þ		Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

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

(Exact name of registrant as specified in its charter)

Delaware		76-0336636
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)
13403 Northwest Freeway, Houston, Texas		77040-6094
(Address of principal executive offices)		(Zip Code)

(713) 690-7300

(Registrant’s telephone number, including area code)

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

Yes þ      No o

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

Large accelerated filer þ		Accelerated filer o		Non-accelerated filer o		Smaller reporting company o
				(Do not check if a smaller reporting company)

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

Yes o      No þ

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, 2008, there were approximately 115.3 million shares of common stock, $1.00 par value issued and outstanding.

 

 

		Page
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets — March 31, 2008 (unaudited) and December 31, 2007			5
Condensed Consolidated Statements of Earnings — Three months ended March 31, 2008 and 2007 (unaudited)			6
Condensed Consolidated Statement of Changes in Shareholders’ Equity — Three months ended March 31, 2008 (unaudited)			7
Condensed Consolidated Statements of Cash Flows — Three months ended March 31, 2008 and 2007 (unaudited)			8
Notes to Condensed Consolidated Financial Statements (unaudited)			9
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			21
Item 3. Quantitative and Qualitative Disclosures About Market Risk			31
Item 4. Controls and Procedures			32
Part II. OTHER INFORMATION
Item 1. Legal Proceedings			32
Item 1A. Risk Factors			33
Item 6. Exhibits			33
Signatures			33
Certification by Chief Executive Officer
Certification by Chief Financial Officer
Certification with Respect to Quarterly Report

FORWARD-LOOKING STATEMENTS

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

Many risks and uncertainties may 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 assessment of underwriting risk;
	•		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 securities markets, which may reduce the value of our investment assets;
	•		our ability to successfully expand our business through the acquisition of insurance-related companies;
	•		impairment of goodwill;
	•		the ability of our insurance company subsidiaries to pay dividends in needed amounts;
	•		fluctuations in foreign exchange rates;

	•		failures of our information technology systems;
	•		developments in the SEC’s inquiry related to our past stock option granting procedures; and
	•		change of control.

We describe these risks and uncertainties in greater detail in Item 1A, Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2007.

These events or factors could cause our results or performance to differ materially from those we express in our forward-looking statements. Although we believe that the assumptions underlying our forward-looking statements are reasonable, any of these assumptions, and, therefore, also the forward-looking statements based on these assumptions, could themselves prove to be inaccurate. In light of the significant uncertainties inherent in the forward-looking statements that are included in this Report, our inclusion of this information is not a representation by us or any other person that our objectives 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,				December 31,
		2008				2007
ASSETS
Investments:
Fixed income securities, at fair value (amortized cost: 2008 - $3,903,397, 2007 - $3,641,667)		$	3,929,549			$	3,666,705
Short-term investments, at cost, which approximates fair value			655,598				783,650
Other investments			214,555				221,922
Total investments			4,799,702				4,672,277
Cash			24,688				39,135
Restricted cash and cash investments			180,754				193,151
Premium, claims and other receivables			775,126				763,401
Reinsurance recoverables			953,925				956,665
Ceded unearned premium			224,785				244,684
Ceded life and annuity benefits			65,892				66,199
Deferred policy acquisition costs			194,957				192,773
Goodwill			817,372				776,046
Other assets			181,217				170,314
Total assets		$	8,218,418			$	8,074,645
LIABILITIES
Loss and loss adjustment expense payable		$	3,318,811			$	3,227,080
Life and annuity policy benefits			65,892				66,199
Reinsurance balances payable			124,077				129,838
Unearned premium			926,940				943,946
Deferred ceding commissions			62,562				68,968
Premium and claims payable			442,379				497,974
Notes payable			364,714				324,714
Accounts payable and accrued liabilities			390,849				375,561
Total liabilities			5,696,224				5,634,280
SHAREHOLDERS’ EQUITY
Common stock, $1.00 par value; 250.0 million shares authorized (shares issued and outstanding: 2008 – 115,298; 2007 – 115,069)			115,298				115,069
Additional paid-in capital			838,648				831,419
Retained earnings			1,514,414				1,445,995
Accumulated other comprehensive income			53,834				47,882
Total shareholders’ equity			2,522,194				2,440,365
Total liabilities and shareholders’ equity		$	8,218,418			$	8,074,645

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,
		2008				2007
REVENUE
Net earned premium		$	493,546			$	497,600
Fee and commission income			30,999				32,125
Net investment income			47,621				49,467
Net realized investment gain (loss)			168				(555	)
Other operating income (loss)			(4,946	)			18,585
Total revenue			567,388				597,222
EXPENSE
Loss and loss adjustment expense, net			293,026				300,472
Policy acquisition costs, net			92,268				89,099
Other operating expense			59,204				57,641
Interest expense			3,959				3,303
Total expense			448,457				450,515
Earnings before income tax expense			118,931				146,707
Income tax expense			37,830				50,017
Net earnings		$	81,101			$	96,690
Basic earnings per share data:
Net earnings per share		$	0.70			$	0.86
Weighted average shares outstanding			115,234				111,959
Diluted earnings per share data:
Net earnings per share		$	0.70			$	0.83
Weighted average shares outstanding			116,372				117,009
Cash dividends declared, per share		$	0.11			$	0.10

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, 2008

(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, 2007		$	115,069			$	831,419			$	1,445,995			$	47,882			$	2,440,365
Net earnings			—				—				81,101				—				81,101
Other comprehensive income			—				—				—				5,952				5,952
Comprehensive income																			87,053
Issuance of 219 shares for exercise of options, including tax benefit of $351			219				4,373				—				—				4,592
Stock-based compensation			10				2,856				—				—				2,866
Cash dividends declared, $0.11 per share			—				—				(12,682	)			—				(12,682	)
Balance at March 31, 2008		$	115,298			$	838,648			$	1,514,414			$	53,834			$	2,522,194

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,
		2008				2007
Cash flows from operating activities:
Net earnings		$	81,101			$	96,690
Adjustments to reconcile net earnings to net cash provided by operating activities:
Change in premium, claims and other receivables			3,779				87,166
Change in reinsurance recoverables			2,671				111,267
Change in ceded unearned premium			19,899				1,890
Change in loss and loss adjustment expense payable			91,845				16,445
Change in reinsurance balances payable			(5,761	)			(8,325	)
Change in unearned premium			(16,960	)			(2,622	)
Change in premium and claims payable, net of restricted cash			(45,449	)			(86,687	)
Change in trading portfolio			9,062				10,958
Depreciation and amortization expense			3,390				3,736
Stock-based compensation expense			2,866				2,211
Other, net			(10,643	)			(2,418	)
Cash provided by operating activities			135,800				230,311
Cash flows from investing activities:
Sales of fixed income securities			120,075				28,483
Maturity or call of fixed income securities			75,875				70,148
Cost of securities acquired			(455,973	)			(367,195	)
Change in short-term investments			128,052				24,857
Sales of other investments			19,038				—
Sale of strategic investments			—				22,950
Payments for purchase of subsidiaries, net of cash received			(71,486	)			(5,917	)
Other, net			(1,670	)			(2,168	)
Cash used by investing activities			(186,089	)			(228,842	)
Cash flows from financing activities:
Advances on line of credit			40,000				11,000
Payments on line of credit and notes payable			—				(11,339	)
Sale of common stock			4,592				8,040
Dividends paid			(12,658	)			(11,173	)
Other, net			3,908				(3,795	)
Cash provided (used) by financing activities			35,842				(7,267	)
Net decrease in cash			(14,447	)			(5,798	)
Cash at beginning of period			39,135				48,290
Cash at end of period		$	24,688			$	42,492

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 and affiliated brokers, producers, agents and third party administrators. Our lines of business include diversified financial products (which includes directors’ and officers’ liability, professional indemnity, employment practices liability, surety and credit); group life, accident and health; aviation; our 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, Belgium 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, 2007 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 condensed consolidated financial statements and in disclosures of contingent assets and liabilities. Ultimate results could differ from those estimates.
		Acquisitions
		On January 2, 2008, we acquired MultiNational Underwriters, LLC, an underwriting agency located in Indianapolis, Indiana, for $42.7 million in cash and a possible additional earnout depending upon future underwriting profit levels. This agency writes domestic and international short-term medical insurance. The results of operations of MultiNational Underwriters were included in our condensed consolidated financial statements beginning on the effective date of the transaction. We valued all identifiable assets and liabilities at fair value and allocated $39.4 million to goodwill in our initial purchase price allocation. We are still in the process of valuing certain agreements to complete our purchase price allocation. Goodwill resulting from this acquisition will be deductible for United States Federal income tax purposes.
		On November 1, 2007, we acquired Ponderosa Management, Inc., the parent company of Pioneer Insurance Company, for $12.2 million in cash. During the first quarter, we completed our purchase price allocation, resulting in final goodwill of $4.5 million.

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited, tables in thousands except per share data)

		Income Tax
		For the three months ended March 31, 2008 and 2007, 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.
		Stock-Based Compensation
		In the first quarter of 2008, we granted 10,000 shares of restricted stock and options for the purchase of 180,000 shares of our common stock at $22.02 per share. The aggregate fair value of these awards was $0.9 million, which will be expensed over a vesting period of three to five years.
		Recent Accounting Pronouncements
		The Financial Accounting Standards Board (FASB) has issued FSP FAS 157-2, Effective Date of FASB Statement No. 157, to delay the effective date of SFAS No. 157, Fair Value Measurements, (discussed in Note 2 below) for nonfinancial assets and nonfinancial liabilities measured at fair value on a nonrecurring basis. For these items, FSP 157-2 will be effective January 1, 2009. We are evaluating what impact these future additional SFAS 157 requirements will have on our consolidated financial statements.
		SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, issued by the FASB, became effective January 1, 2008. SFAS 159 allows a company to make an irrevocable election to measure eligible financial assets and financial liabilities at fair value that are not otherwise measured at fair value. Unrealized gains and losses for those items are reported in current earnings at each subsequent reporting date. As of January 1, 2008, we have not elected to value any additional assets or liabilities at fair value under the guidance of SFAS 159.
		The FASB has issued SFAS No. 141 (revised 2007) (SFAS 141(R)), Business Combinations, and SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of Accounting Research Bulletin No. 51. SFAS 141(R) will change the accounting treatment for business combinations and will impact presentation of financial statements on the acquisition date and accounting for acquisitions in subsequent periods. SFAS 160 will change the accounting and reporting for minority interests, which will be recharacterized as noncontrolling interests and classified as a component of shareholders’ equity. SFAS 141(R) and SFAS 160 will be effective January 1, 2009 and early adoption is not permitted. We are evaluating the impact SFAS 141(R) and SFAS 160 will have on our consolidated financial statements.
		The FASB has issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities – an amendment of FASB Statement No. 133, which expands the required disclosures about a company’s derivative and hedging activities. SFAS 161 will be effective January 1, 2009. We are evaluating the impact SFAS 161 will have on the notes to our consolidated financial statements.
(2)		FAIR VALUE MEASUREMENTS
		Effective January 1, 2008, we adopted SFAS No. 157, Fair Value Measurements, for financial assets and financial liabilities measured at fair value on a recurring basis (at least annually). SFAS 157 defines fair value, establishes a consistent framework for measuring fair value and expands disclosure requirements about fair value measurements. Our adoption of SFAS 157 did not impact our 2008 or prior years’ consolidated financial position, results of operations or cash flows.

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited, tables in thousands except per share data)

SFAS 157 applies to all financial instruments that are measured and reported at fair value. SFAS 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In determining fair value, we generally apply the market approach, which uses prices and other relevant data based on market transactions involving identical or comparable assets and liabilities. The degree of judgment used to measure fair value generally correlates to the type of pricing and other data used as inputs, or assumptions, in the valuation process. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our own market assumptions using the best information available to us. Based on the type of inputs used to measure the fair value of our financial instruments, we classify them into the following three-level hierarchy established by SFAS 157:

	•		Level 1 – Inputs are based on quoted prices in active markets for identical instruments.
	•		Level 2 – Inputs are based on observable market data (other than quoted prices), or are derived from or corroborated by observable market data.
	•		Level 3 – Inputs are unobservable and not corroborated by market data.

Our Level 1 instruments are primarily U.S. Treasuries and equity securities listed on stock exchanges.

Our Level 2 instruments include most of our fixed income securities, which consist of U.S. government and agency securities, municipal bonds, certain corporate debt securities, and certain mortgage and asset-backed securities. Our Level 2 instruments also include our interest rate swap agreements, which were reflected as liabilities in our consolidated balance sheet at March 31, 2008. We obtain fair value measurements for the majority of our Level 2 instruments from an independent pricing service. The fair value measurements consider various observable assumptions, including benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, default rates, loss severity and other economic measures. To validate the independent pricing service’s fair values, we obtain the fair value for our fixed income securities from third party investment managers and compare the two sources of each security’s fair value for reasonableness. In addition, we obtain an understanding of the methods used by the independent pricing service. When fair value measurements are not available from our independent pricing service, we use fair value measurements provided by third party investment managers, which are modeled using valuation methodologies and observable inputs similar to those listed above.

Our Level 3 securities include certain fixed income securities, a short-term investment with extended repayment terms, and two insurance contracts that we account for as derivatives. We determine the fair value for Level 3 instruments based on internally developed models that use assumptions or other data that are not readily observable from objective sources. Because we use the lowest level significant input to determine our hierarchy classifications, a financial instrument may be classified in Level 3 even though there may be significant readily-observable inputs.

We have excluded from our SFAS 157 disclosures certain assets, such as alternative investments and certain strategic investments in insurance-related companies, since we account for them using the equity method of accounting and have not elected to measure them at fair value, pursuant to the guidance of SFAS 159. These assets had a recorded value of approximately $175.2 million at March 31, 2008.

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited, tables in thousands except per share data)

The following table presents our assets and liabilities that are measured at fair value as of March 31, 2008.

		Level 1				Level 2				Level 3				Total
Fixed income securities		$	96,377			$	3,826,224			$	6,948			$	3,929,549
Short-term investments			—				113,646				—				113,646
Other investments			51,151				—				3,576				54,727
Other assets			19,856				—				18,136				37,992
Total assets		$	167,384			$	3,939,870			$	28,660			$	4,135,914
Accounts payable and accrued liabilities		$	—			$	7,017			$	—			$	7,017
Total liabilities		$	—			$	7,017			$	—			$	7,017

The following table presents the changes in fair value of our Level 3 category for the first quarter of 2008.

		Fixed
		income				Other				Other
		securities				investments				assets				Total
Balance at January 1, 2008		$	7,623			$	5,492			$	16,804			$	29,919
Net redemptions			(239	)			(1,875	)			—				(2,114	)
Gains and (losses) – unrealized			(436	)			(41	)			1,332				855
Balance at March 31, 2008		$	6,948			$	3,576			$	18,136			$	28,660

Unrealized gains and losses on our Level 3 fixed income securities and other investments are reported in other comprehensive income within shareholders’ equity, and unrealized gains and losses on our Level 3 other assets are reported in other operating income.

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited, tables in thousands except per share data)

(3)		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
Three months ended March 31, 2008
Direct business		$	483,146			$	511,623			$	292,811
Reinsurance assumed			99,853				93,070				69,272
Reinsurance ceded			(89,352	)			(111,147	)			(69,057	)
Net amounts		$	493,647			$	493,546			$	293,026
Three months ended March 31, 2007
Direct business		$	458,502			$	485,370			$	287,451
Reinsurance assumed			140,599				116,473				62,997
Reinsurance ceded			(102,136	)			(104,243	)			(49,976	)
Net amounts		$	496,965			$	497,600			$	300,472

Ceding commissions netted against policy acquisition costs in the condensed consolidated statements of earnings were $11.7 million in 2008 and $11.2 million in 2007.

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

		March 31,				December 31,
		2008				2007
Reinsurance recoverable on paid losses		$	72,913			$	80,915
Reinsurance recoverable on outstanding losses			463,624				458,190
Reinsurance recoverable on incurred but not reported losses			425,832				426,090
Reserve for uncollectible reinsurance			(8,444	)			(8,530	)
Total reinsurance recoverables		$	953,925			$	956,665

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, market conditions may change or additional information might be obtained that 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.

Our U.S. domiciled insurance companies require 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,
		2008				2007
Payables to reinsurers		$	252,564			$	246,745
Letters of credit			181,298				188,400
Cash deposits			104,436				114,549
Total credits		$	538,298			$	549,694

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

		March 31,				December 31,
		2008				2007
Loss and loss adjustment expense payable		$	3,318,811			$	3,227,080
Reinsurance recoverable on outstanding losses			(463,624	)			(458,190	)
Reinsurance recoverable on incurred but not reported losses			(425,832	)			(426,090	)
Net reserves		$	2,429,355			$	2,342,800
Unearned premium		$	926,940			$	943,946
Ceded unearned premium			(224,785	)			(244,684	)
Net unearned premium		$	702,155			$	699,262
Deferred policy acquisition costs		$	194,957			$	192,773
Deferred ceding commissions			(62,562	)			(68,968	)
Net deferred policy acquisition costs		$	132,395			$	123,805

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited, tables in thousands except per share data)

(4)		EARNINGS PER SHARE
		The following table details the numerator and denominator used in the earnings per share calculations.

		Three months ended March 31,
		2008				2007
Net earnings		$	81,101			$	96,690
Weighted average common shares outstanding			115,234				111,959
Dilutive effect of restricted stock and outstanding options (determined using the treasury stock method)			533				1,008
Dilutive effect of convertible debt (determined using the treasury stock method)			605				4,042
Weighted average common shares and potential common shares outstanding			116,372				117,009
Anti-dilutive stock options not included in treasury stock method computation			5,622				2,229

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited, tables in thousands except per share data)

(5)		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 allocation of certain corporate expenses and certain intercompany interest. All stock-based compensation expense, unallocated corporate expenses and unallocated interest expense are included in the corporate segment since these costs are 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.

		Insurance								Other
		Company				Agency				Operations				Corporate				Total
Three months ended March 31, 2008
Revenue:
Domestic		$	456,928			$	13,951			$	(6,245	)		$	332			$	464,966
Foreign			92,697				9,725				—				—				102,422
Inter-segment			—				17,109				—				—				17,109
Total segment revenue		$	549,625			$	40,785			$	(6,245	)		$	332				584,497
Inter-segment eliminations																			(17,109	)
Consolidated total revenue																		$	567,388
Net earnings (loss):
Domestic		$	66,730			$	4,685			$	(5,080	)		$	(7,667	)		$	58,668
Foreign			20,856				421				—				—				21,277
Total segment net earnings (loss)		$	87,586			$	5,106			$	(5,080	)		$	(7,667	)			79,945
Inter-segment eliminations																			1,156
Consolidated net earnings																		$	81,101
Other items:
Net investment income		$	45,756			$	1,553			$	17			$	295			$	47,621
Depreciation and amortization			1,181				1,491				35				683				3,390
Interest expense			131				2,506				(26	)			1,348				3,959
Capital expenditures			651				1,228				2				779				2,660
Income tax expense (benefit)			38,570				3,545				(3,711	)			(1,280	)			37,124
Inter-segment eliminations																			706
Consolidated income tax expense																		$	37,830

During 2008, the other operations segment recorded an after-tax loss of $5.9 million from the reduction in market value of our two trading securities.

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, 2007
Revenue:
Domestic		$	458,760			$	14,957			$	18,276			$	397			$	492,390
Foreign			94,809				10,023				—				—				104,832
Inter-segment			—				13,986				—				—				13,986
Total segment revenue		$	553,569			$	38,966			$	18,276			$	397				611,208
Inter-segment eliminations																			(13,986	)
Consolidated total revenue																		$	597,222
Net earnings (loss):
Domestic		$	66,795			$	4,704			$	11,379			$	(6,085	)		$	76,793
Foreign			17,381				221				—				—				17,602
Total segment net earnings (loss)		$	84,176			$	4,925			$	11,379			$	(6,085	)			94,395
Inter-segment eliminations																			2,295
Consolidated net earnings																		$	96,690
Other items:
Net investment income		$	45,765			$	2,438			$	987			$	277			$	49,467
Depreciation and amortization			1,179				1,746				112				699				3,736
Interest expense			464				2,765				30				44				3,303
Capital expenditures			1,028				654				—				486				2,168
Income tax expense (benefit)			40,081				4,472				6,490				(2,537	)			48,506
Inter-segment eliminations																			1,511
Consolidated income tax expense																		$	50,017

During 2007, the other operations segment recorded an after-tax gain of $7.0 million from the sale of a strategic investment.

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,
		2008				2007
Diversified financial products		$	192,177			$	192,514
Group life, accident and health			192,446				192,416
Aviation			34,993				39,344
London market account			27,090				33,896
Other specialty lines			46,846				39,738
Discontinued lines			(6	)			(308	)
Net earned premium		$	493,546			$	497,600
Property and casualty		$	25,254			$	27,475
Accident and health			5,745				4,650
Fee and commission income		$	30,999			$	32,125
(6) SUPPLEMENTAL INFORMATION
Supplemental cash flow information was as follows.
		Three months ended March 31,
		2008				2007
Cash received from commutations		$	7,500			$	101,040
Income taxes paid			16,111				10,385
Interest paid			4,091				3,318
Comprehensive income			87,053				91,298

(7)		COMMITMENTS AND CONTINGENCIES
		Litigation
		Based on a voluntary independent investigation by a Special Committee of the Board of Directors in 2006 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 from 1997 through 2005 and into 2006 did not correspond to the price on the stated grant date and that certain option grants were retroactively priced. The investigation was conducted with the help of a law firm that was not previously involved with our stock option plans and procedures. The Special Committee completed the investigation on November 16, 2006. Based upon the Special Committee’s recommendations, the Board of Directors took specific actions. The SEC commenced an informal inquiry upon notification by us of the initiation of our investigation. We provided the results of our internal review and independent investigation to the SEC, and we have responded to requests from the SEC for documents and additional information. In March 2007, the SEC issued a formal order directing a private investigation. We are fully cooperating with the SEC.

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited, tables in thousands except per share data)

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

In addition to the litigation discussed above, the following lawsuits related to the outcome of our stock option investigation have been filed:

Civil Action No. 07-456 (Consolidated); Bacas and Halgren, derivatively on behalf of HCC Insurance Holdings, Inc. v. Way et al.; In the United States District Court for the Southern District of Texas, Houston Division.  This action consolidated all pending derivative suits into one action (Bacas suits). The Bacas action was filed on February 1, 2007, and the Halgren action was filed on February 28, 2007. On February 1, 2008, the parties appeared before the Court to seek approval of a proposed settlement in the case. Under the terms of the settlement, we have or will implement certain corporate governance reforms, and we and our directors’ and officers’ liability insurers agreed to pay up to $3.0 million to plaintiffs’ counsel for their attorneys fees. On April 1, 2008, the Court held a final hearing, granted final approval of the settlement, which includes no admission of liability or wrongdoing by HCC or any other defendants, and dismissed the case with prejudice. The plaintiffs’ attorneys fees were paid as agreed by HCC and its insurers.

Civil Action No. 07-0801; In re HCC Insurance Holdings, Inc. Securities Litigation; In the United States District Court for the Southern District of Texas, Houston Division (formerly referred to as Bristol County Retirement System, individually and on behalf of all others similarly situated v. HCC Insurance Holdings, Inc. et al.).  This action was filed on March 8, 2007. We are named as a defendant in this putative class action along with certain current and former officers and directors. On February 7, 2008, the parties reached an agreement to settle the case and will propose the settlement to the Court for approval. The terms of the settlement, which includes no admission of liability or wrongdoing by HCC or any other defendants, provide for a full and complete release of all claims in the litigation and payment of $10.0 million to be paid into a settlement fund, pending approval by the Court of a plan of distribution. The $10.0 million will be paid by our directors’ and officers’ liability insurers. At a hearing on April 17, 2008, the Court gave preliminary approval of the proposed settlement. The hearing for final approval is scheduled for July 17, 2008.

Indemnifications

In conjunction with the sales of certain 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. Other indemnifications agree to reimburse the purchasers for taxes or ERISA-related amounts, if any, assessed after the sale date but related to pre-sale activities. We cannot quantify the maximum potential exposure covered by all of our indemnifications because the indemnifications cover a variety of matters, operations and scenarios. Certain of these indemnifications have no time limit. For those with a time limit, the longest indemnification expires on December 31, 2009.

HCC Insurance Holdings, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(unaudited, tables in thousands except per share data)

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 alleged to have been incurred in periods prior to our sale of certain subsidiaries or otherwise alleged to be covered under indemnification agreements related to such sales. As of March 31, 2008, we have recorded a liability of $15.6 million and have provided $5.2 million of letters of credit to cover our obligations or anticipated payments under these indemnifications.

Pursuant to our bylaws, Delaware Corporate law and certain contractual agreements, we are required to advance attorneys’ fees and other expenses and indemnify our current and former directors and officers for liabilities arising from any action, suit or proceeding brought because the individual was acting as an officer or director of our company. Under certain limited circumstances, the individual may be required to reimburse us for any advances or indemnification payments made by us. In addition, we maintain directors’ and officers’ liability insurance, which may cover certain of these costs. We expense payments as advanced and recognize offsets if cash reimbursement is expected or received. It is not possible to determine the maximum potential impact on our future consolidated net earnings of any such indemnification costs, since our bylaws, Delaware law and our contractual agreements do not limit any such advances or indemnification payments.

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.

We are a specialty insurance group with offices in the United States, the United Kingdom, Spain, Bermuda, Belgium and Ireland transacting business in more than 100 countries. Our group consists of insurance companies, Lloyd’s of London syndicates, underwriting agencies and reinsurance brokers. Our shares are traded on the New York Stock Exchange, and we had a market capitalization of $2.6 billion at March 31, 2008. We earned $81.1 million or $0.70 per diluted share in the first quarter of 2008, compared to $96.7 million or $0.83 per diluted share in 2007. The decrease in earnings is directly related to $30.2 million ($19.6 million after tax) of investment-related income in 2007 that did not occur in 2008 due to lower income from alternative investments, the change in fair value of our investments in two insurance companies accounted for as trading securities, and a gain on the sale of a strategic investment in 2007. We grew shareholders’ equity by 3% in the first quarter of 2008 to $2.5 billion, principally from net earnings.

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, through a network of independent agents and brokers, directly to customers or through third party administrators. The majority of our business is low limit or small premium business that has less intense price competition, as well as lower catastrophe and volatility risk.

Our major domestic insurance companies are rated “AA (Very Strong)” by Standard & Poor’s Corporation, “AA (Very Strong)” by Fitch Ratings and “A+ (Superior)” by A.M. Best Company, Inc., and our international insurance companies are rated “AA” by Standard & Poor’s Corporation.

We generate our revenue from five primary sources:

	•		risk-bearing earned premium produced by our insurance company operations,
	•		non-risk-bearing fee and commission income received by our underwriting agency and broker operations,
	•		ceding commissions in excess of policy acquisition costs earned by our insurance company operations,
	•		investment income earned by all of our operations, and
	•		other operating income.

We produced $567.4 million of revenue in the first quarter of 2008, a decrease of 5% compared to the first quarter of 2007. This decrease principally resulted from the investment-related items discussed above.

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 2007 and 2008 acquisitions are listed below. Net earnings and cash flows from each acquired business are included in our operations beginning on the effective date of each transaction.

				Effective date
Company		Segment		acquired
Promoregistration.com		Agency		March 2, 2007
Pioneer General Insurance Company		Insurance Company		November 1, 2007
MultiNational Underwriters, LLC		Agency		January 2, 2008

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 2008 compared to first quarter 2007, unless otherwise noted.

Results of Operations

Net earnings decreased 16% to $81.1 million ($0.70 per diluted share) in 2008 from $96.7 million ($0.83 per diluted share) in 2007. The decrease in earnings primarily related to the aggregate of the following items, which resulted in a $30.2 million pretax ($19.6 million after tax) reduction in our 2008 earnings compared to 2007:

	•		Our alternative investments, the income or loss from which are included in net investment income, generated $1.2 million of losses in 2008, compared to $7.0 million of income in 2007.
	•		Our trading portfolio, which in 2008 is composed of the investment in the stock of two insurance companies, had unrealized losses of $9.0 million in 2008, compared to unrealized gains of $2.2 million in 2007. These gains and losses are reported in other operating income (loss). We discontinued the active trading of securities in late 2006.
	•		We sold a strategic investment in 2007 and realized a gain of $10.8 million, which is reported in other operating income (loss). We did not sell any strategic investments in 2008.

The trading losses and reduced income from our alternative investments were a direct result of general market conditions in 2008.

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

		Three months ended March 31,
		2008				2007
Net earned premium			87.0	%			83.3	%
Fee and commission income			5.5				5.4
Net investment income			8.4				8.3
Net realized investment gain (loss)			—				(0.1	)
Other operating income (loss)			(0.9	)			3.1
Total revenue			100.0				100.0
Loss and loss adjustment expense, net			51.6				50.3
Policy acquisition costs, net			16.3				14.9
Other operating expense			10.4				9.7
Interest expense			0.7				0.5
Earnings before income tax expense			21.0				24.6
Income tax expense			6.7				8.4
Net earnings			14.3	%			16.2	%

Total revenue decreased 5% to $567.4 million in 2008 principally due to the investment-related activity described above, as well as a slight decrease in premium due to the softening insurance market.

Our gross written premium, net written premium and net earned premium are detailed below. Gross written premium decreased because we elected not to write certain business, which would have been unprofitable due to competitive pressure on pricing in these lines of business. Net written premium declined less than gross due to increased retentions. See the Insurance Company Segment section below for further discussion of the relationship and changes in premium revenue.

		Three months ended March 31,
		2008				2007
Gross written premium		$	582,999			$	599,101
Net written premium			493,647				496,965
Net earned premium			493,546				497,600

Fee and commission income was relatively flat in 2008. The table below shows the source of our fee and commission income.

		Three months ended March 31,
		2008				2007
Agencies		$	22,284			$	23,356
Insurance companies			8,715				8,769
Fee and commission income		$	30,999			$	32,125

The sources of net investment income are detailed below.

		Three months ended March 31,
		2008				2007
Fixed income securities		$	40,924			$	34,007
Short-term investments			8,592				9,673
Other investments, including alternative investments			(938	)			7,520
Total investment income			48,578				51,200
Investment expense			(957	)			(1,733	)
Net investment income		$	47,621			$	49,467

Net investment income decreased 4% in 2008 due to lower income from our alternative investments, primarily fund-of-fund hedge fund investments, which were impacted by generally poor equity and debt market conditions. Investment income on our fixed income securities increased 20% due to higher fixed income investments, which increased 19% to $3.9 billion at March 31, 2008 compared to $3.3 billion at March 31, 2007. The growth in fixed income securities resulted primarily from cash flow from operations, the increase in net loss reserves particularly from our diversified financial products line of business, which generally has a longer time period between reporting and payment of claims, and our shift away from short-term investments as short-term interest rates declined in 2008. Average yields on our short-term investments decreased from 5.5% in 2007 to 4.8% in 2008, while our fixed income tax equivalent yield was 5.3% in both 2007 and 2008. We continue to invest most of our funds in fixed income securities, with a weighted average duration of 5.0 years at March 31, 2008.

At March 31, 2008, the net unrealized gain on our fixed income securities portfolio was $26.2 million, compared to $25.0 million at December 31, 2007. The change in the net unrealized gain or loss, net of the related income tax effect, is recorded in other comprehensive income and fluctuates with changes in market interest rates. Our general policy has been to hold our fixed income securities, which are classified as available for sale, through periods of fluctuating interest rates and to not realize significant gains or losses from their sale. The net unrealized gain on our fixed income securities portfolio at April 30, 2008 was $17.2 million.

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

		Three months ended March 31,
		2008				2007
Average short-term yield *			4.8	%			5.5	%
Average fixed income yield *			4.4	%			4.4	%
Average fixed income tax equivalent yield *			5.3	%			5.3	%
Weighted average tax equivalent yield *			4.8	%			5.6	%
Weighted average maturity		6.9 years				6.9 years
Weighted average duration		5.0 years				4.7 years
Average rating on fixed income securities		AA+				AAA

At March 31, 2008, within our portfolio of fixed income securities, we held a portfolio of residential mortgage-backed securities (MBSs) and collateralized mortgage obligations (CMOs) with a fair value of $775.0 million. Within our residential MBS/CMO portfolio, $657.4 million of bonds were guaranteed by U.S. government agencies, while $102.2 million, $11.1 million and $4.3 million of bonds were collateralized by prime, Alt A and subprime mortgages, respectively. The underlying mortgages on our $15.4 million of subprime-related securities (i.e. those collateralized by Alt A and subprime mortgages) were issued in the following years: 2002 — $2.7 million; 2003 — $3.2 million; 2004 — $0.2 million; 2005 — $1.0 million; 2006 — $4.1 million and 2007 — $4.2 million. At March 31, 2008, the subprime-related securities had an unrealized loss of $1.4 million, all were current as to principal and interest, and none had an other-than-temporary impairment. These subprime-related securities have an average rating of AAA and a weighted average life of approximately 3.2 years. Our subprime-related securities represented 2.0% of our asset-backed and mortgage-backed securities portfolio and 0.4% of our total fixed income securities portfolio. At March 31, 2008, we held a commercial MBS portfolio with a fair value of $200.9 million, an average rating of AAA, and a weighted average life of approximately 5.0 years. We owned no collateralized debt obligations (CDOs) or collateralized loan obligations (CLOs).

Other operating income was a loss of $4.9 million in 2008 compared to a gain of $18.6 million in 2007. The 2008 loss resulted from reduction in the market value of our two trading securities. The 2007 gain was primarily due to the sale of a strategic investment. Period to period comparisons in this category may vary substantially, depending on acquisition of new investments, income or loss related to changes in the market values of certain investments, and gains or losses related to any disposition. The following table details the components of our other operating income (loss).

		Three months ended March 31,
		2008				2007
Strategic investments		$	913			$	11,659
Trading securities			(9,028	)			2,181
Financial instruments			1,336				1,187
Other			1,833				3,558
Other operating income (loss)		$	(4,946	)		$	18,585

Loss and loss adjustment expense decreased 2% consistent with the slight reduction in net earned premium, and policy acquisition costs increased 4% due to a shift in the mix of business in 2008. See the Insurance Company Segment section below for further discussion of the changes in loss and loss adjustment expense and policy acquisition costs.