e10vq
Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 10-Q
(Mark One)
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: September 30, 2010
OR
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission file number: 001-32938
ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD
(Exact Name of Registrant as Specified in Its Charter)
     
Bermuda   98-0481737
(State or Other Jurisdiction of
Incorporation or Organization)
  (I.R.S. Employer
Identification No.)
27 Richmond Road, Pembroke HM 08, Bermuda
(Address of Principal Executive Offices and Zip Code)
(441) 278-5400
(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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
             
Large accelerated filer þ   Accelerated filer o   Non-accelerated filer o   Smaller reporting company o
        (Do not check if a smaller reporting company)    
     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
     The number of outstanding common shares, par value $0.03 per share, of Allied World Assurance Company Holdings, Ltd as of November 1, 2010 was 42,249,912.
 
 

 


TABLE OF CONTENTS

PART I
Item 1. Financial Statements
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
PART II OTHER INFORMATION
Item 1. Legal Proceedings
Item 1A. Risk Factors
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Other Information
Item 5. Exhibits
SIGNATURES
EXHIBIT INDEX
EX-10.3
EX-31.1
EX-31.2
EX-32.1
EX-32.2
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


Table of Contents

PART I
FINANCIAL INFORMATION
Item 1. Financial Statements.
ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

as of September 30, 2010 and December 31, 2009
(Expressed in thousands of United States dollars, except share and per share amounts)
                 
    As of     As of  
    September 30,     December 31,  
    2010     2009  
ASSETS
               
Fixed maturity investments available for sale, at fair value (amortized cost: 2010: $1,445,143; 2009: $4,260,844)
  $ 1,570,144     $ 4,427,072  
Fixed maturity investments trading, at fair value
    5,231,358       2,544,322  
Other invested assets trading, at fair value
    450,015       184,869  
 
           
Total investments
    7,251,517       7,156,263  
Cash and cash equivalents
    461,286       292,188  
Restricted cash
    370,158       87,563  
Insurance balances receivable
    466,887       395,621  
Prepaid reinsurance
    187,292       186,610  
Reinsurance recoverable
    939,956       919,991  
Accrued investment income
    43,286       53,046  
Net deferred acquisition costs
    102,300       87,821  
Goodwill
    268,376       268,376  
Intangible assets
    57,684       60,359  
Balances receivable on sale of investments
    279,379       55,854  
Net deferred tax assets
    9,633       21,895  
Other assets
    58,086       67,566  
 
           
Total assets
  $ 10,495,840     $ 9,653,153  
 
           
LIABILITIES
               
Reserve for losses and loss expenses
  $ 4,889,825     $ 4,761,772  
Unearned premiums
    1,017,814       928,619  
Reinsurance balances payable
    97,147       102,837  
Balances due on purchases of investments
    586,519       55,670  
Senior notes
    499,017       498,919  
Accounts payable and accrued liabilities
    64,204       92,041  
 
           
Total liabilities
  $ 7,154,526     $ 6,439,858  
 
           
SHAREHOLDERS’ EQUITY
               
Common shares, par value $0.03 per share (2010: 50,793,902; 2009: 49,734,487 shares issued and 2010: 42,394,576; 2009: 49,734,487 shares outstanding)
  $ 1,524     $ 1,492  
Additional paid-in capital
    1,355,685       1,359,934  
Treasury shares, at cost (2010: 8,399,326; 2009: nil)
    (415,009 )      
Accumulated other comprehensive income:
net unrealized gains on investments, net of tax
    111,760       149,849  
Retained earnings
    2,287,354       1,702,020  
 
           
Total shareholders’ equity
  $ 3,341,314     $ 3,213,295  
 
           
Total liabilities and shareholders’ equity
  $ 10,495,840     $ 9,653,153  
 
           
See accompanying notes to the consolidated financial statements.

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME

for the three and nine months ended September 30, 2010 and 2009
(Expressed in thousands of United States dollars, except share and per share amounts)
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2010     2009     2010     2009  
REVENUES:
                               
Gross premiums written
  $ 378,445     $ 401,837     $ 1,376,455     $ 1,374,216  
Premiums ceded
    (76,276 )     (80,881 )     (271,199 )     (286,785 )
 
                       
Net premiums written
    302,169       320,956       1,105,256       1,087,431  
Change in unearned premiums
    37,327       7,815       (88,512 )     (101,020 )
 
                       
Net premiums earned
    339,496       328,771       1,016,744       986,411  
Net investment income
    59,479       73,032       193,975       227,423  
Net realized investment gains
    116,930       46,861       289,350       88,556  
Net impairment charges recognized in earnings:
                               
Total other-than-temporary impairment charges
          (9,861 )     (168 )     (68,049 )
Portion of loss recognized in other comprehensive income, before taxes
          7,908             18,659  
 
                       
Net impairment charges recognized in earnings
          (1,953 )     (168 )     (49,390 )
Other income
          298       913       1,133  
 
                       
 
    515,905       447,009       1,500,814       1,254,133  
 
                       
EXPENSES:
                               
Net losses and loss expenses
    126,988       136,441       547,864       462,657  
Acquisition costs
    41,919       36,630       120,641       110,721  
General and administrative expenses
    69,871       57,521       201,423       176,380  
Amortization and impairment of intangible assets
    892       1,065       2,675       3,195  
Interest expense
    9,533       9,523       28,592       29,492  
Foreign exchange (gain) loss
    (1,387 )     (273 )     248       (660 )
 
                       
 
    247,816       240,907       901,443       781,785  
 
                       
Income before income taxes
    268,089       206,102       599,371       472,348  
Income tax expense
    13,569       5,548       27,152       26,716  
 
                       
NET INCOME
    254,520       200,554       572,219       445,632  
 
                       
Other comprehensive income:
                               
Unrealized gains on investments arising during the period net of applicable deferred income tax (expense) recovery for the three months ended September 30, 2010: $(2,449); 2009: $9,771; and nine months ended September 30, 2010: $(3,138); 2009: $9,330
    47,954       160,823       149,276       236,973  
Portion of other-than-temporary impairment losses recognized in other comprehensive income
          (7,908 )           (18,659 )
Reclassification adjustment for net realized investment gains included in net income, net of applicable income tax
    (32,550 )     (16,542 )     (145,476 )     (2,055 )
 
                       
Other comprehensive income
    15,404       136,373       3,800       216,259  
 
                       
COMPREHENSIVE INCOME
  $ 269,924     $ 336,927     $ 576,019     $ 661,891  
 
                       
PER SHARE DATA
                               
Basic earnings per share
  $ 5.59     $ 4.05     $ 11.78     $ 9.01  
Diluted earnings per share
  $ 5.21     $ 3.83     $ 11.03     $ 8.62  
Weighted average common shares outstanding
    45,544,060       49,574,266       48,580,541       49,449,809  
Weighted average common shares and common share equivalents outstanding
    48,839,991       52,345,913       51,887,390       51,676,006  
Dividends declared per share
  $ 0.20     $ 0.18     $ 0.60     $ 0.54  
See accompanying notes to the consolidated financial statements.

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

for the nine months ended September 30, 2010 and 2009
(Expressed in thousands of United States dollars)
                                                 
                            Accumulated              
            Additional             Other              
            Paid-in     Treasury     Comprehensive     Retained        
    Share Capital     Capital     Shares     Income     Earnings     Total  
December 31, 2009
  $ 1,492     $ 1,359,934     $     $ 149,849     $ 1,702,020     $ 3,213,295  
Cumulative effect adjustment upon adoption of ASU 2010-11, net of deferred taxes1
                        (41,889 )     41,889        
Net income
                            572,219       572,219  
Dividends
                            (28,774 )     (28,774 )
Other comprehensive income:
                                               
Net unrealized gains, net of deferred income tax
                      3,800             3,800  
Portion of other-than-temporary impairment losses recognized in other comprehensive income, net of deferred income tax
                                   
 
                                   
Total other comprehensive income
                      3,800             3,800  
Stock compensation
    32       28,570                         28,602  
Share repurchases
                (415,009 )                 (415,009 )
Repurchase of founder warrants
          (32,819 )                       (32,819 )
 
                                   
September 30, 2010
  $ 1,524     $ 1,355,685     $ (415,009 )   $ 111,760     $ 2,287,354     $ 3,341,314  
 
                                   
 
1   Cumulative effect adjustment reflects adoption of ASU 2010-11 as of July 1, 2010.
                                         
                    Accumulated              
            Additional     Other              
            Paid-in     Comprehensive     Retained        
    Share Capital     Capital     Income     Earnings     Total  
December 31, 2008
  $ 1,471     $ 1,314,785     $ 105,632     $ 994,974     $ 2,416,862  
Cumulative effect adjustment upon adoption of ASC 320-10-652, net of deferred taxes
                (136,848 )     136,848        
Net income
                      445,632       445,632  
Dividends
                      (26,752 )     (26,752 )
Other comprehensive income:
                                       
Unrealized gains
                234,918             234,918  
Portion of other-than-temporary impairment losses recognized in other comprehensive income, net of deferred income tax
                (18,659 )           (18,659 )
 
                             
Total other comprehensive income
                216,259             216,259  
Stock compensation
    17       26,876                   26,893  
 
                             
September 30, 2009
  $ 1,488     $ 1,341,661     $ 185,043     $ 1,550,702     $ 3,078,894  
 
                             
 
2   Cumulative effect adjustment reflects adoption of ASC 320-10-65 as of April 1, 2009.
See accompanying notes to the consolidated financial statements.

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

for the nine months ended September 30, 2010 and 2009
(Expressed in thousands of United States dollars)
                 
    Nine Months Ended  
    September 30,  
    2010     2009  
CASH FLOWS PROVIDED BY OPERATING ACTIVITIES:
               
Net income
  $ 572,219     $ 445,632  
Adjustments to reconcile net income to cash provided by operating activities:
               
Net realized gains on sales of investments
    (145,700 )     (52,806 )
Mark to market adjustments
    (143,650 )     (35,750 )
Net impairment charges recognized in earnings
    168       49,390  
Stock compensation expense
    25,177       25,078  
Insurance balances receivable
    (71,266 )     (59,676 )
Prepaid reinsurance
    (682 )     (5,554 )
Reinsurance recoverable
    (19,965 )     (25,650 )
Accrued investment income
    9,760       (5,648 )
Net deferred acquisition costs
    (14,479 )     (16,795 )
Net deferred tax assets
    15,401       (7,862 )
Other assets
    10,797       (8,353 )
Reserve for losses and loss expenses
    128,053       172,774  
Unearned premiums
    89,195       106,575  
Reinsurance balances payable
    (5,690 )     4,186  
Accounts payable and accrued liabilities
    (27,837 )     (18,663 )
Other items, net
    (2,310 )     321  
 
           
Net cash provided by operating activities
    419,191       567,199  
 
           
CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES:
               
Purchases of fixed maturity investments — available for sale
    (138,918 )     (6,026,003 )
Purchases of fixed maturity investments — trading
    (8,739,173 )     (2,601,489 )
Purchases of other invested assets
    (261,178 )     (151,315 )
Sales of fixed maturity investments — available for sale
    2,057,431       6,704,668  
Sales of fixed maturity investments — trading
    7,583,380       1,287,022  
Sales of other invested assets
    8,579       135,112  
Changes in securities lending collateral received
          171,026  
Purchases of fixed assets
    (7,809 )     (4,077 )
Change in restricted cash
    (282,595 )     33,928  
 
           
Net cash from (used in) investing activities
    219,717       (451,128 )
 
           
CASH FLOWS USED IN FINANCING ACTIVITIES:
               
Dividends paid
    (28,774 )     (26,752 )
Proceeds from the exercise of stock options
    7,053       4,225  
Share repurchase
    (415,009 )      
Repurchase of founder warrants
    (32,819 )        
Repayment of syndicated loan
          (243,750 )
Changes in securities lending collateral
          (177,010 )
 
           
Net cash used in financing activities
    (469,549 )     (443,287 )
 
           
Effect of exchange rate changes on foreign currency cash
    (261 )     831  
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
    169,098       (326,385 )
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR
    292,188       655,828  
 
           
CASH AND CASH EQUIVALENTS, END OF YEAR
  $ 461,286     $ 329,443  
 
           
Supplemental disclosure of cash flow information:
               
— Cash paid for income taxes
  $ 12,820     $ 41,364  
— Cash paid for interest expense
    37,500       39,115  
See accompanying notes to the consolidated financial statements.

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)
1. GENERAL
     Allied World Assurance Company Holdings, Ltd (“Holdings”) was incorporated in Bermuda on November 13, 2001. Holdings, through its wholly-owned subsidiaries (collectively, the “Company”), provides property and casualty insurance and reinsurance on a worldwide basis through operations in Bermuda, the United States, Europe, Hong Kong and Singapore.
2. BASIS OF PREPARATION AND CONSOLIDATION
     These unaudited condensed consolidated financial statements include the accounts of Holdings and its subsidiaries and have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and with Article 10 of Regulation S-X as promulgated by the U.S. Securities and Exchange Commission (“SEC”). Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, these unaudited condensed consolidated financial statements reflect all adjustments that are normal and recurring in nature and necessary for a fair presentation of financial position and results of operations as of the end of and for the periods presented. The results of operations for any interim period are not necessarily indicative of the results for a full year.
     The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The significant estimates reflected in the Company’s financial statements include, but are not limited to:
    The premium estimates for certain reinsurance agreements,
    Recoverability of deferred acquisition costs,
    The reserve for outstanding losses and loss expenses,
    Valuation of ceded reinsurance recoverables,
    Determination of impairment of goodwill and other intangible assets,
    Valuation of financial instruments, and
    Determination of other-than-temporary impairment of investments.
     Inter-company accounts and transactions have been eliminated on consolidation and all entities meeting consolidation requirements have been included in the consolidation. Certain immaterial reclassifications in the unaudited condensed consolidated statements of operations and comprehensive income (“consolidated income statements”) and consolidated statements of cash flows and notes to the unaudited condensed consolidated financial statements have been made to prior years’ amounts to conform to the current year’s presentation.
     These unaudited condensed consolidated financial statements, including these notes, should be read in conjunction with the Company’s audited consolidated financial statements, and related notes thereto, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.
3. NEW ACCOUNTING PRONOUNCEMENTS
     In January 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) 2010-06 “Fair Value Measurements and Disclosures” (“ASU 2010-06”). ASU 2010-06 updated section ASC 820-10 to require a greater level of disaggregated information and more robust disclosure about valuation techniques and inputs to fair value measurements. ASU 2010-06 is effective for interim and annual reporting periods beginning after December 15, 2009, with the exception of the disclosures about purchases, sales, issuances and settlements in the roll forward of activity in Level 3 fair value measures which are effective for interim and annual reporting periods beginning after December 15, 2010. See Note 6 “Fair Value of Financial Instruments” for the Company’s disclosures about the fair value of financial instruments.

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)
     In March 2010, the FASB issued ASU 2010-11 “Derivatives and Hedging: Scope Exception Related to Embedded Credit Derivatives” (“ASU 2010-11”). ASU 2010-11 clarifies the type of embedded credit derivative that is exempt from embedded derivative bifurcation requirements, specifically one that is related only to the subordination of one financial instrument to another. As permitted under the transitional provisions of ASU 2010-11, effective July 1, 2010 the Company has elected the fair value option for any investment in a beneficial interest in a securitized asset. As a result, the Company elected the fair value option for all of its mortgage-backed and asset-backed securities held as of June 30, 2010. On July 1, 2010, the Company reclassified net unrealized gains of $41,889 from “accumulated other comprehensive income” to “retained earnings”. As a result of the fair value election, any changes in fair value of the mortgage-backed and asset-backed securities will be recognized in “net realized investment gains (losses)” on the consolidated income statement. On July 1, 2010, these investments, which totaled $968,825, were classified as “fixed maturity investments trading, at fair value” on the unaudited condensed consolidated balance sheets (“consolidated balance sheets”).
     In July 2010, the FASB issued ASU 2010-20 “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses” (“ASU 2010-20”). ASU 2010-20 enhances disclosures about credit quality of financing receivables and the allowance of credit losses by requiring additional information regarding the Company’s credit risk exposures and evaluating the adequacy of its allowance for credit losses. The balance sheet related disclosures for ASU 2010-20 are effective for the year ended December 31, 2010 and the income statement related disclosures are effective for quarter ended March 31, 2011. The Company is currently assessing the provisions of ASU 2010-20 and its potential impact on future disclosures.
     In October 2010, the FASB issued ASU 2010-26 “Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts” (“ASU 2010-26”). ASU 2010-26 clarifies what costs associated with acquiring or renewing insurance contracts can be deferred and amortized over the coverage period. Under the revised guidance of ASU 2010-26, incremental direct costs that result directly from and are essential to the insurance contract and would not have been incurred had the insurance contract not been written are costs that may be capitalized, including costs relating to activities specifically performed by the Company such as underwriting, policy issuance and processing. ASU 2010-26 will be effective January 1, 2012 and early adoption is permitted. The Company is currently evaluating the provisions of ASU 2010-26 and its potential impact on future financial statements.
4. INVESTMENTS
a) Available for Sale Securities
     The amortized cost, gross unrealized gains, unrealized losses, other-than-temporary-impairment charges (“OTTI”) recorded through other comprehensive income (“OCI”) and fair value of the Company’s available for sale investments by category as of September 30, 2010 and December 31, 2009 are as follows:

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)
                                         
            Gross     Gross              
            Unrealized     Unrealized              
    Cost     Gains     Losses     OTTI OCI     Fair Value  
September 30, 2010
                                       
U.S. Government and Government agencies
  $ 149,915     $ 11,317     $     $     $ 161,232  
Non-U.S. Government and Government agencies
    137,556       12,623       (1,406 )           148,773  
States, municipalities and political subdivisions
    118,985       14,797                   133,782  
Corporate debt:
                                       
Financial institutions
    283,055       18,454       (586 )           300,923  
Industrials
    601,460       52,228                   653,688  
Utilities
    154,172       17,574                   171,746  
 
                             
Total fixed maturity investments, available for sale
  $ 1,445,143     $ 126,993     $ (1,992 )   $     $ 1,570,144  
 
                             
 
                                       
December 31, 2009
                                       
U.S. Government and Government agencies
  $ 689,858     $ 34,831     $ (1,389 )   $     $ 723,300  
Non-U.S. Government and Government agencies
    271,528       13,752       (1,590 )           283,690  
States, municipalities and political subdivisions
    210,315       17,429       (336 )           227,408  
Corporate debt:
                                       
Financial institutions
    684,386       27,695       (1,751 )           710,330  
Industrials
    879,905       46,489       (184 )           926,210  
Utilities
    143,773       10,479                   154,252  
Residential mortgage-backed:
                                       
Non-agency residential
    172,000       4,206       (11,517 )     (1,856 )     162,833  
Agency residential
    708,652       28,882       (1,095 )           736,439  
Commercial mortgage-backed
    406,236       6,482       (7,915 )           404,803  
Asset-backed
    94,191       3,762       (146 )           97,807  
 
                             
Total fixed maturity investments, available for sale
  $ 4,260,844     $ 194,007     $ (25,923 )   $ (1,856 )   $ 4,427,072  
 
                             
b) Trading Securities
     Securities accounted for at fair value with changes in fair value recognized in the consolidated income statements by category as of September 30, 2010 and December 31, 2009 are as follows:
                 
    September 30, 2010     December 31, 2009  
U.S. Government and Government agencies
  $ 1,045,755     $ 655,266  
Non-U.S. Government and Government agencies
    239,489       227,310  
States, municipalities and political subdivisions
    106,566       15,810  
Corporate debt
               
Financial institutions
    943,042       590,130  
Industrials
    393,189       191,729  
Utilities
    77,406       11,934  
Residential mortgage-backed
               
Non-agency residential
    424,124       259,055  
Agency residential
    1,112,192       139,858  
Commercial mortgage-backed
    213,282       18,266  
Asset-backed
    676,313       434,964  
 
           
Total fixed maturity investments, trading
    5,231,358       2,544,322  
Hedge funds
    328,275       184,725  
Equity securities
    121,740       144  
 
           
Total
  $ 5,681,373     $ 2,729,191  
 
           

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)
c) Contractual Maturity Dates
     The contractual maturity dates of available for sale fixed maturity investments as of September 30, 2010 are as follows:
                 
    Amortized Cost     Fair Value  
Due within one year
  $ 141,803     $ 144,347  
Due after one year through five years
    1,079,748       1,171,869  
Due after five years through ten years
    165,654       183,880  
Due after ten years
    57,938       70,048  
 
           
 
  $ 1,445,143     $ 1,570,144  
 
           
     Expected maturities may differ from contractual maturities because borrowers may have the right to prepay obligations with or without prepayment penalties.
d) Other Invested Assets
     As of September 30, 2010, the Company held sixteen hedge fund and private equity investments with a total fair value of $328,275, which comprised 4.1% of the total fair value of its investments and cash and cash equivalents and are summarized as follows by type of investment strategy:
                                                 
                    Long     Short              
Hedge Fund   Fair Value as of     Unfunded     Exposure(1)     Exposure(2)     Gross     Net  
Type   September 30, 2010     Commitments     (% of funded)     (% of funded)     Exposure(3)     Exposure(4)  
Secondary private equity funds
  $ 20,470     $ 41,546       100 %     0 %     100 %     100 %
Distressed
    70,309       38,192       66 %     9 %     75 %     57 %
Equity long/short
    78,330             75 %     44 %     119 %     31 %
Multi-strategy
    108,029             129 %     64 %     193 %     65 %
Event driven
    51,137             114 %     66 %     180 %     48 %
 
                                           
Total
  $ 328,275     $ 79,738                                  
 
                                           
 
(1)   Long exposure represents the ratio of the fund’s long investments in securities to the fund’s equity capital (over 100% may denote explicit borrowing).
 
(2)   Short exposure represents the ratio of the securities sold short to the fund’s equity capital.
 
(3)   Gross exposure is the addition of the long and short exposures (over 100% may denote explicit borrowing).
 
(4)   Net exposure is the subtraction of the short exposure from the long exposure.
    Secondary private equity funds: These funds buy limited partnership interests from existing limited partners of primary private equity funds. As owners of private equity funds seek liquidity, they can sell their existing investments, plus any remaining commitment, to secondary market participants. The Company has invested in two secondary private equity funds to purchase those primary limited partnership interests. The fair values of the investments in this class have been estimated using the net asset value per share of the investments. These funds cannot be redeemed because the investments include restrictions that do not allow for redemption until termination of the fund. The remaining restriction period for these funds ranges from seven to eight years.
    Distressed funds: In distressed debt investing, managers take positions in the debt of companies experiencing significant financial difficulties, including bankruptcy, or in certain positions of the capital structure of structured securities. The manager relies on the fundamental analysis of these securities, including the claims on the assets and the likely return to bondholders. The fair values of the funds in this class have been estimated using the net asset value per share of the funds. The Company has invested in five distressed funds, three of which (representing approximately 34% of the value of the funds in this class) are not

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)
      currently eligible for redemption due to imposed lock-up periods with remaining periods ranging from nine months to seven years. Funds representing approximately 42% of the value of the funds in this class are currently eligible for quarterly redemption with a 65-day notification period, subject to redemption limitations. Funds representing approximately 24% of the value of the funds in this class are currently eligible for quarterly redemption with a 45-day notification period and redemption fee if redeemed prior to January 2012.
    Equity long/short funds: In equity long/short funds, managers take long positions in companies they deem to be undervalued and short positions in companies they deem to be overvalued. Long/short managers may invest in countries, regions or sectors and vary by their use of leverage and target net long position. The fair values of the funds in this class have been estimated using the net asset value per share of the funds. The Company has invested in three equity long/short funds, one of which (representing approximately 36% of the value of the funds in this class) is not currently eligible for redemption due to an imposed lock-up period with a remaining period of three months, at which time the funds will be eligible for quarterly redemption with a 60-day notification period. The remaining two funds, representing approximately 64% of the value of the funds in this class, are currently eligible for quarterly redemption, one with a 30-day notification period or monthly redemption with a 30-day notification period and redemption fee and one with a 60-day notification period.
    Multi-strategy funds: These funds may utilize many strategies employed by specialized funds including distressed investing, equity long/short, merger arbitrage, convertible arbitrage, fixed income arbitrage and macro trading. The fair values of the funds in this class have been estimated using the net asset value per share of the funds. The Company has invested in four multi-strategy funds. Funds representing approximately 24% of the value of the funds in this class currently are not eligible for redemption due to imposed lock-up periods with remaining periods of approximately five months. Funds representing approximately 29% of the value of the funds in this class are currently eligible for quarterly redemption with a 60-day notification period. Funds representing approximately 23% of the value of the funds in this class are currently eligible for quarterly redemption with a 45-day notification period and redemption fee if redeemed prior to December 2010. Funds representing approximately 24% of the value of the funds in this class are currently eligible for redemption of one third of the net asset value. The remaining portion of the net asset value is not currently eligible for redemption due to a three year lock-up period.
    Event driven funds: Event driven strategies seek to deploy capital into specific securities whose returns are affected by a specific event that affects the value of one or more securities of a company. Returns for such securities are linked primarily to the specific outcome of the events and not by the overall direction of the bond or stock markets. Examples could include mergers and acquisitions (arbitrage), corporate restructurings and spin-offs and capital structure arbitrage. The fair values of the funds in this class have been estimated using the net asset value per share of the funds. The Company has invested in two event driven funds. Approximately 50% of the value of the funds is not currently eligible for redemption due to an imposed two year lock-up period. The remaining 50% of the value of the funds in this class is currently eligible for quarterly redemption, but is subject to redemption fees and limitations.
     Three of the Company’s hedge funds, one multi-strategy fund and two event driven funds, had long exposure greater than 100% of the funds’ net asset value (indicating explicit leverage) of 268%, 125% and 103%, respectively, as of September 30, 2010.
     In addition to the sixteen hedge funds outlined above, the Company has committed $50,000 and $25,000 for two new investments, respectively.
e) Net Investment Income
                                 
    For the Three Months Ended     For the Nine Months Ended  
    September 30,     September 30,  
    2010     2009     2010     2009  
Fixed maturities and other investments
  $ 55,165     $ 74,857     $ 193,815     $ 230,438  
Other invested assets
    6,438             7,684       1,487  
Cash and cash equivalents
    183       287       346       1,474  
Expenses
    (2,307 )     (2,112 )     (7,870 )     (5,976 )
 
                       
Net investment income
  $ 59,479     $ 73,032     $ 193,975     $ 227,423  
 
                       

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)
f) Components of Realized Gains and Losses
     Components of realized gains for the three and nine months ended September 30, 2010 and 2009 are summarized in the following table:
                                 
    For the Three Months Ended     For the Nine Months Ended  
    September 30,     September 30,  
    2010     2009     2010     2009  
Gross realized gains on sale of securities
  $ 33,222     $ 19,438     $ 163,461     $ 113,710  
Gross realized losses on sale of securities
    (2,533 )     (943 )     (15,663 )     (60,904 )
Treasury yield hedge
                (3,958 )      
Mark-to-market changes: debt securities trading
    73,563       7,203       134,040       15,015  
Mark-to-market changes: hedge funds and equity securities
    10,818       21,163       9,610       20,735  
Gain on sale of Program Administrator
    1,860             1,860        
 
                       
Net realized investment gains
  $ 116,930     $ 46,861     $ 289,350     $ 88,556  
 
                       
Proceeds from sale of available for sale securities
  $ 208,473     $ 1,616,967     $ 2,054,547     $ 6,982,261  
Proceeds from sale of trading securities
  $ 2,517,784     $ 1,249,780     $ 7,815,137     $ 1,317,185  
     The Company recognized a realized loss of $3,958 related to a U.S. treasury yield hedge transaction that was purchased in May 2010 and terminated in June 2010. In July 2010, the Company sold its program administrator and wholesale brokerage operations for $2,395 in cash and recognized a gain on the sale of $1,860.
g) Pledged Assets
     As of September 30, 2010 and December 31, 2009, $407,052 and $323,681, respectively, of cash and cash equivalents and investments were on deposit with various state or government insurance departments or pledged in favor of ceding companies in order to comply with relevant insurance regulations. In addition, the Company has set up trust accounts to meet security requirements for inter-company reinsurance transactions. These trusts contained assets of $1,215,207 and $701,843 as of September 30, 2010 and December 31, 2009, respectively, and are included in fixed maturity investments.
     The Company also has facilities available for the issuance of letters of credit collateralized against the Company’s investment portfolio. The collateralized portion of these facilities is up to $1,300,000 as of September 30, 2010 and December 31, 2009. See Note 8 “Debt and Financing Arrangements” for details on the facilities.
     The following table shows the Company’s trust accounts on deposit, as well as outstanding and remaining letters of credit facilities, and the collateral committed to support the letters of credit facilities as of September 30, 2010 and December 31, 2009:
                 
    As of     As of  
    September 30,     December 31,  
    2010     2009  
Total trust accounts on deposit
  $ 1,622,259     $ 1,025,524  
Total letters of credit facilities:
               
Citibank Europe plc
    900,000       900,000  
Credit Facility
    800,000       800,000  
 
           
Total letters of credit facilities
    1,700,000       1,700,000  
 
           
Total letters of credit facilities outstanding:
               
Citibank Europe plc
    786,347       794,609  
Credit Facility
    197,446       376,658  
 
           
Total letters of credit facilities outstanding
    983,793       1,171,267  
 
           
Total letters of credit facilities remaining:
               
Citibank Europe plc
    113,653       105,391  
Credit Facility
    602,554       423,342  
 
           
Total letters of credit facilities remaining
    716,207       528,733  
 
           
Collateral committed to support the letter of credit facilities
  $ 1,217,792     $ 1,208,359  
 
           

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)
     Total trust accounts on deposit includes available for sale securities, trading securities and cash and cash equivalents. The fair values of the combined total cash and cash equivalents and investments held under trust were $2,840,051 and $2,233,883 as of September 30, 2010 and December 31, 2009, respectively. Of the total letters of credit facilities outstanding as of September 30, 2010 and December 31, 2009, $7,295 and $263,297 was used to meet security requirements for inter-company transactions and the remaining letters of credit facilities outstanding of $976,498 and $907,970 was used for third-party ceding companies, respectively. Trust accounts were substituted for inter-company letters of credit during 2010.
h) Analysis of Unrealized Losses
     The Company’s primary investment objective is the preservation of capital. Although the Company has been successful in meeting this objective, shifts in interest rates and credit spreads affecting valuation can temporarily place some investments in an unrealized loss position.
     The following table summarizes the market value of those investments in an unrealized loss position for periods less than and greater than 12 months as of September 30, 2010 and December 31, 2009:
                                                 
    September 30, 2010     December 31, 2009  
    Gross Fair     Unrealized             Gross Fair     Unrealized        
    Value     Loss     OTTI OCI     Value     Loss     OTTI OCI  
Less than 12 months
                                               
U.S. Government and Government agencies
  $     $     $     $ 112,349     $ (1,367 )   $  
Non-U.S. Government and Government agencies
    43,038       (794 )             40,450       (1,079 )      
States, municipalities and political subdivisions
                      7,637       (336 )      
Corporate debt
                                               
Financial institutions
    16,164       (586 )           45,697       (560 )      
Industrials
                      18,409       (184 )      
Residential mortgage-backed
                                               
Non-agency residential
                      82,544       (8,797 )     (1,527 )
Agency residential
                      70,525       (1,057 )      
Commercial mortgage-backed
                      56,396       (511 )      
Asset-backed
                      8,516       (120 )      
 
                                   
 
  $ 59,202     $ (1,380 )   $     $ 442,523     $ (14,011 )   $ (1,527 )
 
                                   
 
                                               
More than 12 months
                                               
U.S. Government and Government agencies
  $     $     $     $ 271     $ (22 )   $  
Non-U.S. Government and Government agencies
    2,802     $ (612 )   $       3,700       (511 )      
Corporate debt
                                               
Financial institutions
                      23,462       (1,191 )      
Residential mortgage-backed
                                               
Non-agency residential
                      27,265       (2,720 )     (329 )
Agency residential
                      214       (38 )      
Commercial mortgage-backed
                      149,074       (7,404 )      
Asset-backed
                      419       (26 )      
 
                                   
 
  $ 2,802     $ (612 )   $     $ 204,405     $ (11,912 )   $ (329 )
 
                                   
 
  $ 62,004     $ (1,992 )   $     $ 646,928     $ (25,923 )   $ (1,856 )
 
                                   

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)
     As of September 30, 2010 and December 31, 2009, there were approximately 4 and 159 securities, respectively, in an unrealized loss position. The gross unrealized loss of $1,992 as of September 30, 2010 was primarily the result of widening credit spreads related to increases in market risk premium and reduced market liquidity since the acquisition of these securities. The decrease in the gross unrealized loss from December 31, 2009 to September 30, 2010 is primarily due to selling available for sale debt securities and reinvesting proceeds in trading debt securities thereby reducing unrealized gains/losses recognized in accumulated other comprehensive income.
i) Other-than-temporary impairment charges
     Following the Company’s review of the securities in the investment portfolio during the three and nine months ended September 30, 2010, none and one mortgage-backed security, respectively, was considered to be other-than-temporarily impaired due to the present value of the expected cash flows being lower than the amortized cost. The $168 of OTTI during the nine months ended September 30, 2010 was recognized through earnings due to credit related losses.
     For the mortgage-backed security for which OTTI was recognized due to credit loss during the nine months ended September 30, 2010, the significant inputs utilized to determine a credit loss were the estimated frequency and severity of losses of the underlying mortgages that comprise the mortgage-backed security. The frequency of losses was measured as the credit default rate, which includes such factors such as loan-to-value ratios and credit scores of borrowers. The severity of losses includes such factors as trends in overall housing prices and house prices that are obtained at foreclosure. The frequency and severity inputs were used in projecting the future cash flows of the mortgage backed security. For the security in which the Company recognized an OTTI due to credit loss, the credit default rate was 10.3% and the severity rate was 49.0%.
     Following the Company’s review of the securities in the investment portfolio, 8 securities (7 mortgage-backed securities and 1 corporate bond) were considered to be other-than-temporarily impaired for the three months ended September 30, 2009 due to the present value of the expected cash flows being lower than the amortized cost. Of the $9,861 recognized as OTTI, $1,953 was recognized through earnings in the consolidated income statement due to credit related losses and $7,908 was recognized in “accumulated other comprehensive income” in the consolidated balance sheets.
     For the nine months ended September 30, 2009, 15 securities (13 mortgage-backed securities and 2 corporate bonds) were considered to be other-than-temporarily impaired due to the present value of the expected cash flows being lower than the amortized cost as determined by the Company’s review of the securities in the investment portfolio. Of the $68,049 recognized as OTTI, $49,390 was recognized through earnings in the consolidated income statement due to credit related losses and $18,659 was recognized in “accumulated other comprehensive income” in the consolidated balance sheets.
     The following table shows the range of the credit default rates and severity rates for the mortgage-backed securities for which an OTTI was recognized through earnings during the nine months ended September 30, 2009 as well as the weighted average rates.
         
Significant Input   Range of Inputs   Weighted Average of Input
 
       
Credit default rate
  0.6% - 11.0%   6.1% 
 
       
Severity rate
  30.1% - 100.0%   37.2% 
     The following table summarizes the amounts related to credit losses on debt securities for which a portion of the OTTI was recognized in other comprehensive income in the consolidated income statements for the three and nine months ended September 30, 2010 and 2009:

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)
                                 
    For the Three Months     For the Nine Months  
    ended September 30,     ended September 30,  
    2010     2009     2010     2009  
Beginning balance of credit losses
  $ 1,264     $ 12,614     $ 1,096     $ 7,140  
Additions for credit loss for which OTTI was not previously recognized
          1,135       168       4,302  
Reductions for securities sold during the period (realized)
          (1,826 )           (1,826 )
Reductions for OTTI previously recognized due to intent to sell
                       
Additions resulting from the increase in credit losses
          818             3,125  
Reductions resulting from the improvement in expected cash flows
          (2,230 )           (2,230 )
Adoption of ASU 2010-11
    (1,264 )           (1,264 )      
 
                       
Ending balance of credit losses
  $     $ 10,511     $     $ 10,511  
 
                       
5. DERIVATIVE INSTRUMENTS
     The Company uses currency forward contracts and swaps to manage currency exposure, which are the only derivative instruments used for risk management purposes. The U.S. dollar is the Company’s reporting currency and the functional currency of its operating subsidiaries. The Company enters into insurance and reinsurance contracts where the premiums receivable and losses payable are denominated in currencies other than the U.S. dollar. In addition, the Company maintains a portion of its investments and liabilities in currencies other than the U.S. dollar, primarily the Canadian dollar, Euro and British Sterling. For liabilities incurred in currencies other than U.S. dollars, U.S. dollars are converted to the currency of the loss at the time of claim payment. As a result, the Company has an exposure to foreign currency risk resulting from fluctuations in exchange rates. The Company has developed a hedging strategy using currency forward contracts and swaps to minimize the potential loss of value caused by currency fluctuations. These currency forward contracts and swaps are not designated as hedges and accordingly are carried at fair value on the consolidated balance sheets as a part of “other assets” or “accounts payable and accrued liabilities,” with the corresponding realized and unrealized gains and losses included in “foreign exchange loss” in the unaudited condensed consolidated statements of operations and comprehensive income. The fair value of the currency forward contracts and swaps as of September 30, 2010 was a net receivable of $3,979 and was included in “other assets” on the consolidated balance sheet. The fair value of the currency forward contracts as of December 31, 2009 was a net payable of $1,650 and was included in “accounts payable and accrued expenses” in the consolidated balance sheet.
6. FAIR VALUE OF FINANCIAL INSTRUMENTS
     In accordance with U.S. GAAP, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. There is a three-level valuation hierarchy for disclosure of fair value measurements. The valuation hierarchy is based upon whether the inputs to the valuation of an asset or liability are observable or unobservable in the market at the measurement date, with quoted market prices being the highest level (Level 1) and unobservable inputs being the lowest level (Level 3). A fair value measurement will fall within the level of the hierarchy based on the input that is significant to determining such measurement. The three levels are defined as follows:
    Level 1: Observable inputs to the valuation methodology that are quoted prices (unadjusted) for identical assets or liabilities in active markets.
    Level 2: Observable inputs to the valuation methodology other than quoted market prices (unadjusted) for identical assets or liabilities in active markets. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical assets in markets that are not active and inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the asset or liability.
    Level 3: Inputs to the valuation methodology that are unobservable for the asset or liability.
     The following table shows the fair value of the Company’s financial instruments and where in the fair value hierarchy the fair value measurements are included as of September 30, 2010.

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)
                                         
                    Fair value measurement using:  
                    Quoted prices                
                    in active             Significant  
                    markets for     Significant other     unobservable  
    Carrying     Total fair     identical assets     observable inputs     inputs  
    amount     value     (Level 1)     (Level 2)     (Level 3)  
Available for sale securities:
                                       
U.S. Government and Government agencies
  $ 161,232     $ 161,232     $ 102,241     $ 58,991     $  
Non-U.S. Government and Government agencies
    148,773       148,773             148,773        
States, municipalities and political
    133,782       133,782             133,782        
Corporate debt
    1,126,357       1,126,357             1,126,357        
 
                                   
Total available for sale fixed maturity investments
    1,570,144       1,570,144                          
 
                                   
Trading securities:
                                       
U.S. Government and Government agencies
  $ 1,045,755     $ 1,045,755     $ 931,515     $ 114,240     $  
Non-U.S. Government and Government agencies
    239,489       239,489             239,489        
States, municipalities and political subdivisions
    106,566       106,566             106,566        
Corporate debt
    1,413,637       1,413,637             1,413,637        
Mortgage-backed
    1,749,598       1,749,598             1,520,361       229,237  
Asset-backed
    676,313       676,313             618,621       57,692  
 
                                   
Total trading fixed maturity investments
    5,231,358       5,231,358                          
 
                                   
Total fixed maturity investments
    6,801,502       6,801,502                          
Hedge funds
    328,275       328,275                   328,275  
Equity securities
    121,740       121,740       121,740              
 
                                   
Total investments
    7,251,517       7,251,517                          
 
                                   
Senior notes
  $ 499,017     $ 568,360             568,360        
     The following describes the valuation techniques used by the Company to determine the fair value of financial instruments held as of September 30, 2010.
     U.S. Government and U.S. Government agencies: Comprised primarily of bonds issued by the U.S. treasury, the Federal Home Loan Bank, the Federal Home Loan Mortgage Corporation and the Federal National Mortgage Association. The fair values of the Company’s U.S. government securities are based on quoted market prices in active markets and are included in the Level 1 fair value hierarchy. The Company believes the market for U.S. treasury securities is an actively traded market given the high level of daily trading volume. The fair values of U.S. government agency securities are priced using the spread above the risk-free yield curve. As the yields for the risk-free yield curve and the spreads for these securities are observable market inputs, the fair values of U.S. government agency securities are included in the Level 2 fair value hierarchy.
     Non-U.S. Government and Government agencies: Comprised of fixed income obligations of non-U.S. governmental entities. The fair values of these securities are based on prices obtained from international indices and are included in the Level 2 fair value hierarchy.
     States, municipalities and political subdivisions: Comprised of fixed income obligations of U.S. domiciled state and municipality entities. The fair values of these securities are based on prices obtained from the new issue market, and are included in the Level 2 fair value hierarchy.
     Corporate debt: Comprised of bonds issued by corporations that are diversified across a wide range of issuers and industries. The fair values of corporate bonds that are short-term are priced using spread above the London Interbank Offered Rate yield curve, and

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)
the fair value of corporate bonds that are long-term are priced using the spread above the risk-free yield curve. The spreads are sourced from trade prices and the new issue market. As the significant inputs used to price corporate bonds are observable market inputs, the fair values of corporate bonds are included in the Level 2 fair value hierarchy.
     Mortgage-backed: Primarily comprised of pools of residential and commercial mortgages originated by both U.S. government agencies (such as the Federal National Mortgage Association) and non-U.S. government agency originators. The fair values of mortgage-backed securities originated by U.S. government agencies and non-U.S. government agencies are based on a pricing model that incorporates prepayment speeds and spreads to determine appropriate average life of mortgage-backed securities. The spreads are sourced from broker-dealers, trade prices and the new issue market. As the significant inputs used to price the mortgage-backed securities are observable market inputs, the fair values of these securities are included in the Level 2 fair value hierarchy, unless the significant inputs used to price the mortgage-backed securities are broker-dealer quotes and the Company is not able to determine if those quotes are based on observable market inputs, in which case the fair value is included in the Level 3 hierarchy.
     Asset-backed: Principally comprised of bonds backed by pools of automobile loan receivables, home equity loans, credit card receivables and collateralized loan obligations originated by a variety of financial institutions. The fair values of asset-backed securities are priced using prepayment speed and spread inputs that are sourced from the new issue market. As the significant inputs used to price the asset-backed securities are observable market inputs, the fair values of these securities are included in the Level 2 fair value hierarchy, unless the significant inputs used to price the asset-backed securities are broker-dealer quotes and the Company is not able to determine if those quotes are based on observable market inputs, in which case the fair value is included in the Level 3 hierarchy.
     Hedge funds: Comprised of hedge funds invested in a range of diversified strategies. In accordance with U.S. GAAP, the fair values of the hedge funds are based on the net asset value of the funds as reported by the fund manager, which is not considered an observable input, and as such, the fair values of those hedge funds are included in the Level 3 fair value hierarchy.
     Equity securities: The fair value of the equity securities are prices from market exchanges and therefore included in the Level 1 fair value hierarchy.
     Senior notes: The fair value of the senior notes is based on trades as reported in Bloomberg, which was 113.7% of their principal amount, providing an effective yield of 4.8% as of September 30, 2010. The fair value of the senior notes is included in the Level 2 fair value hierarchy.
     The following is a reconciliation of the beginning and ending balance of financial instruments using significant unobservable inputs (Level 3) for the three and nine months ended September 30, 2010.

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)
                         
    Fair value measurement using significant  
    unobservable inputs (Level 3):  
    Hedge funds     Mortgage-backed     Asset-backed  
Three Months Ended September 30, 2010
                       
Opening balance
  $ 319,592     $ 278,789     $ 103,555  
Total realized and unrealized gains included in net income
    6,093       6,448       406  
Total realized and unrealized losses included in net income
    (3,990 )     (1,548 )     (257 )
Change in unrealized gains included in OCI
          3,238       21  
Change in unrealized losses included in OCI
          (5,119 )     (2 )
Purchases
    6,580       1,115       2,177  
Sales
          (58,998 )     (1,803 )
Cumulative effect adjustment related to the adoption of ASU 2010-11
          1,796       (19 )
Transfers into Level 3
          6,773       5,294  
Transfers out of Level 3
          (3,257 )     (51,680 )
 
                 
Ending balance
  $ 328,275     $ 229,237     $ 57,692  
 
                 
 
                       
Three Months Ended September 30, 2009
                       
Opening balance
  $ 132,560     $     $  
Total gains included in net income:
                       
Realized losses
    (432 )            
Change in fair value of investments
    7,052              
Purchases or sales
    22,660              
Transfers in and/or out of Level 3
                 
 
                 
Ending balance
  $ 161,840     $     $  
 
                 
 
                       
Nine Months Ended September 30, 2010
                       
Opening balance
  $ 184,725     $ 253,979     $ 104,871  
Total realized and unrealized gains included in net income
    8,233       15,928       573  
Total realized and unrealized losses included in net income
    (2,932 )     (41 )      
Change in unrealized gains included in OCI
          2,755       64  
Change in unrealized losses included in OCI
                   
Purchases
    138,249       122,058       53,358  
Sales
          (178,226 )     (7,049 )
Cumulative effect adjustment related to the adoption of ASU 2010-11
          1,796       (19 )
Transfers into Level 3
          55,504       56,034  
Transfers out of Level 3
          (44,516 )     (150,140 )
 
                 
Ending balance
  $ 328,275     $ 229,237     $ 57,692  
 
                 
 
                       
Nine Months Ended September 30, 2009
                       
Opening balance
  $ 48,573     $     $  
Total gains included in net income:
                       
Realized losses
    (3,007 )            
Change in fair value of investments
    15,014              
Purchases or sales
    101,260              
Transfers in and/or out of Level 3
                 
 
                 
Ending balance
  $ 161,840     $     $  
 
                 
     The Company attempts to verify the significant inputs used by broker-dealers in determining the fair value of the securities priced by them. If the Company could not obtain sufficient information to determine if the broker-dealers were using significant observable

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)
inputs such securities have been transferred to Level 3 fair value hierarchy. The Company believes the prices obtained from the broker-dealers are the best estimate of fair value of the securities being priced as the broker-dealers are typically involved in the initial pricing of the security and the Company has compared the price per the broker-dealer to other pricing sources and noted no material differences.
     During the three and nine months ended September 30, 2010, the Company transferred $3,257 and $44,516 of mortgage-backed securities, respectively, and $51,680 and $150,140 of asset-backed securities, respectively, from Level 3 to Level 2 in the fair value hierarchy. The Company transferred those securities as they no longer utilized broker-dealer quotes and instead used other pricing sources that have significant observable inputs. The Company recognizes transfers between levels at the end of the reporting period.
7. RESERVE FOR LOSSES AND LOSS EXPENSES
     The reserve for losses and loss expenses consists of the following:
                 
    September 30,     December 31,  
    2010     2009  
Outstanding loss reserves
  $ 1,181,873     $ 1,152,036  
Reserves for losses incurred but not reported
    3,707,952       3,609,736  
 
           
Reserve for losses and loss expenses
  $ 4,889,825     $ 4,761,772  
 
           
     The table below is a reconciliation of the beginning and ending liability for unpaid losses and loss expenses as of September 30, 2010 and December 31, 2009. Losses incurred and paid are reflected net of reinsurance recoveries.
                 
    September 30,     December 31,  
    2010     2009  
Gross liability at beginning of period
  $ 4,761,772     $ 4,576,828  
Reinsurance recoverable at beginning of period
    (919,991 )     (888,314 )
 
           
Net liability at beginning of period
    3,841,781       3,688,514  
 
           
Net losses incurred related to:
               
Commutation of variable-rated reinsurance contracts
    8,864        
Current year
    778,424       852,052  
Prior years
    (239,424 )     (247,992 )
 
           
Total incurred
    547,864       604,060  
 
           
Net paid losses related to:
               
Current year
    70,701       42,320  
Prior years
    367,851       415,901  
 
           
Total paid
    438,552       458,221  
 
           
Foreign exchange revaluation
    (1,224 )     7,428  
Net liability at end of period
    3,949,869       3,841,781  
Reinsurance recoverable at end of period
    939,956       919,991  
 
           
Gross liability at end of period
  $ 4,889,825     $ 4,761,772  
 
           
     For the nine months ended September 30, 2010, the Company had net favorable reserve development in each of its segments due to actual loss emergence being lower than the initial expected loss emergence. The majority of the net favorable reserve development was recognized in the international insurance segment in the 2004 through 2006 loss years related to the general casualty, healthcare and professional lines of business, which represents a significant portion of the Company’s lines of business.
     For the year ended December 31, 2009, the Company had net favorable reserve development in each of its segments due to actual loss emergence being lower than the initial expected loss emergence. The majority of the net favorable reserve development was recognized in the international insurance segment in the 2004 and 2005 loss years related to the general casualty, healthcare and professional lines of business.

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)
     While the Company has experienced favorable development in its insurance and reinsurance lines, there is no assurance that conditions and trends that have affected the development of liabilities in the past will continue. It is not appropriate to extrapolate future redundancies based on prior years’ development. The methodology of estimating loss reserves is periodically reviewed to ensure that the key assumptions used in the actuarial models continue to be appropriate.
8. DEBT AND FINANCING ARRANGEMENTS
     On July 21, 2006, the Company issued $500,000 aggregate principal amount of 7.50% Senior Notes due August 1, 2016 (“Senior Notes”), with interest on the notes payable on August 1 and February 1 of each year, commencing on February 1, 2007. The Senior Notes were offered by the underwriters at a price of 99.71% of their principal amount, providing an effective yield to investors of 7.54%.
     The Senior Notes can be redeemed by the Company prior to maturity subject to payment of a “make-whole” premium. The Company has no current expectations of calling the notes prior to maturity.
     The Company has a collateralized amended letter of credit facility (the “Credit Facility”) with Citibank Europe plc. that has been and will continue to be used to issue standby letters of credit. The Credit Facility was amended in December 2008 to provide the Company with greater flexibility in the types of securities that are eligible to be posted as collateral and to increase the maximum aggregate amount available under the Credit Facility from $750,000 to $900,000 on an uncommitted basis.
     In November 2007, the Company entered into an $800,000 five-year senior credit facility (the “Facility”) with a syndication of lenders. The Facility consists of a $400,000 secured letter of credit facility for the issuance of standby letters of credit (the “Secured Facility”) and a $400,000 unsecured facility for the making of revolving loans and for the issuance of standby letters of credit (the “Unsecured Facility”). Both the Secured Facility and the Unsecured Facility have options to increase the aggregate commitments by up to $200,000, subject to approval of the lenders. The Facility will be used for general corporate purposes and to issue standby letters of credit. The Facility contains representations, warranties and covenants customary for similar bank loan facilities, including a covenant to maintain a ratio of consolidated indebtedness to total capitalization as of the last day of each fiscal quarter or fiscal year of not greater than 0.35 to 1.0 and a covenant under the Unsecured Facility to maintain a certain consolidated net worth. In addition, each material insurance subsidiary must maintain a financial strength rating from A.M. Best Company of at least A- under the Unsecured Facility and of at least B++ under the Secured Facility. Concurrent with this new Facility, the Company terminated the Letter of Credit Facility with Barclays Bank Plc and all outstanding letters of credit issued thereunder were transferred to the Secured Facility. The Company is in compliance with all covenants under the Facility as of September 30, 2010 and December 31, 2009.
     There are a total of 13 lenders that make up the Facility syndication and that have varying commitments ranging from $20,000 to $87,500. Of the 13 lenders, four have commitments of $87,500 each, four have commitments of $62,500 each, four have commitments of $45,000 each and one has a commitment of $20,000. The one lender in the Facility with a $20,000 commitment has declared bankruptcy under Chapter 11 of the U.S. Bankruptcy Code. This lender did not meet its commitment under the Facility. In July 2010, the Company replaced this bankrupt lender with another lender for the full $20,000 commitment under the Facility.
     In November 2008, Holdings requested a $250,000 borrowing under its Unsecured Facility. The borrowing was requested to ensure the preservation of the Company’s financial flexibility in light of the uncertainty in the credit markets at that time. On November 21, 2008, the Company received $243,750 of loan proceeds from the borrowing, as $6,250 was not received from the lender in bankruptcy. On February 23, 2009, the Company repaid in full the $243,750 borrowing under its Unsecured Facility.

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)
9. GOODWILL AND INTANGIBLE ASSETS
     The following table shows an analysis of goodwill and intangible assets for the nine months ended September 30, 2010 and the year ended December 31, 2009:
                                 
            Intangible              
            assets with     Intangible        
            indefinite     assets with        
    Goodwill     lives     finite lives     Total  
Net balance at December 31, 2008
  $ 268,532     $ 23,920     $ 47,490     $ 339,942  
Additions
                       
Amortization
                (4,185 )     (4,185 )
Impairments
    (156 )           (6,866 )     (7,022 )
 
                       
Net balance at December 31, 2009
    268,376       23,920       36,439       328,735  
Additions
                       
Amortization
                (2,675 )     (2,675 )
 
                       
Net balance at September 30, 2010
    268,376       23,920       33,764       326,060  
 
                       
 
                               
Gross balance
    268,532       23,920       48,200       340,652  
Accumulated amortization
                (7,570 )     (7,570 )
Impairments
    (156 )           (6,866 )     (7,022 )
 
                       
Net balance
  $ 268,376     $ 23,920     $ 33,764     $ 325,060  
 
                       
     The amortization of the intangible assets with definite lives for the remainder of 2010 and for the years ended December 31, 2011, 2012, 2013, 2014 and thereafter will be $808, $2,978, $2,533, $2,533, $2,533 and $22,378, respectively. The intangible assets will be amortized over a weighted average useful life of 12.5 years.
10. INCOME TAXES
     Under current Bermuda law, Holdings and its Bermuda subsidiaries are not required to pay taxes in Bermuda on either income or capital gains. Holdings and Allied World Assurance Company, Ltd have received an assurance from the Bermuda Minister of Finance under the Exempted Undertakings Tax Protection Act 1966 of Bermuda, that in the event of any such taxes being imposed, Holdings and Allied World Assurance Company, Ltd will be exempted from such taxes until March 28, 2016.
     Certain subsidiaries of Holdings file U.S. federal income tax returns and various U.S. state income tax returns, as well as income tax returns in the United Kingdom, Ireland, Switzerland and Hong Kong. The following tax years by jurisdiction are open to examination:
         
    Fiscal Years  
U.S. Internal Revenue Service (“IRS”) for the U.S. subsidiaries
    2006 – 2009  
Inland Revenue for the U.K. branches
    2008 – 2009  
Irish Revenue Commissioners for the Irish subsidiaries
    2005 – 2009  
Swiss Federal Tax Administration for the Swiss branch
    2008 – 2009  
Inland Revenue Department for the Hong Kong branch
                2009  
     To the best of the Company’s knowledge, there are no examinations pending by the Inland Revenue or the Irish Revenue Commissioners. The IRS is currently completing an examination of the 2006 tax returns of Darwin Professional Underwriters, Inc. (“Darwin”). The examination covers the tax return filed for the period subsequent to Darwin’s initial public offering on May 16, 2006 to December 31, 2006.
     Management has deemed all material tax positions to have a greater than 50% likelihood of being sustained based on technical merits if challenged. The Company does not expect any material unrecognized tax benefits within 12 months of January 2010.

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)
11. SHAREHOLDERS’ EQUITY
a) Authorized shares
     The authorized share capital of Holdings as of September 30, 2010 and December 31, 2009 was $10,000. The issued share capital consists of the following:
                 
    September 30,     December 31,  
    2010     2009  
Common shares issued and fully paid, par value $0.03 per share
    50,793,902       49,734,487  
 
           
Share capital at end of period
  $ 1,524     $ 1,492  
 
           
         
    Nine Months Ended
    September 30, 2010
Shares issued, balance at beginning of period
    49,734,487  
Shares issued
    1,059,415  
 
       
Total shares issued at end of period
    50,793,902  
 
       
 
       
Treasury shares issued, balance at beginning of period
     
Shares repurchased
    (8,399,326 )
 
       
Total treasury shares at end of period
    (8,399,326 )
 
       
 
       
Total shares outstanding
    42,394,576  
 
       
     As of September 30, 2010, there were outstanding 38,944,723 voting common shares and 3,449,853 non-voting common shares.
b) Share Warrants
     In conjunction with the private placement offering at the formation of the Company, the Company granted warrants to certain founding shareholders to acquire up to 5,500,000 common shares at an exercise price of $34.20 per share. These warrants are exercisable in certain limited conditions, including a public offering of common shares, and expire November 21, 2011. Any cash dividends paid to shareholders do not impact the exercise price of $34.20 per share for these founder warrants. There are various restrictions on the ability of warrant holders to dispose of their shares. On August 13, 2010, the Company repurchased a warrant owned by The Chubb Corporation (“Chubb”) in a privately negotiated transaction. The warrant entitled Chubb to purchase 2,000,000 of the Company’s common shares for $34.20 per share. The Company repurchased the warrant for an aggregate purchase price of $32,819. After this repurchase, Chubb has no warrants remaining and no other disclosed equity interest in the Company. The repurchase of the warrant was recognized as a reduction in “additional paid-in capital” in the consolidated balance sheets. The repurchase was executed separately from the Company’s $500,000 share repurchase program discussed in Note 11(d) below.
c) Dividends
     In February 2010, the Company declared a dividend of $0.20 per common share payable on April 1, 2010 to shareholders of record on March 16, 2010. In May 2010, the Company declared a quarterly dividend of $0.20 per common share, payable on June 10, 2010 to shareholders of record on May 25, 2010. In August 2010, the Company declared a dividend of $0.20 per common share payable on September 9, 2010 to shareholders of record on August 24, 2010. The total dividends paid amounted to $28,774.
     In February 2009, the Company declared a quarterly dividend of $0.18 per common share on April 2, 2009 payable to shareholders of record on March 17, 2009. In May 2009, the Company declared a quarterly dividend of $0.18 per common share payable on June 11, 2009 to shareholders of record on May 26, 2009. In August 2009, the Company declared a quarterly dividend of $0.18 per common share payable on September 10, 2009 to shareholders of record on August 25, 2009. The total dividends paid amounted to $26,752.
d) Share repurchase
     In May 2010, the board of directors of Holdings authorized the Company to repurchase up to $500,000 of Holdings’ common shares through a share repurchase program. Repurchases under the authorization may be effected from time to time through open market purchases, privately negotiated transactions, tender offers or otherwise. This authorization is effective through May 3, 2012.

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)
The timing, form and amount of the share repurchases under the program will depend on a variety of factors, including market conditions, the Company’s capital position, legal requirements and other factors. At any time, the repurchase program may be modified, extended or terminated by the board of directors. As part of the share repurchase program, we entered into a rule 10b5-1 repurchase plan that enables the Company to complete share repurchases during trading blackout periods. During the three and nine months ended September 30, 2010, the Company repurchased through open market purchases 2,318,285 shares and 3,399,326 shares, at a total cost of $115,920 and $165,009, for an average price of $50.00 per share and $48.54 per share, respectively. We have classified these repurchased shares as “Treasury shares, at cost” on the consolidated balance sheets.
     On August 6, 2010, the Company repurchased 5,000,000 of its common shares for $250,000, or $50.00 per share, in a privately negotiated transaction from GS Capital Partners and other investment funds, which are affiliates of The Goldman Sachs Group, Inc. and founding shareholders of the Company. The shares repurchased were not cancelled and classified these repurchased shares as “Treasury shares, at cost” on the consolidated balance sheets. The repurchase was funded using available cash on hand and was executed separately from the Company’s $500,000 share repurchase program discussed above.
12. EMPLOYEE BENEFIT PLANS
a) Employee option plan
     In 2001, the Company implemented the Allied World Assurance Company Holdings, Ltd Second Amended and Restated 2001 Employee Stock Option Plan (the “Plan”). Under the Plan, up to 4,000,000 common shares of Holdings may be issued. Holdings has filed a registration statement on Form S-8 under the Securities Act of 1933, as amended, to register common shares issued or reserved for issuance under the Plan. These options are exercisable in certain limited conditions, expire after 10 years, and generally vest pro-rata over four years from the date of grant. The exercise price of options issued are determined by the compensation committee of the board of directors but shall not be less than 100% of the fair market value of the common shares of Holdings on the date the option award is granted.
                 
    Nine Months Ended September 30, 2010
            Weighted Average
    Options   Exercise Price
Outstanding at beginning of period
    1,314,907     $ 35.54  
Granted
    311,610       46.05  
Exercised
    (226,289 )     31.17  
Forfeited
    (28,941 )     42.88  
Expired
    (5,062 )     45.72  
 
               
Outstanding at end of period
    1,366,225     $ 38.47  
 
               
     Assumptions used in the option-pricing model for the options granted during the nine months ended September 30, 2010 are as follows:
         
    Options Granted During  
    the Nine Months Ended  
    September 30, 2010  
Expected term of option
    5.47  years
Weighted average risk-free interest rate
    2.65 %
Weighted average expected volatility
    42.35 %
Dividend yield
    1.25 %
Weighted average fair value on grant date
  $ 17.34  
 
     
     The Company has assumed a weighted average annual forfeiture rate of 6.37% in determining the compensation expense over the service period.
     Compensation expense of $706 and $2,256 relating to the options has been included in “general and administrative expenses” in the Company’s consolidated income statements for the three and nine months ended September 30, 2010, respectively. Compensation expense of $643 and $1,950 relating to the options has been included in “general and administrative expenses” in the Company’s consolidated income statements for the three and nine months ended September 30, 2009, respectively. As of September 30, 2010 and December 31, 2009, the Company has recorded in “additional paid-in capital” on the consolidated balance sheets an amount of $37,983 and $28,699, respectively, in connection with all options granted.

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)
b) Stock incentive plan
     In 2004, the Company implemented the Allied World Assurance Company Holdings, Ltd Second Amended and Restated 2004 Stock Incentive Plan (the “Stock Incentive Plan”). The Stock Incentive Plan provides for grants of restricted stock, restricted stock units (“RSUs”), dividend equivalent rights and other equity-based awards. A total of 2,000,000 common shares may be issued under the Stock Incentive Plan. To date, only RSUs have been granted. These RSUs generally vest in the fourth or fifth year from the original grant date, or pro-rata over four years from the date of the grant.
                 
    Nine Months Ended September 30, 2010
            Weighted Average
            Grant Date Fair
    RSUs   Value
Outstanding RSUs at beginning of period
    915,432     $ 36.51  
RSUs granted
    41,197       46.05  
Performance-based RSUs granted
    279,900       46.05  
RSUs fully vested
    (359,660 )     36.86  
RSUs forfeited
    (16,263 )     38.96  
 
               
Outstanding RSUs at end of period
    860,606     $ 39.87  
 
               
     During 2010, the Company granted performance-based RSUs in lieu of utilizing the LTIP (as defined in Note 11(c)). The performance-based RSUs are structured in exactly the same form as shares issued under the LTIP in terms of vesting restrictions and achievement of established performance criteria. For the performance-based RSUs granted in 2010, the Company anticipates that the performance goals are likely to be achieved. Based on the performance goals, the performance-based RSUs granted in 2010 are expensed at 100% of the fair market value of Holding’s common share on the date of grant. The expense is recognized over the performance period.
     Compensation expense of $3,174 and $10,215 relating to the issuance of the RSUs, including the performance based RSUs, has been recognized in “general and administrative expenses” in the Company’s consolidated income statements for the three and nine months ended September 30, 2010, respectively. Compensation expense of $2,101 and $6,725 relating to the issuance of the RSUs, including the performance-based RSUs, has been recognized in “general and administrative expenses” in the Company’s consolidated income statements for the three and nine months ended September 30, 2009, respectively. The compensation expense for the RSUs is based on the fair market value of Holdings’ common shares at the time of grant. The Company has assumed a weighted average annual forfeiture rate of 4.98% in determining the compensation expense over the service period.
     As of September 30, 2010 and December 31, 2009, the Company has recorded $34,759 and $28,827, respectively, in “additional paid-in capital” on the consolidated balance sheets in connection with the RSUs awarded.
c) Long-term incentive plan
     In 2006, the Company implemented the Allied World Assurance Company Holdings, Ltd Second Amended and Restated Long-Term Incentive Plan (“LTIP”). The LTIP provides for performance based equity awards to key employees in order to promote the long-term growth and profitability of the Company. Each award represents the right to receive a number of common shares in the future, based upon the achievement of established performance criteria during the applicable three-year performance period. A total of 2,000,000 common shares may be issued under the LTIP.
                 
    Nine Months Ended September 30, 2010
            Weighted Average
            Grant Date Fair
    LTIP   Value
Outstanding LTIP awards at beginning of period
    1,148,411     $ 42.28  
Additional LTIP awards granted due to the achievement of 2007 - 2009 performance criteria
    181,250       43.40  
LTIP awards vested
    (543,750 )     43.40  
 
               
Outstanding LTIP awards at end of period
    785,911     $ 41.76  
 
               
     Compensation expense of $3,843 and $12,706 relating to the LTIP has been recognized in “general and administrative expenses” in the Company’s consolidated income statements for the three and nine months ended September 30, 2010, respectively. Compensation expense of $4,618 and $13,902 relating to the LTIP has been recognized in “general and administrative expenses” in

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)
the Company’s consolidated income statements for the three and nine months ended September 30, 2009, respectively. The compensation expense for the LTIP is based on the fair market value of the Company’s common shares at the time of grant. The LTIP is deemed to be an equity plan and as such, $72,468 and $59,777 have been included in “additional paid-in capital” on the consolidated balance sheets as of September 30, 2010 and December 31, 2009, respectively.
     In calculating the compensation expense and in the determination of share equivalents for the purpose of calculating diluted earnings per share, it is estimated for the LTIP awards granted in 2008 that the maximum performance goals as set by the LTIP are likely to be achieved over the performance period. Based on the performance goals, the LTIP awards granted in 2008 are expensed at 150% of the fair market value of Holdings’ common shares on the date of grant. For the LTIP awards granted in 2009, the Company anticipates that the performance goals as set by the LTIP are likely to be achieved above the target but below the maximum over the performance period. Based on the performance goals, the LTIP awards granted in 2009 are expensed at 132.5% of the fair market value of Holdings’ common shares on the date of grant. The expense is recognized over the performance period.
d) Cash-equivalent stock awards
     As part of the Company’s annual year-end compensation awards, the Company granted both stock-based awards and cash-equivalent stock awards. The cash-equivalent awards were granted to employees who received RSU and LTIP awards and were granted in lieu of granting the full award as a stock-based award. The cash-equivalent time vesting RSU awards vest pro-rata over four years from the date of grant. The cash-equivalent LTIP awards and performance based RSU awards vest after a three-year performance period. As the cash-equivalent awards are settled in cash, a liability is established equal to the product of the fair market value of Holdings’ common shares as of the end of the reporting period and the total awards outstanding. The liability is included in “accounts payable and accrued expenses” in the consolidated balance sheets and changes in the liability are recorded in “general and administrative expenses” in the consolidated income statements. For the three and nine months ended September 30, 2010, the expense recognized for the cash-equivalent stock awards was $4,767 and $10,088, respectively. For the three and nine months ended September 30, 2009, the expense recognized for the cash-equivalent stock awards was $1,156 and $2,501, respectively.
     The following table shows the stock related compensation expense relating to the stock options, RSUs, LTIP and cash equivalent awards for the three and nine months ended September 30, 2010 and 2009.
                                 
    For the Three Months Ended     For the nine months Ended  
    September 30,     September 30,  
    2010     2009     2010     2009  
Stock Options
  $ 706     $ 643     $ 2,256     $ 1,950  
RSUs
    3,174       2,101       10,215       6,725  
LTIP
    3,843       4,618       12,706       13,902  
Cash-equivalent stock awards
    4,767       1,156       10,088       2,501  
 
                       
Total
  $ 12,490     $ 8,518     $ 35,265     $ 25,078  
 
                       
13. EARNINGS PER SHARE
     The following table sets forth the comparison of basic and diluted earnings per share:
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2010     2009     2010     2009  
Basic earnings per share
                               
Net income
  $ 254,520     $ 200,554     $ 572,219     $ 445,632  
Weighted average common shares outstanding
    45,544,060       49,574,266       48,580,541       49,449,809  
 
                       
Basic earnings per share
  $ 5.59     $ 4.05     $ 11.78     $ 9.01  
 
                       

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2010     2009     2010     2009  
Diluted earnings per share
                               
Net income
  $ 254,520     $ 200,554     $ 572,219     $ 445,632  
Weighted average common shares outstanding
    45,544,060       49,574,266       48,580,541       49,449,809  
Share equivalents:
                               
Warrants and options
    1,689,743       1,493,624       1,627,137       1,045,005  
Restricted stock units
    631,841       449,945       659,402       376,212  
LTIP awards
    974,347       828,078       1,020,310       804,980  
 
                       
Weighted average common shares and common share equivalents outstanding — diluted
    48,839,991       52,345,913       51,887,390       51,676,006  
 
                       
Diluted earnings per share
  $ 5.21     $ 3.83     $ 11.03     $ 8.62  
 
                       
     For the three months ended September 30, 2010, a weighted average of 482,979 employee stock options were considered anti-dilutive and were therefore excluded from the calculation of the diluted earnings per share. For the nine months ended September 30, 2010, a weighted average of 620,556 employee stock options were considered anti-dilutive and were therefore excluded from the calculation of the diluted earnings per share.
     For the three months ended September 30, 2009 a weighted average of 593,704 employee stock options and 4,800 RSUs, respectively, were considered anti-dilutive and were therefore excluded from the calculation of the diluted earnings per share. For the nine months ended September 30, 2009, a weighted average of 719,462 employee stock options and 151,234 RSUs were considered anti-dilutive and were therefore excluded from the calculation of the diluted earnings per share.
14. SEGMENT INFORMATION
     The determination of reportable segments is based on how senior management monitors the Company’s underwriting operations. Management monitors the performance of its direct underwriting operations based on the geographic location of the Company’s offices, the markets and customers served and the type of accounts written. The Company is currently organized into three operating segments: U.S. insurance, international insurance and reinsurance. All product lines fall within these classifications.
     The U.S. insurance segment includes the Company’s direct specialty insurance operations in the United States. This segment provides both direct property and specialty casualty insurance primarily to non-Fortune 1000 North American domiciled accounts. The international insurance segment includes the Company’s direct insurance operations in Bermuda, Europe and Hong Kong. This segment provides both direct property and casualty insurance primarily to Fortune 1000 North American domiciled accounts and mid-sized to large non-North American domiciled accounts. The reinsurance segment includes the reinsurance of property, general casualty, professional liability, specialty lines and property catastrophe coverages written by insurance companies. The Company presently write reinsurance on both a treaty and a facultative basis, targeting several niche reinsurance markets.
     Responsibility and accountability for the results of underwriting operations are assigned by major line of business within each segment. Because the Company does not manage its assets by segment, investment income, interest expense and total assets are not allocated to individual reportable segments. General and administrative expenses are allocated to segments based on various factors, including staff count and each segment’s proportional share of gross premiums written.
     Management measures results for each segment on the basis of the “loss and loss expense ratio,” “acquisition cost ratio,” “general and administrative expense ratio” and the “combined ratio.” The “loss and loss expense ratio” is derived by dividing net losses and loss expenses by net premiums earned. The “acquisition cost ratio” is derived by dividing acquisition costs by net premiums earned. The “general and administrative expense ratio” is derived by dividing general and administrative expenses by net premiums earned. The “combined ratio” is the sum of the “loss and loss expense ratio,” the “acquisition cost ratio” and the “general and administrative expense ratio.”

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)
     The following table provides a summary of the segment results for the three and nine months ended September 30, 2010 and 2009.
                                 
            International              
Three months ended September 30, 2010   U.S. Insurance     Insurance     Reinsurance     Total  
Gross premiums written
  $ 181,232     $ 100,858     $ 96,355     $ 378,445  
Net premiums written
    140,481       65,520       96,168       302,169  
Net premiums earned
    129,650       80,557       129,289       339,496  
Other income
                       
Net losses and loss expenses
    (55,144 )     (11,040 )     (60,804 )     (126,988 )
Acquisition costs
    (18,081 )     29       (23,867 )     (41,919 )
General and administrative expenses
    (31,781 )     (22,819 )     (15,271 )     (69,871 )
 
                       
Underwriting income
    24,644       46,727       29,347       100,718  
Net investment income
                            59,479  
Net realized investment gains
                            116,930  
Net impairment charges recognized in earnings
                             
Amortization and impairment of intangible assets
                            (892 )
Interest expense
                            (9,533 )
Foreign exchange gain
                            1,387  
 
                             
Income before income taxes
                          $ 268,089  
 
                             
 
                               
Loss and loss expense ratio
    42.5 %     13.7 %     47.0 %     37.4 %
Acquisition cost ratio
    13.9 %     0.0 %     18.5 %     12.3 %
General and administrative expense ratio
    24.5 %     28.3 %     11.8 %     20.6 %
 
                       
Combined ratio
    80.9 %     42.0 %     77.3 %     70.3 %
 
                       
                                 
            International              
Three months ended September 30, 2009   U.S. Insurance     Insurance     Reinsurance     Total  
Gross premiums written
  $ 169,629     $ 107,768     $ 124,440     $ 401,837  
Net premiums written
    126,600       69,939       124,417       320,956  
Net premiums earned
    111,558       97,705       119,508       328,771  
Other income
    298                   298  
Net losses and loss expenses
    (42,071 )     (28,301 )     (66,069 )     (136,441 )
Acquisition costs
    (14,354 )     (516 )     (21,760 )     (36,630 )
General and administrative expenses
    (25,929 )     (19,866 )     (11,726 )     (57,521 )
 
                       
Underwriting income
    29,502       49,022       19,953       98,477  
Net investment income
                            73,032  
Net realized investment gains
                            46,861  
Net impairment charges recognized in earnings
                            (1,953 )
Amortization and impairment of intangible assets
                            (1,065 )
Interest expense
                            (9,523 )
Foreign exchange gain
                            273  
 
                             
Income before income taxes
                          $ 206,102  
 
                             
 
                               
Loss and loss expense ratio
    37.7 %     29.0 %     55.3 %     41.5 %
Acquisition cost ratio
    12.9 %     0.5 %     18.2 %     11.1 %
General and administrative expense ratio
    23.2 %     20.3 %     9.8 %     17.5 %
 
                       
Combined ratio
    73.8 %     49.8 %     83.3 %     70.1 %
 
                       

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)
                                 
            International              
Nine months ended September 30, 2010   U.S. Insurance     Insurance     Reinsurance     Total  
Gross premiums written
  $ 532,980     $ 389,881     $ 453,594     $ 1,376,455  
Net premiums written
    407,274       245,110       452,872       1,105,256  
Net premiums earned
    384,514       257,027       375,203       1,016,744  
Other income
    913                   913  
Net losses and loss expenses
    (222,767 )     (133,069 )     (192,028 )     (547,864 )
Acquisition costs
    (50,895 )     29       (69,775 )     (120,641 )
General and administrative expenses
    (89,578 )     (67,321 )     (44,524 )     (201,423 )
 
                       
Underwrting (loss) income
    22,187       56,666       68,876       147,729  
Net investment income
                            193,975  
Net realized investment gains
                            289,350  
Net impairment charges recognized in earnings
                            (168 )
Amortization and impairment of intangible assets
                            (2,675 )
Interest expense
                            (28,592 )
Foreign exchange loss
                            (248 )
 
                             
Loss before income taxes
                          $ 599,371  
 
                             
 
                               
Loss and loss expense ratio
    57.9 %     51.8 %     51.2 %     53.9 %
Acquisition cost ratio
    13.2 %     0.0 %     18.6 %     11.9 %
General and administrative expense ratio
    23.3 %     26.2 %     11.9 %     19.8 %
 
                       
Combined ratio
    94.4 %     78.0 %     81.7 %     85.6 %
 
                       
                                 
            International              
Nine months ended September 30, 2009   U.S. Insurance     Insurance     Reinsurance     Total  
Gross premiums written
  $ 505,710     $ 425,672     $ 442,834     $ 1,374,216  
Net premiums written
    369,912       275,066       442,453       1,087,431  
Net premiums earned
    327,850       320,706       337,855       986,411  
Other income
    1,133                   1,133  
Net losses and loss expenses
    (143,090 )     (141,595 )     (177,972 )     (462,657 )
Acquisition costs
    (42,308 )     (3,243 )     (65,170 )     (110,721 )
General and administrative expenses
    (83,323 )     (58,599 )     (34,458 )     (176,380 )
 
                       
Underwrting income
    60,262       117,269       60,255       237,786  
Net investment income
                            227,423  
Net realized investment gains
                            88,556  
Net impairment charges recognized in earnings
                            (49,390 )
Amortization and impairment of intangible assets
                            (3,195 )
Interest expense
                            (29,492 )
Foreign exchange gain
                            660  
 
                             
Income before income taxes
                          $ 472,348  
 
                             
 
                               
Loss and loss expense ratio
    43.6 %     44.2 %     52.7 %     46.9 %
Acquisition cost ratio
    12.9 %     1.0 %     19.3 %     11.2 %
General and administrative expense ratio
    25.4 %     18.3 %     10.2 %     17.9 %
 
                       
Combined ratio
    81.9 %     63.5 %     82.2 %     76.0 %
 
                       
     The following table shows an analysis of the Company’s net premiums written by geographic location of the Company’s subsidiaries for the three and nine months ended September 30, 2010 and 2009. All inter-company premiums have been eliminated.

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2010     2009     2010     2009  
United States
  $ 184,223     $ 202,302     $ 622,483     $ 615,095  
Bermuda
    88,386       93,638       347,287       363,950  
Europe
    24,293       23,344       115,003       106,257  
Hong Kong
    1,045       1,672       6,658       2,129  
Singapore
    4,222             13,825        
 
                       
Total net premiums written
  $ 302,169     $ 320,956     $ 1,105,256     $ 1,087,431  
 
                       
15. SUBSEQUENT EVENTS
     On September 30, 2010, the Company announced that its board of directors unanimously approved a plan for Holdings to redomesticate its place of incorporation from Bermuda to Switzerland (the “Redomestication”). The completion of the Redomestication is subject to approval by the Company’s shareholders and the Supreme Court of Bermuda. Holders of the Company’s voting and non-voting common shares will be asked to vote in favor of a Scheme of Arrangement at special court-ordered meetings that will be held on Thursday, November 18, 2010. A proxy statement with respect to such shareholder meetings (the “Proxy Statement”) was mailed to the Company’s shareholders on October 14, 2010. If the Scheme of Arrangement is approved by the holders of the Company’s voting and non-voting common shares, the Supreme Court of Bermuda is expected to hold a hearing to approve the Scheme of Arrangement. Assuming the Company receives the necessary shareholder and court approvals, and certain other conditions described in the Proxy Statement are satisfied, the Company expects the Redomestication to be completed before the end of the calendar year 2010. After the Redomestication, the Company will still continue to report under U.S. GAAP and the Company expects its common shares will continue to trade on the New York Stock Exchange under the symbol “AWH,” the same symbol under which the Company’s common shares are currently listed. Upon completion of the transaction, the Company will remain subject to SEC reporting requirements and the Company will continue to report its consolidated financial results in U.S. dollars. The Company believes the Redomestication will also give the Company the ability to maintain a competitive worldwide effective corporate tax rate. See “Summary – The Redomestication” in the Proxy Statement filed with the SEC on October 14, 2010 for further information regarding the transaction.
     On November 4, 2010, the Company declared a quarterly dividend of $0.20 per common share, payable on November 26, 2010 to shareholders of record on November 15, 2010. On the same date, the Company also declared a contingent special dividend of $0.25 per common share related to the Redomestication. Under Swiss law, the Company does not expect to be able to pay a dividend until two months after its next annual meeting which is expected to take place in early May 2011. This special dividend will provide a dividend to shareholders for the interim period. This special dividend will be payable on November 26, 2010 to shareholders of record on November 15, 2010. The Company will only pay the special dividend if it receives the requisite shareholder approval of the proposed Redomestication and the other closing conditions set forth in the Proxy Statement are either waived or satisfied.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
     The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and related notes included elsewhere in this Form 10-Q. References in this Form 10-Q to the terms “we,” “us,” “our,” “the company” or other similar terms mean the consolidated operations of Allied World Assurance Company Holdings, Ltd and its subsidiaries, unless the context requires otherwise. References in this Form 10-Q to the term “Holdings” means Allied World Assurance Company Holdings, Ltd only.
Note on Forward-Looking Statement
     This Form 10-Q and other publicly available documents may include, and our officers and representatives may from time to time make, projections concerning financial information and statements concerning future economic performance and events, plans and objectives relating to management, operations, products and services, and assumptions underlying these projections and statements. These projections and statements are forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995 and are not historical facts but instead represent only our belief regarding future events, many of which, by their nature, are inherently uncertain and outside our control. These projections and statements may address, among other things, our strategy for growth, product development, financial results and reserves. Actual results and financial condition may differ, possibly materially, from these projections and statements and therefore you should not place undue reliance on them. Factors that could cause our actual results to differ, possibly materially, from those in the specific projections and statements are discussed throughout this Management’s Discussion and Analysis of Financial Condition and Results of Operations, in “Risk Factors” in Item 1A of Part I of our 2009 Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission (“SEC”) on March 1, 2010 (the “2009 Form 10-K”) and in the “Risk Factors” and the “Cautionary Statement Regarding Forward-Looking Statements” sections of our definitive proxy statement filed with the SEC on October 14, 2010 (the “Proxy Statement”). We are under no obligation (and expressly disclaim any such obligation) to update or revise any forward-looking statement that may be made from time to time, whether as a result of new information, future developments or otherwise.
Overview
Our Business
     We write a diversified portfolio of property and casualty insurance and reinsurance internationally through our subsidiaries and branches based in Bermuda, Europe, Hong Kong, Singapore and the United States. We manage our business through three operating segments: U.S. insurance, international insurance and reinsurance. As of September 30, 2010, we had approximately $10.5 billion of total assets, $3.3 billion of total shareholders’ equity and $3.8 billion of total capital, which includes shareholders’ equity and senior notes.
     During the three and nine month periods that ended September 30, 2010, we experienced premium rate declines across all of our operating segments and most lines of business. We believe the premium rate decreases are due to increased competition, increased capacity and an absence of large severity casualty losses. We expect this trend to continue during the remainder of 2010, and we are anticipating this trend to continue into 2011. Despite the challenging pricing environment, we do believe that there are opportunities where certain products have adequate premium rates and that the expanded breadth of our operations allows us to target those classes of business. Given these trends, we continue to be selective in the policies and reinsurance contracts we underwrite. Our consolidated gross premiums written decreased by $23.4 million, or 5.8%, for the three months ended September 30, 2010 compared to the three months ended September 30, 2009 and our net income increased $53.9 million, or 26.9%, for the same three-month period. The increase in net income for the three months ended September 30, 2010 compared to the three months ended September 30, 2009 was primarily due to higher net realized investment gains. Our consolidated gross premiums written increased by $2.2 million, or 0.2%, for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009, and our net income increased $126.6 million, or 28.4%, for the same nine-month period. The increase in net income for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009 was primarily due to higher net realized investment gains and lower other-than-temporary-impairment charges (“OTTI”), partially offset by higher net losses and loss expenses due to increased property losses.
Recent Developments
     In March 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) 2010-11 “Derivatives and Hedging: Scope Exception Related to Embedded Credit Derivatives” (“ASU 2010-11”). On June 30, 2010, in accordance with ASU 2010-11, we elected the fair value option for all of our mortgage-backed and asset-backed securities. As a result

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of the fair value election, starting with the three months ended September 30, 2010, any changes in the fair value of the mortgage-backed and asset-backed securities will be recognized through earnings in “net realized investment gains (losses)” on the unaudited condensed consolidated statements of operations and comprehensive income (“consolidated income statements”). On July 1, 2010, we reclassified $968.8 million of mortgage-backed and asset-backed securities, combined, from “fixed maturity investments available for sale, at fair value” to “fixed maturity investments trading, at fair value” on the unaudited condensed consolidated balance sheets (“consolidated balance sheets”). Also on July 1, 2010, we reclassified $41.9 million of net unrealized gains from “accumulated other comprehensive income” to “retained earnings” on the consolidated balance sheets.
     In May 2010, the board of directors of Holdings authorized the company to repurchase up to $500 million of Holdings’ common shares through a share repurchase program. Repurchases under the authorization may be effected from time to time through open market purchases, privately negotiated transactions, tender offers or otherwise. This authorization is effective through May 3, 2012. The timing, form and amount of the share repurchases under the program will depend on a variety of factors, including market conditions, the company’s capital position, legal requirements and other factors. At any time, the repurchase program may be modified, extended or terminated by the board of directors. As part of the share repurchase program, we entered into a rule 10b5-1 repurchase plan that enables us to complete share repurchases during trading blackout periods. During the three and nine months ended September 30, 2010, we repurchased through open-market purchases 2,318,285 shares and 3,399,326 shares at a total cost of $115.9 million and $165.0 million, for an average price of $50.00 per share and $48.54 per share, respectively. We have classified these repurchased shares as “Treasury shares, at cost” on the consolidated balance sheets.
     In June 2010, we received approval from Lloyd’s of London to establish Syndicate 2232 (pseudonym “AWH”) that became fully operational and began writing business in June 2010. The syndicate offers select product lines including international property, general casualty, professional liability and international treaty reinsurance, targeted at key territories such as countries in Latin America and the Asia Pacific region. Syndicate 2232’s primary purpose is to enhance our international insurance and reinsurance platforms and capabilities. For the three and nine months ended September 30, 2010, Syndicate 2232 had gross premiums written of $11.8 million and $15.2 million, respectively.
     On August 6, 2010, we repurchased 5,000,000 of our common shares for $250.0 million, or $50.00 per share, in a privately negotiated transaction from GS Capital Partners and other investment funds, which are affiliates of The Goldman Sachs Group, Inc. and founding shareholders of our company. The shares repurchased were not cancelled and were classified as treasury shares. On August 13, 2010, we repurchased a warrant owned by The Chubb Corporation (“Chubb”) in a privately negotiated transaction. The warrant entitled Chubb to purchase 2,000,000 common shares for $34.20 per share. We repurchased the warrant for an aggregate purchase price of $32.8 million. After this repurchase, Chubb has no warrants remaining and no other disclosed equity interest in the company. The repurchase of the warrants was recognized as a reduction in shareholders’ equity. Both of the aforementioned transactions were funded using available cash on hand and were executed separately from the company’s $500 million share repurchase program.
     On September 30, 2010, we announced that our board of directors unanimously approved a plan for Holdings to redomesticate its place of incorporation from Bermuda to Switzerland (the “Redomestication”). The completion of the Redomestication is subject to approval by the company’s shareholders and the Supreme Court of Bermuda. Holders of our voting and non-voting common shares will be asked to vote in favor of a Scheme of Arrangement at special court-ordered meetings that will be held on Thursday, November 18, 2010. A proxy statement with respect to such shareholder meetings (the “Proxy Statement”) was mailed to our shareholders on October 14, 2010. If the Scheme of Arrangement is approved by the holders of the company’s voting and non-voting common shares, the Supreme Court of Bermuda is expected to hold a hearing to approve the Scheme of Arrangement. Assuming the company receives the necessary shareholder and court approvals, and certain other conditions described in the Proxy Statement are satisfied, the company expects the Redomestication to be completed before the end of the calendar year 2010. After the Redomestication, we will still continue to report under accounting principles generally accepted in the United States of America (“U.S. GAAP”) and we expect our common shares will continue to trade on the New York Stock Exchange under the symbol “AWH,” the same symbol under which our common shares are currently listed. Upon completion of the transaction, we will remain subject to SEC reporting requirements and we will continue to report our consolidated financial results in U.S. dollars. We believe the Redomestication will also give us the ability to maintain a competitive worldwide effective corporate tax rate. See “Summary – The Redomestication” in the Proxy Statement, filed with the SEC on October 14, 2010 for further information regarding the transaction.

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Financial Highlights
                                     
    Three Months Ended September 30,   Nine Months Ended September 30,
    2010   2009   2010   2009
    ($ in millions except share and per share data)
Gross premiums written
  $ 378.4     $ 401.8     $ 1,376.4     $ 1,374.2  
Net income
    254.5       200.6       572.2       445.6  
Operating income
    143.5       155.4       300.5       405.8  
Basic earnings per share:
                               
Net income
  $ 5.59     $ 4.05     $ 11.78     $ 9.01  
Operating income
  $ 3.15     $ 3.13     $ 6.19     $ 8.21  
Diluted earnings per share:
                               
Net income
  $ 5.21     $ 3.83     $ 11.03     $ 8.62  
Operating income
  $ 2.94     $ 2.97     $ 5.79     $ 7.85  
Weighted average common shares outstanding:
                               
Basic
    45,544,060       49,574,266       48,580,541       49,449,809  
Diluted
    48,839,991       52,345,913       51,887,390       51,676,006  
Basic book value per common share
  $ 78.81     $ 62.07     $ 78.81     $ 62.07  
Diluted book value per common share
  $ 72.40     $ 57.20     $ 72.40     $ 57.20  
Annualized return on average equity (ROAE), net income
    31.0 %     28.7 %     24.2 %     22.8 %
Annualized ROAE, operating income
    17.5 %     22.2 %     12.7 %     20.8 %
Non-GAAP Financial Measures
     In presenting the company’s results, management has included and discussed certain non-GAAP financial measures, as such term is defined in Item 10(e) of Regulation S-K promulgated by the SEC. Management believes that these non-GAAP measures, which may be defined differently by other companies, better explain the company’s results of operations in a manner that allows for a more complete understanding of the underlying trends in the company’s business. However, these measures should not be viewed as a substitute for those determined in accordance with U.S. GAAP.
Operating income & operating income per share
     Operating income is an internal performance measure used in the management of our operations and represents after-tax operational results excluding, as applicable, net realized investment gains or losses, net impairment charges recognized in earnings, impairment of intangible assets and foreign exchange gain or loss. We exclude net realized investment gains or losses, net impairment charges recognized in earnings and net foreign exchange gain or loss from our calculation of operating income because the amount of these gains or losses is heavily influenced by and fluctuates in part according to the availability of market opportunities and other factors. We exclude impairment of intangible assets as these are non-recurring charges. We believe these amounts are largely independent of our business and underwriting process and including them distorts the analysis of trends in our operations. In addition to presenting net income determined in accordance with U.S. GAAP, we believe that showing operating income enables investors, analysts, rating agencies and other users of our financial information to more easily analyze our results of operations and our underlying business performance. Operating income should not be viewed as a substitute for U.S. GAAP net income. The following is a reconciliation of operating income to its most closely related U.S. GAAP measure, net income.

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    Three Months Ended September 30,     Nine Months Ended September 30,  
    2010     2009     2010     2009  
    ($ in millions except per share data)  
Net income
  $ 254.5     $ 200.6     $ 572.2     $ 445.6  
Add after tax affect of:
                               
Net realized investment gains
    (109.6 )     (46.9 )     (272.0 )     (88.5 )
Net impairment charges recognized in earnings
          2.0       0.1       49.4  
Foreign exchange (gain) loss
    (1.4 )     (0.3 )     0.2       (0.7 )
 
                       
Operating income
  $ 143.5     $ 155.4     $ 300.5     $ 405.8  
 
                       
Basic per share data:
                               
Net income
  $ 5.59     $ 4.05     $ 11.78     $ 9.01  
Add after tax affect of:
                               
Net realized investment gains
    (2.41 )     (0.95 )     (5.60 )     (1.79 )
Net impairment charges recognized in earnings
          0.04             1.00  
Foreign exchange (gain) loss
    (0.03 )     (0.01 )     0.01       (0.01 )
 
                       
Operating income
  $ 3.15     $ 3.13     $ 6.19     $ 8.21  
 
                       
Diluted per share data:
                               
Net income
  $ 5.21     $ 3.83     $ 11.03     $ 8.62  
Add after tax affect of:
                               
Net realized investment gains
    (2.24 )     (0.89 )     (5.24 )     (1.72 )
Net impairment charges recognized in earnings
          0.04             0.96  
Foreign exchange (gain) loss
    (0.03 )     (0.01 )           (0.01 )
 
                       
Operating income
  $ 2.94     $ 2.97     $ 5.79     $ 7.85  
 
                       
Diluted book value per share
     We have included diluted book value per share because it takes into account the effect of dilutive securities; therefore, we believe it is an important measure of calculating shareholder returns.
                 
    Nine Months Ended September 30,  
    2010     2009  
    ($ in millions except share  
    and per share data)  
Price per share at period end
  $ 56.59     $ 47.93  
 
               
Total shareholders’ equity
  $ 3,341.3     $ 3,078.9  
 
               
Basic common shares outstanding
    42,394,576       49,602,354  
Add:
               
Unvested restricted share units
    580,706       925,437  
Performance based equity awards
    1,409,984       1,329,661  
Dilutive options/warrants outstanding
    4,563,380       6,951,447  
Weighted average exercise price per share
  $ 34.69     $ 34.34  
Deduct:
               
Options bought back via treasury method
    (2,797,512 )     (4,980,125 )
 
           
Common shares and common share equivalents outstanding
    46,151,134       53,828,774  
 
               
Basic book value per common share
  $ 78.81     $ 62.07  
Diluted book value per common share
  $ 72.40     $ 57.20  

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Annualized return on average equity
     Annualized return on average shareholders’ equity (“ROAE”) is calculated using average equity, excluding the average after tax unrealized gains or losses on investments. Unrealized gains or losses on investments are primarily the result of interest rate and credit spread movements and the resultant impact on fixed income securities. Such gains or losses are not related to management actions or operational performance, nor are they likely to be realized. Therefore, we believe that excluding these unrealized gains or losses provides a more consistent and useful measurement of operating performance, which supplements U.S. GAAP information. We present ROAE as a measure that is commonly recognized as a standard of performance by investors, analysts, rating agencies and other users of our financial information.
     Annualized operating return on average shareholders’ equity is calculated using operating income and average shareholders’ equity, excluding the average after tax unrealized gains or losses on investments. Unrealized gains or losses are excluded from equity for the reasons outlined above.
                                 
    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
    2010     2009     2010     2009  
    ($ in millions)  
Opening shareholders’ equity
  $ 3,468.5     $ 2,741.4     $ 3,213.3     $ 2,416.9  
Deduct: accumulated other comprehensive income
    (138.3 )     (48.7 )     (149.8 )     (105.6 )
 
                       
Adjusted opening shareholders’ equity
  $ 3,330.2     $ 2,692.7     $ 3,063.5     $ 2,311.3  
 
                               
Closing shareholders’ equity
  $ 3,341.3     $ 3,078.9     $ 3,341.3     $ 3,078.9  
Deduct: accumulated other comprehensive income
    (111.8 )     (185.0 )     (111.8 )     (185.0 )
 
                       
Adjusted closing shareholders’ equity
  $ 3,229.5     $ 2,893.9     $ 3,229.5     $ 2,893.9  
 
                               
Average shareholders’ equity
  $ 3,279.9     $ 2,793.3     $ 3,146.5     $ 2,602.5  
 
                               
Net income available to shareholders
  $ 254.5     $ 200.6     $ 572.2     $ 445.6  
Annualized return on average shareholders’ equity — net income available to shareholders
    31.0 %     28.7 %     24.2 %     22.8 %
 
                       
 
                               
Operating income available to shareholders
  $ 143.5     $ 155.4     $ 300.5     $ 405.8  
Annualized return on average shareholders’ equity — operating income available to shareholders
    17.5 %     22.2 %     12.7 %     20.8 %
 
                       
Relevant Factors
Revenues
     We derive our revenues primarily from premiums on our insurance policies and reinsurance contracts, net of any reinsurance or retrocessional coverage purchased. Insurance and reinsurance premiums are a function of the amounts and types of policies and contracts we write, as well as prevailing market prices. Our prices are determined before our ultimate costs, which may extend far into the future, are known. In addition, our revenues include income generated from our investment portfolio, consisting of net investment income and net realized investment gains or losses. Investment income is principally derived from interest and dividends earned on investments, partially offset by investment management expenses and fees paid to our custodian bank. Net realized investment gains or losses include gains or losses from the sale of investments, as well as the change in the fair value of investments that we mark-to-market through net income.
     Due to changes in the recognition and presentation of OTTI of our available for sale fixed maturity investments based on guidance issued by the FASB in April 2009, OTTI, which was previously included in “net realized investment gains or losses”, is presented separately in the consolidated income statements as “net impairment charges recognized in earnings”.
Expenses
     Our expenses consist largely of net losses and loss expenses, acquisition costs, and general and administrative expenses. Net losses and loss expenses incurred are comprised of three main components:

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    losses paid, which are actual cash payments to insureds and reinsureds, net of recoveries from reinsurers;
    outstanding loss or case reserves, which represent management’s best estimate of the likely settlement amount for known claims, less the portion that can be recovered from reinsurers; and
    reserves for losses incurred but not reported, or “IBNR”, which are reserves (in addition to case reserves) established by us that we believe are needed for the future settlement of claims. The portion recoverable from reinsurers is deducted from the gross estimated loss.
     Acquisition costs are comprised of commissions, brokerage fees and insurance taxes. Commissions and brokerage fees are usually calculated as a percentage of premiums and depend on the market and line of business. Acquisition costs are reported after (1) deducting commissions received on ceded reinsurance, (2) deducting the part of acquisition costs relating to unearned premiums and (3) including the amortization of previously deferred acquisition costs.
     General and administrative expenses include personnel expenses including stock-based compensation charges, rent expense, professional fees, information technology costs and other general operating expenses.
Ratios
     Management measures results for each segment on the basis of the “loss and loss expense ratio,” “acquisition cost ratio,” “general and administrative expense ratio,” “expense ratio” and the “combined ratio.” Because we do not manage our assets by segment, investment income, interest expense and total assets are not allocated to individual reportable segments. General and administrative expenses are allocated to segments based on various factors, including staff count and each segment’s proportional share of gross premiums written. The “loss and loss expense ratio” is derived by dividing net losses and loss expenses by net premiums earned. The “acquisition cost ratio” is derived by dividing acquisition costs by net premiums earned. The “general and administrative expense ratio” is derived by dividing general and administrative expenses by net premiums earned. The “expense ratio” is the sum of the acquisition cost ratio and the general and administrative expense ratio. The “combined ratio” is the sum of the loss and loss expense ratio, the acquisition cost ratio and the general and administrative expense ratio.
Critical Accounting Policies
     It is important to understand our accounting policies in order to understand our financial position and results of operations. Our unaudited condensed consolidated financial statements reflect determinations that are inherently subjective in nature and require management to make assumptions and best estimates to determine the reported values. If events or other factors cause actual results to differ materially from management’s underlying assumptions or estimates, there could be a material adverse effect on our financial condition or results of operations. We believe that some of the more critical judgments in the areas of accounting estimates and assumptions that affect our financial condition and results of operations are related to reserves for losses and loss expenses, reinsurance recoverables, premiums and acquisition costs, valuation of financial instruments, other than temporary impairment of investments and goodwill and other intangible asset impairment valuation. For a detailed discussion of our critical accounting policies please refer to our 2009 Form 10-K. There were no material changes in the application of our critical accounting estimates subsequent to that report.

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Results of Operations
     The following table sets forth our selected consolidated statement of operations data for each of the periods indicated.
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2010     2009     2010     2009  
            ($ in millions)          
Gross premiums written
  $ 378.4     $ 401.8     $ 1,376.4     $ 1,374.2  
 
                       
Net premiums written
  $ 302.2     $ 321.0     $ 1,105.2     $ 1,087.4  
 
                       
Net premiums earned
    339.5       328.8       1,016.7       986.4  
Net investment income
    59.5       73.0       194.0       227.4  
Net realized investment gains
    116.9       46.9       289.4       88.5  
Net impairment charges recognized in earnings
          (2.0 )     (0.2 )     (49.4 )
Other income
          0.3       0.9       1.1  
 
                       
 
  $ 515.9     $ 447.0     $ 1,500.8     $ 1,254.0  
 
                       
Net losses and loss expenses
  $ 127.0     $ 136.5     $ 547.9     $ 462.7  
Acquisition costs
    41.9       36.6       120.6       110.7  
General and administrative expenses
    69.9       57.5       201.4       176.3  
Amortization and impairment of intangible assets
    0.9       1.1       2.7       3.2  
Interest expense
    9.5       9.5       28.6       29.5  
Foreign exchange (gain) loss
    (1.4 )     (0.3 )     0.2       (0.7 )
 
                       
 
  $ 247.8     $ 240.9     $ 901.4     $ 781.7  
 
                       
Income before income taxes
  $ 268.1     $ 206.1     $ 599.4     $ 472.3  
Income tax expense
    13.6       5.5       27.2       26.7  
 
                       
Net income
  $ 254.5     $ 200.6     $ 572.2     $ 445.6  
 
                       
 
                               
Ratios
                               
Loss and loss expense ratio
    37.4 %     41.5 %     53.9 %     46.9 %
Acquisition cost ratio
    12.3 %     11.1 %     11.9 %     11.2 %
General and administrative expense ratio
    20.6 %     17.5 %     19.8 %     17.9 %
Expense ratio
    32.9 %     28.6 %     31.7 %     29.1 %
Combined ratio
    70.3 %     70.1 %     85.6 %     76.0 %
Comparison of Three Months Ended September 30, 2010 and 2009
Premiums
     Gross premiums written decreased by $23.4 million, or 5.8%, for the three months ended September 30, 2010 compared to the three months ended September 30, 2009. The overall decrease in gross premiums written was primarily the result of the following:
    Gross premiums written in our reinsurance segment decreased by $28.1 million, or 22.6%. The decrease in gross premiums written was primarily due to the renewal timing of several large reinsurance treaties.
    Gross premiums written in our international insurance segment decreased by $6.9 million, or 6.4%, due to the continued trend of the non-renewal of business that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions) and increased competition.
    Gross premiums written in our U.S. insurance segment increased by $11.6 million, or 6.8%. The increase in gross premiums written was primarily due to increased new business, including from new products, for the three months ended September 30, 2010 compared to the three months ended September 30, 2009. This increase was partially offset by the non-renewal of business that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions) and increased competition.

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     The table below illustrates our gross premiums written by geographic location for the three months ended September 30, 2010 and 2009.
                                 
    Three Months Ended              
    September 30,     Dollar     Percentage  
    2010     2009     Change     Change  
    ($ in millions)  
United States
  $ 225.0     $ 245.3     $ (20.3 )     (8.2 )%
Bermuda
    113.2       121.1       (7.9 )     (6.5 )
Europe
    34.2       33.7       0.5       1.4  
Singapore
    4.2             4.2       n/a *
Hong Kong
    1.8       1.7       0.1       5.9  
 
                         
 
  $ 378.4     $ 401.8     $ (23.4 )     (5.8 )%
 
                         
 
*   n/a: not applicable
     Net premiums written decreased by $18.8 million, or 5.9%, for the three months ended September 30, 2010 compared to the three months ended September 30, 2009. The decrease in net premiums written was primarily due to the reduction in gross premiums written. The difference between gross and net premiums written is the cost to us of purchasing reinsurance coverage, including the cost of property catastrophe reinsurance coverage. We ceded 20.2% of gross premiums written for the three months ended September 30, 2010 compared to 20.1% for the same period in 2009.
     Net premiums earned increased by $10.7 million, or 3.3%, for the three months ended September 30, 2010 compared to the three months ended September 30, 2009 as a result of higher net premiums earned for the U.S. insurance and reinsurance segments. This is driven primarily by premium growth of our U.S. operations during the past several quarters.
     We evaluate our business by segment, distinguishing between U.S. insurance, international insurance and reinsurance. The following chart illustrates the mix of our business on both a gross premiums written and net premiums earned basis.
                                 
    Gross
Premiums
Written
    Net
Premiums
Earned
 
    Three Months Ended September 30,  
    2010     2009     2010     2009  
U.S. insurance
    47.9 %     42.2 %     38.2 %     33.9 %
International insurance
    26.6 %     26.8 %     23.7 %     29.7 %
Reinsurance
    25.5 %     31.0 %     38.1 %     36.4 %
 
                       
Total
    100.0 %     100.0 %     100.0 %     100.0 %
 
                       
Net Investment Income
     Net investment income decreased by $13.5 million, or 18.5%, for the three months ended September 30, 2010 compared to the three months ended September 30, 2009. The decrease was primarily due to lower yields on our fixed maturity investments as well as expenditures related to our share repurchases reducing the balance of higher yielding investments. The annualized period book yield of the investment portfolio for the three months ended September 30, 2010 and 2009 was 2.9% and 4.1%, respectively. The decrease in book yield was primarily caused by the overall market interest rate environment, which is at historically low levels. Investment management expenses of $2.3 million and $2.1 million were incurred during the three months ended September 30, 2010 and 2009, respectively. The increase in investment management expenses was primarily due to the increase in the size of our investment portfolio.
     As of September 30, 2010, approximately 96% of our fixed income investments consisted of investment grade securities. As of September 30, 2010, the average credit rating of our fixed income portfolio was AA as rated by Standard & Poor’s and Aa2 as rated by Moody’s. As of December 31, 2009, average credit rating of our fixed income portfolio was AA as rated by Standard & Poor’s and Aa2 as rated by Moody’s. The average duration of fixed maturity investments and cash and cash equivalents was approximately 2.5 years as of September 30, 2010 and 3.2 years as of September 30, 2009.

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Realized Investment Gains/Losses and Net Impairment Charges Recognized in Earnings
     During the three months ended September 30, 2010, we recognized $116.9 million in net realized investment gains compared to net realized investment gains of $46.9 million during the three months ended September 30, 2009. During the three months ended September 30, 2010, we did not recognize any net impairment charges compared to $2.0 million during the three months ended September 30, 2009. Net realized investment gains of $116.9 million for the three months ended September 30, 2010 were comprised of the following:
    Net realized investment gains of $32.6 million primarily from the sale of fixed maturity securities due to the rebalancing of our portfolio from U.S. treasury and agency securities into other assets and shortening the overall duration of our investment portfolio.
    Net realized investment gains of $84.3 million primarily related to the mark-to-market adjustments for our hedge fund investments, equity securities and fixed maturity investments that are accounted for as trading securities.
         
    Mark-to-Market Adjustments  
    for the Three Months Ended  
    September 30, 2010  
    ($ in millions)  
Fixed maturity investments accounted for as trading securities
  $ 73.5  
Hedge funds and equity securities
    10.8  
 
     
Total
  $ 84.3  
 
     
     Net realized investment gains of $46.9 million for the three months ended September 30, 2009 were comprised of the following:
    Net realized investment gains of $18.5 million from the sale of securities, primarily due to the sale of fixed maturity bonds.
    Net realized investment gains of $28.4 million primarily related to the mark-to-market adjustments for our hedge fund investments and fixed maturity investments that are accounted for as trading securities.
     During the three months ended September 30, 2009, we had $2.0 million of net impairment charges recognized in earnings due to credit related losses where the anticipated discounted cash flows of various fixed maturity investments were lower than the amortized cost. The $2.0 million of net impairment charges recognized in earnings consisted of $1.4 million related to mortgage-backed securities and $0.6 million related to a corporate bond.
Other Income
     The other income of nil and $0.3 million for the three months ended September 30, 2010 and 2009, respectively, represents fee income from our program administrator and wholesale brokerage operations. We sold these operations during the three months ended September 30, 2010 for a gain of $1.9 million.
Net Losses and Loss Expenses
     Net losses and loss expenses decreased by $9.5 million, or 7.0%, for the three months ended September 30, 2010 compared to the three months ended September 30, 2009. The decrease in net losses and loss expenses was due to higher net favorable prior year reserve development partially offset by higher attritional loss activity of $20.6 million in the current quarter, with no comparable events having occurred during the three months ended September 30, 2009.
     We recorded net favorable reserve development related to prior years of $101.4 million and $73.5 million during the three months ended September 30, 2010 and 2009, respectively. The following table shows the net favorable reserve development of $101.4 million by loss year for each of our segments for the three months ended September 30, 2010. In the table, a negative number represents net favorable reserve development and a positive number represents net unfavorable reserve development.

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    Loss Reserve Development by Loss Year  
    For the Three Months Ended September 30, 2010  
    2002     2003     2004     2005     2006     2007     2008     2009     Total  
    ($ in millions)  
U.S. insurance
  $ (0.6 )   $ (0.8 )   $ (9.0 )   $ (7.5 )   $ (1.3 )   $ (1.6 )   $ (3.3 )   $ (1.4 )   $ (25.5 )
International insurance
    1.9       (2.5 )     (6.2 )     (26.0 )     (12.3 )     (4.5 )     (11.1 )     (0.1 )     (60.8 )
Reinsurance
    (0.5 )     (0.4 )     (0.1 )     (10.7 )     (5.7 )     (0.3 )     2.0       0.6       (15.1 )
 
                                                     
 
  $ 0.8     $ (3.7 )   $ (15.3 )   $ (44.2 )   $ (19.3 )   $ (6.4 )   $ (12.4 )   $ (0.9 )   $ (101.4 )
 
                                                     
     The following table shows the favorable reserve development of $73.5 million by loss year for each of our segments for the three months ended September 30, 2009. In the table, a negative number represents net favorable reserve development and a positive number represents net unfavorable reserve development.
                                                                 
    Loss Reserve Development by Loss Year  
    For the Three Months Ended September 30, 2009  
    2002     2003     2004     2005     2006     2007     2008     Total  
    ($ in millions)  
U.S. insurance
  $ (2.4 )   $ (7.6 )   $ (9.2 )   $ (5.5 )   $ (3.7 )   $ (0.4 )   $ 1.3     $ (27.5 )
International insurance
    (0.2 )     (0.8 )     (5.2 )     (22.5 )     (3.9 )     (2.1 )     (8.0 )     (42.7 )
Reinsurance
    (2.8 )     (5.1 )     (6.5 )     (1.2 )     (0.3 )     8.1       4.5       (3.3 )
 
                                               
 
  $ (5.4 )   $ (13.5 )   $ (20.9 )   $ (29.2 )   $ (7.9 )   $ 5.6     $ (2.2 )   $ (73.5 )
 
                                               
     The loss and loss expense ratio for the three months ended September 30, 2010 was 37.4% compared to 41.5% for the three months ended September 30, 2009. Net favorable reserve development recognized during the three months ended September 30, 2010 reduced the loss and loss expense ratio by 29.9 percentage points. Thus, the loss and loss expense ratio related to the current loss year was 67.3%. Net favorable reserve development recognized in the three months ended September 30, 2009 reduced the loss and loss expense ratio by 22.4 percentage points. Thus, the loss and loss expense ratio related to that loss year was 63.9%. The increase in the loss and loss expense ratio for the current loss year was primarily due to increased incidences of large individual losses compared to those incurred during the three months ended September 30, 2009. The $20.6 million of current period losses previously noted contributed 6.0 percentage points to the loss and loss expense ratio for the three months ended September 30, 2010.
     The following table shows the components of the decrease in net losses and loss expenses of $9.5 million for the three months ended September 30, 2010 compared to the three months ended September 30, 2009.
                         
    Three Months Ended        
    September 30,     Dollar  
    2010     2009     Change  
    ($ in millions)  
Net losses paid
  $ 173.2     $ 108.6     $ 64.6  
Net change in reported case reserves
    (18.1 )     10.8       (28.9 )
Net change in IBNR
    (28.1 )     17.1       (45.2 )
 
                 
Net losses and loss expenses
  $ 127.0     $ 136.5     $ (9.5 )
 
                 
     The table below is a reconciliation of the beginning and ending reserves for losses and loss expenses for the three months ended September 30, 2010 and 2009. Losses incurred and paid are reflected net of reinsurance recoverables.

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    Three Months Ended  
    September 30,  
    2010     2009  
    ($ in millions)  
Net reserves for losses and loss expenses, July 1
  $ 3,988.0     $ 3,804.0  
Incurred related to:
               
Current period non-catastrophe
    228.4       210.0  
Current period property catastrophe
           
Prior period non-catastrophe
    (96.1 )     (73.4 )
Prior period property catastrophe
    (5.3 )     (0.1 )
 
           
Total incurred
  $ 127.0     $ 136.5  
Paid related to:
               
Current period non-catastrophe
    20.4       10.6  
Current period property catastrophe
    17.1        
Prior period non-catastrophe
    131.9       81.1  
Prior period property catastrophe
    3.8       16.9  
 
           
Total paid
  $ 173.2     $ 108.6  
Foreign exchange revaluation
    8.0       3.7  
 
           
Net reserve for losses and loss expenses, September 30
    3,949.8       3,835.6  
Losses and loss expenses recoverable
    940.0       914.0  
 
           
Reserve for losses and loss expenses, September 30
  $ 4,889.8     $ 4,749.6  
 
           
Acquisition Costs
     Acquisition costs increased by $5.3 million, or 14.5%, for the three months ended September 30, 2010 compared to the three months ended September 30, 2009. The increase in acquisition costs was primarily due to the increase in net premiums earned in our U.S. insurance and reinsurance segments, which typically have higher acquisition costs than our international insurance segment and represent a higher proportion of net premiums earned during the three months ended September 30, 2010 compared to the same period in 2009. Acquisition costs as a percentage of net premiums earned were 12.3% for the three months ended September 30, 2010 compared to 11.1% for the same period in 2009.
General and Administrative Expenses
     General and administrative expenses increased by $12.4 million, or 21.6%, for the three months ended September 30, 2010 compared to the same period in 2009. The increase in general and administrative expenses was primarily due to an increase in global headcount from 628 at September 30, 2009 to 706 at September 30, 2010 resulting in an overall increase in salary and related costs, including stock-based compensation. As a result of the increased staff count, salary and employee welfare costs increased by $8.9 million including increased stock-related compensation costs of $4.0 million. Included in the increase in employee welfare costs was an increase in expense for the Darwin Professional Underwriters, Inc. (“Darwin”) Long Term Incentive Plan (“Darwin LTIP”) of $2.0 million that we assumed as part of the Darwin acquisition for the three months ended September 30, 2010 compared to the same period in 2009. The amount incurred for the Darwin LTIP is a function of pre-acquisition underwriting profitability, including any subsequent loss reserve development. We also incurred approximately $2.4 million in costs during the quarter related to the establishment and operation of Syndicate 2232.
     Our general and administrative expense ratio was 20.6% for the three months ended September 30, 2010, which was higher than the 17.5% for the three months ended September 30, 2009. The increase was primarily due to the factors discussed above.
     Our expense ratio was 32.9% for the three months ended September 30, 2010 compared to 28.6% for the three months ended September 30, 2009 primarily due to an increase in the general and administrative expense ratio.
Amortization and Impairment of Intangible Assets
     The amortization and impairment of intangible assets decreased $0.2 million, or 18.2%, for the three months ended September 30, 2010 compared the three months ended September 30, 2009. The decrease was primarily the result of no longer amortizing the

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trademark intangible asset that was fully impaired during the fourth quarter of 2009. No impairment of intangible assets was recognized during the three months ended September 30, 2010 and September 30, 2009, respectively.
Interest Expense
     Interest expense of $9.5 million was incurred for both the three months ended September 30, 2010 and 2009, and represented the quarterly interest expense on the senior notes.
Net Income
     Net income for the three months ended September 30, 2010 was $254.5 million compared to $200.6 million for the three months ended September 30, 2009. The increase was primarily the result of higher net realized investment gains. Net income for the three months ended September 30, 2010 included a net foreign exchange gain of $1.4 million and an income tax expense of $13.6 million. Net income for the three months ended September 30, 2009 included a net foreign exchange gain of $0.3 million and an income tax expense of $5.5 million.
Comparison of Nine Months Ended September 30, 2010 and 2009
Premiums
     Gross premiums written increased by $2.2 million, or 0.2%, for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009. The overall increase in gross premiums written was primarily the result of the following:
    Gross premiums written in our U.S. insurance segment increased by $27.3 million, or 5.4%. The increase in gross premiums written was primarily due to increased new business, including from new products, for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009. This increase was partially offset by the non-renewal of business that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions) and increased competition.
    Gross premiums written in our international insurance segment decreased by $35.8 million, or 8.4%, due to the continued trend of the non-renewal of business that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions) and increased competition.
    Gross premiums written in our reinsurance segment increased by $10.8 million, or 2.4%. The increase in gross premiums written was primarily due to increased participation on one property reinsurance treaty for $23.6 million in 2010 from $9.0 million in 2009 and new business from the build-out of our international platform. These increases were partially offset by the non-renewal of business that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions), increased competition and increased cedent retention.
     The table below illustrates our gross premiums written by geographic location for the nine months ended September 30, 2010 and 2009.
                                 
    Nine Months Ended              
    September 30,     Dollar     Percentage  
    2010     2009     Change     Change  
    ($ in millions)  
United States
  $ 748.2     $ 751.0     $ (2.8 )     (0.4 )%
Bermuda
    449.7       473.8       (24.1 )     (5.1 )
Europe
    157.3       147.3       10.0       6.8  
Singapore
    13.8             13.8       n/a  
Hong Kong
    7.4       2.1       5.3       n/m *
 
                         
 
  $ 1,376.4     $ 1,374.2     $ 2.2       0.2 %
 
                         
 
*   n/m: not meaningful
     Net premiums written increased by $17.8 million, or 1.6%, for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009. The increase in net premiums written was primarily due to a reduction in premiums ceded. The

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difference between gross and net premiums written is the cost to us of purchasing reinsurance coverage, including the cost of property catastrophe reinsurance coverage. We ceded 19.7% of gross premiums written for the nine months ended September 30, 2010 compared to 20.9% for the same period in 2009. The reduction in premiums ceded was due to lower premiums ceded under our property catastrophe reinsurance coverage, as well as the commutation and adjustment of certain variable-rated reinsurance contracts that have swing-rated provisions.
     Net premiums earned increased by $30.3 million, or 3.1%, for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009 as a result of higher net premiums earned for the U.S. insurance and reinsurance segments. This is driven by increased net premiums written in the current and prior periods, as well as the impact of the commutation of the swing-rated reinsurance contracts which are fully earned.
     We evaluate our business by segment, distinguishing between U.S. insurance, international insurance and reinsurance. The following chart illustrates the mix of our business on both a gross premiums written and net premiums earned basis.
                                 
    Gross
Premiums
Written
    Net
Premiums
Earned
 
    Nine Months Ended September 30,  
    2010     2009     2010     2009  
U.S. insurance
    38.7 %     36.8 %     37.8 %     33.2 %
International insurance
    28.3 %     31.0 %     25.3 %     32.5 %
Reinsurance
    33.0 %     32.2 %     36.9 %     34.3 %
 
                       
Total
    100.0 %     100.0 %     100.0 %     100.0 %
 
                       
Net Investment Income
     Net investment income decreased by $33.4 million, or 14.7%, for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009. The decrease was due to a combination of lower accretion of book value to par value for our fixed maturity investments, lower yields on our fixed maturity investments and an increased allocation to hedge funds, which contribute to our total return but carry no current yield. We increased our hedge fund investments by $166.5 million between September 30, 2009 and September 30, 2010. In response to new OTTI guidance issued by the FASB in April 2009, we increased the book value of our fixed maturity investments for any non-credit OTTI previously recognized, which resulted in higher book values and lower future accretions. The annualized period book yield of the investment portfolio for the nine months ended September 30, 2010 and 2009 was 3.4% and 4.3%, respectively. The decrease in book yield was primarily caused by factors outlined above. Investment management expenses of $7.9 million and $6.0 million were incurred during the nine months ended September 30, 2010 and 2009, respectively. The increase in investment management expenses was due to the increase in the size of our investment portfolio as well as additional fees paid to investment advisors for higher cost investment strategies.
Realized Investment Gains/Losses and Net Impairment Charges Recognized in Earnings
     During the nine months ended September 30, 2010, we recognized $289.4 million in net realized investment gains compared to net realized investment gains of $88.5 million during the nine months ended September 30, 2009. During the nine months ended September 30, 2010, we recognized $0.2 million in net impairment charges recognized in earnings compared to $49.4 million during the nine months ended September 30, 2009. Net realized investment gains of $289.4 million for the nine months ended September 30, 2010 were comprised of the following:
    Net realized investment gains of $149.7 million primarily from the sale of fixed maturity securities due to the rebalancing of our portfolio from U.S. treasury and agency securities into other asset classes and shortening of the overall duration of our investment portfolio.
    Net realized investment gains of $143.7 million primarily related to the mark-to-market adjustments for our hedge fund investments, equity securities and fixed maturity investments that are accounted for as trading securities. We expect the mark-to-market adjustments on our fixed maturity investments that are accounted for as trading securities to increase as we continue to increase the balance of these securities. From December 31, 2009 to September 30, 2010, we have increased the balance of fixed maturity investments accounted for as trading by $2.7 billion, or 105.6%, from $2.5 billion as of December 31, 2009 to $5.2 billion as of September 30, 2010. Contributing to the increase was the reclassification of all of our mortgage-backed and asset-backed securities from available for sale to trading on July 1, 2010 as part of the adoption of ASU 2010-11.

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    Mark-to-Market Adjustments  
    for the Nine Months Ended  
    September 30, 2010  
    ($ in millions)  
Fixed maturity investments accounted for as trading securities
  $ 134.1  
Hedge funds and equity securities
    9.6  
 
     
Total
  $ 143.7  
 
     
    Net realized investment loss of $4.0 million related to a U.S. treasury yield hedge transaction we purchased in May 2010 and terminated in June 2010.
     Net realized investment gains of $88.5 million for the nine months ended September 30, 2009 were comprised of the following:
    Net realized investment gains of $35.7 million primarily related to the mark-to-market adjustments for our hedge fund investments and fixed maturity investments that are accounted for as trading securities.
    Net realized investment gains of $52.8 million from the sale of securities. The net realized investment gains primarily consisted of realized gains of $75.1 million from the sale of fixed maturity investments and hedge funds partially offset by a realized loss of $21.9 million related to the sale of our global high-yield bond fund. In addition, we sold approximately $18.0 million of equity securities that we acquired as part of the acquisition of Darwin. We recognized a realized loss of $0.4 million from that sale.
     During the nine months ended September 30, 2009, we had $49.4 million of net impairment charges recognized in earnings, $7.5 million due to credit related losses where the anticipated discounted cash flows of the various fixed maturity investments were lower than the amortized cost, and $41.9 million of net impairment charges for those securities in an unrealized loss position where our investment managers had the discretion to sell.
Other Income
     The other income of $0.9 million and $1.1 million for the nine months ended September 30, 2010 and 2009, respectively, represents fee income from our program administrator and wholesale brokerage operations. We sold these operations during the nine months ended September 30, 2010 for a gain of $1.9 million.
Net Losses and Loss Expenses
     Net losses and loss expenses increased by $85.2 million, or 18.4%, for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009. The increase in net losses and loss expenses was due to a number of individual losses totaling $142.4 million in the current year, with no comparable events having occurred during the nine months ended September 30, 2009. The increase due to higher loss activity was partially offset by higher net favorable prior year reserve development.
     We recorded net favorable reserve development related to prior years of $239.4 million and $170.3 million during the nine months ended September 30, 2010 and 2009, respectively. The $239.4 million of net favorable reserve development excludes the impact of a commutation of the swing-rated reinsurance contracts of $8.9 million. The following table shows the net favorable reserve development of $239.4 million by loss year for each of our segments for the nine months ended September 30, 2010. In the table, a negative number represents net favorable reserve development and a positive number represents net unfavorable reserve development.
                                                                         
    Loss Reserve Development by Loss Year  
    For the Nine Months Ended September 30, 2010  
    2002     2003     2004     2005     2006     2007     2008     2009     Total  
    ($ in millions)  
U.S. insurance
  $ (1.1 )   $ (2.5 )   $ (23.4 )   $ (20.0 )   $ (3.7 )   $ 0.6     $ 0.6     $ (0.6 )   $ (50.1 )
International insurance
    4.5       (9.3 )     (21.0 )     (69.9 )     (23.6 )     (12.0 )     (14.4 )     4.2       (141.5 )
Reinsurance
    (1.0 )     (1.5 )     (10.0 )     (18.7 )     (6.8 )     (2.5 )     (0.2 )     (7.1 )     (47.8 )
 
                                                     
 
  $ 2.4     $ (13.3 )   $ (54.4 )   $ (108.6 )   $ (34.1 )   $ (13.9 )   $ (14.0 )   $ (3.5 )   $ (239.4 )
 
                                                     

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     The following table shows the favorable reserve development of $170.3 million by loss year for each of our segments for the nine months ended September 30, 2009. In the table, a negative number represents net favorable reserve development and a positive number represents net unfavorable reserve development.
                                                                 
    Loss Reserve Development by Loss Year  
    For the Nine Months Ended September 30, 2009  
    2002     2003     2004     2005     2006     2007     2008     Total  
    ($ in millions)  
U.S. insurance
  $ (6.4 )   $ (21.2 )   $ (26.6 )   $ (14.0 )   $ 3.7     $ 3.7     $ 5.2     $ (55.6 )
International insurance
    (5.7 )     (19.9 )     (43.6 )     (44.3 )     18.0       (7.2 )     12.6       (90.1 )
Reinsurance
    (3.2 )     (14.2 )     (12.5 )     0.2       (0.6 )     3.5       2.2       (24.6 )
 
                                               
 
  $ (15.3 )   $ (55.3 )   $ (82.7 )   $ (58.1 )   $ 21.1     $     $ 20.0     $ (170.3 )
 
                                               
     The loss and loss expense ratio for the nine months ended September 30, 2010 was 53.9% compared to 46.9% for the nine months ended September 30, 2009. Net favorable reserve development recognized and the impact of the commutation adjustment during the nine months ended September 30, 2010 reduced the loss and loss expense ratio by 23.5 percentage points. Thus, the loss and loss expense ratio related to the current loss year was 77.4%. Net favorable reserve development recognized in the nine months ended September 30, 2009 reduced the loss and loss expense ratio by 17.3 percentage points. Thus, the loss and loss expense ratio related to that loss year was 64.2%. The increase in the loss and loss expense ratio for the current loss year was primarily due to a net increase in loss reserves of $142.4 million from a number of earthquakes, explosions and other weather related events during the nine months ended September 30, 2010, which contributed 14.0 points to the current loss year’s loss and loss expense ratio.
     The following table shows the components of the increase in net losses and loss expenses of $85.2 million for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009.
                         
    Nine Months Ended  
    September 30,     Dollar  
    2010     2009     Change  
            ($ in millions)  
Net losses paid
  $ 438.6     $ 323.7     $ 114.9  
Net change in reported case reserves
    60.3       55.8       4.5  
Net change in IBNR
    49.0       83.2       (34.2 )
 
                 
Net losses and loss expenses
  $ 547.9     $ 462.7     $ 85.2  
 
                 
     The table below is a reconciliation of the beginning and ending reserves for losses and loss expenses for the nine months ended September 30, 2010 and 2009. Losses incurred and paid are reflected net of reinsurance recoverables.

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    Nine Months Ended  
    September 30,  
    2010     2009  
    ($ in millions)  
Net reserves for losses and loss expenses, January 1
  $ 3,841.8     $ 3,688.5  
Incurred related to:
               
Commutation of variable-rated reinsurance contracts
    8.9        
Current period non-catastrophe
    713.4       633.0  
Current period property catastrophe
    65.0        
Prior period non-catastrophe
    (229.5 )     (171.9 )
Prior period property catastrophe
    (9.9 )     1.6  
 
           
Total incurred
  $ 547.9     $ 462.7  
Paid related to:
               
Current period non-catastrophe
    34.5       15.5  
Current period property catastrophe
    36.4        
Prior period non-catastrophe
    348.7       253.9  
Prior period property catastrophe
    19.0       54.3  
 
           
Total paid
  $ 438.6     $ 323.7  
Foreign exchange revaluation
    (1.3 )     8.1  
 
           
Net reserve for losses and loss expenses, September 30
    3,949.8       3,835.6  
Losses and loss expenses recoverable
    940.0       914.0  
 
           
Reserve for losses and loss expenses, September 30
  $ 4,889.8     $ 4,749.6  
 
           
Acquisition Costs
     Acquisition costs increased by $9.9 million, or 8.9%, for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009. The increase in acquisition costs was primarily due to the increase in net premiums earned in our U.S. insurance segment and reinsurance segment, which typically have higher acquisition costs than our international insurance segment and represent a higher proportion of net premiums earned during the nine months ended September 30, 2010 compared to the same period in 2009. Acquisition costs as a percentage of net premiums earned were 11.9% for the nine months ended September 30, 2010 compared to 11.2% for the same period in 2009 for the reasons explained above.
General and Administrative Expenses
     General and administrative expenses increased by $25.1 million, or 14.2%, for the nine months ended September 30, 2010 compared to the same period in 2009. The increase in general and administrative expenses was primarily due to the following:
    An overall increase in global headcount from 628 at September 30, 2009 to 706 at September 30, 2010 resulting in an overall increase in salary and related costs of $9.3 million.
    Increased stock-related compensation of $10.2 million, including an increase of $2.2 million for performance-based awards granted under the Company’s equity plans in 2009 to recognize expected performance above the target level. For all performance-based awards, we initially recognize the stock compensation expense at 100% of the fair market value of Holdings’ common shares on the date of grant and reassess, at least annually, the projected growth in book value to determine whether an adjustment to the initial estimate of the expense should be made. During the nine months ended September 30, 2010, we have accrued 132.5% of the fair market value of Holdings’ common shares awarded on the date of grant, as we believe it is probable that we will achieve the performance criteria above target but below the maximum award when these performance-based awards vest at the end of 2011. For additional information on our performance-based awards, see Note 12 “Employee Benefit Plans” in our notes to the unaudited condensed consolidated financial statements.
    An increase of $7.7 million in professional fees during the nine months ended September 30, 2010 primarily related to the establishment and operation of Syndicate 2232 and other strategic initiatives.

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    Decrease of $4.8 million related to the Darwin LTIP. We recognized an increase in the Darwin LTIP of $0.3 million during the nine months ended September 30, 2010 compared to an increase of $5.1 million during the nine months ended September 30, 2009. The amount incurred for the Darwin LTIP is a result of pre-acquisition underwriting profitability, including any subsequent loss reserve development. The reduction in the Darwin LTIP during the nine months ended September 30, 2010 was due to lower favorable reserve development.
     Our general and administrative expense ratio was 19.8% for the nine months ended September 30, 2010, which was higher than the 17.9% for the nine months ended September 30, 2009. The increase was primarily due to the factors discussed above.
     Our expense ratio was 31.7% for the nine months ended September 30, 2010 compared to 29.1% for the nine months ended September 30, 2009 due to an increase in both acquisition cost ratio and general and administrative expense ratio.
Amortization and Impairment of Intangible Assets
     The amortization and impairment of intangible assets decreased $0.5 million, or 15.6%, for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009. The decrease is primarily the result of no longer amortizing the trademark intangible asset that was fully impaired during the fourth quarter of 2009. No impairments were recognized during the nine months ended September 30, 2010 and 2009, respectively.
Interest Expense
     Interest expense decreased $0.9 million, or 3.1%, for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009. Interest expense of $1.0 million was incurred during the three months ended March 31, 2009 on our borrowing of $243.8 million from our $400 million unsecured revolving credit facility, which was paid in full in February 2009.
Net Income
     Net income for the nine months ended September 30, 2010 was $572.2 million compared to $445.6 million for the nine months ended September 30, 2009. The increase was primarily the result of higher net realized investment gains, lower OTTI and higher net premiums earned partially offset by higher net losses and loss expenses and general and administrative expenses. Net income for the nine months ended September 30, 2010 included a net foreign exchange loss of $0.2 million and an income tax expense of $27.2 million. Net income for the nine months ended September 30, 2009 included a net foreign exchange gain of $0.7 million and an income tax expense of $26.7 million.
Underwriting Results by Operating Segments
     Our company is organized into three operating segments:
     U.S. Insurance Segment. The U.S. insurance segment includes our direct specialty insurance operations in the United States. This segment provides both direct property and specialty casualty insurance primarily to non-Fortune 1000 North American domiciled accounts.
     International Insurance Segment. The international insurance segment includes our direct insurance operations in Bermuda, Europe and Hong Kong. This segment provides both direct property and casualty insurance primarily to Fortune 1000 North American domiciled accounts and mid-sized to large non-North American domiciled accounts.
     Reinsurance Segment. Our reinsurance segment has operations in Bermuda, Europe, Singapore and the United States. This segment includes the reinsurance of property, general casualty, professional liability, specialty lines and property catastrophe coverages written by insurance companies. We presently write reinsurance on both a treaty and a facultative basis, targeting several niche reinsurance markets.
U.S. Insurance Segment
     The following table summarizes the underwriting results and associated ratios for the U.S. insurance segment for the three and nine months ended September 30, 2010 and 2009.

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    Three Months Ended   Nine Months Ended
    September 30,   September 30,
    2010   2009   2010   2009
    ($ in millions)
Revenues
                               
Gross premiums written
  $ 181.2     $ 169.6     $ 533.0     $ 505.7  
Net premiums written
    140.5       126.6       407.3       369.9  
Net premiums earned
    129.6       111.6       384.5       327.9  
Other income
          0.3       0.9       1.1  
Expenses
                               
Net losses and loss expenses
  $ 55.1     $ 42.1     $ 222.8     $ 143.1  
Acquisition costs
    18.1       14.3       50.9       42.3  
General and administrative expenses
    31.8       25.9       89.6       83.3  
Underwriting income
    24.6       29.6       22.1       60.3  
Ratios
                               
Loss and loss expense ratio
    42.5 %     37.7 %     57.9 %     43.6 %
Acquisition cost ratio
    13.9 %     12.9 %     13.2 %     12.9 %
General and administrative expense ratio
    24.5 %     23.2 %     23.3 %     25.4 %
Expense ratio
    38.4 %     36.1 %     36.5 %     38.3 %
Combined ratio
    80.9 %     73.8 %     94.4 %     81.9 %
Comparison of Three Months Ended September 30, 2010 and 2009
     Premiums. Gross premiums written increased by $11.6 million, or 6.8%, for the three months ended September 30, 2010 compared to the same period in 2009. The increase in gross premiums written was primarily due to higher volume from new products and increased underwriting staff where we believe profitable underwriting opportunities exist. The increase was partially offset by the non-renewal of business that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions) and increased competition, particularly for public directors and officers liability products in our professional liability line of business.
     The table below illustrates our gross premiums written by line of business for the three months ended September 30, 2010 and 2009.
                                 
    Three Months Ended              
    September 30,     Dollar     Percentage  
    2010     2009     Change     Change  
    ($ in millions)  
Professional liability
  $ 52.3     $ 48.0     $ 4.3       9.0 %
General casualty
    41.5       36.6       4.9       13.4  
Healthcare
    38.9       42.2       (3.3 )     (7.8 )
Programs
    30.9       29.4       1.5       5.1  
General property
    13.3       13.4       (0.1 )     (0.7 )
Other
    4.3             4.3       n/a  
 
                         
 
  $ 181.2     $ 169.6     $ 11.6       6.8 %
 
                         
     Net premiums written increased by $13.9 million, or 11.0%, for the three months ended September 30, 2010 compared to the three months ended September 30, 2009. The increase in net premiums written was primarily due to higher gross premiums written, as well as a reduction of premiums ceded. We ceded 22.5% of gross premiums written for the three months ended September 30, 2010 compared to 25.4% for the same period in 2009. The decrease in the ceded premium ratio was due to a net decrease in the variable-rated reinsurance premiums of $4.9 million. During the three months September 30, 2010 we reduced ceded premiums by $0.8 million, whereas during the three months ended September 30, 2009 we increased ceded premiums by $4.1 million related to the variable-rated reinsurance treaties.
     Net premiums earned increased $18.0 million, or 16.1%, primarily due to the growth of our U.S. insurance operations during 2009 and during the first nine months of 2010.
     Net losses and loss expenses. Net losses and loss expenses increased by $13.0 million, or 30.9%, for the three months ended September 30, 2010 compared to the three months ended September 30, 2009. The increase in net losses and loss expenses was

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primarily due to the growth of the U.S. insurance operations and lower net favorable reserve development recognized during the three months ended September 30, 2010 compared to the three months ended September 30, 2009.
     Overall, our U.S. insurance segment recorded net favorable reserve development of $25.5 million during the three months ended September 30, 2010 compared to net favorable reserve development of $27.5 million for the three months ended September 30, 2009, as shown in the tables below. In the tables, a negative number represents net favorable reserve development and a positive number represents net unfavorable reserve development.
                                                                         
    Loss Reserve Development by Loss Year  
    For the Three Months Ended September 30, 2010  
    2002     2003     2004     2005     2006     2007     2008     2009     Total  
    ($ in millions)  
Professional liability
  $     $     $ (0.1 )   $ (3.6 )   $ (1.7 )   $ (0.1 )   $ (1.4 )   $ 0.2     $ (6.7 )
Healthcare
    (0.3 )     (0.4 )     (1.6 )     (2.8 )     0.4       (1.3 )     (2.1 )     (0.5 )     (8.6 )
General casualty
    (0.3 )     (0.3 )     (7.2 )     (1.0 )                             (8.8 )
General property
          (0.1 )     (0.1 )     (0.1 )           (0.1 )     0.2             (0.2 )
Programs
                                  (0.1 )           (1.1 )     (1.2 )
 
                                                     
 
  $ (0.6 )   $ (0.8 )   $ (9.0 )   $ (7.5 )   $ (1.3 )   $ (1.6 )   $ (3.3 )   $ (1.4 )   $ (25.5 )
 
                                                     
                                                                 
    Loss Reserve Development by Loss Year  
    For the Three Months Ended September 30, 2009  
    2002     2003     2004     2005     2006     2007     2008     Total  
    ($ in millions)  
Professional liability
  $     $     $ (0.8 )   $ (0.5 )   $ (0.8 )   $ 0.8     $ 2.7     $ 1.4  
Healthcare
    (0.3 )     0.2       (2.9 )     (1.8 )     (1.3 )     (1.6 )     (0.4 )     (8.1 )
General casualty
    (1.2 )     (6.2 )     (4.1 )                       1.7       (9.8 )
General property
    (0.9 )     (1.6 )     (1.4 )     (3.1 )     (1.1 )     0.4       (2.0 )     (9.7 )
Programs
                      (0.1 )     (0.5 )           (0.7 )     (1.3 )
 
                                               
 
  $ (2.4 )   $ (7.6 )   $ (9.2 )   $ (5.5 )   $ (3.7 )   $ (0.4 )   $ 1.3     $ (27.5 )
 
                                               
     The loss and loss expense ratio for the three months ended September 30, 2010 was 42.5% compared to 37.7% for the three months ended September 30, 2009. Net favorable reserve development recognized during the three months ended September 30, 2010 decreased the loss and loss expense ratio by 19.7 percentage points. Thus, the loss and loss expense ratio for the current loss year was 62.2%. In comparison, net favorable reserve development recognized in the three months ended September 30, 2009 decreased the loss and loss expense ratio by 24.6 percentage points. In addition, during the three months ended September 30, 2009, the $4.1 million increase in premiums ceded for the variable-rated reinsurance contracts of Darwin that have swing-rated provisions increased the loss and loss expense ratio by 2.1 percentage points. Thus, the loss and loss expense ratio for that loss year was 60.2%.
     The table below is a reconciliation of the beginning and ending reserves for losses and loss expenses for the three months ended September 30, 2010 and 2009. Losses incurred and paid are reflected net of reinsurance recoverables.

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    Three Months Ended  
    September 30,  
    2010     2009  
    ($ in millions)  
Net reserves for losses and loss expenses, July 1
  $ 1,005.7     $ 869.3  
Incurred related to:
               
Current period non-catastrophe
    80.6       69.6  
Current period property catastrophe
           
Prior period non-catastrophe
    (25.8 )     (25.6 )
Prior period property catastrophe
    0.3       (1.9 )
 
           
Total incurred
  $ 55.1     $ 42.1  
Paid related to:
               
Current period non-catastrophe
    7.7       3.0  
Current period property catastrophe
           
Prior period non-catastrophe
    49.9       23.9  
Prior period property catastrophe
    1.1       4.2  
 
           
Total paid
  $ 58.7     $ 31.1  
Net reserve for losses and loss expenses, September 30
    1,002.1       880.3  
Losses and loss expenses recoverable
    380.1       340.7  
 
           
Reserve for losses and loss expenses, September 30
  $ 1,382.2     $ 1,221.0  
 
           
     Acquisition costs. Acquisition costs increased by $3.8 million, or 26.6%, for the three months ended September 30, 2010 compared to the three months ended September 30, 2009. The increase was primarily caused by increased net premiums earned. The acquisition cost ratio increased to 13.9% for the three months ended September 30, 2010 from 12.9% for the same period in 2009.
     General and administrative expenses. General and administrative expenses increased by $5.9 million, or 22.8%, for the three months ended September 30, 2010 compared to the three months ended September 30, 2009. The increase in general and administrative expenses was primarily due to increased salary and related costs including the $2.0 million increase in expense for the Darwin LTIP. The increase in the general and administrative expense ratio from 23.2% for the three months ended September 30, 2009 to 24.5% for the same period in 2010 was primarily the result of the increase in expense for the Darwin LTIP.
Comparison of Nine Months Ended September 30, 2010 and 2009
     Premiums. Gross premiums written increased by $27.3 million, or 5.4%, for the nine months ended September 30, 2010 compared to the same period in 2009. The increase in gross premiums written was primarily due to higher volume from new products and increased underwriting staff where we believe profitable underwriting opportunities exist. The increase was partially offset by the non-renewal of business that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions) and increased competition, particularly for public directors and officers liability products in our professional liability line of business.
     The table below illustrates our gross premiums written by line of business for the nine months ended September 30, 2010 and 2009.
                                 
    Nine Months Ended              
    September 30,     Dollar     Percentage  
    2010     2009     Change     Change  
                    ($ in millions)          
Professional liability
  $ 149.0     $ 145.3     $ 3.7       2.5 %
Healthcare
    127.5       128.4       (0.9 )     (0.7 )
General casualty
    108.0       93.6       14.4       15.4  
Programs
    81.9       79.9       2.0       2.5  
General property
    59.9       58.5       1.4       2.4  
Other
    6.7             6.7       n/a  
 
                         
 
  $ 533.0     $ 505.7     $ 27.3       5.4 %
 
                         

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     Net premiums written increased by $37.4 million, or 10.1%, for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009. The increase in net premiums written was primarily due to higher gross premiums written, as well as a reduction of premiums ceded. The reduction in premiums ceded was primarily due to lower cessions in our general casualty and general property lines of business, as well as the commutation and adjustment of certain variable-rated reinsurance contracts that have swing-rated provisions. Overall, we ceded 23.6% of gross premiums written for the nine months ended September 30, 2010 compared to 26.9% for the nine months ended September 30, 2009. The decrease in the cession percentage was primarily due to the reduction of premiums ceded related to the commutation of the swing-rated reinsurance contracts. Excluding the impact of the commutation, we ceded 25.3% of gross premiums written during the nine months ended September 30, 2010.
     Net premiums earned increased $56.6 million, or 17.3%, primarily due to the growth of our U.S. insurance operations during 2009 and during the first nine months of 2010 and $9.3 million from the commutation, which was fully earned.
     Net losses and loss expenses. Net losses and loss expenses increased by $79.7 million, or 55.7%, for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009. The increase in net losses and loss expenses was primarily due to current year losses from a power plant explosion and floods of $15.0 million, as well as the reduction of ceded IBNR for the commutation of the swing-rated reinsurance contracts and lower net favorable reserve development recognized.
     Overall, our U.S. insurance segment recorded net favorable reserve development of $50.1 million during the nine months ended September 30, 2010 compared to net favorable reserve development of $55.6 million for the nine months ended September 30, 2009, as shown in the tables below. The $50.1 million of net favorable reserve development excludes the impact of the commutation of the swing-rated reinsurance contracts of $8.9 million discussed above. In the tables, a negative number represents net favorable reserve development and a positive number represents net unfavorable reserve development.
                                                                         
    Loss Reserve Development by Loss Year  
    For the Nine Months Ended September 30, 2010  
    2002     2003     2004     2005     2006     2007     2008     2009     Total  
    ($ in millions)  
Professional liability
  $     $     $ (0.8 )   $ (9.5 )   $ (3.0 )   $ (1.0 )   $ (1.3 )   $ 1.8     $ (13.8 )
Healthcare
    (1.1 )     (1.0 )     (2.2 )     (6.4 )     (0.6 )     (0.8 )     (0.4 )     (1.8 )     (14.3 )
General casualty
          (1.3 )     (21.2 )     (2.5 )           (1.0 )     3.6             (22.4 )
General property
          (0.2 )     0.8       (1.6 )     (0.2 )     1.5       (1.3 )           (1.0 )
Programs
                            0.1       1.9             (0.6 )     1.4  
 
                                                     
 
  $ (1.1 )   $ (2.5 )   $ (23.4 )   $ (20.0 )   $ (3.7 )   $ 0.6     $ 0.6     $ (0.6 )   $ (50.1 )
 
                                                     
                                                                 
    Loss Reserve Development by Loss Year  
    For the Nine Months Ended September 30, 2009  
    2002     2003     2004     2005     2006     2007     2008     Total  
    ($ in millions)  
Professional liability
  $     $     $ (2.0 )   $ (1.8 )   $ 8.4     $ 7.8     $ 8.3     $ 20.7  
Healthcare
    (1.1 )     (0.2 )     (9.0 )     (8.0 )     (4.3 )     (3.4 )     (5.7 )     (31.7 )
General casualty
    (3.7 )     (19.4 )     (11.1 )           2.8       0.1       5.3       (26.0 )
General property
    (1.6 )     (1.6 )     (4.5 )     (3.7 )     (1.2 )     (0.4 )     1.9       (11.1 )
Programs
                      (0.5 )     (2.0 )     (0.4 )     (4.6 )     (7.5 )
 
                                               
 
  $ (6.4 )   $ (21.2 )   $ (26.6 )   $ (14.0 )   $ 3.7     $ 3.7     $ 5.2     $ (55.6 )
 
                                               
     The loss and loss expense ratio for the nine months ended September 30, 2010 was 57.9% compared to 43.6% for the nine months ended September 30, 2009. Net favorable reserve development recognized and the impact of the commutation adjustment to ceded IBNR during the nine months ended September 30, 2010 decreased the loss and loss expense ratio by 12.5 percentage points. Thus, the loss and loss expense ratio for the current loss year was 70.4%. In comparison, net favorable reserve development recognized in the nine months ended September 30, 2009 decreased the loss and loss expense ratio by 17.0 percentage points. In addition, during the nine months ended September 30, 2009, the $6.0 million reduction in premiums ceded for the variable-rated reinsurance contracts that have swing-rated provisions reduced the loss and loss expense ratio by 1.1 percentage points. Thus, the loss and loss expense ratio for that loss year was 61.7%. The increase in the loss and loss expense ratio for the current loss year was primarily due to losses from a power plant explosion and floods of $15.0 million. These losses contributed 4.0 percentage points to the current loss year’s loss and

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loss expense ratio, after adjusting for the $9.3 million impact to ceded earned premium of the commuted swing-rated reinsurance contracts previously discussed.
     The table below is a reconciliation of the beginning and ending reserves for losses and loss expenses for the nine months ended September 30, 2010 and 2009. Losses incurred and paid are reflected net of reinsurance recoverables.
                 
    Nine Months Ended  
    September 30,  
    2010     2009  
    ($ in millions)  
Net reserves for losses and loss expenses, January 1
  $ 901.9     $ 819.4  
Incurred related to:
               
Commutation of variable-rated reinsurance contracts
    8.9        
Current period non-catastrophe
    264.0       198.7  
Current period property catastrophe
           
Prior period non-catastrophe
    (51.4 )     (57.6 )
Prior period property catastrophe
    1.3       2.0  
 
           
Total incurred
  $ 222.8     $ 143.1  
Paid related to:
               
Current period non-catastrophe
    10.7       5.5  
Current period property catastrophe
           
Prior period non-catastrophe
    107.2       64.4  
Prior period property catastrophe
    4.7       12.3  
 
           
Total paid
  $ 122.6     $ 82.2  
Net reserve for losses and loss expenses, September 30
    1,002.1       880.3  
Losses and loss expenses recoverable
    380.1       340.7  
 
           
Reserve for losses and loss expenses, September 30
  $ 1,382.2     $ 1,221.0  
 
           
     Acquisition costs. Acquisition costs increased by $8.6 million, or 20.3%, for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009. The increase was primarily caused by increased net premiums earned. The acquisition cost ratio was 13.2% for the nine months ended September 30, 2010 compared to 12.9% for the nine months ended September 30, 2009.
     General and administrative expenses. General and administrative expenses increased by $6.3 million, or 7.6%, for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009. The increase in general and administrative expenses was due to higher salary and related costs from increased headcount offset by the reduction in the Darwin LTIP of $4.8 million. The decrease in the general and administrative expense ratio from 25.4% for the nine months ended September 30, 2009 to 23.3% for the same period in 2010 was primarily the result of the increase in net premiums earned.
International Insurance Segment
     The following table summarizes the underwriting results and associated ratios for the international insurance segment for the three and nine months ended September 30, 2010 and 2009.

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    Three Months Ended   Nine Months Ended
    September 30,   September 30,
    2010   2009   2010   2009
    ($ in millions)
Revenues
                               
Gross premiums written
  $ 100.9     $ 107.8     $ 389.9     $ 425.7  
Net premiums written
    65.5       69.9       245.1       275.1  
Net premiums earned
    80.6       97.7       257.0       320.7  
Expenses
                               
Net losses and loss expenses
  $ 11.1     $ 28.3     $ 133.1     $ 141.6  
Acquisition costs
          0.5             3.2  
General and administrative expenses
    22.8       19.9       67.3       58.6  
Underwriting income
    46.7       49.0       56.6       117.3  
Ratios
                               
Loss and loss expense ratio
    13.7 %     29.0 %     51.8 %     44.2 %
Acquisition cost ratio
    0.0 %     0.5 %     0.0 %     1.0 %
General and administrative expense ratio
    28.3 %     20.3 %     26.2 %     18.3 %
Expense ratio
    28.3 %     20.8 %     26.2 %     19.3 %
Combined ratio
    42.0 %     49.8 %     78.0 %     63.5 %
Comparison of Three Months Ended September 30, 2010 and 2009
     Premiums. Gross premiums written decreased by $6.9 million, or 6.4%, for the three months ended September 30, 2010 compared to the same period in 2009. The decrease in gross premiums written was due to the continued trend of the non-renewal of business that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions) and increased competition in our international insurance segment.
     The table below illustrates our gross premiums written by line of business for the three months ended September 30, 2010 and 2009.
                                 
    Three Months Ended              
    September 30,     Dollar     Percentage  
    2010     2009     Change     Change  
    ($ in millions)  
Professional liability
  $ 35.6     $ 36.5     $ (0.9 )     (2.5 )%
General property*
    25.2       26.8       (1.6 )     (6.0 )
General casualty
    22.4       26.2       (3.8 )     (14.5 )
Healthcare
    17.7       18.3       (0.6 )     (3.3 )
 
                         
 
  $ 100.9     $ 107.8     $ (6.9 )     (6.4 )%
 
                         
 
*   Includes our energy line of business.
     Net premiums written decreased $4.4 million, or 6.3%, for the three months ended September 30, 2010 compared to the three months ended September 30, 2009. The decrease in net premiums written was primarily due to the decrease in gross premiums written. We ceded to reinsurers 35.0% of gross premiums written for the three months ended September 30, 2010 compared to 35.1% for the three months ended September 30, 2009. Net premiums earned decreased $17.1 million, or 17.5%, primarily due to lower net premiums written during 2009 and for the first nine months of 2010.
     Net losses and loss expenses. Net losses and loss expenses decreased by $17.2 million, or 60.8%, for the three months ended September 30, 2010 compared to the three months ended September 30, 2009. The decrease in net losses and loss expenses was primarily due to higher net favorable reserve development recognized and a reduction in business written partially offset by higher attritional loss activity in the current period. During the three months ended September 30, 2010, we incurred net losses and loss expenses of $16.0 million from a gas line explosion and the New Zealand earthquake. No comparable events occurred during the three months ended September 30, 2009. The loss from the gas line explosion was incurred in our general casualty line of business. Overall, our international insurance segment recorded net favorable reserve development of $60.8 million during the three months ended September 30, 2010 compared to net favorable reserve development of $42.7 million for the three months ended September 30, 2009,

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as shown in the tables below. In the tables, a negative number represents net favorable reserve development and a positive number represents net unfavorable reserve development.
                                                                         
    Loss Reserve Development by Loss Year  
    For the Three Months Ended September 30, 2010  
    2002     2003     2004     2005     2006     2007     2008     2009     Total  
    ($ in millions)  
General property
  $     $ 0.1     $ 0.1     $ (2.3 )   $ 0.3     $ 0.1     $ (11.1 )   $ (0.1 )   $ (12.9 )
Professional liability
          (1.3 )     (3.2 )     (11.2 )     (3.5 )                       (19.2 )
General casualty
    2.0       (1.1 )     (2.7 )     (12.0 )     (1.8 )     (4.6 )                 (20.2 )
Healthcare
    (0.1 )     (0.2 )     (0.4 )     (0.5 )     (7.3 )                       (8.5 )
 
                                                     
 
  $ 1.9     $ (2.5 )   $ (6.2 )   $ (26.0 )   $ (12.3 )   $ (4.5 )   $ (11.1 )   $ (0.1 )   $ (60.8 )
 
                                                     
                                                                 
    Loss Reserve Development by Loss Year  
    For the Three Months Ended September 30, 2009  
    2002     2003     2004     2005     2006     2007     2008     Total  
    ($ in millions)  
General property
  $     $     $ (1.0 )   $ 0.5     $ (1.3 )   $ (2.1 )   $ (8.0 )   $ (11.9 )
Professional liability
          (0.2 )     (2.5 )     (14.8 )                       (17.5 )
General casualty
    (0.1 )     (0.6 )     (1.4 )     (1.3 )     (2.6 )                 (6.0 )
Healthcare
    (0.1 )           (0.3 )     (6.9 )                       (7.3 )
 
                                               
 
  $ (0.2 )   $ (0.8 )   $ (5.2 )   $ (22.5 )   $ (3.9 )   $ (2.1 )   $ (8.0 )   $ (42.7 )
 
                                               
     The loss and loss expense ratio for the three months ended September 30, 2010 was 13.7%, compared to 29.0% for the three months ended September 30, 2009. The net favorable reserve development recognized during the three months ended September 30, 2010 decreased the loss and loss expense ratio by 75.4 percentage points. Thus, the loss and loss expense ratio related to the current loss year was 89.1%. Comparatively, the net favorable reserve development recognized during the three months ended September 30, 2009 decreased the loss and loss expense ratio by 43.7 percentage points. Thus, the loss and loss expense ratio related to that period’s business was 72.7%. The increase in the loss and loss expense ratio for the current loss year was primarily due to net incurred losses of $16.0 million noted previously, which occurred during the three months ended September 30, 2010 and contributed 19.9 percentage points to the current year’s losses and loss expense ratio.
     Net paid losses for the three months ended September 30, 2010 and 2009 were $64.8 million and $43.3 million, respectively. The increase in net paid losses was primarily due to net paid losses on current year catastrophe losses.
     The table below is a reconciliation of the beginning and ending reserves for losses and loss expenses for the three months ended September 30, 2010 and 2009. Losses incurred and paid are reflected net of reinsurance recoverables.

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    Three Months Ended  
    September 30,  
    2010     2009  
    ($ in millions)  
Net reserves for losses and loss expenses, July 1
  $ 1,782.8     $ 1,830.8  
Incurred related to:
               
Current period non-catastrophe
    71.4       71.0  
Current period property catastrophe
    0.5        
Prior period non-catastrophe
    (55.4 )     (42.9 )
Prior period property catastrophe
    (5.4 )     0.2  
 
           
Total incurred
  $ 11.1     $ 28.3  
Paid related to:
               
Current period non-catastrophe
    3.7       4.9  
Current period property catastrophe
    17.0        
Prior period non-catastrophe
    42.5       27.1  
Prior period property catastrophe
    1.6       11.3  
 
           
Total paid
  $ 64.8     $ 43.3  
Foreign exchange revaluation
    7.9       3.7  
 
           
Net reserve for losses and loss expenses, September 30
    1,737.0       1,819.5  
Losses and loss expenses recoverable
    559.8       571.6  
 
           
Reserve for losses and loss expenses, September 30
  $ 2,296.8     $ 2,391.1  
 
           
     Acquisition costs. Acquisition costs decreased to slightly less than nil for the three months ended September 30, 2010 from positive $0.5 million for the three months ended September 30, 2009. The negative cost represents ceding commissions received on ceded premiums in excess of the brokerage fees and commissions paid on gross premiums written. The acquisition cost ratio decreased from 0.5% for the three months ended September 30, 2009 to 0.0% for the three months ended September 30, 2010.
     General and administrative expenses. General and administrative expenses increased $2.9 million, or 14.6%, for the three months ended September 30, 2010 compared to the three months ended September 30, 2009. The increase in general and administrative expenses was primarily due to an increase in salary and related costs, including stock-based compensation. The general and administrative expense ratios for the three months ended September 30, 2010 and 2009 were 28.3% and 20.3%, respectively. The increase was due to higher general and administrative expense relative to lower net premiums earned.
Comparison of Nine Months Ended September 30, 2010 and 2009
     Premiums. Gross premiums written decreased by $35.8 million, or 8.4%, for the nine months ended September 30, 2010 compared to the same period in 2009. The decrease in gross premiums written was due to the continued trend of the non-renewal of business that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions) and increased competition in our international insurance segment.
     The table below illustrates our gross premiums written by line of business for the nine months ended September 30, 2010 and 2009.
                                 
    Nine Months Ended              
    September 30,     Dollar     Percentage  
    2010     2009     Change     Change  
            ($ in millions)          
General property*
  $ 124.6     $ 143.5     $ (18.9 )     (13.2 )%
Professional liability
    113.3       124.7       (11.4 )     (9.1 )
General casualty
    99.2       107.6       (8.4 )     (7.8 )
Healthcare
    52.8       49.9       2.9       5.8  
 
                         
 
  $ 389.9     $ 425.7     $ (35.8 )     (8.4 )%
 
                         
 
*   Includes our energy line of business.

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     Net premiums written decreased $30.0 million, or 10.9%, for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009. The decrease in net premiums written was primarily due to the decrease in gross premiums written partially offset by lower premiums ceded on our property catastrophe reinsurance coverage. We ceded to reinsurers 37.1% of gross premiums written for the nine months ended September 30, 2010 compared to 35.4% for the nine months ended September 30, 2009. The increase is primarily due to increased cessions on our general casualty and professional liability lines of business. Net premiums earned decreased $63.7 million, or 19.9%, primarily due to lower net premiums written during 2009 and for the first nine months of 2010.
     Net losses and loss expenses. Net losses and loss expenses decreased by $8.5 million, or 6.0%, for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009. The decrease in net losses and loss expenses was primarily due to higher net favorable reserve development recognized partially offset by higher loss activity in the current period. During the nine months ended September 30, 2010, we experienced net losses and loss expenses of $100.4 million from a number of earthquakes, explosions and other weather related events. Overall, our international insurance segment recorded net favorable reserve development of $141.5 million during the nine months ended September 30, 2010 compared to net favorable reserve development of $90.1 million for the nine months ended September 30, 2009, as shown in the tables below. In the tables, a negative number represents net favorable reserve development and a positive number represents net unfavorable reserve development.
                                                                         
    Loss Reserve Development by Loss Year  
    For the Nine Months Ended September 30, 2010  
    2002     2003     2004     2005     2006     2007     2008     2009     Total  
    ($ in millions)  
General property
  $     $ (0.1 )   $ (0.2 )   $ (4.6 )   $ (5.4 )   $ (5.9 )   $ (25.7 )   $ 4.2     $ (37.7 )
Professional liability
          (5.1 )     (2.6 )     (31.9 )     4.4                         (35.2 )
General casualty
    4.8       (3.2 )     (17.0 )     (24.5 )     (8.0 )     (6.1 )     11.3             (42.7 )
Healthcare
    (0.3 )     (0.9 )     (1.2 )     (8.9 )     (14.6 )                       (25.9 )
 
                                                     
 
  $ 4.5     $ (9.3 )   $ (21.0 )   $ (69.9 )   $ (23.6 )   $ (12.0 )   $ (14.4 )   $ 4.2     $ (141.5 )
 
                                                     
                                                                 
    Loss Reserve Development by Loss Year  
    For the Nine Months Ended September 30, 2009  
    2002     2003     2004     2005     2006     2007     2008     Total  
    ($ in millions)  
General property
  $ (0.3 )   $ (0.9 )   $ (2.8 )   $ (2.1 )   $ (3.1 )   $ (7.3 )   $ 12.3     $ (4.2 )
Professional liability
          (0.4 )     (17.5 )     (27.7 )                 0.2       (45.4 )
General casualty
    (5.0 )     (17.3 )     (17.4 )     (0.5 )     21.1       0.1       0.1       (18.9 )
Healthcare
    (0.4 )     (1.3 )     (5.9 )     (14.0 )                       (21.6 )
 
                                                     
 
  $ (5.7 )   $ (19.9 )   $ (43.6 )   $ (44.3 )   $ 18.0     $ (7.2 )   $ 12.6     $ (90.1 )
 
                                               
     The loss and loss expense ratio for the nine months ended September 30, 2010 was 51.8%, compared to 44.2% for the nine months ended September 30, 2009. The net favorable reserve development recognized during the nine months ended September 30, 2010 decreased the loss and loss expense ratio by 55.1 percentage points. Thus, the loss and loss expense ratio related to the current loss year was 106.9%. Comparatively, the net favorable reserve development recognized during the nine months ended September 30, 2009 decreased the loss and loss expense ratio by 28.1 percentage points. Thus, the loss and loss expense ratio related to that period’s business was 72.3%. The increase in the loss and loss expense ratio for the current loss year was primarily due to net incurred losses of $100.4 million noted above, which occurred during the nine months ended September 30, 2010 and contributed 39.1 percentage points to the current year’s loss and loss expense ratio.
     Net paid losses for the nine months ended September 30, 2010 and 2009 were $184.9 million and $127.2 million, respectively. The increase in net paid losses was primarily due to several large loss payments in our general casualty and professional liability lines of business and net paid losses for current year catastrophe losses.
     The table below is a reconciliation of the beginning and ending reserves for losses and loss expenses for the nine months ended September 30, 2010 and 2009. Losses incurred and paid are reflected net of reinsurance recoverables.

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    Nine Months Ended  
    September 30,  
    2010     2009  
    ($ in millions)  
Net reserves for losses and loss expenses, January 1
  $ 1,790.1     $ 1,797.0  
Incurred related to:
               
Current period non-catastrophe
    224.1       231.7  
Current period property catastrophe
    50.5        
Prior period non-catastrophe
    (131.9 )     (88.5 )
Prior period property catastrophe
    (9.6 )     (1.6 )
 
           
Total incurred
  $ 133.1     $ 141.6  
Paid related to:
               
Current period non-catastrophe
    12.4       6.5  
Current period property catastrophe
    35.9        
Prior period non-catastrophe
    126.0       92.0  
Prior period property catastrophe
    10.6       28.7  
 
           
Total paid
  $ 184.9     $ 127.2  
Foreign exchange revaluation
    (1.3 )     8.1  
 
           
Net reserve for losses and loss expenses, September 30
    1,737.0       1,819.5  
Losses and loss expenses recoverable
    559.8       571.6  
 
           
Reserve for losses and loss expenses, September 30
  $ 2,296.8     $ 2,391.1  
 
           
     Acquisition costs. Acquisition costs decreased $3.2 million, or 100.0%, for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009. The acquisition cost ratio decreased from 1.0% for the nine months ended September 30, 2009 to 0.0% for the nine months ended September 30, 2010.
     General and administrative expenses. General and administrative expenses increased $8.7 million, or 14.8%, for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009. The increase in general and administrative expenses was primarily due to an increase in salary and related costs, including stock-based compensation. The general and administrative expense ratios for the nine months ended September 30, 2010 and 2009 were 26.2% and 18.3%, respectively, due to higher general and administrative expense relative to lower net premiums earned.
Reinsurance Segment
     The following table summarizes the underwriting results and associated ratios for the reinsurance segment for the three and nine months ended September 30, 2010 and 2009.

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    Three Months Ended   Nine Months Ended
    September 30,   September 30,
    2010   2009   2010   2009
    ($ in millions)
Revenues
                               
Gross premiums written
  $ 96.3     $ 124.4     $ 453.6     $ 442.8  
Net premiums written
    96.2       124.4       452.9       442.4  
Net premiums earned
    129.3       119.5       375.2       337.8  
Expenses
                               
Net losses and loss expenses
  $ 60.8     $ 66.1     $ 192.0     $ 177.9  
Acquisition costs
    23.9       21.8       69.8       65.2  
General and administrative expenses
    15.3       11.7       44.5       34.4  
Underwriting income
    29.3       19.9       68.9       60.3  
Ratios
                               
Loss and loss expense ratio
    47.0 %     55.3 %     51.2 %     52.7 %
Acquisition cost ratio
    18.5 %     18.2 %     18.6 %     19.3 %
General and administrative expense ratio
    11.8 %     9.8 %     11.9 %     10.2 %
Expense ratio
    30.3 %     28.0 %     30.5 %     29.5 %
Combined ratio
    77.3 %     83.3 %     81.7 %     82.2 %
Comparison of Three Months Ended September 30, 2010 and 2009
     Premiums. Gross premiums written decreased by $28.1 million, or 22.6%, for the three months ended September 30, 2010 compared to the same period in 2009. The decrease in gross premiums written was primarily due to the timing of renewals of two treaties, a quota share reinsurance treaty for $23.6 million in our property reinsurance line of business and a quota share reinsurance treaty for $10.9 million in our professional liability reinsurance line of business. The property reinsurance treaty was originally bound during in the third quarter of 2009 for $9.0 million and expired on November 30, 2009. The renewed treaty is effective from January 1, 2010 to December 31, 2010. The professional liability reinsurance treaty was previously written in the third quarter of 2009 for $16.5 million and was renewed in the second quarter of 2010 for $10.9 million. Also contributing to these decreases were the non-renewal of business that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions), increased competition and increased cedent retention partially offset by new business written.
     During the three months ended September 30, 2010, our Bermuda, U.S., Singapore and European reinsurance operations had gross premiums written of $44.5 million, $43.7 million, $4.2 million and $3.9 million, respectively. During the three months ended September 30, 2009, our Bermuda, U.S., Singapore and European reinsurance operations had gross premiums written of $47.0 million, $75.7 million, nil, and $1.7 million, respectively.
     The table below illustrates our gross premiums written by line of business for the three months ended September 30, 2010 and 2009.
                                 
    Three Months Ended              
    September 30,     Dollar     Percentage  
    2010     2009     Change     Change  
            ($ in millions)          
General casualty reinsurance
  $ 30.3     $ 42.9     $ (12.6 )     (29.4 )%
International reinsurance
    21.7       13.1       8.6       65.6  
Property reinsurance
    19.2       28.6       (9.4 )     (32.9 )
Professional liability reinsurance
    12.6       28.5       (15.9 )     (55.8 )
Specialty reinsurance
    6.7       4.4       2.3       52.3  
Facultative reinsurance
    5.8       6.9       (1.1 )     (15.9 )
 
                         
 
  $ 96.3     $ 124.4     $ (28.1 )     (22.6 )%
 
                         
     Net premiums written decreased by $28.3 million, or 22.7%, which is consistent with the decrease in gross premiums written. Net premiums earned increased $9.8 million, or 8.2%, due to the increase in net premiums written during 2009 and the first nine months of 2010. Premiums related to our reinsurance business earn at a slower rate than those related to our direct insurance business. Direct insurance premiums typically earn ratably over the term of a policy. Reinsurance premiums under a quota share reinsurance contract are typically earned over the same period as the underlying policies, or risks, covered by the contract. As a result, the earning pattern

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of a quota share reinsurance contract may extend up to 24 months, reflecting the inception dates of the underlying policies. Property catastrophe premiums and premiums for other treaties written on a losses occurring basis earn ratably over the term of the reinsurance contract.
     Net losses and loss expenses. Net losses and loss expenses decreased by $5.3 million, or 8.0%, for the three months ended September 30, 2010 compared to the three months ended September 30, 2009. The decrease in net losses and loss expenses is primarily due to higher net favorable prior year reserve development recognized during the three months ended September 30, 2010 compared to the same period in 2009, as well as $6.0 million of net favorable current year reserve development, partially offset by net losses from the New Zealand earthquake of $9.0 million and the growth of the reinsurance operations. Overall, our reinsurance segment recorded net favorable prior year reserve development of $15.1 million and $3.3 million during the three months ended September 30, 2010 and 2009, respectively, as shown in the tables below. In the tables, a negative number represents net favorable reserve development and a positive number represents net unfavorable reserve development.
                                                                         
    Loss Reserve Development by Loss Year  
    For the Three Months Ended September 30, 2010  
    2002     2003     2004     2005     2006     2007     2008     2009     Total  
    ($ in millions)  
Property reinsurance
  $ (0.1 )   $ (0.5 )   $ (0.7 )   $ (1.0 )   $ (0.8 )   $ (0.3 )   $     $     $ (3.4 )
International reinsurance
    (0.1 )     (0.1 )     (0.1 )     (0.4 )     (0.4 )     1.1       2.4       0.6       3.0  
General casualty reinsurance
          (0.1 )     0.4       (5.2 )     (0.8 )     (0.6 )     (0.1 )           (6.4 )
Professional liability reinsurance
    (0.3 )     0.6       0.5       (3.7 )     (3.7 )     (0.5 )     (0.3 )           (7.4 )
Specialty reinsurance
                (0.3 )     (0.6 )                             (0.9 )
Facultative reinsurance
          (0.3 )     0.1       0.2                               0.0  
 
                                                     
 
  $ (0.5 )   $ (0.4 )   $ (0.1 )   $ (10.7 )   $ (5.7 )   $ (0.3 )   $ 2.0     $ 0.6     $ (15.1 )
 
                                                     
                                                                 
    Loss Reserve Development by Loss Year  
    For the Three Months Ended September 30, 2009  
    2002     2003     2004     2005     2006     2007     2008     Total  
    ($ in millions)  
Property reinsurance
  $     $     $     $ 0.7     $     $     $ 1.0     $ 1.7  
International reinsurance
    (0.2 )     (0.5 )     (0.3 )     (0.2 )                       (1.2 )
General casualty reinsurance
    (0.4 )     (1.7 )     (1.9 )     (2.1 )     (0.3 )                 (6.4 )
Professional liability reinsurance
    (2.2 )     (2.5 )     (2.9 )     (0.2 )           8.1       3.5       3.8  
Specialty reinsurance
                (0.4 )     0.6                         0.2  
Facultative reinsurance
          (0.4 )     (1.0 )                             (1.4 )
 
                                                     
 
  $ (2.8 )   $ (5.1 )   $ (6.5 )   $ (1.2 )   $ (0.3 )   $ 8.1     $ 4.5     $ (3.3 )
 
                                               
     The loss and loss expense ratio for the three months ended September 30, 2010 was 47.0%, compared to 55.3% for the three months ended September 30, 2009. Net favorable reserve development recognized during the three months ended September 30, 2010 reduced the loss and loss expense ratio by 11.7 percentage points. Thus, the loss and loss expense ratio related to the current loss year was 58.7%. In comparison, net favorable reserve development recognized in the three months ended September 30, 2009 reduced the loss and loss expense ratio by 2.8 percentage points. Thus, the loss and loss expense ratio related to that loss year was 58.1%.
     The table below is a reconciliation of the beginning and ending reserves for losses and loss expenses for the three months ended September 30, 2010 and 2009. Losses incurred and paid are reflected net of reinsurance recoverables.

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    Three Months Ended  
    September 30,  
    2010     2009  
    ($ in millions)  
Net reserves for losses and loss expenses, July 1
  $ 1,199.5     $ 1,103.9  
Incurred related to:
               
Current period non-catastrophe
    76.4       69.4  
Current period property catastrophe
    (0.5 )      
Prior period non-catastrophe
    (14.9 )     (4.9 )
Prior period property catastrophe
    (0.2 )     1.6  
 
           
Total incurred
  $ 60.8     $ 66.1  
Paid related to:
               
Current period non-catastrophe
    8.9       2.7  
Current period property catastrophe
    0.1        
Prior period non-catastrophe
    39.5       30.1  
Prior period property catastrophe
    1.1       1.4  
 
           
Total paid
  $ 49.6     $ 34.2  
Net reserve for losses and loss expenses, September 30
    1,210.7       1,135.8  
Losses and loss expenses recoverable
    0.1       1.7  
 
           
Reserve for losses and loss expenses, September 30
  $ 1,210.8     $ 1,137.5  
 
           
     Acquisition costs. Acquisition costs increased by $2.1 million, or 9.6%, for the three months ended September 30, 2010 compared to the three months ended September 30, 2009 primarily as a result of higher net premiums earned. The acquisition cost ratio was 18.5% for the three months ended September 30, 2010, compared to 18.2% for the three months ended September 30, 2009.
     General and administrative expenses. General and administrative expenses increased $3.6 million, or 30.8%, for the three months ended September 30, 2010 compared to the three months ended September 30, 2009. The increase in general and administrative expenses was primarily due to an increase in salary and related costs included stock-based compensation. The 2.0 percentage point increase in the general and administrative expense ratio from 9.8% for the three months ended September 30, 2009 to 11.8% for the three months ended September 30, 2010 was due to higher general and administrative expenses partially offset by higher net premiums earned.
Comparison of Nine Months Ended September 30, 2010 and 2009
     Premiums. Gross premiums written increased by $10.8 million, or 2.4%, for the nine months ended September 30, 2010 compared to the same period in 2009. The increase in gross premiums written was primarily due to increased writings in our property and international reinsurance lines of business with the build out of our London and Singapore offices, including business written through Syndicate 2232. These increases were partially offset by the non-renewal of business that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions), increased competition and increased cedent retention.
     During the nine months ended September 30, 2010, our Bermuda, U.S., Singapore and European reinsurance operations had gross premiums written of $194.2 million, $215.2 million, $13.7 million, and $30.5 million, respectively. During the nine months ended September 30, 2009, our Bermuda, U.S., Singapore and European reinsurance operations had gross premiums written of $180.8 million, $245.2 million, nil and $16.8 million, respectively.
The table below illustrates our gross premiums written by line of business for the nine months ended September 30, 2010 and 2009.
                                 
    Nine months Ended              
    September 30,     Dollar     Percentage  
    2010     2009     Change     Change  
            ($ in millions)          
Property reinsurance
  $ 132.9     $ 100.0     $ 32.9       32.9 %
General casualty reinsurance
    119.6       146.1       (26.5 )     (18.1 )
International reinsurance
    89.8       74.9       14.9       19.9  
Professional liability reinsurance
    72.7       85.2       (12.5 )     (14.7 )
Specialty reinsurance
    26.7       23.6       3.1       13.1  
Facultative reinsurance
    11.9       13.0       (1.1 )     (8.5 )
 
                         
 
  $ 453.6     $ 442.8     $ 10.8       2.4 %
 
                         

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     Net premiums written increased by $10.5 million, or 2.4%, which is consistent with the increase in gross premiums written. Net premiums earned increased $37.4 million, or 11.1%, due to the increase in net premiums written.
     Net losses and loss expenses. Net losses and loss expenses increased by $14.1 million, or 7.9%, for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009. The increase in net losses and loss expenses was primarily due to the growth of the reinsurance operations and higher loss activity of $29.0 million from a number of earthquakes and other weather related events, partially offset by higher net favorable prior year reserve development and $6.0 million of net favorable current year reserve development. Overall, our reinsurance segment recorded net favorable prior year reserve development of $47.8 million and $24.6 million during the nine months ended September 30, 2010 and 2009, respectively, as shown in the tables below. In the tables, a negative number represents net favorable reserve development and a positive number represents net unfavorable reserve development.
                                                                         
    Loss Reserve Development by Loss Year  
    For the Nine Months Ended September 30, 2010  
    2002     2003     2004     2005     2006     2007     2008     2009     Total  
    ($ in millions)  
Property reinsurance
  $ (0.1 )   $ (0.5 )   $ (0.7 )   $ (2.4 )   $ (0.8 )   $ (0.3 )   $ 0.7     $ (7.5 )   $ (11.6 )
International reinsurance
    (0.1 )     (0.3 )     (0.3 )     (0.6 )     (0.4 )     (0.4 )     2.4       0.4       0.7  
General casualty reinsurance
    (0.1 )     (0.1 )     (4.7 )     (8.9 )     (1.4 )     (0.7 )     (0.1 )           (16.0 )
Professional liability reinsurance
    (0.6 )     (1.1 )     (6.3 )     (6.5 )     (4.2 )     (0.7 )     (0.3 )           (19.7 )
Specialty reinsurance
                (0.4 )     (0.1 )           (0.4 )     (2.9 )           (3.8 )
Facultative reinsurance
    (0.1 )     0.5       2.4       (0.2 )                             2.6  
 
                                                     
 
  $ (1.0 )   $ (1.5 )   $ (10.0 )   $ (18.7 )   $ (6.8 )   $ (2.5 )   $ (0.2 )   $ (7.1 )   $ (47.8 )
 
                                                     
                                                                 
    Loss Reserve Development by Loss Year  
    For the Nine Months Ended September 30, 2009  
    2002     2003     2004     2005     2006     2007     2008     Total  
    ($ in millions)  
Property reinsurance
  $     $ 0.3     $ (0.8 )   $ 3.4     $     $ (5.3 )   $ (0.4 )   $ (2.8 )
International reinsurance
    (0.2 )     (0.5 )     1.0       (0.1 )           0.7       (0.9 )      
General casualty reinsurance
    (0.6 )     (4.6 )     (5.3 )     (3.2 )     (0.4 )                 (14.1 )
Professional liability reinsurance
    (2.4 )     (5.3 )     (6.4 )     (1.1 )     (0.2 )     8.1       3.5       (3.8 )
Specialty reinsurance
                (0.9 )     1.2                         0.3  
Facultative reinsurance
          (4.1 )     (0.1 )                             (4.2 )
 
                                               
 
  $ (3.2 )   $ (14.2 )   $ (12.5 )   $ 0.2     $ (0.6 )   $ 3.5     $ 2.2     $ (24.6 )
 
                                               
     The loss and loss expense ratio for the nine months ended September 30, 2010 was 51.2%, compared to 52.7% for the nine months ended September 30, 2009. Net favorable prior year reserve development recognized during the nine months ended September 30, 2010 reduced the loss and loss expense ratio by 12.7 percentage points. Thus, the loss and loss expense ratio related to the current loss year was 63.9%. In comparison, net favorable reserve development recognized in the nine months ended September 30, 2009 reduced the loss and loss expense ratio by 7.3 percentage points. Thus, the loss and loss expense ratio related to that loss year was 60.0%. The increase in the loss and loss expense ratio for the current loss year was primarily due to net incurred losses of $29.0 million noted above, which contributed 7.7 percentage points to the current loss year’s loss and loss expense ratio.
     The table below is a reconciliation of the beginning and ending reserves for losses and loss expenses for the nine months ended September 30, 2010 and 2009. Losses incurred and paid are reflected net of reinsurance recoverables.

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    Nine Months Ended  
    September 30,  
    2010     2009  
    ($ in millions)  
Net reserves for losses and loss expenses, January 1
  $ 1,149.8     $ 1,072.1  
Incurred related to:
               
Current period non-catastrophe
    225.3       202.6  
Current period property catastrophe
    14.5        
Prior period non-catastrophe
    (46.2 )     (25.8 )
Prior period property catastrophe
    (1.6 )     1.2  
 
           
Total incurred
  $ 192.0     $ 178.0  
Paid related to:
               
Current period non-catastrophe
    11.4       3.5  
Current period property catastrophe
    0.5        
Prior period non-catastrophe
    115.5       97.5  
Prior period property catastrophe
    3.7       13.3  
 
           
Total paid
  $ 131.1     $ 114.3  
Net reserve for losses and loss expenses, September 30
    1,210.7       1,135.8  
Losses and loss expenses recoverable
    0.1       1.7  
 
           
Reserve for losses and loss expenses, September 30
  $ 1,210.8     $ 1,137.5  
 
           
     Acquisition costs. Acquisition costs increased by $4.6 million, or 7.1%, for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009 primarily as a result of higher net premiums earned. The acquisition cost ratio was 18.6% for the nine months ended September 30, 2010, compared to 19.3% for the nine months ended September 30, 2009. The decrease in the acquisition cost ratio is due to more business written on an excess-of-loss basis, which typically carries a lower acquisition cost ratio than quota share business.
     General and administrative expenses. General and administrative expenses increased $10.1 million, or 29.4%, for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009. The increase in general and administrative expenses was primarily due to an increase in salary and related costs included stock-based compensation. The 1.7 percentage point increase in the general and administrative expense ratio from 10.2% for the nine months ended September 30, 2009 to 11.9% for the nine months ended September 30, 2010 was due to higher general and administrative expenses partially offset by higher net premiums earned.
Reserves for Losses and Loss Expenses
     Reserves for losses and loss expenses by segment as of September 30, 2010 and December 31, 2009 were comprised of the following:
                                                                 
    U.S. Insurance     International Insurance     Reinsurance     Total  
    Sept. 30,     Dec. 31,     Sept. 30,     Dec. 31,     Sept. 30,     Dec. 31,     Sept. 30,     Dec. 31,  
    2010     2009     2010     2009     2010     2009     2010     2009  
    ($ in millions)  
Case reserves
  $ 292.1     $ 268.1     $ 543.4     $ 570.4     $ 346.3     $ 313.5     $ 1,181.8     $ 1,152.0  
IBNR
    1,090.1       985.6       1,753.4       1,786.0       864.5       838.2       3,708.0       3,609.8  
 
                                               
Reserve for losses and loss expenses
    1,382.2       1,253.7       2,296.8       2,356.4       1,210.8       1,151.7       4,889.8       4,761.8  
Reinsurance recoverables
    (380.1 )     (351.8 )     (559.8 )     (566.3 )     (0.1 )     (1.9 )     (940.0 )     (920.0 )
 
                                               
Net reserve for losses and loss expenses
  $ 1,002.1     $ 901.9     $ 1,737.0     $ 1,790.1     $ 1,210.7     $ 1,149.8     $ 3,949.8     $ 3,841.8  
 
                                               
     We participate in certain lines of business where claims may not be reported for many years. Accordingly, management does not solely rely upon reported claims on these lines for estimating ultimate liabilities. We also use statistical and actuarial methods to estimate