Edgar Filing: HCC INSURANCE HOLDINGS INC/DE/

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q/A


þ		Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the Quarter Ended March 31, 2006.


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


Commission file number		001-13790


		HCC Insurance Holdings, Inc.

		(Exact name of registrant as specified in its charter)

		Delaware		76-0336636

		(State or other jurisdiction of		(IRS Employer
		incorporation or organization)		Identification No.)

		13403 Northwest Freeway, Houston, Texas		77040-6094

		(Address of principal executive offices)		(Zip Code)

		(713) 690-7300

		(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.

Yes þ No o

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

Large accelerated filer þ Accelerated filer o Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No þ

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

On April 30, 2006, there were approximately 111.2 million shares of common stock, $1.00 par value issued and outstanding.

HCC INSURANCE HOLDINGS, INC.
TABLE OF CONTENTS


			Page
Part I.	FINANCIAL INFORMATION
	Item 1.	Financial Statements

		Condensed Consolidated Balance Sheets —
		March 31, 2006 and December 31, 2005 (As restated) (unaudited)		7

		Condensed Consolidated Statements of Earnings —
		Three months ended March 31, 2006 and 2005 (As restated) (unaudited)		8

		Condensed Consolidated Statement of Changes in Shareholders’ Equity —
		Three months ended March 31, 2006 (As restated) (unaudited)		9

		Condensed Consolidated Statements of Cash Flows —
		Three months ended March 31, 2006 and 2005 (As restated) (unaudited)		10

		Notes to Condensed Consolidated Financial Statements (As restated) (unaudited)		11

	Item 2.	Management’s Discussion and Analysis of Financial Condition
		and Results of Operations		32

	Item 3.	Quantitative and Qualitative Disclosures About Market Risk		44

	Item 4.	Controls and Procedures		44

Part II.	OTHER INFORMATION
	Item 1.	Legal Proceedings		46

	Item 1A.	Risk Factors		46

	Item 6.	Exhibits		46

Signatures				47
Certification by Chief Executive Officer
Certification by Chief Financial Officer
Certification with Respect to Quarterly Report

As used in this report, unless otherwise required by the context, the terms “we,” “us” and “our” refer to HCC Insurance Holdings, Inc. and its consolidated subsidiaries and the term “HCC” refers only to HCC Insurance Holdings, Inc.

EXPLANATORY NOTE — RESTATEMENT OF FINANCIAL STATEMENTS

HCC Insurance Holdings, Inc. is amending its quarterly report on Form 10-Q for the quarter ended March 31, 2006 (the “Form 10-Q” or the “Original Filing”). We are restating our condensed consolidated financial statements to reflect certain adjustments as discussed below. The amendment reflects the restatement of our condensed consolidated financial statements as of and for the three months ended March 31, 2006 and 2005.

In light of published reports concerning the pricing of stock options and the timing of stock option grants at numerous other companies, in the second quarter of 2006 we undertook a voluntary internal review of our past practices related to grants of stock options. The voluntary review by our management concluded that the actual accounting measurement dates for certain past stock option grants differed from the originally stated grant dates, which were also utilized as the measurement dates for such awards. In August 2006, our Board of Directors formed a Special Committee of independent directors to commence an investigation of our past stock option granting practices for the period 1995 through 2005. The Special Committee was composed of the members of the Audit Committee of the Board of Directors. The Special Committee retained the law firm of Skadden, Arps, Slate, Meagher & Flom, LLP as its independent legal counsel and LECG as forensic accountants to aid in the investigation.

On November 17, 2006, we announced that the Special Committee had made certain determinations as a result of its review of our past stock option granting practices. The Special Committee found that we had used incorrect accounting measurement dates for stock option grants covering a significant number of employees and members of our Board of Directors during the period 1997 through 2005 and that certain option grants were retroactively priced. Additionally, at the direction of the Special Committee, we reviewed our stock option granting practices from 1992, the year of our initial public stock offering, through 1994 and in 2006 and found incorrect measurement dates due to retroactive pricing were used in 2006. In substantially all of these instances, the price on the actual measurement date was higher than the price on the stated grant date; thus recipients of the options could exercise at a strike price lower than the actual measurement date price. To determine the actual measurement dates, the Special Committee utilized the following sources of information:

	•		The dates on documentation such as e-mails, regulatory form filings, acquisition agreements and other correspondence;

	•		The date that the relevant stock option grant was entered into Equity Edge, our stock option tracking and accounting system;

	•		Requirements of Accounting Principles Board (APB) No. 25, Accounting for Stock Issued to Employees, and related interpretations; and

	•		Guidance from the Office of Chief Accountant of the Securities and Exchange Commission (SEC) contained in a letter dated September 19, 2006.

The Special Committee concluded that mis-priced option grants, the effect of which, together with certain other adjustments, resulted in a cumulative net decrease in shareholders’ equity at December 31, 2005 of $3.3 million, affected all levels of employees. The Special Committee found that Stephen L. Way, Chief Executive Officer, retroactively priced options, that he should have known he was granting options in a manner that conflicted with our stock option plans and public statements, and that this constituted a failure to align the stock option granting process with our stock option plans and public statements. Although finding his actions were inconsistent with the duties and obligations of a chief executive officer of a publicly-traded company, the Special Committee also found that Mr. Way’s motivation appeared to be the attraction and retention of talent and to provide employees with the best option price. The Special Committee also concluded that Christopher L. Martin, Executive Vice President and General Counsel, was aware that options were being retroactively priced in a manner inconsistent with applicable plan terms and the procedures memoranda that he had prepared, that granting in-the-money options had accounting implications, and that he did not properly document our Compensation Committee’s informal delegation of authority to Mr. Way. The Special Committee also found that there was no evidence that Mr. Way or Mr. Martin intended to falsify the consolidated financial statements.

Before the Board of Directors reviewed the results of the investigation, the Chairman of the Compensation Committee tendered his resignation from the Board of Directors on November 8, 2006. After reviewing the results of the investigation, the Board of Directors determined that it would be appropriate to accept the resignations of Mr. Way and Mr. Martin, which both tendered on November 17, 2006. Mr. Way will remain a director of HCC and serve as the non-executive Chairman of the Board of Directors and has entered into a consulting agreement with us to assist in the transition of leadership and to provide strategic guidance. We have entered into agreements with Mr. Way and Mr. Martin which, among other things, require them to disgorge an amount equal to the difference between the actual measurement date prices determined by HCC and the prices at which these individuals exercised mis-priced options since 1997.

For more information on these matters, including a detailed discussion of the financial effects of these matters, refer to Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Restatement of Consolidated Financial Statements, Special Committee and Company Findings” and to Note 2, “Restatement of Consolidated Financial Statements, Special Committee and Company Findings,” of the Notes to Condensed Consolidated Financial Statements.

As a result of the determinations of the Special Committee and because the resulting cumulative charge would be material to the second quarter and full year 2006 consolidated net earnings, we concluded that we needed to amend this Quarterly Report on Form 10-Q for the quarter ended March 31, 2006 as filed on May 10, 2006 (the Original Filing), to restate our condensed consolidated financial statements for the three months ended March 31, 2006 and 2005 and the related disclosures. For this reason, the condensed consolidated financial statements and related financial information contained in such previously filed report should no longer be relied upon. We are making the restatement in accordance with generally accepted accounting principles to record the following:

	•		Non-cash compensation expense for the difference between the stock price on the stated grant date and the actual measurement date and for the fluctuations in stock price in certain instances where variable accounting should have been applied;

	•		Other adjustments that were not recorded in the originally filed financial statements due to their immateriality; and

	•		Related tax effects for all items.

We also concluded we did not maintain an effective control environment as our controls were not adequate to prevent or detect management override by certain former members of senior management related to our stock option granting practices and procedures. Accordingly, we have restated our report on internal control over financial reporting to reflect this material weakness.

We were unable to timely file our quarterly reports on Form 10-Q for the quarters ended June 30, 2006 and September 30, 2006, primarily due to not knowing the financial impact of the Special Committee’s investigation. We have also restated the June 30, 2005 and September 30, 2005 financial statements included in our quarterly reports on Form 10-Q for the respective 2006 quarters.

The increase (decrease) on net earnings of each type of adjustment was as follows (in thousands):


			Non-cash
	Net earnings as		stock option
	previously		compensation											Net earnings
	reported		expense			Other			Tax effect		Total adjustments			as restated

Three months ended March 31,
2006	$	78,551	$	(530	)	$	684		$	437	$	591		$	79,142
2005		57,318		(728	)		(2,153	)		951		(1,930	)		55,388

The restatement adjustments increased (reduced) previously reported diluted net earnings per share by $0.01 and $(0.02) for the three months ended March 31, 2006 and 2005, respectively.

All information in this Form 10-Q/A is as of March 31, 2006 and does not reflect events occurring after the date of the Original Filing, other than the restatement, and updating of disclosures affected by events subsequent to the date of the Original Filing. For the convenience of the reader, this Form 10-Q/A sets forth the Original Filing in its entirety, as amended and modified to reflect the restatement. The following sections of this Form 10-Q/A were amended to reflect the determinations of the Special Committee and the restatement:

Part I — Item 1 — Financial Statements;

Part I — Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations;

Part I — Item 4 — Controls and Procedures;

Part II — Item 1 — Legal Proceedings; and

Part II — Item 6 — Exhibits

This Form 10-Q/A should be read in conjunction with our periodic filings made with the SEC, subsequent to the date of the Original Filing, including any amendments to those filings, as well as any Current Reports filed on Form 8-K subsequent to the date of the Original Filing. In addition, in accordance with applicable rules and regulations promulgated by the SEC, this Form 10-Q/A includes updated certifications from our current Chief Executive Officer and Chief Financial Officer as Exhibits 31.1, 31.2 and 32.1.

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

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

	•		the effects of catastrophic losses;

	•		the cyclical nature of the insurance business;

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

	•		the effects of emerging claim and coverage issues;

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

	•		potential credit risk with brokers;

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

	•		the adequacy of reinsurance protection;

	•		the ability or willingness of reinsurers to pay balances due us;

	•		the occurrence of terrorist activities;

	•		our ability to maintain our competitive position;

	•		changes in our assigned financial strength ratings;

	•		our ability to raise capital in the future;

	•		attraction and retention of qualified employees;

	•		fluctuations in the fixed income securities market, which may reduce the value of our investment assets;

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

	•		our ability to receive dividends from our insurance company subsidiaries in needed amounts;

	•		fluctuations in foreign exchange rates; and

	•		failures of our information technology systems, which could adversely affect our business.

	•		developments in the SEC’s informal inquiry related to our past practices in connection with grants of stock options;

	•		potential issues related to the effects of Sections 409A and 162(m) of the Internal Revenue Code and any expenses associated therewith;

	•		changes to improve our internal controls related to the process of granting, documenting and accounting for stock option awards;

	•		additional expenses and taxes associated with our stock option investigation and related matters;

	•		potential litigation that could result from our stock option investigation;

	•		the ability of our Executive Officers to define and implement a strategic business plan; and

	•		our ability to cure all defaults or events of default under our outstanding loan agreements.

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

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

HCC Insurance Holdings, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

(unaudited, in thousands, except per share data)


	March 31, 2006		December 31, 2005
	(As restated)		(As restated)
ASSETS
Investments:
Fixed income securities, at fair value (amortized cost: 2006 — $2,573,727; 2005 — $2,277,139)	$	2,541,316	$	2,268,624
Short-term investments, at cost, which approximates fair value		592,831		839,581
Other investments, at fair value (cost: 2006 — $216,020; 2005 — $144,897)		230,187		149,223

Total investments		3,364,334		3,257,428
Cash		51,111		73,935
Restricted cash and cash investments		182,568		170,978
Premium, claims and other receivables		855,880		884,654
Reinsurance recoverables		1,349,351		1,361,983
Ceded unearned premium		239,530		239,416
Ceded life and annuity benefits		73,213		73,415
Deferred policy acquisition costs		161,329		156,253
Goodwill		531,286		532,947
Other assets		298,604		277,791

Total assets	$	7,107,206	$	7,028,800


LIABILITIES

Loss and loss adjustment expense payable	$	2,837,495	$	2,813,720
Life and annuity policy benefits		73,213		73,415
Reinsurance balances payable		149,897		176,954
Unearned premium		825,375		807,109
Deferred ceding commissions		66,900		67,886
Premium and claims payable		735,131		753,859
Notes payable		309,426		309,543
Accounts payable and accrued liabilities		354,132		335,879

Total liabilities		5,351,569		5,338,365

SHAREHOLDERS’ EQUITY

Common stock, $1.00 par value; 250.0 million shares authorized (shares issued and outstanding: 2006 — 111,173; 2005 — 110,803)		111,173		110,803
Additional paid-in capital		772,718		762,170
Retained earnings		869,192		798,388
Accumulated other comprehensive income		2,554		19,074

Total shareholders’ equity		1,755,637		1,690,435

Total liabilities and shareholders’ equity	$	7,107,206	$	7,028,800

See Notes to Condensed Consolidated Financial Statements.

HCC Insurance Holdings, Inc. and Subsidiaries

Condensed Consolidated Statements of Earnings

(unaudited, in thousands, except per share data)


	Three months ended March 31,
	2006			2005
	(As restated)			(As restated)
REVENUE

Net earned premium	$	380,571		$	320,117
Fee and commission income		31,669			31,623
Net investment income		36,581			22,341
Net realized investment loss		(1,298	)		(3	)
Other operating income		18,750			4,147

Total revenue		466,273			378,225


EXPENSE

Loss and loss adjustment expense, net		222,067			185,975
Policy acquisition costs, net		76,232			61,145
Other operating expense		47,333			45,677
Interest expense		2,154			1,808

Total expense		347,786			294,605

Earnings before income tax expense		118,487			83,620
Income tax expense		39,345			28,232

Net earnings	$	79,142		$	55,388


Basic earnings per share data:

Net earnings per share	$	0.71		$	0.54

Weighted average shares outstanding		111,014			103,241


Diluted earnings per share data:

Net earnings per share	$	0.68		$	0.52

Weighted average shares outstanding		116,896			105,734


Cash dividends declared, per share	$	0.075		$	0.057

See Notes to Condensed Consolidated Financial Statements.

HCC Insurance Holdings, Inc. and Subsidiaries

Condensed Consolidated Statement of Changes in Shareholders’ Equity

Three months ended March 31, 2006

(As restated)

(unaudited, in thousands, except per share data)


								Accumulated
			Additional					other			Total
	Common		paid-in		Retained			comprehensive			shareholders'
	stock		capital		earnings			income			equity

Balance at December 31, 2005 (As previously reported)	$	110,803	$	747,568	$	817,013		$	18,312		$	1,693,696
Cumulative effect of restatement (Note 2)		—		14,602		(18,625	)		762			(3,261	)

Balance at December 31, 2005 (As restated)		110,803		762,170		798,388			19,074			1,690,435
Net earnings		—		—		79,142			—			79,142
Other comprehensive loss		—		—		—			(16,520	)		(16,520	)

Comprehensive income												62,622
Issuance of 370 shares for exercise of options, including tax benefit of $1,750		370		7,268		—			—			7,638
Stock-based compensation		—		3,280		—			—			3,280
Cash dividends declared, $0.075 per share		—		—		(8,338	)		—			(8,338	)

Balance at March 31, 2006	$	111,173	$	772,718	$	869,192		$	2,554		$	1,755,637

See Notes to Condensed Consolidated Financial Statements.

HCC Insurance Holdings, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(unaudited, in thousands)


	Three months ended March 31,
	2006			2005
	(As restated)			(As restated)

Cash flows from operating activities:
Net earnings	$	79,142		$	55,388
Adjustments to reconcile net earnings to net cash provided by operating activities:
Change in premium, claims and other receivables		44,362			(132,208	)
Change in reinsurance recoverables		12,632			(824	)
Change in ceded unearned premium		(114	)		47,218
Change in loss and loss adjustment expense payable		23,775			49,851
Change in reinsurance balances payable		(27,057	)		(18,782	)
Change in unearned premium		18,266			(16,842	)
Change in premium and claims payable, net of restricted cash		(30,318	)		99,875
Change in trading portfolio		(47,994	)		(41,328	)
Depreciation and amortization expense		3,825			3,710
Stock-based compensation expense		2,703			597
Other, net		(1,131	)		(12,746	)

Cash provided by operating activities		78,091			33,909


Cash flows from investing activities:
Sales of fixed income securities		65,654			55,681
Maturity or call of fixed income securities		59,226			32,250
Cost of securities acquired		(471,614	)		(277,000	)
Change in short-term investments		246,750			145,025
Sale of strategic investment		17,363			—
Earnout payment for purchase of subsidiary		(24,000	)		—
Other, net		(2,047	)		(1,118	)

Cash used by investing activities		(108,668	)		(45,162	)


Cash flows from financing activities:
Issuance of notes payable		11,000			—
Payments on notes payable		(11,107	)		(93	)
Sale of common stock		7,638			21,087
Dividends paid		(8,310	)		(5,783	)
Other		8,532			(3,814	)

Cash provided by financing activities		7,753			11,397


Net increase (decrease) in cash		(22,824	)		144

Cash at beginning of period		73,935			69,933


Cash at end of period	$	51,111		$	70,077

See Notes to Condensed Consolidated Financial Statements.

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited, tables in thousands, except per share data)

(1)		GENERAL INFORMATION

		HCC Insurance Holdings, Inc. and its subsidiaries (collectively, we, us or our) include domestic and foreign property and casualty and life insurance companies, underwriting agencies and reinsurance brokers. We provide specialized property and casualty, surety, and group life, accident and health insurance coverages and related agency and reinsurance brokerage services to commercial customers and individuals. We market our products both directly to customers and through a network of independent brokers, producers and agents. Our lines of business include diversified financial products (which includes directors’ and officers’ liability, professional indemnity, employment practices liability and surety); group life, accident and health; aviation; London market account (which includes energy, marine, property, and accident and health); and other specialty lines of insurance. We operate primarily in the United States, the United Kingdom, Spain, Bermuda and Ireland, although some of our operations have a broader international scope.

		Basis of Presentation

		Our unaudited condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (generally accepted accounting principles) and include the accounts of HCC Insurance Holdings, Inc. and its subsidiaries. We have made all adjustments that, in our opinion, are necessary for a fair presentation of results of the interim periods, and all such adjustments are of a normal recurring nature. All significant intercompany balances and transactions have been eliminated in consolidation. The condensed consolidated financial statements should be read in conjunction with our annual audited consolidated financial statements and related notes. The condensed consolidated balance sheet at December 31, 2005 was derived from audited financial statements, but does not include all disclosures required by generally accepted accounting principles.

		Management must make estimates and assumptions that affect amounts reported in our financial statements and in disclosures of contingent assets and liabilities. Ultimate results could differ from those estimates. We have reclassified certain amounts in our 2005 condensed consolidated financial statements to conform to the 2006 presentation. The reclassifications included the elimination of certain intercompany premium receivable and premium payable balances and reclassification of the corresponding lines in our 2005 condensed statement of cash flows. None of our reclassifications had an effect on our consolidated net earnings, shareholders’ equity or cash flows.

		During 2005, we completed several acquisitions. The results of operations of the acquired entities are included in our condensed consolidated financial statements beginning on the effective date of each acquisition. Thus, our condensed consolidated statements of earnings and cash flows for the three months ended March 31, 2005 do not contain any operations of the entities acquired in 2005 prior to their acquisition date.

		Income Tax

		For the three months ended March 31, 2006 and 2005, the income tax provision was calculated based on an estimated effective tax rate for each fiscal year. Our effective tax rate differs from the United States Federal statutory rate primarily due to tax-exempt municipal bond interest and state income taxes.

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited, tables in thousands, except per share data)

(2)		RESTATEMENT OF FINANCIAL STATEMENTS, SPECIAL COMMITTEE AND COMPANY FINDINGS

		In light of published reports concerning the pricing of stock options and the timing of stock option grants at numerous other companies, in the second quarter of 2006 we undertook a voluntary internal review of our past practices related to grants of stock options. The voluntary review by our management concluded that the actual accounting measurement dates for certain past stock option grants differed from the originally stated grant dates, which were also utilized as the measurement dates for such awards. In August 2006, our Board of Directors formed a Special Committee of independent directors to commence an investigation of our past stock option granting practices for the period 1995 through 2005. The Special Committee was composed of the members of the Audit Committee of the Board of Directors. The Special Committee retained the law firm of Skadden, Arps, Slate, Meagher & Flom, LLP as its independent legal counsel and LECG as forensic accountants to aid in the investigation.

		On November 17, 2006, we announced that the Special Committee had made certain determinations as a result of its review of our past stock option granting practices. The Special Committee found that we had used incorrect accounting measurement dates for stock option grants covering a significant number of employees and members of our Board of Directors during the period 1997 through 2005 and that certain option grants were retroactively priced. Additionally, at the direction of the Special Committee, we reviewed our stock option granting practices from 1992, the year of our initial public stock offering, through 1994 and in 2006 and found incorrect measurement dates due to retroactive pricing were used in 2006. In substantially all of these instances, the price on the actual measurement date was higher than the price on the stated grant date; thus recipients of the options could exercise at a strike price lower than the actual measurement date price. To determine the actual measurement dates, the Special Committee utilized the following sources of information:

	•		The dates on documentation such as e-mails, regulatory form filings, acquisition agreements and other correspondence;

	•		The date that the relevant stock option grant was entered into Equity Edge, our stock option tracking and accounting system;

	•		Requirements of Accounting Principles Board (APB) No. 25, Accounting for Stock Issued to Employees, and related interpretations; and

	•		Guidance from the Office of Chief Accountant of the Securities and Exchange Commission (SEC) contained in a letter dated September 19, 2006.

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited, tables in thousands, except per share data)

As a result of the determinations of the Special Committee and because the resulting cumulative charge would be material to the second quarter and full year 2006 consolidated net earnings, we concluded that we needed to amend this Quarterly Report on Form 10-Q for the quarter ended March 31, 2006 as filed on May 10, 2006 (the Original Filing), to restate our condensed consolidated financial statements for the three months ended March 31, 2006 and 2005 and the related disclosures. However, the impact of the restatement in any of the restated periods is not material. We are making the restatement in accordance with generally accepted accounting principles to record the following:

•		Non-cash compensation expense for the difference between the stock price on the stated grant date and the actual measurement date and for the fluctuations in stock price in certain instances where variable accounting should have been applied.

•		Other adjustments that were not recorded in the originally filed financial statements due to their immateriality. These minor adjustments primarily relate to fee and commission income, loss and loss adjustment expense, policy acquisition costs and other operating expense. In addition, balance sheet reclassifications have been recorded to appropriately present certain reinsurance recoverables and payables.

•		Related tax effects associated with the recognition of non-cash compensation expense and other adjustments as well as additional taxes that may be due and payable.

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited, tables in thousands, except per share data)

Based on the determinations of the Special Committee and our voluntary internal review, we identified a number of occasions during the period 1997 through 2005 and into 2006 on which we used an incorrect measurement date for financial accounting and reporting purposes for options granted. In accordance with Accounting Principles Board (APB) No. 25, Accounting for Stock Issued to Employees, and its related interpretations, we should have recorded compensation expense related to these options for the excess of the market price of our stock on the actual measurement date over the exercise price of the option. For periods commencing January 1, 2006, compensation expense is being recognized in accordance with Statement of Financial Accounting Standards (SFAS) No. 123(R) (revised), Share-Based Payment. However, we determined an incremental amount related to the mis-priced options must be recorded.

The types of errors identified were as follows:

	•		We determined that many block grants to employees during the period 1997 through 2005 were subject to a retroactive look-back period. In all such cases, the price of our stock at the end of the look-back period, which was generally 30 days or less, was higher than the price of our stock on the stated grant date.

	•		In addition to being subject to the retroactive pricing discussed above, we determined that the strike price of block grants in 1999, 2002 and 2005 was determined prior to the final determination of the identity of the employee and/or the number of options to be granted. Further, proper approval, in most cases, had not been given until after the grant date. In all such cases, the price of our stock at the time when all required determinations were final and proper approval had been obtained was higher than the price of our stock on the stated grant date. The time lag between the stated grant date and the finalization of the awards was typically 30-45 days, except in the case of the 2002 grant which was finalized several months subsequent to the stated grant date.

	•		For the period from 1997 to 2005 and into 2006, we determined that there was a regular practice of granting options to newly hired employees and existing employees being promoted after the end of a 30-45 day period following the hire or promotion date. This practice included the use of the 30-45 day period as a look-back period during which the date with the lowest price during that period was selected as the stated grant date.

	•		In several instances, grants to senior executives were determined at a date subsequent to the stated grant date. In most cases, this resulted from extended negotiations of employment agreements and, in some cases, administrative delays. In virtually all cases, the price of our stock at the time the grants were made and properly approved was higher than the price of our stock on the stated grant date.

	•		In a few cases, options were granted and then repriced downward. As a result, variable accounting should have been applied to these options.

	•		We lacked timely or adequate documentation to support the stated grant date in the case of certain of the above errors.

The gross compensation expense recorded to correct the above errors was a non-cash charge and had no impact on our reported net revenue, cash, cash flow or shareholders’ equity.

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited, tables in thousands, except per share data)

In connection with the investigation, we determined that a number of executive officers received in-the-money options. If such options are ultimately determined to be in-the-money grants for tax purposes, pursuant to Section 162(m) of the Internal Revenue Code and, if in the year of exercise the officers’ compensation, including proceeds from options exercised, exceeded $1.0 million, we would not be entitled to a tax deduction for any amount in excess of such $1.0 million for officers covered by Section 162(m). We estimate the tax effect of the deduction was $4.6 million, substantially all of which was recorded as a reduction to shareholders’ equity.

There were immaterial adjustments that were not made in the originally filed consolidated financial statements. We have taken the opportunity presented by this restatement to record these adjustments, which amounted to a net $2.4 million increase in earnings from continuing operations before income tax expense, for the years 2001 through 2005.

The increase (decrease) on net earnings of each type of adjustment was as follows (in thousands):


			Non-cash
	Net earnings as		stock option
	previously		compensation											Net earnings
	reported		expense			Other			Tax effect		Total adjustments			as restated
Three months ended March 31,
2006	$	78,551	$	(530	)	$	684		$	437	$	591		$	79,142
2005		57,318		(728	)		(2,153	)		951		(1,930	)		55,388

The restatement adjustments increased (reduced) previously reported diluted net earnings per share by $0.01 and $(0.02) for the three months ended March 31, 2006 and 2005, respectively.

We are also amending certain other stock option disclosures in the accompanying notes to the condensed consolidated financial statements.

Enacted October 22, 2004, Section 409A of the Internal Revenue Code significantly changed the rules for nonqualified deferred compensation plans. Section 409A imposes certain restrictions and taxes on stock awards that constitute deferred compensation. Section 409A relates specifically to the personal tax liabilities of our employees that have received discounted options. We are currently reviewing the implications of Section 409A on grants awarded with intrinsic value that vested after December 31, 2004 and modifications made to existing grants after October 3, 2004 along with potential remedial actions.

As of December 15, 2006, we have paid direct costs of approximately $6.0 million for costs associated with the Special Committee’s investigation and additional related professional services and consulting fees associated with the restatement effort.

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited, tables in thousands, except per share data)

The following table sets forth the impact of the above adjustments and the related tax effects on our historical condensed consolidated balance sheets as of March 31, 2006 and December 31, 2005.


	March 31, 2006							December 31, 2005
	As							As
	previously							previously
	reported		Adjustments			As restated		reported		Adjustments			As restated

ASSETS
Investments:
Fixed income securities	$	2,541,316	$	—		$	2,541,316	$	2,268,624	$	—		$	2,268,624
Short-term investments		592,831		—			592,831		839,581		—			839,581
Other investments		230,187		—			230,187		149,223		—			149,223

Total investments		3,364,334		—			3,364,334		3,257,428		—			3,257,428
Cash		51,111		—			51,111		73,935		—			73,935
Restricted cash and cash investments		182,568		—			182,568		170,978		—			170,978
Premium, claims and other receivables		855,880		—			855,880		884,654		—			884,654
Reinsurance recoverables		1,349,351		—			1,349,351		1,360,483		1,500			1,361,983
Ceded unearned premium		239,530		—			239,530		239,416		—			239,416
Ceded life and annuity benefits		73,213		—			73,213		73,415		—			73,415
Deferred policy acquisition costs		161,329		—			161,329		156,253		—			156,253
Goodwill		531,286		—			531,286		532,947		—			532,947
Other assets		297,716		888			298,604		276,557		1,234			277,791

Total assets	$	7,106,318	$	888		$	7,107,206	$	7,026,066	$	2,734		$	7,028,800


LIABILITIES

Loss and loss adjustment expense payable	$	2,837,495	$	—		$	2,837,495	$	2,813,720	$	—		$	2,813,720
Life and annuity policy benefits		73,213		—			73,213		73,415		—			73,415
Reinsurance balances payable		149,897		—			149,897		176,954		—			176,954
Unearned premium		825,375		—			825,375		807,109		—			807,109
Deferred ceding commissions		66,900		—			66,900		65,702		2,184			67,886
Premium and claims payable		735,131		—			735,131		753,859		—			753,859
Notes payable		309,426		—			309,426		309,543		—			309,543
Accounts payable and accrued liabilities		350,578		3,554			354,132		332,068		3,811			335,879

Total liabilities		5,348,015	$	3,554		$	5,351,569		5,332,370	$	5,995		$	5,338,365

SHAREHOLDERS’ EQUITY
Common stock		111,173		—			111,173		110,803		—			110,803
Additional paid-in capital		757,850		14,868			772,718		747,568		14,602			762,170
Retained earnings		887,226		(18,034	)		869,192		817,013		(18,625	)		798,388
Accumulated other comprehensive income		2,054		500			2,554		18,312		762			19,074

Total shareholders’ equity	$	1,758,303	$	(2,666	)		1,755,637	$	1,693,696	$	(3,261	)		1,690,435

Total liabilities and shareholders’ equity	$	7,106,318	$	888		$	7,107,206	$	7,026,066	$	2,734		$	7,028,800

Our restated condensed consolidated balance sheets as of March 31, 2006 and December 31, 2005 reflect a $18.0 million and $18.6 million, respectively, decrease to retained earnings and a $14.9 million and $14.6 million, respectively, increase to additional paid-in capital primarily due to additional non-cash stock-based compensation and related tax effect recorded in connection with this restatement to correct prior year stock option-related accounting errors as described above. In 2006 and 2005, the $0.9 million and $1.2 million, respectively, increase to deferred tax assets (included in other assets) and $5.6 million and $5.8 million, respectively, increase to income taxes payable (included in accounts payable and accrued liabilities) resulted primarily due to the timing of the deductibility of certain stock-based compensation costs recorded in connection with the restatement.

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited, tables in thousands, except per share data)

The following table sets forth the impact of the above adjustments and the related tax effects on our historical statements of earnings for the three months ended March 31, 2006 and 2005.


	Quarter ended March 31, 2006									Quarter ended March 31, 2005
	As									As
	previously									previously
	reported			Adjustments			As restated			reported			Adjustments			As restated

REVENUE
Net earned premium	$	380,571			—		$	380,571		$	320,117			—		$	320,117
Fee and commission income		31,468			201			31,669			33,076			(1,453	)		31,623
Net investment income		36,581			—			36,581			22,341			—			22,341
Net realized investment gain		(1,298	)		—			(1,298	)		(3	)		—			(3	)
Other operating income		18,750			—			18,750			4,147			—			4,147

Total revenue		466,072			201			466,273			379,678			(1,453	)		378,225


EXPENSE
Loss and loss adjustment expense, net		220,567			1500		$	222,067			186,063			(88	)	$	185,975
Policy acquisition costs, net		78,215			(1,983	)		76,232			59,357			1,788			61,145
Other operating expense		46,803			530			47,333			45,949			(272	)		45,677
Interest expense		2,154			—			2,154			1,808			—			1,808

Total expense		347,739			47			347,786			293,177			1,428			294,605


Earnings from continuing operations before income tax expense		118,333			154			118,487			86,501			(2,881	)		83,620
Income tax expense on continuing operations		39,782			(437	)		39,345			29,183			(951	)		28,232

Earnings from continuing operations		78,551			591			79,142			57,318			(1,930	)		55,388
Earnings from discontinued operations, net of income taxes		—			—			—			—			—			—


Net earnings	$	78,551		$	591		$	79,142		$	57,318		$	(1,930	)	$	55,388


Basic earnings per share data:

Earnings from continuing operations	$	0.71		$	—		$	0.71		$	0.56		$	(0.02)			0.54
Earnings from discontinued operations		—			—			—			—			—			—


Net earnings	$	0.71		$	—		$	0.71		$	0.56		$	(0.02)			0.54

Weighted average shares outstanding		111,014			—			111,014			103,241			—			103,241


Diluted earnings per share data:

Earnings from continuing operations	$	0.67		$	0.01		$	0.68		$	0.54		$	(0.02)		$	0.52
Earnings from discontinued operations		—			—			—			—			—			—


Net earnings	$	0.67		$	0.01		$	0.68		$	0.54		$	(0.02)		$	0.52


Weighted average shares outstanding		116,896			—			116,896			105,734			—			105,734

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited, tables in thousands, except per share data)

The restatement created a small change in net cash flows from our operating and financing activities. The following table shows the effect of the restatement on our previously reported cash flows:


	Quarter ended March 31, 2006						Quarter ended March 31, 2005
	As						As
	previously						previously			As
	reported			As restated			reported			restated

Net earnings	$	78,551		$	79,142		$	57,318		$	55,388
Adjustments to reconcile net earnings to net cash provided by operating activities:
Change in premium, claims and other receivables		44,362			44,362			(133,768	)		(132,208	)
Change in reinsurance recoverables		11,132			12,632			(824	)		(824	)
Change in ceded unearned premium		(114	)		(114	)		52,300			47,218
Change in loss and loss adjustment expense payable		23,775			23,775			49,939			49,851
Change in reinsurance balances payable		(27,057	)		(27,057	)		(29,842	)		(18,782	)
Stock-based compensation expense		—			2,703			—			597
Other, net		3,509			(1,131	)		(6,629	)		(12,746	)
Cash provided by operating activities		77,937			78,091			33,909			33,909
Cash flows from financing activities:
Sale of common stock		7,792			7,638			21,087			21,087
Cash provided by financing activities		7,907			7,753			11,397			11,397

In connection with the preparation of our restated financial statements, we also determined that the pro forma disclosures for stock-based compensation expense for the three months ended March 31, 2005 required under Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation included in Note 3 of the Notes to Condensed Consolidated Financial Statements, were incorrect. Specifically, the errors related to the effect on the consolidated financial statements resulting from the improper application of APB No. 25 to certain stock option transactions and the use of assumptions for determining the fair value of our stock options on the date of grant. We have corrected these errors in Note 3 to the consolidated financial statements.

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited, tables in thousands, except per share data)

The following table presents the effect of these corrections on our pro forma calculation of our net income and earnings per share for the three months ended March 31, 2005:


	March 31, 2005
	(As
	previously
	reported)			(As restated)
Reported net earnings	$	57,318		$	55,388
Stock-based compensation included in reported net earnings, net of income taxes		—			531
Stock-based compensation using fair value method, net of income taxes		(1,277	)		(1,610	)

Pro forma net earnings	$	56,041		$	54,309


Reported basic earnings per share	$	0.56		$	0.54
Fair value stock-based compensation		(0.02	)		(0.01	)

Pro forma basic earnings per share	$	0.54		$	0.53

Reported diluted earnings per share	$	0.54		$	0.52
Fair value stock-based compensation		(0.01	)		(0.01	)

Pro forma diluted earnings per share	$	0.53		$	0.51

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited, tables in thousands, except per share data)

(3)		STOCK OPTIONS

		Our stock option plans, the 2004 Flexible Incentive Plan and 2001 Flexible Incentive Plan, are administered by the Compensation Committee of the Board of Directors. Options granted under these plans may be used to purchase one share of our common stock. Options vest over a period of up to seven years, which is the requisite service period, and expire four to ten years after grant date.

		Statement of Financial Accounting Standards (SFAS) No. 123(R), Share-Based Payment, requires companies to charge the fair value of stock-based compensation to earnings. Effective January 1, 2006, we adopted SFAS 123(R) using the modified prospective method. We are recognizing compensation expense in 2006 and thereafter based on our unvested stock options granted before January 1, 2006 and all options granted after that date. The 2005 and prior period financial statements were not restated to reflect the implementation of SFAS 123(R). We will use the Black-Scholes single option pricing model to determine the fair value of an option on its grant date and will expense that value on a straight-line basis over the option’s vesting period. We made no modifications to our stock option plans in conjunction with our adoption of SFAS 123(R). In 2005, we accounted for stock options granted to employees in accordance with APB Opinion No. 25, Accounting for Stock Issued to Employees.

		In the first quarter of 2006, we expensed $2.7 million ($1.9 million after tax or $0.02 per diluted share) of stock-based compensation, after the effect of the deferral and amortization of related policy acquisition costs. At March 31, 2006, there was approximately $38.2 million of total unrecognized compensation expense related to unvested options that is expected to be recognized over a weighted-average period of three years. In 2006, we expect to recognize $12.1 million of expense, including the amortization of deferred policy acquisition costs, related to stock-based compensation for options currently outstanding.

		The table below shows the weighted-average fair value of options granted and the related weighted-average assumptions used in the Black-Scholes model. The risk-free interest rate is based on the U.S. Treasury rate that most closely approximates each option’s expected term. We based our expected volatility on the historical volatility of our stock over a period matching each option’s expected term. Our dividend yield is based on an average of our historical dividend payments divided by the stock price. We used historical exercise patterns by grant type to estimate the expected option life.


	Three months ended March 31,
	2006			2005
Fair value of options granted (As restated)	$	7.04		$	7.85
Risk free interest rate		4.5	%		3.8	%
Expected volatility		22	%		32	%
Expected dividend yield		1.0	%		1.0	%
Expected option life	3.5 years			4.9 years

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited, tables in thousands, except per share data)

The following table details our stock option activity during the three months ended March 31, 2006.


				Weighted-		Weighted-
				average		average	Aggregate
	Number			exercise		contractual	intrinsic
	of shares			price		life	value
Outstanding, beginning of year		8,219		$	20.71
Granted		463			31.64
Exercised		(373	)		15.87
Forfeited and expired		(106	)		20.58

Outstanding, end of period		8,203			21.55	4.3 years	$	108,701

Exercisable, end of period		1,660			17.36	3.0 years		28,953

The aggregate intrinsic value (the amount by which the fair value of the underlying stock exceeds the exercise price) of options exercised during the first quarter of 2006 and 2005 was $6.0 million and $13.8 million, respectively. At March 31, 2006, 12.1 million shares of our common stock were authorized and reserved for the exercise of options, of which 8.2 million shares were reserved for options previously granted and 3.9 million shares were reserved for future issuance.

Exercise of options during the first quarter of 2006 and 2005 resulted in cash receipts of $5.9 million and $21.1 million, respectively. We generally recognize a tax benefit when our employees exercise options. SFAS 123(R) requires that we report the tax benefit related to the excess of the tax deductible amount over the recognized compensation expense as financing cash flow, rather than as operating cash flow under APB Opinion No. 25. We recorded a $1.8 million benefit as financing cash flow in the first quarter of 2006 and $1.8 million as operating cash flow in the first quarter of 2005.

Prior to the adoption of SFAS 123(R), we accounted for stock-based compensation using the intrinsic value method prescribed in APB Opinion No. 25 and related interpretations. Under APB Opinion No. 25, compensation cost was measured as of the date the number of shares and exercise price became fixed. The terms of an award were generally fixed on the date of grant, requiring the stock option to be accounted for as a fixed award. For fixed awards, compensation expense was measured as the excess, if any, of the quoted market price of our stock at the date of grant over the exercise price of the option granted. Compensation expense for fixed awards, if any, was recognized ratably over the vesting period using the straight-line single option method.

If the number of shares or exercise price was not fixed upon the date of grant, the award was accounted for as a variable award until the number of shares or the exercise price became fixed, or until the award was exercised, canceled, or expired unexercised. For variable awards, intrinsic value was remeasured each period and was equal to the fair market value of our stock as of the end of the reporting period less the grant exercise price. As a result, the amount of compensation expense or benefit to be recognized each period fluctuated based on changes in our closing price from the end of the previous reporting period to the end of the current reporting period. In cases when our closing stock price did not exceed the recipient’s exercise price, no compensation expense resulted. Compensation expense for variable awards, if any, was recognized in accordance with FIN No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plan, An Interpretation of APB Opinions No. 15 and 25.

We accounted for modifications to stock options under APB No. 25, as subsequently interpreted by FIN No. 44. Modifications included, but were not limited to, acceleration of vesting, extension of the exercise period following termination of employment and/or continued vesting while not providing substantive services. Compensation expense for modified awards was recorded in the period of modification for the intrinsic value of the vested portion of the award, including vesting that occurred while not providing substantive services, after the date of modification. The intrinsic value of the award was the difference between the fair market value of our common stock on the date of modification and the recipient’s exercise price.

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited, tables in thousands, except per share data)

Stock options issued to non-employees were accounted for in accordance with the provisions of SFAS No. 123 and EITF No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services. Compensation expense for stock options issued to non-employees was valued using the Black-Scholes model and was amortized over the vesting period in accordance with FIN No. 28.

Prior to adoption of SFAS 123(R), we were required to disclose the effect on net earnings and earnings per share if we had used the fair value method of SFAS No. 123, Accounting for Stock-Based Compensation, to value stock options. The effect on our consolidated financial results in the first quarter of 2005 if we had valued our options using the fair value method under SFAS 123 and the assumptions listed above for the three months ended March 31, 2005 is as follows:


	(As restated)
Reported net earnings	$	55,388
Stock-based compensation included in reported net earnings, net of income taxes		531
Stock-based compensation using fair value method, net of income taxes		(1,610	)

Pro forma net earnings	$	54,309


Reported basic earnings per share	$	0.54
Fair value stock-based compensation		(0.01	)

Pro forma basic earnings per share	$	0.53


Reported diluted earnings per share	$	0.52
Fair value stock-based compensation		(0.01	)

Pro forma diluted earnings per share	$	0.51

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited, tables in thousands, except per share data)

(4)		REINSURANCE

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


							Loss and loss
	Written			Earned			adjustment
	premium			premium			expense
							(As restated)

Three months ended March 31, 2006

Primary business	$	410,191		$	422,510		$	227,250
Reinsurance assumed		95,867			70,880			45,791
Reinsurance ceded		(113,007	)		(112,819	)		(50,974	)


Net amounts	$	393,051		$	380,571		$	222,067


Three months ended March 31, 2005

Primary business	$	398,281		$	412,095		$	221,446
Reinsurance assumed		76,838			72,580			48,506
Reinsurance ceded		(117,767	)		(164,558	)		(83,977	)


Net amounts	$	357,352		$	320,117		$	185,975

Ceding commissions netted with policy acquisition costs in the condensed consolidated statements of earnings were $10.0 million in 2006 and $30.7 million in 2005.

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


	March 31,			December 31,
	2006			2005
				(As restated)

Reinsurance recoverable on paid losses	$	102,200		$	93,837
Reinsurance recoverable on outstanding losses		730,451			636,225
Reinsurance recoverable on incurred but not reported losses		527,012			644,062
Reserve for uncollectible reinsurance		(10,312	)		(12,141	)


Total reinsurance recoverables	$	1,349,351		$	1,361,983

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited, tables in thousands, except per share data)

Our reserve for uncollectible reinsurance covers potential collectibility issues, including disputed amounts and associated expenses. While we believe the reserve is adequate based on information currently available, conditions may change or additional information might be obtained which may require us to change the reserve in the future. We periodically review our financial exposure to the reinsurance market and the level of our reserve and continue to take actions in an attempt to mitigate our exposure to possible loss.

We limit the liquidity exposure related to our reinsurance recoverables by holding funds, letters of credit or other security, such that net balances due are significantly less than the gross balances shown in our condensed consolidated balance sheets. Additionally, our U.S. domiciled insurance companies require their reinsurers not authorized by the respective states of domicile of our insurance companies to collateralize their reinsurance obligations due to us. The table below shows the amounts of letters of credit and cash deposits held by us as collateral, plus other credits available for potential offset.


	March 31,		December 31,
	2006		2005

Payables to reinsurers	$	293,480	$	291,826
Letters of credit		348,292		350,135
Cash deposits		58,025		64,150


Total credits	$	699,797	$	706,111

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


	March 31,			December 31,
	2006			2005
				(As restated)

Loss and loss adjustment expense payable	$	2,837,495		$	2,813,720
Reinsurance recoverable on outstanding losses		(730,451	)		(636,225	)
Reinsurance recoverable on incurred but not reported losses		(527,012	)		(644,062	)


Net reserves	$	1,580,032		$	1,533,433


Unearned premium	$	825,375		$	807,109
Ceded unearned premium		(239,530	)		(239,416	)


Net unearned premium	$	585,845		$	567,693


Deferred policy acquisition costs	$	161,329		$	156,253
Deferred ceding commissions		(66,900	)		(67,886	)


Net deferred policy acquisition costs	$	94,429		$	88,367

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited, tables in thousands, except per share data)

(5)		EARNINGS PER SHARE

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


	Three months ended March 31,
	2006		2005
	(As restated)		(As restated)

Net earnings	$	79,142	$	55,388


Weighted average common shares outstanding		111,014		103,241
Dilutive effect of outstanding options (determined using the treasury stock method)		1,528		1,589
Dilutive effect of convertible debt (determined using the treasury stock method)		4,354		904


Weighted average common shares and potential common shares outstanding		116,896		105,734


Anti-dilutive stock options not included in treasury stock method computation		2,563		26

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited, tables in thousands, except per share data)

(6)		SEGMENT AND GEOGRAPHIC INFORMATION

		The performance of each segment is evaluated by our management based on net earnings. Net earnings is calculated after tax and after all corporate expense allocations, interest expense on debt incurred at the purchase date, and intercompany eliminations have been charged or credited to our individual segments. All stock-based compensation is included in the corporate segment since it is not included in management’s evaluation of the other segments. The following tables show information by business segment and geographic location. Geographic location is determined by physical location of our offices and does not represent the location of insureds or reinsureds from whom the business was generated. Effective January 1, 2005, we consolidated our largest underwriting agency (agency segment) into HCC Life Insurance Company (insurance company segment).


	Insurance				Other
	Company		Agency		Operations		Corporate			Total

Three months ended March 31, 2006 (As restated)

Revenue:
Domestic	$	343,688	$	14,769	$	19,781	$	1,177		$	379,415
Foreign		76,849		10,009		—		—			86,858
Inter-segment		6		17,958		—		—			17,964


Total segment revenue	$	420,543	$	42,736	$	19,781	$	1,177			484,237


Inter-segment eliminations											(17,964	)


Consolidated total revenue										$	466,273


Net earnings (loss):
Domestic	$	49,969	$	5,235	$	12,989	$	(3,114	)	$	65,079
Foreign		10,088		3,689		—		—			13,777


Total segment net earnings (loss)	$	60,057	$	8,924	$	12,989	$	(3,114	)		78,856


Inter-segment eliminations											286


Consolidated net earnings										$	79,142


Other items:
Net investment income	$	32,007	$	2,296	$	1,635	$	643		$	36,581
Depreciation and amortization		1,138		2,013		127		547			3,825
Interest expense (benefit)		375		2,846		114		(1,181	)		2,154
Capital expenditures		461		815		438		1,366			3,080

Income tax expense (benefit)		28,096		6,668		6,141		(1,858	)		39,047
Inter-segment eliminations											298


Consolidated income tax expense										$	39,345

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited, tables in thousands, except per share data)


	Insurance				Other
	Company		Agency		Operations		Corporate			Total

Three months ended March 31, 2005 (As restated)

Revenue:
Domestic	$	283,672	$	12,762	$	1,906	$	579		$	298,919
Foreign		68,837		10,469		—		—			79,306
Inter-segment		96		21,529		—		—			21,625


Total segment revenue	$	352,605	$	44,760	$	1,906	$	579			399,850


Inter-segment eliminations											(21,625	)


Consolidated total revenue										$	378,225


Net earnings (loss):
Domestic	$	35,081	$	7,044	$	1,091	$	(3,922	)	$	39,294
Foreign		11,647		2,310		—		—			13,957


Total segment net earnings (loss)	$	46,728	$	9,354	$	1,091	$	(3,922	)		53,251


Inter-segment eliminations											2,137


Consolidated net earnings										$	55,388


Other items:
Net investment income	$	20,076	$	1,356	$	539	$	370		$	22,341
Depreciation and amortization		1,207		1,925		126		452			3,710
Interest expense (benefit)		61		2,030		189		(472	)		1,808
Capital expenditures		598		590		—		402			1,590

Income tax expense		20,226		6,191		224		280			26,921
Inter-segment eliminations											1,311


Consolidated income tax expense										$	28,232

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited, tables in thousands, except per share data)

The following tables present selected revenue items by line of business.


	Three months ended March 31,
	2006			2005
	(As restated)			(As restated)

Diversified financial products	$	169,112		$	106,851
Group life, accident and health		127,761			128,945
Aviation		33,197			33,817
London market account		21,928			26,711
Other specialty lines		28,640			21,225
Discontinued lines		(67	)		2,568


Net earned premium	$	380,571		$	320,117


Property and casualty	$	25,407		$	26,066
Accident and health		6,262			5,557


Fee and commission income	$	31,669		$	31,623

(7)		SUPPLEMENTAL INFORMATION

		Supplemental cash flow information was as follows.


	Three months ended March 31,
	2006		2005

Cash received from commutations	$	—	$	32,635
Income taxes paid		16,038		13,886
Interest paid		2,935		2,106
Comprehensive income (As restated)		62,622		37,775

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited, tables in thousands, except per share data)

(8)		COMMITMENTS AND CONTINGENCIES

		Litigation

		We are party to lawsuits, arbitrations and other proceedings that arise in the normal course of our business. Many of such lawsuits, arbitrations and other proceedings involve claims under policies that we underwrite as an insurer or reinsurer, the liabilities for which, we believe, have been adequately included in our loss reserves. Also, from time to time, we are a party to lawsuits, arbitrations and other proceedings that relate to disputes over contractual relationships with third parties, or that involve alleged errors and omissions on the part of our subsidiaries. We have provided accruals for these items to the extent we deem the losses probable and reasonably estimable.

		We are presently engaged in litigation initiated by the appointed liquidator of a former reinsurer concerning payments made to us prior to the date of appointment of the liquidator. The disputed payments, totaling $10.3 million, were made by the now insolvent reinsurer in connection with a commutation agreement. Our understanding is that such litigation is similar to other actions brought by the liquidator. We continue to vigorously contest the action.

		In April 2006, we were named as a defendant in a complaint related to insurance marketing and producer compensation practices. The lawsuit was filed in Federal District Court in Georgia by a number of corporate plaintiffs against approximately 100 insurance entity defendants. The suit has been transferred to the multi-district litigation proceeding pending in the United States District Court for the District of New Jersey for coordinated or consolidated pre-trial proceedings with suits previously transferred that appear to the court to involve common questions of fact. The complaint alleges violations of Federal antitrust law, the Racketeering Influence and Corrupt Organization Act and various state anti-fraud laws. The lawsuit seeks unspecified damages. We are vigorously contesting this action.

		Although the ultimate outcome of the matters mentioned above cannot be determined at this time, based on present information, the availability of insurance coverage and advice received from our outside legal counsel, we believe the resolution of these matters will not have a material adverse effect on our consolidated financial position, results of operations or cash flows.

		Indemnifications

		In conjunction with the sales of business assets and subsidiaries, we have provided indemnifications to the buyers. Certain indemnifications cover typical representations and warranties related to our responsibilities to perform under the sales contracts. We cannot quantify the maximum potential exposure covered by all of our indemnifications because the indemnifications cover a variety of matters, operations and scenarios. Certain of these indemnifications have no time limit. For those with a time limit, the longest such indemnification expires on December 31, 2009.

		We accrue a loss related to our indemnifications when a valid claim is made by a buyer and we believe we have potential exposure. We currently have several claims under indemnifications that cover certain net losses incurred in periods prior to our sale of certain subsidiaries. As of March 31, 2006, we have recorded a liability of $19.9 million and have provided $8.1 million of letters of credit to cover our obligations or anticipated payments under these indemnifications.

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited, tables in thousands, except per share data)

		Stock Option Investigation Matters

		Based on the Special Committee’s voluntary independent investigation of our past practices related to granting stock options, we determined that the price on the actual measurement date for a number of our stock option grants during the period 1997 through 2005 and into 2006 did not correspond to the price on the stated grant date and that certain option grants were retroactively repriced. The investigation was conducted with the help of a law firm that was not previously involved with our stock option plans and procedures. The SEC has commenced an informal inquiry. In connection with its inquiry, we received a document request from the SEC. We intend to fully cooperate with the informal inquiry. We are unable to predict the outcome of or the future costs related to the informal inquiry.

		(9) SUBSEQUENT EVENTS

		On October 30, 2006, we received a registered letter from U.S. Bank, as trustee for the holders of our 2.00% Convertible Notes due 2021, 1.30% Convertible Notes due 2023 and 2.00% Convertible Exchange Notes due 2021, stating that U.S. Bank, as trustee, had not received our consolidated financial statements for the quarter ended June 30, 2006. If we do not file our Quarterly Report on Form 10-Q for the quarter ended June 30, 2006 with the SEC and deliver the report to the trustee within sixty days from the date notice was received from the trustee, such failure to file and deliver will be considered an “Event of Default” under the indenture governing the notes. If an “Event of Default” were to occur under the indentures for any series of the notes, the trustee or holders of at least 25% of the aggregate principal of such series then outstanding could declare all the unpaid principal on such series of notes then outstanding to be immediately due and payable. Likewise, we have not timely delivered our Form 10-Q’s for the quarters ended June 30 and September 30, 2006 as required by the terms of our Revolving Loan Facility agreement. The banks that are a party to the agreement waived certain “Defaults” or “Events of Default” until January 31, 2007. In addition, our restatement of our prior year financial statements might be considered an “Event of Default” which has been waived until January 31, 2007. Our failure to comply with the covenants in the indentures for our convertible notes and our Revolving Loan Facility loan agreement in the future could have a material adverse effect on our stock price, business and financial condition if we would not have available funds at that time to repay any defaulted debt. A default and acceleration under the indentures for our convertible notes and loan agreement may also trigger cross-acceleration under our other debt instruments.

		In December 2006, our existing Revolving Loan Facility was increased by $100.0 million to $300.0 million. Pursuant to the terms of the agreement, the Company can borrow up to $25 million in addition to what is currently borrowed for working capital purposes. However, the full unfunded amount of the facility would be available to pay any potential convertible note conversion or put.

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited, tables in thousands, except per share data)

On August 3, 2006, we reached an agreement to acquire the assets of the Health Products Division (the Division) of Allianz Life Insurance Company of North America for cash consideration of $140.0 million and to assume the Division’s outstanding loss reserves. The Division’s operations include medical stop loss insurance for self-insured corporations and groups; excess insurance for HMOs; provider excess insurance for integrated delivery systems; excess medical reinsurance to small and regional insurance carriers; and Life Trac, a network for providing organ and bone marrow transplants. The Division currently writes more than $300.0 million in annual gross premium. We plan to integrate the Division’s operations into HCC Life Insurance Company, within our insurance company segment. Internal funds were utilized to make the acquisition, which was consummated on October 2, 2006.

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

The following Management’s Discussion and Analysis should be read in conjunction with the Condensed Consolidated Financial Statements and the related Notes thereto. As further described below in Note 2 to our Condensed Consolidated Financial Statements, we restated our Consolidated Financial Statements as of and for the years ended December 31, 1997 through 2005 and as of and for the quarters ended March 31, 2005 and 2006. The effects of these restatements are reflected in our Condensed Consolidated Financial Statements and the related Notes thereto. Management’s Discussion and Analysis has been updated to reflect the effects of the restatement.

RESTATEMENT OF FINANCIAL STATEMENTS, SPECIAL COMMITTEE COMPANY FINDINGS

	•		The dates on documentation such as e-mails, regulatory form filings, acquisition agreements and other correspondence;

	•		The date that the relevant stock option grant was entered into Equity Edge, our stock option tracking and accounting system;

	•		Requirements of Accounting Principles Board (APB) No. 25, Accounting for Stock Issued to Employees, and related interpretations; and

	•		Guidance from the Office of Chief Accountant of the Securities and Exchange Commission (SEC) contained in a letter dated September 19, 2006.

accounting implications, and that he did not properly document our Compensation Committee’s informal delegation of authority to Mr. Way. The Special Committee also found that there was no evidence that Mr. Way or Mr. Martin intended to falsify the consolidated financial statements.

As a result of the determinations of the Special Committee and because the resulting cumulative charge would be material to the second quarter and full year 2006 consolidated net earnings, we concluded that we needed to amend this Quarterly Report on Form 10-Q for the quarter ended March 31, 2006 as filed on May 10, 2006 (the Original Filing), to restate our condensed consolidated financial statements for the three months ended March 31, 2006 and 2005 and the related disclosures. However, the impact of the restatement in any of the restated periods is not material. We are making the restatement in accordance with generally accepted accounting principles to record the following:

	•		Non-cash compensation expense for the difference between the stock price on the stated grant date and the actual measurement date and for the fluctuations in stock price in certain instances where variable accounting should have been applied;

	•		Other adjustments that were not recorded in the originally filed financial statements due to their immateriality; and

	•		Related tax effects for all items.

The types of errors identified were as follows:

	•		We determined that many block grants to employees during the period 1997 through 2005 were subject to a retroactive look-back period. In all such cases, the price of our stock at the end of the look-back period, which was generally 30 days or less, was higher than the price of our stock on the stated grant date.

	•		In addition to being subject to the retroactive pricing discussed above, we determined that the strike price of block grants in 1999, 2002 and 2005 was determined prior to the final determination of the identity of the employee and/or the number of options to be granted. Further, proper approval, in most cases, had not been given until after the grant date. In all such cases, the price of our stock at the time when all required determinations were final and proper approval had been obtained was higher than the price of our stock on the stated grant date. The time lag between the stated grant date and the finalization of the awards was typically 30-45 days, except in the case of the 2002 grant which was finalized several months subsequent to the stated grant date.

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited, tables in thousands, except per share data)

	•		For the period from 1997 to 2005 and into 2006, we determined that there was a regular practice of granting options to newly hired employees and existing employees being promoted after the end of a 30-45 day period following the hire or promotion date. This practice included the use of the 30-45 day period as a look-back period during which the date with the lowest price during that period was selected as the stated grant date.

	•		In several instances, grants to senior executives were determined at a date subsequent to the stated grant date. In most cases, this resulted from extended negotiations of employment agreements and, in some cases, administrative delays. In virtually all cases, the price of our stock at the time the grants were made and properly approved was higher than the price of our stock on the stated grant date.

	•		In a few cases, options were granted and then repriced downward. As a result, variable accounting should have been applied to these options.

	•		We lacked timely or adequate documentation to support the stated grant date in the case of certain of the above errors.

The gross compensation expense recorded to correct the above errors was a non-cash charge and had no impact on our reported net revenue, cash, cash flow or shareholders’ equity.

In connection with the investigation, we determined that a number of executive officers received in-the-money options. If such options are ultimately determined to be in-the-money grants for tax purposes, pursuant to Section 162(m) of the Internal Revenue Code and, if in the year of exercise the officers’ compensation, including proceeds from options exercised, exceeded $1.0 million, we would not be entitled to a tax effect of the deduction for any amount in excess of such $1.0 million for officers covered by Section 162(m). We estimate the tax effect of the deduction was $4.6 million, substantially all of which was recorded as a reduction to shareholders’ equity.

The increase (decrease) on net earnings of each type of adjustment was as follows (in thousands):


			Non-cash
	Net earnings as		stock option
	previously		compensation								Total			Net earnings
	reported		expense			Other			Tax effect		adjustments			as restated

Three months ended March 31,
2006	$	78,551	$	(530	)	$	684		$	437	$	591		$	79,142
2005		57,318		(728	)		(2,153	)		951		(1,930	)		55,388

The restatement adjustments increased (reduced) previously reported diluted net earnings per share by $0.01 and $(0.02) for the three months ended March 31, 2006 and 2005, respectively.

We are also amending certain other stock option disclosures in the accompanying notes to the consolidated financial statements.

As of December 15, 2006, we have paid direct costs of approximately $6.0 million for costs associated with the Special Committee’s investigation and additional related professional services and consulting fees associated with the restatement effort. We expect to pay up to several million dollars of additional expense in the next few months associated with the conclusion of the investigation and restatement of our consolidated financial statements.

Overview

We are a specialty insurance group with offices in the United States, the United Kingdom, Spain, Bermuda and Ireland transacting business in more than 50 countries. Our group consists of insurance companies, underwriting agencies and reinsurance brokers. Our shares are traded on the New York Stock Exchange and had a market capitalization of $3.9 billion at March 31, 2006. We earned $79.1 million or $0.68 per diluted share in the first quarter of 2006 compared to $55.3 million or $0.52 in 2005, despite the dilution from a $150.0 million common stock offering in November 2005. Shareholders’ equity increased by 25% from a year ago to $1.8 billion at March 31, 2006, principally from a combination of net earnings and the 2005 equity offering.

We underwrite a variety of specialty lines of business identified as diversified financial products; group life, accident and health; aviation; London market account; and other specialty lines of business. Products in each line are marketed by our insurance companies and agencies, either through a network of independent agents and brokers, or directly to customers. With the exception of our public company directors’ and officers’ liability business, certain international aviation risks and our London market business, the majority of our business is generally lower limit, smaller premium business that is less susceptible to price competition, severity of loss or catastrophe risk. Our major insurance companies are rated “AA (Very Strong)” by Standard & Poor’s Corporation and “A+ (Superior)” by A.M. Best Company, Inc.

We generate our revenue from four primary sources: 1) risk-bearing earned premium produced by our insurance company operations, 2) non-risk-bearing fee and commission income received by our underwriting agency and intermediary operations, 3) ceding commissions in excess of policy acquisition costs earned by our insurance company operations and 4) investment income earned by all of our operations. We produced $466.1 million of revenue in the first quarter of 2006, an increase of 23% over the first quarter of 2005. The increase was due to higher net earned premium from increased retentions in our diversified financial products line of business, organic growth in certain lines of business and from acquisitions, increased investment income from a 32% growth in total investments and an increase in interest rates, and an increase in other operating income.

During the past several years, we substantially increased our shareholders’ equity by retaining most of our earnings and issuing additional shares of common stock. With this additional equity, we increased the underwriting capacity of our insurance companies and made strategic acquisitions, adding new lines of business or expanding those with favorable underwriting characteristics.

Our 2005 acquisitions are listed below. Net earnings and cash flows from each acquired entity are included in our operations beginning on the effective date of each transaction.


Company	Segment	Effective date acquired

United States Surety Company	Insurance company	March 1, 2005
HCC International Insurance Company	Insurance company	July 1, 2005
Perico Life Insurance Company	Insurance company	November 30, 2005
Perico Ltd.	Agency	December 1, 2005
Illium Insurance Group	Agency	December 31, 2005

The following section discusses our key operating results. Amounts in the following tables are in thousands, except for earnings per share, percentages, ratios and number of employees. Comparisons refer to first quarter 2006 compared to first quarter 2005.

Results of Operations

Net earnings increased 43% to $79.1 million ($0.68 per diluted share) in 2006 from $55.4 million ($0.52 per diluted share) in 2005. Growth in underwriting profits, net investment income and other operating income contributed to the increase in 2006 earnings.

The following table sets forth the relationships of certain income statement items as a percent of total revenue.


	Three months ended March 31,
	2006			2005
	(As restated)			(As restated)
Net earned premium		81.7	%		84.6	%
Fee and commission income		6.8			8.4
Net investment income		7.8			5.9
Net realized investment loss		(0.3	)		—
Other operating income		4.0			1.1

Total revenue		100.0			100.0
Loss and loss adjustment expense, net		47.6			49.1
Policy acquisition costs, net		16.3			16.2
Other operating expense		10.2			12.1
Interest expense		0.5			0.5

Earnings before income tax expense		25.4			22.1
Income tax expense		8.4			7.5

Net earnings		17.0	%		14.6	%

Total revenue increased 23% to $466.3 million in 2006, driven by significant growth in net earned premium, investment income and other operating income, which more than offset the expected decrease in fee and commission income. We expect total revenue to continue to grow throughout 2006.

Gross written premium, net written premium and net earned premium are detailed below. Premium increased from organic growth in certain lines of business and from acquisitions. Increased retentions, particularly in our diversified financial products line of business, contributed to the growth in net written and earned premiums. See the Insurance Company Segment section below for further discussion of the relationship and changes in premium revenue.


	Three months ended March 31,
	2006		2005

Gross written premium	$	506,058	$	475,119

Net written premium		393,051		357,352

Net earned premium		380,571		320,117

Fee and commission income are shown in the table below. Fee and commission income decreased slightly due to our insurance company subsidiaries ceding less insurance, thereby reducing ceding commissions earned by them and reinsurance commissions earned by our reinsurance intermediaries.


	Three months ended March 31,
	2006		2005
	(As restated)		(As restated)

Agency	$	23,061	$	21,987
Insurance companies		8,608		9,636


Fee and commission income	$	31,669	$	31,623

The sources of net investment income are detailed below.


	Three months ended March 31,
	2006			2005

Fixed income securities	$	24,305		$	17,506
Short-term investments		7,540			4,193
Other investments		6,412			1,767


Total investment income		38,257			23,466
Investment expense		(1,676	)		(1,125	)


Net investment income	$	36,581		$	22,341

Net investment income increased 64% in 2006. This increase was primarily due to higher investment assets, which increased to $3.4 billion at March 31, 2006 compared to $2.6 billion at March 31, 2005, increasing interest rates and a better than expected yield on alternative investments. The growth in investment assets resulted from: 1) higher net earnings, 2) higher retentions, 3) commutations of reinsurance recoverables in late 2005, 4) our public offering of common stock in 2005 and 5) the increase in net loss reserves particularly from our diversified financial products line of business, which generally has a longer time period between occurrence and payment of claims. We continue to invest our funds primarily in fixed income securities, slightly extending their duration to 5.0 years at March 31, 2006 from 4.8 years at March 31, 2005 and increasing the percentage of tax-exempt municipal bonds in our investment portfolio. We expect investment assets and investment income to continue to increase in 2006.

At March 31, 2006, our unrealized loss on fixed income securities was $32.4 million, compared to an unrealized loss of $8.5 million at December 31, 2005, due to increases in market interest rates. The change in the unrealized gain or loss, net of the related income tax effect, is recorded in other comprehensive income. This loss is unlikely to affect future net earnings as we often hold our fixed income securities to maturity when we receive the full principal amount.

Information about our portfolio of fixed income securities is as follows:


	Three months ended March 31,
	2006			2005

Average yield		4.12	%		3.92	%
Average tax equivalent yield		5.04	%		4.82	%
Weighted-average maturity	7.8 years			7.4 years
Weighted-average duration	5.0 years			4.8 years

The average yield on our short-term investments increased from 2.5% in 2005 to 4.2% in 2006.

Other operating income increased $14.6 million in 2006. The increase related primarily to a gain from the partial sale of a strategic investment and net gains from trading securities. Period to period comparisons of other operating income may vary substantially depending on market values of trading securities and other financial instruments and on income from strategic investments or dispositions of such investments. The following table details the source of our other operating income.


	Three months ended March 31,
	2006		2005

Strategic investments	$	12,205	$	1,073
Trading securities		4,686		(269	)
Financial instruments		823		2,289
Other		1,036		1,054


Other operating income	$	18,750	$	4,147

Loss and loss adjustment expense increased 19% and policy acquisition costs increased 25% in 2006 primarily due to the growth in net earned premium. See the Insurance Company Segment section below for further discussion of the changes in loss and loss adjustment expense and policy acquisition costs.

Other operating expense, which includes compensation expense, increased 4% in 2006. The increase primarily related to stock option expense under Statement of Financial Accounting Standards (SFAS) No. 123(R) and operating expenses of subsidiaries acquired in the second half of 2005, partially offset by lower legal and accounting expenses. We had 1,458 employees at March 31, 2006 compared to 1,262 a year earlier, with the increase due to acquisitions. See the Recent Accounting Changes section below for further discussion of our adoption of SFAS 123(R) in 2006.

Our effective income tax rate was 33.2% for 2006, compared to 33.8% for 2005.

At March 31, 2006, book value per share was $15.79, up from $15.26 at December 31, 2005. Total assets were $7.1 billion and shareholders’ equity was $1.8 billion, up from $7.0 billion and $1.7 billion, respectively, at December 31, 2005.

Segments

Insurance Company Segment

Net earnings of our insurance company segment increased 29% to $60.1 million in the first quarter of 2006 compared to $46.7 million in the first quarter of 2005. The growth in segment net earnings was driven by an increase in underwriting income, increased investment income and the operations of acquired subsidiaries. Even though there is some pricing competition in certain of our markets, our margins remain at an acceptable level of profitability due to our underwriting expertise and discipline. We expect net earnings from our insurance companies to continue to grow during 2006.

Premium

Gross written premium increased 7% to $506.1 million in 2006. Net written premium increased 10% to $393.1 million and net earned premium increased 19% to $380.6 million in 2006. These increases were primarily due to higher retention levels on non-catastrophe business, acquisitions and the mix of business due to increased premium in lines where we had greater retentions. The overall percentage of retained premium increased to 78% in 2006 from 75% in 2005. Net written and net earned premium are expected to continue to grow in 2006.

The following tables provide premium information by line of business.


	Gross			Net			NWP			Net
	written			written			as % of			earned
	premium			premium			GWP			premium

Three months ended March 31, 2006

Diversified financial products	$	197,246		$	161,645			82	%	$	169,112
Group life, accident and health		134,154			129,443			96			127,761
Aviation		56,234			35,425			63			33,197
London market account		74,507			38,723			52			21,928
Other specialty lines		43,889			27,900			64			28,640
Discontinued lines		28			(85	)		nm			(67	)


Totals	$	506,058		$	393,051			78	%	$	380,571


Three months ended March 31, 2005

Diversified financial products	$	199,072		$	145,997			73	%	$	106,851
Group life, accident and health		150,082			129,449			86			128,945
Aviation		49,102			32,126			65			33,817
London market account		43,196			28,912			67			26,711
Other specialty lines		35,519			21,074			59			21,225
Discontinued lines		(1,852	)		(206	)		nm			2,568


Totals	$	475,119		$	357,352			75	%	$	320,117


		nm — Not meaningful comparison

The changes in premium volume and retention levels between years resulted principally from the following factors:

•

Diversified financial products — Gross written premium was flat. Growth in our surety line of business from both organic growth and our 2005 acquisitions was offset by lower premium volume in our international directors’ and officers’ liability and professional indemnity books of business due to competitive pricing pressure, although profit margins on these lines remain at acceptable levels. The growth in net written and net earned premium was due to increased retentions resulting from a reduction in proportional reinsurance.

	•		Group life, accident and health — Gross written premium declined primarily because we non-renewed a book of business which was 100% reinsured. Profit margins remain at acceptable levels despite competition from the fully insured market.

	•		London market account — Gross written premium increased due to the substantial increase in rates in the energy sector as a result of the 2005 hurricane losses, more than offsetting a reduction in our property premium. Net written premium increased for the same reason and will be reflected in increases in our net earned premium later in 2006 and into 2007. In 2006, to increase our capacity and spread our risk in the energy sector, we entered into a new quota share reinsurance agreement, which resulted in a decrease in our retention although net written premium has still increased. Although the cost of our 2006 excess of loss reinsurance increased, our potential profitability is greater on the increased gross written premium. The reduction in property premium has reduced our aggregate exposure in Florida and the Gulf of Mexico.

	•		Other specialty lines — We experienced organic growth in our other specialty lines of business from increased writings in several products. The mix of products affected the retention percentages. Rates in this line have been relatively stable.

Losses and Loss Adjustment Expenses

Our net adverse development relating to prior year losses included in net incurred loss and loss adjustment expense was $4.1 million in 2006 and $1.6 million in 2005. Deficiencies and redundancies in reserves occur as a result of our continuing review and as losses are finally settled or claims exposures change. We have no material exposure to environmental or asbestos losses and believe we have provided for all material net incurred losses.

Our gross loss ratio was 55.3% in 2006 and 55.7% in 2005. The following table provides comparative net loss ratios by line of business, which were relatively consistent with the prior year ratios.


				Three months ended March 31,
	2006						2005
	Net			Net			Net		Net
	earned			loss			earned		loss
	premium			ratio			premium		ratio
				(As restated)					(As restated)

Diversified financial products	$	169,112			50.8	%	$	106,851		49.0	%
Group life, accident and health		127,761			69.7			128,945		69.0
Aviation		33,197			54.3			33,817		51.6
London market account		21,928			48.1			26,711		44.6
Other specialty lines		28,640			63.9			21,225		59.7
Discontinued lines		(67	)	nm				2,568		102.1


Totals	$	380,571			58.4	%	$	320,117		58.1	%


Expense ratio					27.1					26.9


Combined ratio					85.5	%				85.0	%


		nm — Not meaningful comparison

Policy Acquisition Costs

Policy acquisition costs, which are net of the related portion of commissions on reinsurance ceded, increased to $76.2 million in the first quarter of 2006 from $61.1 million in the first quarter of 2005. Policy acquisition costs as a percentage of net earned premium increased to 20.0% in 2006 from 19.1% in 2005 due to a change in the mix of business and higher retention rates. The expense ratio also increased slightly in 2006 compared to 2005 for the same reasons.

Agency Segment

Revenue from our agency segment decreased to $42.7 million in the first quarter of 2006 from $44.8 million in the first quarter of 2005, primarily due to less business produced in certain lines and the overall effect of ceding less reinsurance. In addition, we consolidated our largest underwriting agency into one of our life insurance companies effective January 1, 2005. As a result, segment net earnings also decreased in 2006 to $8.9 million from $9.4 million in 2005. While increased retentions result in less fee and commission income to our agency segment, they generate increased insurance company revenue and net earnings. We expect the revenue and net earnings of this segment will stabilize in 2006 and only decline slightly due to continuing changes in the mix of business, but should begin to increase again in 2007.

Other Operations Segment

Revenue and net earnings from our other operations segment increased to $19.8 million and $13.0 million, respectively, in 2006 compared to 2005 primarily due to the partial sale of a strategic investment and net gains from trading securities. Results of this segment may vary substantially period to period depending on our investment in or disposition of strategic investments and activity in our trading portfolio. The trading portfolio represents less than 3% of our total investments.

Liquidity and Capital Resources

We receive substantial cash from premiums, reinsurance recoverables, commutations, fee and commission income, proceeds from sales and redemptions of investments and investment income. Our principal cash outflows are for the payment of claims and loss adjustment expenses, premium payments to reinsurers, purchases of investments, debt service, policy acquisition costs, operating expenses, taxes and dividends.

Cash provided by operating activities can fluctuate due to timing differences in the collection of premiums and reinsurance recoverables and the payment of losses and premium and reinsurance balances payable, the completion of commutations and activity in our trading portfolio. Our cash provided by operating activities has been strong in recent years due to: 1) our increasing net earnings, 2) growth in net written premium and net loss reserves due to organic growth, acquisitions and increased retentions, 3) commutations of selected reinsurance agreements and 4) expansion of our diversified financial products line of business as a result of which we retain premium longer due to the longer duration of claims liabilities.

The components of our net operating cash flows are detailed in the following table.


	Three months ended March 31,
	2006			2005
	(As restated)			(As restated)

Net earnings	$	79,142		$	55,388
Change in premium, claims and other receivables, net of reinsurance, other payables and restricted cash		(13,013	)		(51,115	)
Change in unearned premium, net		18,152			30,376
Change in loss and loss adjustment expense payable, net of reinsurance recoverables		36,407			49,027
Change in trading portfolio		(47,994	)		(41,328	)
Other, net		5,397			(8,439	)


Cash provided by operating activities	$	78,091		$	33,909

Cash provided by operating activities increased $44.2 million in 2006. Cash received from commutations, included in cash provided by operating activities, totaled $32.6 million in 2005. Cash flow from operations was unusually low in 2005 due to the timing of receipt of premiums and payment of payables.

Our combined cash and investment portfolio increased by $84.1 million during 2006 to a total of $3.4 billion at March 31, 2006. We maintain a substantial level of cash and liquid short-term investments to meet anticipated payment obligations.

In 2006, we paid $24.0 million, which had been accrued at December 31, 2005, related to an earnout consideration based on the terms of a prior acquisition agreement.

Our $200.0 million Revolving Loan Facility allows us to borrow up to the maximum allowed by the facility on a revolving basis until the facility expires on November 30, 2009. We had no borrowings at March 31, 2006. We have filed registration statements with the United States Securities and Exchange Commission that provide for the issuance of an aggregate of $750.0 million of our securities, of which $375.0 million remains available to be issued. These securities may be debt securities, equity securities or a combination thereof.

As a result of our common stock trading at specified price levels in the first quarter, holders may elect to surrender our 1.30% Convertible Notes and 2.00% Convertible Exchange Notes (Notes) in the second quarter for cash equal to the principal amount of the Notes ($297.4 million at March 31, 2006) and common stock for the value of the conversion premium. We expect to use the Revolving Loan Facility to fund any Notes surrendered in the second quarter, which have been minimal to date. Assuming an average price of $34.00 for our stock, we would issue approximately 4.9 million shares of common stock should all Note holders elect conversion. The dilutive effect of these shares is included in the calculation of our diluted earnings per share in all periods despite the fact that no material conversions have been made and none are expected at this time. Our common stock must meet the specified price levels in each subsequent quarter in order for the Notes to be eligible for conversion in the following quarter.

As a result of our delayed filing of our Form 10-Q for the quarters ended June 30, 2006 and September 30, 2006, we are ineligible to register our securities on Form S-3 or use our previously filed shelf registration statement for sale of our securities by us or resale of our securities by others until we have timely filed all periodic reports under the Securities Exchange Act of 1934 for one year. We may use Form S-1 to raise capital and borrow money utilizing public debt or complete acquisitions of other companies, which could increase transaction costs and adversely impact our ability to raise capital and borrow money or complete acquisitions in a timely manner. In addition, the financial strength ratings of our insurance companies and our debt ratings, which A.M. Best placed under review with negative implications and Fitch Ratings and Standard & Poor’s affirmed with a stable outlook, if reduced, might significantly impede our ability to raise capital and borrow money.

On October 30, 2006, we received a registered letter from U.S. Bank, as trustee for the holders of our 2.00% Convertible Notes due 2021, 1.30% Convertible Notes due 2023 and 2.00% Convertible Exchange Notes due 2021, stating that U.S. Bank, as trustee, had not received our consolidated financial statements for the quarter ended June 30, 2006. If we do not file our Quarterly Report on Form 10-Q for the quarter ended June 30, 2006 with the SEC and deliver the report to the trustee within sixty days from the date notice was received from the trustee, such failure to file and deliver will be considered an “Event of Default” under the indenture governing the notes. If an “Event of Default” were to occur under the indentures for any series of the notes, the trustee or holders of at least 25% of the aggregate principal of such series then outstanding could declare all the unpaid principal on such series of notes then outstanding to be immediately due and payable. Likewise, we have not timely delivered our Form 10-Q’s for the quarters ended June 30 and September 30, 2006 as required by the terms of our Revolving Loan Facility agreement. The banks that are a party to the agreement waived certain “Defaults” or “Events of Default” until January 31, 2007. In addition, our restatement of our prior year financial statements might be considered an “Event of Default” which has been waived until January 31, 2007. Our failure to comply with the covenants in the indentures for our convertible notes and our Revolving Loan Facility loan agreement in the future could have a material adverse effect on our stock price, business and financial condition if we would not have available funds at that time to repay any defaulted debt. A default and acceleration under the indentures for our convertible notes and loan agreement may also trigger cross-acceleration under our other debt instruments.

In December 2006, our existing Revolving Loan Facility was increased by $100.0 million to $300.0 million. Pursuant to the terms of the agreement, the Company can borrow up to $25 million in addition to what is currently borrowed for working capital purposes. However, the full unfunded amount of the facility would be available to pay any potential convertible note conversion or put.

Based on the Special Committee’s voluntary independent investigation of our past practices related to granting stock options, we determined that the price on the actual measurement date for a number of our stock option grants during the period 1997 through 2005 and into 2006 did not correspond to the price on the stated grant date and that certain option grants were retroactively repriced. The investigation was conducted with the help of a law firm that was not previously involved with our stock option plans and procedures. The SEC has commenced an informal inquiry. In connection with its inquiry, we received a document request from the SEC. We intend to fully cooperate with the informal inquiry. We are unable to predict the outcome of or the future cost related to the informal inquiry.

Our debt to total capital ratio was 15.0% at March 31, 2006 and 15.5% at December 31, 2005.

We believe that our operating cash flows, investments, Revolving Loan Facility and other sources of liquidity will provide sufficient sources of liquidity to meet our current operating needs for the foreseeable future.

Recent Accounting Changes

Effective January 1, 2006, we adopted SFAS No. 123(R), Share-Based Payment, using the modified prospective method. In 2006 and thereafter, we will expense the fair value of our unvested stock options granted before January 1, 2006 and all options granted after that date. Prior to adoption, we accounted for our stock options in accordance with Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees. Under the modified prospective method of SFAS 123(R), the 2005 and prior period financial statements were not restated. We made no modifications to our stock option plans in conjunction with the adoption of SFAS 123(R).

In the first quarter of 2006, we expensed $2.7 million ($1.9 million after tax or $0.02 per diluted share) of stock-based compensation, after the effect of the deferral and amortization of related policy acquisition costs. At March 31, 2006, there was approximately $38.2 million of total unrecognized compensation expense related to unvested options that is expected to be recognized over a weighted-average period of three years. In 2006, we expect to recognize $12.1 million of expense, including the amortization of deferred policy acquisition costs, related to stock-based compensation for options currently outstanding. In the first quarter of 2005 we expensed $0.7 million of stock-based compensation under APB Opinion No. 25.

The Financial Accounting Standards Board (FASB) has issued FASB Interpretation (FIN) No. 48, Accounting for Uncertainty in Income Taxes. Effective January 1, 2007, FIN 48 clarifies the accounting for uncertain income tax positions. We are currently reviewing the requirements of FIN 48 to determine the effect it will have on our consolidated financial statements.

The FASB issued SFAS No. 157, Fair Value Measurements (SFAS 157), which clarified the definition of fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurement. SFAS 157 does not require any new fair value measurements and eliminates inconsistencies in guidance found in various prior accounting pronouncements. SFAS 157 will be effective for us on January 1, 2008. We are currently assessing whether the adoption of SFAS 157 will have an impact on our consolidated financial statements.

The Securities and Exchange Commission has issued Staff Accounting Bulletin (SAB) No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements. SAB 108 establishes a standard approach for quantifying the materiality of errors to current and prior period financial statements. SAB 108’s guidelines must be applied in the fourth quarter, and adjustments, if any, will be recorded either by restating prior year financial statements or recording a cumulative effect adjustment as of January 1, 2006. We believe the requirements of SAB 108 will have no effect on our consolidated financial statements.

Critical Accounting Policies

We have made no changes in our methods of application of our critical accounting policies, except for the adoption of SFAS No. 123(R) as discussed above, from the information provided in our Annual Report on Form 10-K/A for the year ended December 31, 2005.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

There have been no material changes in market risk from the information provided in Item 7A, “Quantitative and Qualitative Disclosures About Market Risk,” in our Annual Report on Form 10-K/A for the year ended December 31, 2005.

Item 4. Controls and Procedures

a. Disclosure Controls and Procedures

Background of Restatement

As disclosed in Explanatory Note — Restatement of Consolidated Financial Statements on page 3 of this Form 10-Q/A and in Note 2 to the Condensed Consolidated Financial Statements, in August 2006, our Board of Directors formed a Special Committee of independent directors to commence an investigation of our past stock option granting practices for the period 1995 through 2005. On November 17, 2006, we announced that the Special Committee found that we had used incorrect accounting measurement dates for stock option grants covering a significant number of employees and members of our Board of Directors during the period 1997 through 2005 and that certain option grants were retroactively priced. Additionally, at the direction of the Special Committee, we reviewed our stock option granting practices from 1992, the year of our initial public stock offering, through 1994 and in 2006 and found incorrect measurement dates due to retroactive pricing were used in 2006. In substantially all of these instances, the price on the actual measurement date was higher than the price on the stated grant date.

Before the Board of Directors reviewed the results of the investigation, the Chairman of our Compensation Committee tendered his resignation from the Board of Directors on November 8, 2006. After reviewing the results of the investigation, the Board of Directors determined that it would be appropriate to accept the resignations of Mr. Way and Mr. Martin, which both tendered on November 17, 2006.

We determined that, in accordance with Accounting Principles Board (APB) No. 25, Accounting for Stock Issued to Employees, and its related interpretations, we should have recorded compensation expense related to these mis-priced options for the excess of the market price of our stock on the actual accounting measurement date over the exercise price of the option. As a result, we concluded that we needed to amend our Annual Report on Form 10-K for the year ended December 31, 2005 to restate our consolidated financial statements and the related disclosures for the years ended December 31, 2005, 2004 and 2003 and the condensed consolidated financial statements for the quarter ended March 31, 2006 and all quarters for the years ended December 31, 2005 and 2004, and to record an adjustment to the condensed consolidated financial statements for the quarters ended June 30, 2006 and September 30, 2006. In addition, as discussed below, we concluded that we had a material weakness in our internal control over financial reporting as of March 31, 2006.

As part of the restatement process, we recorded other adjustments in the period 2000 through 2005 that were not recorded in the originally filed financial statements due to their immateriality. We evaluated the control deficiencies that resulted in these adjustments and concluded that these immaterial errors were the result of control deficiencies that did not constitute a material weakness, individually or in the aggregate, in our internal control over financial reporting.

Evaluation of Disclosure Controls and Procedures

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

As of March 31, 2006, an evaluation was carried out under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 (the Act). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were not effective to ensure that information required to be disclosed by us to comply with our disclosure obligations under the Act is recorded, processed, summarized and reported by us within the timeframes specified by the Securities and Exchange Commission in order to comply with our disclosure obligations under the Act because of the material weakness in internal control over financial reporting described below. Notwithstanding this material weakness, our current management has concluded that our consolidated financial statements for the periods covered by and included in this Quarterly Report on Form 10-Q/A are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) and fairly present, in all material respects, our financial position, results of operations and cash flows for each of the periods presented herein.

Material Weakness in Internal Control Over Financial Reporting

A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. Our current management identified the following material weakness in our internal control over financial reporting as of March 31, 2006.

We did not maintain an effective control environment based on the criteria established in the COSO framework. We did not maintain adequate controls to prevent or detect management override by certain former members of senior management related to our stock option granting practices and procedures. This lack of an effective control environment permitted certain former members of senior management to override controls and retroactively price stock option grants, resulting in ineffective controls over our stock option granting practices and procedures. Effective controls, including monitoring and adequate communication, were not maintained to ensure the accuracy, valuation and presentation of activity related to our stock option granting practices and procedures. This control deficiency resulted in misstatement of our stock-based compensation expense, additional paid-in capital and related income tax accounts and related disclosures, and in the restatement of our consolidated financial statements for the years ended December 31, 2005, 2004 and 2003 and the condensed consolidated financial statements for the quarter ended March 31, 2006 and all quarters for the years ended December 31, 2005 and 2004, and the adjustment of the condensed consolidated financial statements for the quarters ended June 30, 2006 and September 30, 2006. This control deficiency could result in misstatement of the aforementioned accounts and disclosures that would result in a material misstatement of our annual or interim consolidated financial statements that would not be prevented or detected. Accordingly, management has determined this control deficiency constitutes a material weakness.

Changes in Internal Control Over Financial Reporting

There have been no changes in our internal control over financial reporting during the last quarter of the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Remediation Plans

We are committed to remediating the material weakness identified above by implementing changes to our internal control over financial reporting to enhance our control environment. During 2006, we implemented or are in the process of implementing new policies and controls related to our stock option granting practices and procedures, as follows:

	•		Before the Board of Directors reviewed the results of the investigation, the Chairman of our Compensation Committee tendered his resignation from the Board of Directors on November 8, 2006. After reviewing the results of the investigation, our Board of Directors determined that it would be appropriate to accept the resignations of our former CEO and General Counsel, which both tendered on November 17, 2006. Our Board of Directors has appointed a new Chairman of our Compensation Committee and a new CEO who, together with other members of our senior management, are committed to achieving transparency through effective corporate governance, a strong control environment, application of business standards reflected in our Code of Business Conduct and Ethics, and completeness and integrity of our financial reporting and disclosure.

	•		We have changed our option granting approval policies and procedures to require Compensation Committee approval of all new option grants on the day of each Compensation Committee meeting preceding the regularly scheduled quarterly Board of Directors meeting. All grants will be appropriately approved and documented in minutes of the meeting, taken contemporaneously with the meeting. All grants will be priced at the market closing price on the day of each such Compensation Committee meeting. We have established processes and procedures to increase the level of communication between the Compensation Committee, senior management and our financial reporting and accounting personnel regarding stock option grants.

We are actively engaged in the implementation of other remediation efforts to address the material weakness identified in our internal control over financial reporting. Although we have not fully remediated the material weakness as of the date of this Form 10-Q/A filing, we believe we have made substantial progress.

Part II — Other Information

Item 1. Legal Proceedings

We are party to lawsuits, arbitrations and other proceedings that arise in the normal course of our business. Many of such lawsuits, arbitrations and other proceedings involve claims under policies that we underwrite as an insurer or reinsurer, the liabilities for which, we believe, have been adequately included in our loss reserves. Also, from time to time, we are a party to lawsuits, arbitrations and other proceedings that relate to disputes over contractual relationships with third parties, or that involve alleged errors and omissions on the part of our subsidiaries. We have provided accruals for these items to the extent we deem the losses probable and reasonably estimable.

In April 2006, we were named as a defendant in a complaint related to insurance marketing and producer compensation practices. The lawsuit was filed in Federal District Court in Georgia by a number of corporate plaintiffs against approximately 100 insurance entity defendants. The suit has been transferred to the multi-district litigation proceeding pending in the United States District Court for the District of New Jersey for coordinated or consolidated pre-trial proceedings with suits previously transferred that appear to the court to involve common questions of fact. The complaint alleges violations of Federal antitrust law, the Racketeering Influence and Corrupt Organization Act and various state anti-fraud laws. The lawsuit seeks unspecified damages. We are vigorously contesting this action.

Although the ultimate outcome of the matters cannot be determined at this time, based on present information, the availability of insurance coverage and advice received from our outside legal counsel, we believe the resolution of these matters will not have a material adverse effect on our consolidated financial position, results of operations or cash flows.

Item 1A. Risk Factors

There have been no material changes in our risk factors described in our Annual Report on Form 10-K/A for the year ended December 31, 2005.

Item 6. Exhibits

a. Exhibits

31.1 Certification by Chief Executive Officer
31.2 Certification by Chief Financial Officer
32.1 Certification with Respect to Quarterly Report

SIGNATURES

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


		HCC Insurance Holdings, Inc.

		(Registrant)

December 26, 2006		/s/ Frank J. Bramanti

(Date)		Frank J. Bramanti Chief Executive Officer

December 26, 2006		/s/ Edward H. Ellis, Jr.

(Date)		Edward H. Ellis, Jr., Executive Vice President
		and Chief Financial Officer

Index to Exhibits

31.1 Certification by Chief Executive Officer
31.2 Certification by Chief Financial Officer
32.1 Certification with Respect to Quarterly Report