##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 FORM 10-Q
 þ
    
    Quarterly Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
for the Quarter Ended
March 31, 2007.
 o
    
    Transition Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934from

to
 Commission file number 001-13790
 HCC Insurance Holdings, Inc.
 
  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)
 
   þ o
  þ o o
  o þ




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##### 



HCC INSURANCE HOLDINGS, INC.
TABLE OF CONTENTS
 PagePart I. FINANCIAL INFORMATIONItem 1. Financial StatementsCondensed Consolidated Balance Sheets 
March 31, 2007 (unaudited) and December 31, 2006
    
    
    5Condensed Consolidated Statements of Earnings 
Three months ended March 31, 2007 and 2006 (unaudited)
    
    
    6Condensed Consolidated Statement of Changes in Shareholders Equity 
Three months ended March 31, 2007 (unaudited)
    
    
    7Condensed Consolidated Statements of Cash Flows 
Three months ended March 31, 2007 and 2006 (unaudited)
    
    
    8Notes to Condensed Consolidated Financial Statements (unaudited)
    
    
    9Item 2. Managements Discussion and Analysis of Financial Condition
and Results of Operations
    
    
    20Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    29Item 4. Controls and Procedures
    
    
    29Part II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    30Item 1A. Risk Factors
    
    
    31Item 6. Exhibits
    
    
    31Signatures
    
    
    31Employment AgreementCertification by CEOCertification by CFOCertification with Respect to Quarterly Report
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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 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;
    
    failures of our information technology systems, which could adversely affect our business;
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
    
    impairment of goodwill;
    
    developments in the SECs inquiry related to our past stock option granting procedures;
    
    litigation related to our past stock option granting procedures; and
    
    change of control.
 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.
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March 31,
    
    
    December 31,2007
    
    
    2006ASSETSInvestments:Fixed income securities, at fair value
(amortized cost: 2007 - $3,298,475; 2006 - $3,008,818)
    
    $
    3,298,657
    
    
    $
    3,007,193Short-term investments, at cost, which approximates fair value
    
    
    682,041
    
    
    
    714,685Other investments, at fair value (cost: 2007 - $175,186; 2006 - $183,450)
    
    
    202,358
    
    
    
    206,117Total investments
    
    
    4,183,056
    
    
    
    3,927,995Cash
    
    
    42,492
    
    
    
    48,290Restricted cash and cash investments
    
    
    171,159
    
    
    
    176,424Premium, claims and other receivables
    
    
    771,462
    
    
    
    864,705Reinsurance recoverables
    
    
    1,058,667
    
    
    
    1,169,934Ceded unearned premium
    
    
    224,235
    
    
    
    226,125Ceded life and annuity benefits
    
    
    70,133
    
    
    
    70,923Deferred policy acquisition costs
    
    
    185,202
    
    
    
    182,410Goodwill
    
    
    742,607
    
    
    
    742,677Other assets
    
    
    183,079
    
    
    
    220,649Total assets
    
    $
    7,632,092
    
    
    $
    7,630,132LIABILITIESLoss and loss adjustment expense payable
    
    $
    3,113,496
    
    
    $
    3,097,051Life and annuity policy benefits
    
    
    70,133
    
    
    
    70,923Reinsurance balances payable
    
    
    114,480
    
    
    
    122,805Unearned premium
    
    
    917,728
    
    
    
    920,350Deferred ceding commissions
    
    
    64,946
    
    
    
    64,949Premium and claims payable
    
    
    554,272
    
    
    
    646,224Notes payable
    
    
    298,281
    
    
    
    308,887Accounts payable and accrued liabilities
    
    
    366,307
    
    
    
    356,140Total liabilities
    
    
    5,499,643
    
    
    
    5,587,329SHAREHOLDERS EQUITYCommon stock, $1.00 par value; 250.0 million shares authorized
(shares issued and outstanding: 2007  112,078; 2006  111,731)
    
    
    112,078
    
    
    
    111,731Additional paid-in capital
    
    
    808,100
    
    
    
    798,213Retained earnings
    
    
    1,183,691
    
    
    
    1,098,887Accumulated other comprehensive income
    
    
    28,580
    
    
    
    33,972Total shareholders equity
    
    
    2,132,449
    
    
    
    2,042,803Total liabilities and shareholders equity
    
    $
    7,632,092
    
    
    $
    7,630,132
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Three months ended March 31,2007
    
    
    2006REVENUENet earned premium
    
    $
    497,600
    
    
    $
    380,571Fee and commission income
    
    
    32,125
    
    
    
    31,669Net investment income
    
    
    49,467
    
    
    
    36,581Net realized investment loss
    
    
    (555
    )
    
    
    (1,298
    )Other operating income
    
    
    18,585
    
    
    
    18,750Total revenue
    
    
    597,222
    
    
    
    466,273EXPENSELoss and loss adjustment expense, net
    
    
    300,472
    
    
    
    222,067Policy acquisition costs, net
    
    
    89,099
    
    
    
    76,232Other operating expense
    
    
    57,641
    
    
    
    47,333Interest expense
    
    
    3,303
    
    
    
    2,154Total expense
    
    
    450,515
    
    
    
    347,786Earnings before income tax expense
    
    
    146,707
    
    
    
    118,487Income tax expense
    
    
    50,017
    
    
    
    39,345Net earnings
    
    $
    96,690
    
    
    $
    79,142Basic earnings per share data:Net earnings per share
    
    $
    0.86
    
    
    $
    0.71Weighted average shares outstanding
    
    
    111,959
    
    
    
    111,014Diluted earnings per share data:Net earnings per share
    
    $
    0.83
    
    
    $
    0.68Weighted average shares outstanding
    
    
    117,009
    
    
    
    116,896Cash dividends declared, per share
    
    $
    0.100
    
    
    $
    0.075
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AccumulatedAdditional
    
    
    
    
    
    
    other
    
    
    TotalCommon
    
    
    paid-in
    
    
    Retained
    
    
    comprehensive
    
    
    shareholdersstock
    
    
    capital
    
    
    earnings
    
    
    income
    
    
    equityBalance at December 31, 2006
    
    $
    111,731
    
    
    $
    798,213
    
    
    $
    1,098,887
    
    
    $
    33,972
    
    
    $
    2,042,803Cumulative effect of accounting change (adoptionof FIN 48)
    
    
    
    
    
    
    
    
    
    
    (678
    )
    
    
    
    
    
    
    (678
    )Net earnings
    
    
    
    
    
    
    
    
    
    
    96,690
    
    
    
    
    
    
    
    96,690Other comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5,392
    )
    
    
    (5,392
    )Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    91,298Issuance of 347 shares for exercise of
options, including tax benefit of $1,571
    
    
    347
    
    
    
    7,693
    
    
    
    
    
    
    
    
    
    
    
    8,040Stock-based compensation
    
    
    
    
    
    
    2,194
    
    
    
    
    
    
    
    
    
    
    
    2,194Cash dividends declared, $0.10 per share
    
    
    
    
    
    
    
    
    
    
    (11,208
    )
    
    
    
    
    
    
    (11,208
    )Balance at March 31, 2007
    
    $
    112,078
    
    
    $
    808,100
    
    
    $
    1,183,691
    
    
    $
    28,580
    
    
    $
    2,132,449
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Three months ended March 31,2007
    
    
    2006Cash flows from operating activities:Net earnings
    
    $
    96,690
    
    
    $
    79,142Adjustments to reconcile net earnings to net cash
provided by operating activities:Change in premium, claims and other receivables
    
    
    87,166
    
    
    
    44,362Change in reinsurance recoverables
    
    
    111,267
    
    
    
    12,632Change in ceded unearned premium
    
    
    1,890
    
    
    
    (114
    )Change in loss and loss adjustment expense payable
    
    
    16,445
    
    
    
    23,775Change in reinsurance balances payable
    
    
    (8,325
    )
    
    
    (27,057
    )Change in unearned premium
    
    
    (2,622
    )
    
    
    18,266Change in premium and claims payable, net of restricted cash
    
    
    (86,687
    )
    
    
    (30,318
    )Change in trading portfolio
    
    
    10,958
    
    
    
    (47,994
    )Depreciation and amortization expense
    
    
    3,736
    
    
    
    3,825Stock-based compensation expense
    
    
    2,211
    
    
    
    2,703Other, net
    
    
    (2,418
    )
    
    
    (1,131
    )Cash provided by operating activities
    
    
    230,311
    
    
    
    78,091Cash flows from investing activities:Sales of fixed income securities
    
    
    28,483
    
    
    
    65,654Maturity or call of fixed income securities
    
    
    70,148
    
    
    
    59,226Cost of securities acquired
    
    
    (367,195
    )
    
    
    (471,614
    )Change in short-term investments
    
    
    24,857
    
    
    
    246,750Sale of strategic investments
    
    
    22,950
    
    
    
    17,363Payments for purchase of subsidiaries, net of cash received
    
    
    (5,917
    )
    
    
    (24,000
    )Other, net
    
    
    (2,168
    )
    
    
    (2,047
    )Cash used by investing activities
    
    
    (228,842
    )
    
    
    (108,668
    )Cash flows from financing activities:Issuance of notes payable
    
    
    11,000
    
    
    
    11,000Payments on notes payable
    
    
    (11,339
    )
    
    
    (11,107
    )Sale of common stock
    
    
    8,040
    
    
    
    7,638Dividends paid
    
    
    (11,173
    )
    
    
    (8,310
    )Other, net
    
    
    (3,795
    )
    
    
    8,532Cash provided (used) by financing activities
    
    
    (7,267
    )
    
    
    7,753Net decrease in cash
    
    
    (5,798
    )
    
    
    (22,824
    )Cash at beginning of period
    
    
    48,290
    
    
    
    73,935Cash at end of period
    
    $
    42,492
    
    
    $
    51,111
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(1)
    
    GENERAL INFORMATIONHCC 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
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; 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 and
Ireland, although some of our operations have a broader international scope.Basis of PresentationOur 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, 2006 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.We completed several acquisitions during 2006. 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, 2007 and 2006 do not contain any
operations of the entities acquired in 2006 prior to their acquisition date.AcquisitionOn October 2, 2006, we acquired the Health Products Division of Allianz Life Insurance
Company of North America (the Health Products Division), which primarily specializes in
medical stop-loss insurance for self-insured corporations and groups, in a purchase business
combination for $140.0 million in cash. In addition, we assumed the Health Products
Divisions outstanding loss reserves totaling $149.7 million and net miscellaneous other
liabilities of $0.4 million, for which Allianz paid us cash. We valued all identifiable
assets and liabilities at fair value, including discounting the loss reserves by $2.9
million, and allocated $137.2 million to goodwill in our initial purchase price allocation.
During the first quarter of 2007, we completed our purchase price allocation and determined
there are no separately identifiable intangible assets that are not subsumed into goodwill,
resulting in no change to the original goodwill amount.
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Premium, claims and other receivables
    
    $
    6,372Goodwill
    
    
    137,154Other assets
    
    
    280Total assets acquired
    
    
    143,806Loss and loss adjustment expense payable
    
    
    146,811Reinsurance balances payable
    
    
    746Premium and claims payable
    
    
    4,375Accounts payable and accrued liabilities
    
    
    1,961Total liabilities assumed
    
    
    153,893Net liabilities assumed
    
    $
    10,087
 Income Tax
  Stock-Based Compensation
  2006 Stock Option Matter
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Recent Accounting Changes
 FIN 48
 Accounting for Uncertainty in Income Taxes
   SFAS 157 and 159
 Fair Value Measurements The Fair Value Option for Financial Assets and Financial
Liabilities
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(2)
    
    REINSURANCEIn 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 lossWritten
    
    
    Earned
    
    
    adjustmentpremium
    
    
    premium
    
    
    expenseThree months ended March 31, 2007Primary business
    
    $
    458,502
    
    
    $
    485,370
    
    
    $
    287,451Reinsurance assumed
    
    
    140,599
    
    
    
    116,473
    
    
    
    62,997Reinsurance ceded
    
    
    (102,136
    )
    
    
    (104,243
    )
    
    
    (49,976
    )Net amounts
    
    $
    496,965
    
    
    $
    497,600
    
    
    $
    300,472Three months ended March 31, 2006Primary business
    
    $
    410,191
    
    
    $
    422,510
    
    
    $
    227,250Reinsurance assumed
    
    
    95,867
    
    
    
    70,880
    
    
    
    45,791Reinsurance ceded
    
    
    (113,007
    )
    
    
    (112,819
    )
    
    
    (50,974
    )Net amounts
    
    $
    393,051
    
    
    $
    380,571
    
    
    $
    222,067
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March 31,
    
    
    December 31,2007
    
    
    2006Commutation receivable
    
    $
    
    
    
    $
    100,000Reinsurance recoverable on paid losses
    
    
    97,073
    
    
    
    96,727Reinsurance recoverable on outstanding losses
    
    
    511,587
    
    
    
    529,562Reinsurance recoverable on incurred but not reported losses
    
    
    465,392
    
    
    
    458,528Reserve for uncollectible reinsurance
    
    
    (15,385
    )
    
    
    (14,883
    )Total reinsurance recoverables
    
    $
    1,058,667
    
    
    $
    1,169,934
   March 31,
    
    
    December 31,2007
    
    
    2006Payables to reinsurers
    
    $
    286,260
    
    
    $
    268,079Letters of credit
    
    
    293,626
    
    
    
    326,204Cash deposits
    
    
    59,586
    
    
    
    61,002Total credits
    
    $
    639,472
    
    
    $
    655,285
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March 31,
    
    
    December 31,2007
    
    
    2006Loss and loss adjustment expense payable
    
    $
    3,113,496
    
    
    $
    3,097,051Reinsurance recoverable on outstanding losses
    
    
    (511,587
    )
    
    
    (529,562
    )Reinsurance recoverable on incurred but not reported losses
    
    
    (465,392
    )
    
    
    (458,528
    )Net reserves
    
    $
    2,136,517
    
    
    $
    2,108,961Unearned premium
    
    $
    917,728
    
    
    $
    920,350Ceded unearned premium
    
    
    (224,235
    )
    
    
    (226,125
    )Net unearned premium
    
    $
    693,493
    
    
    $
    694,225Deferred policy acquisition costs
    
    $
    185,202
    
    
    $
    182,410Deferred ceding commissions
    
    
    (64,946
    )
    
    
    (64,949
    )Net deferred policy acquisition costs
    
    $
    120,256
    
    
    $
    117,461
 (3)
    
    EARNINGS PER SHAREThe following table details the numerator and denominator used in the earnings per share
calculations.
 Three months ended March 31,2007
    
    
    2006Net earnings
    
    $
    96,690
    
    
    $
    79,142Weighted average common shares outstanding
    
    
    111,959
    
    
    
    111,014Dilutive effect of outstanding options (determined
using the treasury stock method)
    
    
    1,008
    
    
    
    1,528Dilutive effect of convertible debt (determined
using the treasury stock method)
    
    
    4,042
    
    
    
    4,354Weighted average common shares and potential
common shares outstanding
    
    
    117,009
    
    
    
    116,896Anti-dilutive stock options not included in
treasury stock method computation
    
    
    2,229
    
    
    
    2,563
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(4)
    
    SEGMENT AND GEOGRAPHIC INFORMATIONThe performance of each segment is evaluated by our management based on net earnings. Net
earnings is calculated after tax and after 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 April
1, 2006, we consolidated our London underwriting agency (agency segment) into HCC
International Insurance Company (insurance company segment).
 Insurance
    
    
    
    
    
    
    OtherCompany
    
    
    Agency
    
    
    Operations
    
    
    Corporate
    
    
    TotalThree months ended March 31, 2007Revenue:Domestic
    
    $
    458,760
    
    
    $
    14,957
    
    
    $
    18,276
    
    
    $
    397
    
    
    $
    492,390Foreign
    
    
    94,809
    
    
    
    10,023
    
    
    
    
    
    
    
    
    
    
    
    104,832Inter-segment
    
    
    
    
    
    
    13,986
    
    
    
    
    
    
    
    
    
    
    
    13,986Total segment revenue
    
    $
    553,569
    
    
    $
    38,966
    
    
    $
    18,276
    
    
    $
    397
    
    
    
    611,208Inter-segment eliminations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (13,986
    )Consolidated total revenue
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    597,222Net earnings (loss):Domestic
    
    $
    66,795
    
    
    $
    4,704
    
    
    $
    11,379
    
    
    $
    (6,085
    )
    
    $
    76,793Foreign
    
    
    17,381
    
    
    
    221
    
    
    
    
    
    
    
    
    
    
    
    17,602Total segment net earnings
(loss)
    
    $
    84,176
    
    
    $
    4,925
    
    
    $
    11,379
    
    
    $
    (6,085
    )
    
    
    94,395Inter-segment eliminations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,295Consolidated net earnings
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    96,690Other items:Net investment income
    
    $
    45,765
    
    
    $
    2,438
    
    
    $
    987
    
    
    $
    277
    
    
    $
    49,467Depreciation and amortization
    
    
    1,179
    
    
    
    1,746
    
    
    
    112
    
    
    
    699
    
    
    
    3,736Interest expense
    
    
    464
    
    
    
    2,765
    
    
    
    30
    
    
    
    44
    
    
    
    3,303Capital expenditures
    
    
    1,028
    
    
    
    654
    
    
    
    
    
    
    
    486
    
    
    
    2,168Income tax expense (benefit)
    
    
    40,081
    
    
    
    4,472
    
    
    
    6,490
    
    
    
    (2,537
    )
    
    
    48,506Inter-segment eliminations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,511Consolidated income tax
expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    50,017
  15




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##### Table of Contents



Insurance
    
    
    
    
    
    
    OtherCompany
    
    
    Agency
    
    
    Operations
    
    
    Corporate
    
    
    TotalThree months ended March 31, 2006Revenue:Domestic
    
    $
    343,688
    
    
    $
    14,769
    
    
    $
    19,781
    
    
    $
    1,177
    
    
    $
    379,415Foreign
    
    
    76,849
    
    
    
    10,009
    
    
    
    
    
    
    
    
    
    
    
    86,858Inter-segment
    
    
    6
    
    
    
    17,958
    
    
    
    
    
    
    
    
    
    
    
    17,964Total segment revenue
    
    $
    420,543
    
    
    $
    42,736
    
    
    $
    19,781
    
    
    $
    1,177
    
    
    
    484,237Inter-segment eliminations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (17,964
    )Consolidated total revenue
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    466,273Net earnings (loss):Domestic
    
    $
    49,969
    
    
    $
    5,235
    
    
    $
    12,989
    
    
    $
    (3,114
    )
    
    $
    65,079Foreign
    
    
    10,088
    
    
    
    3,689
    
    
    
    
    
    
    
    
    
    
    
    13,777Total segment net earnings
(loss)
    
    $
    60,057
    
    
    $
    8,924
    
    
    $
    12,989
    
    
    $
    (3,114
    )
    
    
    78,856Inter-segment eliminations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    286Consolidated net earnings
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    79,142Other items:Net investment income
    
    $
    32,007
    
    
    $
    2,296
    
    
    $
    1,635
    
    
    $
    643
    
    
    $
    36,581Depreciation and amortization
    
    
    1,138
    
    
    
    2,013
    
    
    
    127
    
    
    
    547
    
    
    
    3,825Interest expense (benefit)
    
    
    375
    
    
    
    2,846
    
    
    
    114
    
    
    
    (1,181
    )
    
    
    2,154Capital expenditures
    
    
    461
    
    
    
    815
    
    
    
    438
    
    
    
    1,366
    
    
    
    3,080Income tax expense (benefit)
    
    
    28,096
    
    
    
    6,668
    
    
    
    6,141
    
    
    
    (1,858
    )
    
    
    39,047Inter-segment eliminations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    298Consolidated income tax
expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    39,345
  16




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##### Table of Contents



Three months ended March 31,2007
    
    
    2006Diversified financial products
    
    $
    192,514
    
    
    $
    169,112Group life, accident and health
    
    
    192,416
    
    
    
    127,761Aviation
    
    
    39,344
    
    
    
    33,197London market account
    
    
    33,896
    
    
    
    21,928Other specialty lines
    
    
    39,738
    
    
    
    28,640Discontinued lines
    
    
    (308
    )
    
    
    (67
    )Net earned premium
    
    $
    497,600
    
    
    $
    380,571Property and casualty
    
    $
    27,475
    
    
    $
    25,407Accident and health
    
    
    4,650
    
    
    
    6,262Fee and commission income
    
    $
    32,125
    
    
    $
    31,669
 (5)
    
    SUPPLEMENTAL INFORMATIONSupplemental cash flow information was as follows.
 Three months ended March 31,2007
    
    2006Cash received from commutations
    
    $
    101,040
    
    
    $
    Income taxes paid
    
    
    10,385
    
    
    
    16,038Interest paid
    
    
    3,318
    
    
    
    2,935Comprehensive income
    
    
    91,298
    
    
    
    62,622
 (6)
    
    COMMITMENTS AND CONTINGENCIES2006 Stock Option MatterBased 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 Committee completed the investigation on November 16, 2006. Based on the
Committees recommendations, the Board of Directors took specific actions as a result
thereof. The SEC commenced an inquiry upon notification by us of the initiation of
our investigation. In
this connection, we received document requests from the SEC, and the SEC has been
reviewing the work of the independent investigation. In March 2007, the SEC issued a formal order directing a private investigation.
We intend to fully cooperate with the
SEC. We are unable to predict the outcome of or the future costs related to the ongoing
inquiry.
 17




---



##### Table of Contents



Litigation
   Civil Action No. 07-456; Bacas, derivatively on behalf of HCC Insurance Holdings, Inc. v. Way
et al Civil Action No. 07-709, Halgren, derivatively on behalf of HCC Insurance
Holdings, Inc. v. Way et al.; Bacas Bacas Halgren
 Civil Action No. 07-1084; Intermountain Ironworkers Trust Fund, derivatively and on behalf of
HCC Insurance Holdings, Inc. v. Way et al.; Bacas Bacas
 Civil Action No. 07-550;
International Brotherhood of Electrical Workers Local 98 Pension Fund,
derivatively on behalf of nominal defendant HCC Insurance Holdings, Inc. v. Way et al.;
 Civil Action No. 07-0801; Bristol County Retirement System, individually and on behalf of all
others similarly situated v. HCC Insurance Holdings, Inc. et al Bristol County Bristol County
 18




---



##### Table of Contents



Indemnifications
    Revolving Loan Facility
  19




---



##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and Results
of Operations
  Overview
       Effective dateCompany
    
    Segment
    
    acquiredHealth Products Division ofAllianz Life Insurance Company
    
    Insurance company
    
    October 2, 2006G.B. Kenrick & Associates, Inc.
    
    Agency
    
    July 1, 2006Novia Underwriters, Inc.
    
    Agency
    
    June 30, 2006
  20




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##### Table of Contents



Results of Operations
   Three months ended March 31,2007
    
    
    2006Net earned premium
    
    
    83.3
    %
    
    
    81.7
    %Fee and commission income
    
    
    5.4
    
    
    
    6.8Net investment income
    
    
    8.3
    
    
    
    7.8Net realized investment loss
    
    
    (0.1
    )
    
    
    (0.3
    )Other operating income
    
    
    3.1
    
    
    
    4.0Total revenue
    
    
    100.0
    
    
    
    100.0Loss and loss adjustment expense, net
    
    
    50.3
    
    
    
    47.6Policy acquisition costs, net
    
    
    14.9
    
    
    
    16.3Other operating expense
    
    
    9.7
    
    
    
    10.2Interest expense
    
    
    0.5
    
    
    
    0.5Earnings before income tax expense
    
    
    24.6
    
    
    
    25.4Income tax expense
    
    
    8.4
    
    
    
    8.4Net earnings
    
    
    16.2
    %
    
    
    17.0
    %
   Three months ended March 31,2007
    
    2006Gross written premium
    
    $
    599,101
    
    
    $
    506,058Net written premium
    
    
    496,965
    
    
    
    393,051Net earned premium
    
    
    497,600
    
    
    
    380,571
 21




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##### Table of Contents



Three months ended March 31,2007
    
    
    2006Agencies
    
    $
    23,356
    
    
    $
    23,061Insurance companies
    
    
    8,769
    
    
    
    8,608Fee and commission income
    
    $
    32,125
    
    
    $
    31,669
  Three months ended March 31,2007
    
    
    2006Fixed income securities
    
    $
    34,007
    
    
    $
    24,305Short-term investments
    
    
    9,673
    
    
    
    7,540Other investments
    
    
    7,520
    
    
    
    6,412Total investment income
    
    
    51,200
    
    
    
    38,257Investment expense
    
    
    (1,733
    )
    
    
    (1,676
    )Net investment income
    
    $
    49,467
    
    
    $
    36,581
    Three months ended March 31,2007
    
    
    2006Average yield
    
    
    4.4
    %
    
    
    4.1
    %Average tax equivalent yield
    
    
    5.3
    %
    
    
    5.0
    %Weighted average maturity
    
    6.9 years
    
    7.8 yearsWeighted average duration
    
    4.7 years
    
    5.0 years
 22




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##### Table of Contents



Three months ended March 31,2007
    
    
    2006Strategic investments
    
    $
    11,659
    
    
    $
    12,205Trading securities
    
    
    2,181
    
    
    
    4,686Financial instruments
    
    
    1,187
    
    
    
    823Other
    
    
    3,558
    
    
    
    1,036Other operating income
    
    $
    18,585
    
    
    $
    18,750
     Segments
 Insurance Company Segment
  23




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##### Table of Contents



Premium
   Gross
    
    
    Net
    
    
    NWP
    
    
    Netwritten
    
    
    written
    
    
    as % of
    
    
    earnedpremium
    
    
    premium
    
    
    GWP
    
    
    premiumThree months ended March 31, 2007Diversified financial products
    
    $
    212,253
    
    
    $
    171,792
    
    
    
    81
    %
    
    $
    192,514Group life, accident and health
    
    
    202,906
    
    
    
    192,426
    
    
    
    95
    
    
    
    192,416Aviation
    
    
    51,663
    
    
    
    39,603
    
    
    
    77
    
    
    
    39,344London market account
    
    
    68,135
    
    
    
    45,132
    
    
    
    66
    
    
    
    33,896Other specialty lines
    
    
    64,495
    
    
    
    48,321
    
    
    
    75
    
    
    
    39,738Discontinued lines
    
    
    (351
    )
    
    
    (309
    )
    
    nm
    
    
    (308
    )Totals
    
    $
    599,101
    
    
    $
    496,965
    
    
    
    83
    %
    
    $
    497,600Three months ended March 31, 2006Diversified financial products
    
    $
    197,246
    
    
    $
    161,645
    
    
    
    82
    %
    
    $
    169,112Group life, accident and health
    
    
    134,154
    
    
    
    129,443
    
    
    
    96
    
    
    
    127,761Aviation
    
    
    56,234
    
    
    
    35,425
    
    
    
    63
    
    
    
    33,197London market account
    
    
    74,507
    
    
    
    38,723
    
    
    
    52
    
    
    
    21,928Other specialty lines
    
    
    43,889
    
    
    
    27,900
    
    
    
    64
    
    
    
    28,640Discontinued lines
    
    
    28
    
    
    
    (85
    )
    
    nm
    
    
    (67
    )Totals
    
    $
    506,058
    
    
    $
    393,051
    
    
    
    78
    %
    
    $
    380,571
 
   
    
    Diversified financial products  The growth in our gross written
premium in 2007 resulted principally from organic growth in our surety and credit
businesses, where pricing is stable and competition is reasonable. Gross written
premium declined slightly in our directors and officers liability business, as we
chose to write less business in foreign markets due to strong pricing competition.
Premium volume in our other major products was stable, although pricing for these
products is down slightly. The growth in net written and net earned premium was
due to increased gross written premium.
    
    Group life, accident and health  Gross written, net written and net
earned premium of our medical stop-loss product increased $64.0 million in 2007
from the acquisition of the Health Products Division. We retain all of our medical
stop-loss business because the business is non-volatile and has very little
catastrophe exposure. Profit margins remain at acceptable levels despite
competition from the fully insured market.
 24




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##### Table of Contents




    
    Aviation Our domestic aviation business is stable, while gross
written premium of our international business has declined. We have exercised
underwriting discipline and written less international business due to competition
and resultant pressure on pricing. However, margins on decreased premium volume
are still acceptable. Retention increased as a result of a reduction in
proportional reinsurance.
    
    London market account  Gross written premium decreased in 2007 due to
lower energy and property writings, as we wrote less business in a more competitive
market. Premium rates are down slightly. We reduced our aggregate property
exposure in Florida and other hurricane-exposed onshore areas in 2006 compared to
2005, and we are maintaining the reduced exposure in 2007. Additionally, due to
tightening of policy terms and conditions, our energy catastrophe exposure was
significantly reduced in 2006 and continues as such in 2007. Net written premium
and net earned premium increased due to higher retentions.
    
    Other specialty lines  We experienced growth in our other specialty
lines of business from increased writings in several products and from an
acquisition. Net written premium and net earned premium increased due to higher
gross written premium and retentions. Rates in this line have been relatively
stable.
 Losses and Loss Adjustment Expenses
   Three months ended March 31,2007
    
    
    2006Net
    
    
    Net
    
    
    Net
    
    
    Netearned
    
    
    loss
    
    
    earned
    
    
    losspremium
    
    
    ratio
    
    
    premium
    
    
    ratioDiversified financial products
    
    $
    192,514
    
    
    
    45.5
    %
    
    $
    169,112
    
    
    
    50.8
    %Group life, accident and health
    
    
    192,416
    
    
    
    75.5
    
    
    
    127,761
    
    
    
    69.7Aviation
    
    
    39,344
    
    
    
    50.1
    
    
    
    33,197
    
    
    
    54.3London market account
    
    
    33,896
    
    
    
    57.3
    
    
    
    21,928
    
    
    
    48.1Other specialty lines
    
    
    39,738
    
    
    
    69.8
    
    
    
    28,640
    
    
    
    63.9Discontinued lines
    
    
    (308
    )
    
    nm
    
    
    (67
    )
    
    nmTotals
    
    $
    497,600
    
    
    
    60.4
    %
    
    $
    380,571
    
    
    
    58.4
    %Expense ratio
    
    
    
    
    
    
    23.6
    
    
    
    
    
    
    
    27.1Combined ratio
    
    
    
    
    
    
    84.0
    %
    
    
    
    
    
    
    85.5
    %
 
 nm  Not meaningful comparison  
    
    Diversified financial products  The decrease in the loss ratio was due to better
underwriting results for certain business written in 2006 compared to business
written in 2005. Additionally, our surety business, which has a lower loss ratio than other
business in this line, is growing and reducing the overall loss ratio.
 25




---



##### Table of Contents




    
    Group life, accident and health  The net loss ratio was higher in 2007 due to
the expected higher loss ratio related to the business acquired in the Health
Products Division acquisition. Over time, as this business is re-underwritten, we
expect its loss ratio will decline to the level of our existing medical stop-loss
business.
    
    Aviation and London market account  The lower loss ratio for aviation and the
higher loss ratio for the London market account were due to positive and negative
adjustments in reserves, respectively, as a result of our
settlement, in the first quarter of 2007, of litigation
related to a reinsurer that became insolvent in 1999. These 2007 adjustments decreased the aviation loss
ratio by 10.1 percentage points and increased the London market account loss ratio by 7.9 percentage
points. These adjustments, together with other smaller adjustments related to this settlement that affected
the group life, accident and health and discontinued lines, had a minimal
impact on our consolidated incurred losses.
    
    Other specialty lines  The increase relates to losses in our marine line of
business.
  Policy Acquisition Costs
  Agency Segment
  Other Operations Segment
  Liquidity and Capital Resources
   26




---



##### Table of Contents



Three months ended March 31,2007
    
    
    2006Net earnings
    
    $
    96,690
    
    
    $
    79,142Change in premium, claims and other receivables, net of
reinsurance, other payables and restricted cash
    
    
    (7,846
    )
    
    
    (13,013
    )Change in unearned premium, net
    
    
    (732
    )
    
    
    18,152Change in loss and loss adjustment expense payable, net
of reinsurance recoverables
    
    
    127,712
    
    
    
    36,407Change in trading portfolio
    
    
    10,958
    
    
    
    (47,994
    )Other, net
    
    
    3,529
    
    
    
    5,397Cash provided by operating activities
    
    $
    230,311
    
    
    $
    78,091
        27




---



##### Table of Contents



2006 Stock Option Matter
    Recent Accounting Changes
 FIN 48
 Accounting for Uncertainty in Income Taxes
  28




---



##### Table of Contents



SFAS 157 and 159
 Fair Value Measurements The Fair Value Option for Financial Assets and Financial
Liabilities
 Critical Accounting Policies
 Accounting for Uncertainty in Income Taxes,
 
 Item 3. Quantitative and Qualitative Disclosures About Market Risk
  
 Item 4. Controls and Procedures
      29




---



##### Table of Contents



Part II  Other Information
 
 Item 1. Legal Proceedings
    Civil Action No. 07-456; Bacas, derivatively on behalf of HCC Insurance Holdings, Inc. v. Way
et al Civil Action No. 07-709, Halgren, derivatively on behalf of HCC Insurance
Holdings, Inc. v. Way et al.; Bacas Bacas Halgren
 Civil Action No. 07-1084; Intermountain Ironworkers Trust Fund, derivatively and on behalf of
HCC Insurance Holdings, Inc. v. Way et al.; Bacas Bacas
 30




---



##### Table of Contents



Civil Action No. 07-550;
International Brotherhood of Electrical Workers Local 98 Pension Fund,
derivatively on behalf of nominal defendant HCC Insurance Holdings, Inc. v. Way et al.;
 Civil Action No. 07-0801; Bristol County Retirement System, individually and on behalf of all
others similarly situated v. HCC Insurance Holdings, Inc. et al Bristol County Bristol County
 
 Item 1A. Risk Factors
  
 Item 6. Exhibits
  10.1
    
    Employment Agreement effective as of December 1, 2005 between HCC Service Company (UK)
Branch and Barry Cook31.1
    
    Certification by Chief Executive Officer31.2
    
    Certification by Chief Financial Officer32.1
    
    Certification with Respect to Quarterly Report
 31




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##### Table of Contents



SIGNATURES
  HCC Insurance Holdings, Inc.

(Registrant)May 9, 2007

(Date)
    
    
    
    /s/ Frank J. Bramanti
Frank J. Bramanti, Chief Executive OfficerMay 9, 2007

(Date)
    
    
    
    /s/ Edward H. Ellis, Jr.
Edward H. Ellis, Jr., Executive Vice President
and Chief Financial Officer
 32