Reinsurance

12 Months Ended

Dec. 31, 2011

NOTE 4. Reinsurance

In the normal course of business, OB Holdings’ insurance subsidiaries seek to limit losses that may arise from catastrophes or other events by reinsuring with third-party reinsurers. OB Holdings remains liable for risks reinsured even if the reinsurer does not honor its obligations under reinsurance contracts. The effects of reinsurance on OB Holdings’ insurance subsidiaries’ written and earned premiums and on loss and LAE were as follows:

	Year ended December 31,
	2011			2010			2009
	($ in millions)
Written premiums:
Direct(1)(2)(3)	$	1,077.6		$	1,501.5		$	1,972.4
Assumed(2)	48.2			57.7			58.6
Ceded(1)(2)(3)	(62.9		)	(400.2		)	(213.2		)
Net written premiums	$	1,062.9		$	1,159.0		$	1,817.8
Earned premiums:
Direct	$	1,138.5		$	1,648.7		$	2,021.7
Assumed	43.1			64.2			66.8
Ceded	(166.1		)	(309.0		)	(229.7		)
Net earned premiums	$	1,015.5		$	1,403.9		$	1,858.8
Loss and LAE:
Direct	$	1,151.1		$	877.1		$	1,020.7
Assumed	36.1			138.4			40.8
Ceded	(606.3		)	(157.3		)	(56.2		)
Net loss and LAE	$	580.9		$	858.2		$	1,005.3

(1) Includes non-specialty commercial lines policies written on a direct basis and then ceded 100% to The Hanover, beginning with January 1, 2010 effective dates, as part of the Commercial Lines Transaction, as described below.

(2) Includes traditional personal lines policies not directly written by York and MHIC, which were ceded to Tower as part of the Personal Lines Transaction which closed on July 1, 2010, as described below. Also includes policies assumed for certain specialty lines business written directly by York as part of the Personal Lines Transaction.

(3) Includes policies written under a quota share agreement with a group of reinsurers to cede 30% of written premiums from OneBeacon’s Northeast homeowners business in 2009 and 2010, as described below.

During the years ended December 31, 2011 and 2010, OB Holdings ceded written premiums of $0.6 million and $262.2 million, respectively, earned premiums of $96.6 million and $165.0 million, respectively, and loss and LAE of $62.3 million and $86.5 million, respectively, pursuant to the Commercial Lines Transaction.

During the years ended December 31, 2011 and 2010, OB Holdings ceded written premiums of $(1.9) million and $9.2 million, respectively, earned premiums of $3.6 million and $3.7 million, respectively, and loss and LAE of $1.3 million and $2.1 million, respectively, pursuant to the Personal Lines Transaction. OB Holdings also assumed written premiums of $0 and $0.5 million, respectively, earned premiums of $0.2 million and $0.3 million, respectively, and loss and LAE of $4.0 million and $2.4 million, respectively, during the years ended December 31, 2011 and 2010 pursuant to the Personal Lines Transaction.

In the normal course of its business, OB Holdings purchases reinsurance from high-quality, highly rated, third-party reinsurers in order to minimize loss from large losses or catastrophic events.

The timing and size of catastrophe losses are unpredictable and the level of losses experienced in any year could be material to OB Holdings’ operating results and financial position. Examples of catastrophes include losses caused by earthquakes, wildfires, hurricanes and other types of storms and terrorist acts. The extent of losses caused by catastrophes is a function of the amount and type of insured exposure in an area affected by the event as well as the severity of the event. OB Holdings continually assesses and implements programs to manage its exposure to catastrophe losses through individual risk selection and by limiting its concentration of insurance written in catastrophe-prone areas, such as coastal regions. In addition, OB Holdings imposes wind deductibles on existing coastal windstorm exposures. OB Holdings uses probable maximum loss (“PML”) forecasting to quantify its exposure to catastrophic losses. PML is a statistical modeling technique that measures a company’s catastrophic exposure as the maximum probable loss in a given time period.

OB Holdings seeks to further reduce its potential loss from catastrophe exposures through the purchase of catastrophe reinsurance. Effective May 1, 2011, OB Holdings renewed its property catastrophe reinsurance program through April 30, 2012. The program provides coverage for OB Holdings’ property business as well as certain acts of terrorism. Under the program, the first $50.0 million of losses resulting from any single catastrophe are retained and the next $175.0 million of losses resulting from the catastrophe are reinsured in three layers, although OB Holdings retains a co-participation of 26% of losses from $50.0 million to $100.0 million and 10% of losses from $100.0 million to $175.0 million. Losses from $175.0 million to $225.0 million are fully reinsured. Any loss above $225.0 million would be retained in full. In the event of a catastrophe, OB Holdings’ 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.

OB Holdings had entered into a 30% quota share agreement with a group of reinsurers that ran from January 1, 2009 through December 31, 2009, and had renewed the agreement effective January 1, 2010. Through June 30, 2010, OB Holdings ceded $25.6 million of written premiums from its Northeast homeowners business written through OBIC and its subsidiary companies, along with Adirondack Insurance and NJSIA in New York and New Jersey, respectively. Effective July 1, 2010, the closing date of the Personal Lines Transaction, the agreement was amended to remove OB Holdings as a signatory. During the year ended December 31, 2009, OB Holdings ceded $59.9 million of written premiums under this quota share agreement.

OB Holdings’ property catastrophe reinsurance program does not cover property losses resulting from any nuclear events or biological, chemical or radiological terrorist attacks or losses resulting from acts of terrorism as defined under the Terrorism Act, as amended, committed by an individual or individuals acting on behalf of any foreign person or foreign interest, as well as domestic acts of terrorism.

Since the terrorist attacks of September 11, 2001, OB Holdings has sought to mitigate the risk associated with any future terrorist attacks by limiting the aggregate insured value of policies in geographic areas with exposure to losses from terrorist attacks. This is accomplished by either limiting the total insured values exposed, or, where applicable, through the use of terrorism exclusions.

In December 2007, the United States government extended the Terrorism Risk Insurance Act (the “Terrorism Act”) until December 31, 2014. The Terrorism Act, originally enacted in 2002, established a federal “backstop” for commercial property and casualty losses, including workers compensation, resulting from acts of terrorism by or on behalf of any foreign person or foreign interest. As extended, the law now also covers domestic acts of terrorism. The law limits the industry’s aggregate liability by requiring the federal government to share 85% of certified losses once a company meets a specific retention or deductible as determined by its prior year’s direct written premiums and limits the aggregate liability to be paid by the government and industry without further action by Congress at $100 billion. In exchange for this “back-stop,” primary insurers are required to make coverage available to commercial insureds for losses from acts of terrorism as specified in the Terrorism Act. The following types of coverage are excluded from the program: commercial automobile, burglary and theft, surety, farmowners multi-peril and all professional liability coverage except directors and officers coverage.

OB Holdings estimates its individual retention level for commercial policies subject to the Terrorism Act to be approximately $100 million in 2012. The federal government will pay 85% of covered terrorism losses that exceed OB Holdings’ or the industry’s retention levels in 2012, up to a total of $100 billion.

OB Holdings also purchases property-per-risk reinsurance coverage to reduce large loss volatility. The property-per-risk reinsurance program reinsures losses in excess of $10.0 million up to $100.0 million. Individual risk facultative reinsurance may be purchased above $100.0 million where OB Holdings deems it appropriate. The property-per-risk treaty also provides one limit of reinsurance protection for losses in excess of $10.0 million up to $100.0 million on an individual risk basis for acts of foreign terrorism. However, any nuclear, biological, chemical and radiological terrorist attacks are not covered.

OB Holdings also maintains a casualty reinsurance program that provides protection for individual policies involving workers compensation, general liability, automobile liability, professional liability or umbrella liability in excess of $5.0 million up to $21.0 million ($20.0 million for healthcare professional liability). Casualty losses involving more than one insured are covered by a dedicated treaty up to $40.0 million in excess of a $10.0 million retention.

In connection with the OneBeacon Acquisition, Aviva caused OneBeacon to purchase two reinsurance contracts from subsidiaries of Berkshire Hathaway Inc.: the NICO Cover, a reinsurance contract from NICO for up to $2.5 billion in old A&E claims and certain other exposures and an adverse loss reserve development cover from General Reinsurance Corporation (“GRC”) for up to $570.0 million, comprised of $400.0 million of adverse loss reserve development 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 under GAAP as a seller guarantee.

Pursuant to the GRC Cover, OB Holdings 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. OB Holdings intends to seek reimbursement from GRC only 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 OB Holdings on its own investments. This cost, if any, is expected to be nominal. As of December 31, 2011, OneBeacon has ceded estimated incurred losses of $562.0 million to GRC under the GRC Cover. During the years ended December 31, 2011 and 2010, OB Holdings collected $73.5 million and $61.3 million, respectively, under the GRC Cover.

At December 31, 2011, OB Holdings had $16.5 million of reinsurance recoverables on paid losses and $2,330.8 million (gross of $163.3 million in purchase accounting adjustments, as described in Note 3) that will become recoverable if claims are paid in accordance with current reserve estimates. Reinsurance contracts do not relieve OB Holdings of its obligations. Therefore, collectibility of balances due from reinsurers is critical to OB Holdings’ financial strength. The following table provides a listing of OB Holdings’ top reinsurers for its insurance operations, excluding industry pools and associations and affiliates of OB Holdings, based upon recoverable amounts, the percentage of total reinsurance recoverables and the reinsurer’s A.M. Best Company, Inc. (“A.M. Best”) ratings.

($ in millions)	Balance at December 31, 2011		% of total		A.M. Best Rating(1)
National Indemnity Company and General Reinsurance Corporation(2)	$	1,540.6	66	%	A++
Hanover Insurance Company	90.9		4	%	A
Tokio Marine and Nichido Fire(3)	57.1		2	%	A++
Tower Insurance Company	35.1		1	%	A-
Munich Reinsurance America	26.4		1	%	A+

(1) A.M. Best ratings as detailed above are: “A++” (Superior, which is the highest of fifteen financial strength ratings), “A+” (Superior, which is the second highest of fifteen financial strength ratings), “A” (Excellent, which is the third highest of fifteen financial strength ratings) and “A-” (Excellent, which is the fourth highest of fifteen financial strength ratings).

(2) Includes $198.3 million of Third-Party Recoverables, which NICO would pay under the terms of the NICO Cover if they are unable to collect from third-party reinsurers.

(3) Includes $30.5 million of reinsurance recoverables from various reinsurers that are guaranteed by Tokio Marine and Nichido Fire under the terms of a 100% quota share reinsurance agreement between Houston General Insurance Company and Tokio Marine and Nichido Fire.

- Definition

The entire disclosure pertaining to the existence, magnitude and information about insurance that has been ceded to or assumed from another insurance company, including the methodologies and assumptions used in determining recorded amounts.

+ References

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+ Details

OneBeacon U.S. Holdings, Inc. 10-K