Variable Annuity Reinsurance

White Mountains has entered into agreements to reinsure death and living benefit guarantees associated with certain variable annuities in Japan. At June 30, 2012 and December 31, 2011, the total guarantee value was approximately ¥231.4 billion (approximately $2.9 billion at exchange rates on that date) and ¥233.7 billion (approximately $3.0 billion at exchange rates on that date). The collective account values of the underlying variable annuities were approximately 79% and 78% of the guarantee value at June 30, 2012 and December 31, 2011.

The following table summarizes the pre-tax operating results of WM Life Re for the three and six months ended June 30, 2012 and 2011:



	Three Months Ended						Six Months Ended
	June 30,						June 30,
Millions	2012			2011			2012			2011
Fees, included in other revenues	$	8.0		$	8.0		$	16.0		$	15.9
Change in fair value of variable annuity liability, included in other revenues	(110.5		)	(35.9		)	100.8			16.4
Change in fair value of derivatives, included in other revenues	95.5			22.0			(111.0		)	(43.5		)
Foreign exchange, included in other revenues	7.6			6.9			(15.4		)	2.3
Other investment income and gains (losses)	1.2			(.2		)	(.9		)	(.6		)
Total revenues	1.8			.8			(10.5		)	(9.5		)
Change in fair value of variable annuity death benefit liabilities, included in other expenses	(2.8		)	(.5		)	5.9			2.5
Death benefit claims paid, included in other expenses	(1.7		)	(.7		)	(3.4		)	(1.7		)
General and administrative expenses	(1.3		)	(1.4		)	(2.7		)	(2.1		)
Pre-tax loss	$	(4.0	)	$	(1.8	)	$	(10.7	)	$	(10.8	)

All of White Mountains’ variable annuity reinsurance liabilities were classified as Level 3 measurements at June 30, 2012 and 2011. The following tables summarize the changes in White Mountains’ variable annuity reinsurance liabilities and derivative instruments for the three and six months ended June 30, 2012 and 2011:



	Three Months Ended June 30, 2012
	Variable Annuity (Liabilities)			Derivative Instruments
Millions	Level 3			Level 3 ⁽¹⁾			Level 2 ⁽¹⁾⁽²⁾			Level 1 ⁽³⁾			Total ⁽⁴⁾
Beginning of period	$	(548.5	)	$	183.8		$	(.1	)	$	(9.4	)	$	174.3
Purchases	—			—			—			—			—
Realized and unrealized (losses) gains	(113.3		)	29.5			41.7			24.3			95.5
Transfers in	—			—			—			—			—
Sales/settlements	—			(.3		)	19.4			(38.6		)	(19.5		)
End of period	$	(661.8	)	$	213.0		$	61.0		$	(23.7	)	$	250.3



	Six Months Ended June 30, 2012
	Variable Annuity (Liabilities)			Derivative Instruments
Millions	Level 3			Level 3 ⁽¹⁾			Level 2 ⁽¹⁾⁽²⁾			Level 1 ⁽³⁾			Total ⁽⁴⁾
Beginning of period	$	(768.5	)	$	247.1		$	39.2		$	4.1		$	290.4
Purchases	—			6.1			—			—			6.1
Realized and unrealized gains (losses)	106.7			(30.8		)	(56.5		)	(23.7		)	(111.0		)
Transfers in	—			—			—			—			—
Sales/settlements	—			(9.4		)	78.3			(4.1		)	64.8
End of period	$	(661.8	)	$	213.0		$	61.0		$	(23.7	)	$	250.3



	Three Months Ended June 30, 2011
	Variable Annuity (Liabilities)			Derivative Instruments
Millions	Level 3			Level 3 ⁽¹⁾		Level 2 ⁽¹⁾⁽²⁾			Level 1 ⁽³⁾			Total ⁽⁴⁾
Beginning of period	$	(554.9	)	$	226.0	$	54.8		$	7.3		$	288.1
Purchases	—			—		—			—			—
Realized and unrealized (losses) gains	(36.4		)	6.7		12.5			2.8			22.0
Transfers in	—			—		—			—			—
Sales/settlements	—			—		(19.1		)	(22.0		)	(41.1		)
End of period	$	(591.3	)	$	232.7	$	48.2		$	(11.9	)	$	269.0



	Six Months Ended June 30, 2011
	Variable Annuity (Liabilities)			Derivative Instruments
Millions	Level 3			Level 3 ⁽¹⁾			Level 2 ⁽¹⁾⁽²⁾			Level 1 ⁽³⁾			Total ⁽⁴⁾
Beginning of period	$	(610.2	)	$	275.3		$	72.2		$	—		$	347.5
Purchases	—			5.0			—			—			5.0
Realized and unrealized gains (losses)	18.9			(18.5		)	(8.2		)	(16.8		)	(43.5		)
Transfers in	—			—			—			—			—
Sales/settlements	—			(29.1		)	(15.8		)	4.9			(40.0		)
End of period	$	(591.3	)	$	232.7		$	48.2		$	(11.9	)	$	269.0

⁽¹⁾Consists of over-the-counter instruments.

⁽²⁾Consists of interest rate swaps, total return swaps, foreign currency forward contracts, and bond forwards. 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⁾Consists of 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 $471.6 and $370.5 at June 30, 2012 and 2011 posted as collateral to its reinsurance counterparties.

The fair value of White Mountains’ variable annuity reinsurance liabilities are estimated using actuarial and capital market assumptions related to the projected discounted cash flows over the term of the reinsurance agreement. Assumptions regarding future policyholder behavior, including surrender and lapse rates, are generally unobservable inputs and significantly impact the fair value estimates. Market conditions including, but not limited to, changes in interest rates, equity indices, market volatility and foreign currency exchange rates as well as the variations in actuarial assumptions regarding policyholder behavior may result in significant fluctuations in the fair value estimates. Generally, the liabilities associated with these guarantees increase with declines in the equity markets, interest rates and currencies against the Japanese yen, as well as with increases in market volatilities. White Mountains uses derivative instruments, including put options, interest rate swaps, total return swaps on bond and equity indices and forwards and futures contracts on major equity indices, currency pairs and government bonds, to mitigate the risks associated with changes in the fair value of the reinsured variable annuity guarantees. The types of inputs used to estimate the fair value of these derivative instruments, with the exception of actuarial assumptions regarding policyholder behavior and risk margins, are generally the same as those used to estimate the fair value of variable annuity liabilities.

The following summarizes quantitative information about significant unobservable inputs associated with the fair value estimates for variable annuity reinsurance liabilities and derivative instruments that have been classified as Level 3 measurements:



	June 30, 2012
($ in Millions) Description	Fair Value		Valuation Technique(s)	Unobservable Input	Range					Weighted Average
Variable annuity benefit guarantee liabilities	$	661.8	Discounted cash flows	Surrenders	0.1	%	-	3.0	%	0.7	%
				Mortality	—	%	-	6.4	%	1.0	%
				Foreign exchange volatilities	12.3	%	-	29.1	%	16.5	%
				Index volatilities	13.1	%	-	32.1	%	22.7	%

Foreign exchange and equity index options	$	213.0	Black-Scholes option pricing model	Expected equity dividends	1.5	%	-	4.1	%	2.7	%
			Black-Scholes option pricing model	Foreign exchange volatilities	12.3	%	-	29.1	%	16.5	%
				Index volatilities	13.1	%	-	32.1	%	22.7	%

The following summarizes realized and unrealized derivative gains (losses) recognized in other revenues for the three and six months ended June 30, 2012 and 2011 and the carrying values, included in other assets, at June 30, 2012 and December 31, 2011, by type of instrument:



	Gains (Losses)											Carrying Value
	Three Months Ended					Six Months Ended						As of
	June 30,					June 30,						June 30, 2012		December 31, 2011
Millions	2012		2011			2012			2011			June 30, 2012		December 31, 2011
Fixed income/Interest rate	$	28.6	$	(6.3	)	$	(50.5	)	$	(12.5	)	$	64.8	$	31.1
Foreign exchange	27.4		17.1			(27.5		)	(30.2		)	127.7		161.3
Equity	39.5		11.2			(33.0		)	(.8		)	57.8		98.0
Total	$	95.5	$	22.0		$	(111.0	)	$	(43.5	)	$	250.3	$	290.4

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 OTC 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:



Millions	June 30, 2012		December 31, 2011
Short-term investments	$	86.9	$	73.2
Fixed maturity securities	—		—
Total	$	86.9	$	73.2

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, collateral (held) provided by WM Life Re and net exposure to credit losses on OTC derivative instruments recorded within other assets:



Millions	June 30, 2012			December 31, 2011
OTC derivative instruments ⁽¹⁾	$	282.2		$	295.4
Collateral held	(86.9		)	(73.2		)
Collateral provided	62.6			83.0
Net exposure to credit losses on fair value of OTC instruments	$	257.9		$	305.2

⁽¹⁾Value of OTC derivative instruments as of June 30, 2012 and December 31, 2011 excludes adjustments for counterparty credit risk of $(8.2)

and $(9.1) included in fair value under GAAP.

The following table summarizes uncollateralized amounts due under WM Life Re’s OTC derivative contracts:



	Uncollateralized balance as of
Millions	June 30, 2012		S&P Rating⁽¹⁾
Citigroup ⁽²⁾	$	55.6	A-
Royal Bank of Scotland	67.4		A-
Bank of America	52.9		A-
JP Morgan ⁽²⁾	27.8		A
Nomura ⁽²⁾	30.5		BBB+
Barclays	20.6		A
Goldman Sachs ⁽²⁾	3.1		A-
Total	$	257.9

⁽¹⁾Standard & Poor’s (“S&P”) ratings as detailed above are: “A” (Strong, which is the sixth highest of

twenty-one creditworthiness ratings), “A-” (Strong, which is the seventh highest of twenty-one creditworthiness

ratings) and “BBB+” (Adequate, 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, short-term and fixed maturity investments posted as collateral to its reinsurance counterparties. The additional collateral consists of the following:



Millions	June 30, 2012		December 31, 2011
Cash	$	360.0	$	453.5
Short-term investments	20.6		.6
Fixed maturity investments	91.0		31.2
Total	$	471.6	$	485.3