e10vq

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, 2011.


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 definitions 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 28, 2011, there were approximately 106.5 million shares of common stock outstanding.

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 catastrophe 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 past and future potential credit market downturns, including the potential future ratings downgrade and/or impairment or perceived impairment of debt securities of sovereign issuers, including the United States of America,

	•		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, including defaults, 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,

	•		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, 2010.

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.

HCC Insurance Holdings, Inc. and Subsidiaries

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


	September 30,			December 31,
	2011			2010
ASSETS

Investments
Fixed income securities — available for sale, at fair value (amortized cost: 2011 — $5,356,333; 2010 — $4,864,806)	$	5,651,189		$	4,999,440
Fixed income securities — held to maturity, at amortized cost (fair value: 2011 — $170,556; 2010 — $195,811)		168,614			193,668
Short-term investments, at cost, which approximates fair value		197,986			488,002
Other investments		34,297			5,985

Total investments		6,052,086			5,687,095

Cash		93,137			97,857
Restricted cash		227,562			148,547
Premium, claims and other receivables		677,641			635,867
Reinsurance recoverables		1,071,266			1,006,855
Ceded unearned premium		231,537			278,663
Ceded life and annuity benefits		56,868			58,409
Deferred policy acquisition costs		225,190			212,786
Goodwill		873,375			821,648
Other assets		133,326			116,355

Total assets	$	9,641,988		$	9,064,082


LIABILITIES

Loss and loss adjustment expense payable	$	3,686,570		$	3,471,858
Life and annuity policy benefits		56,868			58,409
Reinsurance, premium and claims payable		321,684			345,730
Unearned premium		1,071,340			1,045,877
Deferred ceding commissions		66,059			72,565
Notes payable		493,752			298,637
Accounts payable and accrued liabilities		678,576			474,574

Total liabilities		6,374,849			5,767,650


SHAREHOLDERS’ EQUITY

Common stock, $1.00 par value; 250,000 shares authorized (shares issued: 2011 — 122,661 and 2010 — 120,942; outstanding: 2011 — 106,511 and 2010 — 114,968)		122,661			120,942
Additional paid-in capital		998,585			954,332
Retained earnings		2,385,638			2,257,895
Accumulated other comprehensive income		202,018			97,186
Treasury stock, at cost (shares: 2011 — 16,150 and 2010 — 5,974)		(441,763	)		(133,923	)

Total shareholders’ equity		3,267,139			3,296,432

Total liabilities and shareholders’ equity	$	9,641,988		$	9,064,082

See Notes to Consolidated Financial Statements.

HCC Insurance Holdings, Inc. and Subsidiaries

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


	Nine months ended September 30,						Three months ended September 30,
	2011			2010			2011		2010
REVENUE

Net earned premium	$	1,576,987		$	1,532,138		$	544,256	$	516,166
Net investment income		158,782			150,603			54,765		51,137
Other operating income		23,625			35,035			8,829		7,888
Net realized investment gain		3,169			7,897			2,674		1,057
Other-than-temporary impairment credit losses		(3,479	)		(300	)		—		(300	)

Total revenue		1,759,084			1,725,373			610,524		575,948


EXPENSE

Loss and loss adjustment expense, net		1,062,240			922,645			380,372		297,138
Policy acquisition costs, net		239,160			242,078			71,299		80,748
Other operating expense		198,511			189,953			70,451		60,770
Interest expense		16,597			15,907			5,610		5,280

Total expense		1,516,508			1,370,583			527,732		443,936


Earnings before income tax expense		242,576			354,790			82,792		132,012
Income tax expense		65,671			106,993			22,355		38,949

Net earnings	$	176,905		$	247,797		$	60,437	$	93,063


Earnings per common share

Basic	$	1.58		$	2.15		$	0.56	$	0.81


Diluted	$	1.57		$	2.15		$	0.56	$	0.81

See Notes to Consolidated Financial Statements.

HCC Insurance Holdings, Inc. and Subsidiaries

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, 2010	$	120,942	$	954,332	$	2,257,895		$	97,186	$	(133,923	)	$	3,296,432

Comprehensive income

Net earnings		—		—		176,905			—		—			176,905

Other comprehensive income
Change in net unrealized gain on investments, net of tax		—		—		—			104,776		—			104,776
Other, net of tax		—		—		—			56		—			56

Total other comprehensive income														104,832


Comprehensive income														281,737

Issuance of 1,458 shares for exercise of options, including tax effect		1,458		34,787		—			—		—			36,245

Purchase of 10,176 common shares		—		—		—			—		(307,840	)		(307,840	)

Stock-based compensation		261		9,466		—			—		—			9,727

Cash dividends declared, $0.445 per share		—		—		(49,162	)		—		—			(49,162	)

Balance at September 30, 2011	$	122,661	$	998,585	$	2,385,638		$	202,018	$	(441,763	)	$	3,267,139

See Notes to Consolidated Financial Statements.

HCC Insurance Holdings, Inc. and Subsidiaries

Consolidated Statements of Cash Flows
(unaudited, in thousands)


	Nine months ended September 30,
	2011			2010
Operating activities
Net earnings	$	176,905		$	247,797
Adjustments to reconcile net earnings to net cash provided by operating activities:
Change in premium, claims and other receivables		(76,927	)		(36,040	)
Change in reinsurance recoverables		(56,510	)		(32,474	)
Change in ceded unearned premium		47,477			(15,368	)
Change in loss and loss adjustment expense payable		196,046			76,829
Change in unearned premium		24,655			30,471
Change in reinsurance, premium and claims payable, excluding restricted cash		(34,052	)		11,501
Change in accounts payable and accrued liabilities		5,082			12,593
Stock-based compensation expense		10,017			9,441
Depreciation and amortization expense		13,214			12,894
(Gain) loss on investments		310			(8,086	)
Other, net		(18,258	)		5,073

Cash provided by operating activities		287,959			314,631


Investing activities
Sales of available for sale fixed income securities		494,532			132,897
Maturity or call of available for sale fixed income securities		318,558			458,495
Maturity or call of held to maturity fixed income securities		24,950			25,187
Cost of available for sale fixed income securities acquired		(1,243,124	)		(1,048,010	)
Cost of held to maturity fixed income securities acquired		—			(115,215	)
Cost of other investments acquired		(33,060	)		—
Change in short-term investments		288,909			328,951
Payments for purchase of businesses, net of cash received		(1,892	)		(36,348	)
Proceeds from sale of subsidiaries and other investments		2,793			19,855
Other, net		(16,977	)		(6,755	)

Cash used by investing activities		(165,311	)		(240,943	)


Financing activities
Advances on line of credit		210,000			—
Payments on line of credit		(15,000	)		—
Payments on convertible notes		—			(64,472	)
Sale of common stock		36,245			18,639
Purchase of common stock		(303,311	)		(11,444	)
Dividends paid		(49,301	)		(46,532	)
Other, net		(6,001	)		(1,126	)

Cash used by financing activities		(127,368	)		(104,935	)


Net decrease in cash		(4,720	)		(31,247	)
Cash at beginning of year		97,857			129,460

Cash at end of period	$	93,137		$	98,213

See Notes to Consolidated Financial Statements.

HCC Insurance Holdings, Inc. and Subsidiaries

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

(1) General Information

HCC Insurance Holdings, Inc. (HCC) and its subsidiaries (collectively we, us or our) include domestic and foreign property and casualty and life insurance companies and underwriting agencies with offices in the United States, the United Kingdom, Spain and Ireland. We underwrite a variety of non-correlated specialty insurance products in more than 180 countries, including property and casualty, accident and health, surety, credit and aviation product lines. We market our products through a network of independent agents and brokers, producers, managing general agents and directly to customers.

Basis of Presentation

Our unaudited 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 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 consolidated financial statements should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2010. The consolidated balance sheet at December 31, 2010 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 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 2010 consolidated financial statements to conform to the 2011 presentation. None of our reclassifications had an effect on our consolidated net earnings, shareholders’ equity or cash flows.

Recently Issued Accounting Guidance

A new accounting standard clarifies the definition of acquisition costs incurred by an insurance company and limits capitalization to such costs directly related to renewing or acquiring new insurance contracts. All costs incurred for unsuccessful marketing or underwriting efforts, along with indirect costs, are to be expensed as incurred. We plan to adopt this guidance on January 1, 2012. The new guidance will have no impact on our cash flows, and we do not expect it to have a significant impact on either our expenses or our pretax earnings. However, our adoption of the new standard will result in a reduction of our deferred policy acquisition costs asset, an adjustment to deferred income taxes, and a corresponding decrease in consolidated shareholders’ equity. We expect to adopt the new standard retrospectively and estimate that the adjustment to our consolidated shareholders’ equity at adoption will be less than $20.0 million.

New accounting guidance provides a consistent definition of fair value and ensures that fair value measurements and required disclosures are similar between GAAP and International Financial Reporting Standards. The new guidance also expands required disclosures for fair value measurements that are estimated using significant unobservable (Level 3) inputs. We will apply the new guidance prospectively beginning January 1, 2012. We do not expect adoption of the new guidance to have a material impact on our consolidated financial position, results of operations or cash flows.

A new accounting standard changes the disclosure of comprehensive income. The new guidance permits entities to present total comprehensive income, net income and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The current option of reporting other comprehensive income and its components in the statement of changes in shareholders’ equity will be eliminated. This guidance is effective on January 1, 2012 and must be applied retrospectively. The consolidated financial statements included in our 2010 Form 10-K comply with the new guidance; however, our interim consolidated financial statements have been prepared using the disclosure option that is being eliminated. While the format of our interim consolidated financial statements will change beginning in the first quarter of 2012, this change will not impact our consolidated financial position, results of operations or cash flows.

HCC Insurance Holdings, Inc. and Subsidiaries

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

A new accounting standard simplifies how entities test goodwill for impairment. The new standard permits an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. Previous guidance required an entity to test goodwill for impairment, at least on an annual basis, by first comparing the fair value of a reporting unit with its carrying amount, including goodwill. If the fair value of a reporting unit is less than its carrying amount, then the second step of the test must be performed to measure the amount of the impairment loss, if any. Under the new rules, an entity is not required to calculate the fair value of a reporting unit unless the entity determines that it is more likely than not that its fair value is less than its carrying amount. The new rules are effective on January 1, 2012. Since we perform our annual goodwill impairment test as of June 30 each year, we will first have the option of using the qualitative approach at June 30, 2012. We do not expect application of the new guidance to have a material impact on our consolidated financial position, results of operations or cash flows.

(2) Fair Value Measurements

We carry 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 consist of U.S. Treasuries and equity securities traded in an active exchange market. We use unadjusted 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. 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 approximately 99% of our 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. No markets for our investments were judged to be inactive at period end. Based on these procedures, we did not adjust the prices or quotes provided by our independent pricing services or third party investment manager as of September 30, 2011 or December 31, 2010.

Our Level 3 securities include certain fixed income securities and an insurance contract, classified in other assets, that we account for as a derivative. In the first quarter of 2010, we terminated our interest in a similar insurance contract and recognized an $8.0 million gain. We determine fair value of our Level 3 securities based on internally developed models that use assumptions or other data that are not readily observable from objective sources.

We exclude from our fair value disclosures our held to maturity investment portfolio measured at amortized cost.

HCC Insurance Holdings, Inc. and Subsidiaries

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

The following tables present our assets that were measured at fair value at September 30, 2011 and December 31, 2010. No liabilities were measured at fair value at either balance sheet date.


	Level 1		Level 2		Level 3		Total
September 30, 2011
Fixed income securities — available for sale
U.S. government and government agency securities	$	185,530	$	107,814	$	—	$	293,344
Fixed income securities of states, municipalities and political subdivisions		—		1,079,859		—		1,079,859
Special purpose revenue bonds of states, municipalities and political subdivisions		—		1,815,959		—		1,815,959
Corporate fixed income securities		—		813,450		156		813,606
Residential mortgage-backed securities		—		1,111,321		—		1,111,321
Commercial mortgage-backed securities		—		249,051		—		249,051
Asset-backed securities		—		33,555		1,062		34,617
Foreign government securities		—		253,432		—		253,432

Total fixed income securities — available for sale		185,530		5,464,441		1,218		5,651,189
Other investments		34,088		—		—		34,088
Other assets		—		—		1,373		1,373

Total assets measured at fair value	$	219,618	$	5,464,441	$	2,591	$	5,686,650


December 31, 2010
Fixed income securities — available for sale
U.S. government and government agency securities	$	148,217	$	176,050	$	—	$	324,267
Fixed income securities of states, municipalities and political subdivisions		—		1,082,057		—		1,082,057
Special purpose revenue bonds of states, municipalities and political subdivisions		—		1,628,059		—		1,628,059
Corporate fixed income securities		—		570,152		242		570,394
Residential mortgage-backed securities		—		995,108		—		995,108
Commercial mortgage-backed securities		—		145,228		—		145,228
Asset-backed securities		—		11,370		1,196		12,566
Foreign government securities		—		241,761		—		241,761

Total fixed income securities — available for sale		148,217		4,849,785		1,438		4,999,440
Other investments		5,575		—		—		5,575
Other assets		—		—		857		857

Total assets measured at fair value	$	153,792	$	4,849,785	$	2,295	$	5,005,872

HCC Insurance Holdings, Inc. and Subsidiaries

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

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


	2011								2010
	Fixed								Fixed
	income			Other					income			Other
	securities			assets		Total			securities			assets			Total
Balance at beginning of year	$	1,438		$	857	$	2,295		$	4,262		$	432		$	4,694
Settlements		—			—		—			—			(8,342	)		(8,342	)
Sales		(144	)		—		(144	)		(100	)		—			(100	)
Gains and (losses) — unrealized		(11	)		263		252			62			(141	)		(79	)
Gains and (losses) — realized		(2	)		—		(2	)		—			8,342			8,342

Balance at March 31		1,281			1,120		2,401			4,224			291			4,515
Sales		(55	)		—		(55	)		(395	)		—			(395	)
Gains and (losses) — unrealized		18			122		140			144			179			323

Balance at June 30		1,244			1,242		2,486			3,973			470			4,443
Sales		(43	)		—		(43	)		(77	)		—			(77	)
Gains and (losses) — unrealized		17			131		148			70			216			286
Transfers out of Level 3		—			—		—			(2,543	)		—			(2,543	)

Balance at September 30	$	1,218		$	1,373	$	2,591		$	1,423		$	686		$	2,109

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. There were no transfers between Level 1, Level 2 or Level 3 in the first nine months of 2011. We transferred investments from Level 3 to Level 2 in 2010 because we were able to determine their fair value using inputs based on observable market data in the period transferred.

(3) Investments

Substantially all of our fixed income securities are investment grade. The cost or amortized cost, gross unrealized gain or loss, and fair value of our fixed income securities were as follows:


	Available for sale
	Cost or		Gross		Gross
	amortized		unrealized		unrealized
	cost		gain		loss			Fair value
September 30, 2011
U.S. government and government agency securities	$	281,758	$	11,587	$	(1	)	$	293,344
Fixed income securities of states, municipalities and political subdivisions		1,005,837		74,210		(188	)		1,079,859
Special purpose revenue bonds of states, municipalities and political subdivisions		1,717,307		99,279		(627	)		1,815,959
Corporate fixed income securities		785,733		34,635		(6,762	)		813,606
Residential mortgage-backed securities		1,045,247		69,261		(3,187	)		1,111,321
Commercial mortgage-backed securities		245,651		9,180		(5,780	)		249,051
Asset-backed securities		34,489		179		(51	)		34,617
Foreign government securities		240,311		13,268		(147	)		253,432

Total fixed income securities — available for sale	$	5,356,333	$	311,599	$	(16,743	)	$	5,651,189

HCC Insurance Holdings, Inc. and Subsidiaries

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


	Available for sale
	Cost or		Gross		Gross
	amortized		unrealized		unrealized
	cost		gain		loss			Fair value
December 31, 2010
U.S. government and government agency securities	$	315,339	$	9,097	$	(169	)	$	324,267
Fixed income securities of states, municipalities and political subdivisions		1,050,969		38,825		(7,737	)		1,082,057
Special purpose revenue bonds of states, municipalities and political subdivisions		1,614,554		34,764		(21,259	)		1,628,059
Corporate fixed income securities		545,883		26,436		(1,925	)		570,394
Residential mortgage-backed securities		958,404		40,949		(4,245	)		995,108
Commercial mortgage-backed securities		136,746		8,518		(36	)		145,228
Asset-backed securities		12,563		78		(75	)		12,566
Foreign government securities		230,348		11,537		(124	)		241,761

Total fixed income securities — available for sale	$	4,864,806	$	170,204	$	(35,570	)	$	4,999,440


	Held to maturity
	Cost or		Gross		Gross
	amortized		unrealized		unrealized
	cost		gain		loss			Fair value
September 30, 2011
U.S. government securities	$	6,998	$	112	$	—		$	7,110
Corporate fixed income securities		113,015		1,552		(569	)		113,998
Foreign government securities		48,601		896		(49	)		49,448

Total fixed income securities — held to maturity	$	168,614	$	2,560	$	(618	)	$	170,556


December 31, 2010
U.S. government securities	$	12,993	$	264	$	—	$	13,257
Corporate fixed income securities		113,296		1,205		(277)		114,224
Foreign government securities		67,379		995		(44)		68,330

Total fixed income securities — held to maturity	$	193,668	$	2,464	$	(321)	$	195,811

HCC Insurance Holdings, Inc. and Subsidiaries

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

All fixed income securities were income producing in 2011. 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, 2011
U.S. government and government agency securities	$	2,250	$	(1	)	$	—	$	—		$	2,250	$	(1	)
Fixed income securities of states, municipalities and political subdivisions		15,360		(119	)		1,476		(69	)		16,836		(188	)
Special purpose revenue bonds of states, municipalities and political subdivisions		73,022		(441	)		29,074		(186	)		102,096		(627	)
Corporate fixed income securities		192,727		(6,322	)		16,964		(440	)		209,691		(6,762	)
Residential mortgage-backed securities		50,867		(2,180	)		8,031		(1,007	)		58,898		(3,187	)
Commercial mortgage-backed securities		94,516		(5,780	)		—		—			94,516		(5,780	)
Asset-backed securities		17,816		(51	)		—		—			17,816		(51	)
Foreign government securities		6,602		(147	)		—		—			6,602		(147	)

Total	$	453,160	$	(15,041	)	$	55,545	$	(1,702	)	$	508,705	$	(16,743	)


December 31, 2010
U.S. government and government agency securities	$	20,976	$	(169	)	$	—	$	—		$	20,976	$	(169	)
Fixed income securities of states, municipalities and political subdivisions		228,228		(7,621	)		2,279		(116	)		230,507		(7,737	)
Special purpose revenue bonds of states, municipalities and political subdivisions		689,190		(21,156	)		6,344		(103	)		695,534		(21,259	)
Corporate fixed income securities		66,029		(1,925	)		—		—			66,029		(1,925	)
Residential mortgage-backed securities		123,782		(3,081	)		22,152		(1,164	)		145,934		(4,245	)
Commercial mortgage-backed securities		—		—			3,084		(36	)		3,084		(36	)
Asset-backed securities		9,174		(75	)		—		—			9,174		(75	)
Foreign government securities		10,699		(124	)		—		—			10,699		(124	)

Total	$	1,148,078	$	(34,151	)	$	33,859	$	(1,419	)	$	1,181,937	$	(35,570	)

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. Our reviews cover all impaired securities where the loss exceeds $0.5 million and the loss either exceeds 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. Any non-credit portion of the other-than-temporary impairment loss is recognized in shareholders’ equity.

HCC Insurance Holdings, Inc. and Subsidiaries

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

Our other-than-temporary impairment losses were as follows:


	Nine months ended September 30,						Three months ended September 30,
	2011			2010			2011		2010
Total other-than-temporary impairment loss	$	(4,677	)	$	(316	)	$	—	$	(316	)
Portion recognized in other comprehensive income		1,198			16			—		16

Net other-than-temporary impairment loss recognized in earnings	$	(3,479	)	$	(300	)	$	—	$	(300	)

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 was as follows:


	Nine months ended September 30,					Three months ended September 30,
	2011			2010		2011		2010
Balance at beginning of period	$	4,273		$	3,848	$	3,847	$	3,848
Credit losses recognized in earnings
Securities previously impaired		1,597			300		—		300
Securities previously not impaired		1,882			—		—		—
Securities sold		(3,905	)		—		—		—

Balance at September 30	$	3,847		$	4,148	$	3,847	$	4,148

We had $1.2 million of after-tax other-than-temporary impairment losses, related to mortgage-backed securities, included in accumulated other comprehensive income within shareholders’ equity at September 30, 2011. This amount includes the after-tax unrealized gains and losses on these impaired securities resulting from changes in their fair value subsequent to their initial other-than-temporary impairment measurement dates.

We do not consider the $16.7 million of gross unrealized losses in our fixed income securities portfolio at September 30, 2011 to be other-than-temporary impairments because: 1) we received substantially all contractual interest and principal payments on these securities as of September 30, 2011, 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, 2011, 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 was 4.3 years at September 30, 2011.


	Available for sale				Held to maturity
	Cost or
	amortized cost		Fair value		Amortized cost		Fair value
Due in 1 year or less	$	247,391	$	251,201	$	56,204	$	56,501
Due after 1 year through 5 years		1,084,679		1,135,759		111,560		113,123
Due after 5 years through 10 years		1,080,746		1,161,310		850		932
Due after 10 years through 15 years		740,889		791,922		—		—
Due after 15 years		877,241		916,008		—		—

Securities with fixed maturities		4,030,946		4,256,200		168,614		170,556
Mortgage-backed and asset-backed securities		1,325,387		1,394,989		—		—

Total fixed income securities	$	5,356,333	$	5,651,189	$	168,614	$	170,556

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to 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,
	2011			2010			2011			2010
Fixed income securities	$	158,941		$	150,001		$	54,896		$	50,921
Short-term investments		420			631			99			271
Other		2,992			3,053			962			1,011

Total investment income		162,353			153,685			55,957			52,203
Investment expense		(3,571	)		(3,082	)		(1,192	)		(1,066	)

Net investment income	$	158,782		$	150,603		$	54,765		$	51,137

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


	Nine months ended September 30,						Three months ended September 30,
	2011			2010			2011			2010
Fixed income securities
Gains	$	8,532		$	8,875		$	4,217		$	1,282
Losses		(5,359	)		(824	)		(1,545	)		(225	)

Net fixed income securities	$	3,173		$	8,051		$	2,672		$	1,057

Other investments
Gains	$	6		$	2		$	2		$	—
Losses		(10	)		(156	)		—			—

Net other investments	$	(4	)	$	(154	)	$	2		$	—

Total
Gains	$	8,538		$	8,877		$	4,219		$	1,282
Losses		(5,369	)		(980	)		(1,545	)		(225	)

Net realized investment gain	$	3,169		$	7,897		$	2,674		$	1,057


(4)	Goodwill

The goodwill balances by reportable segment and the changes in goodwill are shown in the table below.


	U.S. Property		Professional		Accident &		U.S. Surety
	& Casualty		Liability		Health		& Credit		International		Total
Balance at beginning of year	$	223,000	$	249,820	$	144,128	$	79,700	$	125,000	$	821,648
Earnout and other		—		51,727		—		—		—		51,727

Balance at September 30, 2011	$	223,000	$	301,547	$	144,128	$	79,700	$	125,000	$	873,375

We conducted our 2011 goodwill impairment test as of June 30, 2011, which is consistent with the timeframe for our annual assessment in prior years. Based on our latest impairment test, the fair value of each of our reporting units exceeded its carrying amount.

HCC Insurance Holdings, Inc. and Subsidiaries

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

We acquired HCC Global Financial Products (HCC Global), which underwrites our U.S. and International directors’ and officers’ liability business, in 2002. The purchase agreement, as amended, includes a contingency for future earnout payments. The earnout is based on HCC Global’s pretax earnings from the acquisition date through September 30, 2007, with no maximum amount due to the former owners. When conditions specified under the purchase agreement are met, we record a net amount owed to or due from the former owners based on our estimate, at that point in time, of how claims will ultimately be settled. This net amount will fluctuate in the future, and the ultimate total net earnout payments cannot be finally determined until all claims are settled or paid. In March 2011, certain amendments were made to the purchase agreement, which resulted in an adjustment to our estimate of the ultimate amounts to be settled under the agreement. As a result, we increased goodwill by $20.0 million as of March 31, 2011. In September 2011, we increased goodwill by $31.3 million for additional earnout earned and accrued in the quarter.

(5) 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,
	2011			2010			2011			2010
Direct written premium	$	1,724,869		$	1,697,054		$	555,427		$	565,417
Reinsurance assumed		295,268			257,676			73,420			75,239
Reinsurance ceded		(359,046	)		(415,239	)		(116,513	)		(146,218	)

Net written premium	$	1,661,091		$	1,539,491		$	512,334		$	494,438


Direct earned premium	$	1,728,082		$	1,714,252		$	574,571		$	575,216
Reinsurance assumed		255,293			217,621			96,799			76,473
Reinsurance ceded		(406,388	)		(399,735	)		(127,114	)		(135,523	)

Net earned premium	$	1,576,987		$	1,532,138		$	544,256		$	516,166


Direct loss and loss adjustment expense	$	1,197,225		$	1,059,094		$	410,573		$	340,225
Reinsurance assumed		186,805			131,202			44,600			25,413
Reinsurance ceded		(321,790	)		(267,651	)		(74,801	)		(68,500	)

Net loss and loss adjustment expense	$	1,062,240		$	922,645		$	380,372		$	297,138


Policy acquisition costs	$	338,625		$	330,174		$	114,778		$	111,216
Ceding commissions		(99,465	)		(88,096	)		(43,479	)		(30,468	)

Net policy acquisition costs	$	239,160		$	242,078		$	71,299		$	80,748

HCC Insurance Holdings, Inc. and Subsidiaries

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

The table below shows the components of our reinsurance recoverables in our consolidated balance sheets.


	September 30,			December 31,
	2011			2010
Reinsurance recoverable on paid losses	$	55,778		$	75,262
Reinsurance recoverable on outstanding losses		475,671			452,882
Reinsurance recoverable on incurred but not reported losses		542,049			481,204
Reserve for uncollectible reinsurance		(2,232	)		(2,493	)

Total reinsurance recoverables	$	1,071,266		$	1,006,855

At each quarter end, we review our financial exposure to the reinsurance market based on our individual reinsurance recoverable balances as of the prior quarter-end. We take actions to collect outstanding balances or to mitigate our exposure to possible loss, including offsetting past due amounts against letters of credit and other payables. There was no material change in recoverables on paid losses that were outstanding for over 90 days as of September 30, 2011 compared to December 31, 2010. We have a reserve for potentially uncollectible amounts as follows:


	Nine months ended September 30,
	2011			2010
Balance at beginning of year	$	2,493		$	2,945
Provision expense (recovery)		(261	)		—

Balance at September 30	$	2,232		$	2,945

If we collect cash from or resolve a dispute with the reinsurer, we reduce the allowance account. While we believe the reserve is adequate based on information currently available, market conditions may change or additional information might be obtained that may require us to change the reserve in the future.

Reinsurers not authorized by the respective states of domicile of our U.S. domiciled insurance companies are required to collateralize reinsurance obligations due to us. The table below shows the amounts of letters of credit and cash deposits held by us as collateral, plus other credits available for potential offset at September 30, 2011 and December 31, 2010.


	September 30,		December 31,
	2011		2010
Payables to reinsurers	$	230,503	$	243,990
Letters of credit		135,299		145,914
Cash deposits		91,380		81,966

Total credits	$	457,182	$	471,870

The tables below show the calculation of net reserves, net unearned premium and net deferred policy acquisition costs.


	September 30,			December 31,
	2011			2010
Loss and loss adjustment expense payable	$	3,686,570		$	3,471,858
Reinsurance recoverable on outstanding losses		(475,671	)		(452,882	)
Reinsurance recoverable on incurred but not reported losses		(542,049	)		(481,204	)

Net reserves	$	2,668,850		$	2,537,772


Unearned premium	$	1,071,340		$	1,045,877
Ceded unearned premium		(231,537	)		(278,663	)

Net unearned premium	$	839,803		$	767,214


Deferred policy acquisition costs	$	225,190		$	212,786
Deferred ceding commissions		(66,059	)		(72,565	)

Net deferred policy acquisition costs	$	159,131		$	140,221

HCC Insurance Holdings, Inc. and Subsidiaries

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

(6) Notes Payable

Notes payable were as follows:


	September 30,		December 31,
	2011		2010
6.30% Senior Notes	$	298,752	$	298,637
$600.0 million Revolving Loan Facility		195,000		—

Total notes payable	$	493,752	$	298,637

On March 8, 2011, we entered into a new agreement for a four-year $600.0 million Revolving Loan Facility (Facility). The Facility replaced our $575.0 million Revolving Loan Facility, which was due to expire on December 19, 2011. The Facility allows us to borrow up to the maximum allowed on a revolving basis until the Facility expires on March 8, 2015. The borrowing rate is LIBOR plus 137.5 basis points, subject to increase or decrease based on changes in our debt rating. The contractual interest rate on borrowings under the Facility at September 30, 2011 was 1.63%. In addition, we pay a commitment fee of 20 basis points. Letters of credit issued under the Facility further reduced our available borrowing capacity on the remaining Facility to $392.2 million at September 30, 2011. The Facility contains restrictive financial covenants that require HCC to maintain a minimum consolidated net worth (excluding accumulated other comprehensive income) and a leverage ratio of less than or equal to 35%.

We were in compliance with debt covenants related to our Senior Notes, the Facility, and a Standby Letter of Credit Facility at September 30, 2011.

(7) 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,
	2011			2010			2011			2010
Net earnings	$	176,905		$	247,797		$	60,437		$	93,063
Less: net earnings attributable to unvested restricted stock awards and restricted stock units		(2,551	)		(2,746	)		(950	)		(1,067	)

Net earnings available to common stock	$	174,354		$	245,051		$	59,487		$	91,996

Weighted-average common shares outstanding		110,665			113,872			106,919			114,002
Dilutive effect of outstanding options (determined using treasury stock method)		245			254			129			156

Weighted-average common shares and potential common shares outstanding		110,910			114,126			107,048			114,158


Anti-dilutive stock options not included in treasury stock method computation		2,279			4,431			2,744			4,978

HCC Insurance Holdings, Inc. and Subsidiaries

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

(8) Stock-based Compensation

In 2011, we granted the following shares of common stock, restricted stock awards, restricted stock units and 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 awards, 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		28	$	32.54	$	920		—
Restricted stock awards		337		30.74		10,345	3-5 years
Restricted stock units		65		30.25		1,952	4 years
Stock options		291		8.42		2,450	1-5 years

(9) Segments

We report HCC’s results in six operating segments, each of which reports to an HCC executive who is responsible for the segment results. Each of our 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 incurs insurance losses, acquisition costs and other administrative expenses related to our insurance companies and underwriting agencies. We monitor and assess each segment’s pretax results based on underwriting profit, gross and net written premium, and its combined ratio, consisting of the net loss ratio and expense ratio.

Included in the portfolio of products for each underwriting 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, difference in conditions, occupational accident and brown water marine written in the United States.

•

Professional Liability — directors’ and officers’ (D&O) liability, large account errors and omissions liability, fiduciary liability, fidelity, bankers’ blanket bonds and, for some D&O policyholders, employment practices liability 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 surety bonds, commercial surety bonds, and bail bonds written in the United States and credit insurance managed in the United States.

•

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

The Investing segment includes our total investment portfolio, as well as all investment income, investment related expenses, realized investment gains and losses, and other-than-temporary impairment credit losses on investments. All investment activity is reported as revenue, consistent with our consolidated presentation.

HCC Insurance Holdings, Inc. and Subsidiaries

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

In addition to our segments, we include a Corporate & Other category to reconcile segment results to consolidated totals. The Corporate & Other category 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 these six product lines that we no longer write and do not expect to write in the future: 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.

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, 2011

Net earned premium	$	245,121	$	307,240	$	603,656	$	153,309	$	267,458		$	—	$	203		$	1,576,987
Other revenue		16,556		358		3,471		955		2,791			158,472		(506	)		182,097

Segment revenue		261,677		307,598		607,127		154,264		270,249			158,472		(303	)		1,759,084


Loss and LAE		148,783		257,632		438,883		42,351		175,635			—		(1,044	)		1,062,240
Other expense		82,202		40,055		92,882		82,909		99,754			—		56,466			454,268

Segment expense		230,985		297,687		531,765		125,260		275,389			—		55,422			1,516,508

Segment pretax earnings (loss)	$	30,692	$	9,911	$	75,362	$	29,004	$	(5,140	)	$	158,472	$	(55,725	)	$	242,576


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		164,684		196,154		412,438		38,157		107,601			—		3,611			922,645
Other expense		75,890		57,171		89,967		81,699		89,559			—		53,652			447,938

Segment expense		240,574		253,325		502,405		119,856		197,160			—		57,263			1,370,583


Segment pretax earnings (loss)	$	41,981	$	68,982	$	68,164	$	29,026	$	43,488		$	158,200	$	(55,051	)	$	354,790

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to 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, 2011

Net earned premium	$	85,946	$	104,066		$	202,999	$	51,906	$	99,294	$	—	$	45		$	544,256
Other revenue		6,890		109			1,277		254		889		57,439		(590	)		66,268

Segment revenue		92,836		104,175			204,276		52,160		100,183		57,439		(545	)		610,524


Loss and LAE		56,355		119,617			147,278		12,664		45,242		—		(784	)		380,372
Other expense		26,627		6,023			30,887		27,657		35,734		—		20,432			147,360

Segment expense		82,982		125,640			178,165		40,321		80,976		—		19,648			527,732

Segment pretax earnings (loss)	$	9,854	$	(21,465	)	$	26,111	$	11,839	$	19,207	$	57,439	$	(20,193	)	$	82,792


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		61,883		63,212			138,869		10,296		23,227		—		(349	)		297,138
Other expense		21,289		18,866			30,908		28,007		29,654		—		18,074			146,798

Segment expense		83,172		82,078			169,777		38,303		52,881		—		17,725			443,936

Segment pretax earnings (loss)	$	6,663	$	21,638		$	24,588	$	11,631	$	33,124	$	51,894	$	(17,526	)	$	132,012

The Professional Liability segment’s 2011 pretax earnings were impacted by the combined effect of net adverse loss development incurred by the segment and an increase in the 2011 accident year loss ratio for the diversified financial products line of business, which is included in the Professional Liability segment. The combined impact reduced pretax earnings by $75.1 million in the first nine months and $58.1 million in the third quarter of 2011. Catastrophe losses reduced the International segment’s pretax earnings by $101.7 million and $29.4 million in the first nine months and third quarter of 2011, respectively, and $15.6 million in the first nine months of 2010.

(10) Commitments and Contingencies

Catastrophe Exposure

We have exposure to catastrophe losses caused by natural perils (such as hurricanes, earthquakes, floods, tsunamis and tornados), as well as from man-made events (such as terrorist attacks). The incidence, timing and severity of catastrophe 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 2011, we recognized gross losses of $168.0 million from catastrophic events primarily in Japan, New Zealand, the United States and Denmark. After reinsurance and reinstatement premium, our pretax loss was $107.9 million. In 2010, we recognized gross losses from catastrophic events, primarily the Chilean earthquake, of $26.9 million. After reinsurance, our pretax loss was $15.6 million.

HCC Insurance Holdings, Inc. and Subsidiaries

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

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, individually or in the aggregate, 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, 2011, we have recorded a liability of $9.0 million and have provided a $3.0 million escrow account and $5.2 million of letters of credit to cover our obligations or anticipated payments under these indemnifications.

(11) Supplemental Information

Supplemental information was as follows:


	Nine months ended September 30,				Three months ended September 30,
	2011		2010		2011		2010
Income taxes paid	$	88,973	$	101,164	$	31,366	$	34,949
Interest paid		12,937		9,714		785		151
Cash paid for commutations		37,849		—		4,210		—
Comprehensive income		281,737		337,068		116,568		154,317

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 Consolidated Financial Statements and the related Notes as of December 31, 2010 and September 30, 2011.

Overview

We are a specialty insurance group with offices in the United States, the United Kingdom, Spain and Ireland, transacting business in approximately 180 countries. Our shares trade on the New York Stock Exchange and closed at $27.35 on October 28, 2011, resulting in market capitalization of $2.9 billion.

We underwrite a variety of relatively non-correlated specialty insurance products, including property and casualty, accident and health, surety, credit and aviation product lines. We market our insurance products through a network of independent agents and brokers, managing general agents and directly to consumers. In addition, we assume insurance written by other insurance companies. We manage our businesses through five underwriting segments and our Investing segment. Our underwriting segments are U.S. Property & Casualty, Professional Liability, Accident & Health, U.S. Surety & Credit and International.

Our business philosophy is to maximize underwriting profit while managing risk in order to preserve shareholders’ equity, grow book value and maximize earnings. We concentrate our insurance writings in selected specialty insurance lines of business in which we believe we can achieve meaningful underwriting profit. We also rely on our experienced underwriting personnel and our access to and expertise in the reinsurance marketplace to limit or reduce risk. Our business plan is shaped by our underlying business philosophy. As a result, our primary objective is to increase net earnings and grow book value, rather than to grow our market share or our gross written premium.

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

Key facts about our consolidated group as of and for the nine months and quarter ended September 30, 2011 were as follows:

	•		Our common shares closed at $27.05 per share.

	•		We had consolidated shareholders’ equity of $3.3 billion, with a book value per share of $30.67.

	•		We generated year-to-date net earnings of $176.9 million, or $1.57 per diluted share. Our third quarter earnings were $60.4 million, or $0.56 per diluted share.

	•		We produced revenue of $1.8 billion and $610.5 million in the first nine months and third quarter, respectively.

	•		In the first nine months, we recognized gross losses of $168.0 million and net losses, after reinsurance and reinstatement premium, of $107.9 million from catastrophes primarily in Japan, New Zealand, the United States and Denmark, mainly in our International segment. The third quarter included net catastrophe losses of $34.6 million.

	•		Our year-to-date net loss ratio, including the 2011 catastrophe losses, was 67.4% and our combined ratio was 92.2%. The catastrophe losses increased the net loss ratio by 6.5 percentage points and the combined ratio by 6.7 percentage points.

	•		We recorded net adverse (favorable) loss development of $21.6 million and $(0.6) million in the first nine months and third quarter, respectively. We also recognized an additional $28.2 million of losses in the third quarter related to the 2011 accident year, virtually all of which related to the diversified financial products line of business in our Professional Liability segment.

	•		In the third quarter, we recognized $13.0 million of profit commissions due from reinsurers related to the U.S. D&O and International D&O lines of business.

	•		In the third quarter, we borrowed an additional $100.0 million against our new four-year $600.0 million Revolving Loan Facility, primarily to fund share repurchases.

	•		We purchased $307.8 million, or 10.2 million shares, of our common stock at an average cost of $30.25 per share in the first nine months of 2011.

	•		We declared dividends of $0.445 per share and paid $49.3 million of dividends in the first nine months of 2011.

Comparisons in the following sections refer to the first nine months of 2011 compared to the same period of 2010, unless otherwise noted. Amounts in tables are in thousands, except for earnings per share, percentages, ratios and number of employees.

Results of Operations

Our results and key metrics for the nine months and quarter ended September 30, 2011 and 2010 were as follows:


	Nine months ended September 30,						Three months ended September 30,
	2011			2010			2011			2010
Net earnings	$	176,905		$	247,797		$	60,437		$	93,063

Earnings per diluted share	$	1.57		$	2.15		$	0.56		$	0.81


Net loss ratio		67.4	%		60.2	%		69.9	%		57.6	%
Expense ratio		24.8			25.2			22.9			24.6

Combined ratio		92.2	%		85.4	%		92.8	%		82.2	%

Our 2011 and 2010 results include the impact of world-wide catastrophic events. We experienced catastrophe losses primarily from the Japan earthquake and tsunami, New Zealand earthquakes, the United States tornados and Hurricane Irene, and the Denmark storms in 2011 and the Chile earthquake in 2010. We reinsure a portion of our exposure to such catastrophic events, although we incur some additional cost for reinstatement premium to continue our reinsurance coverage for future loss events. The following table summarizes our catastrophe losses, as well as the impact on our net earnings and key metrics in 2011 and 2010:


	Nine months ended September 30,						Three months ended September 30,
	2011			2010			2011			2010
Gross losses	$	167,968		$	26,900		$	47,709		$	(5,000	)
Net losses, after reinsurance and reinstatement premium	$	107,915		$	15,588		$	34,587		$	(5,000	)
Impact of net catastrophe losses on:
Net earnings per diluted share	$	(0.63	)	$	(0.09	)	$	(0.21	)	$	0.03
Net loss ratio (percentage points)		6.5	%		1.0	%		6.2	%		(0.9	)%
Combined ratio (percentage points)		6.7	%		1.0	%		6.3	%		(0.9	)%

Our third quarter 2011 catastrophe losses primarily related to Hurricane Irene in the United States. These catastrophe losses were incurred in our U.S. Property and Casualty and International segments. In the third quarter of 2010, we released $5.0 million of reserves related to the first quarter 2010 catastrophic events, based on revised information related to our ultimate loss exposures.

In addition to the catastrophe losses, we increased our loss reserves by $27.5 million in the third quarter of 2011 to reflect the impact of net favorable prior year loss development and additional accident year 2011 losses. The following table summarizes the impact of these items on our pretax earnings in 2011, compared to 2010:


	Nine months ended September 30,					Three months ended September 30,
	2011			2010		2011			2010
Adverse (favorable) loss development in:
Diversified financial products line of business	$	104,159		$	—	$	87,395		$	—
All other lines of business		(82,536	)		1,259		(88,038	)		(907	)

Total adverse (favorable) loss development		21,623			1,259		(643	)		(907	)
Accident year 2011 additional losses		28,180			—		28,180			—

Decrease (increase) in pretax earnings	$	49,803		$	1,259	$	27,537		$	(907	)

In the third quarter of 2011, we experienced $87.4 million of adverse loss development in the diversified financial products line of business in our Professional Liability segment. In the same quarter, we increased certain ultimate loss ratios for accident year 2011, primarily for the diversified financial products line of business, which generated $28.2 million of additional losses. The adverse loss development was offset by $88.0 million of net favorable loss development, primarily in the U.S. D&O and International D&O lines of business in our Professional Liability segment and in the U.K. professional liability line of business in our International segment. See the “Segment Operations” section below for further discussion of loss activity within each segment. We also recognized $13.0 million of profit commissions due from reinsurers in the U.S. D&O and International D&O lines of business in the third quarter of 2011.

Revenue

Total revenue increased $33.7 million in the first nine months of 2011, compared to the same period in 2010, primarily due to higher net earned premium and net investment income, offset by lower other operating income and net realized investment gains.

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,
	2011		2010		2011		2010
U.S. Property & Casualty	$	409,733	$	415,139	$	144,222	$	146,010
Professional Liability		392,903		414,436		130,631		144,920
Accident & Health		600,584		567,785		202,761		194,377
U.S. Surety & Credit		169,368		173,142		55,415		55,972
International		447,355		381,975		95,774		99,197
Exited Lines		194		2,253		44		180

Total gross written premium	$	2,020,137	$	1,954,730	$	628,847	$	640,656


U.S. Property & Casualty	$	273,212	$	247,717	$	92,776	$	84,250
Professional Liability		287,494		277,956		96,846		99,131
Accident & Health		600,143		567,520		202,643		194,301
U.S. Surety & Credit		155,761		159,626		50,660		52,067
International		344,286		285,763		69,364		64,644
Exited Lines		195		909		45		45

Total net written premium	$	1,661,091	$	1,539,491	$	512,334	$	494,438


U.S. Property & Casualty	$	245,121	$	258,427	$	85,946	$	84,802
Professional Liability		307,240		321,849		104,066		103,696
Accident & Health		603,656		567,739		202,999		193,252
U.S. Surety & Credit		153,309		148,427		51,906		49,807
International		267,458		234,471		99,294		84,539
Exited Lines		203		1,225		45		70

Total net earned premium	$	1,576,987	$	1,532,138	$	544,256	$	516,166

Related to the 2011 catastrophe losses, we recorded a net $14.0 million of reinstatement premium ($15.6 million ceded net of $1.6 million assumed) for continued reinsurance coverage, which reduced the International segment’s 2011 net written and net earned premium. Growth in written premium occurred primarily in the International segment, directly related to our property treaty business, and in the Accident & Health segment related to our medical stop-loss product. See the “Segment Operations” section below for further discussion of the changes in premium revenue within each segment.

Net investment income, which is included in our Investing segment, increased 5% 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 9% from $5.4 billion at September 30, 2010 to $5.8 billion at September 30, 2011. The growth in fixed income securities resulted primarily from cash flow from operations and long-term investment of short-term funds.

The sources of net investment income are detailed below.


	Nine months ended September 30,						Three months ended September 30,
	2011			2010			2011			2010
Fixed income securities
Taxable	$	84,228		$	82,416		$	30,009		$	27,613
Exempt from U.S. income taxes		74,713			67,585			24,887			23,308

Total fixed income securities		158,941			150,001			54,896			50,921
Short-term investments		420			631			99			271
Other		2,992			3,053			962			1,011

Total investment income		162,353			153,685			55,957			52,203
Investment expense		(3,571	)		(3,082	)		(1,192	)		(1,066	)

Net investment income	$	158,782		$	150,603		$	54,765		$	51,137

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


	Nine months ended September 30,				Three months ended September 30,
	2011		2010		2011		2010
Fee and commission income	$	18,658	$	21,465	$	7,391	$	6,311
Financial instruments		516		8,595		131		216
Other		4,451		4,975		1,307		1,361

Other operating income	$	23,625	$	35,035	$	8,829	$	7,888

Our fee and commission income in 2010 included deferred revenue from a subsidiary sold in late 2009. The financial instruments line relates to derivative contracts denominated in British pound sterling and includes the effect of foreign currency fluctuations compared to the U.S. dollar. In the first quarter of 2010, we terminated 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. 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. The gain was included in our U.S. Property & Casualty segment’s 2010 results.

Loss and Loss Adjustment Expense

The tables below detail, by segment, our net loss and loss adjustment expense, the amount of loss development included in our net loss and loss adjustment expense, and our net loss ratios.


	Nine months ended September 30,						Three months ended September 30,
	2011			2010			2011			2010
U.S. Property & Casualty	$	148,783		$	164,684		$	56,355		$	61,883
Professional Liability		257,632			196,154			119,617			63,212
Accident & Health		438,883			412,438			147,278			138,869
U.S. Surety & Credit		42,351			38,157			12,664			10,296
International		175,635			107,601			45,242			23,227
Exited Lines		(1,044	)		3,611			(784	)		(349	)

Net loss and loss adjustment expense	$	1,062,240		$	922,645		$	380,372		$	297,138


Adverse (favorable) loss development:
U.S. Property & Casualty	$	(4,613	)	$	9,751		$	(7,163	)	$	4,427
Professional Liability		48,137			2,202			31,153			(22	)
Accident & Health		2,540			2,642			230			186
U.S. Surety & Credit		(2,767	)		(7,853	)		(2,786	)		(3,654	)
International		(20,623	)		(8,415	)		(21,287	)		(1,724	)
Exited Lines		(1,051	)		2,932			(790	)		(120	)

Total adverse (favorable) loss development		21,623			1,259			(643	)		(907	)
Catastrophe losses		93,907			15,588			32,187			(5,000	)
All other net loss and loss adjustment expense		946,710			905,798			348,828			303,045

Net loss and loss adjustment expense	$	1,062,240		$	922,645		$	380,372		$	297,138


U.S. Property & Casualty		60.7	%		63.7	%		65.6	%		73.0	%
Professional Liability		83.9			60.9			114.9			61.0
Accident & Health		72.7			72.6			72.6			71.9
U.S. Surety & Credit		27.6			25.7			24.4			20.7
International		65.7			45.9			45.6			27.5

Consolidated net loss ratio		67.4	%		60.2	%		69.9	%		57.6	%

Consolidated accident year net loss ratio		66.0	%		60.0	%		70.0	%		57.7	%

Loss development represents an increase or decrease in estimates of ultimate losses related to prior accident years. Deficiencies and redundancies in ultimate loss estimates occur as we review our loss exposure with our actuaries, increasing or reducing estimates of our ultimate losses as a result of such reviews and as losses are finally settled or claims exposures change. We recognized adverse (favorable) loss development of $21.6 million and $1.3 million in the first nine months of 2011 and 2010, respectively, and $(0.6) million and $(0.9) million in the third quarter of 2011 and 2010, respectively. In the third quarter of 2011, we increased reserves for our diversified financial products line of business, included in the Professional Liability segment, by $114.7 million, which includes $87.4 million related to prior years, due to revised assumptions with respect to claims frequency and severity in the 2009 — 2011 accident years. This adverse development was offset by net favorable development of $88.0 million, primarily in our U.S. D&O and International D&O lines of business in our Professional Liability segment and in the U.K. professional liability

line of business in our International segment. The favorable development in these lines of business related to lower than expected reported loss development for accident years 2002 — 2005 for the D&O lines of business and primarily for accident years 2004 — 2009 for the U.K. professional liability line of business. See the “Segment Operations” section below for further discussion of the changes in our net loss and loss adjustment expense and net loss ratios within each segment. Our consolidated accident year net loss ratio was higher in 2011, primarily due to the higher amount of catastrophe losses and $28.2 million of additional losses related to our third-quarter increase in certain ultimate loss ratios for accident year 2011, primarily related to the diversified financial products line of business.

The table below provides a reconciliation of our consolidated reserves for loss and loss adjustment expense payable, net of reinsurance ceded, the amount of our paid claims, and our net paid loss ratio.


	Nine months ended September 30,						Three months ended September 30,
	2011			2010			2011			2010
Net reserves for loss and loss adjustment expense payable at beginning of period	$	2,537,772		$	2,555,840		$	2,612,945		$	2,568,317
Net reserve additions from acquired businesses		645			8,110			—			—
Foreign currency adjustment		5,364			(11,677	)		(22,622	)		36,109
Net loss and loss adjustment expense		1,062,240			922,645			380,372			297,138
Net loss and loss adjustment expense payments		(937,171	)		(872,838	)		(301,845	)		(299,484	)

Net reserves for loss and loss adjustment expense
payable at end of period	$	2,668,850		$	2,602,080		$	2,668,850		$	2,602,080

Net paid loss ratio		59.4	%		57.0	%		55.5	%		58.0	%

The net paid loss ratio was higher year-to-date in 2011 primarily due to higher claims payments for our directors’ and officers’ (D&O) lines of businesses and our property treaty and property (direct and facultative) product lines, including $20.2 million related to the 2011 catastrophic events. These increases were partially offset by lower claims payments for our medical stop-loss and aviation businesses, as well as higher subrogation received related to our U.S. credit line of business. In addition, in 2011 we commuted certain loss reserves included in our Exited Lines for $37.8 million. These commutations increased our year-to-date net paid loss ratio by 2.4 percentage points. The amount of claims paid fluctuates period to period due to our mix of business and the timing of claims settlement and catastrophic events.

Our gross loss ratio was 69.8% and 61.6% in the first nine months of 2011 and 2010, respectively, and 67.8% and 56.1% in the third quarter of 2011 and 2010, respectively. The 2011 catastrophe losses increased our reported gross loss ratios by 8.4 percentage points in the first nine months and 7.0 percentage points in the third quarter of 2011, while the 2010 catastrophe losses increased our reported gross loss ratio by 1.4 percentage points in the first nine months of 2010.

Policy Acquisition Costs

Our policy acquisition cost percentage was 15.2% and 15.8% in the first nine months of 2011 and 2010, respectively, and 13.1% and 15.6% in the third quarter of 2011 and 2010, respectively. The 2011 year-to-date policy acquisition cost percentage was reduced 0.9 percentage points due to $15.3 million of profit commissions due from reinsurers (recorded as an offset to policy acquisition costs) and increased 0.2 percentage points due to $14.0 million of reinstatement premium (recorded as a reduction of net earned premium). The 2011 third quarter policy acquisition cost percentage was reduced 2.8 percentage points due to $15.3 million of profit commissions due from reinsurers and increased 0.1 percentage points due to $2.4 million of reinstatement premium. Profit commissions and reinstatement premium had minimal impact on the 2010 policy acquisition cost percentage. The remaining increase in our policy acquisition cost percentage primarily related to higher average commission and premium tax expense in 2011 due to changes in the mix of business.

Other Operating Expense

Other operating expense increased 5% year-over-year and 16% quarter-over-quarter in 2011, primarily due to the combined effect of higher salary, employee benefits and information technology expense in 2011, fluctuations in foreign currency rates period-over-period, and certain non-recurring costs in 2010. We recognized currency conversion benefit (expense) of $2.5 million in the first nine months and $0.5 million in the third quarter of 2011, compared to $(1.5) million in the first nine months and $1.2 million in the third

quarter of 2010. The first nine months of 2010 included $3.0 million of direct costs incurred in the first quarter to terminate a derivative contract.

For the first nine months of 2011, 67% of our other operating expense related to compensation and benefits of our employees. We had 1,869 employees at September 30, 2011 compared to 1,878 a year earlier. Other operating expense included year-to-date stock-based compensation expense of $10.4 million in 2011 and $9.9 million in 2010. At September 30, 2011, there was approximately $26.8 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 3.6 years.

Interest Expense

Interest expense on debt and short-term borrowings was $16.6 million and $15.9 million in the first nine months of 2011 and 2010, respectively, and $5.6 million and $5.3 million in the third quarter of 2011 and 2010, respectively, primarily related to our fixed rate Senior Notes. The increase in 2011 related to $195.0 million of borrowings on our Revolving Loan Facility.

Income Tax Expense

Our effective income tax rate was 27.1% for the first nine months of 2011, compared to 30.2% for the first nine months of 2010. The lower effective rate in 2011 related to the increased benefit from tax-exempt investment income relative to a lower pretax income base.

Segment Operations

Each of our insurance 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. The insurance segments also write facultative or individual account reinsurance, as well as treaty reinsurance business. In some cases, we purchase reinsurance to limit the segments’ net losses from both individual policy losses and multiple policy losses from catastrophic events. Our segments maintain disciplined expense management and a streamlined management structure, which results in favorable expense ratios. The following provides operational information about our five underwriting segments and our Investing segment.

U.S. Property & Casualty Segment

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


	Nine months ended September 30,						Three months ended September 30,
	2011			2010			2011			2010
Net earned premium	$	245,121		$	258,427		$	85,946		$	84,802
Other revenue		16,556			24,128			6,890			5,033

Segment revenue		261,677			282,555			92,836			89,835


Loss and loss adjustment expense, net		148,783			164,684			56,355			61,883
Other expense		82,202			75,890			26,627			21,289

Segment expense		230,985			240,574			82,982			83,172

Segment pretax earnings	$	30,692		$	41,981		$	9,854		$	6,663


Net loss ratio		60.7	%		63.7	%		65.6	%		73.0	%
Expense ratio		31.4			26.9			28.7			23.7

Combined ratio		92.1	%		90.6	%		94.3	%		96.7	%


	Nine months ended September 30,						Three months ended September 30,
	2011			2010			2011			2010
Aviation	$	83,879		$	87,248		$	29,279		$	28,950
E&O		56,354			74,079			17,997			23,013
Public Risk		36,523			34,526			13,344			11,600
Other		68,365			62,574			25,326			21,239

Total net earned premium	$	245,121		$	258,427		$	85,946		$	84,802

Aviation		64.9	%		62.7	%		67.1	%		69.7	%
E&O		73.7			84.9			108.6			133.8
Public Risk		84.5			58.8			115.1			37.3
Other		32.1			42.8			7.1			31.1

Total net loss ratio		60.7	%		63.7	%		65.6	%		73.0	%


Aviation	$	116,933		$	121,600		$	37,877		$	44,692
E&O		52,961			63,316			15,963			19,018
Public Risk		55,724			50,397			21,426			15,706
Other		184,115			179,826			68,956			66,594

Total gross written premium	$	409,733		$	415,139		$	144,222		$	146,010


Aviation	$	88,786		$	84,097		$	29,701		$	30,347
E&O		52,035			63,256			15,449			19,019
Public Risk		43,926			36,635			17,530			12,985
Other		88,465			63,729			30,096			21,899

Total net written premium	$	273,212		$	247,717		$	92,776		$	84,250

Our U.S. Property & Casualty segment 2011 pretax earnings declined year-over-year, primarily due to lower net earned premium, higher operating expenses, and the effect of a $5.0 million gain in 2010 related to termination of a derivative contract. The impact of these items was partially offset by favorable loss development in 2011, compared to adverse development in 2010. The 2011 pretax earnings increased quarter-to-quarter, primarily due to a similar trend in loss development.

Gross written premium was lower in 2011 due to competition and other business factors that particularly affected the E&O product line. E&O premium was also impacted by our more restrictive underwriting of this product line starting in 2009. Total net written premium increased in certain other product lines, as changes in the timing and amount of our reinsurance program costs offset the decrease in E&O premium. Net earned premium was lower in 2011 mainly due to reduced E&O premium.

The segment’s lower net loss ratios in 2011, compared to 2010, primarily reflect the change in loss development year-over-year. The segment had favorable development of $4.6 million in the first nine months of 2011, compared to adverse development of $9.8 million in the same period of 2010. The third quarter development was a favorable $7.2 million in 2011 and an adverse $4.4 million in 2010. Both years experienced adverse development in our E&O and employment practices liability (included in Other) lines of business. In addition, 2011 experienced offsetting favorable development in our disability, contingency and other lines of business (included in Other). Our Public Risk product line incurred $5.0 million of catastrophe losses in the third quarter of 2011.

The segment’s expense ratios were higher year-over-year, primarily due to higher compensation costs and lower segment revenue in 2011 compared to 2010. During 2010, we terminated our interest in a derivative contract, which generated $5.0 million of pretax earnings. We recognized a gain of $8.0 million, which was included in other revenue, and incurred reinsurance and other direct costs of $3.0 million, which were included in other expense.

Professional Liability Segment

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


	Nine months ended September 30,						Three months ended September 30,
	2011			2010			2011			2010
Net earned premium	$	307,240		$	321,849		$	104,066		$	103,696
Other revenue		358			458			109			20

Segment revenue		307,598			322,307			104,175			103,716


Loss and loss adjustment expense, net		257,632			196,154			119,617			63,212
Other expense		40,055			57,171			6,023			18,866

Segment expense		297,687			253,325			125,640			82,078

Segment pretax earnings (loss)	$	9,911		$	68,982		$	(21,465	)	$	21,638


Net loss ratio		83.9	%		60.9	%		114.9	%		61.0	%
Expense ratio		13.0			17.7			5.8			18.2

Combined ratio		96.9	%		78.6	%		120.7	%		79.2	%


U.S. D&O	$	270,408		$	285,100		$	90,154		$	92,721
International D&O		36,832			36,749			13,912			10,975

Total net earned premium	$	307,240		$	321,849		$	104,066		$	103,696


U.S. D&O		96.6	%		61.0	%		151.3	%		61.0	%
International D&O		(10.0	)		60.5			(120.8	)		60.3

Total net loss ratio		83.9	%		60.9	%		114.9	%		61.0	%


U.S. D&O	$	312,881		$	344,510		$	112,220		$	124,366
International D&O		80,022			69,926			18,411			20,554

Total gross written premium	$	392,903		$	414,436		$	130,631		$	144,920


U.S. D&O	$	239,894		$	249,882		$	86,202		$	90,871
International D&O		47,600			28,074			10,644			8,260

Total net written premium	$	287,494		$	277,956		$	96,846		$	99,131

Our Professional Liability segment earnings declined in 2011, compared to 2010, due to adverse loss development, partially offset by increased income related to profit commissions due from reinsurers. The segment’s gross written premium decreased in 2011 because we wrote less D&O business in the United States due to competition. Net written premium as a percentage of gross written premium was higher in 2011 due to a change in our reinsurance programs.

The segment had adverse loss development of $48.1 million and $31.2 million for the first nine months and third quarter of 2011, respectively, compared to $2.2 million and none in the same periods of 2010. The 2011 development relates to the diversified financial products line of business (included in U.S. D&O), which provides coverage for private equity partnerships, hedge funds and investment managers.

In the third quarter of 2011, this line of business recorded $87.4 million of adverse development, as well as $27.3 million of additional losses due to the increase in its 2011 accident year loss ratio. This adverse development resulted primarily from revised assumptions in the quarter with regards to the frequency and severity of claims in the 2009 — 2011 accident years. For year-to-date 2011, the diversified financial products line of business had $104.2 million of adverse development.

Our U.S. D&O and International D&O lines of business had favorable development of $32.1 million and $24.1 million, respectively, in the third quarter of 2011, which partially offset the adverse development described above. The favorable development related to lower than expected reported loss development in accident years 2002 — 2005. The higher 2011 loss ratios for U.S. D&O, shown above, include the impact of the adverse development for the diversified financial products line of business, partially offset by the favorable development for the U.S. D&O line of business. The negative 2011 loss ratios for International D&O reflect the favorable development on that line of business.

The segment’s lower expense ratios in 2011 primarily relate to prior years’ profit commissions due from reinsurers, recorded by the U.S. D&O and International D&O lines of business in the third quarter of 2011. The profit commissions, which offset the segment’s other expense, reduced the 2011 year-to-date and third quarter expense ratios by 4.3 percentage points and 12.5 percentage points, respectively.

Accident & Health Segment

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


	Nine months ended September 30,						Three months ended September 30,
	2011			2010			2011			2010
Net earned premium	$	603,656		$	567,739		$	202,999		$	193,252
Other revenue		3,471			2,830			1,277			1,113

Segment revenue		607,127			570,569			204,276			194,365


Loss and loss adjustment expense, net		438,883			412,438			147,278			138,869
Other expense		92,882			89,967			30,887			30,908

Segment expense		531,765			502,405			178,165			169,777

Segment pretax earnings	$	75,362		$	68,164		$	26,111		$	24,588


Net loss ratio		72.7	%		72.6	%		72.6	%		71.9	%
Expense ratio		15.3			15.8			15.1			15.9

Combined ratio		88.0	%		88.4	%		87.7	%		87.8	%


Medical Stop-loss	$	527,255		$	488,256		$	176,199		$	164,698
Other		76,401			79,483			26,800			28,554

Total net earned premium	$	603,656		$	567,739		$	202,999		$	193,252


	Nine months ended September 30,						Three months ended September 30,
	2011			2010			2011			2010
Medical Stop-loss		74.2	%		74.0	%		74.5	%		74.1	%
Other		62.6			64.4			59.8			59.1

Total net loss ratio		72.7	%		72.6	%		72.6	%		71.9	%


Medical Stop-loss	$	527,401		$	488,256		$	176,247		$	164,698
Other		73,183			79,529			26,514			29,679

Total gross written premium	$	600,584		$	567,785		$	202,761		$	194,377


Medical Stop-loss	$	527,255		$	488,256		$	176,199		$	164,698
Other		72,888			79,264			26,444			29,603

Total net written premium	$	600,143		$	567,520		$	202,643		$	194,301

Our Accident & Health segment pretax earnings increased 11% in 2011, primarily due to higher medical stop-loss premium from rate increases and writing new business. The segment had adverse loss development of $2.5 million in the first nine months of 2011 and $2.6 million in the same period of 2010. The adverse development primarily related to our short-term medical insurance and HMO reinsurance lines of business (both included in Other).

U.S. Surety & Credit Segment

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


	Nine months ended September 30,						Three months ended September 30,
	2011			2010			2011			2010
Net earned premium	$	153,309		$	148,427		$	51,906		$	49,807
Other revenue		955			455			254			127

Segment revenue		154,264			148,882			52,160			49,934


Loss and loss adjustment expense, net		42,351			38,157			12,664			10,296
Other expense		82,909			81,699			27,657			28,007

Segment expense		125,260			119,856			40,321			38,303

Segment pretax earnings	$	29,004		$	29,026		$	11,839		$	11,631


Net loss ratio		27.6	%		25.7	%		24.4	%		20.7	%
Expense ratio		53.7			54.9			53.0			56.1

Combined ratio		81.3	%		80.6	%		77.4	%		76.8	%


Surety	$	121,093		$	119,325		$	40,284		$	39,777
Credit		32,216			29,102			11,622			10,030

Total net earned premium	$	153,309		$	148,427		$	51,906		$	49,807


	Nine months ended September 30,						Three months ended September 30,
	2011			2010			2011			2010
Surety		25.2	%		22.2	%		25.1	%		15.9	%
Credit		36.6			40.3			21.8			39.4

Total net loss ratio		27.6	%		25.7	%		24.4	%		20.7	%


Surety	$	127,219		$	132,137		$	40,257		$	43,437
Credit		42,149			41,005			15,158			12,535

Total gross written premium	$	169,368		$	173,142		$	55,415		$	55,972


Surety	$	119,780		$	127,348		$	37,037		$	42,038
Credit		35,981			32,278			13,623			10,029

Total net written premium	$	155,761		$	159,626		$	50,660		$	52,067

Our U.S. Surety & Credit segment pretax earnings were flat year-over-year. The segment had favorable loss development of $2.8 million and $7.9 million in the first nine months of 2011 and 2010, respectively, and $2.8 million and $3.7 million in the third quarter of 2011 and 2010, respectively. The 2011 favorable development related to lower than expected reported loss development in our Credit product line. The 2010 development related to revised loss estimates for both our Surety and Credit product lines.

International Segment

The following tables summarize the operations of the International segment.


	Nine months ended September 30,						Three months ended September 30,
	2011			2010			2011			2010
Net earned premium	$	267,458		$	234,471		$	99,294		$	84,539
Other revenue		2,791			6,177			889			1,466

Segment revenue		270,249			240,648			100,183			86,005


Loss and loss adjustment expense, net		175,635			107,601			45,242			23,227
Other expense		99,754			89,559			35,734			29,654

Segment expense		275,389			197,160			80,976			52,881

Segment pretax income (loss)	$	(5,140	)	$	43,488		$	19,207		$	33,124


Net loss ratio		65.7	%		45.9	%		45.6	%		27.5	%
Expense ratio		36.9			37.2			35.7			34.5

Combined ratio		102.6	%		83.1	%		81.3	%		62.0	%


Energy	$	47,369		$	39,566		$	18,686		$	12,777
Property Treaty		64,528			32,533			26,563			16,924
Liability		60,181			60,478			20,283			19,929
Surety & Credit		56,009			53,800			19,952			17,916
Other		39,371			48,094			13,810			16,993

Total net earned premium	$	267,458		$	234,471		$	99,294		$	84,539


	Nine months ended September 30,						Three months ended September 30,
	2011			2010			2011			2010
Energy		52.5	%		25.4	%		41.2	%		3.3	%
Property Treaty		95.9			47.0			85.2			(5.2	)
Liability		18.1			55.4			(47.1	)		55.9
Surety & Credit		40.9			38.1			40.2			37.5
Other		140.0			58.8			119.0			34.3

Total net loss ratio		65.7	%		45.9	%		45.6	%		27.5	%


Energy	$	113,410		$	97,053		$	17,029		$	16,731
Property Treaty		124,750			71,404			20,635			16,309
Liability		68,713			68,501			20,642			19,464
Surety & Credit		65,853			57,019			18,664			16,774
Other		74,629			87,998			18,804			29,919

Total gross written premium	$	447,355		$	381,975		$	95,774		$	99,197


Energy	$	68,329		$	51,716		$	5,432		$	4,251
Property Treaty		100,139			61,994			14,013			12,948
Liability		63,248			63,410			18,815			17,663
Surety & Credit		62,155			51,278			18,689			14,605
Other		50,415			57,365			12,415			15,177

Total net written premium	$	344,286		$	285,763		$	69,364		$	64,644

Our International segment’s pretax earnings were impacted by losses from world-wide catastrophic events in 2011 and 2010. We experienced catastrophe losses primarily from the Japan earthquake and tsunami, New Zealand earthquakes, the United States tornados and Hurricane Irene, and the Denmark storms in 2011 and the Chile earthquake in 2010. The catastrophic events impacted our energy and property treaty product lines, as well as our property (direct and facultative) and accident and health lines of business (both included in Other). We reinsured a portion of our exposure to these catastrophic events and incurred net reinstatement premium for continued reinsurance coverage, which reduced the segment’s 2011 net written and net earned premium. The following table summarizes the segment’s catastrophe losses, as well as the impact on key metrics in 2011 and 2010:


	Nine months ended September 30,						Three months ended September 30,
	2011			2010			2011			2010
Loss and loss adjustment expense (benefit), after reinsurance	$	87,672		$	15,588		$	27,000		$	(5,000	)
Reinstatement premium, net		14,008			—			2,400			—

Total net catastrophe losses (benefit)	$	101,680		$	15,588		$	29,400		$	(5,000	)


Impact of net catastrophe losses (benefit):
Net loss ratio (in percentage points)		34.4	%		6.7	%		27.7	%		(5.9)	%
Expense ratio (in percentage points)		1.8			—			0.9			—

Combined ratio		36.2	%		6.7	%		28.6	%		(5.9)	%

The increase in gross written, net written and net earned premium year-over-year principally related to our new property treaty business, which we began to write in late 2009. In 2011, we wrote more energy business due to industry rate increases and expansion of our wind storm aggregates and retained a higher percentage of this business. Written and earned premium in our international Surety & Credit and Other product lines fluctuated year-over-year due to changes in market rate pricing and our reinsurance programs. Other revenue in 2010 included third party revenue earned by our reinsurance broker, which we sold in late 2009.

The segment had $20.6 million and $21.3 million of favorable loss development in the first nine months of 2011 and 2010 respectively, and $8.4 million and $1.7 million of favorable development in the same period of 2010. The 2011 development included $18.9 million of favorable development for our U.K. professional liability line of business (included in Liability). This business experienced lower than expected reported loss development for accident years 2004 — 2010, with approximately half of the favorable development in accident year 2009. The 2011 and 2010 year-to-date development included $5.5 million and $9.1 million, respectively, of favorable development related to prior years’ catastrophe losses.

The Liability net loss ratios reflect the 2011 favorable development. The Energy, Property Treaty and Other net loss ratios reflect the catastrophe losses in the first nine months of 2011 and 2010, as well as the favorable development related to prior years’ catastrophe losses.

The segment’s expense ratio was lower for the first nine months of 2011, primarily due to higher segment revenue in 2011 compared to 2010, as well as currency conversion expense in 2010.

Investing Segment

We invest substantially all of our funds in highly-rated fixed income securities, the majority of which are designated as available for sale securities. We held $5.8 billion of fixed income securities at September 30, 2011, compared to $5.2 billion at December 31, 2010. At September 30, 2011, 99% of our fixed income securities were investment grade, of which 81% were rated AAA or AA. The average rating of our fixed income securities portfolio was AA at September 30, 2011, compared to AA+ at June 30, 2011. The decline in the average rating was a direct result of Standard & Poor’s Corporation’s downgrade of the U.S. government debt rating in August 2011. The average long-term tax equivalent yield of our fixed income securities portfolio was 4.8% on September 30, 2011. The portfolio has a weighted-average life of 7.7 years and a weighted-average duration of 5.2 years.

The following tables summarize the investment results and key metrics related to our Investing segment.


	Nine months ended September 30,						Three months ended September 30,
	2011			2010			2011			2010
Fixed income securities	$	158,941		$	150,001		$	54,896		$	50,921
Short-term investments		420			631			99			271
Other investments		2,992			3,053			962			1,011
Net realized investment gain		3,169			7,897			2,674			1,057
Other-than-temporary impairment credit losses		(3,479	)		(300	)		—			(300	)
Investment expense		(3,571	)		(3,082	)		(1,192	)		(1,066	)

Segment pretax earnings	$	158,472		$	158,200		$	57,439		$	51,894


Average investments, at cost	$	5,646,500		$	5,334,463		$	5,701,695		$	5,350,244
Average long-term yield *		4.0	%		4.1	%		4.0	%		4.1	%
Average long-term tax equivalent yield *		4.8	%		4.9	%		4.8	%		4.9	%
Average combined tax equivalent yield *		4.6	%		4.5	%		4.7	%		4.6	%
Weighted-average life of fixed income securities	7.7 years			6.7 years
Weighted-average duration of fixed income securities	5.2 years			4.6 years
Weighted-average combined duration	5.0 years			4.4 years
Average rating of fixed income securities	AA			AA+


*		Excluding realized and unrealized gains and losses.

The ratings of our fixed income securities at September 30, 2011 were as follows:


	Available for sale					Held to maturity
	at fair value					at amortized cost
	Amount		%			Amount		%
AAA	$	849,992		15	%	$	53,195		31	%
AA		3,754,273		66			35,421		21
A		838,381		15			78,717		47
BBB		181,819		3			1,281		1
BB and below		26,724		1			—		—

Total fixed income securities	$	5,651,189		100	%	$	168,614		100	%

This table summarizes our investments by type, substantially all of which were reported at fair value, at September 30, 2011 and December 31, 2010.


	September 30, 2011					December 31, 2010
	Amount		%			Amount		%
U.S. government and government agency securities	$	300,342		5	%	$	337,260		6	%
Fixed income securities of states, municipalities and political subdivisions		1,079,859		18			1,082,057		19
Special purpose revenue bonds of states, municipalities and political subdivisions		1,815,959		30			1,628,059		29
Corporate fixed income securities		926,621		15			683,690		12
Residential mortgage-backed securities		1,111,321		18			995,108		17
Commercial mortgage-backed securities		249,051		4			145,228		3
Asset-backed securities		34,617		1			12,566		—
Foreign government securities		302,033		5			309,140		5
Short-term investments		197,986		3			488,002		9
Other investments		34,297		1			5,985		—

Total investments	$	6,052,086		100	%	$	5,687,095		100	%

Our total investments increased $365.0 million in 2011, principally from operating cash flow and a $160.2 million increase in the net unrealized gain at September 30, 2011 compared to December 31, 2010. In the past twelve months, we substantially reduced our short-term investments, and re-invested the funds in long-term fixed income securities, in order to maximize our investment return.

The methodologies used to determine the fair value of our investments are described in Note 2, “Fair Value Measurements”, to the Consolidated Financial Statements. At September 30, 2011, the net unrealized gain on our available for sale fixed income securities portfolio was $294.9 million, compared to $194.0 million at June 30, 2011 and $134.6 million at December 31, 2010. The change in the net unrealized gain or loss, net of the related income tax effect, is recorded in other comprehensive income. Our general policy has been to hold our available for sale fixed income securities through periods of fluctuating interest rates.

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 individual securities within our available for sale fixed income securities was $16.7 million at September 30, 2011 and $35.6 million at December 31, 2010. We evaluate the securities in our fixed income securities portfolio for possible other-than-temporary impairment losses at each quarter end. We recognized $3.5 million of other-than-temporary impairment credit losses in the first nine months of 2011, and $0.3 million in the same period of 2010. For additional disclosures about these credit losses and a description of the accounting polices and procedures that we use to determine our other-than-temporary impairment losses, see Note 3, “Investments” to the 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, 2010.

At September 30, 2011, we held $1.8 billion of special purpose revenue bonds, as well as $1.1 billion of general obligation bonds, which are issued by states, municipalities and political subdivisions and collectively referred to, in the investment market, as municipal bonds. The overall rating of our municipal bonds was AA+ at September 30, 2011. Within our municipal bond portfolio, we held $226.1 million of pre-refunded bonds, which are supported by U.S. government debt obligations. Our special purpose revenue bonds are secured by revenue sources specific to each security. At September 30, 2011, the percentages of our special purpose revenue bond portfolio supported by these major revenue sources were as follows: 1) water and sewer — 24%, 2) education — 21%, 3) transportation — 19% and pre-refunded bonds — 6%.

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, 2011. Although recent economic conditions in the United States may reduce the sources of revenue to support certain of these securities, the majority are supported by revenue from essential sources, as indicated above, which we believe generate a stable source of revenue.

At September 30, 2011, we held a commercial MBS securities portfolio with a fair value of $249.1 million, an average rating of AA+ and an average loan-to-value ratio of 70%. We owned no collateralized debt obligations (CDOs) or collateralized loan obligations (CLOs), and we are not counterparty to any credit default swap transactions.

At September 30, 2011, we held $168.6 million of fixed income securities that we designated as held to maturity. We maintain these securities, which are denominated in currencies other than the functional currency of the investing subsidiary, to hedge the currency conversion risk associated with insurance claims that we will pay in these same currencies. Effective in 2011, we discontinued designating new investment purchases as held to maturity securities and plan to designate future investment purchases as available for sale securities. Any unrealized currency conversion gains and losses on available for sale securities must be recorded in other comprehensive income within shareholders’ equity, rather than in net earnings. The pretax income statement benefit related to this change in our investment management philosophy approximated $2.5 million in the first nine months of 2011. This change will create greater volatility in our currency conversion benefit or expense in future periods. All currency conversion benefit or expense, except for the conversion gains and losses on available for sale securities, is recorded in Corporate & Other beginning in 2011.

Realized gains and losses from sales of securities are usually minimal, unless we sell securities for investee credit-related reasons, or because we can reinvest the proceeds at a higher effective yield. We recognized $3.2 million of net realized investment gains in the first nine months of 2011, compared to $7.9 million of net gain in the same period of 2010.

Corporate & Other

The following table summarizes Corporate & Other activity.


	Nine months ended September 30,						Three months ended September 30,
	2011			2010			2011			2010
Net earned premium	$	203		$	1,225		$	45		$	70
Other revenue		(506	)		987			(590	)		129

Total revenue		(303	)		2,212			(545	)		199


Loss and loss adjustment expense		(1,044	)		3,611			(784	)		(349	)
Other expense — Exited Lines		3,285			3,124			1,183			1,049
Other expense — Corporate		37,000			35,152			13,802			11,909
Interest expense		16,181			15,376			5,447			5,116

Total expense		55,422			57,263			19,648			17,725

Pretax loss	$	(55,725	)	$	(55,051	)	$	(20,193	)	$	(17,526	)

Our Corporate expenses not allocable to the segments increased $1.8 million year-over-year, primarily due to higher information technology costs related to implementation of a new company-wide financial reporting system and higher employee benefit costs, partially offset by a $2.5 million currency conversion benefit in the first nine months of 2011. Interest expense increased due to accelerated recognition of capitalized debt issuance costs in the first quarter of 2011 related to our previous Revolving Loan Facility, which we replaced in March 2011 (see further discussion below).

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 $291.1 million of unrestricted cash and liquid short-term investments at September 30, 2011.

	•		Our available for sale bond portfolio, of which $113.3 million was held directly by the parent company, had a fair value of $5.7 billion at September 30, 2011, compared to $5.0 billion at December 31, 2010. We intend to hold these securities until their maturity, but we would be able to sell securities to generate cash if the need arises.

	•		In March 2011, we replaced our $575.0 million Revolving Loan Facility with a four-year $600.0 million Revolving Loan Facility that matures on March 8, 2015, of which $392.2 million of borrowing capacity remained at September 30, 2011.

	•		Our long-term 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 13.1% at September 30, 2011 and 8.3% December 31, 2010, with the increase related to our borrowings under the Revolving Loan Facility.

	•		We have a $90.0 million Standby Letter of Credit Facility that expires on December 31, 2014, which is used to guarantee our performance in two Lloyd’s of London syndicates.

	•		Our domestic insurance subsidiaries have the ability to pay $183.6 million in dividends to the parent company in the fourth quarter of 2011 without obtaining special permission from state regulatory authorities. Our underwriting agencies have no restrictions on the amount of dividends that can be paid. HCC can utilize these dividends for any purpose, including to pay down debt, pay dividends to shareholders, fund acquisitions, purchase our common stock and pay operating expenses.

	•		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.

Capital Management

Revolving Loan Facility

On March 8, 2011, we entered into a new agreement for a four-year $600.0 million Revolving Loan Facility (Facility). The Facility replaced our $575.0 million Revolving Loan Facility, which was due to expire on December 19, 2011. The Facility allows us to borrow up to the maximum allowed on a revolving basis until the Facility expires on March 8, 2015. As of September 30, 2011, we had borrowed $195.0 million under the Facility, primarily to fund repurchases of our common stock. The borrowing rate is LIBOR plus 137.5 basis points, subject to increase or decrease based on changes in our debt rating. The contractual interest rate on borrowings under the Facility at September 30, 2011 was 1.63%. In addition, we pay a commitment fee of 20 basis points. Letters of credit issued under the Facility further reduced our available borrowing capacity on the remaining Facility to $392.2 million at September 30, 2011. The Facility contains restrictive financial covenants that require HCC to maintain a minimum consolidated net worth (excluding accumulated other comprehensive income) and a leverage ratio of less than or equal to 35%. We were in compliance with these covenants at September 30, 2011.

Senior Notes

In 2009, we issued $300.0 million of 6.30% Senior Notes due 2019. The Senior Notes were priced at a discount of $1.5 million, for an effective interest rate of 6.37%. We pay interest semi-annually in arrears on May 15 and November 15 of each year. The Senior Notes may be redeemed in whole at any time or in part from time to time, at our option, at the redemption price determined in the manner described in the indenture governing the Senior Notes. The indenture contains restrictive covenants that impose conditions on our ability to create liens on any capital stock of our restricted subsidiaries (as defined in the indenture) or to engage in sales of the capital stock of our restricted subsidiaries. We were in compliance with the requirements of these covenants at September 30, 2011.

Standby Letter of Credit Facility

In 2010, we entered into a $90.0 million Standby Letter of Credit Facility (Standby Facility) that is used to guarantee our performance in two Lloyds’s of London syndicates. The Standby Facility expires on December 31, 2014. We pay an annual fee of 90 basis points. The Standby Facility contains restrictive financial covenants that require HCC to maintain a minimum consolidated net worth (excluding accumulated other comprehensive income) and a leverage ratio of less than or equal to 35%. We were in compliance with these covenants at September 30, 2011.

Share Repurchases

On March 10, 2011, the Board approved the purchase of up to $300.0 million of our common stock. This plan was exhausted in September and, on September 23, 2011, the Board approved purchases of an additional $300.0 million (the Plan). Purchases may be made in the open market or in privately negotiated transactions from time-to-time in compliance with applicable laws, rules and regulations, including Rule 10b-18 under the Securities Exchange Act of 1934, as amended. Purchases under the Plan will be made opportunistically from time-to-time, subject to market and business conditions, the level of cash generated from our operations, cash required for acquisitions, our debt covenant compliance, and other relevant factors. The Plan does not obligate us to purchase any particular number of shares, has no expiration date, and may be suspended or discontinued at any time at the Board’s discretion. In the third quarter of 2011, we purchased $106.2 million, or 3.8 million shares, at an average cost of $27.73 per share, of which $7.8 million, or 0.3 million shares, were purchased under the Plan. We purchased $307.8 million, or 10.2 million shares, at an average cost of $30.25 in the first nine months of 2011.

Earnouts

We acquired HCC Global Financial Products (HCC Global), which underwrites our U.S. and International directors’ and officers’ liability business, in 2002. The purchase agreement, as amended, includes a contingency for future earnout payments. The earnout is based on HCC Global’s pretax earnings from the acquisition date through September 30, 2007, with no maximum amount due to the former owners. When conditions specified under the purchase agreement are met, we record a net amount owed to or due from the former owners based on our estimate, at that point in time, of how claims will ultimately be settled. This net amount will fluctuate in the future, and the ultimate total net earnout payments cannot be finally determined until all claims are settled or paid. In March 2011, certain amendments were made to the purchase agreement, which resulted in an adjustment to our estimate of the ultimate amounts to be settled under the agreement. As a result, we increased goodwill by $20.0 million as of March 31, 2011. In September, 2011, we increased goodwill by $31.3 million for additional earnout earned and accrued in the quarter related to favorable loss development in the U.S. D&O and International D&O lines of business.

Cash Flow

We receive substantial cash from premiums, reinsurance recoverables, surety collateral, 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, return of surety collateral, 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 premium receivables, reinsurance recoverables and surety collateral; the payment of losses, premium payables and return of surety collateral; and the completion of commutations.

We generated cash from operations of $288.0 million and $314.6 million in the first nine months of 2011 and 2010, respectively. The components of our net operating cash flows are summarized in the following table.


	Nine months ended September 30,
	2011			2010
Net earnings	$	176,905		$	247,797
Change in premium, claims and other receivables, net of reinsurance, premium and claims payables and excluding restricted cash		(110,979	)		(24,539	)
Change in unearned premium, net		72,132			15,103
Change in loss and loss adjustment expense payable, net of reinsurance recoverables		139,536			44,355
(Gain) loss on investments		310			(8,086	)
Other, net		10,055			40,001

Cash provided by operating activities	$	287,959		$	314,631

Cash provided by operating activities was lower in 2011 than in 2010 primarily due to higher claims payments, activity related to surety collateral funds, and inward commutations completed in 2011. We paid $26.5 million more claims in 2011 compared to 2010, of which $20.2 million related to the 2011 catastrophic events, and had a $4.2 million net outflow of surety collateral funds. In 2011, we also paid $37.8 million to commute certain loss reserves in our Exited lines, which reduced our 2011 operating cash flow.

Recent Accounting Guidance

See Note 1, “General Information” to the Consolidated Financial Statements for a description of recently issued accounting guidance that will impact our consolidated financial statements in future periods.

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, 2010. We have made no changes in the identification or methods of application of these policies.

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, 2010.

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, 2011. Based on this evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective as of September 30, 2011.

(b) Changes in Internal Control over Financial Reporting

During the third quarter of 2011, we identified no changes in our internal control over financial reporting that occurred during the quarter ended September 30, 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Part II — Other Information

Item 1. Legal Proceedings

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, 2010.

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

On September 23, 2011, the Board approved the purchase of up to an aggregate of $300.0 million of our common stock (the Plan). This new authorization follows the completion of a $300.0 million share repurchase program approved on March 10, 2011. Purchases under the Plan may be made in the open market or in privately negotiated transactions from time-to-time in compliance with applicable laws, rules and regulations, including Rule 10b-18 under the Securities Exchange Act of 1934, as amended. Purchases will be made opportunistically from time to, subject to market and business conditions, the level of cash generated from our operations, cash required for acquisitions, our debt covenant compliance, and other relevant factors. The Plan does not obligate us to purchase any particular number of shares, has no expiration date, and may be suspended or discontinued at any time at the Board’s discretion.

During the third quarter of 2011, 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
March 2011 Plan
July 1 - July 31, 2011		314,379	$	30.96		314,379	$	88,619,230
August 1 - August 31, 2011		3,227,237	$	27.46		3,227,237	$	36
September 1 - September 30, 2011		—		—		—		—

September 2011 Plan
September 1 - September 30, 2011		287,711	$	27.23		287,711	$	292,166,062

Item 3. Defaults Upon Senior Securities

None.

Item 4. [Removed and Reserved]

Item 5. Other Information

None.

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 Secretary of State of Delaware on July 23, 1996 and May 21, 1998, respectively (incorporated by reference to Exhibit 4.1 to the Company’s Registration Statement on Form S-8 (Registration No. 333-61687) filed on August 17, 1998).

3.2		Amended and Restated Bylaws of HCC Insurance Holdings, Inc. (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on April 3, 2008).

4.1		Indenture, dated August 23, 2001, between HCC Insurance Holdings, Inc. and First Union National Bank related to Debt Securities (incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on August 24, 2001).

4.2		Form of Fourth Supplemental Indenture, dated November 16, 2009, between HCC Insurance Holdings, Inc. and U.S. Bank National Association related to the 6.30% Senior Notes due 2019 (incorporated by reference to Exhibit 4.2 to the Company’s Current Report on Form 8-K filed on November 13, 2009).

10.1		Separation Agreement, dated September 13, 2011, between HCC Insurance Holdings, Inc. and W. Tobin Whamond (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on September 13, 2011).

10.2		First Amendment to Loan Agreement, dated September 22, 2011, among HCC Insurance Holdings, Inc., Wells Fargo Bank, National Association, as Administrative Agent, Barclays Bank PLC and Bank of America, N.A., as Co-Syndication Agents, JPMorgan Chase Bank, N.A. and The Royal Bank of Scotland PLC, as Co-Documentation Agents, and the other lenders party thereto (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on September 28, 2011).

12		Statement of Ratios

31.1		Certification by Chief Executive Officer.

31.2		Certification by Chief Financial Officer.

32		Certification with Respect to Quarterly Report.

101		The following financial statements from our Quarterly Report on Form 10-Q for the quarter ended Septmeber 30, 2011, formatted in XBRL: (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Earnings, (iii) Consolidated Statement of Changes in Shareholders’ Equity, (iv) Consolidated Statements of Cash Flows and (v) Notes to 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.


	Page
Part I. FINANCIAL INFORMATION

Item 1. Financial Statements

Consolidated Balance Sheets — September 30, 2011 and December 31, 2010		5

Consolidated Statements of Earnings — Nine months and three months ended September 30, 2011 and 2010		6

Consolidated Statement of Changes in Shareholders’ Equity — Nine months ended September 30, 2011		7

Consolidated Statements of Cash Flows — Nine months ended September 30, 2011 and 2010		8

Notes to Consolidated Financial Statements		9

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		24

Item 3. Quantitative and Qualitative Disclosures About Market Risk		42

Item 4. Controls and Procedures		42


Part II. OTHER INFORMATION

Item 1. Legal Proceedings		43

Item 1A. Risk Factors		43

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		43

Item 3. Defaults Upon Senior Securities		43

Item 4. [Removed and Reserved]		43

Item 5. Other Information		43

Item 6. Exhibits		44

Signatures		45
EX-12
EX-31.1
EX-31.2
EX-32
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


				HCC Insurance Holdings, Inc.
				(Registrant)

November 7, 2011				/s/ John N. Molbeck, Jr.
(Date)				John N. Molbeck, Jr.,
				Chief Executive Officer

November 7, 2011				/s/ Pamela J. Penny
(Date)				Pamela J. Penny, Executive Vice President
				and Chief Accounting Officer