UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x                              QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the period ended September 30, 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.

Large accelerated filer x   Accelerated filer o   Non-accelerated filer  o

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

As of October 31, 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, September 30, 2006 and December 31, 2005			3
		Consolidated Statements of Income and Comprehensive Income, Three and Nine Months Ended September 30, 2006 and 2005			4
		Consolidated Statements of Common Shareholders’ Equity, Nine Months Ended September 30, 2006 and 2005			5
		Consolidated Statements of Cash Flows, Nine Months Ended September 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			32
		Results of Operations—Three and Nine Months Ended September 30, 2006 and 2005			32
		Non-GAAP Financial Measures			48
		Liquidity and Capital Resources			49
		Critical Accounting Estimates			53
		Forward-Looking Statements			54
Item 3.		Quantitative and Qualitative Disclosures About Market Risk			55
Item 4.		Controls and Procedures			56
PART II.		OTHER INFORMATION
Items 1 through 6.					56
SIGNATURES					58

 

2

 

PART I. FINANCIAL INFORMATION.

Item 1. Financial Statements

WHITE MOUNTAINS INSURANCE GROUP, LTD.
CONSOLIDATED BALANCE SHEETS

($ in millions, except share and per share amounts)		September 30, 2006			December 31, 2005
		Unaudited
Assets
Fixed maturity investments, at fair value (amortized cost: $7,026.7 and $7,548.4)		$	7,089.2		$	7,582.7
Common equity securities, at fair value (cost: $844.0 and $796.5)		1,042.0			967.8
Short-term investments, at amortized cost (which approximates fair value)		1,222.8			727.8
Other investments (cost: $462.6 and $510.8)		498.0			588.1
Total investments		9,852.0			9,866.4
Cash		210.3			187.7
Reinsurance recoverable on unpaid losses		2,348.0			3,003.6
Reinsurance recoverable on unpaid losses - Berkshire Hathaway Inc.		1,902.3			2,022.1
Reinsurance recoverable on paid losses		89.3			77.0
Insurance and reinsurance premiums receivable		1,002.3			1,014.3
Securities lending collateral		583.8			674.9
Funds held by ceding companies		467.5			620.4
Investments in unconsolidated insurance affiliates		529.1			479.7
Deferred tax asset		288.9			341.2
Deferred acquisition costs		333.5			288.4
Ceded unearned premiums		113.7			200.7
Investment income accrued		81.8			93.5
Accounts receivable on unsettled investment sales		354.1			21.7
Other assets		555.5			526.5
Total assets		$	18,712.1		$	19,418.1
Liabilities
Loss and loss adjustment expense reserves		$	9,114.2		$	10,231.2
Reserves for structured contracts		153.5			224.6
Unearned insurance and reinsurance premiums		1,714.9			1,582.0
Debt		794.2			779.1
Securities lending payable		583.8			674.9
Deferred tax liability		241.1			274.3
Ceded reinsurance payable		135.6			204.5
Funds held under reinsurance treaties		119.6			171.4
Accounts payable on unsettled investment purchases		303.5			43.4
Other liabilities		1,178.5			1,165.5
Preferred stock subject to mandatory redemption:
Held by Berkshire Hathaway Inc. (redemption value $300.0)		234.5			214.0
Held by others (redemption value $20.0)		20.0			20.0
Total liabilities		14,593.4			15,584.9
Common shareholders’ equity
Common shares at $1 par value per share—authorized 50,000,000 shares;issued and outstanding 10,780,053 and 10,779,223 shares		10.8			10.8
Paid-in surplus		1,715.9			1,716.4
Retained earnings		2,218.2			1,899.8
Accumulated other comprehensive income, after-tax:
Net unrealized gains on investments		165.7			233.9
Net unrealized foreign currency translation gains (losses)		11.5			(21.8		)
Minimum pension liability and other		(3.4		)	(4.0		)
Unearned compensation - restricted common share awards		—			(1.9		)
Total common shareholders’ equity		4,118.7			3,833.2
Total liabilities and common shareholders’ equity		$	18,712.1		$	19,418.1

 

See Notes to Consolidated Financial Statements

3

 

WHITE MOUNTAINS INSURANCE GROUP, LTD.

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
Unaudited

		Three Months Ended						Nine Months Ended
		September 30,						September 30,
(Millions, except per share amounts)		2006			2005			2006			2005
Revenues:
Earned insurance and reinsurance premiums		$	918.9		$	982.4		$	2,773.4		$	2,880.8
Net investment income		108.7			110.8			311.6			389.3
Net realized investment gains		67.8			18.9			202.8			119.3
Other revenue		90.8			65.5			157.1			184.4
Total revenues		1,186.2			1,177.6			3,444.9			3,573.8
Expenses:
Loss and loss adjustment expenses		558.1			929.6			1,885.9			2,119.1
Insurance and reinsurance acquisition expenses		189.3			199.7			562.6			572.9
Other underwriting expenses		122.8			104.4			361.5			352.9
General and administrative expenses		55.8			40.8			125.5			142.0
Accretion of fair value adjustment to loss and loss adjustment expense reserves		6.6			9.1			18.2			28.1
Interest expense on debt		12.9			11.5			36.5			34.8
Interest expense - dividends on preferred stock subject to mandatory redemption		7.6			7.6			22.7			22.7
Interest expense - accretion on preferred stock subject to mandatory redemption		7.3			5.7			20.6			16.1
Total expenses		960.4			1,308.4			3,033.5			3,288.6
Pre-tax income (loss)		225.8			(130.8		)	411.4			285.2
Income tax benefit (provision)		(69.3		)	55.6			(66.9		)	(56.1		)
Income (loss) before equity in earnings of unconsolidated affiliates		156.5			(75.2		)	344.5			229.1
Equity in earnings of unconsolidated insurance affiliates		5.6			8.9			29.4			27.7
Net income (loss)		162.1			(66.3		)	373.9			256.8
Change in net unrealized gains and losses for investments held		151.8			(66.9		)	55.6			.3
Change in foreign currency translation and other		1.0			1.6			33.9			(67.0		)
Recognition of net unrealized gains and losses for investments sold		(39.2		)	(55.5		)	(114.6		)	(127.6		)
Comprehensive net income (loss)		$	275.7		$	(187.1	)	$	348.8		$	62.5
Basic earnings (loss) per share		$	15.05		$	(6.16	)	$	34.72		$	23.87
Diluted earnings (loss) per share		15.01			(6.16		)	34.61			23.73
Dividends declared and paid per common share		$	2.00		$	2.00		$	6.00		$	6.00

 

See Notes to Consolidated Financial Statements

4

 

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		373.9			—			373.9			—			—
Other comprehensive loss, after-tax		(25.1		)	—			—			(25.1		)	—
Cumulative effect adjustment - hybrid instruments		—			—			9.2			(9.2		)	—
Cumulative effect adjustment - share-based compensation		—			(1.9		)	—			—			1.9
Dividends declared on common shares		(64.7		)	—			(64.7		)	—			—
Issuances of common shares		.1			.1			—			—			—
Amortization of restricted common share awards		1.3			1.3			—			—			—
Balances at September 30, 2006		$	4,118.7		$	1,726.7		$	2,218.2		$	173.8		$	—

 

					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		256.8			—			256.8			—			—
Other comprehensive income, after-tax		(194.3		)	—			—			(194.3		)	—
Dividends declared on common shares		(64.6		)	—			(64.6		)	—			—
Changes to accrued option expense		(.6		)	(.6		)	—			—			—
Issuances of common shares		.3			.3			—			—			—
Repurchases and retirements of common shares		(.5		)	(.4		)	(.1		)	—			—
Amortization of restricted common share awards		1.8			—			—			—			1.8
Balances at September 30, 2005		$	3,882.8		$	1,729.3		$	1,888.0		$	267.9		$	(2.4	)

 

See Notes to Consolidated Financial Statements

5

WHITE MOUNTAINS INSURANCE GROUP, LTD.

CONSOLIDATED STATEMENTS OF CASH FLOWS

Unaudited

		Nine Months Ended September 30,
(Millions)		2006			2005
Cash flows from operations:
Net income		$	373.9		$	256.8
Charges (credits) to reconcile net income to net cash used for operations:
Net realized investment gains		(202.8		)	(119.3		)
Other operating items:
Net change in loss and loss adjustment expense reserves		(833.7		)	1,018.8
Net change in reinsurance recoverable on paid and unpaid losses		519.5			(1,132.3		)
Net change in unearned insurance and reinsurance premiums		168.2			93.1
Net change in reserves for structured contracts		(71.1		)	(107.0		)
Net change in funds held by ceding companies		157.5			206.0
Net change in deferred acquisition costs		(50.0		)	(17.7		)
Net change in funds held under reinsurance treaties		(49.9		)	38.7
Net change in insurance and reinsurance premiums receivable		16.0			(164.6		)
Net change in other assets and liabilities, net		33.5			(104.4		)
Net cash provided from (used for) operations		61.1			(31.9		)
Cash flows from investing activities:
Net change in short-term investments		(472.4		)	(21.4		)
Sales of fixed maturity investments		3,398.4			4,345.9
Maturities, calls and paydowns of fixed maturity investments		613.4			722.9
Sales of common equity securities		557.7			409.1
Sales of other investments		49.9			114.8
Sales of consolidated affiliate, net of cash sold		121.1			180.6
Sale of renewal rights		32.0			—
Purchases of other investments		(80.6		)	(126.9		)
Purchases of common equity securities		(435.8		)	(335.9		)
Purchases of fixed maturity investments		(3,671.6		)	(5,286.6		)
Net change in unsettled investment purchases and sales		(72.2		)	124.9
Net acquisitions of property and equipment		(11.9		)	(36.4		)
Net cash provided from investing activities		28.0			91.0
Cash flows from financing activities:
Issuance of debt		65.0			—
Repayment of debt		(50.0		)	—
Cash dividends paid to common shareholders		(64.7		)	(64.6		)
Cash dividends paid to preferred shareholders		(22.7		)	(22.7		)
Proceeds from issuances of common shares		.1			.3
Net cash used for financing activities		(72.3		)	(87.0		)
Effect of exchange rate changes on cash		5.8			(9.8		)
Net increase (decrease) in cash during the period		22.6			(37.7		)
Cash balances at beginning of period		187.7			243.1
Cash balances at end of period		$	210.3		$	205.4
Supplemental cash flows information:
Interest paid		$	23.9		$	21.7
Net Federal income taxes received		17.5			8.6

 

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, Ltd. 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 and brokers. OneBeacon was acquired by White Mountains in 2001 (the “OneBeacon Acquisition”).  During the third quarter of 2006, OneBeacon Insurance Group, Ltd. (“OneBeacon Ltd.”) filed a registration statement on Form S-1 (the “OneBeacon S-1”) with the Securities and Exchange Commission (“SEC”) for a proposed initial public offering of up to 20 million of its common shares (the “Offering”), which represents 20% of the total common shares of OneBeacon Ltd. before an option for the underwriters to purchase an additional 3 million shares. In connection with the Offering, White Mountains undertook an internal reorganization (the “Reorganization”) and formed OneBeacon Ltd. for the purpose of holding certain of its property and casualty insurance businesses. As a result of the Reorganization, certain of White Mountains’ businesses that have been historically reported as part of its Other Operations segment, including the legal entities that issued the Senior Notes and mandatorily redeemable preferred stock, are now owned by OneBeacon Ltd., and accordingly have been included in the OneBeacon segment. In addition, certain other businesses of White Mountains that will not be held by OneBeacon Ltd. following the Offering that have been historically reported as part of its OneBeacon segment are included in the Other Operations segment.

The White Mountains Re segment consists of White Mountains Re Group, Ltd. and its subsidiaries (collectively “White Mountains Re”). White Mountains Re offers 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”, a wholly-owned subsidiary of Folksamerica Holding Company, “Folksamerica Holdings”), 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 and White Mountains Re Underwriting Services Ltd. (collectively, “WMU”). WMU is an underwriting advisory company specializing in international property and marine excess reinsurance.

The Esurance segment consists of Esurance Holdings, Inc. and its subsidiaries (collectively, “Esurance”). Esurance, which has been a unit of White Mountains since 2000, and wholly-owned since 2006, sells 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”), its newly formed weather risk management business through its new subsidiary, Galileo Weather Risk Management, Ltd. (“Galileo”), its newly formed variable annuity reinsurance business through its new subsidiary, White Mountains Life Re Limited,  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”).

7

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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.

Weather Derivative Contracts

During 2006, White Mountains entered into the weather risk management business through its newly formed subsidiary, Galileo. Galileo offers weather risk management products, which, at September 30, 2006, were 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.  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.

Galileo’s weather derivatives are not designed to, and do not meet the GAAP criteria for hedge accounting.  Accordingly, changes in fair value of exchange traded contracts are recognized as gains or losses within the income statement. The gain or 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 September 30, 2006, White Mountains recognized a net asset of $3.0 million for the fair value of exchange traded weather derivative contracts and a net liability of $8.8 million for weather derivative contracts valued based on internal pricing models.  The net liability balance includes $5.2 million of deferred gains.  Galileo has also received consideration of $5.2 million on its derivative contracts outstanding.   For the three and nine months ended September 30, 2006, Galileo recognized $1.5 million of net losses on its weather derivatives portfolio.

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

Variable Annuity Reinsurance

In August 2006, White Mountains entered into an agreement to reinsure death and living benefit guarantees associated with certain variable annuities issued in Japan.

Guaranteed minimum accumulation benefits (“GMABs”) are paid to an annuitant for any shortfall between accumulated account value at the end of the accumulation period and the annuitant’s total deposit, less any withdrawal payments made to the annuitant during the accumulation period. GMABs meet the definition of a derivative for accounting purposes and are accounted for under FAS 133. Therefore, GMABs are carried at fair value, with changes thereon recognized in income in the period of the change. The liability for the reinsured GMAB contracts has been determined using internal valuation models that use assumptions for interest rates, equity markets, foreign exchange rates and market volatilities at the valuation date, as well as annuitant-related actuarial assumptions, including surrender and mortality rates.

           If an annuitant dies during the accumulation period of an annuity contract, guaranteed minimum death benefits (“GMDBs”) are paid to the annuitant’s beneficiary for shortfalls between accumulated account value at the time of an annuitant’s death and the annuitant’s total deposit, less any living benefit payments or withdrawal payments previously made to the annuitant. GMDBs are accounted for in accordance with Statement of Position 03-1, “Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts” (the “SOP”). The liability for the reinsured GMDB contracts has been calculated using the methodology prescribed within the SOP for variable annuity contracts and based on investment returns, mortality, surrender rates and other assumptions.

8

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The valuation of these liabilities involve significant judgment and is subject to change based upon changes in capital market assumptions and emerging surrender and mortality experience of the underlying contracts in force.

White Mountains has entered into derivative contracts that are designed to economically hedge against changes in the fair value of living and death benefit liabilities. The derivatives include futures and over-the-counter option contracts on interest rates, major equity indices, and foreign currencies. All derivative instruments are recorded as assets or liabilities at fair value on the balance sheet. These derivative financial instruments do not meet the hedging criteria under FAS 133, and accordingly, changes in fair value are recognized in the current period as gains or losses in the income statement.

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.

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 with 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 nine months ended September 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.

9

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Millions, except per share amounts		Three Months Ended September 30, 2005			Nine Months Ended September 30, 2005
Net income (loss), as reported		$	(66.3	)	$	256.8
Add: Option income included in reported net income under APB 25 and FIN 28		(.7		)	(.6		)
Less: Option expense determined under FAS 123		—			(.1		)
Net income, pro forma		$	(67.0	)	$	256.1
Earnings per share:
Basic - as reported		$	(6.16	)	$	23.87
Basic - pro forma		(6.23		)	23.80
Diluted - as reported		$	(6.16	)	$	23.73
Diluted - pro forma		(6.23		)	23.72

 

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 nine months ended September 30, 2006 and 2005:

		Three Months Ended September 30,										Nine Months Ended September 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		$	57.6		222,690		$	138.3		183,031		$	100.5		368,646		$	340.0
Payments and deferrals (1) (2)		—		—			—		—			(64,100	)	(57.0		)	(212,611	)	(234.5		)
Forfeitures and cancellations		—		—			(24,350	)	(7.7		)	(4,753	)	(1.8		)	(25,785	)	(9.2		)
New awards		—		—			15,527		—			71,185		—			83,617		—
Expense recognized		—		10.0			—		(0.4		)	—		25.9			—		33.9
Ending September 30,		185,363		$	67.6		213,867		$	130.2		185,363		$	67.6		213,867		$	130.2

(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.

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

 

If 100% of the outstanding performance shares had been vested on September 30, 2006, the total additional compensation cost to be recognized would have been $50.7 million, based on current accrual factors (common share price and payout assumptions).

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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 nine months ended September 30, 2006 and 2005:

		Three Months Ended September 30,										Nine Months Ended September 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,		10,000		$	1.0		14,000		$	3.1		13,000		$	1.9		15,000		$	4.2
Granted		—		—			—		—			—		—			—		—
Vested		—		—			—		—			(3,000	)	—			(1,000	)	—
Forfeited		—		—			(1,000	)	(.3		)	—					(1,000	)	(.3		)
Expense recognized		—		(.4		)	—		(.4		)	—		(1.3		)	—		(1.5		)
Non-vested at September 30,		10,000		$	.6		13,000		$	2.4		10,000		$	.6		13,000		$	2.4

 

The 10,000 Restricted Shares outstanding at September 30, 2006 are scheduled to cliff vest on February 23, 2007.  The unrecognized compensation cost of $.6 million at September 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.

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

		Three Months Ended September 30,						Nine Months Ended September 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		(1,200		)	—			(1,200		)	—
Exercised		—			(450		)	(830		)	(2,250		)
Ending balance - outstanding Options		32,250			44,280			32,250			44,280
Outstanding Options - exercisable		8,250			8,280			8,250			8,280
Exercise price - outstanding Options at beginning of period		$	153.65		$	144.95		$	149.25		$	140.80
Intrinsic value of Options exercised		$	—		$	.2		$	.3		$	1.1
Exercise price - outstanding Options at end of period		$	155.93		$	147.10		$	155.93		$	147.10
Compensation expense (income)		$	—		$	(.7	)	$	—		$	(.6	)

 

The total in-the-money value of all outstanding Options and those Options currently exercisable at September 30, 2006 was $11.0 million and $2.8 million, respectively. The remaining term of all outstanding Options is 41 months.  White Mountains expects approximately 6,000 Options to become exercisable in 2006 and will issue common shares

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when the Options are exercised.

On October 18, 2006, in connection with the Offering, OneBeacon Ltd. issued 1,420,000 options to acquire its common shares to certain members of OneBeacon Ltd. management. The options have a 5 ½ year term and a $30.00 per share strike price. The options will not be exercisable if OneBeacon Ltd.’s Offering is not consummated within 60 days of the grant date.

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 September 30, 2006, White Mountains had $389.1 million of convertible bonds recorded in fixed maturity investments.

Recent Accounting Pronouncements

Defined Benefit Pension and Other Postretirement Plans

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans which amends FASB Statement Nos. 87, 88, 106 and 132(R). The Statement requires an employer that sponsors a defined benefit plan to recognize the funded status of a benefit plan, measured as the difference between plan assets at fair value and the projected benefit obligation (for defined benefit pension plans) or the accumulated benefit obligation (for other postretirement benefit plans) in its statement of financial position. The Statement also requires recognition of amounts previously deferred and amortized under FAS 87 and FAS 106 in other comprehensive income in the period in which they occur. Under the new Statement, plan assets and obligations must be measured as of the fiscal year end. The Statement is effective for fiscal years beginning after December 15, 2006. White Mountains does not expect adoption to have a significant effect on its financial condition, results of operations or cash flows.

Fair Value Measurements

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“FAS 157”). The Statement provides a revised definition of fair value and guidance on the methods used to measure fair value. The Statement also expands financial statement disclosure requirements for fair value information. The Statement establishes a fair value hierarchy that distinguishes between assumptions based on market data from independent sources (“observable inputs”) and a reporting entity’s internal assumptions based upon the best information available when external market data is limited or unavailable (“unobservable inputs”). The fair value hierarchy in FAS 157 prioritizes inputs within three levels. Quoted prices in active markets have the highest priority (Level 1) followed by observable inputs other than quoted prices (Level 2) and unobservable inputs having the lowest priority (Level 3). The guidance in FAS 157 is applicable to derivatives as well as other financial instruments measured at fair value and nullifies the guidance in EITF 02-3, FAS 133 and FAS 155 that provided for the deferral of gains at the date of initial measurement. The Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, with earlier application allowed for entities that have not issued financial statements in the fiscal year of adoption. White Mountains has not yet determined the effect of adoption on its financial condition, results of operations or cash flows.

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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 and requires additional disclosures.  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 does not expect the adoption to have a material effect on its financial condition, results of operations or cash flows.

Note 2.  Significant Transactions

On August 3, 2006, White Mountains Re sold its wholly-owned subsidiary, Sirius America Insurance Company (“Sirius America”), to an investor group led by Lightyear Capital for $138.8 million in cash, which was $16.9 million above the book value of Sirius America at the time of the sale. As part of the transaction, White Mountains acquired an equity interest of approximately 17% in the acquiring entity and accounts for its remaining interest in Sirius America on the equity method. White Mountains recognized a gain of $14 million ($9.1 million after tax) on the sale through other revenues in the third quarter of 2006 and has deferred $2.9 million ($1.9 million after tax) of the gain related to its remaining equity interest in Sirius America.

On August 16, 2006, OneBeacon signed a binding agreement to transfer to QBE Insurance Group, Ltd. (“QBE”) certain assets and the right to renew existing policies of Agri, a division of OneBeacon that provides commercial farm and ranch and commercial agricultural products. The gross written premiums for Agri totaled $85.7 million in 2005. The sale closed on September 29, 2006 for $32.0 million in cash and resulted in the recognition of a pre-tax gain of $30.4 million in the third quarter. In connection with this sale, OneBeacon has entered into agreements under which, at the option of QBE, OneBeacon will write the policies of Agri on a direct basis and cede 100% of this business to QBE.

 

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