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 March 31, 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 (Do not check if a smaller reporting company)		Smaller reporting company o

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 April 29, 2011, there were approximately 113.7 million shares of common stock outstanding.

 

 

HCC Insurance Holdings, Inc. and Subsidiaries

Table of Contents

		Page
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets — March 31, 2011 and December 31, 2010			5
Consolidated Statements of Earnings — Three months ended March 31, 2011 and 2010			6
Consolidated Statement of Changes in Shareholders’ Equity — Three months ended March 31, 2011			7
Consolidated Statements of Cash Flows — Three months ended March 31, 2011 and 2010			8
Notes to Consolidated Financial Statements			9
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			23
Item 3. Quantitative and Qualitative Disclosures About Market Risk			40
Item 4. Controls and Procedures			40
Part II. OTHER INFORMATION
Item 1. Legal Proceedings			41
Item 1A. Risk Factors			41
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			41
Item 3. Defaults Upon Senior Securities			41
Item 4. [Removed and Reserved]			41
Item 5. Other Information			41
Item 6. Exhibits			42
Signatures			43
EX-12
EX-31.1
EX-31.2
EX-32.1
EX-101 INSTANCE DOCUMENT
EX-101 SCHEMA DOCUMENT
EX-101 CALCULATION LINKBASE DOCUMENT
EX-101 LABELS LINKBASE DOCUMENT
EX-101 PRESENTATION LINKBASE DOCUMENT
EX-101 DEFINITION LINKBASE DOCUMENT

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 the credit market downturn and subprime market exposures,
	•		the effects of emerging claim and coverage issues,
	•		the effects of extensive governmental regulation of the insurance industry,
	•		potential credit risk with brokers,
	•		the effects of industry consolidations,
	•		our assessment of underwriting risk,
	•		our retention of risk, which could expose us to potential losses,
	•		the adequacy of reinsurance protection,
	•		the ability and willingness of reinsurers to pay balances due us,
	•		the occurrence of terrorist activities,
	•		our ability to maintain our competitive position,
	•		changes in our assigned financial strength ratings,
	•		our ability to raise capital and funds for liquidity in the future,
	•		attraction and retention of qualified employees,
	•		fluctuations in securities markets, 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)

		March 31,				December 31,
		2011				2010
ASSETS
Investments
Fixed income securities — available for sale, at fair value (amortized cost: 2011 — $5,183,041; 2010 — $4,864,806)		$	5,299,461			$	4,999,440
Fixed income securities — held to maturity, at amortized cost (fair value: 2011 — $181,468; 2010 — $195,811)			180,222				193,668
Short-term investments, at cost, which approximates fair value			258,724				488,002
Other investments			7,645				5,985
Total investments			5,746,052				5,687,095
Cash			98,783				97,857
Restricted cash			170,768				148,547
Premium, claims and other receivables			645,278				635,867
Reinsurance recoverables			1,115,249				1,006,855
Ceded unearned premium			243,877				278,663
Ceded life and annuity benefits			57,893				58,409
Deferred policy acquisition costs			216,105				212,786
Goodwill			841,734				821,648
Other assets			120,562				116,355
Total assets		$	9,256,301			$	9,064,082
LIABILITIES
Loss and loss adjustment expense payable		$	3,660,290			$	3,471,858
Life and annuity policy benefits			57,893				58,409
Reinsurance, premium and claims payable			341,017				345,730
Unearned premium			1,028,173				1,045,877
Deferred ceding commissions			66,065				72,565
Notes payable			298,675				298,637
Accounts payable and accrued liabilities			496,028				474,574
Total liabilities			5,948,141				5,767,650
SHAREHOLDERS’ EQUITY
Common stock, $1.00 par value; 250,000 shares authorized (shares issued: 2011 — 121,871 and 2010 — 120,942; outstanding: 2011 — 114,586 and 2010 — 114,968)			121,871				120,942
Additional paid-in capital			976,710				954,332
Retained earnings			2,288,247				2,257,895
Accumulated other comprehensive income			95,477				97,186
Treasury stock, at cost (shares: 2011 — 7,285 and 2010 — 5,974)			(174,145	)			(133,923	)
Total shareholders’ equity			3,308,160				3,296,432
Total liabilities and shareholders’ equity		$	9,256,301			$	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)

		Three months ended March 31,
		2011				2010
REVENUE
Net earned premium		$	508,480			$	509,587
Net investment income			51,595				49,249
Other operating income			7,321				17,941
Net realized investment gain (loss)			(559	)			4,525
Other-than-temporary impairment credit losses			(3,129	)			—
Total revenue			563,708				581,302
EXPENSE
Loss and loss adjustment expense, net			347,586				326,521
Policy acquisition costs, net			83,378				79,698
Other operating expense			64,312				66,668
Interest expense			5,553				5,390
Total expense			500,829				478,277
Earnings before income tax expense			62,879				103,025
Income tax expense			15,889				31,671
Net earnings		$	46,990			$	71,354
Earnings per common share
Basic		$	0.41			$	0.62
Diluted		$	0.41			$	0.62

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			—				—				46,990				—				—				46,990
Other comprehensive income Change in net unrealized gain on investments, net of tax			—				—				—				(7,734	)			—				(7,734	)
Other, net of tax			—				—				—				6,025				—				6,025
Total other comprehensive income																							(1,709	)
Comprehensive income																							45,281
Issuance of 849 shares for exercise of options, including tax effect			849				19,676				—				—				—				20,525
Purchase of 1,311 common shares			—				—				—				—				(40,222	)			(40,222	)
Stock-based compensation			80				2,702				—				—				—				2,782
Cash dividends declared, $0.145 per share			—				—				(16,638	)			—				—				(16,638	)
Balance at March 31, 2011		$	121,871			$	976,710			$	2,288,247			$	95,477			$	(174,145	)		$	3,308,160

See Notes to Consolidated Financial Statements.

HCC Insurance Holdings, Inc. and Subsidiaries

Consolidated Statements of Cash Flows
(unaudited, in thousands)

		Three months ended March 31,
		2011				2010
Operating activities
Net earnings		$	46,990			$	71,354
Adjustments to reconcile net earnings to net cash provided by operating activities:
Change in premium, claims and other receivables			(29,384	)			(24,890	)
Change in reinsurance recoverables			(98,459	)			(21,839	)
Change in ceded unearned premium			35,386				7,548
Change in loss and loss adjustment expense payable			159,429				28,921
Change in unearned premium			(19,014	)			(17,600	)
Change in reinsurance, premium and claims payable, excluding restricted cash			(8,612	)			(4,500	)
Change in accounts payable and accrued liabilities			(5,680	)			(18,215	)
Stock-based compensation expense			3,072				3,080
Depreciation and amortization expense			4,449				3,971
(Gain) loss on investments			3,688				(5,011	)
Other, net			(9,807	)			19,657
Cash provided by operating activities			82,058				42,476
Investing activities
Sales of available for sale fixed income securities			48,932				67,689
Maturity or call of available for sale fixed income securities			186,908				115,793
Maturity or call of held to maturity fixed income securities			19,082				8,260
Cost of available for sale fixed income securities acquired			(522,918	)			(381,704	)
Cost of held to maturity fixed income securities acquired			—				(44,901	)
Cost of other investments acquired			(3,061	)			—
Change in short-term investments			228,608				223,947
Payments for purchase of businesses, net of cash received			(1,892	)			(36,348	)
Proceeds from sale of subsidiary			278				14,851
Other, net			(4,717	)			(3,824	)
Cash used by investing activities			(48,780	)			(36,237	)
Financing activities
Payments on convertible notes			—				(64,472	)
Sale of common stock			20,525				7,173
Purchase of common stock			(35,709	)			—
Dividends paid			(16,670	)			(15,460	)
Other, net			(498	)			(3,048	)
Cash used by financing activities			(32,352	)			(75,807	)
Net increase (decrease) in cash			926				(69,568	)
Cash at beginning of year			97,857				129,460
Cash at end of period		$	98,783			$	59,892

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. This guidance must be adopted by January 1, 2012, either prospectively or retrospectively, with early adoption permitted. We plan to adopt this guidance on January 1, 2012. We are currently assessing the impact it will have on our consolidated financial statements.

(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.

HCC Insurance Holdings, Inc. and Subsidiaries

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

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 over 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 as of March 31, 2011 or December 31, 2010. 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 March 31, 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.

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

		Level 1				Level 2				Level 3				Total
March 31, 2011
Fixed income securities — available for sale
U.S. government and government agency securities		$	262,814			$	192,301			$	—			$	455,115
Fixed income securities of states, municipalities and political subdivisions			—				1,049,922				—				1,049,922
Special purpose revenue bonds of states, municipalities and political subdivisions			—				1,613,903				—				1,613,903
Corporate fixed income securities			—				631,582				153				631,735
Residential mortgage-backed securities			—				1,103,089				—				1,103,089
Commercial mortgage-backed securities			—				143,639				—				143,639
Asset-backed securities			—				40,604				1,128				41,732
Foreign government securities			—				260,326				—				260,326
Total fixed income securities — available for sale			262,814				5,035,366				1,281				5,299,461
Other investments			7,520				—				—				7,520
Other assets			—				—				1,120				1,120
Total assets measured at fair value		$	270,334			$	5,035,366			$	2,401			$	5,308,101

HCC Insurance Holdings, Inc. and Subsidiaries

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

		Level 1				Level 2				Level 3				Total
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

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

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 quarter of 2011 or 2010.

HCC Insurance Holdings, Inc. and Subsidiaries

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

(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
March 31, 2011
U.S. government and government agency securities		$	447,995			$	7,497			$	(377	)		$	455,115
Fixed income securities of states, municipalities and political subdivisions			1,019,142				38,045				(7,265	)			1,049,922
Special purpose revenue bonds of states, municipalities and political subdivisions			1,598,826				34,218				(19,141	)			1,613,903
Corporate fixed income securities			611,273				23,378				(2,916	)			631,735
Residential mortgage-backed securities			1,075,527				33,829				(6,267	)			1,103,089
Commercial mortgage-backed securities			135,141				8,501				(3	)			143,639
Asset-backed securities			41,759				67				(94	)			41,732
Foreign government securities			253,378				7,614				(666	)			260,326
Total fixed income securities — available for sale		$	5,183,041			$	153,149			$	(36,729	)		$	5,299,461
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

HCC Insurance Holdings, Inc. and Subsidiaries

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

		Held to maturity
		Cost or				Gross				Gross
		amortized				unrealized				unrealized
		cost				gain				loss				Fair value
March 31, 2011
U.S. government securities		$	12,995			$	210			$	—			$	13,205
Corporate fixed income securities			116,890				972				(636	)			117,226
Foreign government securities			50,337				728				(28	)			51,037
Total fixed income securities — held to maturity		$	180,222			$	1,910			$	(664	)		$	181,468
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

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
March 31, 2011
U.S. government and government agency securities		$	90,555			$	(377	)		$	—			$	—			$	90,555			$	(377	)
Fixed income securities of states, municipalities and political subdivisions			188,081				(7,247	)			151				(18	)			188,232				(7,265	)
Special purpose revenue bonds of states, municipalities and political subdivisions			645,544				(18,916	)			8,763				(225	)			654,307				(19,141	)
Corporate fixed income securities			129,775				(2,916	)			—				—				129,775				(2,916	)
Residential mortgage-backed securities			286,999				(4,082	)			18,026				(2,185	)			305,025				(6,267	)
Commercial mortgage-backed securities			141				(1	)			345				(2	)			486				(3	)
Asset-backed securities			21,787				(94	)			—				—				21,787				(94	)
Foreign government securities			42,074				(666	)			—				—				42,074				(666	)
Total		$	1,404,956			$	(34,299	)		$	27,285			$	(2,430	)		$	1,432,241			$	(36,729	)

HCC Insurance Holdings, Inc. and Subsidiaries

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

		Less than 12 months								12 months or more								Total
						Unrealized								Unrealized								Unrealized
		Fair value				losses				Fair value				losses				Fair value				losses
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.

In the first quarter of 2011, we identified an error related to our adoption of the other-than-temporary impairment loss recognition accounting guidance that was effective as of April 1, 2009. The error understated amortized cost for six residential mortgage-backed securities at the adoption date, as well as their related unrealized loss included in accumulated other comprehensive income. The error was immaterial to 2011 and all prior periods; accordingly, we recorded an other-than-temporary impairment credit loss of $3.1 million in the first quarter of 2011 to correct the error. We recognized no additional other-than-temporary impairment losses in the first quarter of 2011 and none in the first quarter of 2010.

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:

		Three months ended March 31,
		2011				2010
Balance at beginning of year		$	4,273			$	3,848
Credit losses recognized in earnings
Securities previously impaired			1,247				—
Securities previously not impaired			1,838				—
Securities sold			(673	)			—
Balance at March 31		$	6,685			$	3,848

We had $0.3 million of after-tax other-than-temporary impairment losses, related to mortgage-backed securities, included in accumulated other comprehensive income within shareholders’ equity at March 31, 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.

HCC Insurance Holdings, Inc. and Subsidiaries

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

We do not consider the $36.7 million of gross unrealized losses in our fixed income securities portfolio at March 31, 2011 to be other-than-temporary impairments because: 1) we received substantially all contractual interest and principal payments on these securities as of March 31, 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 March 31, 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 4.9 years at March 31, 2011.

		Available for sale								Held to maturity
		Cost or
		amortized cost				Fair value				Amortized cost				Fair value
Due in 1 year or less		$	247,954			$	251,586			$	39,918			$	40,353
Due after 1 year through 5 years			1,206,646				1,251,068				137,431				138,194
Due after 5 years through 10 years			967,821				1,002,038				2,873				2,921
Due after 10 years through 15 years			766,633				771,854				—				—
Due after 15 years			741,560				734,455				—				—
Securities with fixed maturities			3,930,614				4,011,001				180,222				181,468
Mortgage-backed and asset-backed securities			1,252,427				1,288,460				—				—
Total fixed income securities		$	5,183,041			$	5,299,461			$	180,222			$	181,468

The sources of net investment income were as follows:

		Three months ended March 31,
		2011				2010
Fixed income securities		$	52,006			$	48,599
Short-term investments			156				190
Other			642				1,508
Total investment income			52,804				50,297
Investment expense			(1,209	)			(1,048	)
Net investment income		$	51,595			$	49,249

HCC Insurance Holdings, Inc. and Subsidiaries

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

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

		Three months ended March 31,
		2011				2010
Fixed income securities
Gains		$	216			$	4,901
Losses			(779	)			(223	)
Net fixed income securities			(563	)			4,678
Other investments
Gains			4				2
Losses			—				(155	)
Net other investments			4				(153	)
Total
Gains			220				4,903
Losses			(779	)			(378	)
Net realized investment gain (loss)		$	(559	)		$	4,525

(4) Goodwill

When we complete a business combination, goodwill is either allocated to the acquired business or, if there are synergies with our other businesses, allocated to the different reporting units based on their respective share of the estimated future cash flows.

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.

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 adjustment			—				20,086				—				—				—				20,086
Balance at March 31, 2011		$	223,000			$	269,906			$	144,128			$	79,700			$	125,000			$	841,734

HCC Insurance Holdings, Inc. and Subsidiaries

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

(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.

		Three months ended March 31,
		2011				2010
Direct written premium		$	508,141			$	509,192
Reinsurance assumed			141,067				113,304
Reinsurance ceded			(110,324	)			(124,245	)
Net written premium		$	538,884			$	498,251
Direct earned premium		$	574,808			$	571,962
Reinsurance assumed			79,381				69,240
Reinsurance ceded			(145,709	)			(131,615	)
Net earned premium		$	508,480			$	509,587
Direct loss and loss adjustment expense		$	442,754			$	360,951
Reinsurance assumed			73,907				52,835
Reinsurance ceded			(169,075	)			(87,265	)
Net loss and loss adjustment expense		$	347,586			$	326,521
Policy acquisition costs		$	111,358			$	109,105
Ceding commissions			(27,980	)			(29,407	)
Net policy acquisition costs		$	83,378			$	79,698

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

		March 31,				December 31,
		2011				2010
Reinsurance recoverable on paid losses		$	68,337			$	75,262
Reinsurance recoverable on outstanding losses			480,295				452,882
Reinsurance recoverable on incurred but not reported losses			568,899				481,204
Reserve for uncollectible reinsurance			(2,282	)			(2,493	)
Total reinsurance recoverables		$	1,115,249			$	1,006,855

HCC Insurance Holdings, Inc. and Subsidiaries

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

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 from December 31, 2010 for recoverables on paid losses that were outstanding for over 90 days. We have a reserve for potentially uncollectible amounts as follows:

		Three months ended March 31,
		2011				2010
Balance at beginning of year		$	2,493			$	2,945
Provision expense (recovery)			(211	)			—
Balance at March 31		$	2,282			$	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 March 31, 2011 and December 31, 2010.

		March 31,				December 31,
		2011				2010
Payables to reinsurers		$	240,659			$	243,990
Letters of credit			157,824				145,914
Cash deposits			95,573				81,966
Total credits		$	494,056			$	471,870

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

		March 31,				December 31,
		2011				2010
Loss and loss adjustment expense payable		$	3,660,290			$	3,471,858
Reinsurance recoverable on outstanding losses			(480,295	)			(452,882	)
Reinsurance recoverable on incurred but not reported losses			(568,899	)			(481,204	)
Net reserves		$	2,611,096			$	2,537,772
Unearned premium		$	1,028,173			$	1,045,877
Ceded unearned premium			(243,877	)			(278,663	)
Net unearned premium		$	784,296			$	767,214
Deferred policy acquisition costs		$	216,105			$	212,786
Deferred ceding commissions			(66,065	)			(72,565	)
Net deferred policy acquisition costs		$	150,040			$	140,221

HCC Insurance Holdings, Inc. and Subsidiaries

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

(6) 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. The borrowing rate is LIBOR plus 137.5 basis points, subject to increase or decrease based on changes in our debt rating. In addition, we pay a commitment fee of 20 basis points. Letters of credit issued under the Facility reduce our available borrowing capacity. As of March 31, 2011, we had not borrowed under the Facility; however outstanding letters of credit reduced our available Facility balance to $586.8 million. 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 March 31, 2011.

(7) Earnings Per Share

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

		Three months ended March 31,
		2011				2010
Net earnings		$	46,990			$	71,354
Less: net earnings attributable to unvested restricted stock awards and restricted stock units			(598	)			(752	)
Net earnings available to common stock		$	46,392			$	70,602
Weighted-average common shares outstanding			113,754				113,668
Dilutive effect of outstanding options (determined using treasury stock method)			352				456
Weighted-average common shares and potential common shares outstanding			114,106				114,124
Anti-dilutive stock options not included in treasury stock method computation			2,397				3,413