defined below) if they are unable to collect from third party reinsurers. OneBeacon also has an additional $408 million of Third Party Recoverables from various reinsurers, the majority of which are rated “A” or better by A.M. Best.

(3)             At June 30, 2006, OneBeacon had assumed balances payable and expenses payable of approximately $5.0 million under its renewal rights agreement with Liberty Mutual Insurance Group (“Liberty Mutual”), which expired on October 31, 2003. In the event of a Liberty Mutual insolvency, OneBeacon has the right to offset these balances against its reinsurance recoverable due from Liberty Mutual.

In connection with the OneBeacon Acquisition, the seller caused OneBeacon to purchase two reinsurance contracts: a full risk-transfer cover from NICO for up to $2.5 billion in old A&E claims and certain other exposures (the “NICO Cover”) and an adverse development cover from General Reinsurance Corporation (“GRC”) for up to $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”). NICO and GRC are wholly-owned subsidiaries of Berkshire Hathaway Inc. (“Berkshire”).

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. White Mountains estimates that on an incurred basis, net of Third Party Recoverables, as of June 30, 2006 it has used approximately $2.1 billion of the coverage provided by NICO. Approximately $816 million of these incurred losses have been paid by NICO through June 30, 2006. At June 30, 2006, $27.4 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 White Mountains’ 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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