HCC INSURANCE HOLDINGS INC/DE/ - 10-Q Quarterly Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q

[X] Quarterly Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, for the Quarter Ended September 30,
2002.

[ ] Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 from _______ to __________

Commission file number 0-20766
----------------------------------------------------

HCC Insurance Holdings, Inc.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)

Delaware 76-0336636
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(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)

13403 Northwest Freeway, Houston, Texas 77040-6094
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(Address of principal executive offices) (Zip Code)

(713) 690-7300
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(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 X No
----- -----

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

On October 31, 2002, there were 62.3 million shares of common stock, $1.00 par
value issued and outstanding.

HCC INSURANCE HOLDINGS, INC.
INDEX

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 future capital expenditures, business strategy,
competitive strengths, goals, growth of our business and operations, plans 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 impact the matters
addressed in these forward-looking statements.

Many possible events or factors could affect our future financial results and
performance. These 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 which
are included in this report, our inclusion of this information is not a
representation by us or any other person that our objectives and plans will be
achieved.

Our forward-looking statements speak only as of 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.

2

HCC Insurance Holdings, Inc. and Subsidiaries

---------

Condensed Consolidated Balance Sheets

(unaudited, in thousands)

--------

See Notes to Condensed Consolidated Financial Statements.

3

HCC Insurance Holdings, Inc. and Subsidiaries

--------

Condensed Consolidated Statements of Earnings

(unaudited, in thousands, except per share data)

--------

See Notes to Condensed Consolidated Financial Statements.

4

HCC Insurance Holdings, Inc. and Subsidiaries
Condensed Consolidated Statements of Changes in Shareholders' Equity
For the nine months ended September 30, 2002
and for the year ended December 31, 2001

(unaudited, in thousands, except per share data)

--------

See Notes to Condensed Consolidated Financial Statements.

5

HCC Insurance Holdings, Inc. and Subsidiaries
Condensed Consolidated Statements of Changes in Shareholders' Equity
For the nine months ended September 30, 2002
and for the year ended December 31, 2001

(unaudited, in thousands, except per share data)

(continued)

------

See Notes to Condensed Consolidated Financial Statements.

6

HCC Insurance Holdings, Inc. and Subsidiaries

---------

Condensed Consolidated Statements of Cash Flows

(unaudited, in thousands)

See Notes to Condensed Consolidated Financial Statements

7

HCC Insurance Holdings, Inc. and Subsidiaries

---------

Notes to Condensed Consolidated Financial Statements

(unaudited, in thousands)

---------

(1) GENERAL INFORMATION

HCC Insurance Holdings, Inc. and its subsidiaries ("we," "us" and "our")
provide specialized property and casualty and accident and health insurance
coverages, underwriting agency and intermediary services to commercial
customers and individuals. Our lines of business include group life,
accident and health; aviation; property, marine and energy; and other
specialty insurance and reinsurance. We operate primarily in the United
States and in the United Kingdom, although some of our operations have a
broader international scope. We underwrite insurance on both a direct
basis, where we insure a risk in exchange for a premium, and a reinsurance
basis, where we insure all or a portion of another insurance company's risk
in exchange for all or portion of the premium. We market our products both
directly to customers and through a network of independent and affiliated
agents and brokers.

Basis of Presentation

The unaudited condensed consolidated financial statements have been
prepared in conformity with accounting principles generally accepted in the
United States of America and include all adjustments which are, in our
opinion, necessary for a fair presentation of the results of the interim
periods. All adjustments made to the interim periods are of a normal
recurring nature. The condensed consolidated financial statements include
the accounts of HCC Insurance Holdings, Inc. and those of its wholly-owned
subsidiaries. All significant intercompany balances and transactions have
been eliminated. The condensed consolidated financial statements for
periods reported should be read in conjunction with the annual audited
consolidated financial statements and related notes. The condensed
consolidated balance sheet as of December 31, 2001, and the condensed
consolidated statement of changes in shareholders' equity for the year then
ended were derived from audited financial statements, but do not include
all disclosures required by accounting principles generally accepted in the
United States of America.

Income Tax

For the nine months ended September 30, 2002 and 2001, the income tax
provision has been calculated based on an estimated effective tax rate for
each of the fiscal years. The difference between our effective tax rate and
the Federal statutory rate is primarily the result of state income taxes,
tax exempt municipal bond interest and, in 2001, goodwill amortization.

Effects of Recent Accounting Pronouncements

Statement of Financial Accounting Standards ("SFAS") No. 142 entitled
"Goodwill and Other Intangible Assets" was issued in June, 2001, and became
effective for us on January 1, 2002. SFAS No. 142 requires goodwill to be
tested for impairment at a level referred to as a reporting unit. After the
initial adoption, goodwill of a reporting unit will be tested for
impairment on an annual basis and between annual tests if an event occurs
or circumstances change that would more likely than not reduce the fair
value of a reporting unit below its carrying amount. SFAS No. 142 also
requires the discontinuance of the amortization of

8

HCC Insurance Holdings, Inc. and Subsidiaries

---------

Notes to Condensed Consolidated Financial Statements

(unaudited, in thousands)

(continued)

(1) GENERAL INFORMATION, CONTINUED

goodwill effective January 1, 2002 and that goodwill recognized for
acquisitions which were consummated after July 1, 2001 not be amortized.
During the first six months of 2002, we determined our reporting units,
completed our initial goodwill impairment testing, completed our first
annual impairment testing as of June 30, 2002 and determined we did not
have to record an impairment charge. SFAS No. 142 is not expected to have a
material effect on our financial position or cash flows.

The tables below reconcile net earnings and earnings per share we reported
to adjusted amounts that we would have reported had we adopted SFAS No. 142
on January 1, 2001 instead of January 1, 2002:

9

HCC Insurance Holdings, Inc. and Subsidiaries

---------

Notes to Condensed Consolidated Financial Statements

(unaudited, in thousands)

(continued)

(1) GENERAL INFORMATION, CONTINUED

The following tables show the balances of our intangible assets, which are
included in other assets on our condensed consolidated balance sheets,
after our adoption of SFAS No. 142 effective January 1, 2002:

Intangible assets not subject to amortization --
insurance company and other licenses $ 6,792
============

Intangible assets subject to amortization:
Gross amounts recorded $ 10,231
Less accumulated amortization (722)
------------

NET INTANGIBLE ASSETS SUBJECT TO AMORTIZATION $ 9,509
============

Amortization of intangible assets which are subject to amortization under
SFAS No. 142 amounted to $2.5 million during the first nine months of 2002.
There was an insignificant amount of amortization for the same period of
2001, as substantially all of our intangible assets subject to amortization
were acquired in our October 2001 acquisitions. Estimated amortization
expense for 2002 and future years as of January 1, 2002 are as follows:

2002 $ 3,267
2003 2,294
2004 1,477
2005 972
2006 367
Thereafter 1,132
---------------

TOTAL $ 9,509
===============

SFAS No. 146 entitled " Accounting for Costs Associated with Exit or
Disposal Activities" was issued in July, 2002 and will become effective for
us on January 1, 2003. SFAS No. 146 will spread out the reporting of
expenses related to restructurings and is a change to existing guidance.
The commitment to a plan to exit an activity or dispose of long-lived
assets will no longer be enough to record a one-time charge for most
anticipated coats. Instead, companies will record exit or disposal costs
when they are incurred and can be measured at fair value and the liability
will be subsequently adjusted for changes in estimated cash flow. We do not
expect the adoption of SFAS No. 146 to have a material effect on our
financial position, results of operations or cash flows.

10

HCC Insurance Holdings, Inc. and Subsidiaries

---------

Notes to Condensed Consolidated Financial Statements

(unaudited, in thousands)

(continued)

(1) GENERAL INFORMATION, CONTINUED

Unusual Loss Events

During 2001, we experienced three significant gross losses. The first loss
was the September 11 terrorist attacks, which produced the largest loss to
our insurance company operations in our history. At that time we recorded
our initial estimates of gross and net incurred losses of $141.0 million
and $35.0 million, respectively. The other two losses were the Petrobras
and Total Oil Company incidents, which produced gross losses of $55.0
million and $49.0 million, respectively. Because these policies were
substantially reinsured, the net losses were not material to our results of
operations. Additionally, during 2002, as a result of further evaluation,
we reduced our gross losses from the September 11, terrorist attacks by
$21.5 million and reduced our gross losses from the Total loss by $14.0
million. The Petrobras loss was paid during 2001 and all reinsurance
recoverables were collected at that time. A substantial portion of the
Total Oil Company loss has been paid during 2002 and the related
reinsurance recoverables have been collected. We expect the remainder to be
settled during the fourth quarter of 2002.

During the first nine months of 2002 we recorded incurred losses in the
amount of $7.7 million related to certain business included in discontinued
lines. This business was acquired as part of our purchase of Centris in
1999 and was subsequently sold. The business was of the type that we have
not historically written.

Other Information

During September, 2001 we recorded several charges totaling $37.3 million
related to our primary workers' compensation line of business. Included in
this charge was $15.0 million related to the impairment of goodwill
associated with the primary workers' compensation line of business.

Reclassifications

Certain amounts in our 2001 condensed consolidated financial statements
have been reclassified to conform to the 2002 presentation. Such
reclassifications had no effect on our net earnings, shareholders' equity
or cash flows.

(2) STRATEGIC INVESTMENTS AND ACQUISITIONS

SureTec Financial Corp.

During September, 2002, we invested a total of $5.0 million in SureTec
Financial Corp. The investment consisted of a combination of a 23% equity
interest and a $2.5 million note receivable and will provide SureTec with
additional capital for its insurance company subsidiary, SureTec Insurance
Company. We will use the equity method of accounting for our equity
investment in SureTec. SureTec is a Houston based property and casualty
insurance holding company whose subsidiaries specialize in underwriting
contract surety and providing other related services to the construction
industry, primarily in Texas. Recently, A.M. Best Company assigned an
initial rating of A- (Excellent) to SureTec Insurance Company based upon
the expertise of SureTec's management and in anticipation of this
additional capital contribution.

11

HCC Insurance Holdings, Inc. and Subsidiaries

--------

Notes to Condensed Consolidated Financial Statements

(unaudited, in thousands)

(continued)

(2) STRATEGIC INVESTMENTS AND ACQUISITIONS, CONTINUED

MAG Global Financial Products, LLC

During October 2002, we completed the acquisition of all of the outstanding
shares of a specialty underwriting agency, MAG Global Financial Products,
LLC ("MAG"). This business combination will be recorded using the purchase
method of accounting. The agency is a leader in the directors and officers
liability line of business and was acquired to expand our agency operations
and provide us an entry into underwriting that line of business. It has a
profitable history, a market leadership position and a workforce with
significant expertise and reputation to justify any goodwill to be
recorded. The results of operations will be included in our consolidated
financial statements beginning on the effective date of the acquisition.

Total consideration paid in October was $6.2 million which approximates the
stockholders' equity of MAG based on generally accepted accounting
principles in the United States of America. Initial consideration will be
adjusted to actual stockholders' equity during the fourth quarter of 2002
after MAG's financial statements as of the acquisition date are finalized.
Additional payments to the sellers are due based on MAG's pre-tax earnings
from the acquisition date through September 30, 2007. Although the purchase
accounting for the acquisition has not been finalized, we do not expect
significant intangible assets to result from the acquisition. Any goodwill
ultimately recorded will be deductible for U.S. Federal income tax
purposes.

(3) REINSURANCE

In the normal course of business our insurance companies cede a portion of
their premium to non-affiliated domestic and foreign reinsurers through
treaty and facultative reinsurance agreements. Although the ceding of
reinsurance does not discharge the primary insurer from liability to its
policyholders, our insurance companies participate in such agreements for
the purpose of limiting their loss exposure, protecting them against
catastrophic loss and diversifying their business. The following table
represents the effect of such reinsurance transactions on premium and loss
and loss adjustment expense:

12

HCC Insurance Holdings, Inc. and Subsidiaries

--------

Notes to Condensed Consolidated Financial Statements

(unaudited, in thousands)

(continued)

(3) REINSURANCE, CONTINUED

13

HCC Insurance Holdings, Inc. and Subsidiaries

--------

Notes to Condensed Consolidated Financial Statements

(unaudited, in thousands)

(continued)

(3) REINSURANCE, CONTINUED

The table below represents the composition of reinsurance recoverables in
our condensed consolidated balance sheets:

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

14

HCC Insurance Holdings, Inc. and Subsidiaries

--------

Notes to Condensed Consolidated Financial Statements

(unaudited, in thousands)

(continued)

(3) REINSURANCE, CONTINUED

Our insurance companies require their reinsurers not authorized by the
respective states of domicile of our insurance companies to collateralize
the reinsurance obligations due to us. The table below shows amounts held
by us as collateral plus other credits available for potential offset.

We have a reserve of $9.6 million as of September 30, 2002 for potential
collectibility issues related to reinsurance recoverables and associated
expenses. The reserve for uncollectible reinsurance increased due to
provisions of $5.3 million and $1.6 million for the nine and three months,
respectively, ended September 30, 2002. The adverse economic environment in
the worldwide insurance industry in recent years and the terrorist attacks
on September 11, 2001 have placed great pressure on reinsurers and the
results of their operations. Ultimately, these conditions could affect
reinsurers' solvency. Historically, there have been insolvencies following
a period of competitive pricing in the industry, such as the marketplace
has experienced for the last several years. While we believe that our
overall reserve is adequate based on currently available information,
conditions may change or additional information might be obtained which may
result in a future change in the reserve. We periodically review our
financial exposure to the reinsurance market and the level of our reserve
and continue to take actions in an attempt to mitigate our risk.

A number of reinsurers have delayed or suspended the payment of amounts
recoverable under certain reinsurance contracts to which we are a party.
Such delays have affected, although not materially to date, the investment
income of our insurance companies, but not to any extent their liquidity.
We limit our liquidity exposure by holding funds, letters of credit or
other security such that net balances due to us are significantly less than
the gross balances shown in our consolidated balance sheets. In some
instances, the reinsurers have withheld payment without reference to a
substantive basis for the delay or suspension. In other cases, the
reinsurers have claimed they are not liable for payment to us of all or
part of the amounts due under the applicable reinsurance agreement. We
believe these claims are without merit and expect to collect a substantial
portion of the amounts recoverable. We are currently in negotiations with
most of these parties, but if such negotiations do not result in a
satisfactory resolution of the matters in question, we may seek or be
involved in a judicial or arbitral determination of these matters. In some
cases, the final resolution of such disputes through arbitration or
litigation may extend over several years.

15

HCC Insurance Holdings, Inc. and Subsidiaries

--------

Notes to Condensed Consolidated Financial Statements

(unaudited, in thousands)

(continued)

(3) REINSURANCE, CONTINUED

In this regard, as of September 30, 2002, our insurance companies had
initiated three litigation or arbitration proceedings against reinsurers
and were involved in one arbitration proceeding initiated by a reinsurer.
These proceedings primarily concern the collection of amounts owing under
reinsurance agreements. As of such date, our insurance companies had an
aggregate amount of $16.2 million which had not been paid to us under the
agreements and we estimate that there could be up to an additional $14.3
million of incurred losses and loss expenses and other balances due under
the subject agreements. During the nine months ended September 30, 2002, we
negotiated the settlement of two arbitrations with reinsurers under which
the reinsurers agreed to pay the full amounts due to us, which we estimate
to be $27.5 million in the aggregate. In addition, because our insurance
companies, principally Houston Casualty Company, participated in facilities
or pools of companies which were managed by one of our underwriting
agencies, they are indirectly involved in any proceedings involving
collections which affect the applicable facilities or pools of companies.
As of September 30, 2002, Houston Casualty Company's allocated portion of
these actions was $3.0 million and we estimate that there could be up to an
additional $2.4 million of incurred losses and loss expenses. Neither
Houston Casualty Company nor its affiliated underwriting agency has any net
exposure on the portion of the amounts which are due to the non-affiliated
companies who also participated in the applicable facilities or pool of
companies.

(4) SEGMENT AND GEOGRAPHIC INFORMATION

The performance of each segment is evaluated based upon net earnings and is
calculated after tax and after all corporate expense allocations, purchase
price allocations and intercompany eliminations have been charged or
credited to the individual segments. The following tables show information
by business segment and geographic location. Geographic location is
determined by physical location of our offices and does not represent the
location of insureds or reinsureds from whom the business was generated.

Effective January 1, 2001 and 2002, we consolidated the operations of three
and one of our underwriting agencies, respectively, into the operations of
our insurance companies. Policies incepting on or after the effective
dates, along with associated expenses, will be reported in the insurance
company segment. The administration of all policies incepting before the
effective dates, which are now in run off, along with associated expenses,
will continue to be reported in the underwriting agency segment. This
consolidation will affect the comparability of segment information between
periods.

SFAS No. 142, which we adopted effective January 1, 2002, required the
discontinuance of the amortization of goodwill and indefinite lived
intangible assets on a prospective basis. This will affect the
comparability of certain segment information between periods. Pro forma
segment information is shown in the tables for the nine and three months
ended September 30, 2001, as if we had adopted SFAS No. 142 as of January
1, 2001.

16

HCC Insurance Holdings, Inc. and Subsidiaries

--------

Notes to Condensed Consolidated Financial Statements

(unaudited, in thousands)

(continued)

(4) SEGMENT AND GEOGRAPHIC INFORMATION, CONTINUED

During the first nine months of 2002, the insurance company segment recorded a
charge of $5.0 million (net of income tax) related to a discontinued line of
business.

17

HCC Insurance Holdings, Inc. and Subsidiaries

--------

Notes to Condensed Consolidated Financial Statements

(unaudited, in thousands)

(continued)

(4) SEGMENT AND GEOGRAPHIC INFORMATION, CONTINUED

During the first nine months of 2001, the insurance company segment recorded
two large unusual items: 1) a $22.8 million (net of income tax) loss due to
the terrorist attacks on September 11 and 2) a $29.4 million charge (net of
income tax) related to lines of business being exited. Of the latter amount,
$15.0 million was an impairment of goodwill which was not deductible for
income tax purposes.

18

HCC Insurance Holdings, Inc. and Subsidiaries

--------

Notes to Condensed Consolidated Financial Statements

(unaudited, in thousands)

(continued)

(4) SEGMENT AND GEOGRAPHIC INFORMATION, CONTINUED

During the third quarter of 2002, the insurance company segment recorded a
charge of $5.0 million (net of income tax) related to a discontinued line of
business.

19

HCC Insurance Holdings, Inc. and Subsidiaries

--------

Notes to Condensed Consolidated Financial Statements

(unaudited, in thousands)

(continued)

(4) SEGMENT AND GEOGRAPHIC INFORMATION, CONTINUED

During the third quarter of 2001, the insurance company segment recorded two
large unusual items: 1) a $22.8 million (net of income tax) loss due to the
terrorist attacks on September 11 and 2) a $29.4 million charge (net of income
tax) related to lines of business being exited. Of the latter amount, $15.0
million was an impairment of goodwill which was not deductible for income tax
purposes.

20

HCC Insurance Holdings, Inc. and Subsidiaries

--------

Notes to Condensed Consolidated Financial Statements

(unaudited, in thousands)

(continued)

(4) SEGMENT AND GEOGRAPHIC INFORMATION, CONTINUED

The following tables present revenue by line of business within each
operating segment for the periods indicated:

Goodwill assigned to our operating segments after our adoption of SFAS No.
142 effective January 1, 2002 was as follows:

Insurance company $ 130,504
Underwriting agency 107,598
Intermediary 77,216
------------

TOTAL GOODWILL $ 315,318
============

21

HCC Insurance Holdings, Inc. and Subsidiaries

--------

Notes to Condensed Consolidated Financial Statements

(unaudited, in thousands)

(continued)

(5) EARNINGS PER SHARE

Basic earnings per share is based on the weighted average number of common
shares outstanding during the period divided into net earnings. Diluted
earnings per share is based on the weighted average number of common shares
outstanding plus the potential common shares outstanding during the period
divided into net earnings. Outstanding common stock options, when dilutive,
are considered to be potential common shares for the purpose of the diluted
calculation. The treasury stock method is used to calculate potential
common shares due to options. Contingent shares to be issued are included
in the earnings per share computation only when the underlying conditions
for issuance have been met.

The following table provides a reconciliation of the denominators used in
the earnings per share calculations:

22

HCC Insurance Holdings, Inc. and Subsidiaries

--------

Notes to Condensed Consolidated Financial Statements

(unaudited, in thousands)

(continued)

(6) SUPPLEMENTAL INFORMATION

Supplemental information is summarized below:

(7) NOTES PAYABLE

The table below shows the composition of our notes payable as shown in our
condensed consolidated balance sheet.

During April 2002, we drew down $40.0 million on our bank facility as
partial funding for a $50.0 million capital contribution to our largest
insurance company, Houston Casualty Company, to support its growth and
increased business opportunities. Since that time, we have repaid $10.0
million on our bank facility using funds generated from operating cash
flows. As of September 30, 2002, the weighted average interest rate on our
bank facility outstanding debt was 2.8%.

Under the terms of the related indenture agreement, our outstanding 2%
convertible notes could have been put, or sold back, to us on September 1,
2002 at the option of the note holders. On September 4, 2002, we paid
$49,000 in cash for the notes which were so tendered. Under the indenture
agreement, the next available date for the remaining noteholders to
exercise their put rights is September 1, 2004.

23

HCC Insurance Holdings, Inc. and Subsidiaries

--------

Notes to Condensed Consolidated Financial Statements

(unaudited, in thousands)

(continued)

(8) COMMITMENTS AND CONTINGENCIES

In addition to the matters discussed in Note (3), Reinsurance, we are party
to numerous lawsuits and other proceedings that arise in the normal course
of our business. Many of these lawsuits 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 party to lawsuits and other
proceedings which relate to disputes over contractual relationships with
third parties, or which involve alleged errors and omissions on the part of
our subsidiaries. In addition, we are presently engaged in litigation
initiated by the appointed liquidator of a former reinsurer concerning
payments made to us prior to the date of the appointment of the liquidator.
The disputed payments were made by the now insolvent reinsurer in
connection with a commutation agreement. Our understanding is that such
litigation is one of a number of similar actions brought by the liquidator.
We intend to vigorously contest the action. We believe the resolution of
the lawsuits in which we are a party will not have a material adverse
effect on our financial position, results of operations or cash flows.

24

MANAGEMENT'S DISCUSSION AND ANALYSIS

Statement of Financial Accounting Standards ("SFAS") No. 142 entitled "Goodwill
and Other Intangible Assets" became effective for us on January 1, 2002 and
required the discontinuance of the amortization of goodwill and indefinite lived
intangible assets on a prospective basis. This will affect the comparability of
financial results between periods. See "Effects of Recent Accounting
Pronouncements" for additional information.

NINE MONTHS ENDED SEPTEMBER 30, 2002 VERSUS NINE MONTHS ENDED SEPTEMBER 30, 2001

Results of Operations

Total revenue increased 29% to $483.3 million for the first nine months of 2002
from $373.3 million for the same period in 2001. The revenue increase in the
insurance company segment resulted from organic growth in our existing lines of
business, the addition of new specialty lines of business and increased
retention levels. The revenue in the underwriting agency segment increased due
to organic growth and two acquisitions made in late 2001, but was offset by
reduced revenue in the intermediary and other operations segments as a result of
market conditions and the sale or other disposition of various operations in
2001.

Net investment income decreased to $28.1 million for the first nine months of
2002 from $30.6 million for the same period in 2001. This decrease was due to
the decrease in interest rates partially offset by the higher level of invested
assets which resulted from cash flow provided by operating activities and
capital contributions made to our insurance company segment. Although we expect
investment assets to continue to increase, investment income is unlikely to show
much growth until interest rates rise.

Compensation expense increased to $58.7 million during the first nine months of
2002 from $51.1 million for the same period in 2001. Much of this increase was
due to the two underwriting agency subsidiaries acquired in late 2001, somewhat
offset by a decrease from operations sold or otherwise disposed of during the
same period.

The first nine months of 2001 were adversely affected as we experienced the
largest loss to our insurance company operations in our history due to the
terrorist attack on September 11, with incurred net losses of $35.0 million. In
2001, we also recorded a charge totaling $37.3 million related to our primary
workers' compensation line of business and other lines that we had decided to
cease writing. Included in this charge was $15.0 million related to the
impairment of goodwill associated with the primary workers' compensation line of
business.

Other operating expense decreased to $36.6 million during the first nine months
of 2002 compared to the $55.3 million for the same period in 2001. As compared
to the prior period, current expense increased as a result of the two
acquisitions made in 2001 and the increase in the provision for uncollectible
reinsurance, offset by the reduction in the amortization of goodwill, operations
sold or disposed of and the charge for lines of business being exited in 2001.

Interest expense was $6.9 million for the first nine months of 2002 compared to
$6.6 million for the same period in 2001. Included in the current period is $2.9
million representing the amortization of underwriting discounts and other costs
of our August 2001 issuance of 2% convertible notes. These costs were fully
amortized by the end of August 2002.

Income tax expense was $41.0 million for the first nine months of 2002 compared
to $16.1 million for the same period in 2001. Our effective tax rate was 35.6%
in the current period. The unusual tax rate for 2001 results from the write off
related to the impairment of goodwill, which was not deductible for income tax
purposes.

Net earnings increased to $74.3 million, or $1.18 per diluted share, for the
first nine months of 2002 from $6.4 million, or $0.11 per diluted share, for the
same period in 2001. The increase in net earnings resulted from increased
revenue and an improved underwriting performance by the insurance company
segment, net of a charge in 2002 related to a discontinued line of business
($5.0 million or $0.08 per share). Other events affecting the comparison include
losses from the September 11 terrorist attacks recorded during 2001 ($22.8
million or $0.39 per share), the charge for lines of business being

25

exited during 2001 ($29.6 million or $0.50 per share) and from the
non-amortization of goodwill in accordance with SFAS No. 142 ($8.8 million or
$0.15 per share).

Our book value per share was $13.72 as of September 30, 2002, up from $12.40 as
of December 31, 2001. Net earnings and the unrealized gain on available for sale
securities contributed to the increase in book value per share.

SEGMENTS

Insurance Companies

The following tables provide information by line of business (in thousands):

26

Gross written premium increased 11% to $852.1 million for the first nine months
of 2002 from $766.6 million for the same period in 2001. This increase was 23%
before the reduction due to discontinued lines of business. The increase
resulted from organic growth and premium rate increases in our aviation and
property, marine and energy lines of business, plus other specialty lines of
business not previously written, offset by the decrease in discontinued lines.
Gross written premium is expected to continue to increase into 2003.

Net written premium for the first nine months of 2002 increased 48% to $402.2
million from $271.3 million for the same period in 2001, as our insurance
companies have increased retentions on the group life, accident and health and
the property, marine and energy segments, in addition to the effect of the
changes in gross premium described above. Net earned premium also increased 45%
to $362.4 million for the same reasons. Increases in net written and net earned
premiums were 65% and 51%, respectively, before the reduction in discontinued
lines of business. Increases in net written and net earned premium are expected
to continue.

Loss and loss adjustment expense was $221.2 million for the first nine months of
2002 compared to $216.1 million for the same period in 2001. The 2001 net loss
expense included $35.0 million from the September 11 terrorist attacks and $18.8
million from the charge for lines of business being exited. Prior year net
reserve redundancies included in loss and loss adjustment expense approximated
$4.1 million and $6.9 million for the first nine months of 2002 and 2001,
respectively. The redundancies resulted from the settlement of claims for less
than amounts previously reserved. Because of these items, and generally better
underwriting results in 2002 as a result of higher pricing and improved policy
terms and conditions, the net loss ratio was greatly improved at 61.1% for the
first nine months of 2002 compared to 86.8% for the same period in 2001, on
substantially increased earned premiums. During the first nine months of 2002 we
also recorded incurred losses in the amount of $7.7 million related to certain
business included in discontinued lines. This business was acquired as part of
our purchase of Centris in 1999 and was subsequently sold. The business was of a
type that we have not historically written. Based on our current evaluations, we
do not expect any further development from this business in future periods. The
gross loss ratio was 61.5% in the first nine months of 2002 compared to 112.7%
for the same period in 2001. During the first nine months of 2001, we recorded
gross losses of $55.0 million due to the Petrobras production platform, $141.0
million due to the September 11 terrorist attacks and $49.0 million due to the
Total Oil Company loss. Additionally, in 2002, as a result of further
evaluation, we reduced our gross losses from the September 11 terrorist attacks
by $21.5 million and reduced the gross losses from the Total loss by $14.0
million.

27

The tables below show the composition of net and gross incurred loss and loss
adjustment expense (amounts in thousands):

Policy acquisition costs, which are net of commissions on reinsurance ceded,
increased to $44.5 million during the first nine months of 2002, from $21.5
million in the same period in 2001. This increase is due to the higher earned
premium and the reduction in ceding commissions as a result of our retaining
more business. The expense ratio was unchanged at 26.2% for the first nine
months of 2002 compared to the same period in 2001. Because of our improved loss
ratio, our combined ratio improved substantially to 87.3% for the first nine
months of 2002, compared to 113.0% for the same period in 2001.

Net earnings of our insurance companies increased to $48.0 million in the first
nine months of 2002 from a net loss of $21.4 million for the same period in
2001, due to increased revenue, improved underwriting results and the charge to
exit primary workers' compensation and other lines in 2001. Barring future
catastrophic events, we expect this trend to continue into 2003. Only $1.6
million of the increase was due to the adoption of SFAS No. 142.

Underwriting Agencies

Management fees increased 31% to $57.1 million for the first nine months of
2002, compared to $43.7 million for the same period in 2001. The underwriting
agencies acquired in late 2001 accounted for much of the increase, partially
offset by a decrease in management fees from our other underwriting agencies as
we continued the consolidation of other pre-existing underwriting agency
operations into our insurance companies. Net earnings of our underwriting
agencies increased to $17.6 million for the first nine months of 2002 from $13.0
million in 2001 as a result of increased revenue and the adoption of SFAS No.
142. There was $4.5 million (net of income tax) of goodwill amortization
recorded in 2001. We expect further improvement in 2003 due to our recent
acquisition of MAG Global Financial Products, LLC during the fourth quarter of
2002 and organic growth.

Intermediaries

Commission income decreased to $31.6 million for the first nine months of 2002,
compared to $34.3 million for the same period in 2001 due to general market
conditions and less ceded reinsurance being placed on behalf of our insurance
companies as they increased their retentions. Net earnings of our intermediaries
increased to $7.1 million for the first nine months of 2002 compared to $6.2
million for the same period in 2001 due to the

28

adoption of SFAS No. 142. There was $2.6 million (net of income tax) of goodwill
amortization recorded in 2001.

Other Operations

The decrease in other operating income to $2.9 million during the first nine
months of 2002 from $15.8 million for the same period in 2001 was principally
from the disposition or closure of certain operations during 2001 and the
resultant gains totaling $8.2 million from these dispositions. Net earnings of
other operations decreased to $0.8 million in 2002 from $6.7 million in 2001 for
the same reasons. Period to period comparisons may vary substantially depending
on other operating investments or dispositions thereof in any given period.
Recent investments and future dispositions should have a positive effect on this
segment's revenue and earnings in future periods.

Corporate

The net income of the corporate segment was $1.3 million for the first nine
months of 2002 compared to $0.8 million for the same period in 2001. This
improvement resulted from the reduction of interest expense allocated to the
corporate segment.

THREE MONTHS ENDED SEPTEMBER 30, 2002 VERSUS THREE MONTHS ENDED SEPTEMBER 30,
2001

Results of Operations

Total revenue increased 28% to $175.7 million for the third quarter of 2002 from
$137.6 million for the same period in 2001. The revenue increase in the
insurance company segment resulted from organic growth in our existing lines of
business, the addition of new specialty lines of business, and increased
retention levels. Also, the revenue in the underwriting agency segment increased
due to organic growth and two acquisitions made in late 2001, but was offset by
reduced revenue in the other operations segment as a result of the sale or other
disposition of various operations in 2001.

Net investment income for the third quarter of 2002 was flat at $9.9 million
compared to $10.1 million for the same period in 2001. The lack of growth was
due to the decrease in interest rates partially offset by the higher level of
invested assets which resulted from cash flow provided by operating activities
and capital contributions made to our insurance company segment. Although we
expect investment assets to continue to increase, investment income is unlikely
to show much growth until interest rates rise.

Compensation expense increased to $19.2 million during the third quarter of 2002
from $15.7 million for the same period in 2001. Much of this increase was due to
the two underwriting agency subsidiaries acquired in late 2001, somewhat offset
by a decrease from operations sold or otherwise disposed of during the same
period.

The third quarter of 2001 was adversely affected as we experienced the largest
loss to our insurance company operations in our history due to the terrorist
attack on September 11, with incurred net losses of $35.0 million. In 2001, we
also recorded a charge totaling $37.3 million related to our primary workers'
compensation line of business and other lines that we had decided to cease
writing. Included in this charge was $15.0 million related to the impairment of
goodwill associated with the primary workers' compensation line of business.

Other operating expense decreased to $12.6 million during the third quarter of
2002 compared to $27.8 million in 2001. As compared to the prior period, current
expense increased as a result of the two acquisitions made in 2001 and the
increase in the provision for uncollectible reinsurance, offset by the reduction
in the amortization of goodwill, operations sold or disposed of and the charge
for lines of business being exited in 2001.

Interest expense was $2.1 million for the third quarter of 2002 compared to $1.5
million for the same period in 2001. Included in the current period is $0.7
million representing the amortization of underwriting discounts and other costs
of our August 2001 issuance of 2% convertible notes. These costs were fully
amortized by the end of August 2002.

29

Income tax expense was $13.5 million for the third quarter of 2002 compared to a
$6.7 million tax benefit for the same period in 2001. Our effective tax rate was
35.7% in the current period. The unusual tax rate for 2001 results from the
impairment of goodwill, which was not deductible for income tax purposes.

Net earnings increased to $24.3 million, or $0.39 per diluted share, for the
third quarter of 2002 from a loss of $29.1 million, or $0.49 per diluted share,
for the same period in 2001. The increase in net earnings resulted from
increased revenue and an improved underwriting performance by the insurance
company segment, net of a charge in 2002 related to a discontinued line of
business ($5.0 million or $0.08 per share). Other events affecting the
comparison include losses from the September 11 terrorist attacks during 2001
($22.8 million or $0.39 per share), the charge for lines of business being
exited during 2001 ($29.6 million or $0.50 per share) and from the
non-amortization of goodwill in accordance with SFAS No. 142 ($3.1 million or
$0.05 per share).

Our book value per share was $13.72 as of September 30, 2002, up from $13.21 as
of June 30, 2002. Net earnings and unrealized gain on available for sale
securities contributed to the increase in book value per share.

SEGMENTS

Insurance Companies

The following tables provide information by line of business (in thousands):

Gross written premium increased 23% to $298.5 million for the third quarter of
2002 from $242.9 million for the same period in 2001. This increase was 37%
before the reduction due to discontinued lines of business. The net increase
resulted from organic growth and premium rate increases on all lines of business
except for other specialty lines, which we had not previously written, and
offset by the decrease in discontinued lines. Gross written premium is expected
to continue to increase into 2003.

Net written premium for the third quarter of 2002 increased 55% to $144.6
million from $93.2 million for the same period in 2001, as our insurance
companies have increased retentions on the group life, accident and health and
the property, marine and energy segments, in addition to the effect of the
changes in gross premium described above. Net earned premium increased 46% to
$136.3 million for the same reasons. Increases in net written and net earned
premiums were 80% and 57%, respectively, before the reduction in discontinued
lines of business. Increases in net written and net earned premium are expected
to continue.

Loss and loss adjustment expense was $85.2 million for the third quarter of 2002
compared to $119.2 million for the same period in 2001. The 2001 net loss
expense includes $35.0 million from the September 11 terrorist attacks and $18.8
million from the charge for lines of business being exited. Prior year net
reserve redundancies included in loss and loss adjustment expense approximated
$2.2 million and $2.8 million for the third quarters of 2002 and 2001,
respectively. The redundancies resulted from the settlement of claims for less
than amounts previously reserved. Because of these items, and generally better
underwriting results in 2002 as a result of higher pricing and improved policy
terms and conditions, the net loss ratio was greatly improved at 62.5% for the
third quarter of 2002 from 127.5% for the same period in 2001, on substantially
increased earned premiums. During the third quarter of 2002 we also recorded
incurred losses in the amount of $7.7 million related to certain business
included in discontinued lines. This business was written by an insurance
company which was acquired as part of our purchase of Centris in 1999 and was
subsequently sold. The business was of a type that we have not historically
written. Based on our current evaluations, we do not expect any further
development from this business in future periods. The gross loss ratio was 64.1%
in the third quarter of 2002 compared to 167.5% for the same period in 2001.
During the third quarter of 2001, we recorded gross losses of $141.0 million due
to the September 11 terrorist attacks and $49.0 million due to the Total Oil
Company loss. Additionally, in 2002, as a result of further evaluation, we
reduced the gross losses from the Total loss by $14.0 million.

31

The tables below show the composition of net and gross incurred loss and loss
adjustment expense (amounts in thousands):

Policy acquisition costs, which are net of commissions on reinsurance ceded,
increased to $19.0 million during the third quarter of 2002, from $9.3 million
in the same period in 2001. This increase is due to the higher earned premium
and the reduction in ceding commissions on business as a result of our retaining
more business. The expense ratio was 27.1% for the third quarter of 2002
compared to 24.7% for the same period in 2001. The increase in the expense ratio
was caused by the increase in policy acquisition costs. However, because of our
improved loss ratio, our combined ratio improved substantially to 89.6% for the
third quarter of 2002, compared to 152.2% for the same period in 2001.

Net earnings of our insurance companies increased to $15.0 million in the third
quarter of 2002 from a net loss of $41.7 million for the same period in 2001,
due to increased revenue and improved underwriting results. Barring future
catastrophic events, we expect continued improvement into 2003. Only $0.5
million of the increase was due to the adoption of SFAS No. 142.

Underwriting Agencies

Management fees increased 29% to $18.1 million for the third quarter of 2002,
compared to $14.0 million for the same period in 2001. The underwriting agencies
acquired in late 2001 accounted for much of the increase, partially offset by a
decrease in management fees from our other underwriting agencies as we continued
the consolidation of other pre-existing underwriting agency operations into our
insurance companies. Net earnings of our underwriting agencies increased to $5.9
million in the third quarter of 2002 from $4.2 million in 2001 as a result of
increased revenue and the adoption of SFAS No. 142. There was $1.6 million (net
of income tax) of goodwill amortization recorded in 2001. We expect further
improvement in 2003 due to our recent acquisition of MAG Global Financial
Products, LLC during the fourth quarter of 2002 and organic growth.

32

Intermediaries

Commission income increased to $10.4 million for the third quarter of 2002,
compared to $9.5 million for the same period in 2001, despite poor market
conditions and less ceded reinsurance being placed on behalf of our insurance
companies as they increased their retentions. Net earnings of our intermediaries
increased to $2.9 million for the third quarter of 2002 compared to $2.0 million
for the same period of 2001, primarily due to the adoption of SFAS No. 142.
There was $0.9 million (net of income tax) of goodwill amortization recorded in
2001.

Other Operations

The decrease in other operating income to $1.0 million during the third quarter
of 2002 from $10.4 million for the same period in 2001 was principally from the
disposition or closure of certain operations during 2001 and the resultant gains
totaling $8.2 million from these dispositions. Net earnings of other operations
decreased to $0.5 million in 2002 from $5.9 million in 2001 for the same
reasons. Quarter to quarter comparisons may vary substantially depending on
other operating investments or dispositions thereof in any given period. Recent
investments and future dispositions should have a positive effect on this
segment's revenue and earnings in future periods.

Corporate

The net income of the corporate segment was less than $0.1 million for the third
quarter of 2002 compared to net income of $0.4 million for the same period in
2001. The difference was due to investment and other income recorded during the
third quarter of 2001 which did not occur in 2002.

LIQUIDITY AND CAPITAL RESOURCES

We receive substantial cash from premiums, collection of reinsurance
recoverables, management fees and commission income and, to a lesser extent,
investment income and proceeds from sales and redemptions of investments and
other assets. Our principal cash outflows are for the payment of claims and loss
adjustment expenses, payment of premiums to reinsurers, purchase of investments,
debt service, policy acquisition costs, operating expenses, income and other
taxes and dividends. Variations in operating cash flows, which were $122.8
million for the first nine months of 2002 compared to $82.0 million for the same
period in 2001 ($76.1 million for the third quarter of 2002 compared to $65.4
million for the third quarter of 2001), can occur due to timing differences in
either the payment of claims and the collection of related recoverables or the
collection of receivables and the payment of related payable amounts. We limit
our liquidity exposure by holding funds, letters of credit and other security
such that net balances due to us are generally less than the gross balances
shown in our condensed consolidated balance sheets.

We maintain a substantial level of cash and liquid short-term investments which
are used to meet anticipated payment obligations. Our consolidated cash and
investment portfolio increased $166.4 million, or 18% during 2002 and totaled
$1.1 billion as of September 30, 2002, of which $317.8 million was cash and
short-term investments. The increase in investments resulted primarily from the
positive operating cash flows and the capital contribution we made to Houston
Casualty Company during 2002.

During April 2002, we drew down $40.0 million on our bank line of credit as
partial funding for a $50.0 million capital contribution to our largest
insurance company, Houston Casualty Company, to support its growth and increased
business opportunities. Since that time, we have repaid $10.0 million on our
bank facility using funds generated from operating cash flows. Because of the
utilization of our bank facility, our debt to total capital ratio increased to
19.5% as of September 30, 2002, compared to 19.2% as of December 31, 2001. As of
September 30, 2002, the weighted average interest rate on our bank facility
outstanding debt was 2.8%.

33

Under the terms of the related indenture agreement, our outstanding 2%
convertible notes could have been put, or sold back, to us on September 1, 2002
at the option of the note holders. On September 4, 2002 we paid $49,000 in cash
for the notes which were so tendered. Under the indenture agreement, the next
available date for the remaining noteholders to exercise their put rights is
September 1, 2004.

We have a reserve of $9.6 million as of September 30, 2002 for potential
collectibility issues related to reinsurance recoverables and associated
expenses. The reserve for uncollectible reinsurance increased due to provisions
of $5.3 million and $1.6 million during the nine and three months, respectfully,
ended September 30, 2002. The adverse economic environment in the worldwide
insurance industry in recent years and the terrorist attacks on September 11,
2001 have placed great pressure on reinsurers and the results of their
operations. Ultimately, these conditions could affect reinsurers' solvency.
Historically, there have been insolvencies following a period of competitive
pricing in the industry, such as the marketplace has experienced for the last
several years. While we believe that our overall reserve is adequate based on
currently available information, conditions may change or additional information
might be obtained which may result in a future change in the reserve. We
periodically review our financial exposure to the reinsurance market and the
level of our reserve and continue to take actions in an attempt to mitigate our
risk.

The reduction in the gross loss ratio, together with reduction in ceded premium,
is causing the reduction in ceded loss and loss adjustment expense and this is
having a positive effect on our reinsurance recoverable balances. We are also
making payments and collecting the corresponding recoverables on the two
catastrophe losses which occurred during the third quarter 2001; the terrorist
attacks on September 11 and the Total Oil Company loss. We expect this trend to
continue over the next few quarters, barring another catastrophe, despite the
reinsurance additions from our new specialty liability lines of business, which
are more heavily reinsured than most of our other lines of business.

A number of reinsurers have delayed or suspended the payment of amounts
recoverable under certain reinsurance contracts to which we are a party. Such
delays have affected, although not materially to date, the investment income of
our insurance companies, but not to any extent their liquidity. We limit our
liquidity exposure by holding funds, letters of credit or other security such
that net balances due to us are significantly less than the gross balances shown
in our consolidated balance sheets. In some instances, the reinsurers have
withheld payment without reference to a substantive basis for the delay or
suspension. In other cases, the reinsurers have claimed they are not liable for
payment to us of all or part of the amounts due under the applicable reinsurance
agreement. We believe these claims are without merit and expect to collect a
substantial portion of the amounts recoverable. We are currently in negotiations
with most of these parties, but if such negotiations do not result in a
satisfactory resolution of the matters in question, we may seek or be involved
in a judicial or arbitral determination of these matters. In some cases, the
final resolution of such disputes through arbitration or litigation may extend
over several years.

In this regard, as of September 30, 2002, our insurance companies had initiated
three litigation or arbitration proceedings against reinsurers and were involved
in one arbitration proceeding initiated by a reinsurer. These proceedings
primarily concern the collection of amounts owing under reinsurance agreements.
As of such date, our insurance companies had an aggregate amount of $16.2
million which had not been paid to us under the agreements and we estimate that
there could be up to an additional $14.3 million of incurred losses and loss
expenses and other balances due under the subject agreements. During the nine
months ended September 30, 2002, we negotiated the settlement of two
arbitrations with reinsurers under which the reinsurers agreed to pay the full
amounts due to us, which we estimate to be $27.5 million in the aggregate. In
addition, because our insurance companies, principally Houston Casualty Company,
participated in facilities or pools of companies which were managed by one of
our underwriting agencies, they are indirectly involved in any proceedings
involving collections which affect the applicable facilities or pools of
companies. As of September 30, 2002, Houston Casualty Company's allocated
portion of these actions was $3.0 million and we estimate that there could be up
to an additional $2.4 million of incurred losses and loss expenses. Neither
Houston Casualty Company nor its affiliated underwriting agency has any net
exposure on the portion of the amounts which are due to the non-affiliated
companies who also participated in the applicable facilities or pool of
companies.

We believe that our operating cash flows, short-term investments and bank
facility will provide sufficient sources of liquidity to meet our operating
needs for the foreseeable future.

34

Effects of Recent Accounting Pronouncements

Statement of Financial Accounting Standards ("SFAS") No. 142 entitled "Goodwill
and Other Intangible Assets" was issued in June, 2001, and became effective for
us on January 1, 2002. SFAS No. 142 requires goodwill to be tested for
impairment at a level referred to as a reporting unit. After the initial
adoption, goodwill of a reporting unit will be tested for impairment on an
annual basis and between annual tests if an event occurs or circumstances change
that would more likely than not reduce the fair value of a reporting unit below
its carrying amount. SFAS No. 142 also requires the discontinuance of the
amortization of goodwill effective January 1, 2002 and that goodwill recognized
for acquisitions which were consummated after July 1, 2001 not be amortized.
During the first six months of 2002 we determined our reporting units, completed
our initial goodwill impairment testing, completed our first annual impairment
testing as of June 30, 2002 and determined we did not have to record an
impairment charge. SFAS No. 142 is not expected to have a material effect on our
financial position or cash flows.

SFAS No. 146 entitled " Accounting for Costs Associated with Exit or Disposal
Activities" was issued in July, 2002 and will become effective for us on January
1, 2003. SFAS No. 146 will spread out the reporting of expenses related to
restructurings and is a change to existing guidance. The commitment to a plan to
exit an activity or dispose of long-lived assets will no longer be enough to
record a one-time charge for most anticipated coats. Instead, companies will
record exit or disposal costs when they are incurred and can be measured at fair
value and the liability will be subsequently adjusted for changes in estimated
cash flow. We do not expect the adoption of SFAS No. 146 to have a material
effect on our financial position, results of operations or cash flows.

Significant Accounting Policies

Other than our adoption of SFAS No. 142 described above, we have made no changes
in our methods of application of our significant accounting policies from the
information provided in our Annual Report on Form 10-K for the year ended
December 31, 2001.

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" of our
Annual Report on Form 10-K for the year ended December 31, 2001.

CONTROLS AND PROCEDURES

a. Evaluation of disclosure controls and procedures.

Within the 90 days prior to the date of this report, we carried out an
evaluation, under the supervision and with the participation of our
management, including our Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of our disclosure
controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon
that evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that our disclosure controls and procedures are effective in
timely alerting them to material information relating to HCC Insurance
Holdings, Inc. and its subsidiaries required to be included in our periodic
SEC filings.

b. Changes in internal controls.

There have been no significant changes in our internal controls or in other
factors which could significantly affect internal controls subsequent to
the date we carried out our evaluation.

35

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

In addition to the matters discussed in Note (3), Reinsurance,
we are party to numerous lawsuits and other proceedings that
arise in the normal course of our business. Many of these
lawsuits 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 party to lawsuits
and other proceedings which relate to disputes over
contractual relationships with third parties, or which involve
alleged errors and omissions on the part of our subsidiaries.
In addition, we are presently engaged in litigation initiated
by the appointed liquidator of a former reinsurer concerning
payments made to us prior to the date of the appointment of
the liquidator. The disputed payments were made by the now
insolvent reinsurer in connection with a commutation
agreement. Our understanding is that such litigation is one of
a number of similar actions brought by the liquidator. We
intend to vigorously contest the action. We believe the
resolution of the lawsuits in which we are a party will not
have a material adverse effect on our financial position,
results of operations or cash flows.

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits

99.1 Certification with respect to quarterly report.

(b) Reports on Form 8-K

On July 10, 2002, we reported on Form 8-K our
previously announced authorization to repurchase up
to 3.0 million shares of our common stock.

On August 6, 2002, we reported on Form 8-K our
intention to pay the purchase price in cash of any of
our 2% Convertible Notes which might be tendered to
us on September 1, 2002.

On August 9, 2002, we reported on Form 8-K our
announcement of financial results for the second
quarter of 2002.

On September 4, 2002, we reported on Form 8-K that we
paid less than $0.1 million in cash for 2%
Convertible Notes which were tendered to us on
September 1, 2002.

36

SIGNATURES

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

HCC Insurance Holdings, Inc.
-----------------------------------------------
(Registrant)

November 13, 2002 /s/ Stephen L. Way
- ---------------------- -----------------------------------------------
(Date) Stephen L. Way, Chairman of the Board
and Chief Executive Officer

November 13, 2002 /s/ Edward H. Ellis, Jr.
- ---------------------- -----------------------------------------------
(Date) Edward H. Ellis, Jr., Executive Vice President
and Chief Financial Officer

37

CERTIFICATIONS

I, Stephen L. Way, certify that:

1. I have reviewed this quarterly report on Form 10-Q of HCC Insurance
Holdings, Inc.;

2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;

3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;

b. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and

c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):

a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and

b. any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.

November 13, 2002 /s/ Stephen L. Way
------------------------- --------------------------------------
(Date) Stephen L. Way, Chairman of the Board
and Chief Executive Officer

38

CERTIFICATIONS

I, Edward H. Ellis, Jr., certify that:

1. I have reviewed this quarterly report on Form 10-Q of HCC Insurance
Holdings, Inc.;

2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;

3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;

b. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and

c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):

a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and

b. any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.

November 13, 2002 /s/ Edward H. Ellis, Jr.
---------------------- ----------------------------------------------
(Date) Edward H. Ellis, Jr., Executive Vice President
and Chief Financial Officer

39

INDEX TO EXHIBITS