8. Share-based Compensation

The fair value method of accounting is used for equity-based compensation plans. Under the fair value method, compensation cost is measured based on the fair value of the award at the measurement date and recognized over the requisite service period. We use the Black-Scholes model to estimate the fair values on the measurement date for share options and share appreciation rights (“SARs”). The Black-Scholes model uses several assumptions to value a share award. The volatility assumption is based on the historical change in Argo Group’s stock price over the previous five years preceding the measurement date. The risk-free rate of return assumption is based on the five-year U.S. Treasury constant maturity rate on the measurement date. The expected award life is based upon the average holding period over the history of the incentive plan. The following table summarizes the assumptions we used for the nine months ended September 30, 2012 and 2011:


	2012	2011
Risk-free rate of return	0.68% to 1.11%	0.89% to 2.07%
Expected dividend yields	1.63% to 1.67%	1.37% to 1.54%
Expected award life (years)	5.03 to 5.04	5.04 to 5.07
Expected volatility	32.5% to 32.8%	32.1% to 32.5%

Argo Group’s 2007 Long-Term Incentive Plan

In November 2007, the shareholders of Argo Group approved the 2007 Long-Term Incentive Plan (the “2007 Plan”), which provides for an aggregate of 4.5 million shares of our common stock that may be issued to certain executives, non-employee directors and other key employees. The share awards may be in the form of share options, SARs, restricted shares, restricted share units, performance units, performance shares or other share-based incentive awards. Shares issued under this plan may be shares that are authorized and unissued or shares that we reacquired, including shares purchased on the open market. Share options and SARs will count as one share for the purposes of the limits under the 2007 Plan; restricted shares, restricted share units, performance units, performance shares or other share-based incentive awards that settle in common shares will count as 2.75 shares for purpose of the limits under the 2007 Plan.

Share options may be in the form of incentive share options, non-qualified share options and restorative options. Share options are required to have an exercise price that is not less than the market value on the date of grant. We are prohibited from repricing the options. The term of the share options cannot exceed seven years from the grant date.

A summary of option activity under the 2007 Plan as of September 30, 2012, and changes during the nine months then ended is as follows:


	Shares			Weighted-Average Exercise Price
Outstanding at January 1, 2012		411,314		$	36.70
Granted		0		$	0.00
Exercised		0		$	0.00
Expired or forfeited		(5,731	)	$	35.29

Outstanding at September 30, 2012		405,583		$	36.72

Options outstanding under this plan vest over a one to five year period, subject to continued employment. Expense recognized under this plan for share options was $0.5 million and $0.9 million for the nine months ended September 30, 2012 and 2011, respectively. Compensation expense from all equity-based compensation awards is included in “Underwriting, acquisition and insurance expense” in the accompanying Consolidated Statements of Income (Loss). Unamortized expense for these options was $0.1 million as of September 30, 2012.

A summary of restricted share activity under the 2007 Plan as of September 30, 2012, and changes during the nine months then ended is as follows:


	Shares			Weighted-Average Grant Date Fair Value
Outstanding at January 1, 2012		148,373		$	31.09
Granted		163,598		$	29.64
Vested and issued		(43,277	)	$	32.64
Expired or forfeited		(26,177	)	$	32.56

Outstanding at September 30, 2012		242,517		$	30.16

The restricted shares will vest over two to four years. Expense recognized under this plan for the restricted shares was $1.4 million and $1.1 million for the nine months ended September 30, 2012 and 2011, respectively. As of September 30, 2012, there was $6.0 million of total unrecognized compensation cost related to restricted shares.

A summary of stock-settled SARs activity under the 2007 Plan as of September 30, 2012, and changes during the nine months then ended is as follows:


	Shares			Weighted-Average Exercise Price
Outstanding at January 1, 2012		927,225		$	30.18
Granted		370,720		$	29.59
Exercised		(2,764	)	$	28.01
Expired or forfeited		(142,255	)	$	32.26

Outstanding at September 30, 2012		1,152,926		$	29.74

The stock-settled SARs vest over a one to four year period. Upon exercise of the stock-settled SARs, the employee is entitled to receive shares of our common stock equal to the appreciation of the stock as compared to the exercise price. Expense recognized for the stock-settled SARs was $1.7 million and $1.0 million for the nine months ended September 30, 2012 and 2011, respectively. As of September 30, 2012, there was $4.7 million of total unrecognized compensation cost related to stock-settled SARs.

A summary of cash-settled SARs activity under the 2007 Plan as of September 30, 2012, and changes during the nine months then ended is as follows:


	Shares			Weighted-Average Exercise Price
Outstanding at January 1, 2012		1,086,043		$	30.38
Granted		829,278		$	29.65
Exercised		(14,199	)	$	28.04
Expired or forfeited		(117,518	)	$	31.92

Outstanding at September 30, 2012		1,783,604		$	29.95

The cash-settled SARs vest over a one to four year period. Upon exercise of the cash-settled SARs, the employee is entitled to receive cash payment for the appreciation in the value of our common stock over the exercise price. We are accounting for the cash-settled SARs as liability awards, which require the awards to be re-valued at each reporting period. Expense recognized for the cash-settled SARs totaled $3.6 million for the nine months ended September 30, 2012. Due to the decline in our stock price from December 31, 2010 to September 30, 2011, the revaluation of the cash-settled SARs resulted in a $1.3 million reduction to expense for the nine months ended September 30, 2011. As of September 30, 2012, there was $6.9 million of total unrecognized compensation cost related to cash-settled SARs.

Argo Group International Holdings Ltd. Deferred Compensation Plan for Non-Employee Directors

In February 2008, the Board of Directors approved the Argo Group International Holdings, Ltd. Deferred Compensation Plan for Non-Employee Directors (“Directors Plan”), a non-funded and non-qualified deferred compensation plan. Under the Directors Plan, non-employee directors can elect each year to defer payment of 50% or 100% of their cash compensation payable during the next calendar year. During the time that the cash compensation amounts are deferred, such amounts are credited with interest earned at a rate two percent above the prime rate, to be re-set each May 1. In addition, the Directors Plan calls for us to grant a match equal to 75% of the cash compensation amounts deferred in the form of “Stock Units,” which provide directors with the economic equivalent of stock ownership and are credited as a bookkeeping entry to each director’s “Stock Unit Account.” Each Stock Unit is valued at the closing price of our common stock on the national exchange on which it is listed as of the date credited for all purposes under the Directors Plan and fluctuates daily thereafter on that same basis. Distributions from the Directors Plan will occur six months after the non-employee director ceases to be a member of the Board due to retirement or termination without cause or change in control, or immediately upon disability or death. The non-employee directors are responsible for all tax requirements on the deferred compensation and any related earnings. The Directors Plan provides for a Stock Unit Account to be established for each non-employee director upon their election to the Board and credits their account with an initial bookkeeping entry for 1,650 Stock Units. Under the Directors Plan, we recorded compensation expense of $0.9 million and $0.4 million for the nine months ended September 30, 2012 and 2011, respectively.

Argonaut Group’s Amended and Restated Stock Incentive Plan

Argonaut Group, Inc.’s Amended and Restated Stock Incentive Plan, as approved by the shareholders (the “Amended Plan”), provided for an aggregate of up to 6,250,000 shares of our common stock that may be issued to certain executives and other key employees. The stock awards were issued in the form of non-qualified stock options and non-vested stock.

A summary of option activity under the Amended Plan as of September 30, 2012, and changes during the nine months then ended is as follows:


	Shares			Weighted-Average Exercise Price
Outstanding at January 1, 2012		408,671		$	35.93
Granted		0		$	0.00
Exercised		(10,097	)	$	23.29
Expired or forfeited		(179,190	)	$	34.99

Outstanding at September 30, 2012		219,384		$	37.29

All options granted under the Amended Plan were fully vested in August 2011.