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Variable Annuity Reinsurance and Weather Derivatives | 12 Months Ended
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Dec. 31, 2011
Variable Annuity Reinsurance and Weather Derivatives |
Variable Annuity Reinsurance and Weather Derivatives |
NOTE 8. Variable Annuity Reinsurance and Weather Derivatives White Mountains has entered into agreements to reinsure death and living benefit guarantees associated with certain variable annuities in Japan. At December 31, 2011, the total guarantee value was approximately ¥233.7 billion (approximately $3.0 billion at exchange rates on that date). The collective account values of the underlying variable annuities were approximately 78% of the guarantee value at December 31, 2011. The following table summarizes the pre-tax operating results of WM Life Re for the years ended December 31, 2011, 2010 and 2009:
|  | Year Ended December 31, |
Millions |  | 2011 |  | 2010 |  | 2009 |
Fees, included in other revenues |  | $ | 32.5 |  | $ | 30.2 |  | $ | 28.5 |
Change in fair value of variable annuity liability, included in other revenues |  | (156.5 | ) | (223.5 | ) | 77.1 |
Change in fair value of derivatives, included in other revenues |  | 92.9 |  | 127.0 |  | (158.4 | )
Foreign exchange, included in other revenues |  | 15.1 |  | 21.4 |  | (3.9 | )
Other investment income and gains (losses) |  | (.9 | ) | (.9 | ) | (1.4 | )
Total revenues |  | (16.9 | ) | (45.8 | ) | (58.1 | )
Change in fair value of variable annuity death benefit liabilities, included in other expenses |  | (1.8 | ) | (6.0 | ) | 9.3 |
Death benefit claims paid, included in other expenses |  | (3.8 | ) | (2.7 | ) | (2.2 | )
General and administrative expenses |  | (4.7 | ) | (6.3 | ) | (5.6 | )
Pre-tax loss |  | $ | (27.2 | ) | $ | (60.8 | ) | $ | (56.6 | )
For the years ended December 31, 2011, 2010 and 2009 the change in the fair value of the variable annuity liability included $7.2 million, $47.7 million and $22.4 million of losses associated with changes in projected surrender assumptions. All of White Mountains’ variable annuity reinsurance liabilities were classified as Level 3 measurements at December 31, 2011. The following table summarizes the changes in White Mountains’ variable annuity reinsurance liabilities and derivative instruments for the year ended December 31, 2011:
|  | Variable Annuity (Liabilities) |  | Derivative Instruments |
Millions |  | Level 3 |  | Level 3 (1) |  | Level 2 (1)(2) |  | Level 1 (3) |  | Total(4) |
Balance at January 1, 2011 |  | $ | (610.2 | ) | $ | 275.3 |  | $ | 72.2 |  | $ | — |  | $ | 347.5 |
Purchases |  | — |  | 5.0 |  | — |  | — |  | 5.0 |
Realized and unrealized gains (losses) |  | (158.3 | ) | 14.5 |  | 67.7 |  | 10.7 |  | 92.9 |
Transfers in (out) |  | — |  | — |  | — |  | — |  | — |
Sales/settlements |  | — |  | (47.7 | ) | (100.7 | ) | (6.6 | ) | (155.0 | )
Balance at December 31, 2011 |  | $ | (768.5 | ) | $ | 247.1 |  | $ | 39.2 |  | $ | 4.1 |  | $ | 290.4 |
(1) Comprises over-the-counter instruments. (2) Comprises interest rate swaps, total return swaps and foreign currency forward contracts. Fair value measurement based upon bid/ask pricing quotes for similar instruments that are actively traded, where available. Swaps for which an active market does not exist have been priced using observable inputs including the swap curve and the underlying bond index. (3) Comprises exchange traded equity index, foreign currency and interest rate futures. Fair value measurements based upon quoted prices for identical instruments that are actively traded. (4) In addition to derivative instruments, WM Life Re held cash, short-term and fixed maturity investments of $485.3 at December 31, 2011 posted as collateral to its counterparties. The following summarizes realized and unrealized derivative gains (losses) recognized in other revenues for the years ended December 31, 2011, 2010, and 2009 and the carrying values at December 31, 2011 and 2010 by type of instrument:
|  |  |  |  |  |  |  | Carrying Value |
|  | Year Ended December 31, |  | December 31, |
Millions |  | 2011 |  | 2010 |  | 2009 |  | 2011 |  | 2010 |
Fixed income/interest rate |  | $ | 8.9 |  | $ | 17.6 |  | $ | 8.0 |  | $ | 31.1 |  | $ | 43.9 |
Foreign exchange |  | 29.5 |  | 144.6 |  | (69.5 | ) | 161.3 |  | 225.3 |
Equity |  | 54.5 |  | (35.2 | ) | (96.9 | ) | 98.0 |  | 78.3 |
Total |  | $ | 92.9 |  | $ | 127.0 |  | $ | (158.4 | ) | $ | 290.4 |  | $ | 347.5 |
WM Life Re enters into both over-the-counter (“OTC”) and exchange traded derivative instruments to economically hedge the liability from the variable annuity benefit guarantee. In the case of OTC derivatives, WM Life Re has exposure to credit risk for amounts that are uncollateralized by counterparties. WM Life Re’s internal risk management guidelines establish net counterparty exposure thresholds that take into account over-the-counter counterparties’ credit ratings. WM Life Re has entered into master netting agreements with certain of its counterparties whereby the collateral provided (held) is calculated on a net basis. The following summarizes collateral provided to WM Life Re from counterparties:
|  | Year Ended December 31, |
Millions |  | 2011 |  | 2010 |
Short term investments |  | $ | 73.2 |  | $ | 52.4 |
Fixed maturity securities |  | — |  | 48.6 |
Total |  | $ | 73.2 |  | $ | 101.0 |
Collateral held by or provided by WM Life Re in the form of fixed maturity securities comprise U.S. Treasury securities, which are recorded at fair value. Collateral in the form of short-term investments consists of money-market instruments, carried at amortized cost, which approximates fair value. The following summarizes the value of collateral provided (held) by WM Life Re and net exposure on OTC derivative instruments recorded within other assets:
Millions |  | December 31, 2011 |  | December 31, 2010 |
OTC derivative instruments(1) |  | $ | 295.4 |  | $ | 351.5 |
Collateral held |  | (73.2 | ) | (101.0 | )
Collateral provided |  | 83.0 |  | 25.3 |
Net exposure on fair value of OTC instruments |  | $ | 305.2 |  | $ | 275.8 |
(1) Value of OTC derivative instruments as of December 31, 2011 and 2010 excludes adjustments for counterparty credit risk of $(9.1) and $(4.0) included in fair value under GAAP. The following table summarizes uncollateralized amounts due under WM Life Re’s OTC derivative contracts as of December 31, 2011 by counterparty:
Millions |  | Uncollateralized balance as of December 31, 2011 |  | Standard & Poor’s Rating(1) |
Royal Bank of Scotland |  | $ | 82.5 |  | A- |
Citigroup (2) |  | 67.7 |  | A- |
Bank of America |  | 54.2 |  | A- |
JP Morgan Chase(2) |  | 34.2 |  | A |
Nomura(2) |  | 31.9 |  | BBB+ |
Barclays |  | 25.1 |  | A |
Goldman Sachs |  | 9.6 |  | A- |
Total |  | $ | 305.2 |  |  |
(1) Standard & Poor’s ratings as detailed above are: “A” (which is the sixth highest of twenty-one creditworthiness ratings), “A-” (which is the seventh highest of twenty-one creditworthiness ratings), and BBB+ (which is the eighth highest of twenty-one creditworthiness ratings). (2) Collateral provided (held) calculated under master netting agreement. The OTC derivative contracts are subject to restrictions on liquidation of the instruments and distribution of proceeds under collateral agreements. In addition, WM Life Re held cash and short-term investments posted as collateral to its reinsurance counterparties. The total collateral comprises the following:
|  | Year Ended December 31, |
Millions |  | 2011 |  | 2010 |
Cash |  | $ | 453.5 |  | $ | 291.1 |
Short-term investments |  | .6 |  | 31.6 |
Fixed maturity investments |  | 31.2 |  | 3.3 |
Total |  | $ | 485.3 |  | $ | 326.0 |
Weather Derivatives During 2009, White Mountains sold Galileo Weather Risk Management Advisors LLC, Galileo Weather Risk Management Ltd and Galileo Weather Risks Advisors Limited for nominal consideration. White Mountains retained the outstanding weather derivative contracts and stopped writing any new contracts. Effective December 2009, White Mountains entered into an agreement to novate the remaining outstanding weather derivative contracts to an unrelated third party. White Mountains was released from any liability related to the weather derivative contracts and all guaranties related to the weather business were terminated. For the year ended December 31, 2009, $2.6 million of net losses were recognized on the weather and weather contingent derivatives portfolio.

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