White Mountains Insurance Group (WTM)

TOP CONTRIBUTORS

William Haddad

Dan Pan

White Mountains Insurance Group (WTM) is an insurance company that sells property & casualty insurance, reinsurance, and auto insurance. Increased competition in the insurance industry has led to a decrease in net written premiums, which have stagnated in the last 3 years for WTM. ^[1] This increase in competition has resulted from other companies, such as Lloyd's, increasing their underwriting capacities to take advantage of increased premiums. ^[2] Esurance, which WTM acquired in 2000, has been the largest source of growth for WTM, as its policies have risen from 43,000 in 2002 to 485,000 in 2007. ^[3] Esurance, an online auto insurer, has become the third largest issuer of online insurance quotes and the third most recognizable brand in the online auto insurance markets. ^[4]

However, WTM has maintained positive growth of revenue through acquisitions -- discounting for a one time after-tax gain of $171 million from an offering of OneBeacon in 2006, revenues have steadily increased over the past three years as gross written premiums have decreased ^[5]. WTM's dependency on inorganic growth means that it must constantly look for acquisition opportunities. Also, WTM's selectivity in acquisitions and underwriting may also lead to a large cash position and be hampered by regulatory constraints. ^[6]

Company Overview

White Mountains' revenue comes from the premiums that they receive from customers and the returns they earn from investing those premiums. Since 2005, net written premiums have decreased due to increased competition.^[7]. However, WTM's investment returns have outpaced the S&P 500 in 2007 and earned 0.8% in the first quarter of 2008 ^[8].

Business Segments

2007 Revenue by Segment ^[9]

• OneBeacon (48.02% Total Revenue, 58.47% Pre-Tax Income), the firm's most profitable segment, underwrites specialty, commercial, and personal insurance. Specialty insurance is insurance for the health-care, marine, and agricultural industries. The commercial segment insures businesses against accidents and other occupational risks. The personal insurance division provides insurance to individuals for their homes and cars. Last year, OneBeacon's adjusted book value per share including dividends rose 16.2% and its pre-tax income went up 27.8% ^[10]. Management was also able to lower the combined ratio, a firm's incurred losses and expenses divided by its earned premium, from 96% to 93% ^[11]. OneBeacon offers specialty insurance throughout the U.S., while the commercial and personal insurance businesses are focused in the Northeastern United States and exposed to regional risk.

• White Mountains Re (30.12% Total Revenue, 43.53% Pre-Tax Income) provides reinsurance (insurance for insurers) for property, casualty, accident & health, agriculture, aviation, and space through its subsidiaries all over the world. Other insurance companies pay White Mountains Re premiums in return for taking on the risks associated with insurance policies they have already written. Over 90% of its regional exposure comes from the United States and Canada ^[12]. White Mountains Re has been facing increased competition from companies such as Lloyd's of London and Swiss Re. Over the past 2 years, the gross written premiums of White Mountains Re have been reduced by 34.6% due to competition. ^[13] However, the company has been growing its reinsurance business in Scandinavia. Sirius International, a subsidiary of White Mountains Re, is the largest reinsurance company domiciled in Scandinavia and has expanded by purchasing a Denmark-based insurer ^[14].

• Esurance (17.13% Total Revenue, -10.66% Pre-Tax Income) sells auto insurance to individuals over the internet in 28 states across the US ^[15]. The online operation of its business leads to lower operating costs than many of its competitors. The rise in Esurance's gross written premiums from 2006 to 2007 increased by 34% ^[16]. However, there was also a ninefold increase in the pre-tax loss for Esurance ^[17]. This loss resulted from poor underwriting and an increase in expenses, as Esurance had $1.16 of expenses and claims for each dollar of premium ^[18]. An 8% increase in Esurance's current ratio demonstrates how its tremendous growth in gross written premiums has not been with the best customers ^[19]. For Esurance to continue to grow into a major player in the car insurance market, greater controls on underwriting are a must. Furthermore, the car insurance industry is very competitive, causing Esurance to spend over a $100 million in advertising last year to compete with rivals such as Geico and Allstate ^[20]. This advertising war will be problematic if it continues to escalate and becomes a larger expense. Esurance has also begun a plan to cross-sell other forms of insurance with fellow insurers, as they try to create a one stop shop for insurance products ^[21].

• Other Operations (4.73% Total Revenue, 8.66% Pre-Tax Income): In addition to its 3 largest subsidiaries, WTM has other segments which sell weather risk insurance and manage the investments of the parent company. Galileo, the new weather risk management business, sells insurance to governments, energy, and construction companies. WM Advisors, the entity that invests WTM's money, has assets under management of $29.6 billion, which have fixed income, equity, and limited partnership investments ^[22]. In 2007, the return on White Mountain's portfolio amounted to 7.6% in comparison to a 5.5% return for the S&P500 over the same time ^[23].

Business & Financial Metrics

From 2006 to 2007, WTM's total revenues and pre-tax income decreased by 1.25% and 6.62%, respectively ^[24]. However, this decrease was due to a one time OneBeacon offering worth $171.3 million.^[25] Excluding that loss, total revenues increased 2.4% and pre-tax income increased 22.02% ^[26]. WTM's combined ratio, the ratio of incurred losses and expenses to earned premium, decreased 3% from 2006 due to a reduction in expenses as well as better underwriting ^[27].

White Mountains Net Income and Total Revenue^[28]

^[29]

^[30]

Key Trends and Forces

Catastrophic Events and Weather Increase Claims

As with all insurance companies, WTM has a large loss exposure to catastrophic events. OneBeacon does most of its business throughout the Northeast US, so any large weather or terrorist events would lead to increased losses. Galileo also has exposure to the weather derivatives which it sells to its clients. White Mountains Re is also exposed to significant catastrophe risk because it is the insurer of insurers. Any large disaster will force it to pay out a lot in claims. All of these businesses try to hedge these risks through reinsurance and derivatives. However, while that minimizes the risks, it does not eliminate them. In 2006, White Mountains Re recorded $86 million of unfavorable development due to Hurricanes Katrina, Rita, and Wilma ^[31].

Credit Crunch Devalues Fixed Income Investments

WTM has protected itself from sub-prime mortgage backed securities, holding none as of the end of 2007.^[32] However, this does not protect it from the negative effects which the credit crunch will have on other investments it has. As banks become less inclined to lend and interest rates rise, the value of WTM's fixed income portfolio drops. WTM estimates that a 1 percent increase in investment grade debt interest rates will lead to losses of $121.2 million for its Fixed Income Assets^[33]. The increase in interest rates also increases WTM's borrowing costs. However, this risk is limited by swaps which WTM enters into to hedge out its future interest rate risk.

Dependence on Inorganic Growth Leads to Idle Cash

As of late, WTM has acquired other insurance companies which are undervalued and has used these transactions to increase its float. The troubles in the financial sector have led to a devaluation in the values in many members of the insurance industry. As other companies become cheaper, the number of opportunities WTM has for acquisitions increases as well. However, a lack of attractive investments leads to WTM maintaining a large position in idle cash, which has no prospect of increasing shareholder value. As of the end of 2007, WTM possessed $171.3 million in cash in addition to over $1.3 billion of short-term investments, which could potentially be used in a takeover ^[34].

Slowing Auto Market and High Gas Prices Reduces Customers

For several years, the number of automobile registrations has remained flat and the average age of cars on the road has risen ^[35]. This means that the number of cars on the road is not growing like it once was and that the cars that are on the road are worth less. This leads to less premiums for the auto insurance market. This is only made worse by higher oil prices which have risen drastically. Auto companies have had and are expecting growth to slow. For example, Toyota is anticipating a 7% decline in U.S. sales in 2008 from 2007 ^[36].

Competition

The insurance industry has been experiencing increased competition due to an excess of underwriting capacity. This competition has driven down premiums and made the insurance business less profitable. In the United States, Bermuda, and Europe, WTM faces competition from large global reinsurers such as Swiss Re, Lloyd's of London, and Berkshire Hathaway, as well as smaller companies XL Capital, Transatlantic Holdings, Everest Re Group (RE), and ACE Limited. ^[37]

In the personal property insurance market, WTM faces competition from household names such as Allstate (ALL), AIG (AIG), and State Farm, which are able to sell automobile and other property insurance bundled together. ^[38] The U.S. property and casualty insurance market is fragmented-- WTM is 27th with 0.6% of the net written premiums. ^[39] However, Allstate, AIG, and State Farm, the market leaders, together represent 24.7% of the market. ^[40] Additionally, Esurance has to compete directly with Geico and Progressive in the auto insurance market. ^[41] Advertising is important in the personal insurance industry to attract customers from the competition. Esurance has been making a strong advertising push to catch up to direct insurers, Geico and Progressive, which also offer auto insurance without an agent.^[42] Competition in the auto insurance market is intense because it is difficult for competitors to differentiate themselves from each other.

References

1. ↑ WTM 2007 10k pg. 50-55  
2. ↑ Lloyd's underwriting capacity to hit record.
3. ↑ WTM 2007 10k pg. 25  
4. ↑ WTM 2007 10k pg. 25  
5. ↑ WTM 2007 10k pg. 48  
6. ↑ WTM 2007 10k pg. 40  
7. ↑ WTM 2007 10k pg. 51  
8. ↑ White Mountains Insurance (WTM).
9. ↑ WTM 2007 10k pg. 48-60  
10. ↑ WTM 2007 10k pg. 51  
11. ↑ WTM 2007 10k pg. 51  
12. ↑ WTM 2007 10k pg. 18  
13. ↑ WTM 2007 10k pg. 56  
14. ↑ WTM 2007 10k pg. 14-15  
15. ↑ WTM 2007 10k pg. 24  
16. ↑ WTM 2007 10k pg. 58  
17. ↑ WTM 2007 10k pg. 58  
18. ↑ Esurance adds employees, boosts premium.
19. ↑ Esurance adds employees, boosts premium.
20. ↑ Esurance adds employees, boosts premium.
21. ↑ Esurance adds employees, boosts premium.
22. ↑ WTM 2007 10k pg. 28  
23. ↑ WTM 2007 10k pg. 61  
24. ↑ WTM 2007 10k pg. 49  
25. ↑ WTM 2007 10k pg. 49  
26. ↑ WTM 2007 10k pg. 49  
27. ↑ WTM 2007 10k pg. 46, 51, 107  
28. ↑ WTM 2007 10k pg. 48-60  
29. ↑ WTM 2007 10k pg. 46, 51, 107  
30. ↑ WTM 2007 10k pg. 46, 50, 55, 58  
31. ↑ WTM 2007 10k pg. 58  
32. ↑ WTM 2007 10k pg. 64  
33. ↑ WTM 2007 10k pg. 97  
34. ↑ WTM 2007 10k pg. 106  
35. ↑ Where's the Growth in the Auto Insurance Market?.
36. ↑ Toyota cuts global sales outlook.
37. ↑ WTM 2007 10k pg. 42  
38. ↑ WTM 2007 10k pg. 42  
39. ↑ Top U.S. P&C Groups by Net Premiums Written.
40. ↑ Top U.S. P&C Groups by Net Premiums Written.
41. ↑ WTM 2007 10k pg. 42  
42. ↑ Where's the Growth in the Auto Insurance Market?.