WHITE MOUNTAINS INSURANCE GROUP LTD annual report, FY2018

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White Mountains Insurance Group, Ltd. — 2018 Form 10-K

Business context and reporting period. This annual filing covers the year ended December 31, 2018; it is not a standalone fourth-quarter report. White Mountains is an acquisition- and investment-oriented holding company with four reporting segments: municipal bond insurance (HG Global/BAM), specialty insurance distribution (NSM), marketing technology (MediaAlpha) and Other Operations. Amounts below are in U.S. dollars unless stated otherwise.

Financial performance and position

Metric20182017
Revenue$369.1 million$373.8 million
Pre-tax income (loss), continuing operations$(178.2) million$7.8 million
Net income (loss) attributable to common shareholders$(141.2) million$627.2 million
Comprehensive income (loss) attributable to common shareholders$(145.7) million$630.5 million
Basic and diluted loss per share$(41.76)Income per share of $146.06
Total assets / total liabilities$3,362.6 million / $644.4 million$3,659.2 million / $298.4 million
Common shareholders’ equity / book value per share$2,843.1 million / $896.00$3,492.5 million / $931.30
Adjusted book value per share (non-GAAP)$887.85$914.75
Total debt$192.7 million$23.8 million
Cash flow from continuing operations$(31.1) million$(62.4) million

Net loss in 2018 largely reflected a $108.3 million pre-tax investment loss and a $17.3 million loss related to the Sirius Group sale tax contingency. The 2017 comparison benefited from the $554.5 million after-tax OneBeacon sale gain. Continuing-operations income tax benefit was $4.0 million in 2018. Total cash at year-end was $110.3 million, including $50.0 million of restricted cash. At the holding-company and intermediate-holding-company level, management reported $536 million of net unrestricted cash, short-term investments and fixed-maturity investments, plus $926 million of common equities and $67 million of other long-term investments. Management said expected cash needs were adequately covered. No consolidated operating cash flow was generated in 2018.

  • Investments: Portfolio carrying value was $2,542.9 million, down from $3,380.7 million. Fixed maturities were $1,077.5 million, common equities $925.6 million and other long-term investments $325.6 million. Total pre-tax investment return was -1.7%, versus 5.6% in 2017; fixed-income return was 1.2% and equity/other-long-term-investment return was -3.6%.
  • Debt and liquidity: Debt rose primarily with NSM’s acquisition financing. NSM had $180.4 million of term loans outstanding at a 7.42% effective rate; $150.2 million was hedged through an interest-rate swap. NSM’s leverage ratio was 4.0x against a 5.5x maximum covenant, and the company reported compliance with all debt covenants. Total debt was 6.3% of non-GAAP adjusted capital.
  • Segment results: HG Global/BAM reported a $29.4 million pre-tax loss; NSM reported a $5.2 million pre-tax loss for its post-acquisition period; MediaAlpha reported $8.9 million pre-tax income; and Other Operations reported a $152.5 million pre-tax loss, principally reflecting investment losses.
  • Operating indicators: MediaAlpha revenue was $297.1 million, with $50.5 million gross profit, a 17.1% gross margin, and $32.3 million adjusted EBITDA (non-GAAP). NSM reported $94.7 million commission revenue, $65.8 million gross profit, and $15.5 million adjusted EBITDA (non-GAAP) from May 11 through year-end.

Material changes versus the prior comparable period

  • White Mountains acquired 95% of NSM in May 2018 for approximately $276 million. NSM subsequently acquired Fresh Insurance and KBK. NSM’s reported results therefore cover only the post-acquisition period, while its full-year controlled premiums and commission figures include the business’s pre-acquisition period.
  • MediaAlpha advertising and commission revenue increased to $295.5 million from $163.2 million, and adjusted EBITDA rose to $32.3 million from $11.3 million. Growth was primarily in property-and-casualty and health/life/Medicare advertising.
  • BAM insured $12.0 billion of municipal bonds, up from $10.4 billion; gross written premiums and member surplus contributions collected were $106.7 million versus $100.6 million. Pricing eased to 93 basis points from 99 basis points. Claims-paying resources increased 23% to $871.4 million.
  • Common shareholders’ equity declined by $649.4 million, reflecting the annual loss and $519.4 million of share repurchases, among other movements. White Mountains repurchased 592,458 shares at an average $876.69 and paid a $1.00-per-share dividend.
  • Investment results reversed from $133.3 million of net realized and unrealized gains in 2017 to $108.3 million of losses in 2018. The filing attributes the weaker year mainly to the fourth-quarter equity-market decline.
  • As of February 26, 2019, a MediaAlpha recapitalization valued the business at approximately $350 million; White Mountains retained a 42% fully diluted interest and received about $88 million net cash. The company estimated this would add approximately $55 per share to year-end book value and adjusted book value.

Outlook, risks, contingencies and unusual items

  • Outlook: The filing provides no formal consolidated earnings or revenue guidance. Management projected gradual growth in BAM insured par and premiums over the following six years, then a flattening trend, and continued to estimate full repayment of BAM Surplus Notes about nine years before their 2042 maturity. These projections depend on market and operating assumptions.
  • BAM exposure: BAM had an “AA/stable” S&P rating as of February 2019. HG Re provides first-loss protection up to 15% of par on BAM policies, subject to collateral limits. BAM’s $481 million surplus-note principal and $144 million accrued interest are subject to NYDFS payment approval; BAM paid $23 million of principal and interest during 2018. The company noted that nonpayment or rating deterioration could affect results and BAM’s ability to write business.
  • NSM concentration and contingent obligation: NSM placed approximately 33% of premiums with its largest carrier and 58% with its five largest carriers in 2018. If NSM and White Mountains cannot facilitate a sale of certain U.S. collector-car renewal rights by December 31, 2019, AIG may require NSM to purchase them for $82.5 million; White Mountains guaranteed the obligation. Management stated the rights’ estimated fair value was at least that amount and recorded no liability.
  • Acquisition accounting and leverage: Goodwill and other intangible assets totaled $537.5 million, largely from NSM and related acquisitions; KBK purchase-price allocation remained preliminary. The filing identifies impairment risk if acquired businesses underperform assumptions. NSM’s contingent consideration liabilities were $20.2 million at year-end.
  • Other contingencies and subsequent events: A Swedish court ruled against Sirius Group on disputed interest deductions; White Mountains recorded a $17.3 million loss under its sale indemnity, and the decision was appealed. In February 2019, White Mountains agreed to buy Oaktree’s Kudu interests for about $50 million, assume approximately $167 million of unfunded commitments, increase its ownership to 99% and expect to consolidate Kudu after closing.
  • Market and valuation risks: The portfolio is exposed to equity-market, interest-rate, credit-spread and foreign-currency movements; year-end foreign-currency net assets were $243.8 million. Private investments and other Level 3 valuations involve judgment and may be illiquid. Other disclosed risks include carrier dependence, cybersecurity, regulation, tax treatment and potential goodwill impairment.
  • Governance and controls: Management and the auditor concluded internal control over financial reporting was effective, but NSM—representing 27.5% of consolidated revenue—was excluded from the 2018 control assessment because it was acquired during the year.

Most important facts for investors to verify

  1. Reconcile the 2018 loss and book-value decline to investment performance, share repurchases, acquisitions and the Sirius tax contingency; distinguish recurring operating performance from market and transaction items.
  2. Assess whether NSM can sustain earnings and reduce 4.0x leverage, including carrier concentration, acquisition earnouts and the $82.5 million renewal-rights obligation.
  3. Evaluate the recoverability and payment timing of BAM Surplus Notes, the adequacy of collateral and claims-paying resources, and the durability of BAM’s “AA/stable” rating.
  4. Confirm the accounting and per-share effect of the post-year-end MediaAlpha transaction, including the $88 million distribution, retained 42% interest and anticipated deconsolidation.
  5. Review the valuation assumptions and liquidity of private investments, especially PassportCard/DavidShield, and monitor the Kudu purchase and assumed unfunded commitments.
  6. Check subsequent developments in the Sirius tax appeal and confirm the effect of the new debt, commitments and 2019 lease-accounting adoption on liquidity and reported results.