10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

þ Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

for the Quarterly Period Ended September 30, 2010.

o Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

from                      to                     

Commission file number 001-13790

HCC Insurance Holdings, Inc.

(Exact name of registrant as specified in its charter)

Delaware	76-0336636
(State or other jurisdiction of incorporation or organization)	(IRS Employer Identification No.)
13403 Northwest Freeway, Houston, Texas	77040-6094
(Address of principal executive offices)	(Zip Code)

(713) 690-7300

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer þ	Accelerated filer o	Non-accelerated filer o	Smaller reporting company o
		(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

Indicate the number of shares outstanding of each of the registrant’s classes of common stock as of the latest practicable date.

On October 31, 2010, there were approximately 115.3 million shares of common stock outstanding.

HCC INSURANCE HOLDINGS, INC.

TABLE OF CONTENTS

	Page
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets — September 30, 2010 and December 31, 2009 (unaudited)		5
Condensed Consolidated Statements of Earnings — Nine months and three months ended September 30, 2010 and 2009 (unaudited)		6
Condensed Consolidated Statement of Changes in Shareholders’ Equity — Nine months ended September 30, 2010 (unaudited)		7
Condensed Consolidated Statements of Cash Flows — Nine months ended September 30, 2010 and 2009 (unaudited)		8
Notes to Condensed Consolidated Financial Statements (unaudited)		9
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		27
Item 3. Quantitative and Qualitative Disclosures About Market Risk		48
Item 4. Controls and Procedures		48
Part II. OTHER INFORMATION
Item 1. Legal Proceedings		49
Item 1A. Risk Factors		49
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		49
Item 6. Exhibits		50
Signatures		51
EX-12
EX-31.1
EX-31.2
EX-32.1
EX-101 INSTANCE DOCUMENT
EX-101 SCHEMA DOCUMENT
EX-101 CALCULATION LINKBASE DOCUMENT
EX-101 LABELS LINKBASE DOCUMENT
EX-101 PRESENTATION LINKBASE DOCUMENT
EX-101 DEFINITION LINKBASE DOCUMENT

2

FORWARD-LOOKING STATEMENTS

This Report on Form 10-Q contains certain “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, which are intended to be covered by the safe harbors created by those laws. We have based these forward-looking statements on our current expectations and projections about future events. These forward-looking statements include information about possible or assumed future results of our operations. All statements, other than statements of historical facts, included or incorporated by reference in this Report that address activities, events or developments that we expect or anticipate may occur in the future, including such things as growth of our business and operations, business strategy, competitive strengths, goals, plans, future capital expenditures and references to future successes may be considered forward-looking statements. Also, when we use words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan,” “probably” or similar expressions, we are making forward-looking statements.

Many risks and uncertainties may have an impact on the matters addressed in these forward-looking statements, which could affect our future financial results and performance, including, among other things:

• the effects of catastrophic losses,

• the cyclical nature of the insurance business,

• inherent uncertainties in the loss estimation process, which can adversely impact the adequacy of loss reserves,

• the impact of the credit market downturn and subprime market exposures,

• the effects of emerging claim and coverage issues,

• the effects of extensive governmental regulation of the insurance industry,

• potential credit risk with brokers,

• the effects of industry consolidations,

• our assessment of underwriting risk,

• our retention of risk, which could expose us to potential losses,

• the adequacy of reinsurance protection,

• the ability and willingness of reinsurers to pay balances due us,

• the occurrence of terrorist activities,

• our ability to maintain our competitive position,

• changes in our assigned financial strength ratings,

• our ability to raise capital and funds for liquidity in the future,

• attraction and retention of qualified employees,

• fluctuations in securities markets, which may reduce the value of our investment assets, reduce investment income or generate realized investment losses,

• our ability to successfully expand our business through the acquisition of insurance-related companies,

• impairment of goodwill,

3

• the ability of our insurance company subsidiaries to pay dividends in needed amounts,

• fluctuations in foreign exchange rates,

• failures or constraints of our information technology systems,

• changes to the country’s health care delivery system,

• the effects , if any, of climate change, on the risks we insure,

• change of control, and

• difficulties with outsourcing relationships.

We describe these risks and uncertainties in greater detail in Item 1A, Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2009.

These events or factors could cause our results or performance to differ materially from those we express in our forward-looking statements. Although we believe that the assumptions underlying our forward-looking statements are reasonable, any of these assumptions, and, therefore, also the forward-looking statements based on these assumptions, could themselves prove to be inaccurate. In light of the significant uncertainties inherent in the forward-looking statements that are included in this Report, our inclusion of this information is not a representation by us or any other person that our objectives or plans will be achieved.

Our forward-looking statements speak only at the date made, and we will not update these forward-looking statements unless the securities laws require us to do so. In light of these risks, uncertainties and assumptions, any forward-looking events discussed in this Report may not occur.

4

HCC Insurance Holdings, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets
(unaudited, in thousands except per share data)

	September 30,			December 31,
	2010			2009
ASSETS
Investments
Fixed income securities — available for sale, at fair value (amortized cost: 2010 — $4,865,445; 2009 — $4,381,762)	$	5,166,709		$	4,538,073
Fixed income securities — held to maturity, at amortized cost (fair value: 2010 — $198,317; 2009 — $104,008)		193,841			102,792
Short-term investments, at cost, which approximates fair value		474,066			810,673
Other investments		433			4,691
Total investments		5,835,049			5,456,229
Cash		98,213			129,460
Restricted cash and cash investments		157,677			146,133
Premium, claims and other receivables		658,670			600,332
Reinsurance recoverables		1,042,650			1,016,411
Ceded unearned premium		283,529			270,436
Ceded life and annuity benefits		58,985			61,313
Deferred policy acquisition costs		219,062			208,463
Goodwill		821,700			822,006
Other assets		118,360			123,608
Total assets	$	9,293,895		$	8,834,391
LIABILITIES
Loss and loss adjustment expense payable	$	3,555,505		$	3,492,309
Life and annuity policy benefits		58,985			61,313
Reinsurance balances payable		202,202			182,661
Unearned premium		1,069,594			1,044,747
Deferred ceding commissions		72,714			71,595
Premium and claims payable		142,445			154,596
Notes payable		298,598			298,483
Accounts payable and accrued liabilities		556,750			497,504
Total liabilities		5,956,793			5,803,208
SHAREHOLDERS’ EQUITY
Common stock, $1.00 par value; 250,000 shares authorized (shares issued: 2010 — 120,398 and 2009 — 118,724; outstanding: 2010 — 115,268 and 2009 — 114,051)		120,398			118,724
Additional paid-in capital		940,745			914,339
Retained earnings		2,177,266			1,977,254
Accumulated other comprehensive income		208,936			119,665
Treasury stock, at cost (shares: 2010 — 5,130 and 2009 — 4,673)		(110,243	)		(98,799	)
Total shareholders’ equity		3,337,102			3,031,183
Total liabilities and shareholders’ equity	$	9,293,895		$	8,834,391

See Notes to Condensed Consolidated Financial Statements.

5

HCC Insurance Holdings, Inc. and Subsidiaries

Condensed Consolidated Statements of Earnings
(unaudited, in thousands except per share data)

	Nine months ended September 30,						Three months ended September 30,
	2010			2009			2010			2009
REVENUE
Net earned premium	$	1,532,138		$	1,524,425		$	516,166		$	520,059
Net investment income		150,603			141,740			51,137			48,111
Other operating income		35,035			69,765			7,888			12,166
Net realized investment gain		7,897			4,852			1,057			864
Other-than-temporary impairment loss
Total loss		(316	)		(6,089	)		(316	)		(380	)
Portion recognized in other comprehensive income		16			810			16			55
Net loss recognized in earnings		(300	)		(5,279	)		(300	)		(325	)
Total revenue		1,725,373			1,735,503			575,948			580,875
EXPENSE
Loss and loss adjustment expense, net		922,645			911,944			297,138			303,808
Policy acquisition costs, net		242,078			223,186			80,748			71,492
Other operating expense		189,953			195,509			60,770			64,985
Interest expense		15,907			11,816			5,280			3,549
Total expense		1,370,583			1,342,455			443,936			443,834
Earnings before income tax expense		354,790			393,048			132,012			137,041
Income tax expense		106,993			123,972			38,949			42,720
Net earnings	$	247,797		$	269,076		$	93,063		$	94,321
Earnings per common share
Basic	$	2.15		$	2.39		$	0.81		$	0.84
Diluted	$	2.15		$	2.37		$	0.81		$	0.83

See Notes to Condensed Consolidated Financial Statements.

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HCC Insurance Holdings, Inc. and Subsidiaries

Condensed Consolidated Statement of Changes in Shareholders’ Equity
(unaudited, in thousands except per share data)

								Accumulated
			Additional					other						Total
	Common		paid-in		Retained			comprehensive			Treasury			shareholders’
	stock		capital		earnings			income			stock			equity
Balance at December 31, 2009	$	118,724	$	914,339	$	1,977,254		$	119,665		$	(98,799	)	$	3,031,183
Comprehensive income
Net earnings		—		—		247,797			—			—			247,797
Other comprehensive income
Change in net unrealized gain on investments, net of tax		—		—		—			92,707			—			92,707
Other, net of tax		—		—		—			(3,436	)		—			(3,436	)
Total other comprehensive income															89,271
Comprehensive income															337,068
Issuance of 948 shares for exercise of options, including tax effect		948		17,691		—			—			—			18,639
Purchase of 457 common shares		—		—		—			—			(11,444	)		(11,444	)
Stock-based compensation		726		8,715		—			—			—			9,441
Cash dividends declared, $0.415 per share		—		—		(47,785	)		—			—			(47,785	)
Balance at September 30, 2010	$	120,398	$	940,745	$	2,177,266		$	208,936		$	(110,243	)	$	3,337,102

See Notes to Condensed Consolidated Financial Statements.

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HCC Insurance Holdings, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows
(unaudited, in thousands)

	Nine months ended September 30,
	2010			2009
Operating activities
Net earnings	$	247,797		$	269,076
Adjustments to reconcile net earnings to net cash provided by operating activities:
Change in premium, claims and other receivables		(36,040	)		36,443
Change in reinsurance recoverables		(32,474	)		14,853
Change in ceded unearned premium		(15,368	)		(25,093	)
Change in loss and loss adjustment expense payable		76,829			51,519
Change in reinsurance balances payable		21,435			24,548
Change in unearned premium		30,471			39,441
Change in premium and claims payable, net of restricted cash		(9,934	)		(63,727	)
Change in accounts payable and accrued liabilities		12,593			22,132
Stock-based compensation expense		9,441			12,472
Depreciation and amortization expense		12,894			11,796
Gain on investments		(8,086	)		(3,152	)
Other, net		5,073			27,238
Cash provided by operating activities		314,631			417,546
Investing activities
Sales of available for sale fixed income securities		132,897			337,615
Maturity or call of available for sale fixed income securities		458,495			260,839
Maturity or call of held to maturity fixed income securities		25,187			86,190
Cost of available for sale fixed income securities acquired		(1,048,010	)		(1,020,506	)
Cost of held to maturity fixed income securities acquired		(115,215	)		(59,677	)
Change in short-term investments		328,951			(91,617	)
Proceeds from sales of strategic and other investments		4,577			114,940
Payments for purchase of businesses, net of cash received		(36,348	)		(37,995	)
Proceeds from sale of subsidiaries		15,278			6,188
Other, net		(6,755	)		(13,109	)
Cash used by investing activities		(240,943	)		(417,132	)
Financing activities
Advances on line of credit		—			115,000
Payments on line of credit		—			(15,032	)
Payments on convertible notes		(64,472	)		—
Sale of common stock		18,639			9,423
Purchase of common stock		(11,444	)		(35,464	)
Dividends paid		(46,532	)		(42,244	)
Other, net		(1,126	)		(2,570	)
Cash provided (used) by financing activities		(104,935	)		29,113
Net increase (decrease) in cash		(31,247	)		29,527
Cash at beginning of year		129,460			27,347
Cash at end of period	$	98,213		$	56,874

See Notes to Condensed Consolidated Financial Statements.

8

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements
(unaudited, tables in thousands except per share data)

(1) General Information

HCC Insurance Holdings, Inc. and its subsidiaries (collectively HCC, we, us or our) include domestic and foreign property and casualty and life insurance companies and underwriting agencies. We operate primarily in the United States, the United Kingdom, Spain and Ireland, although some of our operations have a broader international scope. We market our products both directly to customers and through a network of independent brokers, producers, agents and third party administrators. We provide specialized property and casualty, surety and credit, and accident and health insurance coverages and related agency services to commercial customers and individuals.

Basis of Presentation

Our unaudited condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP) and include the accounts of HCC Insurance Holdings, Inc. and its subsidiaries. We have made all adjustments that, in our opinion, are necessary for a fair statement of results of the interim periods, and all such adjustments are of a normal recurring nature. All significant intercompany balances and transactions have been eliminated in consolidation. The condensed consolidated financial statements should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2009. The condensed consolidated balance sheet at December 31, 2009 was derived from the audited financial statements, but does not include all disclosures required by GAAP.

Management must make estimates and assumptions that affect amounts reported in our condensed consolidated financial statements and in disclosures of contingent assets and liabilities. Ultimate results could differ from those estimates. We have reclassified certain amounts in our 2009 condensed consolidated financial statements to conform to the 2010 presentation, including the reclassification related to fee and commission income discussed below. None of our reclassifications had an effect on our consolidated net earnings, shareholders’ equity or cash flows.

HCC completed the reorganization of its management structure in the third quarter of 2010. Our segment reporting structure has been realigned to reflect these changes. See Note 2, “Segments” for a discussion of our new segment structure.

In connection with our resegmentation, we changed the presentation of our consolidated income statement to better represent our current operations. Previously, we presented reinsurance ceding commissions that exceeded policy acquisition costs as a component of fee and commission income, within total revenue. We now present all ceding commissions as an offset to policy acquisition costs, within total expense, and classify the remaining fee and commission income as a component of other operating income, within total revenue.

Accounting Guidance in 2010

A new accounting standard, originally issued as SFAS No. 167, Amendments to FASB Interpretation No. 46(R), became effective January 1, 2010. The guidance, which was incorporated into Accounting Standards Codification (ASC) Topic 810, Consolidation, changes various aspects of accounting for and disclosures of interests in variable interest entities. Our adoption of this guidance as of January 1, 2010 had no material impact on our condensed consolidated financial statements.

Effective January 1, 2010, we adopted Accounting Standards Update (ASU) No. 2010-06, which incorporated changes in disclosure requirements into ASC Topic 820, Fair Value Measurements and Disclosures. Where applicable, we have included the additional required disclosures in the notes to our condensed consolidated financial statements.

A new accounting standard, ASU 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses, was issued in July 2010. The new guidance expands disclosures related to financing receivables, including the nature of credit risk in financing receivables, how that risk is analyzed in determining the related allowance for credit losses, and changes to the allowance during the reporting period. We will provide the additional required disclosures in our Form 10-K for the year ended December 31, 2010.

A new accounting standard, originally issued as EITF 09-G, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts, was ratified in September 2010. The guidance, which will be incorporated into ASC Topic 944, Financial Services — Insurance, clarifies the definition of what constitutes an acquisition cost and limits the types of acquisition costs that

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HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, tables in thousands except per share data)

can be capitalized by insurance entities to those that are “directly related to” the acquisition of new and renewal insurance contracts. Under the new guidance, direct costs only include those that result in the successful acquisition of a policy. All costs incurred for unsuccessful efforts, along with indirect costs, are to be expensed as incurred. This guidance must be adopted by January 1, 2012, either prospectively or retrospectively, and may be adopted earlier at the beginning of an annual period. We are currently evaluating the timing and effect of our adoption of this guidance.

Derivative Financial Instruments

At December 31, 2009, we had interests in two long-term mortgage impairment insurance contracts that were denominated in British pound sterling. The exposure with respect to these two contracts was measured based on movement in a specified United Kingdom housing index. In the first quarter of 2010, we commuted our interest in one contract for $8.3 million cash. We recognized a gain of $8.0 million, which is included in other operating income in our condensed consolidated statements of earnings. The remaining contract qualifies as a derivative financial instrument, is unhedged and is reported at fair value in other assets in our condensed consolidated balance sheets. We record changes in fair value and any foreign exchange gain/loss on this contract as a component of other operating income.

Stock-based Compensation

In the first nine months of 2010, we granted the following shares of common stock, restricted stock, restricted stock units and stock options for the purchase of shares of our common stock. For all grants except stock options, we measure fair value based on our closing stock price on the grant date. For stock options, we use the Black-Scholes single option pricing model to determine the fair value of an option on its grant date. The fair value of the common stock was expensed on the grant date. The fair value of the restricted stock, restricted stock units and stock options will be expensed over the vesting period.

			Weighted-average
	Number		grant date		Aggregate		Vesting
	of shares		fair value		fair value		period
Common stock		33	$	25.33	$	840
Restricted stock		760		27.54		20,941	3-10 years
Restricted stock units		60		25.96		1,555	3-10 years
Stock options		395		6.07		2,398	5 years

Income Taxes

For the nine months ended September 30, 2010 and 2009, the income tax provision was calculated based on an estimated effective tax rate for each year. Our effective tax rate differs from the U.S. Federal statutory rate primarily due to the effect of tax-exempt municipal bond interest.

Disposition

In 2010, we sold an inactive subsidiary, HCC Insurance Company, for $14.7 million cash and realized a $0.5 million gain.

10

HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, tables in thousands except per share data)

(2) Segments

In the third quarter of 2010, our chief executive officer, in the role of chief operating decision maker (CODM), completed the reorganization of HCC’s management structure in order to manage and evaluate the company’s operations from an insurance underwriting perspective, in line with our portfolio of insurance products. We have changed HCC’s segment reporting structure to reflect these changes. Previously, we reported our results in the Insurance Company, Agency, and Other Operations segments. We now report HCC’s results in the following six operating segments, each of which reports to an executive of HCC who is responsible for the segment results.

• U.S. Property & Casualty

• Professional Liability

• Accident & Health

• U.S. Surety & Credit

• International

• Investing

Insurance Underwriting Segments

Each of the five insurance-related segments bears risk for insurance coverage written within its portfolio of insurance products. Each segment generates income from premium written by our underwriting agencies, through third party agents and brokers, or on a direct basis. Fee and commission income earned by our agencies from third party insurance companies is included in segment revenue. Each segment also incurs insurance losses, acquisition costs and other administrative expenses related to our insurance companies and underwriting agencies. The CODM monitors and assesses each segment’s pretax results based on underwriting profit, gross and net written premium, and its combined ratio, consisting of the loss ratio and expense ratio.

Included in the portfolio of products for each insurance segment are the following key products:

• U.S. Property & Casualty — aviation, small account errors and omissions liability, public risk, employment practices liability, title, residual value, disability, contingency, kidnap and ransom and brown water marine written in the United States.

• Professional Liability — directors’ and officers’ liability, large account errors and omissions liability, diversified financial products and fidelity written in the United States and internationally.

• Accident & Health — medical stop-loss, short-term domestic and international medical, HMO reinsurance and medical excess written in the United States.

• U.S. Surety & Credit — contract, commercial, court and bail bonds written in the United States and credit insurance managed in the United States.

• International — energy, property treaty, liability, surety, credit, property, ocean marine, accident and health and other smaller product lines written outside the United States.

Investing Segment

The Investing segment includes our total investment portfolio, as well as all investment income, investment related expenses and realized investment gains and losses. All investment activity is reported as revenue, consistent with our consolidated presentation. While the insurance underwriting segments generate the cash flow underlying these investments, our CODM does not include investment income in his assessment of the underwriting results of the insurance underwriting segments. Rather, investments and investment results are managed and evaluated centrally.

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HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, tables in thousands except per share data)

Corporate & Other

The Corporate & Other category is used to reconcile segment results to consolidated totals and includes corporate operating expenses not allocable to the segments, interest expense on long-term debt, and underwriting results of our Exited Lines. Our Exited Lines include six product lines that we no longer write and do not expect to write in the future. The Exited Lines include: 1) accident and health business managed by our underwriting agency, LDG Reinsurance, 2) workers’ compensation, 3) provider excess, 4) Spanish medical malpractice, 5) U.K. motor and 6) film completion bonds. We have included premium, losses and expenses related to our Exited Lines in the Corporate & Other category for all periods presented.

All stock-based compensation is included in Corporate & Other because it is not included in the CODM’s evaluation of the five insurance underwriting segments. All contractual and discretionary bonuses are expensed in the respective employee’s segment in the year the bonuses are earned. Any such bonuses that will be paid by restricted stock awards, which will be granted by the Compensation Committee in the following year, are reversed within corporate operating expenses. The appropriate stock-based compensation expense will be recorded in Corporate & Other as the awards vest in future years. The majority of our depreciation and amortization expense is included in Corporate & Other.

All prior period information included in this Form 10-Q has been adjusted to present our segment disclosures and information on a consistent basis with our new segment reporting structure.

The following tables present information by business segment.

	U.S. Property		Professional			Accident		U.S. Surety						Corporate
	& Casualty		Liability			& Health		& Credit		International		Investing		& Other			Consolidated
Nine months ended September 30, 2010
Net earned premium	$	258,427	$	321,849		$	567,739	$	148,427	$	234,471	$	—	$	1,225		$	1,532,138
Other revenue		24,128		458			2,830		455		6,177		158,200		987			193,235
Segment revenue		282,555		322,307			570,569		148,882		240,648		158,200		2,212			1,725,373
Loss and LAE, net		164,684		196,154			412,438		38,157		107,601		—		3,611			922,645
Other expense		75,890		57,171			89,967		81,699		88,441		—		54,770			447,938
Segment expense		240,574		253,325			502,405		119,856		196,042		—		58,381			1,370,583
Segment pretax earnings	$	41,981	$	68,982		$	68,164	$	29,026	$	44,606	$	158,200	$	(56,169	)	$	354,790
Nine months ended September 30, 2009
Net earned premium	$	289,195	$	330,614		$	553,967	$	135,436	$	189,148	$	—	$	26,065		$	1,524,425
Other revenue		46,815		(134	)		3,964		182		18,803		141,313		135			211,078
Segment revenue		336,010		330,480			557,931		135,618		207,951		141,313		26,200			1,735,503
Loss and LAE, net		164,346		202,741			406,722		39,849		68,931		—		29,355			911,944
Other expense		85,813		38,988			88,802		72,527		83,941		—		60,440			430,511
Segment expense		250,159		241,729			495,524		112,376		152,872		—		89,795			1,342,455
Segment pretax earnings	$	85,851	$	88,751		$	62,407	$	23,242	$	55,079	$	141,313	$	(63,595	)	$	393,048

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HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, tables in thousands except per share data)

	U.S. Property		Professional			Accident		U.S. Surety						Corporate
	& Casualty		Liability			& Health		& Credit		International		Investing		& Other			Consolidated
Three months ended September 30, 2010
Net earned premium	$	84,802	$	103,696		$	193,252	$	49,807	$	84,539	$	—	$	70		$	516,166
Other revenue		5,033		20			1,113		127		1,466		51,894		129			59,782
Segment revenue		89,835		103,716			194,365		49,934		86,005		51,894		199			575,948
Loss and LAE, net		61,883		63,212			138,869		10,296		23,227		—		(349	)		297,138
Other expense		21,289		18,866			30,908		28,007		29,365		—		18,363			146,798
Segment expense		83,172		82,078			169,777		38,303		52,592		—		18,014			443,936
Segment pretax earnings	$	6,663	$	21,638		$	24,588	$	11,631	$	33,413	$	51,894	$	(17,815	)	$	132,012
Three months ended September 30, 2009
Net earned premium	$	94,453	$	121,387		$	185,937	$	45,709	$	65,421	$	—	$	7,152		$	520,059
Other revenue		6,979		(151	)		1,045		70		5,853		48,650		(1,630	)		60,816
Segment revenue		101,432		121,236			186,982		45,779		71,274		48,650		5,522			580,875
Loss and LAE, net		52,957		73,752			135,708		12,098		23,165		—		6,128			303,808
Other expense		27,601		9,250			29,899		25,332		28,478		—		19,466			140,026
Segment expense		80,558		83,002			165,607		37,430		51,643		—		25,594			443,834
Segment pretax earnings	$	20,874	$	38,234		$	21,375	$	8,349	$	19,631	$	48,650	$	(20,072	)	$	137,041

The following table presents total assets by segment. Assets in the insurance underwriting segments include goodwill that was allocated in conjunction with our resegmentation. See Note 3, “Goodwill” below for further discussion of the goodwill allocation. Goodwill was allocated to the December 31, 2009 balances based on the goodwill balances in each reportable segment as of September 30, 2010.

	September 30,		December 31,
	2010		2009
U.S. Property & Casualty	$	988,326	$	971,521
Professional Liability		979,606		954,613
Accident & Health		250,042		254,652
U.S. Surety & Credit		182,879		200,243
International		647,734		585,385
Investing		5,899,685		5,510,715
Corporate & Other		345,623		357,262
Total	$	9,293,895	$	8,834,391

13

HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, tables in thousands except per share data)

For purposes of the disclosures in the tables below, we determine geographic location by the country of domicile of our subsidiaries that write the business and not by the location of insureds or reinsureds from whom the business was generated. The tables below present the split of our revenue, pretax earnings and total assets by geographic location.

	Nine months ended September 30,				Three months ended September 30,
	2010		2009		2010		2009
Domestic	$	1,361,153	$	1,402,396	$	448,535	$	464,422
Foreign		364,220		333,107		127,413		116,453
Total revenue	$	1,725,373	$	1,735,503	$	575,948	$	580,875
Domestic	$	262,311	$	295,816	$	78,767	$	98,672
Foreign		92,479		97,232		53,245		38,369
Total pretax earnings	$	354,790	$	393,048	$	132,012	$	137,041

	September 30,		December 31,
	2010		2009
Domestic	$	7,034,297	$	6,768,475
Foreign		2,259,598		2,065,916
Total assets	$	9,293,895	$	8,834,391

(3) Goodwill

We conducted our annual goodwill impairment test as of June 30, 2010, based on our prior reporting units, and noted no indicators of impairment. An indicator of impairment of goodwill exists when the fair value of a reporting unit is less than its carrying amount. We will conduct our next annual goodwill impairment test as of June 30, 2011, unless other events occur that indicate there is an impairment in our goodwill prior to that date.

In connection with the changes to our segment reporting structure, we allocated our consolidated goodwill to new reporting units and tested goodwill for impairment as of September 30, 2010. Based on this impairment test, the fair value of each new reporting unit exceeded its carrying amount.

We now have five reporting units, which are the same as our new insurance underwriting segments. To determine the fair value of each reporting unit, we utilized the income and market valuation approaches and based our assumptions and inputs on market participant data, as well as our own data. For the income approach, we estimated the present value of each reporting unit’s expected cash flows to determine its fair value. We utilized estimated future cash flows of the portfolio of products included in each reporting unit, as well as a risk-appropriate rate of return specific to each reporting unit. We utilized our budgets and projection of future operations based on historical and expected industry trends to estimate our future cash flows and their probability of occurring as projected. We also determined fair value of each reporting unit based on market participant data, and used those results to test the reasonableness and validity of the income approach results.

For goodwill impairment testing purposes only, we allocated the investments and investment income from the Investing segment to the five reporting units. We assigned investments to each reporting unit based on the amount of capital required by the reporting unit to maintain an A+ rating under A.M. Best’s capital allocation model. We assumed the same investment income rate of return for all investments.

14

HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, tables in thousands except per share data)

We allocated goodwill to the reporting units based on the relative fair value of each reporting unit to the sum of the reporting units’ total fair value at September 30, 2010. In future periods, when we complete a business acquisition, we will assign goodwill to the applicable reporting units, based on the reporting unit’s share of the estimated future cash flows of all acquired insurance products.

There were no significant changes in goodwill related to our prior reportable segments during 2010. The balances by reportable segment after our resegmentation are presented below.

	September 30,
	2010
U.S. Property & Casualty	$	223,000
Professional Liability		250,000
Accident & Health		144,000
U.S. Surety & Credit		79,700
International		125,000
Total	$	821,700

(4) Fair Value Measurements

We value financial assets and financial liabilities at fair value. In determining fair value, we generally apply the market approach, which uses prices and other relevant data based on market transactions involving identical or comparable assets and liabilities. We classify our financial instruments into the following three-level hierarchy:

• Level 1 — Inputs are based on quoted prices in active markets for identical instruments.

• Level 2 — Inputs are based on observable market data (other than quoted prices), or are derived from or corroborated by observable market data.

• Level 3 — Inputs are unobservable and not corroborated by market data.

Our Level 1 investments are primarily U.S. Treasuries listed on exchanges. We use quoted prices for identical instruments to measure fair value.

Our Level 2 investments include most of our fixed income securities, which consist of U.S. government agency securities, municipal bonds, certain corporate debt securities, and certain mortgage-backed and asset-backed securities. Our Level 2 instruments also include our interest rate swap agreements, which are reflected as liabilities in our condensed consolidated balance sheets. We measure fair value for the majority of our Level 2 investments using quoted prices of securities with similar characteristics. The remaining investments are valued using pricing models or matrix pricing. The fair value measurements consider observable assumptions, including benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, default rates, loss severity and other economic measures.

We use independent pricing services to assist us in determining fair value for over 99% of our Level 1 and Level 2 investments. The pricing services provide a single price or quote per security. We use data provided by our third party investment manager to value the remaining Level 2 investments. To validate that these quoted and modeled prices are reasonable estimates of fair value, we perform various quantitative and qualitative procedures, including: 1) evaluation of the underlying methodologies, 2) analysis of recent sales activity, 3) analytical review of our fair values against current market prices, and 4) comparison of the pricing services’ fair value to other pricing services’ fair value for the same investment. Based on these procedures, we did not adjust the prices or quotes provided by our independent pricing services or third party investment managers as of September 30, 2010 or December 31, 2009. In addition, we did not apply GAAP criteria for determining the fair value of securities in inactive markets since no markets for our investments were judged to be inactive as of September 30, 2010 or December 31, 2009.

Our Level 3 securities include certain fixed income securities, and an insurance contract that we account for as a derivative classified in other assets. We determine fair value based on internally developed models that use assumptions or other data that are not readily observable from objective sources. Because we use the lowest level significant input to determine our hierarchy classifications, a financial instrument may be classified in Level 3 even though there may be significant readily-observable inputs.

15

HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, tables in thousands except per share data)

In the first quarter of 2010, we commuted our interest in a second insurance contract that was accounted for as a derivative and also classified in other assets in Level 3 at December 31, 2009.

The following tables present our assets and interest rate swap liabilities that were measured at fair value.

	Level 1		Level 2			Level 3		Total
September 30, 2010
Fixed income securities — available for sale
U.S. government and government agency securities	$	152,578	$	183,041		$	—	$	335,619
Fixed income securities of states, municipalities and political subdivisions		—		1,132,448			—		1,132,448
Special purpose revenue bonds of states, municipalities and political subdivisions		—		1,575,914			—		1,575,914
Corporate fixed income securities		—		591,335			156		591,491
Residential mortgage-backed securities		—		1,099,360			—		1,099,360
Commercial mortgage-backed securities		—		157,730			—		157,730
Asset-backed securities		—		4,302			1,267		5,569
Foreign government securities		—		268,578			—		268,578
Total fixed income securities — available for sale		152,578		5,012,708			1,423		5,166,709
Other investments		12		—			—		12
Other assets		—		—			686		686
Total assets measured at fair value	$	152,590	$	5,012,708		$	2,109	$	5,167,407
Accounts payable and accrued liabilities	$	—	$	(471	)	$	—	$	(471	)
Total liabilities measured at fair value	$	—	$	(471	)	$	—	$	(471	)

16

HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, tables in thousands except per share data)

	Level 1		Level 2			Level 3		Total
December 31, 2009
Fixed income securities — available for sale
U.S. government and government agency securities	$	178,927	$	134,620		$	—	$	313,547
Fixed income securities of states, municipalities and political subdivisions		—		1,059,426			—		1,059,426
Special purpose revenue bonds of states, municipalities and political subdivisions		—		1,146,334			—		1,146,334
Corporate fixed income securities		—		686,170			151		686,321
Residential mortgage-backed securities		—		944,182			—		944,182
Commercial mortgage-backed securities		—		143,412			2,805		146,217
Asset-backed securities		—		13,059			1,306		14,365
Foreign government securities		—		227,681			—		227,681
Total fixed income securities — available for sale		178,927		4,354,884			4,262		4,538,073
Other investments		14		—			—		14
Other assets		—		—			432		432
Total assets measured at fair value	$	178,941	$	4,354,884		$	4,694	$	4,538,519
Accounts payable and accrued liabilities	$	—	$	(2,367	)	$	—	$	(2,367	)
Total liabilities measured at fair value	$	—	$	(2,367	)	$	—	$	(2,367	)

We excluded from our fair value disclosures our held to maturity investment portfolio, measured at amortized cost, and our other investments, measured at cost, of which $4.1 million were redeemed in the second quarter of 2010.

The following tables present the changes in fair value of our Level 3 assets.

	2010									2009
	Fixed									Fixed
	income			Other						income			Other
	securities			assets			Total			securities			assets		Total
Fair value at beginning of year	$	4,262		$	432		$	4,694		$	6,515		$	16,100	$	22,615
Net redemptions		(572	)		(8,342	)		(8,914	)		(1,590	)		—		(1,590	)
Gains and (losses) — unrealized		276			254			530			1,018			3,469		4,487
Gains and (losses) — realized		—			8,342			8,342			30			—		30
Transfers into Level 3		—			—			—			6,263			—		6,263
Transfers out of Level 3		(2,543	)		—			(2,543	)		(3,661	)		—		(3,661	)
Fair value at September 30	$	1,423		$	686		$	2,109		$	8,575		$	19,569	$	28,144

17

HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, tables in thousands except per share data)

	2010								2009
	Fixed								Fixed
	income			Other					income			Other
	securities			assets		Total			securities			assets			Total
Fair value at June 30	$	3,973		$	470	$	4,443		$	5,982		$	19,757		$	25,739
Net redemptions		(77	)		—		(77	)		(327	)		—			(327	)
Gains and (losses) — unrealized		70			216		286			487			(188	)		299
Transfers into Level 3		—			—		—			4,348			—			4,348
Transfers out of Level 3		(2,543	)		—		(2,543	)		(1,915	)		—			(1,915	)
Fair value at September 30	$	1,423		$	686	$	2,109		$	8,575		$	19,569		$	28,144

Unrealized gains and losses on our Level 3 fixed income securities are reported in other comprehensive income within shareholders’ equity, and unrealized gains and losses on our Level 3 other assets are reported in other operating income. We transferred investments into Level 3 in 2009 due to our inability to obtain fair values using inputs based on observable market data. We transferred investments from Level 3 to Level 2 in both years because we were able to determine their fair value using inputs based on observable market data in the period transferred.

(5) Investments

Substantially all of our fixed income securities are investment grade and 97% are rated “A” or better. The cost or amortized cost, gross unrealized gain or loss, and fair value of our fixed income securities were as follows:

	Cost or		Gross		Gross
	amortized		unrealized		unrealized
	cost		gain		loss			Fair value
Available for sale at September 30, 2010
U.S. government and government agency securities	$	321,725	$	13,894	$	—		$	335,619
Fixed income securities of states, municipalities and political subdivisions		1,055,013		77,737		(302	)		1,132,448
Special purpose revenue bonds of states, municipalities and political subdivisions		1,485,705		90,680		(471	)		1,575,914
Corporate fixed income securities		554,739		36,753		(1	)		591,491
Residential mortgage-backed securities		1,042,769		59,021		(2,430	)		1,099,360
Commercial mortgage-backed securities		147,854		10,087		(211	)		157,730
Asset-backed securities		5,436		133		—			5,569
Foreign government securities		252,204		16,442		(68	)		268,578
Total fixed income securities — available for sale	$	4,865,445	$	304,747	$	(3,483	)	$	5,166,709

18

HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, tables in thousands except per share data)

	Cost or		Gross		Gross
	amortized		unrealized		unrealized
	cost		gain		loss			Fair value
Available for sale at December 31, 2009
U.S. government and government agency securities	$	308,618	$	6,255	$	(1,326	)	$	313,547
Fixed income securities of states, municipalities and political subdivisions		1,012,262		49,491		(2,327	)		1,059,426
Special purpose revenue bonds of states, municipalities and political subdivisions		1,101,566		46,551		(1,783	)		1,146,334
Corporate fixed income securities		657,653		28,785		(117	)		686,321
Residential mortgage-backed securities		915,203		35,130		(6,151	)		944,182
Commercial mortgage-backed securities		151,357		630		(5,770	)		146,217
Asset-backed securities		15,118		445		(1,198	)		14,365
Foreign government securities		219,985		7,914		(218	)		227,681
Total fixed income securities — available for sale	$	4,381,762	$	175,201	$	(18,890	)	$	4,538,073
Held to maturity at September 30, 2010
U.S. government securities	$	12,990	$	337	$	—		$	13,327
Corporate fixed income securities		104,979		2,174		(8	)		107,145
Foreign government securities		75,872		1,973		—			77,845
Total fixed income securities — held to maturity	$	193,841	$	4,484	$	(8	)	$	198,317
Held to maturity at December 31, 2009
U.S. government securities	$	14,988	$	269	$	—		$	15,257
Corporate fixed income securities		7,594		95		(4	)		7,685
Foreign government securities		80,210		1,579		(723	)		81,066
Total fixed income securities — held to maturity	$	102,792	$	1,943	$	(727	)	$	104,008

19

HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, tables in thousands except per share data)

All fixed income securities were income producing in 2010. The following table displays the gross unrealized losses and fair value of all available for sale fixed income securities that were in a continuous unrealized loss position for the periods indicated.

	Less than 12 months					12 months or more					Total
			Unrealized					Unrealized					Unrealized
	Fair value		losses			Fair value		losses			Fair value		losses
September 30, 2010
Fixed income securities of states, municipalities and political subdivisions	$	18,576	$	(211	)	$	2,309	$	(91	)	$	20,885	$	(302	)
Special purpose revenue bonds of states, municipalities and political subdivisions		58,839		(374	)		7,260		(97	)		66,099		(471	)
Corporate fixed income securities		1,966		(1	)		—		—			1,966		(1	)
Residential mortgage-backed securities		47,248		(339	)		25,897		(2,091	)		73,145		(2,430	)
Commercial mortgage-backed securities		—		—			7,298		(211	)		7,298		(211	)
Foreign government securities		11,111		(68	)		—		—			11,111		(68	)
Total	$	137,740	$	(993	)	$	42,764	$	(2,490	)	$	180,504	$	(3,483	)
December 31, 2009
U.S. government and government agency securities	$	101,542	$	(1,326	)	$	—	$	—		$	101,542	$	(1,326	)
Fixed income securities of states, municipalities and political subdivisions		48,836		(985	)		19,816		(1,342	)		68,652		(2,327	)
Special purpose revenue bonds of states, municipalities and political subdivisions		76,305		(1,305	)		25,261		(478	)		101,566		(1,783	)
Corporate fixed income securities		13,773		(117	)		—		—			13,773		(117	)
Residential mortgage-backed securities		147,621		(2,018	)		40,568		(4,133	)		188,189		(6,151	)
Commercial mortgage-backed securities		30,209		(418	)		73,451		(5,352	)		103,660		(5,770	)
Asset-backed securities		2,476		(246	)		7,532		(952	)		10,008		(1,198	)
Foreign government securities		4,153		(130	)		8,593		(88	)		12,746		(218	)
Total	$	424,915	$	(6,545	)	$	175,221	$	(12,345	)	$	600,136	$	(18,890	)

A security has an impairment loss when its fair value is less than its cost or amortized cost at the balance sheet date. We evaluate the securities in our fixed income securities portfolio for possible other-than-temporary impairment losses at each quarter end. During 2010 and 2009, our reviews covered all impaired securities where the loss exceeded $0.5 million and the loss either exceeded 10% of cost or the security had been in a loss position for longer than twelve consecutive months.

For other-than-temporary impairment losses, we recognize an other-than-temporary impairment loss in earnings in the period that we determine: 1) we intend to sell the security, 2) it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis or 3) the security has a credit loss. We recognized $0.3 million of other-than-temporary impairment credit losses in the nine months and three months ended September 30, 2010, compared to $5.3 million and $0.3 million in the nine months and three months ended September 30, 2009, respectively.

20

HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, tables in thousands except per share data)

Since April 1, 2009, when we adopted a new accounting standard for other-than-temporary impairment losses, we have recognized credit losses on certain impaired fixed income securities, for which each security also had an impairment loss recorded in other comprehensive income. The rollforward of these credit losses, beginning at the date of adoption of the new accounting standard, was as follows:

	Nine months ended September 30,				Three months ended September 30,
	2010		2009		2010		2009
Balance at beginning of period	$	3,848	$	—	$	3,848	$	3,373
Credit losses included in retained earnings related to adoption of new accounting standard		—		2,723		—		—
Credit losses recognized in earnings
Securities previously impaired		300		550		300		200
Securities previously not impaired		—		425		—		125
Balance at September 30	$	4,148	$	3,698	$	4,148	$	3,698

We had $5.0 million after-tax of other-than-temporary impairments, primarily related to mortgage-backed and asset-backed securities, included in accumulated other comprehensive income within shareholders’ equity at September 30, 2010.

We do not consider the $3.5 million of gross unrealized losses in our fixed income securities portfolio at September 30, 2010 to be other-than-temporary impairments as of that date because: 1) we received substantially all contractual interest and principal payments on these securities as of September 30, 2010, 2) we do not intend to sell the securities, 3) it is more likely than not that we will not be required to sell the securities before recovery of their amortized cost bases and 4) the unrealized loss relates to non-credit factors, such as interest rate changes and market conditions.

The amortized cost and fair value of our fixed income securities at September 30, 2010, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. The weighted-average life of our mortgage-backed and asset-backed securities at September 30, 2010 was 2.5 years.

	Available for sale				Held to maturity
	Cost or
	amortized cost		Fair value		Amortized cost		Fair value
Due in 1 year or less	$	237,836	$	241,269	$	25,128	$	25,345
Due after 1 year through 5 years		1,096,709		1,163,110		157,528		161,062
Due after 5 years through 10 years		871,163		945,571		11,185		11,910
Due after 10 years through 15 years		764,784		818,781		—		—
Due after 15 years		698,894		735,319		—		—
Securities with fixed maturities		3,669,386		3,904,050		193,841		198,317
Mortgage-backed and asset-backed securities		1,196,059		1,262,659		—		—
Total fixed income securities	$	4,865,445	$	5,166,709	$	193,841	$	198,317

21

HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, tables in thousands except per share data)

The sources of net investment income were as follows:

	Nine months ended September 30,						Three months ended September 30,
	2010			2009			2010			2009
Fixed income securities	$	150,001		$	140,483		$	50,921		$	47,571
Short-term investments		631			1,791			271			321
Other		3,053			2,194			1,011			1,143
Total investment income		153,685			144,468			52,203			49,035
Investment expense		(3,082	)		(2,728	)		(1,066	)		(924	)
Net investment income	$	150,603		$	141,740		$	51,137		$	48,111

Realized pretax gains (losses) on the sale of investments, which exclude other-than-temporary impairment losses, were as follows:

	Nine months ended September 30,
	2010								2009
	Gains		Losses			Net			Gains		Losses			Net
Fixed income securities	$	8,875	$	(824	)	$	8,051		$	7,593	$	(3,289	)	$	4,304
Other		2		(156	)		(154	)		710		(162	)		548
Realized investment gain (loss)	$	8,877	$	(980	)	$	7,897		$	8,303	$	(3,451	)	$	4,852

	Three months ended September 30,
	2010							2009
	Gains		Losses			Net		Gains		Losses			Net
Fixed income securities	$	1,282	$	(225	)	$	1,057	$	1,960	$	(1,122	)	$	838
Other		—		—			—		27		(1	)		26
Realized investment gain (loss)	$	1,282	$	(225	)	$	1,057	$	1,987	$	(1,123	)	$	864

22

HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, tables in thousands except per share data)

(6) Earnings Per Share

The following table details the numerator and denominator used in our earnings per share calculations.

	Nine months ended September 30,						Three months ended September 30,
	2010			2009			2010			2009
Net earnings	$	247,797		$	269,076		$	93,063		$	94,321
Less: net earnings attributable to unvested restricted stock and restricted stock units		(2,746	)		(1,436	)		(1,067	)		(537	)
Net earnings available to common stock	$	245,051		$	267,640		$	91,996		$	93,784
Weighted-average common shares outstanding		113,872			112,154			114,002			111,892
Dilutive effect of outstanding options (determined using treasury stock method)		254			283			156			371
Dilutive effect of convertible debt (determined using treasury stock method)		—			478			—			683
Weighted-average common shares and potential common shares outstanding		114,126			112,915			114,158			112,946
Anti-dilutive stock options not included in treasury stock method computation		4,431			5,672			4,978			5,279

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HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, tables in thousands except per share data)

(7) Reinsurance

In the normal course of business, our insurance companies cede a portion of their premium to domestic and foreign reinsurers through treaty and facultative reinsurance agreements. Although ceding for reinsurance purposes does not discharge the direct insurer from liability to its policyholder, our insurance companies participate in such agreements in order to limit their loss exposure, protect them against catastrophic loss and diversify their business. The following tables present the effect of such reinsurance transactions on our premium, loss and loss adjustment expense and policy acquisition costs.

	Nine months ended September 30,						Three months ended September 30,
	2010			2009			2010			2009
Direct written premium	$	1,697,054		$	1,709,613		$	565,417		$	559,142
Reinsurance assumed		257,676			194,473			75,239			61,240
Reinsurance ceded		(415,239	)		(376,197	)		(146,218	)		(127,095	)
Net written premium	$	1,539,491		$	1,527,889		$	494,438		$	493,287
Direct earned premium	$	1,714,252		$	1,688,378		$	575,216		$	583,130
Reinsurance assumed		217,621			186,611			76,473			61,648
Reinsurance ceded		(399,735	)		(350,564	)		(135,523	)		(124,719	)
Net earned premium	$	1,532,138		$	1,524,425		$	516,166		$	520,059
Direct loss and loss adjustment expense	$	1,059,094		$	1,026,184		$	340,225		$	329,561
Reinsurance assumed		131,202			93,704			25,413			28,701
Reinsurance ceded		(267,651	)		(207,944	)		(68,500	)		(54,454	)
Net loss and loss adjustment expense	$	922,645		$	911,944		$	297,138		$	303,808
Policy acquisition costs	$	330,174		$	313,247		$	111,214		$	108,998
Ceding commissions		(88,096	)		(90,061	)		(30,466	)		(37,506	)
Net policy acquisition costs	$	242,078		$	223,186		$	80,748		$	71,492

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HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, tables in thousands except per share data)

The tables below show the components of reinsurance recoverables in our condensed consolidated balance sheets and the calculation of net reserves, net unearned premium and net deferred policy acquisition costs.

	September 30,			December 31,
	2010			2009
Reinsurance recoverable on paid losses	$	92,170		$	82,887
Reinsurance recoverable on outstanding losses		471,580			495,964
Reinsurance recoverable on incurred but not reported losses		481,845			440,505
Reserve for uncollectible reinsurance		(2,945	)		(2,945	)
Total reinsurance recoverables	$	1,042,650		$	1,016,411
Loss and loss adjustment expense payable	$	3,555,505		$	3,492,309
Reinsurance recoverable on outstanding losses		(471,580	)		(495,964	)
Reinsurance recoverable on incurred but not reported losses		(481,845	)		(440,505	)
Net reserves	$	2,602,080		$	2,555,840
Unearned premium	$	1,069,594		$	1,044,747
Ceded unearned premium		(283,529	)		(270,436	)
Net unearned premium	$	786,065		$	774,311
Deferred policy acquisition costs	$	219,062		$	208,463
Deferred ceding commissions		(72,714	)		(71,595	)
Net deferred policy acquisition costs	$	146,348		$	136,868

(8) Supplemental Information

Supplemental information was as follows:

	Nine months ended September 30,				Three months ended September 30,
	2010		2009		2010		2009
Income taxes paid	$	101,164	$	121,572	$	34,949	$	32,756
Interest paid		9,714		9,827		151		3,578
Cash paid for commutation		—		43,900		—		43,900
Comprehensive income		337,068		404,005		154,317		185,298

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HCC Insurance Holdings, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(unaudited, tables in thousands except per share data)

(9) Commitments and Contingencies

Catastrophe and Large Loss Exposure

We have exposure to catastrophic losses caused by natural perils (such as hurricanes and earthquakes), as well as from man-made events (such as terrorist attacks). The incidence, timing and severity of catastrophic losses are unpredictable. We assess our exposures in areas most vulnerable to natural catastrophes and apply procedures to ascertain our probable maximum loss from a single event. We maintain reinsurance protection that we believe is sufficient to limit our exposure to a foreseeable event. In the first quarter of 2010, we recognized gross losses from catastrophic events, primarily the Chilean earthquake, of $31.9 million. After reinsurance, our pretax loss was $20.6 million. In the third quarter, we released $5.0 million of gross and net reserves related to the first-quarter catastrophic events, based on recent claims information about the potential losses. In the second quarter of 2010, we recognized gross losses for the Deepwater Horizon rig disaster of $28.2 million. Due to significant facultative reinsurance, in addition to our treaty reinsurance, our pretax net loss was minimal.

Litigation

We are a party to lawsuits, arbitrations and other proceedings that arise in the normal course of our business. Many of such lawsuits, arbitrations and other proceedings involve claims under policies that we underwrite as an insurer or reinsurer, the liabilities for which, we believe, have been adequately included in our loss reserves. Also, from time to time, we are a party to lawsuits, arbitrations and other proceedings that relate to disputes with third parties, or that involve alleged errors and omissions on the part of our subsidiaries. We have provided accruals for these items to the extent we deem the losses probable and reasonably estimable. Although the ultimate outcome of these matters cannot be determined at this time, based on present information, the availability of insurance coverage and advice received from our outside legal counsel, we believe the resolution of any such matters will not have a material adverse effect on our consolidated financial position, results of operations or cash flows.

Indemnifications

In conjunction with the sales of business assets and subsidiaries, we have provided indemnifications to the buyers. Certain indemnifications cover typical representations and warranties related to our responsibilities to perform under the sales contracts. Under other indemnifications, we agree to reimburse the purchasers for taxes or ERISA-related amounts, if any, assessed after the sale date but related to pre-sale activities. We cannot quantify the maximum potential exposure covered by all of our indemnifications because the indemnifications cover a variety of matters, operations and scenarios. Certain of these indemnifications have no time limit. For those with a time limit, the longest such indemnification expires in 2025. We accrue a loss when a valid claim is made by a purchaser and we believe we have potential exposure. At September 30, 2010, we have recorded a liability of $10.6 million and have provided a $3.0 million escrow account and $9.7 million of letters of credit to cover our obligations or anticipated payments under these indemnifications.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following Management’s Discussion and Analysis should be read in conjunction with the Condensed Consolidated Financial Statements and the related Notes thereto.

Overview

We are a specialty insurance group with offices in the United States, the United Kingdom, Spain and Ireland, transacting business in approximately 150 countries. Our group consists of insurance companies, underwriting agencies and 100% participation in an active Lloyd’s of London syndicate that we manage. Our shares trade on the New York Stock Exchange and closed at $26.09 on September 30, 2010. We had a market capitalization of $3.1 billion at October 31, 2010.

We underwrite a variety of relatively non-correlated specialty lines of business. Insurance products are marketed by our insurance companies, internal agencies and the syndicate through a network of independent agents and brokers, directly to customers, or through third party administrators. The majority of our business is low limit or small premium business that has less intense price competition, as well as lower catastrophe and volatility risk. We reinsure a significant portion of our catastrophic exposure to hurricanes, earthquakes and large losses to minimize the impact on our net earnings and shareholders’ equity.

Our major domestic and international insurance companies have a financial strength rating of “AA (Very Strong)” from Standard & Poor’s Corporation. Our major domestic insurance companies have a financial strength rating of “AA (Very Strong)” from Fitch Ratings, “A1 (Good Security)” from Moody’s Investors Service, Inc., and “A+ (Superior)” from A.M. Best Company, Inc.

     Key facts about our consolidated group as of and for the nine months and quarter ended September 30, 2010 are as follows:

• We had consolidated shareholders’ equity of $3.3 billion. Our book value per share increased in the first nine months to $28.95.

• We had year-to-date net earnings of $247.8 million, or $2.15 per diluted share. Our third quarter earnings were $93.1 million, or $0.81 per diluted share.

• We produced total revenue of $1.7 billion and $575.9 million in the first nine months and third quarter, respectively.

• We recognized year-to-date pretax gross losses of $26.9 million and pretax net losses, after reinsurance, of $15.6 million from catastrophic events that occurred in the first quarter. We recognized $28.2 million of pretax gross losses for the Deepwater Horizon rig disaster for which we had minimal net loss primarily due to significant facultative reinsurance, in addition to our treaty reinsurance. These losses increased our net loss ratio and combined ratio by 1.0 percentage point and decreased net earnings by $0.09 per diluted share for the nine-month period.

• Our year-to-date net loss ratio, including the year-to-date catastrophic losses, was 60.2% and our combined ratio was 85.3%.

• We declared dividends of $0.415 per share and paid $46.5 million of dividends in the first nine months of 2010.

• We hold a total investment portfolio of $5.8 billion, of which $5.4 billion are fixed income securities with an average rating of AA+.

• We purchased $10.2 million of our common stock at an average cost of $25.10 per share during the quarter.

Comparisons in the following sections refer to the first nine months of 2010 compared to the same period of 2009, unless otherwise noted. Amounts in tables are in thousands, except for earnings per share, percentages, ratios and number of employees.

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Reporting Segment Changes

In the third quarter of 2010, our chief executive officer, in the role of chief operating decision maker (CODM), completed the reorganization of HCC’s management structure in order to manage and evaluate the company’s operations from an insurance underwriting perspective, in line with our portfolio of insurance products. We have changed our segment reporting structure to reflect these changes. Previously, we reported our results in the Insurance Company, Agency, and Other Operations segments. We now report our results in the following six operating segments, each of which reports to an executive of HCC who is responsible for the segment results:

• U.S. Property & Casualty

• Professional Liability

• Accident & Health

• U.S. Surety & Credit

• International

• Investing

See Note 2, “Segments” in the attached condensed consolidated financial statements for additional discussion of our new segments. In addition, in connection with our resegmentation, we changed the presentation of our consolidated income statement and redefined the calculation of our expense ratio. We previously presented reinsurance ceding commissions that exceeded policy acquisition costs as a component of fee and commission income, within total revenue. We now present all ceding commissions as an offset to policy acquisition costs, within total expense. We also now present an expense ratio for each reportable segment. All of our expense ratios are calculated using amounts included in our GAAP consolidated financial statements. The formulas are as follows:

• Consolidated – sum of other expense for each of our insurance segments, divided by the sum of segment revenue for each of our insurance segments.

• Segment – segment other expense divided by segment revenue.

Results of Operations

Net earnings were $247.8 million ($2.15 per diluted share) in the first nine months of 2010, compared to $269.1 million ($2.37 per diluted share) in the same period of 2009 and $93.1 million ($0.81 per diluted share) in the third quarter of 2010, compared to $94.3 million ($0.83 per diluted share) in the third quarter of 2009.

Significant matters impacting net earnings in 2010 and 2009 were as follows:

• We had pretax net favorable reserve development of $36.6 million and $25.4 million in the first nine months and the third quarter of 2009, respectively. We had minimal reserve development in 2010. See the “Loss and Loss Adjustment Expense” section below for further discussion of these reserve changes.

• In the first quarter of 2010, we recognized gross losses of $31.9 million from catastrophic events, the most significant of which was the Chilean earthquake. After reinsurance, our pretax loss was $20.6 million. In the second quarter, we recognized gross losses for the Deepwater Horizon rig disaster of $28.2 million. Due to significant facultative reinsurance, in addition to treaty reinsurance, our pretax net loss was minimal. In the third quarter, we reduced our gross and net loss reserves related to the first-quarter catastrophes by $5.0 million based on recent claims information about the potential losses.

• In the first quarter of 2010, we commuted our interest in a long-term mortgage impairment insurance contract that had been accounted for as a derivative financial instrument and recognized a $5.0 million pretax gain. The contract was denominated in British pound sterling. We received £5.6 million ($8.3 million) of cash, which was included in other operating income, and incurred related expenses of $3.0 million, which were included in other operating expense.

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• In the first quarter of 2009, we commuted, loss-free, all liability under a contract with Mortgage Guarantee Insurance Company (MGIC) to provide reinsurance coverage for certain residential mortgage guaranty contracts and recognized a $15.6 million pretax gain. We had been recording revenue under this contract using the deposit method of accounting because we determined the contract did not transfer significant underwriting risk. We received a cash termination payment of $25.0 million, which was included in other operating income. This additional revenue was partially offset by $9.9 million of expenses for reinsurance and other direct costs, which were included in other operating expense.

Revenue

Total revenue decreased $10.1 million in the first nine months of 2010, compared to the same period in 2009, due to lower other operating income partially offset by higher net earned premium, primarily in our International segment, and improved investment results.

Gross written premium, net written premium and net earned premium are detailed below by segment.

	Nine months ended September 30,				Three months ended September 30,
	2010		2009		2010		2009
Gross written premium
U.S. Property & Casualty	$	415,139	$	475,345	$	146,010	$	159,498
Professional Liability		414,436		435,821		144,920		151,442
Accident & Health		567,785		550,925		194,377		185,423
U.S. Surety & Credit		173,142		148,444		55,972		52,105
International		381,975		269,924		99,197		64,892
Exited Lines		2,253		23,627		180		7,022
	$	1,954,730	$	1,904,086	$	640,656	$	620,382
Net written premium
U.S. Property & Casualty	$	247,717	$	299,935	$	84,250	$	97,221
Professional Liability		277,956		309,963		99,131		107,727
Accident & Health		567,520		550,563		194,301		185,284
U.S. Surety & Credit		159,626		139,715		52,067		47,921
International		285,763		205,050		64,644		48,276
Exited Lines		909		22,663		45		6,858
	$	1,539,491	$	1,527,889	$	494,438	$	493,287
Net earned premium
U.S. Property & Casualty	$	258,427	$	289,195	$	84,802	$	94,453
Professional Liability		321,849		330,614		103,696		121,387
Accident & Health		567,739		553,967		193,252		185,937
U.S. Surety & Credit		148,427		135,436		49,807		45,709
International		234,471		189,148		84,539		65,421
Exited Lines		1,225		26,065		70		7,152
	$	1,532,138	$	1,524,425	$	516,166	$	520,059

Growth in premium occurred primarily in the International segment, directly related to property treaty business that we began to write in late 2009. There were offsetting increases and decreases in premium in our other segments, which partially offset the reduction of premium in our Exited Lines. See the “Segment Operations” section below for further discussion of the relationship and changes in premium revenue within each segment.

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The sources of net investment income are detailed below.

	Nine months ended September 30,						Three months ended September 30,
	2010			2009			2010			2009
Fixed income securities
Taxable	$	82,416		$	78,894		$	27,613		$	26,795
Exempt from U.S. income taxes		67,585			61,589			23,308			20,776
Total fixed income securities		150,001			140,483			50,921			47,571
Short-term investments		631			1,791			271			321
Other		3,053			2,194			1,011			1,143
Total investment income		153,685			144,468			52,203			49,035
Investment expense		(3,082	)		(2,728	)		(1,066	)		(924	)
Net investment income	$	150,603		$	141,740		$	51,137		$	48,111

Net investment income increased 6% year-over-year primarily due to higher income from fixed income securities, generated from an increased amount of investments. Our fixed income securities portfolio increased 10% from $4.9 billion at September 30, 2009 to $5.4 billion at September 30, 2010. The growth in fixed income securities resulted primarily from cash flow from operations and reinvestment of funds that were held in short-term investments at December 31, 2009. Short-term investment income declined in the three and nine month periods, due to lower average short-term investment balances and lower short-term market interest rates. Other investment income for year-to-date 2009 included a $1.0 million loss on hedge fund investments.

The following table details the components of our other operating income.

	Nine months ended September 30,				Three months ended September 30,
	2010		2009		2010		2009
Fee and commission income	$	21,465	$	34,941	$	6,311	$	10,761
Contract using deposit accounting		—		25,532		—		—
Financial instruments		8,595		3,469		216		(188	)
Strategic investments		677		4,714		120		2,859
Other		4,298		1,109		1,241		(1,266	)
Other operating income	$	35,035	$	69,765	$	7,888	$	12,166

Fee and commission income decreased year-over-year, primarily in our International segment, mainly due to selling our U.K. reinsurance broker in 2009. The nine month periods of 2010 and 2009 included an $8.0 million gain related to commuting a derivative contract and $25.0 million from commutation of the MGIC reinsurance contract, respectively, both of which are included in our U.S. Property & Casualty segment.

Loss and Loss Adjustment Expense

Our gross loss ratio was 61.6% and 59.7% in the first nine months of 2010 and 2009, respectively, and 56.1% and 55.6% in the third quarter of 2010 and 2009, respectively. The 2010 year-to-date loss ratio included 1.4 percentage points and 1.5 percentage points for the 2010 catastrophe losses and the Deepwater Horizon rig disaster, respectively.

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The tables below show the composition of net incurred loss and loss adjustment expense and the net loss ratio by segment.

	Nine months ended September 30,											Three months ended September 30,
	2010					2009						2010						2009
			Loss						Loss						Loss						Loss
	Amount		ratio			Amount			ratio			Amount			ratio			Amount			ratio
2010 catastrophes	$	15,588		1.0	%	$	—			—	%	$	(5,000	)		(1.0	)%	$	—			—	%
Adverse (favorable) reserve development		1,259		0.1			(36,647	)		(2.4	)		(907	)		(0.2	)		(25,375	)		(4.9	)
All other net incurred loss and loss adjustment expense		905,798		59.1			948,591			62.2			303,045			58.8			329,183			63.3
Net incurred loss and loss adjustment expense	$	922,645		60.2	%	$	911,944			59.8	%	$	297,138			57.6	%	$	303,808			58.4	%

	Nine months ended September 30,						Three months ended September 30,
		2010			2009			2010			2009
U.S. Property & Casualty		63.7	%		56.8	%		73.0	%		56.1	%
Professional Liability		60.9			61.3			61.0			60.8
Accident & Health		72.6			73.4			71.9			73.0
U.S. Surety & Credit		25.7			29.4			20.7			26.5
International		45.9			36.4			27.5			35.4
Total loss ratio		60.2			59.8			57.6			58.4
Expense ratio		25.1			23.6			24.5			22.9
Combined ratio		85.3	%		83.4	%		82.1	%		81.3	%
Our net loss ratio for the first nine months of 2010 was 60.2%, which included 1.0 percentage point for the 2010 catastrophes. The 2009 year-to-date and third quarter net loss ratios included the effect of favorable reserve development. Deficiencies and redundancies in reserves occur as we review our loss reserves with our actuaries, increasing or reducing loss reserves as a result of such reviews and as losses are finally settled or claims exposures change. See the “Segment Operations” section below for further discussion of the changes in our loss and loss adjustment expense within each segment.
The table below provides a reconciliation of our reserves for loss and loss adjustment expense payable, net of reinsurance ceded, the amount of our paid claims and our net paid loss ratios.
	Nine months ended September 30,						Three months ended September 30,
	2010			2009			2010			2009
Net reserves for loss and loss adjustment expense payable at beginning of period	$	2,555,840		$	2,416,271		$	2,568,317		$	2,563,196
Net reserve additions from acquired businesses		8,110			36,522			—			1,600
Foreign currency adjustment		(11,677	)		29,109			36,109			(247	)
Incurred loss and loss adjustment expense		922,645			911,944			297,138			303,808
Loss and loss adjustment expense payments		(872,838	)		(838,494	)		(299,484	)		(313,005	)
Net reserves for loss and loss adjustment expense payable at end of period	$	2,602,080		$	2,555,352		$	2,602,080		$	2,555,352
Net paid loss ratio		57.0	%		55.0	%		58.0	%		60.2	%

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The net paid loss ratio is the percentage of losses paid, net of reinsurance, divided by earned premium for the period. The year-to-date net paid loss ratio was higher in 2010, primarily due to a higher amount of claims payments for our directors’ and officers’ liability, credit and medical stop-loss products than in the same period of 2009. The amount of claims paid fluctuates period to period due to our mix of business and the timing of claims settlement and catastrophic events.

All Other Expenses

Our policy acquisition cost percentage was 15.8% and 14.6% in the nine month period of 2010 and 2009, respectively, and 15.6% and 13.7% in the third quarter of 2010 and 2009, respectively. Our policy acquisition costs increased 8% year-over-year principally due to the effect of a $3.8 million premium deficiency reserve recorded at December 31, 2008 in our International segment, which reduced the amount of policy acquisition costs recognized throughout 2009.

Other operating expense, which includes compensation expense, decreased 3% year-over-year and 6% quarter-over-quarter. We had 1,878 employees at September 30, 2010 compared to 1,916 a year earlier. In 2009, we sold our U.K. reinsurance broker and the operations of our commercial marine agency business, which reduced our other operating expense and the number of employees in 2010. Other operating expense for year-to-date 2010 included $3.0 million of costs directly related to the commutation of a derivative contract, and year-to-date 2009 included $9.9 million of costs directly related to commuting the MGIC reinsurance contract. Currency conversion expense was $1.5 million in the first nine months of 2010. There was a currency conversion benefit of $0.9 million in the first nine months of 2009, as well as a benefit of $1.2 million and $0.7 million in the third quarter of 2010 and 2009, respectively.

Other operating expense includes $9.9 million and $11.5 million in the first nine months of 2010 and 2009, respectively, of stock-based compensation expense, after the effect of the deferral and amortization of policy acquisition costs related to stock-based compensation for our underwriters. Stock-based compensation was lower in 2010 due to the forfeiture of restricted stock grants by former employees and full vesting of certain stock options. In the first nine months of 2010, we granted $22.5 million of restricted stock awards and units, with a weighted-average life of 5.9 years. At September 30, 2010, there was approximately $27.9 million of total unrecognized compensation expense related to unvested options and restricted stock awards and units that is expected to be recognized over a weighted-average period of 3.9 years.

Our effective income tax rate was 30.2% for the first nine months of 2010, compared to 31.5% for the first nine months of 2009. The lower effective rate in 2010 related to the reversal of certain liabilities for uncertain tax positions and the increased benefit from tax-exempt investment income relative to a lower pretax income base.

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Segment Operations

U.S. Property & Casualty Segment

Our U.S. Property & Casualty segment writes specialty lines of insurance such as aviation, small account errors and omissions (E&O) liability, public risk, employment practices liability, title, residual value, disability, contingency, kidnap and ransom and brown water marine. The products are written through our underwriting agencies, third party agents and brokers, or on a direct basis in the United States. The majority of the business is primary coverage, with reinsurance on certain product lines. Claims for most products are reported and settled on a short to medium-term basis.

The following tables summarize the operations of the U.S. Property & Casualty segment.

	Nine months ended September 30,						Three months ended September 30,
	2010			2009			2010			2009
Net earned premium	$	258,427		$	289,195		$	84,802		$	94,453
Other revenue		24,128			46,815			5,033			6,979
Segment revenue		282,555			336,010			89,835			101,432
Loss and loss adjustment expense, net		164,684			164,346			61,883			52,957
Other expense		75,890			85,813			21,289			27,601
Segment expense		240,574			250,159			83,172			80,558
Segment pretax earnings	$	41,981		$	85,851		$	6,663		$	20,874
Net loss ratio		63.7	%		56.8	%		73.0	%		56.1	%
Expense ratio		26.9			25.5			23.7			27.2
Combined ratio		90.6	%		82.3	%		96.7	%		83.3	%
Net earned premium
Aviation	$	87,248		$	98,514		$	28,950		$	33,053
E&O		74,079			90,468			23,013			29,604
Public Risk		34,526			28,853			11,600			11,045
Other		62,574			71,360			21,239			20,751
Total	$	258,427		$	289,195		$	84,802		$	94,453
Net loss ratio
Aviation		62.7	%		60.3	%		69.7	%		66.7	%
E&O		84.9			63.1			133.8			68.6
Public Risk		58.8			64.1			37.3			60.4
Other		42.8			41.1			31.1			18.9
Total		63.7	%		56.8	%		73.0	%		56.1	%

33

	Nine months ended September 30,						Three months ended September 30,
	2010			2009			2010			2009
Gross written premium
Aviation	$	121,600		$	133,913		$	44,692		$	50,162
E&O		63,316			84,118			19,018			26,760
Public Risk		50,397			52,071			15,706			16,194
Other		179,826			205,243			66,594			66,382
Total	$	415,139		$	475,345		$	146,010		$	159,498
Net written premium
Aviation	$	84,097		$	95,655		$	30,347		$	34,779
E&O		63,256			84,055			19,019			26,759
Public Risk		36,635			39,647			12,985			11,796
Other		63,729			80,578			21,899			23,887
Total	$	247,717		$	299,935		$	84,250		$	97,221
Retention rate
Aviation		69	%		71	%		68	%		69	%
E&O		100			100			100			100
Public Risk		73			76			83			73
Other		35			39			33			36
Total		60	%		63	%		58	%		61	%

Segment earnings declined in 2010 due to: 1) lower net earned premium, primarily related to pricing competition and the mix of products in this segment, 2) the effect of adverse development in 2010 compared to favorable reserve development in 2009, which impacted the third quarter results of both years, and 3) lower year-over-year earnings due to a pretax gain of $5.0 million in 2010 and $15.6 million in 2009 related to commutations.

In 2010, we wrote less premium in most product lines due to continuing pricing competition in the segment’s markets. In particular, Aviation experienced price decreases in its U.S. markets. Our E&O volume also declined as we continued to re-underwrite that product, employing more stringent underwriting criteria in reaction to higher losses. In addition, we wrote less residual value insurance (included in Other).

The increase in the segment’s loss ratios for 2010 was due to the change in development year-over-year. The segment had adverse reserve development of $9.8 million and $4.4 million in the nine months and third quarter of 2010, respectively, compared to favorable reserve development of $9.4 million and $6.6 million in the same periods of 2009. In 2010, E&O experienced adverse development related to the 2006 – 2009 underwriting years, which was partially offset by favorable development in Public Risk and several smaller product lines (included in Other) in the third quarter. The favorable development in 2009 primarily related to Aviation, Public Risk and several smaller product lines. Higher 2009 accident year losses increased Aviation’s third quarter 2009 loss ratio.

In the first quarter of 2010, we commuted our interest in a mortgage impairment insurance contract, which generated $5.0 million of pretax earnings. In the same quarter of 2009, we commuted the MGIC contract, which generated $15.6 million of pretax earnings. Related to these commutations, we received cash of $8.3 million in 2010 and $25.0 million in 2009, which is included in other revenue. We also incurred reinsurance and other direct costs of $3.0 million in 2010 and $9.9 million in 2009, which are included in other expense. The segment’s remaining other revenue relates to fee and commission income earned by our agencies from third party insurance companies.

34

Professional Liability Segment

Our Professional Liability segment includes our directors’ and officers’ (D&O) liability, large account errors and omissions liability, diversified financial products and fidelity coverages, which are written in the United States and internationally through our underwriting agencies. Policies provide both primary and excess coverage, are generally long-tailed and may have potential severity. Claims on the directors’ and officers’ liability excess layers generally take longer to settle than claims in our other segments, due to litigation involving the insureds.

The following tables summarize the operations of the Professional Liability segment.

	Nine months ended September 30,						Three months ended September 30,
	2010			2009			2010			2009
Net earned premium	$	321,849		$	330,614		$	103,696		$	121,387
Other revenue		458			(134	)		20			(151	)
Segment revenue		322,307			330,480			103,716			121,236
Loss and loss adjustment expense, net		196,154			202,741			63,212			73,752
Other expense		57,171			38,988			18,866			9,250
Segment expense		253,325			241,729			82,078			83,002
Segment pretax earnings	$	68,982		$	88,751		$	21,638		$	38,234
Net loss ratio		60.9	%		61.3	%		61.0	%		60.8	%
Expense ratio		17.7			11.8			18.2			7.6
Combined ratio		78.6	%		73.1	%		79.2	%		68.4	%
Net earned premium
U.S. D&O	$	229,034		$	225,412		$	73,835		$	81,737
International D&O		36,749			44,799			10,975			19,009
Other		56,066			60,403			18,886			20,641
Total	$	321,849		$	330,614		$	103,696		$	121,387
Net loss ratio
U.S. D&O		61.0	%		62.8	%		60.3	%		63.8	%
International D&O		60.5			49.3			60.3			36.6
Other		60.9			64.8			63.9			71.0
Total		60.9	%		61.3	%		61.0	%		60.8	%

35

	Nine months ended September 30,						Three months ended September 30,
	2010			2009			2010			2009
Gross written premium
U.S. D&O	$	267,302		$	289,226		$	98,813		$	103,324
International D&O		69,926			67,612			20,554			23,409
Other		77,208			78,983			25,553			24,709
Total	$	414,436		$	435,821		$	144,920		$	151,442
Net written premium
U.S. D&O	$	198,043		$	219,377		$	73,037		$	79,541
International D&O		28,074			37,187			8,260			12,486
Other		51,839			53,399			17,834			15,700
Total	$	277,956		$	309,963		$	99,131		$	107,727
Retention rate
U.S. D&O		74	%		76	%		74	%		77	%
International D&O		40			55			40			53
Other		67			68			70			64
Total		67	%		71	%		68	%		71	%

Segment earnings declined in 2010 due to lower net earned premium, $10.1 million of reduced profit commissions from reinsurers, and higher operating expenses. The compound effect of these three factors caused the 2010 expense ratios to be higher than the 2009 expense ratios.

We wrote less D&O business in the U.S. in 2010 due to pricing competition that began at the end of 2009. We purchased more reinsurance in 2010 for our International D&O in order to continue to offer our insureds large limits.

The segment had minimal reserve development in 2010 and 2009. In the third quarter of 2009, the International D&O reserves had favorable development, which was substantially offset by adverse development in the U.S. D&O reserves. The loss ratios for products in Other were higher in 2009, due to adverse reserve development and 2009 accident year losses.

36

Accident & Health Segment

Our Accident & Health segment includes medical stop-loss, short-term domestic and international medical, HMO reinsurance and medical excess coverages, which are written in the United States. The majority of the business covers groups of employees, and claims are reported and settled quickly.

The following tables summarize the operations of the Accident & Health segment.

	Nine months ended September 30,						Three months ended September 30,
	2010			2009			2010			2009
Net earned premium	$	567,739		$	553,967		$	193,252		$	185,937
Other revenue		2,830			3,964			1,113			1,045
Segment revenue		570,569			557,931			194,365			186,982
Loss and loss adjustment expense, net		412,438			406,722			138,869			135,708
Other expense		89,967			88,802			30,908			29,899
Segment expense		502,405			495,524			169,777			165,607
Segment pretax earnings	$	68,164		$	62,407		$	24,588		$	21,375
Net loss ratio		72.6	%		73.4	%		71.9	%		73.0	%
Expense ratio		15.8			15.9			15.9			16.0
Combined ratio		88.4	%		89.3	%		87.8	%		89.0	%
Net earned premium
Medical Stop-loss	$	488,256		$	473,271		$	164,698		$	157,429
Other		79,483			80,696			28,554			28,508
Total	$	567,739		$	553,967		$	193,252		$	185,937
Net loss ratio
Medical Stop-loss		74.0	%		73.7	%		74.1	%		74.2	%
Other		64.4			71.6			59.1			66.3
Total		72.6	%		73.4	%		71.9	%		73.0	%

37

	Nine months ended September 30,						Three months ended September 30,
	2010			2009			2010			2009
Gross written premium
Medical Stop-loss	$	488,256		$	473,273		$	164,698		$	157,429
Other		79,529			77,652			29,679			27,994
Total	$	567,785		$	550,925		$	194,377		$	185,423
Net written premium
Medical Stop-loss	$	488,256		$	473,271		$	164,698		$	157,429
Other		79,264			77,292			29,603			27,855
Total	$	567,520		$	550,563		$	194,301		$	185,284
Retention rate
Medical Stop-loss		100	%		100	%		100	%		100	%
Other		100			100			100			100
Total		100	%		100	%		100	%		100	%

Segment earnings increased in 2010 due to rate increases in excess of medical inflation in our medical stop-loss line. The lower loss ratios in 2010 mainly reflected reduced losses in our short-term medical product line.

38

U.S. Surety & Credit Segment

Our U.S. Surety & Credit segment includes contract, commercial, court and bail bonds written in the United States and credit insurance managed in the United States. Claims for all products are reported quickly, but settled on a medium-term basis.

The following tables summarize the operations of the U.S. Surety & Credit segment.

	Nine months ended September 30,						Three months ended September 30,
	2010			2009			2010			2009
Net earned premium	$	148,427		$	135,436		$	49,807		$	45,709
Other revenue		455			182			127			70
Segment revenue		148,882			135,618			49,934			45,779
Loss and loss adjustment expense, net		38,157			39,849			10,296			12,098
Other expense		81,699			72,527			28,007			25,332
Segment expense		119,856			112,376			38,303			37,430
Segment pretax earnings	$	29,026		$	23,242		$	11,631		$	8,349
Net loss ratio		25.7	%		29.4	%		20.7	%		26.5	%
Expense ratio		54.9			53.5			56.1			55.3
Combined ratio		80.6	%		82.9	%		76.8	%		81.8	%
Net earned premium
Surety	$	119,325		$	107,995		$	39,777		$	37,598
Credit		29,102			27,441			10,030			8,111
Total	$	148,427		$	135,436		$	49,807		$	45,709
Net loss ratio
Surety		22.2	%		22.0	%		15.9	%		20.6	%
Credit		40.3			58.8			39.4			53.6
Total		25.7	%		29.4	%		20.7	%		26.5	%

39

	Nine months ended September 30,						Three months ended September 30,
	2010			2009			2010			2009
Gross written premium
Surety	$	132,137		$	114,668		$	43,437		$	41,916
Credit		41,005			33,776			12,535			10,189
Total	$	173,142		$	148,444		$	55,972		$	52,105
Net written premium
Surety	$	127,348		$	110,502		$	42,038		$	40,026
Credit		32,278			29,213			10,029			7,895
Total	$	159,626		$	139,715		$	52,067		$	47,921
Retention rate
Surety		96	%		96	%		97	%		95	%
Credit		79			86			80			77
Total		92	%		94	%		93	%		92	%

Segment earnings increased year-over-year due to the effect of higher net earned premium and favorable loss experience in 2010, partially offset by higher expenses. In early 2009, we purchased a surety insurance company, which increased written and earned premium for the Surety product line in 2010. We wrote more Credit premium in 2010 due to improved pricing.

The segment had favorable reserve development of $7.9 million and $3.7 million in the nine months and third quarter of 2010, respectively, compared to $4.1 million in both periods of 2009, mainly related to the Surety product line. The Credit product line experienced several large losses in the nine months and third quarter of 2009, due to weak economic conditions in the world credit markets.

40

International Segment

Our International segment includes energy, property treaty, liability, surety, credit, property, ocean marine, accident and health and other smaller product lines written outside the United States. Products in this segment are susceptible to catastrophic events and large losses, for which we maintain excess of loss, quota share and facultative reinsurance protection to limit our exposure to such losses. Claims for most products are reported and settled on a medium-term basis.

The following tables summarize the operations of the International segment.

	Nine months ended September 30,						Three months ended September 30,
	2010			2009			2010			2009
Net earned premium	$	234,471		$	189,148		$	84,539		$	65,421
Other revenue		6,177			18,803			1,466			5,853
Segment revenue		240,648			207,951			86,005			71,274
Loss and loss adjustment expense, net		107,601			68,931			23,227			23,165
Other expense		88,441			83,941			29,365			28,478
Segment expense		196,042			152,872			52,592			51,643
Segment pretax earnings	$	44,606		$	55,079		$	33,413		$	19,631
Net loss ratio		45.9	%		36.4	%		27.5	%		35.4	%
Expense ratio		36.8			40.4			34.1			40.0
Combined ratio		82.7	%		76.8	%		61.6	%		75.4	%
Net earned premium
Energy	$	39,566		$	34,968		$	12,777		$	12,546
Property Treaty		32,533			—			16,924			—
Liability		60,478			61,363			19,929			20,687
Surety & Credit		53,800			50,429			17,916			17,778
Other		48,094			42,388			16,993			14,410
Total	$	234,471		$	189,148		$	84,539		$	65,421
Net loss ratios
Energy		25.4	%		17.9	%		3.3	%		36.9	%
Property Treaty		47.0			—			(5.2	)		—
Liability		55.4			25.6			55.9			14.0
Surety & Credit		38.1			53.0			37.5			48.6
Other		58.8			47.8			34.3			48.5
Total		45.9	%		36.4	%		27.5	%		35.4	%

41

	Nine months ended September 30,						Three months ended September 30,
	2010			2009			2010			2009
Gross written premium
Energy	$	97,053		$	92,277		$	16,731		$	14,645
Property Treaty		71,404			—			16,309			—
Liability		68,501			66,466			19,464			20,795
Surety & Credit		57,019			55,149			16,774			15,574
Other		87,998			56,032			29,919			13,878
Total	$	381,975		$	269,924		$	99,197		$	64,892
Net written premium
Energy	$	51,716		$	50,268		$	4,251		$	2,551
Property Treaty		61,994			—			12,948			—
Liability		63,410			59,641			17,663			19,603
Surety & Credit		51,278			49,953			14,605			14,818
Other		57,365			45,188			15,177			11,304
Total	$	285,763		$	205,050		$	64,644		$	48,276
Retention rate
Energy		53	%		54	%		25	%		17	%
Property Treaty		87			—			79			—
Liability		93			90			91			94
Surety & Credit		90			91			87			95
Other		65			81			51			81
Total		75	%		76	%		65	%		74	%

Segment earnings decreased year-over-year due to the net effect of: 1) catastrophic events in the first quarter of 2010, which generated $15.6 million of net losses, 2) higher favorable reserve development in 2009 and 3) lower other revenue, due to the sale of our U.K. reinsurance broker in the third quarter of 2009, partially offset by 4) higher net earned premium. The increase in premium substantially related to Property Treaty, which we began to write in late 2009. In addition, in 2010, we wrote more short tail property business (included in Other), which was substantially reinsured.

In the first quarter of 2010, we recognized gross losses of $31.9 million from catastrophic events, the most significant of which was the Chilean earthquake. After reinsurance, the pretax loss was $20.6 million, which primarily impacted our Energy and Property Treaty lines. In the third quarter, we reduced our Energy gross and net loss reserves related to the first-quarter catastrophes by $5.0 million, based on recent claims information about the potential losses. In the second quarter of 2010, we recognized gross losses of $28.2 million for the Deepwater Horizon rig disaster. Due to significant facultative reinsurance, in addition to treaty reinsurance, our pretax net loss was minimal.

The International segment had favorable reserve development of $8.4 million and $1.7 million in the nine months and third quarter of 2010, respectively, compared to $27.3 million and $14.0 million in the same periods of 2009. The 2010 development related to the reduction of Energy reserves for the 2005 and 2008 hurricanes. The 2009 development related to Energy reserves for the 2005 hurricanes and to our U.K. professional liability line (included in Liability) for the 2004 – 2006 underwriting years. Property Treaty experienced particularly favorable loss experience in 2010, which we reflected in our loss expectations in the third quarter. Our U.K. Credit line incurred higher losses in 2009 due to the U.K. financial conditions that time.

42

Investing Segment

Our Investing segment includes our total consolidated investment portfolio, as well as investment income and investment related expenses, realized gains and losses and other-than-temporary impairment losses on investments.

The following table summarizes activity in the Investing segment.

	Nine months ended September 30,						Three months ended September 30,
	2010			2009			2010			2009
Fixed income securities	$	150,001		$	140,483		$	50,921		$	47,571
Short-term investments		631			1,791			271			321
Other investments		3,053			2,194			1,011			1,143
Net realized investment gain		7,897			4,852			1,057			864
Other-than-temporary impairments		(300	)		(5,279	)		(300	)		(325	)
Investment expenses		(3,082	)		(2,728	)		(1,066	)		(924	)
Segment pretax earnings	$	158,200		$	141,313		$	51,894		$	48,650

At September 30, 2010, we had $5.8 billion of total investments, an increase of $378.8 million from December 31, 2009. This table summarizes our investments by type, substantially all of which are reported at fair value, at September 30, 2010 and December 31, 2009.

	September 30, 2010					December 31, 2009
	Amount		%			Amount		%
U.S. government and government agency securities	$	348,609		6	%	$	328,535		6	%
Fixed income securities of states, municipalities and political subdivisions		1,132,448		19			1,059,426		19
Special purpose revenue bonds of states, municipalities and political subdivisions		1,575,914		27			1,146,334		21
Corporate fixed income securities		696,470		12			693,915		13
Residential mortgage-backed securities		1,099,360		19			944,182		17
Commercial mortgage-backed securities		157,730		3			146,217		3
Asset-backed securities		5,569		—			14,365		—
Foreign government securities		344,450		6			307,891		6
Short-term investments		474,066		8			810,673		15
Other investments		433		—			4,691		—
Total investments	$	5,835,049		100	%	$	5,456,229		100	%

43

This table shows the average amount of investments, the net investment income we earned, the related yields and duration, and the average rating of our fixed income securities.

	Nine months ended September 30,						Three months ended September 30,
	2010			2009			2010			2009
Average investments, at cost	$	5,334,463		$	5,015,803		$	5,350,244		$	5,194,608
Net investment income *		150,603			141,740			51,137			48,111
Average short-term yield *		0.2	%		0.4	%		0.2	%		0.2	%
Average long-term yield *		4.1	%		4.1	%		4.1	%		4.2	%
Average long-term tax equivalent yield *		4.9	%		4.9	%		4.9	%		5.0	%
Average combined tax equivalent yield *		4.5	%		4.6	%		4.6	%		4.4	%
Weighted-average life of fixed income securities	6.7 years			6.5 years
Weighted-average duration of fixed income securities	4.6 years			4.7 years
Weighted-average combined duration	4.4 years			4.3 years
Average rating of fixed income securities	AA+			AA+

* Excluding realized and unrealized gains and losses.

This table summarizes our investments in fixed income securities by their rating category at September 30, 2010.

	Available for sale					Held to maturity
	at fair value					at amortized cost
	Amount		%			Amount		%
AAA	$	2,467,554		48	%	$	83,596		43	%
AA		1,928,022		37			32,374		17
A		642,683		12			76,582		39
BBB		91,112		2			1,289		1
BB and below		37,338		1			—		—
Total fixed income securities	$	5,166,709		100	%	$	193,841		100	%

The overall rating of our municipal bonds (consisting of our fixed income securities of states, municipalities and political subdivisions and our special purpose revenue bonds of states, municipalities and political subdivisions) was AA+ at September 30, 2010. Our portfolio of special purpose revenue bonds at September 30, 2010 and December 31, 2009 included $128.6 million and $138.7 million, respectively, of pre-refunded bonds that are supported by U.S. government debt obligations. The remaining special purpose bonds are secured by revenue sources specific to each security. The table below summarizes our percentage holdings of special purpose revenue bonds by revenue source.

	September 30,			December 31,
	2010			2009
Water and sewer		25	%		27	%
Education		16			14
Transportation		14			13
Special tax		11			11
Pre-refunded		8			13
Leasing		8			8
Electric		8			7
Other		10			7
Total		100	%		100	%

44

Many of our special purpose revenue bonds are insured by mono-line insurance companies or supported by credit enhancement programs of various states and municipalities. We view bond insurance as credit enhancement and not credit substitution. We base our investment decision on the strength of the issuer. A credit review is performed on each issuer and on the sustainability of the revenue source before we acquire a special purpose revenue bond and periodically, on an ongoing basis, thereafter. The underlying average credit rating of our special purpose revenue bond issuers, excluding any bond insurance, was AA+ at September 30, 2010. Although recent economic conditions in the United States may reduce the source of revenue to support certain of these securities, the majority are supported by revenue from essential sources, such as water and sewer, education and transportation fees, which we believe generate a stable source of revenue.

At September 30, 2010, we held a corporate bond portfolio with a carrying value of $696.5 million, an overall rating of A, and a weighted-average life of approximately 3.4 years.

At September 30, 2010, we also held a portfolio of residential mortgage-backed securities (MBSs) and collateralized mortgage-obligations (CMOs) with a fair value of $1.1 billion. Within our residential MBS/CMO portfolio, $1.0 billion of securities, or 95%, were issued by the Federal National Mortgage Association (Fannie Mae), the Government National Mortgage Association (GNMA) and the Federal Home Loan Mortgage Corporation (Freddie Mac), which are backed by the U.S. government. Of the remaining $54.4 million of residential mortgage-backed securities, 89% were collateralized by prime mortgages.

At September 30, 2010, we held a commercial MBS securities portfolio with a fair value of $157.7 million, an average rating of AA+, an average loan-to-value ratio of 73%, and a weighted-average life of approximately 4.5 years. We owned no collateralized debt obligations (CDOs) or collateralized loan obligations (CLOs), and we have never been counterparty to any credit default swap transactions.

This table indicates the expected maturity distribution of our fixed income securities at September 30, 2010.

						Mortgage-backed and
	Available for sale at					asset-backed at					Held to maturity at					Total fixed income
	amortized cost					amortized cost					amortized cost					securities
	Amount		%			Amount		%			Amount		%			Amount		%
One year or less	$	237,836		6	%	$	142,089		12	%	$	25,128		13	%	$	405,053		8	%
One year to five years		1,096,709		30			896,923		75			157,528		81			2,151,160		43
Five years to ten years		871,163		24			149,876		12			11,185		6			1,032,224		20
Ten years to fifteen years		764,784		21			7,171		1			—		—			771,955		15
More than fifteen years		698,894		19			—		—			—		—			698,894		14
Total fixed income securities	$	3,669,386		100	%	$	1,196,059		100	%	$	193,841		100	%	$	5,059,286		100	%

A security has an impairment loss when its fair value is less than its cost or amortized cost at the balance sheet date. The gross unrealized losses of the individual securities within our available for sale fixed income securities portfolios were $3.5 million at September 30, 2010, compared to $18.9 million at December 31, 2009. We evaluate the securities in our fixed income securities portfolio for possible other-than-temporary impairment losses at each quarter end. For a description of the accounting polices and procedures that we use to determine our other-than-temporary impairment losses, see Note 5, “Investments” in the notes to these condensed consolidated financial statements and “Critical Accounting Policies – Other-than-temporary Impairments in Investments” in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2009. We recognized $0.3 million of other-than-temporary impairment credit losses in the first nine months and third quarter of 2010, compared to $5.3 million and $0.3 million in the first nine months and third quarter of 2009, respectively.

At September 30, 2010, the net unrealized gain on our available for sale fixed income securities portfolio was $301.3 million, compared to $156.3 million at December 31, 2009. The change in the net unrealized gain, net of the related income tax effect, is recorded in other comprehensive income and fluctuates with changes in market interest rates. Our general policy has been to hold our fixed income securities, most of which are classified as available for sale, through periods of fluctuating interest rates and to not

45

realize significant gains or losses from their sale. We recognized $7.9 million and $4.9 million of pretax net realized investment gains in the first nine months of 2010 and 2009, respectively.

Corporate & Other

A Corporate & Other category includes operations not related to our segments, including unallocable corporate operating expenses, consolidated interest expense and underwriting results of our Exited Lines of business. The Exited Lines include: 1) accident and health business managed by our underwriting agency, LDG Reinsurance, 2) workers’ compensation, 3) provider excess, 4) Spanish medical malpractice, 5) U.K. motor and 6) film completion bonds. We no longer write the Exited Lines and do not expect to write these product lines in the future.

The following table summarizes activity in the Corporate & Other category.

	Nine months ended September 30,						Three months ended September 30,
	2010			2009			2010			2009
Net earned premium	$	1,225		$	26,065		$	70		$	7,152
Other revenue		987			135			129			(1,630	)
Total revenue		2,212			26,200			199			5,522
Loss and loss adjustment expense		3,611			29,355			(349	)		6,128
Other expense — Exited Lines		3,124			6,493			1,049			2,187
Other expense — Corporate		36,270			42,854			12,198			13,980
Interest expense		15,376			11,093			5,116			3,299
Total expense		58,381			89,795			18,014			25,594
Pretax loss	$	(56,169	)	$	(63,595	)	$	(17,815	)	$	(20,072	)

Net earned premium and losses decreased in 2010 because we sold the renewal rights to provider excess and stopped writing film completion bonds in 2009. In 2010, we had $3.0 million of adverse reserve development on the LDG accident and health business due to receipt of new claims information. Our Corporate expenses not allocable to the segments decreased $6.6 million year-over-year, principally due to lower expense in 2010 related to bonuses, stock-based compensation and the fair value adjustment on our interest rate swap agreements. Our interest expense increased in 2010 because we issued long-term debt in late 2009 at a higher fixed rate than the floating rate related to our prior line of credit borrowings.

Liquidity and Capital Resources

Credit market disruptions in recent years have resulted in a tightening of available sources of credit and significant liquidity concerns for many companies. We believe we have sufficient sources of liquidity at a reasonable cost at the present time, based on the following:

• We held $572.3 million of cash and liquid short-term investments at September 30, 2010.

• Our available for sale bond portfolio had a fair value of $5.2 billion at September 30, 2010, compared to $4.5 billion at December 31, 2009, and has an average rating of AA+. We intend to hold these securities until their maturity, but we would be able to sell securities to generate cash if the need arises.

• Our insurance subsidiaries have sufficient resources to pay potential claims. At September 30, 2010, they had $774.2 million of cash, short-term investments, maturing bonds, and principal payments from mortgage-backed and asset-backed securities that will be available cash resources during the next twelve months.

• Our debt consists of $300.0 million principal amount of unsecured 6.30% Senior Notes due November 15, 2019. Our debt to total capital ratio was 8.2% at September 30, 2010 and 9.0% at December 31, 2009.

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• We have a committed $575.0 million Revolving Loan Facility at a rate of 30-day LIBOR plus 25 basis points that matures December 19, 2011. Letters of credit issued on behalf of certain of our subsidiaries reduce available borrowing capacity under the facility. At September 30, 2010, we had $556.6 million of unused capacity, which we can draw against at any time at our request. The facility agreement contains two restrictive financial covenants, with which we were in compliance at September 30, 2010.

• During 2010, there was no significant change in our Standby Letter of Credit Facility used to guarantee our performance in our Lloyd’s of London syndicates.

• Our domestic insurance subsidiaries have the ability to pay $217.8 million in dividends in 2010 to our holding company without obtaining special permission from state regulatory authorities. Our underwriting agencies have no restrictions on the amount of dividends that can be paid to our holding company. The holding company can utilize these dividends for any purpose, including to pay down debt, pay dividends to shareholders, fund acquisitions, purchase common stock and pay operating expenses. Cash flow available to the holding company in 2010 is expected to be more than ample to cover the holding company’s required cash disbursements.

• We have a “Universal Shelf” registration statement that provides for the issuance of an aggregate of $1.0 billion of securities, of which we have $700.0 million of remaining capacity. These securities may be debt securities, equity securities, or a combination thereof. The shelf registration statement provides us the means to access the debt and equity markets relatively quickly, if we are satisfied with the current pricing in the financial market.

Cash Flow

We receive substantial cash from premiums, reinsurance recoverables, outward commutations, proceeds from sales and redemptions of investments and investment income. Our principal cash outflows are for the payment of claims and loss adjustment expenses, premium payments to reinsurers, inward commutations, purchases of investments, debt service, policy acquisition costs, operating expenses, taxes, dividends and common stock purchases. Cash provided by operating activities can fluctuate due to timing differences in the collection of premiums and reinsurance recoverables and the payment of losses and premium and reinsurance balances payable and the completion of commutations.

We generated cash from operations of $314.6 million and $417.5 million in the first nine months of 2010 and 2009, respectively. The components of our net operating cash flows are summarized in the following table.

	Nine months ended September 30,
	2010			2009
Net earnings	$	247,797		$	269,076
Change in premium, claims and other receivables, net of reinsurance, other payables and restricted cash		(24,539	)		(2,736	)
Change in unearned premium, net		15,103			14,348
Change in loss and loss adjustment expense payable, net of reinsurance recoverables		44,355			66,372
Gain on investments		(8,086	)		(3,152	)
Other, net		40,001			73,638
Cash provided by operating activities	$	314,631		$	417,546

Timing differences in the collection of premium and payment of reinsurance balances payable reduced our cash provided by operating activities in 2010, compared to 2009. In addition, we had $34.3 million of higher claims payments in 2010. Our operating cash flow is also impacted by the timing of cash receipts and payments related to commutations. In 2009, we commuted certain loss reserves for $43.9 million of cash, which reduced cash provided by operating activities in 2009. We received $25.0 million to commute the MGIC reinsurance contract in 2009 and $8.3 million to commute a derivative contract in 2010.

We maintain a substantial level of cash and liquid short-term investments to meet anticipated payment obligations. During January 2010, we paid the final $64.5 million due to previous holders of our 1.3% Convertible Notes that were submitted for conversion in December 2009 using cash held as of December 31, 2009. Our combined cash and short-term investments totaled $572.3 million at September 30, 2010.

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Accounting Guidance in 2010

A new accounting standard, originally issued as SFAS No. 167, Amendments to FASB Interpretation No. 46(R), became effective January 1, 2010. The guidance, which was incorporated into Accounting Standards Codification (ASC) Topic 810, Consolidation, changes various aspects of accounting for and disclosures of interests in variable interest entities. Our adoption of this guidance as of January 1, 2010 had no material impact on our condensed consolidated financial statements.

Effective January 1, 2010, we adopted Accounting Standards Update (ASU) No. 2010-06, which incorporated changes in disclosure requirements into ASC Topic 820, Fair Value Measurements and Disclosures. Where applicable, we have included the additional required disclosures in the notes to our condensed consolidated financial statements.

A new accounting standard, ASU 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses, was issued in July 2010. The new guidance expands disclosures related to financing receivables, including the nature of credit risk in financing receivables, how that risk is analyzed in determining the related allowance for credit losses, and changes to the allowance during the reporting period. We will provide the additional required disclosures in our Form 10-K for the year ended December 31, 2010.

A new accounting standard, originally issued as EITF 09-G, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts, was ratified in September 2010. The guidance, which will be incorporated into ASC Topic 944, Financial Services – Insurance, clarifies the definition of what constitutes an acquisition cost and limits the types of acquisition costs that can be capitalized by insurance entities to those that are “directly related to” the acquisition of new and renewal insurance contracts. Under the new guidance, direct costs only include those that result in the successful acquisition of a policy. All costs incurred for unsuccessful efforts, along with indirect costs, are to be expensed as incurred. This guidance must be adopted by January 1, 2012, either prospectively or retrospectively, and may be adopted earlier at the beginning of an annual period. We are currently evaluating the timing and effect of our adoption of this guidance.

Critical Accounting Policies

We provided information about our critical accounting policies in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies”, in our Annual Report on Form 10-K for the year ended December 31, 2009. We have made no changes in the identification or methods of application of these policies, except as related to the “Valuation of Goodwill”. During the third quarter of 2010, we realigned our segments and allocated our goodwill to new reporting units, as described in Note 2, “Segments” and Note 3, “Goodwill” in our Notes to the Condensed Consolidated Financial Statements for the period ended September 30, 2010.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

There have been no material changes in market risk from the information provided in Item 7A, “Quantitative and Qualitative Disclosures About Market Risk,” in our Annual Report on Form 10-K for the year ended December 31, 2009.

Item 4. Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Act)) that are designed to ensure that required information is recorded, processed, summarized and reported within the required timeframe, as specified in rules set forth by the Securities and Exchange Commission. Our disclosure controls and procedures are also designed to ensure that information required to be disclosed is accumulated and communicated to management, including our Chief Executive Officer (CEO) and Chief Financial Officer (CFO), to allow timely decisions regarding required disclosures.

Our management, with the participation of our CEO and CFO, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2010. Based on this evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective as of September 30, 2010.

(b) Changes in Internal Control over Financial Reporting

During the third quarter of 2010, there were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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Part II — Other Information

Item 1. Legal Proceedings

We are a party to lawsuits, arbitrations and other proceedings that arise in the normal course of our business. Many of such lawsuits, arbitrations and other proceedings involve claims under policies that we underwrite as an insurer or reinsurer, the liabilities for which, we believe, have been adequately included in our loss reserves. Also, from time to time, we are a party to lawsuits, arbitrations and other proceedings that relate to disputes with third parties, or that involve alleged errors and omissions on the part of our subsidiaries. We have provided accruals for these items to the extent we deem the losses probable and reasonably estimable. Although the ultimate outcome of these matters cannot be determined at this time, based on present information, the availability of insurance coverage and advice received from our outside legal counsel, we believe the resolution of any such matters will not have a material adverse effect on our consolidated financial position, results of operations or cash flows.

Item 1A. Risk Factors

There have been no material changes in the risk factors described in our Annual Report on Form 10-K for the year ended December 31, 2009.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

On June 20, 2008, our Board of Directors approved the purchase of up to $100.0 million of our common stock. On May 27, 2010, our Board of Directors approved a new authorization for $300.0 million and cancelled the $0.7 million remaining under the original authorization. The new share purchase plan authorizes purchases to be made in the open market or in privately negotiated transactions from time-to-time in compliance with applicable rules and regulations, including Rule 10b-18 under the Securities Exchange Act of 1934, as amended. Purchases under the plan will be subject to market and business conditions, as well as the level of cash generated from our operations, cash required for acquisitions, debt covenant compliance, trading price of the stock being at or below book value and other relevant factors. The purchase plan does not obligate us to purchase any particular number of shares, and may be suspended or discontinued at any time at our discretion. As of September 30, 2010, we had paid $110.2 million to purchase 5,130,077 shares of our common stock in the open market pursuant to these purchase programs.

During the third quarter of 2010, we purchased our common stock, as follows:

					Total number of shares		Approximate dollar
					purchased as part of		value of shares that may
	Total number of		Average price		publicly announced		yet be purchased under
Period	shares purchased		paid per share		plans or programs		the plans or programs
July 1 - July 31, 2010		—		—		—	$	299,248,840
August 1 - August 31, 2010		407,166	$	25.10		407,166	$	289,027,526
September 1 - September 30, 2010		—		—		—	$	289,027,526

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Item 6. Exhibits

a. Exhibits

3.1	Restated Certificate of Incorporation and Certificate of Amendment of Certificate of Incorporation of HCC Insurance Holdings, Inc., filed with the Delaware Secretary of State on July 23, 1996 and May 21, 1998, respectively (incorporated by reference to Exhibit 4.1 to our Registration Statement of Form S-8 (Registration No. 333-61687) filed August 17, 1998).
3.2	Amended and Restated Bylaws of HCC Insurance Holdings, Inc., as amended (incorporated by reference to Exhibit 3.1 to our Form 8-K filed April 3, 2008).
12	Statement of Ratio of Earnings to Fixed Charges.

31.1	Certification by Chief Executive Officer.
31.2	Certification by Chief Financial Officer.
32.1	Certification with Respect to Quarterly Report.
101	The following financial statements from the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2010, formatted in XBRL: (i) Condensed Consolidated Balance Sheets, (ii) Condensed Consolidated Statements of Earnings, (iii) Condensed Consolidated Statement of Changes in Shareholders’ Equity, (iv) Condensed Consolidated Statements of Cash Flows, and (v) Notes to Condensed Consolidated Financial Statements.*

* The XBRL related information in Exhibit 101 shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to liability of that section and shall not be incorporated by reference into any filing or other document pursuant to the Securities Act of 1933, as amended, except as shall be expressly set forth by specific reference in such filing or document.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	HCC Insurance Holdings, Inc.
	(Registrant)
November 8, 2010	/s/ John N. Molbeck, Jr.
(Date)	John N. Molbeck, Jr., President
	and Chief Executive Officer
November 8, 2010	/s/ Pamela J. Penny
(Date)	Pamela J. Penny, Executive Vice President
	and Chief Accounting Officer

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EX-12

Exhibit 12

HCC Insurance Holdings, Inc. and Subsidiaries
Statement of Ratio of Earnings to Fixed Charges
(unaudited, in thousands)

	Nine months ended September 30,				Three months ended September 30,
	2010		2009		2010		2009
Interest factor of rent expense (1)	$	4,045	$	3,982	$	1,381	$	1,341
Interest expense		15,907		11,816		5,280		3,549
Capitalized interest		—		51		—		—
Total fixed charges	$	19,952	$	15,849	$	6,661	$	4,890
Earnings before income tax expense	$	354,790	$	393,048	$	132,012	$	137,041
Interest factor of rent expense (1)		4,045		3,982		1,381		1,341
Interest expense		15,907		11,816		5,280		3,549
Earnings per calculation	$	374,742	$	408,846	$	138,673	$	141,931
Ratio of earnings to fixed charges (2)		18.78		25.80		20.82		29.02

(1)	Estimated to be 33% of total rent expense.
(2)	Earnings per calculation divided by total fixed charges.

EX-31.1

Exhibit 31.1

CERTIFICATION BY CHIEF EXECUTIVE OFFICER

I, John N. Molbeck, Jr., certify that:

1.	I have reviewed this quarterly report on Form 10-Q of HCC Insurance Holdings, Inc.;
2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.	The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a.	Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b.	Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
c.	Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d.	Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a.	All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b.	Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

November 8, 2010	/s/ John N. Molbeck, Jr.
(Date)	John N. Molbeck, Jr., President
	and Chief Executive Officer

EX-31.2

Exhibit 31.2

CERTIFICATION BY CHIEF FINANCIAL OFFICER

I, Brad T. Irick, certify that:

1.	I have reviewed this quarterly report on Form 10-Q of HCC Insurance Holdings, Inc.;
2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.	The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a.	Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b.	Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
c.	Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d.	Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a.	All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b.	Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

November 8, 2010	/s/ Brad T. Irick
(Date)	Brad T. Irick, Executive Vice President
	and Chief Financial Officer

EX-32.1

Exhibit 32.1

CERTIFICATION WITH RESPECT TO
QUARTERLY REPORT OF
HCC INSURANCE HOLDINGS, INC.

     The undersigned, being the Chief Executive Officer and Chief Financial Officer of HCC Insurance Holdings, Inc. (the Company), pursuant to 18 U.S.C. §1350 as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002, do hereby certify to the best of their knowledge with respect to the Quarterly Report of the Company on Form 10-Q, as filed with the Securities and Exchange Commission for the quarter ended September 30, 2010 (the Report):

1.	that the Report fully complies with all requirements of Section 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended; and
2.	that the information contained in the report fairly presents, in all material respects, the financial condition and results of operations of the Company as of and for the periods presented in the Report.

November 8, 2010	/s/ John N. Molbeck, Jr.
(Date)	John N. Molbeck, Jr., President
	and Chief Executive Officer
November 8, 2010	/s/ Brad T. Irick
(Date)	Brad T. Irick, Executive Vice President
	and Chief Financial Officer

A signed original of this written statement required by §906 has been provided to HCC Insurance Holdings, Inc. and will be retained by HCC Insurance Holdings, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.