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White Mountains Insurance (NYSE:WTM) held its annual analyst meeting on June 17, and I finally got around to listening to the webcast. The URL is here if you want to listen yourself.

I have written three other posts on the meeting. They are:

WTM - Introductory Comments

WTM - The Reserve Issue

WTM - Review of One Beacon

Review of White Mountains Re

The next business segment to present was White Mountains Re. WTM already covered the reserve issues here at the start of the analyst meeting, so it spent most of the time discussing other issues. They first presented net written premiums and combined ratios for the last five years.

The results show exactly what an investor wants to see at an insurance company: A declining combined ratio, with strong net premiums written growth, but the growth tailing off as the soft market starts and the company refuses to write unprofitable business. Management seemed to confirm this also.

“We showed a little bit of growth in the hard market from 2004-2006 but now you see our premiums coming down and from 2006 where we wrote $1.3 billion we’ve now declined to $1.1 billion which is about a 15% decline. That’s the front edge of our soft market strategy.”

Management reiterated this philosophy later on in the presentation. “We are not going to write under-priced business and we are not very focused on the top line. We are really focused on your bottom line and if we need to get smaller to maintain our returns we are going to do that and we’ll return the capital we are not using to WTM and it will be put to good use elsewhere. Most of the shrink (in premiums) is coming from the North American market where prices are declining more rapidly than Europe and elsewhere. The European market tends to be more stable.”

WTM Re is unofficially projecting a combined ratio less than 100% for the full year 2008, and explained. “We had a fairly calm first half of the year so far and if we include a full catastrophe load in second half results which is the long term average catastrophe experience…we can report a combined ratio of less than 100% for the year.”

Management covered the three segments under the WTM Re Organization – WTM Re America, WTM Re Sirius and WTM Re Bermuda.

WTM Re America

This unit has $900 million in regulatory capital and writes business in the excess and surplus market, property casualty, accident and health, and agricultural market. Management said that the casualty market is the one line coming down the most. “The casualty business is the one that is actually shrinking probably most rapidly. That was a $350 million business in the hard market and it is heading down to just north of a $100 million business next year.”

Also in this business unit is WTM Re Solutions, which is located in Simsbury, CT. They specialize in acquiring broken insurance and reinsurance properties that are mostly in run off situations. They have closed five deals since 2001 and have generated total expected profits in excess of $150 million.

WTM Re Sirius

This appears to be the crown jewel of the entire company. Sirius is a European based company that was bought by WTM in 2004 for $427.5 million, which was less than book value, and it now produces $125-150 million in earnings. Ray Barrette said earlier in the presentation that Sirius has a safety reserve that exceeds the total price that WTM paid for it.

The management at WTM Re explained the safety reserve:

“Sirius has in its U.S GAAP books a $400 million deferred tax liability. We don’t ever expect to pay that deferred tax liability, not a penny of it. The Swedish regulators don’t require recordation of that liability, in fact they count that money as capital. And the ratings agencies count that money as capital. But it’s not in our GAAP net worth, but when we look at Sirius business, however, we think of that as quasi equity that’s really a cheap source of leverage in that business.”

The 10-K explains it in more formal terms:

“In accordance with provisions of Swedish law, Sirius International is permitted to transfer up to the full amount of its pre-tax income, subject to certain limitations, into an untaxed reserve referred to as a safety reserve, which equaled $1.4 billion at December 31, 2007. Under GAAP, an amount equal to the safety reserve, net of the related deferred tax liability established at the Swedish tax rate of 28%, is classified as shareholder's equity. Generally, this deferred tax liability is only required to be paid by Sirius International if it fails to maintain predetermined levels of premium writings and loss reserves in future years. As a result of the indefinite deferral of these taxes, Swedish regulatory authorities do not apply any taxes to the safety reserve when calculating solvency capital under Swedish insurance regulations. Accordingly, under local statutory requirements, an amount equal to the deferred tax liability on Sirius International's safety reserve ($398 million at December 31, 2007) is included in solvency capital. Access to the safety reserve is restricted to coverage of aggregate losses and requires the approval of Swedish regulatory authorities.”

WTM Re Bermuda

This is the newest operating affiliate of WTM Re and it has been capitalized with $776 million at the end of 2007. It began writing business in the second quarter of 2008.

WTM Re Outlook

Premium will shrink to $ 1.1 billion in 2008, down 13% roughly from 2007, as the company maintains underwriting discipline. WTM Re will become a smaller, more profitable company, with lots of capital to pursue opportunities during the upcoming soft market.

Management added this at the end regarding increased competition coming into the market. The comments require further investigation:

“We’ve got players coming in from all over the place into our business, whether they are hedge funds or private equity using all different types of securities, CAT bonds, sidecars. We have used a couple of sidecars in the past ourselves. Many of these sources of capital have a lower cost of capital for the risk they are taking on than we do on our own balance sheet.”

“That’s a tough equation to win and rather than trying to compete with that in our present format, we will have to become more and more competitive in those markets and use those tools.”

“So over time I would expect and this will be gradual that WTM RE will become more of a service company and less of a risk bearing entity and that will produce better and less risky returns and free up more of our capital for use at WTM.”

Disclosure: Long WTM