##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 FORM 10-K/A
 þ Annual 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.
 December 31, 2005
 001-13790
 
  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)
     Title of each class:
    
    Name of each exchange on which registered:COMMON STOCK, $1.00 PAR VALUE
    
    New York Stock Exchange
   þ o
  o þ
  o þ
 o
  Large accelerated filer þ
    
    Accelerated filer o
    
    Non-accelerated filer o
  o þ




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##### Table of Contents








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##### 



HCC INSURANCE HOLDINGS, INC.
 TABLE OF CONTENTS
 PagePART I.ITEM 1.
    
    Business
    
    
    10ITEM 1A.
    
    Risk Factors
    
    
    33ITEM 1B.
    
    Unresolved Staff Comments
    
    
    40ITEM 2.
    
    Properties
    
    
    41ITEM 3.
    
    Legal Proceedings
    
    
    41ITEM 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    42PART II.ITEM 5.
    
    Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
    
    
    42ITEM 6.
    
    Selected Financial Data
    
    
    43ITEM 7.
    
    Management's Discussion and Analysis of Financial Condition and Results of Operations
    
    
    47ITEM 7A.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    80ITEM 8.
    
    Financial Statements and Supplementary Data
    
    
    81ITEM 9.
    
    Changes in and Disagreements with Accountants on Accounting and Financial Disclosures
    
    
    81ITEM 9A.
    
    Controls and Procedures
    
    
    81ITEM 9B.
    
    Other Information
    
    
    84PART III.ITEM 10.
    
    Directors and Executive Officers of the Registrant
    
    
    85ITEM 11.
    
    Executive Compensation
    
    
    85ITEM 12.
    
    Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters
    
    
    85ITEM 13.
    
    Certain Relationships and Related Transactions
    
    
    85ITEM 14.
    
    Principal Accountant Fees and Services
    
    
    86PART IV.ITEM 15.
    
    Exhibits and Financial Statement Schedules
    
    
    86SIGNATURES
    
    
    
    
    87Statement Regarding Computation of RatiosPowers of AttorneyCertification by Chief Executive OfficerCertification by Chief Financial OfficerCertification with Respect to Annual Report
   3




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##### Table of Contents




    
    The dates on documentation such as e-mails, regulatory form filings, acquisition
agreements and other correspondence;
    
    The date that the relevant stock option grant was entered into Equity Edge, our stock
option tracking and accounting system;
    
    Requirements of Accounting Principles Board (APB) No. 25, Accounting for Stock Issued to
Employees, and related interpretations; and
    
    Guidance from the Office of Chief Accountant of the Securities and Exchange Commission
(SEC) contained in a letter dated September 19, 2006.
   4




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
    
    Non-cash compensation expense for the difference between the stock price on the stated
grant date and the actual measurement date and for the fluctuations in stock price in
certain instances where variable accounting should have been applied;
    
    Other adjustments that were not recorded in the originally filed financial statements
due to their immateriality; and
    
    Related tax effects for all items.
    5




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##### Table of Contents



Increase
(decrease) in net earnings and retained earnings:Non-cash compensation expense related to stock option grants (including $994
recorded as accrued expenses)
    
    $
    (26,608
    )Net adjustments for immaterial items previously unrecorded
    
    
    1,316Reduction in earnings from continuing operations before income tax expense
    
    
    (25,292
    )Related income tax benefit
    
    
    6,667Reduction in net earnings from continuing operations and net earnings
    
    
    
    
    
    $
    (18,625
    )Increase
(decrease) to additional paid-in capital:Increase related to non-cash compensation expense
    
    $
    25,614Reduction related to tax effects previously credited to additional paid-in capital
    
    
    (11,012
    )Net increase in additional paid-in capital
    
    
    
    
    
    
    14,602Increase in other comprehensive income for immaterial items previously unrecorded
    
    
    
    
    
    
    762Net decrease in shareholders equity at December 31, 2005
    
    
    
    
    
    $
    (3,261
    )
 6




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##### Table of Contents



Non-cashstock optionNet earnings as
    
    
    compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net earningspreviously reported
    
    
    expense
    
    
    Other
    
    
    Tax effect
    
    
    Total adjustments
    
    
    as restatedYears ended December 31,
1997
    
    $
    50,083
    
    
    $
    (3,789
    )
    
    $
    
    
    
    $
    1,326
    
    
    $
    (2,463
    )
    
    $
    47,6201998
    
    
    73,110
    
    
    
    (3,664
    )
    
    
    
    
    
    
    1,273
    
    
    
    (2,391
    )
    
    
    70,7191999
    
    
    26,572
    
    
    
    (1,474
    )
    
    
    
    
    
    
    (148
    )
    
    
    (1,622
    )
    
    
    24,9502000
    
    
    55,468
    
    
    
    (4,586
    )
    
    
    (1,124
    )
    
    
    1,830
    
    
    
    (3,880
    )
    
    
    51,5882001
    
    
    30,197
    
    
    
    (2,201
    )
    
    
    1,881
    
    
    
    88
    
    
    
    (232
    )
    
    
    29,9652002
    
    
    105,828
    
    
    
    (2,043
    )
    
    
    (27
    )
    
    
    561
    
    
    
    (1,509
    )
    
    
    104,319Cumulative effect at December 31, 2002
    
    
    341,258
    
    
    
    (17,757
    )
    
    
    730
    
    
    
    4,930
    
    
    
    (12,097
    )
    
    
    329,1612003
    
    
    143,561
    
    
    
    (3,279
    )
    
    
    1,270
    
    
    
    475
    
    
    
    (1,534
    )
    
    
    142,0272004
    
    
    163,025
    
    
    
    (2,571
    )
    
    
    2,453
    
    
    
    (208
    )
    
    
    (326
    )
    
    
    162,6992005
    
    
    195,860
    
    
    
    (3,001
    )
    
    
    (3,137
    )
    
    
    1,470
    
    
    
    (4,668
    )
    
    
    191,192Cumulative effect at December 31, 2005
    
    $
    843,704
    
    
    $
    (26,608
    )
    
    $
    1,316
    
    
    $
    6,667
    
    
    $
    (18,625
    )
    
    $
    825,079
  
  7




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FORWARD-LOOKING STATEMENTS
 This report on Form 10-K/A contains certain forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934,
which are intended to be covered by the safe harbors created by those laws. We have based these
forward-looking statements on our current expectations and projections about future events. These
forward-looking statements include information about possible or assumed future results of our
operations. All statements, other than statements of historical facts, included or incorporated by
reference in this report that address activities, events or developments that we expect or
anticipate may occur in the future, including such things as future capital expenditures, business
strategy, competitive strengths, goals, growth of our business and operations, plans and references
to future successes may be considered forward-looking statements. Also, when we use words such as
anticipate, believe, estimate, expect, intend, plan, probably or similar expressions,
we are making forward-looking statements.
 Many risks and uncertainties may impact the matters addressed in these forward-looking statements,
which could affect our future financial results and performance, including, among other things:
 
    
    the effects of catastrophic losses;
    
    the cyclical nature of the insurance business;
    
    inherent uncertainties in the loss estimation process, which can adversely impact the adequacy of loss reserves;
    
    the effects of emerging claim and coverage issues;
    
    the effects of extensive governmental regulation of the insurance industry;
    
    potential credit risk with brokers;
    
    our increased retention of risk, which could expose us to greater potential losses;
    
    the adequacy of reinsurance protection;
    
    the ability or willingness of reinsurers to pay balances due us;
    
    the occurrence of terrorist activities;
    
    our ability to maintain our competitive position;
    
    changes in our assigned financial strength ratings;
    
    our ability to raise capital in the future;
    
    attraction and retention of qualified employees;
    
    fluctuations in the fixed income securities market, which may reduce the value of our investment assets;
    
    our ability to successfully expand our business through the acquisition of insurance-related companies;
    
    our ability to receive dividends from our insurance company subsidiaries in needed amounts;
    
    fluctuations in foreign exchange rates;
    
    failures of our information technology systems, which could adversely affect our business;
    
    developments in the SECs informal inquiry related to our past practices in connection with grants of stock options;
    
    potential issues related to the effects of Sections 409A and162(m)of the Internal
Revenue Code and any expenses associated therewith;
 8




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##### Table of Contents




    
    changes to improve our internal controls related to the process of granting, documenting
and accounting for stock option awards;
    
    additional expenses and taxes associated with our stock option investigation and related matters;
    
    potential litigation that could result from our stock option investigation;
    
    the ability of our Executive Officers to define and implement a strategic business plan; and
    
    our ability to cure all defaults or events of default under our outstanding loan agreements.
 These events or factors could cause our results or performance to differ materially from those
we express in our forward-looking statements. Although we believe that the assumptions underlying
our forward-looking statements are reasonable, any of these assumptions, and, therefore, also the
forward-looking statements based on these assumptions, could themselves prove to be inaccurate. In
light of the significant uncertainties inherent in the forward-looking statements which are
included in this report, our inclusion of this information is not a representation by us or any
other person that our objectives and plans will be achieved.
 Our forward-looking statements speak only at the date made and we will not update these
forward-looking statements unless the securities laws require us to do so. In light of these
risks, uncertainties and assumptions, any forward-looking events discussed in this report may not
occur.
 9




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##### Table of Contents



PART I
 
 ITEM 1. BUSINESS
 Business Overview
 www.hcc.com.
     
    
    Diversified financial products
    
    Group life, accident and
health
    
    Aviation
    
    London market account
    
    Other specialty lines
 th nd
 10




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Our Strategy
     11




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##### Table of Contents




    
    emphasize the underwriting of lines of business where there is an anticipation of
underwriting profits based on various factors including premium rates, the availability and
cost of reinsurance and market conditions;
    
    limit our insurance companies aggregate net loss exposure from a catastrophic loss
through the use of reinsurance for those lines of business exposed to such losses and
diversification into lines of business not exposed to such losses; and
    
    consider the potential acquisition of specialty insurance operations and other strategic
investments.
 Industry Segment and Geographic Information
  Recent Acquisitions
   12




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##### Table of Contents



Recent Disposition
  Insurance Company Operations
 Lines of Business
  2005
    
    
    2004
    
    
    2003Diversified financial products
    
    $
    908,526
    
    
    
    45
    %
    
    $
    857,299
    
    
    
    43
    %
    
    $
    553,501
    
    
    
    32
    %Group life, accident and health
    
    
    593,382
    
    
    
    29
    
    
    
    584,747
    
    
    
    30
    
    
    
    565,494
    
    
    
    33Aviation
    
    
    210,530
    
    
    
    10
    
    
    
    204,963
    
    
    
    10
    
    
    
    214,718
    
    
    
    12London market account
    
    
    144,425
    
    
    
    7
    
    
    
    178,950
    
    
    
    9
    
    
    
    223,149
    
    
    
    13Other specialty lines
    
    
    176,139
    
    
    
    9
    
    
    
    133,964
    
    
    
    7
    
    
    
    73,475
    
    
    
    4Discontinued lines of business
    
    
    5,284
    
    
    
    
    
    
    
    15,230
    
    
    
    1
    
    
    
    109,557
    
    
    
    6Total gross written premium
    
    $
    2,038,286
    
    
    
    100
    %
    
    $
    1,975,153
    
    
    
    100
    %
    
    $
    1,739,894
    
    
    
    100
    %
 13




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##### Table of Contents



2005
    
    
    2004
    
    
    2003Diversified financial products
    
    $
    675,942
    
    
    
    45
    %
    
    $
    404,870
    
    
    
    37
    %
    
    $
    183,560
    
    
    
    21
    %Group life, accident and health
    
    
    502,805
    
    
    
    34
    
    
    
    343,996
    
    
    
    31
    
    
    
    299,913
    
    
    
    35Aviation
    
    
    130,743
    
    
    
    9
    
    
    
    144,687
    
    
    
    13
    
    
    
    99,447
    
    
    
    12London market account
    
    
    78,809
    
    
    
    5
    
    
    
    107,509
    
    
    
    10
    
    
    
    155,987
    
    
    
    18Other specialty lines
    
    
    109,106
    
    
    
    7
    
    
    
    83,980
    
    
    
    7
    
    
    
    36,837
    
    
    
    4Discontinued lines of business
    
    
    3,819
    
    
    
    
    
    
    
    20,477
    
    
    
    2
    
    
    
    89,758
    
    
    
    10Total net written premium
    
    $
    1,501,224
    
    
    
    100
    %
    
    $
    1,105,519
    
    
    
    100
    %
    
    $
    865,502
    
    
    
    100
    %
  2005
    
    
    2004
    
    
    2003Diversified financial products
    
    
    74
    %
    
    
    47
    %
    
    
    33
    %Group life, accident and health
    
    
    85
    
    
    
    59
    
    
    
    53Aviation
    
    
    62
    
    
    
    71
    
    
    
    46London market account
    
    
    55
    
    
    
    60
    
    
    
    70Other specialty lines
    
    
    62
    
    
    
    63
    
    
    
    50Continuing lines of business percentage retained
    
    
    74
    %
    
    
    55
    %
    
    
    48
    %
 Underwriting
  Diversified Financial Products
   
    
    directors and officers liability
    
    employment practices liability
    
    mortgage guaranty
    
    professional indemnity
 
    
    residual value insurance
    
    surety and credit
    
    other financial products
    14




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##### Table of Contents



Group Life, Accident and Health
    Aviation
   
    
    antique and vintage military aircraft
    
    cargo operators
    
    commuter airlines
    
    corporate aircraft
 
    
    fixed base operations
    
    military and law enforcement aircraft
    
    private aircraft owners
    
    rotor wing aircraft
     15




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##### Table of Contents



London Market Account
  2005
    
    
    2004
    
    
    2003Marine
    
    $
    23,799
    
    
    $
    19,537
    
    
    $
    14,552Energy
    
    
    15,621
    
    
    
    26,258
    
    
    
    40,065Property
    
    
    18,379
    
    
    
    19,613
    
    
    
    24,857Accident and health
    
    
    21,010
    
    
    
    42,101
    
    
    
    76,513Total London market account net written premium
    
    $
    78,809
    
    
    $
    107,509
    
    
    $
    155,987
    
    
    drilling rigs
    
    gas production and gathering platforms
    
    natural gas facilities
 
    
    petrochemical plants
    
    pipelines
    
    refineries
      
    
    factories
    
    hotels
    
    industrial plants
 
    
    office buildings
    
    retail locations
    
    utilities
    16




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##### Table of Contents



Other Specialty Lines
  Principal Insurance Companies
 Houston Casualty Company
  Houston Casualty Company-London
  U.S. Specialty Insurance Company
  HCC Life Insurance Company
  Avemco Insurance Company
  17




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##### Table of Contents



American Contractors Indemnity Company
  HCC Europe
  HCC Reinsurance Company
  HCC Specialty Insurance Company
  United States Surety Company
  Perico Life Insurance Company
  HCC International Insurance Company
  18




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##### Table of Contents



Underwriting Agency Operations
 
 Professional Indemnity Agency
  HCC Specialty Underwriters
  HCC Global Financial Products
  HCC Diversified Financial Products
  Covenant Underwriters
  HCC Indemnity Guaranty Agency
  Illium Insurance Group
  19




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##### Table of Contents



Reinsurance and Insurance Broker Operations
  Rattner Mackenzie
  Continental Underwriters
  HCC Risk Management
  Other Operations
  20




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##### Table of Contents



Operating Ratios
 Premium to Surplus Ratio
  2005
    
    
    2004
    
    
    2003
    
    
    2002
    
    
    2001Gross written premium
    
    $
    2,049,116
    
    
    $
    1,992,361
    
    
    $
    1,746,413
    
    
    $
    1,163,397
    
    
    $
    1,014,833Net written premium
    
    
    1,495,931
    
    
    
    1,121,343
    
    
    
    867,795
    
    
    
    545,475
    
    
    
    371,409Policyholders surplus
    
    
    1,110,268
    
    
    
    844,851
    
    
    
    591,889
    
    
    
    523,807
    
    
    
    401,393Gross written premium ratio
    
    
    184.6
    %
    
    
    235.8
    %
    
    
    295.1
    %
    
    
    222.1
    %
    
    
    252.8
    %Gross written premium
industry average (1)
    
    
    *
    
    
    
    201.6
    %
    
    
    219.3
    %
    
    
    244.4
    %
    
    
    210.8
    %Net written premium ratio
    
    
    134.7
    %
    
    
    132.7
    %
    
    
    146.6
    %
    
    
    104.1
    %
    
    
    92.5
    %Net written premium
industry average (1)
    
    
    *
    
    
    
    108.5
    %
    
    
    117.4
    %
    
    
    130.3
    %
    
    
    112.0
    %
 
 (1)
    
    Source: A.M. Best Company, Inc.*
    
    Not available  Combined Ratio  GAAP
  2005
    
    
    2004
    
    
    2003
    
    
    2002
    
    
    2001(As restated)
    
    
    (As restated)
    
    
    (As restated)
    
    
    (As restated)
    
    
    (As restated)Loss ratio
    
    
    67.1
    %
    
    
    63.8
    %
    
    
    66.1
    %
    
    
    60.8
    %
    
    
    78.0
    %Expense ratio
    
    
    26.1
    
    
    
    26.7
    
    
    
    24.6
    
    
    
    25.5
    
    
    
    25.4Combined ratio  GAAP
    
    
    93.2
    %
    
    
    90.5
    %
    
    
    90.7
    %
    
    
    86.3
    %
    
    
    103.4
    %
 21




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##### Table of Contents



Combined Ratio  Statutory
  2005
    
    
    2004
    
    
    2003
    
    
    2002
    
    
    2001Loss ratio
    
    
    67.1
    %
    
    
    64.3
    %
    
    
    66.8
    %
    
    
    62.0
    %
    
    
    78.0
    %Expense ratio
    
    
    25.5
    
    
    
    26.7
    
    
    
    23.0
    
    
    
    23.9
    
    
    
    23.8Combined ratio  Statutory
    
    
    92.6
    %
    
    
    91.0
    %
    
    
    89.8
    %
    
    
    85.9
    %
    
    
    101.8
    %Industry average
    
    
    *
    
    
    
    98.3
    %
    
    
    100.1
    %
    
    
    107.5
    %
    
    
    115.9
    %
 
 *
    
    Not available  Reserves
     22




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23




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##### Table of Contents



2005
    
    
    2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000
    
    
    1999
    
    
    1998
    
    
    1997
    
    
    1996
    
    
    1995(As restated)
    
    (As restated)
    
    (As restated)Balance sheet reserves
    
    $
    2,813,720
    
    
    $
    2,089,199
    
    
    $
    1,525,313
    
    
    $
    1,158,915
    
    
    $
    1,132,258
    
    
    $
    944,117
    
    
    $
    871,104
    
    
    $
    460,511
    
    
    $
    275,008
    
    
    $
    229,049
    
    
    $
    200,756Reserve adjustments from
acquisition and disposition
of subsidiaries
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,587
    
    
    
    
    
    
    
    (66,571
    )
    
    
    (32,437
    )
    
    
    (136
    )
    
    
    
    
    
    
    
    
    
    
    Adjusted reserves
    
    
    2,813,720
    
    
    
    2,089,199
    
    
    
    1,525,313
    
    
    
    1,164,502
    
    
    
    1,132,258
    
    
    
    877,546
    
    
    
    838,667
    
    
    
    460,375
    
    
    
    275,008
    
    
    
    229,049
    
    
    
    200,756Cumulative paid at:One year later
    
    
    
    
    
    
    511,766
    
    
    
    396,077
    
    
    
    441,775
    
    
    
    390,232
    
    
    
    400,279
    
    
    
    424,379
    
    
    
    229,746
    
    
    
    160,324
    
    
    
    119,453
    
    
    
    118,656Two years later
    
    
    
    
    
    
    
    
    
    
    587,349
    
    
    
    571,907
    
    
    
    612,129
    
    
    
    537,354
    
    
    
    561,246
    
    
    
    367,512
    
    
    
    209,724
    
    
    
    179,117
    
    
    
    167,459Three years later
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    682,534
    
    
    
    726,805
    
    
    
    667,326
    
    
    
    611,239
    
    
    
    419,209
    
    
    
    241,523
    
    
    
    193,872
    
    
    
    207,191Four years later
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    803,152
    
    
    
    720,656
    
    
    
    686,730
    
    
    
    435,625
    
    
    
    259,067
    
    
    
    212,097
    
    
    
    214,046Five years later
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    758,126
    
    
    
    721,011
    
    
    
    453,691
    
    
    
    262,838
    
    
    
    223,701
    
    
    
    226,762Six years later
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    725,639
    
    
    
    462,565
    
    
    
    267,038
    
    
    
    225,595
    
    
    
    233,831Seven years later
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    462,126
    
    
    
    270,362
    
    
    
    227,177
    
    
    
    235,236Eight years later
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    268,939
    
    
    
    228,621
    
    
    
    235,950Nine years later
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    230,745
    
    
    
    236,726Ten years later
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    236,996Re-estimated liability at:End of year
    
    
    2,813,720
    
    
    
    2,089,199
    
    
    
    1,525,313
    
    
    
    1,164,502
    
    
    
    1,132,258
    
    
    
    877,546
    
    
    
    838,667
    
    
    
    460,375
    
    
    
    275,008
    
    
    
    229,049
    
    
    
    200,756One year later
    
    
    
    
    
    
    2,118,471
    
    
    
    1,641,426
    
    
    
    1,287,003
    
    
    
    1,109,098
    
    
    
    922,080
    
    
    
    836,775
    
    
    
    550,409
    
    
    
    308,501
    
    
    
    252,236
    
    
    
    243,259Two years later
    
    
    
    
    
    
    
    
    
    
    1,666,931
    
    
    
    1,393,143
    
    
    
    1,241,261
    
    
    
    925,922
    
    
    
    868,438
    
    
    
    545,955
    
    
    
    316,250
    
    
    
    249,013
    
    
    
    248,372Three years later
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,464,448
    
    
    
    1,384,608
    
    
    
    1,099,657
    
    
    
    854,987
    
    
    
    547,179
    
    
    
    304,281
    
    
    
    250,817
    
    
    
    247,053Four years later
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,455,046
    
    
    
    1,102,636
    
    
    
    900,604
    
    
    
    537,968
    
    
    
    305,022
    
    
    
    247,245
    
    
    
    248,687Five years later
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,135,143
    
    
    
    887,272
    
    
    
    522,183
    
    
    
    295,975
    
    
    
    249,853
    
    
    
    248,559Six years later
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    894,307
    
    
    
    521,399
    
    
    
    296,816
    
    
    
    243,015
    
    
    
    250,176Seven years later
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    513,918
    
    
    
    292,544
    
    
    
    242,655
    
    
    
    246,661Eight years later
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    291,164
    
    
    
    241,904
    
    
    
    246,159Nine years later
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    244,687
    
    
    
    245,408Ten years later
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    245,970Cumulative redundancy
(deficiency)
    
    
    
    
    
    $
    (29,272
    )
    
    $
    (141,618
    )
    
    $
    (299,946
    )
    
    $
    (322,788
    )
    
    $
    (257,597
    )
    
    $
    (55,640
    )
    
    $
    (53,543
    )
    
    $
    (16,156
    )
    
    $
    (15,638
    )
    
    $
    (45,214
    )
 24




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##### Table of Contents




    
    During 2005 and 2004, we recorded $49.8 million and $127.7 million, respectively, in
gross losses related to the 2001 and 2000 accident years on certain assumed accident and
health reinsurance contracts reported in discontinued lines of business, due to our
processing of additional information received and our continuing evaluation of reserves on
this business.
    
    During 2005, we reduced our gross reserves on the 2004 hurricanes by $13.4 million to
reflect current estimates of our remaining liabilities, which partially offset the 2005
adverse development discussed above.
    
    During 2003, we recorded $132.9 million in gross losses related to 1999 and 2000
accident years on certain assumed accident and health reinsurance contracts reported in
discontinued lines of business, due to our processing of additional information received
and our continuing evaluation of reserves on this business.
    
    The 2000 and 1999 years in the table were also negatively affected by late reporting
loss information received during 2001 for certain discontinued business.
    
    
    We had development of large claims on individual policies which were either reported
late or for which reserves were increased as subsequent information became available. As
these policies were substantially reinsured, there was no material effect on our net
earnings.
    
    During 1999, in connection with the insolvency of one of the insurance companies that we
reinsured and the commutation of all liabilities with another, we re-evaluated all loss
reserves and incurred but not reported loss reserves related to business placed with these
reinsurers to determine the ultimate losses we might conservatively expect. These reserves
were then used as the basis for the determination of the provision for reinsurance recorded
in 1999.
 25




---



##### Table of Contents



2005
    
    
    2004
    
    
    2003(As restated)
    
    
    (As restated)Reserves for loss and loss adjustment expense payable
at beginning of year
    
    $
    2,089,199
    
    
    $
    1,525,313
    
    
    $
    1,158,915Reserve additions from acquisition of subsidiaries
    
    
    19,236
    
    
    
    15,537
    
    
    
    5,587Incurred loss and loss adjustment expense:Provision for loss and loss adjustment expense
for claims occurring in current
year
    
    
    1,567,501
    
    
    
    1,173,042
    
    
    
    922,838Increase in estimated loss and loss adjustment
expense for claims occurring in prior years *
    
    
    29,272
    
    
    
    116,113
    
    
    
    122,501Incurred loss and loss adjustment expense
    
    
    1,596,773
    
    
    
    1,289,155
    
    
    
    1,045,339Loss and loss adjustment expense payments for
claims occurring during:Current year
    
    
    379,722
    
    
    
    344,729
    
    
    
    242,753Prior years
    
    
    511,766
    
    
    
    396,077
    
    
    
    441,775Loss and loss adjustment expense payments
    
    
    891,488
    
    
    
    740,806
    
    
    
    684,528Reserves for loss and loss adjustment
expense payable at end of year
    
    $
    2,813,720
    
    
    $
    2,089,199
    
    
    $
    1,525,313
 *
    
    Changes in loss and loss adjustment expense reserves for losses occurring in prior years
reflect the gross effect of the resolution of losses for other than the reserve value and the
subsequent adjustments of loss reserves.
 26




---



##### Table of Contents



2005
    
    
    2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000
    
    
    1999
    
    
    1998
    
    
    1997
    
    
    1996
    
    
    1995(As restated)
    
    
    
    
    
    
    
    
    
    
    (As restated)Reserves, net of reinsurance
    
    $
    1,533,433
    
    
    $
    1,059,283
    
    
    $
    705,200
    
    
    $
    458,702
    
    
    $
    313,097
    
    
    $
    249,872
    
    
    $
    273,606
    
    
    $
    118,912
    
    
    $
    119,634
    
    
    $
    117,283
    
    
    $
    99,259Reserve adjustments from
acquisition and disposition
of subsidiaries
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,587
    
    
    
    
    
    
    
    (6,048
    )
    
    
    (3,343
    )
    
    
    (410
    )
    
    
    
    
    
    
    
    
    
    
    Effect on loss reserves of 1999
write off of reinsurance
recoverables
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    63,851
    
    
    
    15,008
    
    
    
    2,636
    
    
    
    1,442Adjusted reserves, net of
reinsurance
    
    
    1,533,433
    
    
    
    1,059,283
    
    
    
    705,200
    
    
    
    464,289
    
    
    
    313,097
    
    
    
    243,824
    
    
    
    270,263
    
    
    
    182,353
    
    
    
    134,642
    
    
    
    119,919
    
    
    
    100,701Cumulative paid, net of
reinsurance, at:One year later
    
    
    
    
    
    
    172,224
    
    
    
    141,677
    
    
    
    136,561
    
    
    
    126,019
    
    
    
    102,244
    
    
    
    145,993
    
    
    
    56,052
    
    
    
    48,775
    
    
    
    47,874
    
    
    
    41,947Two years later
    
    
    
    
    
    
    
    
    
    
    135,623
    
    
    
    173,566
    
    
    
    131,244
    
    
    
    139,659
    
    
    
    174,534
    
    
    
    103,580
    
    
    
    64,213
    
    
    
    66,030
    
    
    
    56,803Three years later
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    136,106
    
    
    
    163,808
    
    
    
    118,894
    
    
    
    185,744
    
    
    
    113,762
    
    
    
    80,227
    
    
    
    72,863
    
    
    
    64,798Four years later
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    93,405
    
    
    
    138,773
    
    
    
    180,714
    
    
    
    121,293
    
    
    
    81,845
    
    
    
    81,620
    
    
    
    67,355Five years later
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    158,935
    
    
    
    197,416
    
    
    
    120,452
    
    
    
    84,986
    
    
    
    81,968
    
    
    
    72,627Six years later
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    200,833
    
    
    
    127,254
    
    
    
    87,626
    
    
    
    82,681
    
    
    
    73,501Seven years later
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    131,631
    
    
    
    89,194
    
    
    
    84,108
    
    
    
    73,792Eight years later
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    88,061
    
    
    
    84,847
    
    
    
    74,836Nine years later
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    84,770
    
    
    
    75,216Ten years later
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    74,782Re-estimated liability, net of
reinsurance, at:End of year
    
    
    1,533,433
    
    
    
    1,059,283
    
    
    
    705,200
    
    
    
    464,289
    
    
    
    313,097
    
    
    
    243,824
    
    
    
    270,263
    
    
    
    182,353
    
    
    
    134,642
    
    
    
    119,919
    
    
    
    100,701One year later
    
    
    
    
    
    
    1,084,677
    
    
    
    735,678
    
    
    
    487,403
    
    
    
    306,318
    
    
    
    233,111
    
    
    
    260,678
    
    
    
    186,967
    
    
    
    120,049
    
    
    
    116,145
    
    
    
    95,764Two years later
    
    
    
    
    
    
    
    
    
    
    770,497
    
    
    
    500,897
    
    
    
    338,194
    
    
    
    222,330
    
    
    
    254,373
    
    
    
    175,339
    
    
    
    116,745
    
    
    
    101,595
    
    
    
    94,992Three years later
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    571,403
    
    
    
    366,819
    
    
    
    259,160
    
    
    
    244,650
    
    
    
    171,165
    
    
    
    110,673
    
    
    
    97,353
    
    
    
    85,484Four years later
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    418,781
    
    
    
    267,651
    
    
    
    258,122
    
    
    
    163,349
    
    
    
    107,138
    
    
    
    95,118
    
    
    
    80,890Five years later
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    296,396
    
    
    
    254,579
    
    
    
    155,931
    
    
    
    103,243
    
    
    
    93,528
    
    
    
    79,626Six years later
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    271,563
    
    
    
    157,316
    
    
    
    101,538
    
    
    
    91,413
    
    
    
    79,968Seven years later
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    156,376
    
    
    
    99,872
    
    
    
    90,951
    
    
    
    78,614Eight years later
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    97,965
    
    
    
    90,534
    
    
    
    78,810Nine years later
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    90,011
    
    
    
    78,499Ten years later
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    77,732Cumulative redundancy
(deficiency)
    
    
    
    
    
    $
    (25,394
    )
    
    $
    (65,297
    )
    
    $
    (107,114
    )
    
    $
    (105,684
    )
    
    $
    (52,572
    )
    
    $
    (1,300
    )
    
    $
    25,977
    
    
    $
    36,677
    
    
    $
    29,908
    
    
    $
    22,969
 27




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##### Table of Contents



2005
    
    
    2004
    
    
    2003(As restated)
    
    
    
    
    
    
    (As restated)Net reserves for loss and loss adjustment expense
payable at beginning of year
    
    $
    1,059,283
    
    
    $
    705,200
    
    
    $
    458,702Net reserve additions from acquisition of subsidiaries
    
    
    12,491
    
    
    
    11,647
    
    
    
    5,587Incurred loss and loss adjustment expense:Provision for loss and loss adjustment expense for
claims occurring in current year
    
    
    894,303
    
    
    
    614,752
    
    
    
    464,886Increase in estimated loss and loss adjustment
expense for claims occurring in prior years *
    
    
    25,394
    
    
    
    30,478
    
    
    
    23,114Incurred loss and loss adjustment expense
    
    
    919,697
    
    
    
    645,230
    
    
    
    488,000Loss and loss adjustment expense payments for claims
occurring during:Current year
    
    
    285,814
    
    
    
    161,117
    
    
    
    110,528Prior years
    
    
    172,224
    
    
    
    141,677
    
    
    
    136,561Loss and loss adjustment expense payments
    
    
    458,038
    
    
    
    302,794
    
    
    
    247,089Net reserves for loss and loss adjustment expense
payable at end of year
    
    $
    1,533,433
    
    
    $
    1,059,283
    
    
    $
    705,200
 
 *
    
    Changes in loss and loss adjustment expense reserves for losses occurring in prior years
reflect the net effect of the resolution of losses for other than the reserve value and the
subsequent adjustments of loss reserves.   Regulation
  28




---



##### Table of Contents



Insurance Companies
  
    
    approval of policy forms and premium rates;
    
    licensing of insurers and their agents;
    
    periodic examinations of our operations and finances;
    
    prescribing the form and content of records of financial condition required to be filed;
    
    requiring deposits for the benefit of policyholders;
    
    requiring certain methods of accounting;
    
    requiring reserves for unearned premium, losses and other purposes;
    
    restrictions on the ability of our insurance companies to pay dividends;
    
    restrictions on the nature, quality and concentration of investments;
    
    restrictions on transactions between insurance companies and their affiliates;
    
    restrictions on the size of risks insurable under a single policy; and
    
    standards of solvency, including risk-based capital measurement (which is a measure
developed by the National Association of Insurance Commissioners and used by state
insurance regulators to identify insurance companies that potentially are inadequately
capitalized).
    29




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##### Table of Contents



Underwriting Agencies and Reinsurance and Insurance Brokers
  
    
    advertising and business practice rules;
    
    contractual requirements;
    
    financial security;
    
    licensing as agents, brokers, reinsurance brokers, managing general agents or third party administrators;
    
    limitations on authority; and
    
    recordkeeping requirements.
 Statutory Accounting Principles
  
    
    a liability is recorded for certain reinsurance recoverables under statutory accounting
principles whereas, under generally accepted accounting principles, there is no such
provision unless the recoverables are deemed to be doubtful of collection;
    
    certain assets which are considered non-admitted assets are eliminated from a balance
sheet prepared in accordance with statutory accounting principles but are included in a
balance sheet prepared in accordance with generally accepted accounting principles;
    
    only some of the deferred tax asset is recognized under statutory accounting principles;
    
    fixed-income investments classified as available for sale are recorded at market value
for generally accepted accounting principles and at amortized cost under statutory
accounting principles;
 30




---



##### Table of Contents




    
    outstanding losses and unearned premium are reported on a gross basis under generally
accepted accounting principles and on a net basis under statutory accounting principles;
and
    
    under statutory accounting principles, policy acquisition costs are expensed as incurred
and, under generally accepted accounting principles, such costs are deferred and amortized
to expense as the related premium is earned.
  Insurance Holding Company Acts
  Assessments
  Insurance Regulations Concerning Change of Control
  Risk-Based Capital
  31




---



##### Table of Contents



Insurance Regulatory Information System
  Terrorism Risk Insurance Act
   Legislative Initiatives
   32




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##### Table of Contents



Employees
  
 ITEM 1A. RISK FACTORS
 RISKS RELATING TO OUR INDUSTRY
 Because we are a property and casualty insurer, our business may suffer as a result of unforeseen
catastrophic losses.
  The insurance and reinsurance business is historically cyclical, and we expect to experience
periods with excess underwriting capacity and unfavorable premium rates, which could cause our
results to fluctuate.
  33




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##### Table of Contents



Our loss reserves are based on an estimate of our future liability, which may prove to be
inadequate.
  The effects of emerging claim and coverage issues on our business are uncertain.
  We are subject to extensive governmental regulation, which could adversely affect our business.
  34




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##### Table of Contents



Our reliance on brokers subjects us to their credit risk.
  RISKS RELATING TO OUR BUSINESS
 Our increased retentions in various lines of business means that we are exposed to a greater
portion of potential losses.
  If we are unable to purchase adequate reinsurance protection for some of the risks we have
underwritten, we will be exposed to any resulting losses.
  If the companies that provide our reinsurance do not pay all of our claims, we could incur severe
losses.
  35




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##### Table of Contents



As a primary insurer, we may have significant exposure for terrorist acts.
  We may be unsuccessful in competing against larger or more well established business rivals.
  If the rating agencies downgrade us, our business and competitive position in the industry may
suffer.
  We may require additional capital in the future, which may not be available or may only be
available on unfavorable terms.
  36




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##### Table of Contents



We may be unable to attract and retain qualified employees.
  We invest a significant amount of our assets in fixed income securities that have experienced
market fluctuations, which may greatly reduce the value of our investment portfolio.
  Our strategy of acquiring other companies for growth may not succeed.
  37




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##### Table of Contents



We are an insurance holding company and, therefore, may not be able to receive dividends in needed
amounts from our subsidiaries.
  Because we operate internationally, fluctuations in currency exchange rates may affect our
receivable and payable balances and our reserves.
  Our information technology systems may fail or suffer a loss of security, which could adversely
affect our business.
   The SECs informal inquiry related to our stock option granting procedures is on-going, and the
scope and outcome could have a negative impact on the price of our securities and on our business.
  38




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##### Table of Contents



If we do not maintain compliance with the listing requirements of the New York Stock Exchange
(NYSE), our common stock could be delisted, which would reduce the price of our common stock and
the levels of liquidity available to our shareholders.
  The matters relating to the Special Committee of the Board of Directors investigation of our
historical stock option granting practices and the restatement of our consolidated financial
statements may result in future litigation, which could harm our business and financial condition.
  The loss of Stephen L. Way as our Chief Executive Officer could weaken our strategic leadership and
have a material adverse effect on our business and development.
  Our failure to comply with any of the covenants in the indentures for our convertible notes and in
our revolving loan facility could have a material adverse impact on our business and our financial
condition.
  39




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##### Table of Contents



Our certificate of incorporation and our bylaws do not have provisions that could delay or prevent
a change in control.
  
 ITEM 1B. UNRESOLVED STAFF COMMENTS
  40




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##### Table of Contents



ITEM 2. PROPERTIES
   Subsidiary
    
    Location
    
    Sq. Ft.
    
    Termination Date of LeaseHouston Casualty Company
    
    Houston, Texas
    
    
    77,000
    
    
    OwnedHCC and Houston Casualty Company
    
    Houston, Texas
    
    
    51,000
    
    
    OwnedProfessional Indemnity Agency
    
    Mount Kisco, New York
    
    
    38,000
    
    
    OwnedU.S. Specialty Insurance
Company Aviation Division
    
    Dallas, Texas
    
    
    28,000
    
    
    August 31, 2013HCC Specialty Underwriters
    
    Wakefield, Massachusetts
    
    
    28,000
    
    
    December 31, 2010HCC Life Insurance Company
    
    Atlanta, Georgia
    
    
    27,000
    
    
    December 31, 2011
  
 ITEM 3. LEGAL PROCEEDINGS
     41




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##### Table of Contents



ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
  
 PART II
 
 ITEM 5.
    
    MARKET FOR THE REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 Price Range of Common Stock
   2005
    
    
    2004
    
    
    2003High
    
    
    Low
    
    
    High
    
    
    Low
    
    
    High
    
    
    LowFirst quarter
    
    $
    26.17
    
    
    $
    21.31
    
    
    $
    23.17
    
    
    $
    20.01
    
    
    $
    17.64
    
    
    $
    14.87Second quarter
    
    
    26.96
    
    
    
    23.05
    
    
    
    22.93
    
    
    
    20.30
    
    
    
    20.13
    
    
    
    17.10Third quarter
    
    
    28.89
    
    
    
    25.11
    
    
    
    22.39
    
    
    
    19.23
    
    
    
    20.84
    
    
    
    19.13Fourth quarter
    
    
    32.95
    
    
    
    26.91
    
    
    
    22.83
    
    
    
    18.35
    
    
    
    21.39
    
    
    
    18.73
  Shareholders
  Dividend Policy
  2005
    
    
    2004
    
    
    2003First quarter
    
    $
    .057
    
    
    $
    .050
    
    
    $
    .043Second quarter
    
    
    .075
    
    
    
    .050
    
    
    
    .043Third quarter
    
    
    .075
    
    
    
    .057
    
    
    
    .050Fourth quarter
    
    
    .075
    
    
    
    .057
    
    
    
    .050
  42




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##### Table of Contents



ITEM 6. SELECTED FINANCIAL DATA
   43




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##### Table of Contents



2005
    
    
    2004
    
    
    2003
    
    
    2002(2)
    
    
    2001(2)(7)(As previously
    
    
    
    
    
    
    
    
    
    
    (As previously(As restated)
    
    
    (As restated)
    
    
    (As restated)
    
    
    reported)
    
    
    (Adjustments)
    
    
    (As restated)
    
    
    reported)
    
    
    (Adjustments)
    
    
    (As restated)Statement of earnings data:RevenueNet earned premium
    
    $
    1,369,988
    
    
    $
    1,010,692
    
    
    $
    738,272
    
    
    $
    505,521
    
    
    $
    
    
    
    $
    505,521
    
    
    $
    342,787
    
    
    $
    
    
    
    $
    342,787Fee and commission income
    
    
    132,628
    
    
    
    183,802
    
    
    
    142,615
    
    
    
    115,919
    
    
    
    171
    
    
    
    116,090
    
    
    
    111,016
    
    
    
    (171
    )
    
    
    110,845Net investment income
    
    
    98,851
    
    
    
    64,885
    
    
    
    47,335
    
    
    
    37,755
    
    
    
    
    
    
    
    37,755
    
    
    
    39,562
    
    
    
    
    
    
    
    39,562Net realized investment gain
    
    
    1,448
    
    
    
    5,822
    
    
    
    527
    
    
    
    453
    
    
    
    
    
    
    
    453
    
    
    
    393
    
    
    
    1,019
    
    
    
    1,412Other operating income
    
    
    39,773
    
    
    
    19,406
    
    
    
    13,215
    
    
    
    6,985
    
    
    
    
    
    
    
    6,985
    
    
    
    17,451
    
    
    
    481
    
    
    
    17,932Total revenue
    
    
    1,642,688
    
    
    
    1,284,607
    
    
    
    941,964
    
    
    
    666,633
    
    
    
    171
    
    
    
    666,804
    
    
    
    511,209
    
    
    
    1,329
    
    
    
    512,538ExpenseLoss and loss adjustment
expense, net
    
    
    919,697
    
    
    
    645,230
    
    
    
    488,000
    
    
    
    306,491
    
    
    
    652
    
    
    
    307,143
    
    
    
    267,390
    
    
    
    
    
    
    
    267,390Policy acquisition costs, net
    
    
    261,708
    
    
    
    222,323
    
    
    
    137,212
    
    
    
    99,521
    
    
    
    
    
    
    
    99,521
    
    
    
    66,313
    
    
    
    (1,000
    )
    
    
    65,313Other operating expense
    
    
    180,990
    
    
    
    168,045
    
    
    
    144,574
    
    
    
    99,924
    
    
    
    1,589
    
    
    
    101,513
    
    
    
    113,806
    
    
    
    2,273
    
    
    
    116,079Interest expense
    
    
    7,684
    
    
    
    8,374
    
    
    
    7,453
    
    
    
    8,301
    
    
    
    
    
    
    
    8,301
    
    
    
    8,875
    
    
    
    376
    
    
    
    9,251Total expense
    
    
    1,370,079
    
    
    
    1,043,972
    
    
    
    777,239
    
    
    
    514,237
    
    
    
    2,241
    
    
    
    516,478
    
    
    
    456,384
    
    
    
    1,649
    
    
    
    458,033Earnings from continuing
operations
before income tax expense
    
    
    272,609
    
    
    
    240,635
    
    
    
    164,725
    
    
    
    152,396
    
    
    
    (2,070
    )
    
    
    150,326
    
    
    
    54,825
    
    
    
    (320
    )
    
    
    54,505Income tax expense on continuing
operations
    
    
    84,177
    
    
    
    81,940
    
    
    
    59,382
    
    
    
    52,933
    
    
    
    (561
    )
    
    
    52,372
    
    
    
    27,764
    
    
    
    (88
    )
    
    
    27,676Earnings from continuing
operations
    
    
    188,432
    
    
    
    158,695
    
    
    
    105,343
    
    
    
    99,463
    
    
    
    (1,509
    )
    
    
    97,954
    
    
    
    27,061
    
    
    
    (232
    )
    
    
    26,829Earnings from discontinued
operations, net of income taxes
(6)
    
    
    2,760
    
    
    
    4,004
    
    
    
    36,684
    
    
    
    6,365
    
    
    
    
    
    
    
    6,365
    
    
    
    3,136
    
    
    
    
    
    
    
    3,136Net earnings
    
    $
    191,192
    
    
    $
    162,699
    
    
    $
    142,027
    
    
    $
    105,828
    
    
    $
    (1,509
    )
    
    $
    104,319
    
    
    $
    30,197
    
    
    $
    (232
    )
    
    $
    29,965Basic earnings per share data:Earnings from continuing
operations
    
    $
    1.78
    
    
    $
    1.63
    
    
    $
    1.11
    
    
    $
    1.06
    
    
    $
    (0.01
    )
    
    $
    1.05
    
    
    $
    0.31
    
    
    $
    (0.01
    )
    
    $
    0.30Earnings from discontinued
operations (6)
    
    
    0.03
    
    
    
    0.04
    
    
    
    0.39
    
    
    
    0.07
    
    
    
    
    
    
    
    0.07
    
    
    
    0.04
    
    
    
    
    
    
    
    0.04Net earnings
    
    $
    1.81
    
    
    $
    1.67
    
    
    $
    1.50
    
    
    $
    1.13
    
    
    $
    (0.01
    )
    
    $
    1.12
    
    
    $
    0.35
    
    
    $
    (0.01
    )
    
    $
    0.34Weighted average shares
outstanding
    
    
    105,463
    
    
    
    97,257
    
    
    
    94,919
    
    
    
    93,338
    
    
    
    
    
    
    
    93,338
    
    
    
    87,482
    
    
    
    
    
    
    
    87,482Diluted earnings per share
data:Earnings from continuing
operations
    
    $
    1.72
    
    
    $
    1.61
    
    
    $
    1.09
    
    
    $
    1.05
    
    
    $
    (0.01
    )
    
    $
    1.04
    
    
    $
    0.30
    
    
    $
    
    
    
    $
    .030Earnings from discontinued
operations (6)
    
    
    0.03
    
    
    
    0.04
    
    
    
    0.38
    
    
    
    0.07
    
    
    
    
    
    
    
    0.07
    
    
    
    0.04
    
    
    
    
    
    
    
    0.04Net earnings
    
    $
    1.75
    
    
    $
    1.65
    
    
    $
    1.47
    
    
    $
    1.12
    
    
    $
    (0.01
    )
    
    $
    1.11
    
    
    $
    0.34
    
    
    $
    
    
    
    $
    0.34Weighted average shares
outstanding
    
    
    109,437
    
    
    
    98,826
    
    
    
    96,576
    
    
    
    94,406
    
    
    
    
    
    
    
    94,406
    
    
    
    89,429
    
    
    
    
    
    
    
    89,429Cash dividends declared, per share
    
    $
    0.282
    
    
    $
    0.213
    
    
    $
    0.187
    
    
    $
    0.170
    
    
    $
    
    
    
    $
    0.170
    
    
    $
    0.163
    
    
    $
    
    
    
    $
    0.163
 44




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##### Table of Contents



2005
    
    
    2004
    
    
    2003(2)
    
    
    2002(2)
    
    
    2001(2)(As
    
    
    
    
    
    
    
    
    
    
    (As
    
    
    
    
    
    
    
    
    
    
    (Aspreviously
    
    
    
    
    
    
    
    
    
    
    previously
    
    
    
    
    
    
    
    
    
    
    previously(As restated)
    
    
    (As restated)
    
    
    reported)
    
    
    (Adjustments)
    
    
    (As restated)
    
    
    reported)
    
    
    (Adjustments)
    
    
    (As restated)
    
    
    reported)
    
    
    (Adjustments)
    
    
    (As restated)Balance sheet data:Total investments
    
    $
    3,257,428
    
    
    $
    2,468,491
    
    
    $
    1,707,300
    
    
    $
    
    
    
    $
    1,707,300
    
    
    $
    1,777,775
    
    
    $
    
    
    
    $
    1,177,775
    
    
    $
    885,659
    
    
    $
    
    
    
    $
    885,659Premium, claims and other receivables
    
    
    884,654
    
    
    
    891,360
    
    
    
    932,417
    
    
    
    1,835
    
    
    
    934,252
    
    
    
    772,772
    
    
    
    16,454
    
    
    
    789,226
    
    
    
    665,965
    
    
    
    18,589
    
    
    
    684,554Reinsurance recoverables
    
    
    1,361,983
    
    
    
    1,104,026
    
    
    
    916,190
    
    
    
    (15,415
    )
    
    
    900,775
    
    
    
    798,934
    
    
    
    (1,739
    )
    
    
    797,195
    
    
    
    899,128
    
    
    
    19,068
    
    
    
    918,196Ceded unearned premium
    
    
    239,416
    
    
    
    311,973
    
    
    
    291,591
    
    
    
    
    
    
    
    291,591
    
    
    
    164,224
    
    
    
    
    
    
    
    164,224
    
    
    
    71,140
    
    
    
    813
    
    
    
    71,953Goodwill
    
    
    532,947
    
    
    
    444,031
    
    
    
    386,507
    
    
    
    1,516
    
    
    
    388,023
    
    
    
    335,288
    
    
    
    
    
    
    
    335,288
    
    
    
    315,318
    
    
    
    
    
    
    
    315,318Total assets
    
    
    7,028,800
    
    
    
    5,900,568
    
    
    
    4,897,682
    
    
    
    (14,337
    )
    
    
    4,883,345
    
    
    
    3,723,396
    
    
    
    15,567
    
    
    
    3,738,963
    
    
    
    3,219,120
    
    
    
    46,390
    
    
    
    3,265,510Loss and loss adjustment expense payable
    
    
    2,813,720
    
    
    
    2,089,199
    
    
    
    1,535,288
    
    
    
    (9,975
    )
    
    
    1,525,313
    
    
    
    1,155,290
    
    
    
    3,625
    
    
    
    1,158,915
    
    
    
    1,130,748
    
    
    
    1,510
    
    
    
    1,132,258Unearned premium
    
    
    807,109
    
    
    
    741,706
    
    
    
    592,311
    
    
    
    
    
    
    
    592,311
    
    
    
    331,050
    
    
    
    
    
    
    
    331,050
    
    
    
    179,530
    
    
    
    
    
    
    
    179,530Premium and claims payable
    
    
    753,859
    
    
    
    766,765
    
    
    
    778,945
    
    
    
    5,093
    
    
    
    784,038
    
    
    
    750,046
    
    
    
    9,864
    
    
    
    759,910
    
    
    
    717,159
    
    
    
    15,500
    
    
    
    732,659Notes payable
    
    
    309,543
    
    
    
    311,277
    
    
    
    310,404
    
    
    
    
    
    
    
    310,404
    
    
    
    230,027
    
    
    
    
    
    
    
    230,027
    
    
    
    181,928
    
    
    
    
    
    
    
    181,928Shareholders equity
    
    
    1,690,435
    
    
    
    1,325,498
    
    
    
    1,046,920
    
    
    
    (515
    )
    
    
    1,046,405
    
    
    
    882,907
    
    
    
    1,764
    
    
    
    884,671
    
    
    
    763,453
    
    
    
    1,894
    
    
    
    765,347Book value per share (8)
    
    $
    15.26
    
    
    $
    12.99
    
    
    $
    10.91
    
    
    $
    
    
    
    $
    10.91
    
    
    $
    9.43
    
    
    $
    0.02
    
    
    $
    9.45
    
    
    $
    8.27
    
    
    $
    0.02
    
    
    $
    8.29
 45




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##### Table of Contents



(1)
    
    See Note 2  Restatement of Consolidated Financial Statements, Special
Committee and Company Findings to our Consolidated Financial Statements for a discussion
of these adjustments.(2)
    
    The consolidated statement of earnings data for 2002 and 2001, and the consolidated
balance sheet data for 2003, 2002 and 2001, have been revised to reflect adjustments
related to the restatement described under Managements Discussion and Analysis of
Financial Condition and Results of Operations  Restatement of Consolidated Financial
Statements, Special Committee and Company Findings and Note 2 of the Notes to Consolidated
Financial Statements. Pre-tax adjustments recorded in 2002 and 2001 included non-cash
stock-based compensation expense totaling $2.0 million and $2.2 million, respectively. The
cumulative after-tax impact of all restatement adjustments related to years prior to 2001
totaled $10.4 million and has been reflected as an adjustment to shareholders equity at
December 31, 2000.On a pre-tax basis, the cumulative net impact of all restatement adjustments related to years
prior to 2001 totaled $14.6 million. These adjustments consisted primarily of the following:
 
    
    The pre-tax impact of charges related to stock option grant measurement date
errors in the period 1997 through 2000 totaling $3.8 million, $3.7 million, $1.5
million, and $4.6 million, respectively;
    
    The pre-tax income decrease of other previously unrecorded adjustments in 2000 totaling $1.1 million; and
    
    Income tax expense (benefit) of $(1.3) million $(1.3) million, $0.1 million and $(1.8) million in the period 1997 through 2000.
 The impact on previously reported net income of these adjustments was a decrease of $3.9
million, $1.6 million, $2.4 million and $2.5 million, or 7%, 6%, 3% and 5%, for 2000, 1999,
1998 and 1997, respectively. The impact on previously reported diluted income per share of
these adjustments was a decrease of $0.05, $0.02, $0.04 and $0.03 for 2000, 1999, 1998 and
1997, respectively.(3)
    
    The consolidated balance sheet data has been adjusted to reflect the cumulative
restatement adjustments. See Note 2  Restatement of Consolidated Financial Statements,
Special Committee and Company Findings to our Consolidated Financial Statements for a
discussion of these statements.(4)
    
    In 2005, the Board of Directors declared a three-for-two stock split in the form of a
50% stock dividend on our shares of $1.00 par value common stock. All shares outstanding
and per share amounts have been adjusted to reflect the effect of the stock split for all
periods presented.(5)
    
    Certain amounts in the 2001-2004 selected consolidated financial data have been
reclassified to conform to the 2005 presentation. The reclassifications included the
elimination of certain intercompany premium receivable and premium payable balances. Such
reclassifications had no effect on our consolidated net earnings, shareholders equity or
cash flows.(6)
    
    We sold our retail brokerage operation, HCC Employee Benefits, Inc., in 2003. The net
earnings of HCC Employee Benefits, the 2003 gain on sale and the subsequent gains in 2004
and 2005 from a contractual earnout are classified as discontinued operations. Consistent
with this presentation, all pre-sale revenue and expense of HCC Employee Benefits was
reclassified to discontinued operations.(7)
    
    During 2002, we adopted SFAS No. 142, Goodwill and Other Intangible Assets, which
required that goodwill and indefinite-lived intangible assets no longer be amortized. The
adjusted amounts that we would have reported in 2001 had we adopted SFAS 142 on January 1,
2001 are as follows:
 Adjusted net earnings
    
    $
    41,352Adjusted basic earnings per share
    
    $
    0.47Adjusted diluted earnings per share
    
    $
    0.46
 (8)
    
    Book value per share is calculated by dividing the sum of outstanding shares plus
contractually issuable shares into total shareholders equity.
 46




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##### Table of Contents



ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
  Restatement of Consolidated Financial Statements, Special Committee and Company Findings
   
    
    The dates on documentation such as e-mails, regulatory form filings, acquisition
agreements and other correspondence;
    
    The date that the relevant stock option grant was entered into Equity Edge, our stock
option tracking and accounting system;
    
    Requirements of Accounting Principles Board (APB) No. 25, Accounting for Stock Issued to
Employees, and related interpretations; and
    
    Guidance from the Office of Chief Accountant of the Securities and Exchange Commission
(SEC) contained in a letter dated September 19, 2006.
  47




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##### Table of Contents




    
    Non-cash compensation expense for the difference between the stock price on the stated
grant date and the actual measurement date and for the fluctuations in stock price in
certain instances where variable accounting should have been applied;
    
    Other adjustments that were not recorded in the originally filed financial statements
due to their immateriality; and
    
    Related tax effects for all items.
   Accounting for Stock Issued to
Employees Share-Based Payment
 48




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##### Table of Contents




    
    We determined that many block grants to employees during the period 1997 through 2005
were subject to a retroactive look-back period. In all such cases, the price of our stock
at the end of the look-back period, which was generally 30 days or less, was higher than
the price of our stock on the stated grant date.
    
    In addition to being subject to the retroactive pricing discussed above, we determined
that the strike price of block grants in 1999, 2002 and 2005 was determined prior to the
final determination of the identity of the employee and/or the number of options to be
granted. Further, proper approval, in most cases, had not been given until after the grant
date. In all such cases, the price of our stock at the time when all required
determinations were final and proper approval had been obtained was higher than the price
of our stock on the stated grant date. The time lag between the stated grant date and the
finalization of the awards was typically 30-45 days, except in the case of the 2002 grant
which was finalized several months subsequent to the stated grant date.
    
    For the period from 1997 to 2005 and into 2006, we determined
that there was a
regular practice of granting options to newly hired employees and existing employees being
promoted after the end of a 30-45 day period following the hire or promotion date. This
practice included the use of the 30-45 day period as a look-back period during which the
date with the lowest price during that period was selected as the stated grant date.
    
    In several instances, grants to senior executives were determined at a date subsequent
to the stated grant date. In most cases, this resulted from extended negotiations of
employment agreements and, in some cases, administrative delays. In virtually all cases,
the price of our stock at the time the grants were made and properly approved was higher
than the price of our stock on the stated grant date.
    
    In a few cases, options were granted and then repriced downward. As a
result, variable accounting should have been applied to these options.
    
    We lacked timely or adequate documentation to support the stated grant date in the case
of certain of the above errors.
    49




---



##### Table of Contents



Increase
(decrease) in net earnings and retained earnings:Non-cash compensation expense related to stock option grants (including $994
recorded as accrued expenses)
    
    $
    (26,608
    )Net adjustments for immaterial items previously unrecorded
    
    
    1,316Reduction in earnings from continuing operations before income tax expense
    
    
    (25,292
    )Related income tax benefit
    
    
    6,667Reduction in net earnings from continuing operations and net earnings
    
    
    
    
    
    $
    (18,625
    )Increase
(decrease) to additional paid-in capital:Increase related to non-cash compensation expense
    
    $
    25,614Reduction related to tax effects previously credited to additional paid-in capital
    
    
    (11,012
    )Net increase in additional paid-in capital
    
    
    
    
    
    
    14,602Increase in other comprehensive income for immaterial items previously unrecorded
    
    
    
    
    
    
    762Net decrease in shareholders equity at December 31, 2005
    
    
    
    
    
    $
    (3,261
    )
  Non-cashstock optionNet earnings as
    
    
    compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net earningspreviously reported
    
    
    expense
    
    
    Other
    
    
    Tax effect
    
    
    Total adjustments
    
    
    as restatedYears ended December 31,
1997
    
    $
    50,083
    
    
    $
    (3,789
    )
    
    $
    
    
    
    $
    1,326
    
    
    $
    (2,463
    )
    
    $
    47,6201998
    
    
    73,110
    
    
    
    (3,664
    )
    
    
    
    
    
    
    1,273
    
    
    
    (2,391
    )
    
    
    70,7191999
    
    
    26,572
    
    
    
    (1,474
    )
    
    
    
    
    
    
    (148
    )
    
    
    (1,622
    )
    
    
    24,9502000
    
    
    55,468
    
    
    
    (4,586
    )
    
    
    (1,124
    )
    
    
    1,830
    
    
    
    (3,880
    )
    
    
    51,5882001
    
    
    30,197
    
    
    
    (2,201
    )
    
    
    1,881
    
    
    
    88
    
    
    
    (232
    )
    
    
    29,9652002
    
    
    105,828
    
    
    
    (2,043
    )
    
    
    (27
    )
    
    
    561
    
    
    
    (1,509
    )
    
    
    104,319Cumulative effect at December 31, 2002
    
    
    341,258
    
    
    
    (17,757
    )
    
    
    730
    
    
    
    4,930
    
    
    
    (12,097
    )
    
    
    329,1612003
    
    
    143,561
    
    
    
    (3,279
    )
    
    
    1,270
    
    
    
    475
    
    
    
    (1,534
    )
    
    
    142,0272004
    
    
    163,025
    
    
    
    (2,571
    )
    
    
    2,453
    
    
    
    (208
    )
    
    
    (326
    )
    
    
    162,6992005
    
    
    195,860
    
    
    
    (3,001
    )
    
    
    (3,137
    )
    
    
    1,470
    
    
    
    (4,668
    )
    
    
    191,192Cumulative effect at December 31, 2005
    
    $
    843,704
    
    
    $
    (26,608
    )
    
    $
    1,316
    
    
    $
    6,667
    
    
    $
    (18,625
    )
    
    $
    825,079
 50




---



##### Table of Contents



51




---



##### Table of Contents



Overview
       52




---



##### Table of Contents



Company
    
    Segment
    
    Effective date acquiredCovenant Underwriters and Continental Underwriters
    
    Agency
    
    July 1, 2003American Contractors Indemnity Company
    
    Insurance company
    
    January 31, 2004RA&MCO Insurance Services
    
    Agency
    
    October 1, 2004United States Surety Company
    
    Insurance company
    
    March 1, 2005HCC International Insurance Company
(formerly De Montfort Insurance Company)
    
    Insurance company
    
    July 1, 2005Perico Life Insurance Company
(formerly MIC Life Insurance Corporation)
    
    Insurance company
    
    November 30, 2005Perico Ltd.
    
    Agency
    
    December 1, 2005Illium Insurance Group
    
    Agency
    
    December 31, 2005
  Results of Operations
    53




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##### Table of Contents



Effect of hurricanes and commutations2005
    
    
    2004
    
    
    2003
    
    
    2005
    
    
    2004
    
    
    2003(As restated)
    
    
    (As restated)
    
    
    (As restated)Gross incurred loss and
loss adjustment expense
    
    $
    1,596,773
    
    
    $
    1,289,155
    
    
    $
    1,045,339
    
    
    $
    394,625
    
    
    $
    89,795
    
    
    $
    Net incurred loss and
loss adjustment expense
    
    
    919,697
    
    
    
    645,230
    
    
    
    488,000
    
    
    
    99,226
    
    
    
    23,335
    
    
    
    28,751Ceded earned premium
    
    
    617,402
    
    
    
    849,610
    
    
    
    748,799
    
    
    
    16,533
    
    
    
    9,806
    
    
    
    Net earnings (loss)
    
    
    191,192
    
    
    
    162,699
    
    
    
    142,027
    
    
    
    (75,171
    )
    
    
    (21,464
    )
    
    
    (18,688
    )Diluted earnings (loss) per share
    
    
    1.75
    
    
    
    1.65
    
    
    
    1.47
    
    
    
    (0.69
    )
    
    
    (0.22
    )
    
    
    (0.19
    )
  2005
    
    
    2004
    
    
    2003(As restated)
    
    
    (As restated)
    
    
    (As restated)Ratios:Net loss ratio
    
    
    67.1
    %
    
    
    63.8
    %
    
    
    66.1
    %Expense ratio
    
    
    26.1
    
    
    
    26.7
    
    
    
    24.6Combined ratio
    
    
    93.2
    %
    
    
    90.5
    %
    
    
    90.7
    %Effect of hurricanes and commutations:Net loss ratio
    
    
    7.9
    %
    
    
    2.9
    %
    
    
    3.9
    %Expense ratio
    
    
    0.3
    
    
    
    0.3
    
    
    
    Combined ratio
    
    
    8.2
    %
    
    
    3.2
    %
    
    
    3.9
    %
 54




---



##### Table of Contents



2005
    
    
    2004
    
    
    2003(As restated)
    
    
    (As restated)
    
    
    (As restated)Net earned premium
    
    
    83.4
    %
    
    
    78.7
    %
    
    
    78.4
    %Fee and commission income
    
    
    8.1
    
    
    
    14.3
    
    
    
    15.1Net investment income
    
    
    6.0
    
    
    
    5.1
    
    
    
    5.0Net realized investment gain
    
    
    0.1
    
    
    
    0.4
    
    
    
    0.1Other operating income
    
    
    2.4
    
    
    
    1.5
    
    
    
    1.4Total revenue
    
    
    100.0
    
    
    
    100.0
    
    
    
    100.0Loss and loss adjustment expense, net
    
    
    56.0
    
    
    
    50.2
    
    
    
    51.8Policy acquisition costs, net
    
    
    15.9
    
    
    
    17.3
    
    
    
    14.6Other operating expense
    
    
    11.0
    
    
    
    13.1
    
    
    
    15.3Interest expense
    
    
    0.5
    
    
    
    0.7
    
    
    
    0.8Earnings from continuing operations
before income tax expense
    
    
    16.6
    
    
    
    18.7
    
    
    
    17.5Income tax expense
    
    
    5.1
    
    
    
    6.3
    
    
    
    6.3Earnings from continuing operations
    
    
    11.5
    %
    
    
    12.4
    %
    
    
    11.2
    %
   2005
    
    
    2004
    
    
    2003Gross written premium
    
    $
    2,038,286
    
    
    $
    1,975,153
    
    
    $
    1,739,894Net written premium
    
    
    1,501,224
    
    
    
    1,105,519
    
    
    
    865,502Net earned premium
    
    
    1,369,988
    
    
    
    1,010,692
    
    
    
    738,272
  2005
    
    
    2004
    
    
    2003(As restated)
    
    
    (As restated)Agencies
    
    $
    94,972
    
    
    $
    127,453
    
    
    $
    105,899Insurance companies
    
    
    37,656
    
    
    
    56,349
    
    
    
    43,244Other
    
    
    
    
    
    
    
    
    
    
    (6,528
    )Fee and commission income
    
    $
    132,628
    
    
    $
    183,802
    
    
    $
    142,615
 55




---



##### Table of Contents



2005
    
    
    2004
    
    
    2003Fixed income securities
    
    $
    77,842
    
    
    $
    55,929
    
    
    $
    40,927Short-term investments
    
    
    21,208
    
    
    
    9,735
    
    
    
    7,422Other investments
    
    
    3,615
    
    
    
    1,366
    
    
    
    488Total investment income
    
    
    102,665
    
    
    
    67,030
    
    
    
    48,837Investment expense
    
    
    (3,814
    )
    
    
    (2,145
    )
    
    
    (1,502
    )Net investment income
    
    $
    98,851
    
    
    $
    64,885
    
    
    $
    47,335
    56




---



##### Table of Contents



2005
    
    
    2004
    
    
    2003Trading securities
    
    $
    16,619
    
    
    $
    2,604
    
    
    $
    5,583Strategic investments
    
    
    10,241
    
    
    
    5,103
    
    
    
    3,212Sale of non-operating assets
    
    
    4,271
    
    
    
    1,531
    
    
    
    Financial instruments
    
    
    3,898
    
    
    
    4,297
    
    
    
    Other
    
    
    4,744
    
    
    
    5,871
    
    
    
    4,420Other operating income
    
    $
    39,773
    
    
    $
    19,406
    
    
    $
    13,215
      Segments
  Insurance Company Segment
  57




---



##### Table of Contents



Premium
   2005
    
    
    2004
    
    
    2003Amount
    
    
    %
    
    
    Amount
    
    
    %
    
    
    Amount
    
    
    %Primary
    
    $
    1,768,284
    
    
    
    87
    %
    
    $
    1,674,075
    
    
    
    85
    %
    
    
    1,377,999
    
    
    $
    79
    %Reinsurance assumed
    
    
    270,002
    
    
    
    13
    
    
    
    301,078
    
    
    
    15
    
    
    
    361,895
    
    
    
    21Gross written premium
    
    
    2,038,286
    
    
    
    100
    
    
    
    1,975,153
    
    
    
    100
    
    
    
    1,739,894
    
    
    
    100Reinsurance ceded
    
    
    (537,062
    )
    
    
    (26
    )
    
    
    (869,634
    )
    
    
    (44
    )
    
    
    (874,392
    )
    
    
    (50
    )Net written premium
    
    
    1,501,224
    
    
    
    74
    
    
    
    1,105,519
    
    
    
    56
    
    
    
    865,502
    
    
    
    50Change in unearned premium
    
    
    (131,236
    )
    
    
    (7
    )
    
    
    (94,827
    )
    
    
    (5
    )
    
    
    (127,230
    )
    
    
    (8
    )Net earned premium
    
    $
    1,369,988
    
    
    
    67
    %
    
    $
    1,010,692
    
    
    
    51
    %
    
    $
    738,272
    
    
    
    42
    %
  Gross
    
    
    Net
    
    
    NWP
    
    
    Netwritten
    
    
    written
    
    
    as % of
    
    
    earnedpremium
    
    
    premium
    
    
    GWP
    
    
    premiumYear ended December 31, 2005Diversified financial products
    
    $
    908,526
    
    
    $
    675,942
    
    
    
    74
    %
    
    $
    531,136Group life, accident and health
    
    
    593,382
    
    
    
    502,805
    
    
    
    85
    
    
    
    504,382Aviation
    
    
    210,530
    
    
    
    130,743
    
    
    
    62
    
    
    
    136,197London market account
    
    
    144,425
    
    
    
    78,809
    
    
    
    55
    
    
    
    93,017Other specialty lines
    
    
    176,139
    
    
    
    109,106
    
    
    
    62
    
    
    
    97,721Discontinued lines
    
    
    5,284
    
    
    
    3,819
    
    
    nm
    
    
    
    7,535Totals
    
    $
    2,038,286
    
    
    $
    1,501,224
    
    
    
    74
    %
    
    $
    1,369,988
 58




---



##### Table of Contents



Gross
    
    
    Net
    
    
    NWP
    
    
    Netwritten
    
    
    written
    
    
    as % of
    
    
    earnedpremium
    
    
    premium
    
    
    GWP
    
    
    premiumYear ended December
31, 2004Diversified financial products
    
    $
    857,299
    
    
    $
    404,870
    
    
    
    47
    %
    
    $
    310,809Group life, accident and health
    
    
    584,747
    
    
    
    343,996
    
    
    
    59
    
    
    
    343,913Aviation
    
    
    204,963
    
    
    
    144,687
    
    
    
    71
    
    
    
    127,248London market account
    
    
    178,950
    
    
    
    107,509
    
    
    
    60
    
    
    
    111,341Other specialty lines
    
    
    133,964
    
    
    
    83,980
    
    
    
    63
    
    
    
    69,089Discontinued lines
    
    
    15,230
    
    
    
    20,477
    
    
    
    nm
    
    
    
    48,292Totals
    
    $
    1,975,153
    
    
    $
    1,105,519
    
    
    
    56
    %
    
    $
    1,010,692Year ended December
31, 2003Diversified financial products
    
    $
    553,501
    
    
    $
    183,560
    
    
    
    33
    %
    
    $
    123,562Group life, accident and health
    
    
    565,494
    
    
    
    299,913
    
    
    
    53
    
    
    
    290,009Aviation
    
    
    214,718
    
    
    
    99,447
    
    
    
    46
    
    
    
    97,536London market account
    
    
    223,149
    
    
    
    155,987
    
    
    
    70
    
    
    
    137,572Other specialty lines
    
    
    73,475
    
    
    
    36,837
    
    
    
    50
    
    
    
    12,443Discontinued lines
    
    
    109,557
    
    
    
    89,758
    
    
    
    nm
    
    
    
    77,150Totals
    
    $
    1,739,894
    
    
    $
    865,502
    
    
    
    50
    %
    
    $
    738,272
   
    
    Diversified financial products   The largest gross and net premium growth in 2005 and
2004 was in our diversified financial products line of business. We experienced significant
growth in our directors and officers liability gross written premium in 2004. In
response to some increased competition and a reduction in available reinsurance at an
acceptable cost, we scaled back our writing of this business in 2005. Rates for the other
products in this line have been relatively stable with the exception of surety for which
rates have been increasing. Our professional indemnity and surety business increased in
2005 due to organic growth and acquisitions. The growth in net written and net earned
premium in both years was due to increased retentions resulting from a reduction in
proportional reinsurance, some of which has been replaced by excess of loss reinsurance.
    
    Group life, accident and health   Profit margins remain at acceptable levels despite
increased competition from the fully insured market. We increased our retentions in 2005
and 2004 as this line of business generally is not volatile and has very little catastrophe
exposure.
    
    Aviation   Our aviation premium retention levels were mostly unchanged in 2005 after
excluding the effects of a portfolio transfer that occurred in 2004. This 2004 portfolio
transfer recaptured ceded unearned premium and increased net written premium, but not gross
written premium, as a result of a reduction in ceded reinsurance. There has been
increasing competition in the international aviation component of this line, but margins
are still acceptable. Our domestic business is very stable.
 59




---



##### Table of Contents




    
    London market account   We reduced our London market account premium writings in 2004
and again in 2005, due to more selective underwriting in response to reduced premium rates
from increased competition. Premium rates have generally increased in 2006 as a result of
the hurricane losses. Net written premium was reduced by $18.7 million in 2005 and $15.3
million in 2004 for additional excess of loss premium to reinstate catastrophe reinsurance
coverage, which distorts the retention percentages. Because of the catastrophe exposure,
we purchase excess of loss reinsurance at a significant cost. Since there generally is a
fixed minimum cost, the retention percentage decreases as our written premium decreases.
    
    Other specialty lines   We experienced organic growth in our other specialty lines of
business from increased writings in several products. The mix of products will affect the
retention percentages. Rates in this line have been relatively stable.
 Reinsurance
     60




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##### Table of Contents



Losses and Loss Adjustment Expenses
  2005
    
    
    2004
    
    
    2003(As restated)Loss
    
    
    
    
    
    
    Loss
    
    
    
    
    
    
    LossAmount
    
    
    ratio
    
    
    Amount
    
    
    ratio
    
    
    Amount
    
    
    ratio2005 hurricanes
    
    $
    394,625
    
    
    
    19.9
    %
    
    $
    
    
    
    
    
    %
    
    $
    
    
    
    
    
    %2004 hurricanes
    
    
    (13,423
    )
    
    
    (0.7
    )
    
    
    89,795
    
    
    
    4.8
    
    
    
    
    
    
    
    Other reserve redundancies
    
    
    (7,080
    )
    
    
    (0.4
    )
    
    
    (11,594
    )
    
    
    (0.6
    )
    
    
    (10,423
    )
    
    
    (0.7
    )Discontinued line of
business
adjustments
    
    
    49,775
    
    
    
    2.5
    
    
    
    127,707
    
    
    
    6.9
    
    
    
    132,924
    
    
    
    8.9All other gross incurred
loss and loss
adjustment expense
    
    
    1,172,876
    
    
    
    59.0
    
    
    
    1,083,247
    
    
    
    58.2
    
    
    
    922,838
    
    
    
    62.1Gross incurred
loss and loss
expense adjustment
    
    $
    1,596,773
    
    
    
    80.3
    %
    
    $
    1,289,155
    
    
    
    69.3
    %
    
    $
    1,045,339
    
    
    
    70.3
    %
   61




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##### Table of Contents



2005
    
    
    2004
    
    
    2003(As restated)
    
    
    
    
    
    
    
    
    
    
    (As restated)Loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    LossAmount
    
    
    ratio
    
    
    Amount
    
    
    Loss ratio
    
    
    Amount
    
    
    ratio2005 hurricanes
    
    $
    73,185
    
    
    
    5.3
    %
    
    $
    
    
    
    
    
    %
    
    $
    
    
    
    
    
    %2004 hurricanes
    
    
    (7,167
    )
    
    
    (0.5
    )
    
    
    23,335
    
    
    
    2.3
    
    
    
    
    
    
    
    Commutations
    
    
    26,041
    
    
    
    1.9
    
    
    
    
    
    
    
    
    
    
    
    28,751
    
    
    
    3.9Discontinued line of
business adjustments
    
    
    8,929
    
    
    
    0.7
    
    
    
    27,326
    
    
    
    2.7
    
    
    
    
    
    
    
    Other reserve
deficiencies
(redundancies)
    
    
    (2,409
    )
    
    
    (0.2
    )
    
    
    3,152
    
    
    
    0.3
    
    
    
    (5,637
    )
    
    
    (0.8
    )All other net incurred
loss and
loss adjustment
expense
    
    
    821,118
    
    
    
    59.9
    
    
    
    591,417
    
    
    
    58.5
    
    
    
    464,886
    
    
    
    63.0Net incurred
loss and
loss adjustment
expense
    
    $
    919,697
    
    
    
    67.1
    %
    
    $
    645,230
    
    
    
    63.8
    %
    
    $
    488,000
    
    
    
    66.1
    %
   2005
    
    
    2004
    
    
    2003Net
    
    
    Net
    
    
    Net
    
    
    Net
    
    
    Net
    
    
    Netearned
    
    
    loss
    
    
    earned
    
    
    loss
    
    
    earned
    
    
    losspremium
    
    
    ratio
    
    
    premium
    
    
    ratio
    
    
    premium
    
    
    ratio(As
    
    
    
    
    
    
    (As
    
    
    
    
    
    
    (Asrestated)
    
    
    
    
    
    
    restated)
    
    
    
    
    
    
    restated)Diversified financial products
    
    $
    531,136
    
    
    
    48.1
    %
    
    $
    310,809
    
    
    
    47.6
    %
    
    $
    123,562
    
    
    
    47.8
    %Group life, accident and health
    
    
    504,382
    
    
    
    71.6
    
    
    
    343,913
    
    
    
    66.7
    
    
    
    290,009
    
    
    
    61.6Aviation
    
    
    136,197
    
    
    
    67.3
    
    
    
    127,248
    
    
    
    63.2
    
    
    
    97,536
    
    
    
    61.5London market account
    
    
    93,017
    
    
    
    106.0
    
    
    
    111,341
    
    
    
    65.9
    
    
    
    137,572
    
    
    
    52.8Other specialty lines
    
    
    97,721
    
    
    
    72.6
    
    
    
    69,089
    
    
    
    63.5
    
    
    
    12,443
    
    
    
    62.1Discontinued lines
    
    
    7,535
    
    
    
    551.3
    
    
    
    48,292
    
    
    
    145.2
    
    
    
    77,150
    
    
    
    142.6Totals
    
    $
    1,369,988
    
    
    
    67.1
    %
    
    $
    1,010,692
    
    
    
    63.8
    %
    
    $
    738,272
    
    
    
    66.1
    %Expense ratio
    
    
    
    
    
    
    26.1
    
    
    
    
    
    
    
    26.7
    
    
    
    
    
    
    
    24.6Combined ratio
    
    
    
    
    
    
    93.2
    %
    
    
    
    
    
    
    90.5
    %
    
    
    
    
    
    
    90.7
    %
 62




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##### Table of Contents




    
    Group life, accident and health  Rate pressure from competition as well as
medical cost inflation have resulted in increasing loss ratios in this line of business,
however our underwriting margins remain satisfactory.
    
    Aviation  The 2005 hurricanes increased the net loss ratio 5.0% and the 2004
hurricanes increased the net loss ratio 6.5%. The 2005 net loss ratio also includes the
positive impact from the release of redundant reserves related to the 2004 hurricanes.
Excluding the impact of the hurricanes, 2005 had worse than expected underwriting
experience due to some unusually large international losses.
    
    London market account  The 2005 hurricanes increased the net loss ratio
63.2% and the 2004 hurricanes increased the net loss ratio 14.1%. The London market
account line of business can have relatively high year-to-year volatility due to
catastrophe exposure.
    
    Other specialty lines The 2005 hurricanes increased the net loss ratio 14.0%
and the 2004 hurricanes increased the net loss ratio 6.5%.
    
    Discontinued lines  The commutation losses in 2005 and 2003 affected the net
loss ratios for those years. In addition, the 2005 and 2004 net loss ratios were impacted
by loss reserve strengthening of $8.9 million and $27.3 million, respectively, on certain
assumed accident and health reinsurance contracts.
 Policy Acquisition Costs
  Statutory
  Agency Segment
  63




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##### Table of Contents



Liquidity and Capital Resources
 Cash Flow
 .
    2005
    
    
    2004
    
    
    2003(As restated)
    
    
    (As restated)
    
    
    (As restated)Net earnings
    
    $
    191,192
    
    
    $
    162,699
    
    
    $
    142,027Change in premium, claims and other receivables,
net of reinsurance, other payables and
restricted cash
    
    
    (59,717
    )
    
    
    237
    
    
    
    (26,513
    )Change in unearned premium, net
    
    
    121,242
    
    
    
    104,895
    
    
    
    133,894Change in loss and loss adjustment expense payable,
net of reinsurance recoverables
    
    
    454,859
    
    
    
    349,813
    
    
    
    262,818Gain on sale of subsidiaries
    
    
    (8,717
    )
    
    
    (6,317
    )
    
    
    (52,681
    )Change in trading portfolio
    
    
    (66,809
    )
    
    
    25,673
    
    
    
    12,741Other, net
    
    
    (8,060
    )
    
    
    31,703
    
    
    
    55,812Cash provided by operating activities
    
    $
    623,990
    
    
    $
    668,703
    
    
    $
    528,098
  64




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##### Table of Contents



Investments
      2005
    
    
    2004
    
    
    2003Average investments, at cost
    
    $
    2,822,686
    
    
    $
    2,054,620
    
    
    $
    1,403,690Net investment income *
    
    
    98,851
    
    
    
    64,885
    
    
    
    47,335Average short-term yield *
    
    
    2.7
    %
    
    
    1.7
    %
    
    
    1.8
    %Average long-term yield *
    
    
    4.0
    %
    
    
    3.9
    %
    
    
    4.2
    %Average long-term tax equivalent yield *
    
    
    4.9
    %
    
    
    4.8
    %
    
    
    5.0
    %Weighted average combined tax equivalent yield *
    
    
    4.1
    %
    
    
    3.8
    %
    
    
    3.8
    %Weighted average maturity
    
    
    7.6
    years
    
    
    6.6
    years
    
    
    4.5
    yearsWeighted average duration
    
    
    4.9
    years
    
    
    4.6
    years
    
    
    3.7
    yearsAverage S&P rating
    
    AAA
    
    AAA
    
    AA+
 
 *
    
    Excluding realized and unrealized investment gains and losses. 65




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##### Table of Contents



Amount
    
    
    %Short-term investments
    
    $
    839,581
    
    
    
    26
    %U.S. government
    
    
    89,724
    
    
    
    3States, municipalities and political subdivisions
    
    
    418,873
    
    
    
    13Special revenue fixed income securities
    
    
    723,101
    
    
    
    22Corporate fixed income securities
    
    
    375,582
    
    
    
    11Asset-backed and mortgage-backed securities
    
    
    355,372
    
    
    
    11Foreign securities
    
    
    305,972
    
    
    
    9Other investments
    
    
    149,223
    
    
    
    5Total investments
    
    $
    3,257,428
    
    
    
    100
    %
  Amount
    
    
    %AAA
    
    $
    1,593,663
    
    
    
    70
    %AA
    
    
    273,714
    
    
    
    12A
    
    
    390,074
    
    
    
    17BBB
    
    
    10,526
    
    
    
    1BB and below
    
    
    647
    
    
    
    Total fixed income securities
    
    $
    2,268,624
    
    
    
    100
    %
  Amount
    
    
    %One year or less
    
    $
    146,924
    
    
    
    6
    %One year to five years
    
    
    561,240
    
    
    
    25Five years to ten years
    
    
    467,542
    
    
    
    21Ten years to fifteen years
    
    
    301,264
    
    
    
    13More than fifteen years
    
    
    436,282
    
    
    
    19Securities with fixed maturities
    
    
    1,913,252
    
    
    
    84Asset-backed and mortgage-backed securities
    
    
    355,372
    
    
    
    16Total fixed income securities
    
    $
    2,268,624
    
    
    
    100
    %
   66




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##### Table of Contents



Maturities / Estimated payment datesTotal
    
    
    2006
    
    
    2007-2008
    
    
    2009-2010
    
    
    ThereafterCash and investment maturities
of insurance companies
    
    $
    2,969,277
    
    
    $
    897,421
    
    
    $
    469,980
    
    
    $
    380,460
    
    
    $
    1,221,416Estimated loss and loss adjustment
expense payments, net of
reinsurance
    
    
    1,533,433
    
    
    
    537,968
    
    
    
    552,721
    
    
    
    259,741
    
    
    
    183,003Estimated available cash flow
    
    $
    1,435,844
    
    
    $
    359,453
    
    
    $
    (82,741
    )
    
    $
    120,719
    
    
    $
    1,038,413
  67




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##### Table of Contents



Contractual Obligations
  Estimated Payment DatesTotal
    
    
    2006
    
    
    2007-2008
    
    
    2009-2010
    
    
    ThereafterGross loss and loss adjustment
expense payable (1)Diversified financial products
    
    $
    953,131
    
    
    $
    199,984
    
    
    $
    388,204
    
    
    $
    238,847
    
    
    $
    126,096Group life, accident and health
    
    
    204,100
    
    
    
    169,698
    
    
    
    26,734
    
    
    
    6,077
    
    
    
    1,591Aviation
    
    
    193,242
    
    
    
    95,036
    
    
    
    65,946
    
    
    
    21,309
    
    
    
    10,951London market account
    
    
    578,253
    
    
    
    239,558
    
    
    
    284,154
    
    
    
    48,084
    
    
    
    6,457Other specialty lines
    
    
    195,918
    
    
    
    93,245
    
    
    
    75,064
    
    
    
    22,276
    
    
    
    5,333Discontinued lines
    
    
    689,076
    
    
    
    146,469
    
    
    
    222,988
    
    
    
    122,863
    
    
    
    196,756Total loss and loss adjustment
expense payable
    
    
    2,813,720
    
    
    
    943,990
    
    
    
    1,063,090
    
    
    
    459,456
    
    
    
    347,184Life and annuity policy benefits
    
    
    73,415
    
    
    
    1,859
    
    
    
    3,577
    
    
    
    3,397
    
    
    
    64,5821.30% Convertible Notes (2) (3)
    
    
    125,812
    
    
    
    125,812
    
    
    
    
    
    
    
    
    
    
    
    2.00% Convertible Exchange Notes (2) (3)
    
    
    174,120
    
    
    
    174,120
    
    
    
    
    
    
    
    
    
    
    
    Other notes payable (3)
    
    
    13,899
    
    
    
    1,003
    
    
    
    11,753
    
    
    
    508
    
    
    
    635$200.0 million Revolving Loan Facility
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Operating leases
    
    
    59,123
    
    
    
    10,582
    
    
    
    18,936
    
    
    
    12,150
    
    
    
    17,455Earnout liabilities
    
    
    32,318
    
    
    
    32,318
    
    
    
    
    
    
    
    
    
    
    
    Indemnifications
    
    
    20,748
    
    
    
    13,294
    
    
    
    1,968
    
    
    
    2,172
    
    
    
    3,314Total obligations
    
    $
    3,313,155
    
    
    $
    1,302,978
    
    
    $
    1,099,324
    
    
    $
    477,683
    
    
    $
    433,170
  (1)
    
    The estimated loss and loss adjustment expense payments for future periods assume that the
percentage of ultimate losses paid from one period to the next will be relatively consistent
over time. Actual payments will be influenced by many factors and could vary from the
estimated amounts above.(2)
    
    The 1.30% Convertible Notes mature in 2023 and the 2.00% Convertible Exchange Notes mature in
2021, but are shown in the 2006 column since they may be surrendered for cash at the option of
the holders in the first quarter of 2006 because our stock traded at specified price levels in
2005. Both convertible notes have various put and redemption dates as disclosed in Note 6 to
the Consolidated Financial Statements.(3)
    
    Amounts include interest payable in respective periods.
   68




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Subsidiary Dividends
   Lines of Credit
    69




---



##### Table of Contents



Other
       70




---



##### Table of Contents



Impact of Inflation
    Foreign Exchange Rate Fluctuations
  Critical Accounting Policies
  Loss and Loss Adjustment Expense
  71




---



##### Table of Contents



Recorded
    
    
    Actuarial
    
    
    Low end of
    
    
    High end ofnet reserves
    
    
    point estimate
    
    
    actuarial range
    
    
    actuarial rangeTotal net reserves
    
    $
    1,533,433
    
    
    $
    1,509,149
    
    
    $
    1,418,139
    
    
    $
    1,647,937Individual lines of business:Diversified financial products
    
    $
    551,350
    
    
    $
    548,060
    
    
    $
    477,296
    
    
    $
    644,673Group life, accident and health
    
    
    162,076
    
    
    
    165,545
    
    
    
    151,301
    
    
    
    181,882Aviation
    
    
    104,727
    
    
    
    97,998
    
    
    
    91,060
    
    
    
    106,615London market account
    
    
    197,142
    
    
    
    192,228
    
    
    
    182,571
    
    
    
    217,638Other specialty lines
    
    
    105,020
    
    
    
    98,112
    
    
    
    92,944
    
    
    
    108,997Discontinued lines
    
    
    413,118
    
    
    
    407,206
    
    
    
    358,389
    
    
    
    490,719Total net reserves
    
    $
    1,533,433
   72




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##### Table of Contents



ClaimsCharacteristicsSpeed ofloss
    
    Reserve
    
    Major actuarialLine of Business
    
    Products
    
    Underwriting
    
    Duration
    
    reporting
    
    volatility
    
    assumptionsDiversified 
financial products
    
    Directors and
officers liability
    
    Primary
    
    Medium
    
    Moderate
    
    Medium
    
    Historical and industry loss
reporting patternsProfessional
indemnity
    
    Primary
    
    Medium
    
    Moderate
    
    Low
    
    Historical loss reporting patternsSurety
    
    Primary
    
    Medium
    
    Fast
    
    Low
    
    Historical loss payment and
reporting patternsGroup life,
accident and health
    
    Medical stop-loss
    
    Primary
    
    Short
    
    Fast
    
    Low
    

Medical cost and utilization
trends
Historical loss payment and reporting
      patterns
Rate changesAviation
    
    Aviation
    
    Primary and
subscription
    
    Medium
    
    Fast
    
    Medium
    
    Historical loss payment and
reporting patterns
Rate changesLondon 
market 
account
    
    Accident
and health
    
    Primary and assumed
    
    Medium to Long
    
    Slow
    
    High
    
    Historical loss payment and
reporting patternsEnergy *
    
    Subscription
    
    Medium
    
    Moderate
    
    Medium
    
    Historical loss payment and
reporting patterns
Historical severity and frequency
Historical large loss experienceProperty *
    
    Subscription
    
    Medium
    
    Moderate
    
    Medium
    
    Historical loss payment and
reporting patterns
Historical severity and frequency
Historical large loss experienceOther specialty
    
    Surplus lines
business
    
    Assumed
    
    Medium
    
    Moderate
    
    Medium
    
    Historical loss payment and
reporting patternsDiscontinued
    
    Accident and health
reinsurance
    
    Assumed
    
    Long
    
    Slow
    
    High
    
    Historical and industry loss
payment and     reporting patterns
 
 *
    
    Includes catastrophe losses 73




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74




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##### Table of Contents



% Net IBNRto net totalGross
    
    
    Ceded
    
    
    Net
    
    
    reserves(As restated)
    
    
    (As restated)At December 31, 2005Reported loss reserves:Diversified financial products
    
    $
    319,000
    
    
    $
    126,665
    
    
    $
    192,335Group life, accident and health
    
    
    129,601
    
    
    
    6,366
    
    
    
    123,235Aviation
    
    
    118,122
    
    
    
    55,602
    
    
    
    62,520London market account
    
    
    345,605
    
    
    
    260,473
    
    
    
    85,132Other specialty lines
    
    
    51,634
    
    
    
    27,590
    
    
    
    24,044Subtotal reported reserves
    
    
    963,962
    
    
    
    476,696
    
    
    
    487,266Incurred but not reported reserves:Diversified financial products
    
    
    634,131
    
    
    
    275,116
    
    
    
    359,015
    
    
    
    65
    %Group life, accident and health
    
    
    74,499
    
    
    
    35,658
    
    
    
    38,841
    
    
    
    24Aviation
    
    
    75,120
    
    
    
    32,913
    
    
    
    42,207
    
    
    
    40London market account
    
    
    232,648
    
    
    
    120,638
    
    
    
    112,010
    
    
    
    57Other specialty lines
    
    
    144,284
    
    
    
    63,308
    
    
    
    80,976
    
    
    
    77Subtotal incurred but not reported reserves
    
    
    1,160,682
    
    
    
    527,633
    
    
    
    633,049
    
    
    
    57Discontinued lines reported reserves
    
    
    437,681
    
    
    
    159,529
    
    
    
    278,152Discontinued lines incurred but not reported
reserves
    
    
    251,395
    
    
    
    116,429
    
    
    
    134,966
    
    
    
    33Total loss and loss adjustment expense
payable
    
    $
    2,813,720
    
    
    $
    1,280,287
    
    
    $
    1,533,433
    
    
    
    50
    %
 75




---



##### Table of Contents



% Net IBNRto net totalGross
    
    
    Ceded
    
    
    Net
    
    
    reservesAt December 31, 2004Reported loss reserves:Diversified financial products
    
    $
    149,448
    
    
    $
    64,852
    
    
    $
    84,596Group life, accident and health
    
    
    128,973
    
    
    
    31,235
    
    
    
    97,738Aviation
    
    
    108,277
    
    
    
    48,301
    
    
    
    59,976London market account
    
    
    182,585
    
    
    
    106,249
    
    
    
    76,336Other specialty lines
    
    
    26,717
    
    
    
    14,349
    
    
    
    12,368Subtotal reported reserves
    
    
    596,000
    
    
    
    264,986
    
    
    
    331,014Incurred but not reported reserves:Diversified financial products
    
    
    462,795
    
    
    
    257,853
    
    
    
    204,942
    
    
    
    71
    %Group life, accident and health
    
    
    90,396
    
    
    
    30,131
    
    
    
    60,265
    
    
    
    38Aviation
    
    
    55,169
    
    
    
    24,117
    
    
    
    31,052
    
    
    
    34London market account
    
    
    98,530
    
    
    
    31,090
    
    
    
    67,440
    
    
    
    47Other specialty lines
    
    
    62,206
    
    
    
    28,930
    
    
    
    33,276
    
    
    
    73Subtotal incurred but not reported reserves
    
    
    769,096
    
    
    
    372,121
    
    
    
    396,975
    
    
    
    55Discontinued lines reported reserves
    
    
    453,394
    
    
    
    241,481
    
    
    
    211,913Discontinued lines incurred but not reported
reserves
    
    
    270,709
    
    
    
    151,328
    
    
    
    119,381
    
    
    
    36Total loss and loss adjustment expense
payable
    
    $
    2,089,199
    
    
    $
    1,029,916
    
    
    $
    1,059,283
    
    
    
    49
    %
    
    
    Diversified financial products  Total net reserves in our diversified financial
products line of business increased $261.8 million from 2004 to 2005 as this relatively new
line of business continues to grow. The incurred but not reported portion of the total
reserves for this line of business is higher than in most of our other lines, since these
losses report slower and have a longer duration.
 76




---



##### Table of Contents




    
    Group life, accident and health  Incurred but not reported reserves have decreased and
reported reserves have increased due to a speed up in the reporting of medical stop-loss
claims.
    
    London market account  Total net reserves in our London market account increased $53.4
million and the percentage of incurred but not reported reserves increased in 2005, due to
estimated unreported claims for the 2005 hurricanes.
    
    Discontinued lines  Total net reserves for our discontinued lines increased $81.8
million in 2005 primarily as a result of a commutation. The percentage of net incurred but
not reported reserves to total reserves for discontinued lines decreased to 33% as claims
continued to be reported and reported reserves were reassessed.
   Reinsurance Recoverables
  .
  77




---



##### Table of Contents



Deferred Taxes
  Valuation of Goodwill
 Using Cash Flow Information and
Present Values in Accounting Measurements
 Other-Than-Temporary Impairments on Investments
  Recent Accounting Pronouncements
 Share-Based Payment
 Share-Based Payment
  78




---



##### Table of Contents



Other-Than-Temporary Impairments
 The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments. The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments.
 79




---



##### Table of Contents



Accounting Changes and Corrections
 Accounting Changes and Error Corrections Accounting Changes Reporting Accounting Changes in Interim Financial
Statements.
 Uncertainty in Income Taxes
 Accounting for Uncertainty in Income Taxes
 Fair Value Measurements
 Fair Value Measurements
 Prior Year Misstatements
 Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year
Financial Statements.
 
 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
   Interest Rate Risk
  80




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##### Table of Contents



Foreign Exchange Risk
  December 31,2005
    
    
    2004Hypothetical
    
    
    
    
    
    
    HypotheticalU.S. dollar
    
    
    10% change
    
    
    U.S. dollar
    
    
    10% changeequivalent
    
    
    in fair value
    
    
    equivalent
    
    
    in fair valueBritish pound sterling
    
    $
    11,590
    
    
    $
    1,159
    
    
    $
    6,163
    
    
    $
    616Euro
    
    
    2,291
    
    
    
    229
    
    
    
    2,117
    
    
    
    212Canadian dollar
    
    
    522
    
    
    
    52
    
    
    
    2,537
    
    
    
    254
  
 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
  
 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES
  
 ITEM 9A. CONTROLS AND PROCEDURES
 a. Disclosure Controls and Procedures
 Background of Restatement
  81




---



##### Table of Contents



Accounting for
Stock Issued to Employees
  Evaluation of Disclosure Controls and Procedures
   82




---



##### Table of Contents



Managements Report on Internal Control Over Financial Reporting (Restated)
   Internal Control-Integrated Framework
    Internal Control-Integrated Framework.
 83




---



##### Table of Contents



Changes in Internal Control Over Financial Reporting
  Remediation Plans
  
    
    Before the Board of Directors reviewed the results
of the investigation, the Chairman of our Compensation Committee tendered his resignation from the Board of
Directors on November 8, 2006. After reviewing the results of the investigation, our Board of Directors determined that
it would be appropriate to accept the resignations of our former CEO
and General Counsel, which both tendered on November 17, 2006.
Our Board of Directors has appointed a new Chairman of our Compensation Committee and a new
CEO who, together with other members of our senior management, are committed to achieving
transparency through effective corporate governance, a strong control environment,
application of business standards reflected in our Code of Business Conduct and Ethics, and
completeness and integrity of our financial reporting and disclosure.
    
    We have changed our option granting approval policies and procedures to require
Compensation Committee approval of all new option grants on the day of each Compensation
Committee meeting preceding the regularly scheduled quarterly Board of Directors meeting.
All grants will be appropriately approved and documented in minutes of the meeting, taken
contemporaneously with the meeting. All grants will be priced at the market closing price
on the day of each such Compensation Committee meeting. We have established processes and
procedures to increase the level of communication between the Compensation Committee,
senior management and our financial reporting and accounting personnel regarding stock
option grants.
  
 ITEM 9B. OTHER INFORMATION
  84




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##### Table of Contents



PART III
 
 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
 Code of Business Conduct and Ethics
 www.hcc.com
   
 ITEM 11. EXECUTIVE COMPENSATION
  
 ITEM 12.
    
    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS
  
 ITEM 13.
    
    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
   85




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##### Table of Contents



ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
  
 PART IV
 
 ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
 (a) Financial Statement Schedules
  (b) Exhibits
  86




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##### Table of Contents



SIGNATURES
  HCC Insurance Holdings, Inc.
(Registrant)Dated: December 26, 2006
    By:
    /s/ FRANK J. BRAMANTI(Frank J. Bramanti)Chief Executive Officer  Name
    
    Title
    
    Date/s/ FRANK J. BRAMANTI

(Frank J. Bramanti)
    
    Director, Chief Executive Officer and
Principal Executive Officer
    
    December 26, 2006/s/ PATRICK B. COLLINS*

(Patrick B. Collins)
    
    Director
    
    December 26, 2006/s/ JAMES R. CRANE*

(James R. Crane)
    
    Director
    
    December 26, 2006/s/ J. ROBERT DICKERSON*

(J. Robert Dickerson)
    
    Director
    
    December 26, 2006/s/ WALTER M. DUER*

(Walter M. Duer)
    
    Director
    
    December 26, 2006/s/ EDWARD H. ELLIS, JR.

(Edward H. Ellis, Jr.)
    
    Director, Executive Vice President and Chief
Financial Officer (Chief Accounting
Officer)
    
    December 26, 2006/s/ JAMES C. FLAGG, PH.D.*

(James C. Flagg, Ph.D.)
    
    Director
    
    December 26, 2006/s/ ALLAN W. FULKERSON*

(Allan W. Fulkerson)
    
    Director
    
    December 26, 2006/s/ JOHN N. MOLBECK, JR.*

(John N. Molbeck, Jr.)
    
    Director, President and Chief Operating Officer
    
    December 26, 2006/s/ MICHAEL A. F. ROBERTS*

(Michael A. F. Roberts)
    
    Director
    
    December 26, 2006(Stephen L. Way)
    
    Chairman of the Board, Director
 By:
    */s/ EDWARD H. ELLIS, JR.Edward H. Ellis, Jr., Attorney-in-fact 87




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##### Table of Contents



INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
 Report of Independent Registered Public Accounting Firm
    
    
    F-1Consolidated
Balance Sheets at December 31, 2005 and 2004, As restated
    
    
    F-3Consolidated Statements of Earnings for the three years ended December 31, 2005, As restated
    
    
    F-4Consolidated Statements of Comprehensive Income for the three years ended December 31, 2005, As restated
    
    
    F-5Consolidated Statements of Changes in Shareholders Equity for the three years ended
December 31, 2005, As restated
    
    
    F-6Consolidated Statements of Cash Flows for the three years ended December 31, 2005, As restated
    
    
    F-7Notes to Consolidated Financial Statements
    
    
    F-8SCHEDULES:Schedule 1 Summary of Investments other than Investments in Related Parties
    
    
    S-1Schedule 2
Condensed Financial Information of Registrant, As restated
    
    
    S-2Schedule 3 Supplementary Insurance Information, As restated
    
    
    S-7Schedule 4 Reinsurance
    
    
    S-8Schedule 5 Valuation and Qualifying Accounts
    
    
    S-9
  88




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##### Table of Contents



Report of Independent Registered Public Accounting Firm
 
  Consolidated financial statements and financial statement schedules
 
  Internal control over financial reporting
 Internal Control  Integrated Framework
      F-1




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##### Table of Contents



Internal Control  Integrated Framework Internal Control  Integrated Framework
 
  F-2




---



##### Table of Contents



December 31,2005
    
    
    2004(As restated)
    
    
    (As restated)ASSETSInvestments:Fixed income securities, at fair value
(amortized cost: 2005 - $2,277,139; 2004 - $1,682,421)
    
    $
    2,268,624
    
    
    $
    1,703,171Short-term investments, at cost, which approximates fair value
    
    
    839,581
    
    
    
    729,985Other investments, at fair value (cost: 2005 - $144,897; 2004 - $34,137)
    
    
    149,223
    
    
    
    35,335Total investments
    
    
    3,257,428
    
    
    
    2,468,491Cash
    
    
    73,935
    
    
    
    69,933Restricted cash and cash investments
    
    
    170,978
    
    
    
    188,510Premium, claims and other receivables
    
    
    884,654
    
    
    
    891,360Reinsurance recoverables
    
    
    1,361,983
    
    
    
    1,104,026Ceded unearned premium
    
    
    239,416
    
    
    
    311,973Ceded life and annuity benefits
    
    
    73,415
    
    
    
    74,627Deferred policy acquisition costs
    
    
    156,253
    
    
    
    139,199Goodwill
    
    
    532,947
    
    
    
    444,031Other assets
    
    
    277,791
    
    
    
    208,418Total assets
    
    $
    7,028,800
    
    
    $
    5,900,568LIABILITIESLoss and loss adjustment expense payable
    
    $
    2,813,720
    
    
    $
    2,089,199Life and annuity policy benefits
    
    
    73,415
    
    
    
    74,627Reinsurance balances payable
    
    
    176,954
    
    
    
    217,938Unearned premium
    
    
    807,109
    
    
    
    741,706Deferred ceding commissions
    
    
    67,886
    
    
    
    93,480Premium and claims payable
    
    
    753,859
    
    
    
    766,765Notes payable
    
    
    309,543
    
    
    
    311,277Accounts payable and accrued liabilities
    
    
    335,879
    
    
    
    280,078Total liabilities
    
    
    5,338,365
    
    
    
    4,575,070SHAREHOLDERS EQUITYCommon stock, $1.00 par value; 250.0 million shares authorized
(shares issued and outstanding: 2005 - 110,803; 2004 - 102,057)
    
    
    110,803
    
    
    
    68,038Additional paid-in capital
    
    
    762,170
    
    
    
    582,566Retained earnings
    
    
    798,388
    
    
    
    637,259Accumulated other comprehensive income
    
    
    19,074
    
    
    
    37,635Total shareholders equity
    
    
    1,690,435
    
    
    
    1,325,498Total liabilities and shareholders equity
    
    $
    7,028,800
    
    
    $
    5,900,568
  F-3




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##### Table of Contents



Years ended December 31,2005
    
    
    2004
    
    
    2003(As restated)
    
    
    (As restated)
    
    
    (As restated)REVENUENet earned premium
    
    $
    1,369,988
    
    
    $
    1,010,692
    
    
    $
    738,272Fee and commission income
    
    
    132,628
    
    
    
    183,802
    
    
    
    142,615Net investment income
    
    
    98,851
    
    
    
    64,885
    
    
    
    47,335Net realized investment gain
    
    
    1,448
    
    
    
    5,822
    
    
    
    527Other operating income
    
    
    39,773
    
    
    
    19,406
    
    
    
    13,215Total revenue
    
    
    1,642,688
    
    
    
    1,284,607
    
    
    
    941,964EXPENSELoss and loss adjustment expense, net
    
    
    919,697
    
    
    
    645,230
    
    
    
    488,000Policy acquisition costs, net
    
    
    261,708
    
    
    
    222,323
    
    
    
    137,212Other operating expense
    
    
    180,990
    
    
    
    168,045
    
    
    
    144,574Interest expense
    
    
    7,684
    
    
    
    8,374
    
    
    
    7,453Total expense
    
    
    1,370,079
    
    
    
    1,043,972
    
    
    
    777,239Earnings from continuing operations
before income tax expense
    
    
    272,609
    
    
    
    240,635
    
    
    
    164,725Income tax expense on continuing operations
    
    
    84,177
    
    
    
    81,940
    
    
    
    59,382Earnings from continuing operations
    
    
    188,432
    
    
    
    158,695
    
    
    
    105,343Earnings from discontinued operations, net of income taxes
of $1,686 in 2005, $2,313 in 2004 and $26,289 in 2003
    
    
    2,760
    
    
    
    4,004
    
    
    
    36,684Net earnings
    
    $
    191,192
    
    
    $
    162,699
    
    
    $
    142,027Basic earnings per share data:Earnings from continuing operations
    
    $
    1.78
    
    
    $
    1.63
    
    
    $
    1.11Earnings from discontinued operations
    
    
    0.03
    
    
    
    0.04
    
    
    
    0.39Net earnings
    
    $
    1.81
    
    
    $
    1.67
    
    
    $
    1.50Weighted average shares outstanding
    
    
    105,463
    
    
    
    97,257
    
    
    
    94,919Diluted earnings per share data:Earnings from continuing operations
    
    $
    1.72
    
    
    $
    1.61
    
    
    $
    1.09Earnings from discontinued operations
    
    
    0.03
    
    
    
    0.04
    
    
    
    0.38Net earnings
    
    $
    1.75
    
    
    $
    1.65
    
    
    $
    1.47Weighted average shares outstanding
    
    
    109,437
    
    
    
    98,826
    
    
    
    96,576
  F-4




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##### Table of Contents



Years ended December 31,2005
    
    
    2004
    
    
    2003(As restated)
    
    
    (As restated)
    
    
    (As restated)Net earnings
    
    $
    191,192
    
    
    $
    162,699
    
    
    $
    142,027Other comprehensive income (loss):Investment gains (losses):Investment gains (losses) during the year, net of
income tax charge (benefit) of $(2,946) in 2005,
$6,091 in 2004 and $(1,048) in 2003
    
    
    (4,257
    )
    
    
    10,955
    
    
    
    (1,962
    )Less reclassification adjustment for gains
included in net earnings, net of income tax
charge of $2,479 in 2005, $2,433 in 2004
and $184 in 2003
    
    
    (4,605
    )
    
    
    (4,518
    )
    
    
    (343
    )Foreign currency translation adjustment
    
    
    (9,699
    )
    
    
    6,287
    
    
    
    6,451Other comprehensive income (loss)
    
    
    (18,561
    )
    
    
    12,724
    
    
    
    4,146Comprehensive income
    
    $
    172,631
    
    
    $
    175,423
    
    
    $
    146,173
  F-5




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##### Table of Contents



AccumulatedAdditional
    
    
    
    
    
    
    other
    
    
    TotalCommon
    
    
    paid-in
    
    
    Retained
    
    
    comprehensive
    
    
    shareholdersstock
    
    
    capital
    
    
    earnings
    
    
    income
    
    
    equityBalance at December 31, 2002  As previously reported
    
    $
    62,358
    
    
    $
    416,406
    
    
    $
    383,378
    
    
    $
    20,765
    
    
    $
    882,907Cumulative effect of restatement (Note 2)
    
    
    
    
    
    
    13,861
    
    
    
    (12,097
    )
    
    
    
    
    
    
    1,764Balance at December 31, 2002, as restated
    
    
    62,358
    
    
    
    430,267
    
    
    
    371,281
    
    
    
    20,765
    
    
    
    884,671Net earnings
    
    
    
    
    
    
    
    
    
    
    142,027
    
    
    
    
    
    
    
    142,027Other comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,146
    
    
    
    4,146Issuance of 1,860 shares for exercise of options,
including tax benefit of $1,811
    
    
    1,240
    
    
    
    20,850
    
    
    
    
    
    
    
    
    
    
    
    22,090Issuance of 78 shares of contractually issuable stock
    
    
    52
    
    
    
    (52
    )
    
    
    
    
    
    
    
    
    
    
    Issuance of 472 shares for purchased company
    
    
    314
    
    
    
    7,958
    
    
    
    
    
    
    
    
    
    
    
    8,272Stock-based compensation
    
    
    
    
    
    
    2,979
    
    
    
    
    
    
    
    
    
    
    
    2,979Cash dividends declared, $0.187 per share
    
    
    
    
    
    
    
    
    
    
    (17,780
    )
    
    
    
    
    
    
    (17,780
    )Balance at December 31, 2003
    
    
    63,964
    
    
    
    462,002
    
    
    
    495,528
    
    
    
    24,911
    
    
    
    1,046,405Net earnings
    
    
    
    
    
    
    
    
    
    
    162,699
    
    
    
    
    
    
    
    162,699Other comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    12,724
    
    
    
    12,724Issuance of 4,500 shares in public offering, net of costs
    
    
    3,000
    
    
    
    93,668
    
    
    
    
    
    
    
    
    
    
    
    96,668Issuance of 1,485 shares for exercise of options,
including tax benefit of $2,969
    
    
    990
    
    
    
    22,087
    
    
    
    
    
    
    
    
    
    
    
    23,077Issuance of 126 shares for purchased company
and strategic investment
    
    
    84
    
    
    
    2,576
    
    
    
    
    
    
    
    
    
    
    
    2,660Stock-based compensation
    
    
    
    
    
    
    2,233
    
    
    
    
    
    
    
    
    
    
    
    2,233Cash dividends declared, $0.213 per share
    
    
    
    
    
    
    
    
    
    
    (20,968
    )
    
    
    
    
    
    
    (20,968
    )Balance at December 31, 2004
    
    
    68,038
    
    
    
    582,566
    
    
    
    637,259
    
    
    
    37,635
    
    
    
    1,325,498Net earnings
    
    
    
    
    
    
    
    
    
    
    191,192
    
    
    
    
    
    
    
    191,192Other comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (18,561
    )
    
    
    (18,561
    )Issuance of 4,688 shares in public offering, net of costs
    
    
    4,688
    
    
    
    145,276
    
    
    
    
    
    
    
    
    
    
    
    149,964Issuance of 2,439 shares for exercise of options,
including tax benefit of $6,168
    
    
    1,785
    
    
    
    40,522
    
    
    
    
    
    
    
    
    
    
    
    42,307Issuance of 1,624 shares for purchased companies
and convertible debt
    
    
    1,227
    
    
    
    26,226
    
    
    
    
    
    
    
    
    
    
    
    27,453Stock-based compensation
    
    
    
    
    
    
    2,645
    
    
    
    
    
    
    
    
    
    
    
    2,645Three-for-two stock split
    
    
    35,065
    
    
    
    (35,065
    )
    
    
    
    
    
    
    
    
    
    
    Cash dividends declared, $0.282 per share
    
    
    
    
    
    
    
    
    
    
    (30,063
    )
    
    
    
    
    
    
    (30,063
    )Balance at December 31, 2005
    
    $
    110,803
    
    
    $
    762,170
    
    
    $
    798,388
    
    
    $
    19,074
    
    
    $
    1,690,435
  F-6




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##### Table of Contents



Years ended December 31,2005
    
    
    2004
    
    
    2003(As restated)
    
    
    (As restated)
    
    
    (As restated)Cash flows from operating activities:Net earnings
    
    $
    191,192
    
    
    $
    162,699
    
    
    $
    142,027Adjustments to reconcile net earnings to net
cash provided by operating activities:Change in premium, claims and other receivables
    
    
    (6,094
    )
    
    
    70,411
    
    
    
    (121,834
    )Change in reinsurance recoverables
    
    
    (250,829
    )
    
    
    (198,536
    )
    
    
    (103,580
    )Change in ceded unearned premium
    
    
    82,433
    
    
    
    (17,422
    )
    
    
    (127,367
    )Change in loss and loss adjustment expense payable
    
    
    705,688
    
    
    
    548,349
    
    
    
    366,398Change in reinsurance balances payable
    
    
    (49,772
    )
    
    
    (72,009
    )
    
    
    120,064Change in unearned premium
    
    
    38,809
    
    
    
    122,317
    
    
    
    261,261Change in premium and claims payable, net of
restricted cash
    
    
    (3,851
    )
    
    
    1,835
    
    
    
    (24,743
    )Gain on sale of subsidiaries
    
    
    (8,717
    )
    
    
    (6,317
    )
    
    
    (52,681
    )Change in trading portfolio
    
    
    (66,809
    )
    
    
    25,673
    
    
    
    12,741Depreciation and amortization expense
    
    
    14,647
    
    
    
    16,139
    
    
    
    12,828Stock-based compensation expense
    
    
    2,645
    
    
    
    2,233
    
    
    
    2,979Other, net
    
    
    (25,352
    )
    
    
    13,331
    
    
    
    40,005Cash provided by operating activities
    
    
    623,990
    
    
    
    668,703
    
    
    
    528,098Cash flows from investing activities:Sales of fixed income securities
    
    
    237,480
    
    
    
    253,398
    
    
    
    167,357Maturity or call of fixed income securities
    
    
    186,075
    
    
    
    154,357
    
    
    
    142,652Cost of securities acquired
    
    
    (1,054,529
    )
    
    
    (935,053
    )
    
    
    (694,211
    )Change in short-term investments
    
    
    (72,703
    )
    
    
    (160,229
    )
    
    
    (202,904
    )Payments for purchase of subsidiaries, net of cash received
    
    
    (94,056
    )
    
    
    (93,543
    )
    
    
    (16,680
    )Sale of subsidiaries and other operating investments
    
    
    21,116
    
    
    
    
    
    
    
    82,618Other, net
    
    
    3,637
    
    
    
    268
    
    
    
    (17,655
    )Cash used by investing activities
    
    
    (772,980
    )
    
    
    (780,802
    )
    
    
    (538,823
    )Cash flows from financing activities:Issuance of notes payable, net of costs
    
    
    46,528
    
    
    
    29,000
    
    
    
    174,845Payments on notes payable
    
    
    (48,181
    )
    
    
    (40,176
    )
    
    
    (108,813
    )Sale of common stock, net of costs
    
    
    186,103
    
    
    
    116,776
    
    
    
    20,279Dividends paid and other, net
    
    
    (31,458
    )
    
    
    (19,984
    )
    
    
    (19,476
    )Cash provided by financing activities
    
    
    152,992
    
    
    
    85,616
    
    
    
    66,835Net increase (decrease) in cash
    
    
    4,002
    
    
    
    (26,483
    )
    
    
    56,110Cash at beginning of year
    
    
    69,933
    
    
    
    96,416
    
    
    
    40,306Cash at end of year
    
    $
    73,935
    
    
    $
    69,933
    
    
    $
    96,416
  F-7




---



##### Table of Contents



(1)
    
    GENERAL INFORMATION AND SIGNIFICANT ACCOUNTING AND REPORTING POLICIESHCC 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.Our principal domestic insurance companies are Houston Casualty
Company, U.S. Specialty Insurance Company, HCC Life Insurance Company,
Avemco Insurance Company and American Contractors Indemnity Company.
These companies operate throughout the United States with headquarters
in Houston, Texas, Atlanta, Georgia and Los Angeles, California. All
of our principal domestic insurance companies operate on an admitted
basis, except Houston Casualty Company, which also insures
international risks. Our foreign insurance companies are HCC
International Insurance Company, HCC Europe, HCC Reinsurance Company
and the London branch of Houston Casualty Company. These companies
operate from the United Kingdom, Spain, Bermuda and Ireland.Our underwriting agencies provide underwriting management and claims
servicing for insurance and reinsurance companies, in specialized
lines of business within the property and casualty and group life,
accident and health insurance sectors. Our principal domestic
agencies are Professional Indemnity Agency, Inc., HCC Specialty
Underwriters, HCC Global Financial Products, Covenant Underwriters and
HCC Indemnity Guaranty Agency. Our agencies operate throughout the
United States. Our principal foreign agency is HCC Global Financial
Products, with headquarters in Barcelona, Spain. In 2006, we intend to
consolidate the operations of one of our foreign agencies, HCC
Diversified Financial Products, into HCC International Insurance
Company.Our reinsurance and insurance brokers provide brokerage, consulting
and other broker services to insurance and reinsurance companies,
commercial customers and individuals in the same lines of business as
the insurance companies and underwriting agencies operate. Our
principal reinsurance brokers are Rattner Mackenzie and HCC Risk
Management, operating principally in London, England, Hamilton,
Bermuda and Houston, Texas. Our insurance broker is Continental
Underwriters.
 F-8




---



##### Table of Contents



Basis of Presentation
   Investments
    F-9




---



##### Table of Contents



Derivative Financial Instruments
  Net Earned Premium, Policy Acquisition Costs and Ceding Commissions
   F-10




---



##### Table of Contents



Fee and Commission Income
   Strategic Investments and Other Operating Income
  Premium, Claims and Other Receivables
  Loss
and Loss Adjustment Expense Payable
  F-11




---



##### Table of Contents



Reinsurance
  Goodwill and Intangible Assets
  Using Cash Flow Information and Present Value in
Accounting Measurements
  Cash and Short-term Investments
    F-12




---



##### Table of Contents



Restricted Cash and Cash Investments
  Foreign Currency
   Income Taxes
  Earnings Per Share
  F-13




---



##### Table of Contents



Stock-Based Compensation
 Accounting for Stock-Based Compensation Accounting for Stock Issued to
Employees
 Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award
Plan An Interpretation of APB Opinions No. 15 and 25
 Accounting for Certain Transactions Involving Stock Compensation  an interpretation of
APB Opinion No. 25
 Accounting for Equity Instruments That Are Issued to Other Than
Employees for Acquiring, or in Conjunction with Selling, Goods or
Services
 F-14




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##### Table of Contents



Accounting for Stock-Based Compensation
 2005
    
    
    2004
    
    
    2003(As restated)
    
    
    (As restated)
    
    
    (As restated)Reported net earnings
    
    $
    191,192
    
    
    $
    162,699
    
    
    $
    142,027Stock-based compensation included in
reported net earnings, net of income taxes
    
    
    2,114
    
    
    
    1,920
    
    
    
    2,359Stock-based compensation using fair value
method, net of income taxes
    
    
    (8,258
    )
    
    
    (6,140
    )
    
    
    (9,031
    )Pro forma net earnings
    
    $
    185,048
    
    
    $
    158,479
    
    
    $
    135,355Reported basic earnings per share
    
    $
    1.81
    
    
    $
    1.67
    
    
    $
    1.50Fair value stock-based compensation
    
    
    (0.06
    )
    
    
    (0.04
    )
    
    
    (0.07
    )Pro forma basic earnings per share
    
    $
    1.75
    
    
    $
    1.63
    
    
    $
    1.43Reported diluted earnings per share
    
    $
    1.75
    
    
    $
    1.65
    
    
    $
    1.47Fair value stock-based compensation
    
    
    (0.06
    )
    
    
    (0.05
    )
    
    
    (0.07
    )Pro forma diluted earnings per share
    
    $
    1.69
    
    
    $
    1.60
    
    
    $
    1.40
  2005
    
    
    2004
    
    
    2003Average fair value of options (As restated):Granted at market value
    
    $
    7.17
    
    
    $
    6.34
    
    
    $
    4.38Granted below market value
    
    
    8.96
    
    
    
    6.11
    
    
    
    4.90Risk free interest rate
    
    
    4.0
    %
    
    
    3.4
    %
    
    
    2.8
    %Expected volatility factor
    
    
    32
    %
    
    
    32
    %
    
    
    32
    %Dividend yield
    
    
    1.11
    %
    
    
    1.02
    %
    
    
    1.07
    %Expected option life
    
    4.8 years
    
    4.5 years
    
    4.4 years
 Share-Based
Payment
 F-15




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##### Table of Contents



Stock Split
  Large Loss Events
   F-16




---



##### Table of Contents



Effect of hurricanes and commutations2005
    
    
    2004
    
    
    2003
    
    
    2005
    
    
    2004
    
    
    2003(As restated)
    
    
    (As restated)
    
    
    (As restated)Gross incurred loss and
loss adjustment expense
    
    $
    1,596,773
    
    
    $
    1,289,155
    
    
    $
    1,045,339
    
    
    $
    394,625
    
    
    $
    89,795
    
    
    $
    Net incurred loss and
loss adjustment expense
    
    
    919,697
    
    
    
    645,230
    
    
    
    488,000
    
    
    
    99,226
    
    
    
    23,335
    
    
    
    28,751Ceded earned premium
    
    
    617,402
    
    
    
    849,610
    
    
    
    748,799
    
    
    
    16,533
    
    
    
    9,806
    
    
    
    Net earnings (loss)
    
    
    191,192
    
    
    
    162,699
    
    
    
    142,027
    
    
    
    (75,171
    )
    
    
    (21,464
    )
    
    
    (18,688
    )
 Recent Accounting Pronouncements
 The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments
 Accounting Changes and Error Corrections Accounting Changes Reporting Accounting Changes in Interim
Financial Statements.
 F-17




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##### Table of Contents



(2)
    
    RESTATEMENT OF CONSOLIDATED FINANCIAL STATEMENTS, SPECIAL COMMITTEE
AND COMPANY FINDINGSIn light of published reports concerning the pricing of stock options and the timing of stock
option grants at numerous other companies, in the second quarter of 2006 we undertook a
voluntary internal review of our past practices related to grants of stock options. The
voluntary review by our management concluded that the actual accounting measurement dates for
certain past stock option grants differed from the originally stated grant dates, which were
also utilized as the measurement dates for such awards. In August 2006, our Board of
Directors formed a Special Committee of independent directors to commence an investigation of
our past stock option granting practices for the period 1995 through 2005. The Special
Committee was composed of the members of the Audit Committee of the Board of Directors. The
Special Committee retained the law firm of Skadden, Arps, Slate, Meagher & Flom, LLP as its
independent legal counsel and LECG as forensic accountants to aid in the investigation.On November 17, 2006, we announced that the Special Committee had made certain determinations
as a result of its review of our past stock option granting practices. The Special Committee
found that we had used incorrect accounting measurement dates for stock option grants
covering a significant number of employees and members of our Board of Directors during the
period 1997 through 2005 and that certain option grants were retroactively priced.
Additionally, at the direction of the Special Committee, we reviewed our stock option
granting practices from 1992, the year of our initial public stock offering, through 1994 and
in 2006 and found incorrect measurement dates due to retroactive pricing were used in 2006.
In substantially all of these instances, the price on the actual measurement date was higher
than the price on the stated grant date; thus recipients of the options could exercise at a
strike price lower than the actual measurement date price. To determine the actual
measurement dates, the Special Committee utilized the following sources of information:
 
    
    The dates on documentation such as e-mails, regulatory form filings, acquisition
agreements and other correspondence;
    
    The date that the relevant stock option grant was entered into Equity Edge, our stock
option tracking and accounting system;
    
    Requirements of Accounting Principles Board (APB) No. 25, Accounting for Stock Issued
to Employees, and related interpretations; and
    
    Guidance from the Office of Chief Accountant of the Securities and Exchange
Commission (SEC) contained in a letter dated September 19, 2006.
 The Special Committee concluded that mis-priced option grants, the effect of which, together
with certain other adjustments, resulted in a cumulative net decrease in shareholders equity
at December 31, 2005 of $3.3 million, affected all levels of employees. The Special
Committee found that Stephen L. Way, Chief Executive Officer, retroactively priced options,
that he should have known he was granting options in a manner that conflicted with our stock
option plans and public statements, and that this constituted a failure to align the stock
option granting process with our stock option plans and public
statements. Although finding his
actions were inconsistent with the duties and obligations of a chief executive officer of a
publicly-traded company, the Special Committee also found that Mr. Ways motivation appeared
to be the attraction and retention of talent and to provide employees with the best
 F-18




---



##### Table of Contents



option price. The Special Committee also concluded that Christopher L. Martin, Executive
Vice President and General Counsel, was aware that options were being retroactively priced in
a manner inconsistent with applicable plan terms and the procedures memoranda that he had
prepared, that granting in-the-money options had accounting implications, and that he did not
properly document our Compensation Committees informal delegation of authority to Mr. Way.
The Special Committee also found that there was no evidence that Mr. Way or Mr. Martin
intended to falsify the consolidated financial statements.Before the Board of Directors reviewed the results
of the investigation, the Chairman of our Compensation Committee tendered his resignation from the Board of
Directors on November 8, 2006. After reviewing the results of the investigation, the Board of Directors determined that it
would be appropriate to accept the resignations of Mr. Way and Mr. Martin, which both
tendered on November 17, 2006. Mr. Way will remain a director of HCC and serve as the
non-executive Chairman of the Board of Directors and has entered into a consulting agreement
with us to assist in the transition of leadership and to provide strategic guidance. We have
entered into agreements with Mr. Way and Mr. Martin which, among other things, require them
to disgorge an amount equal to the difference between the actual measurement date prices
determined by HCC and the prices at which these individuals exercised mis-priced options
since 1997.As a result of the determinations of the Special Committee
and because the resulting cumulative charge would be material to the second quarter and full year 2006 consolidated
net earnings, we concluded that we needed to
amend this Annual Report on Form 10-K for the year ended December 31, 2005 as filed on March
16, 2006 (the Original Filing), to restate our consolidated financial statements for the
years ended December 31, 2005, 2004 and 2003 and the related disclosures. However, the impact
of the restatement in any of the periods is not material.
We are making the
restatement in accordance with generally accepted accounting principles to record the
following:
 
    
    Non-cash compensation expense for the difference between the stock price on the
stated grant date and the actual measurement date and for the fluctuations in stock price in
certain instances where variable accounting should have been applied.
    
    Other adjustments that were not recorded in the originally filed financial statements
due to their immateriality. These minor adjustments primarily relate
to fee and commission income, loss and loss adjustment expense,
policy acquisition costs and other operating expense. In addition,
balance sheet reclassifications have been recorded to appropriately
present certain reinsurance recoverables and payables.
    
    Related tax benefits associated with the recognition of
non-cash compensation expense and other adjustments as well as
additional taxes that may be due and payable.
 Based on the determinations of the Special Committee and our voluntary internal review, we
identified a number of occasions during the period 1997 through 2005 and into 2006 on which
we used an incorrect measurement date for financial accounting and reporting purposes for
options granted. In accordance with Accounting Principles Board (APB) No. 25, Accounting for
Stock Issued to Employees, and its related interpretations, we should have recorded
compensation expense related to these options for the excess of the market price of our stock
on the actual measurement date over the exercise price of the option. For periods commencing
January 1, 2006, compensation expense is being recognized in accordance with Statement of
Financial Accounting Standards (SFAS) No. 123(R) (revised), Share-Based Payment. However,
we determined an incremental amount related to the mis-priced options must be recorded.
 F-19




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##### Table of Contents




    
    We determined that many block grants to employees during the period 1997 through 2005
were subject to a retroactive look-back period. In all such cases, the price of our stock at
the end of the look-back period, which was generally 30 days or less, was higher than the
price of our stock on the stated grant date.
    
    In addition to being subject to the retroactive pricing discussed above, we
determined that the strike price of block grants in 1999, 2002 and 2005 was determined prior
to the final determination of the identity of the employee and/or the number of options to be
granted. Further, proper approval, in most cases, had not been given until after the grant
date. In all such cases, the price of our stock at the time when all required determinations
were final and proper approval had been obtained was higher than the price of our stock on
the stated grant date. The time lag between the stated grant date and the finalization of
the awards was typically 30-45 days, except in the case of the 2002 grant which was finalized
several months subsequent to the stated grant date.
    
    For the period from 1997 to 2005 and into 2006, we determined
that there was a
regular practice of granting options to newly hired employees and existing employees being
promoted after the end of a 30-45 day period following the hire or promotion date. This
practice included the use of the 30-45 day period as a look-back period during which the date
with the lowest price during that period was selected as the stated grant date.
    
    In several instances, grants to senior executives were determined at a date
subsequent to the stated grant date. In most cases, this resulted from extended negotiations
of employment agreements and, in some cases, administrative delays. In virtually all cases,
the price of our stock at the time the grants were made and properly approved was higher than
the price of our stock on the stated grant date.
    
    In a few cases, options were granted and then repriced downward. As a
result, variable accounting should have been applied to these options.
    
    We lacked timely or adequate documentation to support the stated grant date in the
case of certain of the above errors.
    F-20




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##### Table of Contents



Increase
(decrease) in net earnings and retained earnings:Non-cash compensation expense related to stock option grants (including $994
recorded as accrued expenses)
    
    $
    (26,608
    )Net adjustments for immaterial items previously unrecorded
    
    
    1,316Reduction in earnings from continuing operations before income tax expense
    
    
    (25,292
    )Related income tax benefit
    
    
    6,667Reduction in net earnings from continuing operations and net earnings
    
    
    
    
    
    $
    (18,625
    )Increase
(decrease) to additional paid-in capital:Increase related to non-cash compensation expense
    
    $
    25,614Reduction related to tax effects previously credited to additional paid-in capital
    
    
    (11,012
    )Net increase in additional paid-in capital
    
    
    
    
    
    
    14,602Increase in other comprehensive income for immaterial items previously unrecorded
    
    
    
    
    
    
    762Net decrease in shareholders equity at December 31, 2005
    
    
    
    
    
    $
    (3,261
    )
 F-21




---



##### Table of Contents



Non-cashstock optionNet earnings as
    
    
    compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net earningspreviously reported
    
    
    expense
    
    
    Other
    
    
    Tax effect
    
    
    Total adjustments
    
    
    as restatedYears ended December 31,
1997
    
    
    
    
    
    $
    (3,789
    )
    
    $
    
    
    
    $
    1,326
    
    
    $
    (2,463
    )1998
    
    
    
    
    
    
    (3,664
    )
    
    
    
    
    
    
    1,273
    
    
    
    (2,391
    )1999
    
    
    
    
    
    
    (1,474
    )
    
    
    
    
    
    
    (148
    )
    
    
    (1,622
    )2000
    
    
    
    
    
    
    (4,586
    )
    
    
    (1,124
    )
    
    
    1,830
    
    
    
    (3,880
    )2001
    
    
    
    
    
    
    (2,201
    )
    
    
    1,881
    
    
    
    88
    
    
    
    (232
    )2002
    
    
    
    
    
    
    (2,043
    )
    
    
    (27
    )
    
    
    561
    
    
    
    (1,509
    )Cumulative effect at December 31, 2002
    
    
    
    
    
    
    (17,757
    )
    
    
    730
    
    
    
    4,930
    
    
    
    (12,097
    )2003
    
    
    143,561
    
    
    
    (3,279
    )
    
    
    1,270
    
    
    
    475
    
    
    
    (1,534
    )
    
    
    142,0272004
    
    
    163,025
    
    
    
    (2,571
    )
    
    
    2,453
    
    
    
    (208
    )
    
    
    (326
    )
    
    
    162,6992005
    
    
    195,860
    
    
    
    (3,001
    )
    
    
    (3,137
    )
    
    
    1,470
    
    
    
    (4,668
    )
    
    
    191,192Cumulative effect at December 31, 2005
    
    
    
    
    
    $
    (26,608
    )
    
    $
    1,316
    
    
    $
    6,667
    
    
    $
    (18,625
    )
    F-22




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##### Table of Contents



CumulativeYears Ended December 31,
    
    
    
    
    
    
    January 1, 1997through1997 through
    
    
    December 31,2005
    
    
    2004
    
    
    2003
    
    
    2002
    
    
    2005Non-cash compensation expense, related
to stock option grants (including $994
recorded as accrued expenses)
    
    $
    (3,001
    )
    
    $
    (2,571
    )
    
    $
    (3,279
    )
    
    $
    (17,757
    )
    
    $
    (26,608
    )Net adjustments for immaterial items
previously unrecorded
    
    
    (3,137
    )
    
    
    2,453
    
    
    
    1,270
    
    
    
    730
    
    
    
    1,316Reduction in earnings from
continuing operations before income tax
expense
    
    
    (6,138
    )
    
    
    (118
    )
    
    
    (2,009
    )
    
    
    (17,027
    )
    
    
    (25,292
    )Related income tax (expense) benefit
    
    
    1,470
    
    
    
    (208
    )
    
    
    475
    
    
    
    4,930
    
    
    
    6,667Reduction in net earnings from
continuing operations
    
    $
    (4,668
    )
    
    $
    (326
    )
    
    $
    (1,534
    )
    
    $
    (12,097
    )
    
    $
    (18,625
    )
  CumulativeYears Ended December 31,
    
    
    
    
    
    
    January 1, 1997through1997 through
    
    
    December 31,2005
    
    
    2004
    
    
    2003
    
    
    2002
    
    
    2005Revenue
    
    $
    (1,654
    )
    
    $
    1,453
    
    
    $
    
    
    
    $
    
    
    
    $
    (201
    )Loss and loss adjustment expense, net
    
    
    1,500
    
    
    
    
    
    
    
    652
    
    
    
    (652
    )
    
    
    1,500Policy acquisition costs, net
    
    
    (3,983
    )
    
    
    2,000
    
    
    
    1,000
    
    
    
    1,000
    
    
    
    17Other operating expense
    
    
    (2,001
    )
    
    
    (3,571
    )
    
    
    (3,661
    )
    
    
    (17,375
    )
    
    
    (26,608
    )Total reductions in earnings
from continuing operations
before income tax
    
    $
    (6,138
    )
    
    $
    (118
    )
    
    $
    (2,009
    )
    
    $
    (17,027
    )
    
    $
    (25,292
    )
 F-23




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##### Table of Contents



Year ended December 31, 2005
    
    
    Year ended December 31, 2004
    
    
    Year ended December 31, 2003As previously
    
    
    
    
    
    
    
    
    
    
    As previously
    
    
    
    
    
    
    
    
    
    
    As previouslyreported
    
    
    Adjustments
    
    
    As restated
    
    
    reported
    
    
    Adjustments
    
    
    As restated
    
    
    reported
    
    
    Adjustments
    
    
    As restatedREVENUENet earned premium
    
    $
    1,369,988
    
    
    $
    
    
    
    $
    1,369,988
    
    
    $
    1,010,692
    
    
    $
    
    
    
    $
    1,010,692
    
    
    $
    738,272
    
    
    $
    
    
    
    $
    738,272Fee and commission income
    
    
    134,282
    
    
    
    (1,654
    )
    
    
    132,628
    
    
    
    182,349
    
    
    
    1,453
    
    
    
    183,802
    
    
    
    142,615
    
    
    
    
    
    
    
    142,615Net investment income
    
    
    98,851
    
    
    
    
    
    
    
    98,851
    
    
    
    64,885
    
    
    
    
    
    
    
    64,885
    
    
    
    47,335
    
    
    
    
    
    
    
    47,335Net realized investment gain
    
    
    1,448
    
    
    
    
    
    
    
    1,448
    
    
    
    5,822
    
    
    
    
    
    
    
    5,822
    
    
    
    527
    
    
    
    
    
    
    
    527Other operating income
    
    
    39,773
    
    
    
    
    
    
    
    39,773
    
    
    
    19,406
    
    
    
    
    
    
    
    19,406
    
    
    
    13,215
    
    
    
    
    
    
    
    13,215Total revenue
    
    
    1,644,342
    
    
    
    (1,654
    )
    
    
    1,642,688
    
    
    
    1,283,154
    
    
    
    1,453
    
    
    
    1,284,607
    
    
    
    941,964
    
    
    
    
    
    
    
    941,964EXPENSELoss and loss adjustment expense, net
    
    
    921,197
    
    
    
    (1,500
    )
    
    
    919,697
    
    
    
    645,230
    
    
    
    
    
    
    
    645,230
    
    
    
    488,652
    
    
    
    (652
    )
    
    
    488,000Policy acquisition costs, net
    
    
    257,725
    
    
    
    3,983
    
    
    
    261,708
    
    
    
    224,323
    
    
    
    (2,000
    )
    
    
    222,323
    
    
    
    138,212
    
    
    
    (1,000
    )
    
    
    137,212Other operating expense
    
    
    178,989
    
    
    
    2,001
    
    
    
    180,990
    
    
    
    164,474
    
    
    
    3,571
    
    
    
    168,045
    
    
    
    140,913
    
    
    
    3,661
    
    
    
    144,574Interest expense
    
    
    7,684
    
    
    
    
    
    
    
    7,684
    
    
    
    8,374
    
    
    
    
    
    
    
    8,374
    
    
    
    7,453
    
    
    
    
    
    
    
    7,453Total expense
    
    
    1,365,595
    
    
    
    4,484
    
    
    
    1,370,079
    
    
    
    1,042,401
    
    
    
    1,571
    
    
    
    1,043,972
    
    
    
    775,230
    
    
    
    2,009
    
    
    
    777,239Earnings from continuing operations
before income tax expense
    
    
    278,747
    
    
    
    (6,138
    )
    
    
    272,609
    
    
    
    240,753
    
    
    
    (118
    )
    
    
    240,635
    
    
    
    166,734
    
    
    
    (2,009
    )
    
    
    164,725Income tax expense on continuing
operations
    
    
    85,647
    
    
    
    (1,470
    )
    
    
    84,177
    
    
    
    81,732
    
    
    
    208
    
    
    
    81,940
    
    
    
    59,857
    
    
    
    (475
    )
    
    
    59,382Earnings from continuing operations
    
    
    193,100
    
    
    
    (4,668
    )
    
    
    188,432
    
    
    
    159,021
    
    
    
    (326
    )
    
    
    158,695
    
    
    
    106,877
    
    
    
    (1,534
    )
    
    
    105,343Earnings from discontinued operations,
net of income taxes
    
    
    2,760
    
    
    
    
    
    
    
    2,760
    
    
    
    4,004
    
    
    
    
    
    
    
    4,004
    
    
    
    36,684
    
    
    
    
    
    
    
    36,684Net earnings
    
    $
    195,860
    
    
    $
    (4,668
    )
    
    $
    191,192
    
    
    $
    163,025
    
    
    $
    (326
    )
    
    $
    162,699
    
    
    $
    143,561
    
    
    $
    (1,534
    )
    
    $
    142,027Basic earnings per share data:Earnings from continuing operations
    
    $
    1.83
    
    
    $
    (0.05
    )
    
    $
    1.78
    
    
    $
    1.64
    
    
    $
    (0.01
    )
    
    $
    1.63
    
    
    $
    1.12
    
    
    $
    (0.01
    )
    
    $
    1.11Earnings from discontinued operations
    
    
    0.03
    
    
    
    
    
    
    
    0.03
    
    
    
    0.04
    
    
    
    
    
    
    
    0.04
    
    
    
    0.39
    
    
    
    
    
    
    
    0.39Net earnings
    
    $
    1.86
    
    
    $
    (0.05
    )
    
    $
    1.81
    
    
    $
    1.68
    
    
    $
    (0.01
    )
    
    $
    1.67
    
    
    $
    1.51
    
    
    $
    (0.01
    )
    
    $
    1.50Weighted average shares outstanding
    
    
    105,463
    
    
    
    
    
    
    
    105,463
    
    
    
    97,257
    
    
    
    
    
    
    
    97,257
    
    
    
    94,919
    
    
    
    
    
    
    
    94,919Diluted earnings per share data:Earnings from continuing operations
    
    $
    1.76
    
    
    $
    (0.04
    )
    
    $
    1.72
    
    
    $
    1.61
    
    
    $
    
    
    
    $
    1.61
    
    
    $
    1.11
    
    
    $
    (0.02
    )
    
    $
    1.09Earnings from discontinued operations
    
    
    0.03
    
    
    
    
    
    
    
    0.03
    
    
    
    0.04
    
    
    
    
    
    
    
    0.04
    
    
    
    0.38
    
    
    
    
    
    
    
    0.38Net earnings
    
    $
    1.79
    
    
    $
    (0.04
    )
    
    $
    1.75
    
    
    $
    1.65
    
    
    $
    
    
    
    $
    1.65
    
    
    $
    1.49
    
    
    $
    (0.02
    )
    
    $
    1.47Weighted average shares outstanding
    
    
    109,437
    
    
    
    
    
    
    
    109,437
    
    
    
    98,826
    
    
    
    
    
    
    
    98,826
    
    
    
    96,576
    
    
    
    
    
    
    
    96,576
 F-24




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##### Table of Contents



December 31, 2005
    
    
    December 31, 2004As
    
    
    
    
    
    
    
    
    
    
    Aspreviously
    
    
    
    
    
    
    As
    
    
    previously
    
    
    
    
    
    
    Asreported
    
    
    Adjustments
    
    
    restated
    
    
    reported
    
    
    Adjustments
    
    
    restatedASSETSInvestments:Fixed income securities
    
    $
    2,268,624
    
    
    $
    
    
    
    $
    2,268,624
    
    
    $
    1,703,171
    
    
    $
    
    
    
    $
    1,703,171Short-term investments
    
    
    839,581
    
    
    
    
    
    
    
    839,581
    
    
    
    729,985
    
    
    
    
    
    
    
    729,985Other investments
    
    
    149,223
    
    
    
    
    
    
    
    149,223
    
    
    
    35,335
    
    
    
    
    
    
    
    35,335Total investments
    
    
    3,257,428
    
    
    
    
    
    
    
    3,257,428
    
    
    
    2,468,491
    
    
    
    
    
    
    
    2,468,491Cash
    
    
    73,935
    
    
    
    
    
    
    
    73,935
    
    
    
    69,933
    
    
    
    
    
    
    
    69,933Restricted cash and cash investments
    
    
    170,978
    
    
    
    
    
    
    
    170,978
    
    
    
    188,510
    
    
    
    
    
    
    
    188,510Premium, claims and other receivables
    
    
    884,654
    
    
    
    
    
    
    
    884,654
    
    
    
    889,800
    
    
    
    1,560
    
    
    
    891,360Reinsurance recoverables
    
    
    1,360,483
    
    
    
    1,500
    
    
    
    1,361,983
    
    
    
    1,104,026
    
    
    
    
    
    
    
    1,104,026Ceded unearned premium
    
    
    239,416
    
    
    
    
    
    
    
    239,416
    
    
    
    317,055
    
    
    
    (5,082
    )
    
    
    311,973Ceded life and annuity benefits
    
    
    73,415
    
    
    
    
    
    
    
    73,415
    
    
    
    74,627
    
    
    
    
    
    
    
    74,627Deferred policy acquisition costs
    
    
    156,253
    
    
    
    
    
    
    
    156,253
    
    
    
    139,199
    
    
    
    
    
    
    
    139,199Goodwill
    
    
    532,947
    
    
    
    
    
    
    
    532,947
    
    
    
    444,031
    
    
    
    
    
    
    
    444,031Other assets
    
    
    276,557
    
    
    
    1,234
    
    
    
    277,791
    
    
    
    208,954
    
    
    
    (536
    )
    
    
    208,418Total assets
    
    $
    7,026,066
    
    
    $
    2,734
    
    
    $
    7,028,800
    
    
    $
    5,904,626
    
    
    $
    (4,058
    )
    
    $
    5,900,568LIABILITIESLoss and loss adjustment expense payable
    
    $
    2,813,720
    
    
    $
    
    
    
    $
    2,813,720
    
    
    $
    2,089,199
    
    
    $
    
    
    
    $
    2,089,199Life and annuity policy benefits
    
    
    73,415
    
    
    
    
    
    
    
    73,415
    
    
    
    74,627
    
    
    
    
    
    
    
    74,627Reinsurance balances payable
    
    
    176,954
    
    
    
    
    
    
    
    176,954
    
    
    
    228,998
    
    
    
    (11,060
    )
    
    
    217,938Unearned premium
    
    
    807,109
    
    
    
    
    
    
    
    807,109
    
    
    
    741,706
    
    
    
    
    
    
    
    741,706Deferred ceding commissions
    
    
    65,702
    
    
    
    2,184
    
    
    
    67,886
    
    
    
    94,896
    
    
    
    (1,416
    )
    
    
    93,480Premium and claims payable
    
    
    753,859
    
    
    
    
    
    
    
    753,859
    
    
    
    766,765
    
    
    
    
    
    
    
    766,765Notes payable
    
    
    309,543
    
    
    
    
    
    
    
    309,543
    
    
    
    311,277
    
    
    
    
    
    
    
    311,277Accounts payable and accrued liabilities
    
    
    332,068
    
    
    
    3,811
    
    
    
    335,879
    
    
    
    273,493
    
    
    
    6,585
    
    
    
    280,078Total liabilities
    
    
    5,332,370
    
    
    
    5,995
    
    
    
    5,338,365
    
    
    
    4,580,961
    
    
    
    (5,891
    )
    
    
    4,575,070SHAREHOLDERS EQUITYCommon stock
    
    
    110,803
    
    
    
    
    
    
    
    110,803
    
    
    
    68,038
    
    
    
    
    
    
    
    68,038Additional paid-in capital
    
    
    747,568
    
    
    
    14,602
    
    
    
    762,170
    
    
    
    566,776
    
    
    
    15,790
    
    
    
    582,566Retained earnings
    
    
    817,013
    
    
    
    (18,625
    )
    
    
    798,388
    
    
    
    651,216
    
    
    
    (13,957
    )
    
    
    637,259Accumulated other comprehensive income
    
    
    18,312
    
    
    
    762
    
    
    
    19,074
    
    
    
    37,635
    
    
    
    
    
    
    
    37,635Total shareholders equity
    
    
    1,693,696
    
    
    
    (3,261
    )
    
    
    1,690,435
    
    
    
    1,323,665
    
    
    
    1,833
    
    
    
    1,325,498Total liabilities and
shareholders equity
    
    $
    7,026,066
    
    
    $
    2,734
    
    
    $
    7,028,800
    
    
    $
    5,904,626
    
    
    $
    (4,058
    )
    
    $
    5,900,568
 F-25




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##### Table of Contents



Years Ended December 31,2005
    
    
    2004
    
    
    2003As
    
    
    
    
    
    
    As
    
    
    
    
    
    
    Aspreviously
    
    
    
    
    
    
    previously
    
    
    As
    
    
    previously
    
    
    Asreported
    
    
    As restated
    
    
    reported
    
    
    restated
    
    
    reported
    
    
    restatedNet earnings
    
    $
    195,860
    
    
    $
    191,192
    
    
    $
    163,025
    
    
    $
    162,699
    
    
    $
    143,561
    
    
    $
    142,027Adjustments to reconcile net earnings
to net cash provided by operating activities:Change in premium, claims and other
receivables
    
    
    (7,654
    )
    
    
    (6,094
    )
    
    
    70,136
    
    
    
    70,411
    
    
    
    (134,112
    )
    
    
    (121,834
    )Change in reinsurance recoverables
    
    
    (249,329
    )
    
    
    (250,829
    )
    
    
    (183,121
    )
    
    
    (198,536
    )
    
    
    (117,256
    )
    
    
    (103,580
    )Change in ceded unearned premium
    
    
    87,515
    
    
    
    82,433
    
    
    
    (22,504
    )
    
    
    (17,422
    )
    
    
    (127,367
    )
    
    
    (127,367
    )Change in loss and loss adjustment
expense payable
    
    
    705,688
    
    
    
    705,688
    
    
    
    538,374
    
    
    
    548,349
    
    
    
    379,998
    
    
    
    366,398Change in reinsurance balances payable
    
    
    (60,832
    )
    
    
    (49,772
    )
    
    
    (69,647
    )
    
    
    (72,009
    )
    
    
    130,257
    
    
    
    120,064Change in premium and claims payable,
net of restricted cash
    
    
    (3,851
    )
    
    
    (3,851
    )
    
    
    6,928
    
    
    
    1,835
    
    
    
    (22,263
    )
    
    
    (24,743
    )Stock-based compensation expense
    
    
    
    
    
    
    2,645
    
    
    
    
    
    
    
    2,233
    
    
    
    
    
    
    
    2,979Other, net
    
    
    (21,337
    )
    
    
    (25,352
    )
    
    
    7,700
    
    
    
    13,331
    
    
    
    41,131
    
    
    
    40,005
 Accounting for
Stock-Based Compensation
 F-26




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##### Table of Contents



2005
    
    
    2004
    
    
    2003As
    
    
    
    
    
    
    As
    
    
    
    
    
    
    Aspreviously
    
    
    As
    
    
    previously
    
    
    As
    
    
    previously
    
    
    Asreported
    
    
    restated
    
    
    reported
    
    
    restated
    
    
    reported
    
    
    restatedReported net earnings
    
    $
    195,860
    
    
    $
    191,192
    
    
    $
    163,025
    
    
    $
    162,699
    
    
    $
    143,561
    
    
    $
    142,027Stock-based compensation included
in reported net earnings,
net of income taxes
    
    
    
    
    
    
    2,114
    
    
    
    
    
    
    
    1,920
    
    
    
    
    
    
    
    2,359Stock-based compensation using fair
value method, net of income taxes
    
    
    (6,916
    )
    
    
    (8,258
    )
    
    
    (4,883
    )
    
    
    (6,140
    )
    
    
    (7,705
    )
    
    
    (9,031
    )Pro forma net earnings
    
    $
    188,944
    
    
    $
    185,048
    
    
    $
    158,142
    
    
    $
    158,479
    
    
    $
    135,856
    
    
    $
    135,355Reported basic earnings per share
    
    $
    1.86
    
    
    $
    1.81
    
    
    $
    1.68
    
    
    $
    1.67
    
    
    $
    1.51
    
    
    $
    1.50Fair value stock-based compensation
    
    
    (0.07
    )
    
    
    (0.06
    )
    
    
    (0.05
    )
    
    
    (0.04
    )
    
    
    (0.08
    )
    
    
    (0.07
    )Pro forma basic earnings per share
    
    $
    1.79
    
    
    $
    1.75
    
    
    $
    1.63
    
    
    $
    1.63
    
    
    $
    1.43
    
    
    $
    1.43Reported diluted earnings per share
    
    $
    1.79
    
    
    $
    1.75
    
    
    $
    1.65
    
    
    $
    1.65
    
    
    $
    1.49
    
    
    $
    1.47Fair value stock-based compensation
    
    
    (0.06
    )
    
    
    (0.06
    )
    
    
    (0.05
    )
    
    
    (0.05
    )
    
    
    (0.08
    )
    
    
    (0.07
    )Pro forma diluted earnings per share
    
    $
    1.73
    
    
    $
    1.69
    
    
    $
    1.60
    
    
    $
    1.60
    
    
    $
    1.41
    
    
    $
    1.40
 F-27




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##### Table of Contents



(3)
    
    ACQUISITIONS, GOODWILL AND DISPOSITIONAcquisitionsDuring the past three years, we have completed numerous acquisitions. We acquired these
companies to diversify into new specialty lines of business or to grow existing lines of
business. The business combinations were recorded using the purchase method of accounting, and
the results of operations of the acquired businesses were included in our consolidated
financial statements beginning on the effective date of each transaction. The following table
provides additional information on these acquisitions (in millions):
 Initial
    
    
    Goodwill
    
    
    DeductibleEffective date
    
    consideration
    
    
    recognized
    
    
    goodwillCovenant Underwriters and
Continental Underwriters
    
    July 1, 2003
    
    $
    19.9
    
    
    $
    19.1
    
    
    YesAmerican Contractors Indemnity
Company
    
    January 31, 2004
    
    
    46.8
    
    
    
    10.5
    
    
    NoRA&MCO Insurance Services
    
    October 1, 2004
    
    
    8.5
    
    
    
    7.7
    
    
    NoUnited States Surety Company
    
    March 1, 2005
    
    
    19.4
    
    
    
    12.6
    
    
    NoHCC International Insurance
Company
(formerly De Montfort Insurance
Company)
    
    July 1, 2005
    
    
    24.6
    
    
    
    15.8
    
    
    NoPerico Life Insurance Company
(formerly MIC Life Insurance
Corporation)
    
    November 30, 2005
    
    
    20.0
    
    
    
    
    
    
    YesPerico Ltd.
    
    December 1, 2005
    
    
    33.4
    
    
    
    31.8
    
    
    YesIllium Insurance Group
    
    December 31, 2005
    
    
    3.0
    
    
    
    1.5
    
    
    No
 In the above table, the initial consideration column represents cash and the value of our
common stock paid for the acquisition. The goodwill recognized column represents goodwill
recorded through December 31, 2005, including earnout amounts based on earnings of the
acquired company subsequent to its acquisition. The deductible goodwill column indicates if
the goodwill is deductible for income tax purposes.
 F-28




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##### Table of Contents



We accrue earnout amounts when the conditions for their accrual have been satisfied under the
applicable agreement. At December 31, 2005, accrued earnouts totaled $32.3 million. In
addition, we will pay up to a maximum of $9.2 million with respect to two of the acquisitions
if certain earnings targets are reached through December 31, 2006. The purchase agreement for
one acquisition includes terms requiring additional consideration based on pre-tax earnings
through September 30, 2007, with no maximum amount specified. Any contingent consideration
accrued or payable in future years has been or will be recorded as an increase in goodwill.When we acquire a new subsidiary, goodwill is either allocated to that particular subsidiary
or, if there are synergies with other subsidiaries, allocated to the different reporting units
based on their respective share of the estimated future cash flows. In 2005, we eliminated a
tax valuation allowance, which we had established when we acquired a subsidiary in 2002, and
reversed the subsidiarys remaining $4.7 million of goodwill. In 2004, we recorded a $5.6
million reduction in goodwill due to a tax refund as a result of an adjustment to
pre-acquisition taxable income of an acquired subsidiary. The changes in goodwill were as
follows:
 InsuranceCompany
    
    
    Agency
    
    
    TotalBalance at December 31, 2003(As restated)
    
    $
    165,234
    
    
    $
    222,789
    
    
    $
    388,023Additions:New acquisitions (As restated)
    
    
    16,354
    
    
    
    2,823
    
    
    
    19,177Earnouts
    
    
    26,697
    
    
    
    15,716
    
    
    
    42,413Transfer on reorganization
    
    
    11,266
    
    
    
    (11,266
    )
    
    
    Reduction for tax settlement
    
    
    (4,201
    )
    
    
    (1,381
    )
    
    
    (5,582
    )Balance at December 31, 2004
    
    
    215,350
    
    
    
    228,681
    
    
    
    444,031Additions:New acquisitions
    
    
    59,881
    
    
    
    1,628
    
    
    
    61,509Earnouts
    
    
    24,162
    
    
    
    7,922
    
    
    
    32,084Transfer on reorganization
    
    
    45,353
    
    
    
    (45,353
    )
    
    
    Reduction for tax adjustment
    
    
    (4,677
    )
    
    
    
    
    
    
    (4,677
    )Balance at December 31, 2005
    
    $
    340,069
    
    
    $
    192,878
    
    
    $
    532,947
 DispositionIn December 2003, we sold the business of our retail brokerage subsidiary, HCC Employee
Benefits, Inc., for $62.5 million in cash. We recognized a gain of $52.7 million ($30.1
million after-tax) in 2003 and additional gains of $6.3 million ($4.0 million after-tax) in
2004 and $4.4 million ($2.8 million after-tax) in 2005 from a contractual earnout, which is
now completed. The after-tax earnings from discontinued operations and the gain on sale are
reported as earnings from discontinued operations in the consolidated statements of earnings.
Goodwill was reduced $8.3 million as a result of the disposition. Discontinued operations for
the year ended December 31, 2003 consisted of revenue of $22.9 million and earnings before
income tax expense of $10.3 million. Earnings before income tax expense in 2003 excluded
allocated general corporate overhead expenses of $1.7 million.
 F-29




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##### Table of Contents



(4)
    
    INVESTMENTSSubstantially all of our fixed income securities are investment grade
and 99% are rated A or better. The cost or amortized cost, gross
unrealized gain or loss and estimated fair value of investments in
fixed income securities, all of which are classified as available for
sale, were as follows:
 Gross
    
    
    GrossCost or
    
    
    unrealized
    
    
    unrealized
    
    
    Estimatedamortized cost
    
    
    gain
    
    
    loss
    
    
    fair valueDecember 31, 2005U.S. government
    
    $
    90,404
    
    
    $
    167
    
    
    $
    (847
    )
    
    $
    89,724States, municipalities and
political subdivisions
    
    
    1,138,499
    
    
    
    10,109
    
    
    
    (6,634
    )
    
    
    1,141,974Corporate fixed income securities
    
    
    381,917
    
    
    
    340
    
    
    
    (6,675
    )
    
    
    375,582Asset-backed and mortgage-backed
securities
    
    
    361,456
    
    
    
    562
    
    
    
    (6,646
    )
    
    
    355,372Foreign securities
    
    
    304,863
    
    
    
    2,412
    
    
    
    (1,303
    )
    
    
    305,972Total fixed income securities
    
    $
    2,277,139
    
    
    $
    13,590
    
    
    $
    (22,105
    )
    
    $
    2,268,624December 31, 2004U.S. government
    
    $
    87,652
    
    
    $
    688
    
    
    $
    (214
    )
    
    $
    88,126States, municipalities and
political subdivisions
    
    
    727,437
    
    
    
    15,609
    
    
    
    (1,696
    )
    
    
    741,350Corporate fixed income securities
    
    
    374,130
    
    
    
    4,644
    
    
    
    (1,438
    )
    
    
    377,336Asset-backed and mortgage-backed
securities
    
    
    248,449
    
    
    
    1,764
    
    
    
    (1,510
    )
    
    
    248,703Foreign securities
    
    
    244,753
    
    
    
    3,176
    
    
    
    (273
    )
    
    
    247,656Total fixed income securities
    
    $
    1,682,421
    
    
    $
    25,881
    
    
    $
    (5,131
    )
    
    $
    1,703,171
 F-30




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##### Table of Contents



All fixed income securities were income producing during 2005, except for one security valued at
$0.4 million. The following table displays the gross unrealized losses and fair value of all
investments that were in a continuous unrealized loss position for the periods indicated:
 Less than 12 months
    
    
    12 months or more
    
    
    TotalUnrealized
    
    
    
    
    
    
    Unrealized
    
    
    
    
    
    
    UnrealizedFair value
    
    
    losses
    
    
    Fair value
    
    
    losses
    
    
    Fair value
    
    
    lossesDecember 31, 2005U.S. government
    
    $
    50,108
    
    
    $
    (449
    )
    
    $
    28,585
    
    
    $
    (398
    )
    
    $
    78,693
    
    
    $
    (847
    )States, municipalities and political
subdivisions
    
    
    464,533
    
    
    
    (4,614
    )
    
    
    95,327
    
    
    
    (2,020
    )
    
    
    559,860
    
    
    
    (6,634
    )Corporate fixed income securities
    
    
    119,762
    
    
    
    (2,175
    )
    
    
    194,057
    
    
    
    (4,500
    )
    
    
    313,819
    
    
    
    (6,675
    )Asset-backed and mortgage-backed
securities
    
    
    162,251
    
    
    
    (2,078
    )
    
    
    147,552
    
    
    
    (4,568
    )
    
    
    309,803
    
    
    
    (6,646
    )Foreign securities
    
    
    72,365
    
    
    
    (832
    )
    
    
    43,465
    
    
    
    (471
    )
    
    
    115,830
    
    
    
    (1,303
    )Total securities
    
    $
    869,019
    
    
    $
    (10,148
    )
    
    $
    508,986
    
    
    $
    (11,957
    )
    
    $
    1,378,005
    
    
    $
    (22,105
    )December 31, 2004U.S. government
    
    $
    52,473
    
    
    $
    (197
    )
    
    $
    489
    
    
    $
    (17
    )
    
    $
    52,962
    
    
    $
    (214
    )States, municipalities and political
subdivisions
    
    
    170,352
    
    
    
    (1,091
    )
    
    
    27,500
    
    
    
    (605
    )
    
    
    197,852
    
    
    
    (1,696
    )Corporate fixed income securities
    
    
    143,057
    
    
    
    (1,170
    )
    
    
    14,419
    
    
    
    (268
    )
    
    
    157,476
    
    
    
    (1,438
    )Asset-backed and mortgage-backed
securities
    
    
    140,536
    
    
    
    (1,057
    )
    
    
    12,096
    
    
    
    (453
    )
    
    
    152,632
    
    
    
    (1,510
    )Foreign securities
    
    
    47,775
    
    
    
    (252
    )
    
    
    10,549
    
    
    
    (21
    )
    
    
    58,324
    
    
    
    (273
    )Total securities
    
    $
    554,193
    
    
    $
    (3,767
    )
    
    $
    65,053
    
    
    $
    (1,364
    )
    
    $
    619,246
    
    
    $
    (5,131
    )
 We regularly review our investments for possible impairments based on the criteria in Note
1. The determination that a security has incurred an other-than-temporary decline in value
and the amount of any loss recognition requires management judgment and a continual review of
our investments. We considered all of the losses at December 31, 2005 and 2004 shown above to
be temporary based on the results of our review.
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The amortized cost and estimated fair value of fixed income securities at December 31, 2005,
by contractual maturity, are shown below. Expected maturities may differ from contractual
maturities because borrowers may have the right to call or prepay obligations with or without
call or prepayment penalties. The weighted average life of our asset-backed and
mortgage-backed securities was 2.6 years.
 Amortized
    
    
    Estimatedcost
    
    
    fair valueDue in 1 year or less
    
    $
    147,717
    
    
    $
    146,924Due after 1 year through 5 years
    
    
    565,851
    
    
    
    561,240Due after 5 years through 10 years
    
    
    468,075
    
    
    
    467,542Due after 10 years through 15 years
    
    
    299,078
    
    
    
    301,264Due after 15 years
    
    
    434,962
    
    
    
    436,282Securities with fixed maturities
    
    
    1,915,683
    
    
    
    1,913,252Asset-backed and mortgage-backed securities
    
    
    361,456
    
    
    
    355,372Total fixed income securities
    
    $
    2,277,139
    
    
    $
    2,268,624
 At December 31, 2005, our domestic insurance companies had deposited fixed income securities
of $37.4 million (amortized cost of $37.3 million) to meet the deposit requirements of various
insurance departments. In addition, we had a deposit of fixed income securities of $60.3
million (amortized cost of $60.9 million) at Lloyds of London, which serves as security for
our participation in a Lloyds syndicate. There are withdrawal and other restrictions on
these deposits, but we direct how the deposits are invested and we earn interest on the funds.The sources of net investment income were as follows:
 2005
    
    
    2004
    
    
    2003Fixed income securities
    
    $
    77,842
    
    
    $
    55,929
    
    
    $
    40,927Short-term investments
    
    
    21,208
    
    
    
    9,735
    
    
    
    7,422Other investments
    
    
    3,615
    
    
    
    1,366
    
    
    
    488Total investment income
    
    
    102,665
    
    
    
    67,030
    
    
    
    48,837Investment expense
    
    
    (3,814
    )
    
    
    (2,145
    )
    
    
    (1,502
    )Net investment income
    
    $
    98,851
    
    
    $
    64,885
    
    
    $
    47,335
 F-32




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##### Table of Contents



Gains
    
    
    Losses
    
    
    NetYear
ended December 31, 2005Fixed income securities
    
    $
    3,562
    
    
    $
    (1,475
    )
    
    $
    2,087Other investments
    
    
    156
    
    
    
    (795
    )
    
    
    (639
    )Realized gain (loss)
    
    $
    3,718
    
    
    $
    (2,270
    )
    
    $
    1,448Year
ended December 31, 2004Fixed income securities
    
    $
    7,035
    
    
    $
    (1,088
    )
    
    $
    5,947Other investments
    
    
    64
    
    
    
    (189
    )
    
    
    (125
    )Realized gain (loss)
    
    $
    7,099
    
    
    $
    (1,277
    )
    
    $
    5,822Year
ended December 31, 2003Fixed income securities
    
    $
    3,113
    
    
    $
    (1,230
    )
    
    $
    1,883Other investments
    
    
    40
    
    
    
    (1,396
    )
    
    
    (1,356
    )Realized gain (loss)
    
    $
    3,153
    
    
    $
    (2,626
    )
    
    $
    527
  2005
    
    
    2004
    
    
    2003Fixed income securities
    
    $
    (29,265
    )
    
    $
    (9,288
    )
    
    $
    (3,738
    )Strategic and other investments
    
    
    14,978
    
    
    
    19,383
    
    
    
    201Net unrealized investment gains (losses)
    
    $
    (14,287
    )
    
    $
    10,095
    
    
    $
    (3,537
    )
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##### Table of Contents



(5)
    
    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.
 Written
    
    
    Earned
    
    
    Loss and losspremium
    
    
    premium
    
    
    adjustment expense(As restated)Year
ended December 31, 2005Primary business
    
    $
    1,768,284
    
    
    $
    1,694,446
    
    
    $
    1,329,931Reinsurance assumed
    
    
    270,002
    
    
    
    292,944
    
    
    
    266,842Reinsurance ceded
    
    
    (537,062
    )
    
    
    (617,402
    )
    
    
    (677,076
    )Net amounts
    
    $
    1,501,224
    
    
    $
    1,369,988
    
    
    $
    919,697Year
ended December 31, 2004Primary business
    
    $
    1,674,075
    
    
    $
    1,557,806
    
    
    $
    966,163Reinsurance assumed
    
    
    301,078
    
    
    
    302,496
    
    
    
    322,992Reinsurance ceded
    
    
    (869,634
    )
    
    
    (849,610
    )
    
    
    (643,925
    )Net amounts
    
    $
    1,105,519
    
    
    $
    1,010,692
    
    
    $
    645,230Year
ended December 31, 2003Primary business
    
    $
    1,377,999
    
    
    $
    1,189,356
    
    
    $
    693,553Reinsurance assumed
    
    
    361,895
    
    
    
    297,715
    
    
    
    351,786Reinsurance ceded
    
    
    (874,392
    )
    
    
    (748,799
    )
    
    
    (557,339
    )Net amounts
    
    $
    865,502
    
    
    $
    738,272
    
    
    $
    488,000
 Ceding commissions netted with policy acquisition costs in the consolidated statements of
earnings were $96.0 million in 2005, $113.5 million in 2004 and $113.8 million in 2003.
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##### Table of Contents



The table below shows the components of reinsurance recoverables reported in our
consolidated balance sheets.
 2005
    
    
    2004(As restated)Reinsurance recoverable on paid losses
    
    $
    93,837
    
    
    $
    94,535Reinsurance recoverable on outstanding losses
    
    
    636,225
    
    
    
    509,512Reinsurance recoverable on incurred but not reported losses
    
    
    644,062
    
    
    
    520,404Reserve for uncollectible reinsurance
    
    
    (12,141
    )
    
    
    (20,425
    )Total reinsurance recoverables
    
    $
    1,361,983
    
    
    $
    1,104,026
 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 at December 31, 2005 and
2004.
 2005
    
    
    2004Payables to reinsurers
    
    $
    291,826
    
    
    $
    350,514Letters of credit
    
    
    350,135
    
    
    
    265,152Cash deposits
    
    
    64,150
    
    
    
    68,307Total credits
    
    $
    706,111
    
    
    $
    683,973
 The tables below present the calculation of net reserves, net unearned premium and net
deferred policy acquisition costs at December 31, 2005 and 2004.
 2005
    
    
    2004(As restated)
    
    
    (As restated)Loss and loss adjustment expense payable
    
    $
    2,813,720
    
    
    $
    2,089,199Reinsurance recoverable on outstanding losses
    
    
    (636,225
    )
    
    
    (509,512
    )Reinsurance recoverable on incurred but not reported losses
    
    
    (644,062
    )
    
    
    (520,404
    )Net reserves
    
    $
    1,533,433
    
    
    $
    1,059,283Unearned premium
    
    $
    807,109
    
    
    $
    741,706Ceded unearned premium
    
    
    (239,416
    )
    
    
    (311,973
    )Net unearned premium
    
    $
    567,693
    
    
    $
    429,733Deferred policy acquisition costs
    
    $
    156,253
    
    
    $
    139,199Deferred ceding commissions
    
    
    (67,886
    )
    
    
    (93,480
    )Net deferred policy acquisition costs
    
    $
    88,367
    
    
    $
    45,719
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##### Table of Contents



In order to reduce our exposure to reinsurance credit risk, we evaluate the financial
condition of our reinsurers and place our reinsurance with a diverse group of companies and
syndicates, which we believe to be financially sound. The following table shows reinsurance
balances relating to our reinsurers with a net recoverable balance greater than $25.0 million
at December 31, 2005 and 2004. The total recoverables column includes paid losses
recoverable, outstanding losses recoverable, incurred but not reported losses recoverable and
ceded unearned premium. The total credits column includes letters of credit, cash deposits
and other payables.
 Total
    
    
    Total
    
    
    NetReinsurer
    
    Rating
    
    Location
    
    recoverables
    
    
    credits
    
    
    recoverablesDecember 31,
2005Hannover Rueckversicherungs AG
    
    A
    
    Germany
    
    $
    147,589
    
    
    $
    28,232
    
    
    $
    119,357Lloyds Syndicate Number 0033
    
    A-
    
    United Kingdom
    
    
    43,756
    
    
    
    681
    
    
    
    43,075Arch Reinsurance Ltd.
    
    A-
    
    Bermuda
    
    
    52,226
    
    
    
    11,544
    
    
    
    40,682Everest Reinsurance Company
    
    A+
    
    Delaware
    
    
    53,344
    
    
    
    13,741
    
    
    
    39,603Odyssey America Reinsurance Corp.
    
    A
    
    Connecticut
    
    
    39,973
    
    
    
    3,474
    
    
    
    36,499Swiss Reinsurance America Corp.
    
    A+
    
    New York
    
    
    43,470
    
    
    
    7,749
    
    
    
    35,721Platinum Underwriters Reinsurance Co.
    
    A
    
    Maryland
    
    
    38,159
    
    
    
    4,422
    
    
    
    33,737ACE Property & Casualty Insurance Co.
    
    A+
    
    Pennsylvania
    
    
    31,139
    
    
    
    2,036
    
    
    
    29,103Harco National Insurance Company
    
    A-
    
    Illinois
    
    
    29,873
    
    
    
    3,657
    
    
    
    26,216Transatlantic Reinsurance Company
    
    A+
    
    New York
    
    
    26,661
    
    
    
    1,331
    
    
    
    25,330Lloyds Syndicate Number 0958
    
    B
    
    United Kingdom
    
    
    26,332
    
    
    
    1,091
    
    
    
    25,241December 31,
2004Hannover Rueckversicherungs AG
    
    A
    
    Germany
    
    $
    66,961
    
    
    $
    21,261
    
    
    $
    45,700Everest Reinsurance Company
    
    A+
    
    Delaware
    
    
    55,443
    
    
    
    12,139
    
    
    
    43,304Harco National Insurance Company
    
    A-
    
    Illinois
    
    
    51,067
    
    
    
    8,879
    
    
    
    42,188Lloyds Syndicate Number 2488
    
    A-
    
    United Kingdom
    
    
    41,460
    
    
    
    2,941
    
    
    
    38,519Lloyds Syndicate Number 0033
    
    A-
    
    United Kingdom
    
    
    31,560
    
    
    
    574
    
    
    
    30,986Lloyds Syndicate Number 1101
    
    B-
    
    United Kingdom
    
    
    31,663
    
    
    
    774
    
    
    
    30,889Lloyds Syndicate Number 1206
    
    B-
    
    United Kingdom
    
    
    31,242
    
    
    
    358
    
    
    
    30,884Odyssey America Reinsurance Corp.
    
    A
    
    Connecticut
    
    
    29,551
    
    
    
    2,637
    
    
    
    26,914Platinum Underwriters Reinsurance Co.
    
    A
    
    Maryland
    
    
    36,658
    
    
    
    10,669
    
    
    
    25,989
 Ratings for companies are published by A.M. Best Company, Inc. Ratings for individual
Lloyds syndicates are published by Moodys Investors Services, Inc. Lloyds of London is an
insurance and reinsurance marketplace composed of many independent underwriting syndicates
financially supported by a central trust fund. Lloyds of London is rated A by A.M. Best
Company, Inc.
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##### Table of Contents



Certain reinsurers have delayed or suspended payment of amounts recoverable under reinsurance
contracts to which we are a party. We limit our liquidity exposure by holding funds, letters
of credit or other security, such that net balances due are significantly less than the gross
balances shown in our consolidated balance sheets. We are currently in negotiations with most
of these parties but, if such negotiations do not result in a satisfactory resolution of the
matters in question, we may seek or be involved in litigation or arbitration. We resolved
certain arbitrations in 2005; amounts with respect to the remaining arbitration and litigation
proceedings that we initiated are not material.We have a reserve of $12.1 million at December 31, 2005 for potential collectibility issues
related to reinsurance recoverables, including disputed amounts and associated expenses.
While we believe the reserve is adequate based on information currently available, conditions
may change or additional information might be obtained which may require us to change the
reserve in the future. We periodically review our financial exposure to the reinsurance
market and the level of our reserve and continue to take actions in an attempt to mitigate our
exposure to possible loss. We assessed the collectibility of our year-end recoverables
related to our hurricane losses and believe the recoverables are collectible based on
currently available information.HCC Life Insurance Company previously sold its entire block of individual life insurance and
annuity business to Swiss Re Life & Health America, Inc. (rated A+ by A.M. Best Company,
Inc.) in the form of an indemnity reinsurance contract. Ceded life and annuity benefits
amounted to $73.4 million and $74.6 million at December 31, 2005 and 2004, respectively.
 F-37




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##### Table of Contents



(6)
    
    LIABILITY FOR UNPAID LOSS AND LOSS ADJUSTMENT EXPENSEThe following table provides a reconciliation of the liability for unpaid loss and loss
adjustment expense payable.
 2005
    
    
    2004
    
    
    2003(As restated)
    
    
    (As restated)
    
    
    (As restated)Reserves for loss and loss adjustment expense
payable at beginning of year
    
    $
    2,089,199
    
    
    $
    1,525,313
    
    
    $
    1,158,915Less reinsurance recoverables
    
    
    1,029,916
    
    
    
    820,113
    
    
    
    700,213Net reserves at beginning of year
    
    
    1,059,283
    
    
    
    705,200
    
    
    
    458,702Net reserve addition from acquisition of subsidiaries
    
    
    12,491
    
    
    
    11,647
    
    
    
    5,587Incurred loss and loss adjustment expense:Provision for loss and loss adjustment expense
for claims occurring in current year
    
    
    894,303
    
    
    
    614,752
    
    
    
    464,886Increase in estimated loss and loss
adjustment expense for claims occurring in
prior years
    
    
    25,394
    
    
    
    30,478
    
    
    
    23,114Incurred loss and loss adjustment expense
    
    
    919,697
    
    
    
    645,230
    
    
    
    488,000Loss and loss adjustment expense payments
for claims occurring during:Current year
    
    
    285,814
    
    
    
    161,117
    
    
    
    110,528Prior years
    
    
    172,224
    
    
    
    141,677
    
    
    
    136,561Loss and loss adjustment expense payments
    
    
    458,038
    
    
    
    302,794
    
    
    
    247,089Net reserves at end of year
    
    
    1,533,433
    
    
    
    1,059,283
    
    
    
    705,200Plus reinsurance recoverables
    
    
    1,280,287
    
    
    
    1,029,916
    
    
    
    820,113Reserves for loss and loss adjustment expense
at end of year
    
    $
    2,813,720
    
    
    $
    2,089,199
    
    
    $
    1,525,313
 We had net loss and loss adjustment expense adverse development relating to prior year losses
of $25.4 million in 2005, $30.5 million in 2004 and $23.1 million in 2003. The 2005 development
resulted from a commutation charge of $26.0 million and a net redundancy of $0.6 million from all
other sources. Our 2004 deficiency included a charge of $27.3 million related to adverse
development in certain assumed accident and health business, and we had a net deficiency of $3.2
million from all other sources. The 2003 development resulted from a commutation charge of $28.8
million, partially offset by a net redundancy of $5.7 million from all other sources. Deficiencies
and redundancies in the reserves occur as we continually review our loss reserves with our
actuaries, increasing or reducing loss reserves as a result of such reviews and as losses are
finally settled and claims exposures are reduced. We believe we have provided for all material net
incurred losses.
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##### Table of Contents



We have no material exposure to environmental pollution losses. Our largest insurance company
subsidiary only began writing business in 1981 and its policies normally contain pollution
exclusion clauses which limit pollution coverage to sudden and accidental losses only, thus
excluding intentional dumping and seepage claims. Policies issued by our other insurance
company subsidiaries do not have significant environmental exposures because of the types of
risks covered. Therefore, we do not expect to experience any material loss development for
environmental pollution claims. Likewise, we have no material exposure to asbestos claims.(7)
    
    NOTES PAYABLENotes payable at December 31, 2005 and 2004 are shown in the table
below. The aggregate estimated fair value of our 1.30% and 2.00%
convertible notes ($399.5 million and $332.8 million at December 31,
2005 and 2004, respectively) is based on quoted market prices. The
estimated fair value of our other debt is based on current rates
offered to us for debt with similar terms and approximates the
carrying value at both balance sheet dates.
 2005
    
    
    20041.30% Convertible Notes
    
    $
    125,000
    
    
    $
    125,0002.00% Convertible Exchange Notes
    
    
    172,400
    
    
    
    172,442$200.0 million Revolving Loan Facility
    
    
    
    
    
    
    Other debt
    
    
    12,143
    
    
    
    13,835Total notes payable
    
    $
    309,543
    
    
    $
    311,277
 Our 1.30% Convertible Notes are due in 2023. We pay interest semi-annually on April 1 and
October 1. Each one thousand dollar principal amount of notes is convertible into 44.1501
shares of our common stock, which represents an initial conversion price of $22.65 per share.
The initial conversion price is subject to change under certain conditions. Holders may
surrender notes for conversion if, as of the last day of the preceding calendar quarter, the
closing sale price of our common stock for at least 20 consecutive trading days during the
period of 30 consecutive trading days ending on the last trading day of that quarter is more
than 130% ($29.45 per share) of the conversion price per share of our common stock. We must
settle any conversions by paying cash for the principal amount of the notes and issuing our
common stock for the value of the conversion premium. We can redeem the notes for cash at any
time on or after April 1, 2009. Holders may require us to repurchase the notes on April 1,
2009, 2014 or 2019, or if a change in control of HCC Insurance Holdings, Inc. occurs on or
before April 1, 2009. The repurchase price to settle any such put or change in control
provisions will equal the principal amount of the notes plus accrued and unpaid interest and
will be paid in cash.
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##### Table of Contents



Our 2.00% Convertible Exchange Notes are due in 2021. We pay interest semi-annually on March 1
and September 1. In November 2004, we exchanged substantially all of our 2.00% Convertible
Notes for 2.00% Convertible Exchange Notes, which have terms economically similar to the
original notes. We recorded no gain or loss for the debt exchange and expensed all debt
issuance costs. Each one thousand dollar principal amount is convertible into 46.8823 shares
of our common stock, which represents an initial conversion price of $21.33 per share. The
initial conversion price is subject to change under certain conditions. Holders may surrender
notes for conversion if, as of the last day of the preceding calendar quarter, the closing
sale price of our common stock for at least 20 trading days in the period of 30 consecutive
trading days ending on the last trading day of that quarter is more than 120% ($25.60 per
share) of the conversion price per share of our common stock. We must settle any conversion
by paying cash for the principal amount of the notes and issuing our common stock for the
value of the conversion premium. We can redeem the notes for cash at any time on or after
September 1, 2007. Holders may require us to repurchase the notes on September 1, 2007, 2011
or 2016, or if a change in control of HCC Insurance Holdings, Inc. occurs on or before
September 1, 2007. The repurchase price to settle any such put or change in control
provisions will equal the principal amount of the notes plus accrued and unpaid interest and
will be paid in cash.Our $200.0 million Revolving Loan Facility allows us to borrow up to the maximum allowed by
the facility on a revolving basis until the facility expires on November 30, 2009. The
facility is collateralized in part by the pledge of our insurance companies stock and
guaranties entered into by our underwriting agencies and reinsurance brokers. The facility
agreement contains certain restrictive covenants which we believe are typical for similar
financing arrangements.In 2006, we entered into a $34.0 million Standby Letter of Credit Facility, which allows us to
replace a portion of our funds at Lloyds of London with standby letters of credit. Any
letters of credit issued under the Standby Letter of Credit Facility will be unsecured
commitments of HCC. The Standby Letter of Credit Facility contains standard restrictive
covenants, which in many cases are identical to or incorporate by reference the restrictive
covenants from our Revolving Loan Facility.At December 31, 2005, certain of our subsidiaries maintained revolving lines of credit with a
bank in the combined maximum amount of $45.2 million available through November 30, 2009.
Advances under the lines of credit are limited to amounts required to fund draws, if any, on
letters of credit issued by the bank on behalf of the subsidiaries and short-term direct cash
advances. The lines of credit are collateralized by securities having an aggregate market
value of up to $56.5 million, the actual amount of collateral at any one time being 125% of
the aggregate amount outstanding. Interest on the lines is payable at the banks prime rate
of interest (7.25% at December 31, 2005) for draws on the letters of credit and either prime
or prime less 1% on short-term cash advances. At December 31, 2005, letters of credit
totaling $16.7 million had been issued to insurance companies by the bank on behalf of our
subsidiaries, with total securities of $20.9 million collateralizing the lines.
 F-40




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##### Table of Contents



(8)
    
    INCOME TAXESAt December 31, 2005 and 2004, we had current income taxes payable of
$21.3 million and $18.1 million, respectively, included in accounts
payable and accrued liabilities in the consolidated balance sheets.The following table summarizes the differences between our effective
tax rate for financial statement purposes and the Federal statutory
rate:
 2005
    
    
    2004
    
    
    2003(As restated)
    
    
    (As restated)
    
    
    (As restated)Statutory tax rate
    
    
    35
    %
    
    
    35
    %
    
    
    35
    %Federal tax on continuing operations at statutory rate
    
    $
    95,413
    
    
    $
    84,223
    
    
    $
    57,653Nontaxable municipal bond interest and
dividends received deduction
    
    
    (12,267
    )
    
    
    (7,076
    )
    
    
    (4,126
    )Non-deductible compensation
    
    
    969
    
    
    
    775
    
    
    
    1,481Other non deductible expenses
    
    
    816
    
    
    
    394
    
    
    
    725State income taxes, net of federal tax benefit
    
    
    3,591
    
    
    
    2,962
    
    
    
    3,164Foreign income taxes
    
    
    15,024
    
    
    
    12,639
    
    
    
    15,076Foreign tax credit
    
    
    (14,981
    )
    
    
    (12,456
    )
    
    
    (14,599
    )Dividends received deduction on repatriated foreign earnings
    
    
    (2,784
    )
    
    
    
    
    
    
    Other, net
    
    
    (1,604
    )
    
    
    479
    
    
    
    8Income tax expense from continuing operations
    
    $
    84,177
    
    
    $
    81,940
    
    
    $
    59,382Effective tax rate, continuing operations
    
    
    30.9
    %
    
    
    34.1
    %
    
    
    36.1
    %Federal tax on discontinued operations at statutory rate
    
    $
    1,556
    
    
    $
    2,211
    
    
    $
    22,041Book over tax basis in stock of subsidiary
    
    
    
    
    
    
    
    
    
    
    2,896State income taxes, net of federal tax benefit, and other
    
    
    130
    
    
    
    102
    
    
    
    1,352Income tax expense on discontinued operations
    
    $
    1,686
    
    
    $
    2,313
    
    
    $
    26,289Effective tax rate, discontinued operations
    
    
    37.9
    %
    
    
    36.6
    %
    
    
    41.7
    %Total income tax expense
    
    $
    85,863
    
    
    $
    84,253
    
    
    $
    85,671Total effective tax rate
    
    
    31.0
    %
    
    
    34.1
    %
    
    
    37.6
    %
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##### Table of Contents



The components of income tax expense were as follows:
 2005
    
    
    2004
    
    
    2003(As restated)
    
    
    (As restated)
    
    
    (As restated)Federal current
    
    $
    69,113
    
    
    $
    82,856
    
    
    $
    57,961Federal deferred
    
    
    (5,485
    )
    
    
    (18,112
    )
    
    
    (16,359
    )Total federal
    
    
    63,628
    
    
    
    64,744
    
    
    
    41,602State current
    
    
    4,266
    
    
    
    7,065
    
    
    
    7,167State deferred
    
    
    1,259
    
    
    
    (2,508
    )
    
    
    (1,356
    )Total state
    
    
    5,525
    
    
    
    4,557
    
    
    
    5,811Foreign current
    
    
    15,155
    
    
    
    11,462
    
    
    
    11,285Foreign deferred
    
    
    (131
    )
    
    
    1,177
    
    
    
    684Total foreign
    
    
    15,024
    
    
    
    12,639
    
    
    
    11,969Income tax expense from continuing operations
    
    $
    84,177
    
    
    $
    81,940
    
    
    $
    59,382Federal current
    
    $
    3,528
    
    
    $
    1,898
    
    
    $
    25,038Federal deferred
    
    
    (2,042
    )
    
    
    271
    
    
    
    (815
    )Total federal
    
    
    1,486
    
    
    
    2,169
    
    
    
    24,223State current
    
    
    475
    
    
    
    110
    
    
    
    1,792State deferred
    
    
    (275
    )
    
    
    34
    
    
    
    274Total state
    
    
    200
    
    
    
    144
    
    
    
    2,066Income tax expense from discontinued operations
    
    $
    1,686
    
    
    $
    2,313
    
    
    $
    26,289Total income tax expense
    
    $
    85,863
    
    
    $
    84,253
    
    
    $
    85,671
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The net deferred tax asset is included in other assets in our consolidated balance sheets.
The composition of deferred tax assets and liabilities at December 31, 2005 and 2004 was as
follows:
 2005
    
    
    2004(As restated)
    
    
    (As restated)Excess of financial unearned premium over tax
    
    $
    32,932
    
    
    $
    27,238Effect of loss reserve discounting and salvage
and subrogation accrual for tax
    
    
    34,903
    
    
    
    21,341Excess of financial accrued expenses over tax
    
    
    23,264
    
    
    
    20,602Allowance for bad debts, not deductible for tax
    
    
    7,047
    
    
    
    7,925Federal tax net operating loss carryforwards
    
    
    1,581
    
    
    
    2,354State tax net operating loss carryforwards
    
    
    3,910
    
    
    
    4,103Foreign branch net operating loss carryforwards
    
    
    3,244
    
    
    
    1,194Valuation allowance
    
    
    (10,293
    )
    
    
    (17,358
    )Total deferred tax assets
    
    
    96,588
    
    
    
    67,399Unrealized gain on increase in value of securities
available for sale (shareholders equity)
    
    
    9,927
    
    
    
    14,086Deferred policy acquisition costs, net of ceding
commissions, deductible for tax
    
    
    11,087
    
    
    
    3,970Amortizable goodwill for tax
    
    
    18,953
    
    
    
    13,012Book basis in net assets of foreign subsidiaries
in excess of tax
    
    
    8,032
    
    
    
    5,354Property and equipment depreciation and other items
    
    
    6,519
    
    
    
    5,771Total deferred tax liabilities
    
    
    54,518
    
    
    
    42,193Net deferred tax asset
    
    $
    42,070
    
    
    $
    25,206
 Changes in the valuation allowance account applicable to deferred tax assets result primarily
from the acquisition and expiration of net operating losses and other tax attributes related
to acquired subsidiaries. In 2005, we eliminated a valuation allowance that we had
established when we acquired a subsidiary in 2002. Changes in the valuation allowance were as
follows:
 2005
    
    
    2004
    
    
    2003(As restated)
    
    
    (As restated)
    
    
    (As restated)Balance at beginning of year
    
    $
    17,358
    
    
    $
    17,444
    
    
    $
    11,547Increase due to acquisitions
    
    
    
    
    
    
    611
    
    
    
    4,900Reduction related to 2002 acquisition
    
    
    (5,511
    )
    
    
    
    
    
    
    Other
    
    
    (1,554
    )
    
    
    (697
    )
    
    
    997Balance at end of year
    
    $
    10,293
    
    
    $
    17,358
    
    
    $
    17,444
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At December 31, 2005, we have Federal and state tax net operating loss carryforwards of
approximately $13.8 million and $61.5 million, respectively, which will expire in varying
amounts through 2025. Future use of certain carryforwards is subject to statutory limitations
due to prior changes of ownership. Approximately $9.3 million of Federal tax loss
carryforwards relate to our foreign insurance companies and can only be used against future
taxable income of those entities. We have recorded valuation allowances of $1.6 million
against our Federal loss carryforwards, substantially all of which would reduce goodwill if
the carryforwards are realized, and $3.1 million against our state loss carryforwards. Based
on our history of taxable income in our domestic insurance and other operations and our
projections of future taxable income in our domestic and foreign insurance operations, we
believe it is more likely than not that the deferred tax assets related to our loss
carryforwards, for which there are no valuation allowances, will be realized.The American Jobs Creation Act of 2004 provided U.S. corporations with a one time opportunity
to repatriate earnings of certain foreign subsidiaries at materially reduced tax rates by
allowing a temporary dividends received deduction if the repatriated amounts were reinvested
in the United States in accordance with the provision of the law. We had previously recorded
deferred taxes on the undistributed earnings of our foreign subsidiaries at the U.S. statutory
rate of 35%. In 2005, we repatriated $14.2 million from certain foreign subsidiaries and
recognized a $2.8 million tax benefit in accordance with FASB Staff Position No. 109-2,
Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the
American Jobs Creation Act of 2004.(9)
    
    SHAREHOLDERS EQUITYIn 2005 and 2004, we sold 4.7 million and 4.5 million shares of our
common stock in public offerings at prices of $32.05 and $22.17 per
share, respectively. Net proceeds from the offerings totaled $150.0
million in 2005 and $96.7 million in 2004, after deducting the
underwriting discount and offering expenses. In 2005, we used $108.0
million of the proceeds to make capital contributions to our insurance
company subsidiaries and used the remainder for acquisitions. In
2004, we used $75.0 million of the proceeds to make a capital
contribution to an insurance company subsidiary and $17.0 million to
pay down bank debt.At December 31, 2005, 12.5 million shares of our common stock were
reserved for the exercise of options, of which 8.2 million shares were
reserved for options previously granted and 4.3 million shares were
reserved for future issuances.
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The components of accumulated other comprehensive income in our consolidated balance sheets
were as follows:
 AccumulatedUnrealized
    
    
    Foreign
    
    
    otherinvestment
    
    
    currency
    
    
    comprehensivegain (loss)
    
    
    translation
    
    
    income(As restated)
    
    
    (As restated)Balance at December 31,
2002
    
    $
    21,649
    
    
    $
    (884
    )
    
    $
    20,765Net change for year
    
    
    (2,305
    )
    
    
    6,451
    
    
    
    4,146Balance at December 31,
2003
    
    
    19,344
    
    
    
    5,567
    
    
    
    24,911Net change for year
    
    
    6,437
    
    
    
    6,287
    
    
    
    12,724Balance at December 31,
2004
    
    
    25,781
    
    
    
    11,854
    
    
    
    37,635Net change for year
    
    
    (8,862
    )
    
    
    (9,699
    )
    
    
    (18,561
    )Balance at December 31,
2005
    
    $
    16,919
    
    
    $
    2,155
    
    
    $
    19,074
 U.S. insurance companies are limited to the amount of dividends they can pay to their parent
by the laws of their state of domicile. The maximum dividends that our direct domestic
subsidiaries can pay in 2006 without special permission is $90.3 million. One of our
insurance companies cannot pay a dividend in 2006 without special permission because it paid a
special approved dividend in 2005.(10)
    
    EARNINGS PER SHAREThe following table details the numerator and denominator used in the earnings per share calculations.
 2005
    
    
    2004
    
    
    2003Net earnings (As restated)
    
    $
    191,192
    
    
    $
    162,699
    
    
    $
    142,027Weighted average common shares outstanding
    
    
    105,463
    
    
    
    97,257
    
    
    
    94,919Dilutive effect of outstanding options
(determined using the treasury stock method)
    
    
    1,659
    
    
    
    1,569
    
    
    
    1,657Dilutive effect of convertible debt
(determined using the treasury stock method)
    
    
    2,315
    
    
    
    
    
    
    
    Weighted average common shares and
potential common shares outstanding
    
    
    109,437
    
    
    
    98,826
    
    
    
    96,576Anti-dilutive stock options not included in
treasury stock method computation
    
    
    118
    
    
    
    6
    
    
    
    306
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##### Table of Contents



(11)
    
    STOCK OPTIONSOur stock option plans, the 2004 Flexible Incentive Plan and 2001 Flexible Incentive Plan, are administered by the
Compensation Committee of the Board of Directors. Options granted under these plans may be used to purchase one share of
our common stock. Options cannot be repriced downward under these plans.The following table details our stock option activity during the three years ended December 31, 2005.
 2005
    
    
    2004
    
    
    2003Average
    
    
    
    
    
    
    Average
    
    
    
    
    
    
    AverageNumber
    
    
    exercise
    
    
    Number
    
    
    exercise
    
    
    Number
    
    
    exerciseof shares
    
    
    price
    
    
    of shares
    
    
    price
    
    
    of shares
    
    
    priceOutstanding, beginning of year
    
    
    7,178
    
    
    $
    15.99
    
    
    
    8,291
    
    
    $
    14.99
    
    
    
    9,557
    
    
    $
    13.99Granted at market value
    
    
    143
    
    
    
    23.27
    
    
    
    382
    
    
    
    20.26
    
    
    
    23
    
    
    
    14.99Granted below market value
    
    
    3,671
    
    
    
    25.72
    
    
    
    662
    
    
    
    20.27
    
    
    
    690
    
    
    
    16.35Exercised
    
    
    (2,459
    )
    
    
    14.91
    
    
    
    (1,494
    )
    
    
    13.77
    
    
    
    (1,889
    )
    
    
    10.46Forfeited and expired
    
    
    (314
    )
    
    
    17.97
    
    
    
    (663
    )
    
    
    15.92
    
    
    
    (90
    )
    
    
    14.35Outstanding, end of year
    
    
    8,219
    
    
    
    20.71
    
    
    
    7,178
    
    
    
    15.99
    
    
    
    8,291
    
    
    
    14.99Exercisable, end of year
    
    
    1,766
    
    
    
    16.90
    
    
    
    2,919
    
    
    
    15.26
    
    
    
    2,807
    
    
    
    14.41
 Options outstanding and exercisable at December 31, 2005 were as follows:
 Options outstanding
    
    
    Options exercisableAverage
    
    
    
    
    
    
    AverageRange of
    
    Number of
    
    
    Average remaining
    
    
    exercise
    
    
    Number of
    
    
    exerciseexercise prices
    
    shares
    
    
    contractual life
    
    
    price
    
    
    shares
    
    
    priceUnder $16.36
    
    
    1,963
    
    
    3.5 years
    
    $
    14.50
    
    
    
    562
    
    
    $
    14.54$16.36-$20.05
    
    
    2,115
    
    
    3.4 years
    
    
    17.64
    
    
    
    1,000
    
    
    
    17.34$20.06-$25.50
    
    
    1,156
    
    
    4.8 years
    
    
    22.80
    
    
    
    204
    
    
    
    21.22Over $25.50
    
    
    2,985
    
    
    5.6 years
    
    
    26.17
    
    
    
    
    
    
    
    Total options
    
    
    8,219
    
    
    4.4 years
    
    
    20.71
    
    
    
    1,766
    
    
    
    16.90
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##### Table of Contents



(12)
    
    SEGMENT AND GEOGRAPHIC DATA
 We classify our activities into the following three operating business segments based on services
provided: 1) insurance company, 2) agency and 3) other operations. See Note 1 for a description of the
principal subsidiaries included in and the services provided by our insurance company and agency segments.
Our other operations segment includes insurance-related investments that we make periodically. Corporate
includes general corporate operations and those minor operations not included in a segment. Inter-segment
revenue consists primarily of fee and commission income of our agency segment charged to our insurance
company segment. Inter-segment pricing (either flat rate fees or as a percentage of premium) approximates
what is charged to unrelated parties for similar services. Effective January 1, 2005, we consolidated
our largest underwriting agency (agency segment) into HCC Life Insurance Company (insurance company
segment) and, in 2006, we intend to consolidate our London underwriting agency (agency segment) into HCC
International Insurance Company (insurance segment).The performance of each segment is evaluated by our management based on net earnings. Net earnings is
calculated after tax and after all corporate expense allocations, interest expense on debt incurred at the
purchase date, and intercompany eliminations have been charged or credited to our individual segments.
All stock-based compensation is included in the corporate segment since it is not included in managements
evaluation of the other segments. The following tables show information by business segment and
geographic location. Geographic location is determined by physical location of our offices and does not
represent the location of insureds or reinsureds from whom the business was generated.
 F-47




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##### Table of Contents



Insurance
    
    
    
    
    
    
    OtherCompany
    
    
    Agency
    
    
    Operations
    
    
    Corporate
    
    
    TotalYear ended
December 31, 2005 (As restated)Revenue:Domestic
    
    $
    1,216,894
    
    
    $
    62,111
    
    
    $
    35,324
    
    
    $
    6,784
    
    
    $
    1,321,113Foreign
    
    
    281,697
    
    
    
    39,878
    
    
    
    
    
    
    
    
    
    
    
    321,575Inter-segment
    
    
    158
    
    
    
    86,877
    
    
    
    
    
    
    
    
    
    
    
    87,035Total segment revenue
    
    $
    1,498,749
    
    
    $
    188,866
    
    
    $
    35,324
    
    
    $
    6,784
    
    
    
    1,729,723Inter-segment eliminations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (87,035
    )Consolidated total revenue
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    1,642,688Net earnings:Domestic
    
    $
    119,634
    
    
    $
    31,158
    
    
    $
    22,605
    
    
    $
    352
    
    
    $
    173,749Foreign
    
    
    6,488
    
    
    
    7,294
    
    
    
    
    
    
    
    
    
    
    
    13,782Total segment net earnings
    
    $
    126,122
    
    
    $
    38,452
    
    
    $
    22,605
    
    
    $
    352
    
    
    
    187,531Inter-segment eliminations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    901Earnings from discontinued
operations,
net of income taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,760Consolidated net earnings
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    191,192Other items:Net investment income
    
    $
    88,397
    
    
    $
    7,437
    
    
    $
    794
    
    
    $
    2,223
    
    
    $
    98,851Depreciation and amortization
    
    
    4,825
    
    
    
    7,381
    
    
    
    459
    
    
    
    1,982
    
    
    
    14,647Interest expense (benefit)
    
    
    445
    
    
    
    9,173
    
    
    
    699
    
    
    
    (2,633
    )
    
    
    7,684Capital expenditures
    
    
    2,134
    
    
    
    3,046
    
    
    
    716
    
    
    
    4,937
    
    
    
    10,833Income tax expense (benefit)
    
    
    49,327
    
    
    
    26,174
    
    
    
    10,282
    
    
    
    (2,034
    )
    
    
    83,749Inter-segment eliminations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    428Consolidated income tax expense
on continuing operations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    84,177
 For 2005, earnings before income taxes were $257.8 million for our domestic subsidiaries
(including discontinued operations) and $19.3 million for our foreign subsidiaries and
branches. During 2005, the insurance company segment recorded after-tax losses of $58.2
million due to the 2005 hurricanes and $16.9 million due to commutations.
 F-48




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##### Table of Contents



Insurance
    
    
    
    
    
    
    OtherCompany
    
    
    Agency
    
    
    Operations
    
    
    Corporate
    
    
    TotalYear ended
December 31, 2004 (As restated)Revenue:Domestic
    
    $
    884,857
    
    
    $
    86,806
    
    
    $
    13,020
    
    
    $
    4,721
    
    
    $
    989,404Foreign
    
    
    250,718
    
    
    
    44,485
    
    
    
    
    
    
    
    
    
    
    
    295,203Inter-segment
    
    
    553
    
    
    
    95,475
    
    
    
    
    
    
    
    
    
    
    
    96,028Total segment revenue
    
    $
    1,136,128
    
    
    $
    226,766
    
    
    $
    13,020
    
    
    $
    4,721
    
    
    
    1,380,635Inter-segment eliminations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (96,028
    )Consolidated total revenue
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    1,284,607Net earnings (loss):Domestic
    
    $
    84,522
    
    
    $
    37,438
    
    
    $
    7,871
    
    
    $
    (4,243
    )
    
    $
    125,588Foreign
    
    
    24,764
    
    
    
    16,208
    
    
    
    
    
    
    
    
    
    
    
    40,972Total segment net earnings
(loss)
    
    $
    109,286
    
    
    $
    53,646
    
    
    $
    7,871
    
    
    $
    (4,243
    )
    
    $
    166,560Inter-segment eliminations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (7,865
    )Earnings from discontinued
operations,
net of income taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,004Consolidated net earnings
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    162,699Other items:Net investment income
    
    $
    59,073
    
    
    $
    3,559
    
    
    $
    1,236
    
    
    $
    1,017
    
    
    $
    64,885Depreciation and amortization
    
    
    4,568
    
    
    
    9,729
    
    
    
    531
    
    
    
    1,311
    
    
    
    16,139Interest expense (benefit)
    
    
    856
    
    
    
    8,491
    
    
    
    768
    
    
    
    (1,741
    )
    
    
    8,374Capital expenditures
    
    
    3,451
    
    
    
    1,984
    
    
    
    16
    
    
    
    2,885
    
    
    
    8,336Income tax expense
    
    
    51,404
    
    
    
    31,440
    
    
    
    2,964
    
    
    
    1,625
    
    
    
    87,433Inter-segment eliminations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5,493
    )Consolidated income tax expense
on continuing operations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    81,940
 For 2004, earnings before income taxes were $189.1 million for our domestic subsidiaries
(including discontinued operations) and $57.9 million for our foreign subsidiaries and
branches. During 2004, the insurance company segment recorded an after-tax loss of $21.5
million due to the 2004 hurricanes.
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Insurance
    
    
    
    
    
    
    OtherCompany
    
    
    Agency
    
    
    Operations
    
    
    Corporate
    
    
    TotalYear ended
December 31, 2003 (As restated)Revenue:Domestic
    
    $
    606,469
    
    
    $
    65,484
    
    
    $
    11,725
    
    
    $
    790
    
    
    $
    684,468Foreign
    
    
    219,578
    
    
    
    37,918
    
    
    
    
    
    
    
    
    
    
    
    257,496Inter-segment
    
    
    
    
    
    
    96,869
    
    
    
    
    
    
    
    
    
    
    
    96,869Total segment revenue
    
    $
    826,047
    
    
    $
    200,271
    
    
    $
    11,725
    
    
    $
    790
    
    
    
    1,038,833Inter-segment eliminations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (96,869
    )Consolidated total revenue
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    941,964Net earnings (loss):Domestic
    
    $
    56,935
    
    
    $
    37,663
    
    
    $
    6,014
    
    
    $
    (7,787
    )
    
    $
    92,825Foreign
    
    
    18,335
    
    
    
    12,065
    
    
    
    
    
    
    
    
    
    
    
    30,400Total segment net earnings
(loss)
    
    $
    75,270
    
    
    $
    49,728
    
    
    $
    6,014
    
    
    $
    (7,787
    )
    
    
    123,225Inter-segment eliminations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (17,882
    )Earnings from discontinued
operations,
net of income taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    36,684Consolidated net earnings
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    142,027Other items:Net investment income *
    
    $
    42,345
    
    
    $
    3,796
    
    
    $
    224
    
    
    $
    970
    
    
    $
    47,335Depreciation and amortization *
    
    
    3,271
    
    
    
    6,283
    
    
    
    664
    
    
    
    2,435
    
    
    
    12,653Interest expense (benefit)
    
    
    62
    
    
    
    7,877
    
    
    
    770
    
    
    
    (1,256
    )
    
    
    7,453Capital expenditures *
    
    
    2,618
    
    
    
    2,997
    
    
    
    
    
    
    
    16,047
    
    
    
    21,662Income tax expense
    
    
    35,478
    
    
    
    33,075
    
    
    
    2,699
    
    
    
    (993
    )
    
    
    70,259Inter-segment eliminations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (10,877
    )Consolidated
income tax expenseon continuing operations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    59,382
 
 *
    
    Excludes immaterial amounts related to discontinued operations. For 2003, earnings before income taxes were $180.5 million for our domestic subsidiaries
(including discontinued operations) and $47.2 million for our foreign subsidiaries and
branches. During 2003, the insurance company segment recorded an after-tax loss of $18.7
million due to a commutation.
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The following tables present selected revenue items by line of business:
 2005
    
    
    2004
    
    
    2003Diversified financial products
    
    $
    531,136
    
    
    $
    310,809
    
    
    $
    123,562Group life, accident and health
    
    
    504,382
    
    
    
    343,913
    
    
    
    290,009Aviation
    
    
    136,197
    
    
    
    127,248
    
    
    
    97,536London market account
    
    
    93,017
    
    
    
    111,341
    
    
    
    137,572Other specialty lines
    
    
    97,721
    
    
    
    69,089
    
    
    
    12,443Discontinued lines
    
    
    7,535
    
    
    
    48,292
    
    
    
    77,150Net earned premium
    
    $
    1,369,988
    
    
    $
    1,010,692
    
    
    $
    738,272(As restated)
    
    (As restated)Property and casualty
    
    $
    113,725
    
    
    $
    127,502
    
    
    $
    85,244Accident and health
    
    
    18,903
    
    
    
    56,300
    
    
    
    57,371Fee and commission income
    
    $
    132,628
    
    
    $
    183,802
    
    
    $
    142,615
 Assets by business segment and geographic location are shown in the following tables.
 Insurance
    
    
    
    
    
    
    OtherCompany
    
    
    Agency
    
    
    Operations
    
    
    Corporate
    
    
    TotalDecember 31,
2005 (As restated)Domestic
    
    $
    3,981,574
    
    
    $
    634,263
    
    
    $
    170,620
    
    
    $
    152,652
    
    
    $
    4,939,109Foreign
    
    
    1,464,306
    
    
    
    625,385
    
    
    
    
    
    
    
    
    
    
    
    2,089,691Total assets
    
    $
    5,445,880
    
    
    $
    1,259,648
    
    
    $
    170,620
    
    
    $
    152,652
    
    
    $
    7,028,800December 31,
2004 (As restated)Domestic
    
    $
    3,262,639
    
    
    $
    710,386
    
    
    $
    109,642
    
    
    $
    117,317
    
    
    $
    4,199,984Foreign
    
    
    1,032,089
    
    
    
    668,495
    
    
    
    
    
    
    
    
    
    
    
    1,700,584Total assets
    
    $
    4,294,728
    
    
    $
    1,378,881
    
    
    $
    109,642
    
    
    $
    117,317
    
    
    $
    5,900,568
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(13)
    
    COMMITMENTS AND CONTINGENCIESLitigationWe are party to lawsuits, arbitrations and other proceedings that
arise in the normal course of our business. Many of such lawsuits,
arbitrations and other proceedings involve claims under policies that
we underwrite as an insurer or reinsurer, the liabilities for which,
we believe, have been adequately included in our loss reserves. Also,
from time to time, we are a party to lawsuits, arbitrations and other
proceedings that relate to disputes over contractual relationships
with third parties, or that involve alleged errors and omissions on
the part of our subsidiaries. We have provided accruals for these
items to the extent we deem the losses probable and reasonably
estimable.We are presently engaged in litigation initiated by the appointed
liquidator of a former reinsurer concerning payments made to us prior
to the date of appointment of the liquidator. The disputed payments,
totaling $10.3 million, were made by the now insolvent reinsurer in
connection with a commutation agreement. Our understanding is that
such litigation is similar to other actions brought by the
liquidator. We continue to vigorously contest the action.Although the ultimate outcome of the matters mentioned above cannot
be determined at this time, based on present information, the
availability of insurance coverage and advice received from our
outside legal counsel, we believe the resolution of these matters
will not have a material adverse effect on our consolidated financial
position, results of operations or cash flows.Catastrophe ExposureWe write business in areas exposed to catastrophic losses and have
significant exposures to this type of loss in California, the
Atlantic Coast of the United States, certain United States Gulf Coast
states (particularly Louisiana, Florida and Texas), the Caribbean and
Mexico. We assess our overall exposures to a single catastrophic
event and apply procedures to ascertain our probable maximum loss
from any single event. We maintain reinsurance protection that we
believe is sufficient to cover any foreseeable event.IndemnificationsIn conjunction with the sales of business assets and subsidiaries, we
have provided indemnifications to the buyers. Certain
indemnifications cover typical representations and warranties related
to our responsibilities to perform under the sales contracts. 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 such indemnification expires on
December 31, 2009.We accrue a loss related to our indemnifications when a valid claim is made by a buyer and we
believe we have potential exposure. We currently have several claims under indemnifications
that cover certain net losses 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 December 31, 2005, we have recorded a liability of $20.7 million
and have provided $8.1 million of letters of credit to cover our obligations or anticipated
payments under these indemnifications.
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Terrorist ExposureUnder the Federal Terrorism Risk Extension Insurance Act of 2005, we are required to offer
terrorism coverage to our commercial policyholders in certain lines of business written in the
United States, for which we may, when warranted, charge an additional premium. The
policyholders may or may not accept such coverage. This law also established a deductible
that each insurer would have to meet before U.S. Federal reimbursement would occur. For 2006,
our deductible is approximately $91.9 million. The Federal government would provide
reimbursement for 90% of any additional covered losses in 2006 up to the maximum amount set
out in the Act. Currently, the law expires on December 31, 2007.LeasesWe lease administrative office facilities and transportation equipment under long-term
non-cancelable operating leases that expire at various dates through 2025. The agreements
generally require us to pay rent, utilities, real estate taxes, insurance and repairs. We
recognize rent expense on a straight-line basis over the term of the lease, including
free-rent periods. Rent expense under operating leases totaled $9.8 million in 2005, $9.3
million in 2004 and $8.6 million in 2003.At December 31, 2005, future minimum rental payments required under long-term, non-cancelable
operating leases, excluding certain expenses payable by us, were as follows:
 Years ended December 31,2006
    
    $
    10,5822007
    
    
    10,1392008
    
    
    8,7972009
    
    
    6,4612010
    
    
    5,689Thereafter
    
    
    17,455Total future minimum rental payments
    
    $
    59,123
 (14)
    
    RELATED PARTY TRANSACTIONSWe have strategic investments in a limited liability corporation and
a related entity for which one of our Directors previously served in
management and advisory roles. The carrying value of these
investments was $15.1 million at December 31, 2004. Income and
realized gains (losses) from these investments totaled $0.5 million
in 2004 and $(0.6) million in 2003. An entity that this Director is
affiliated with serves as the investment manager for fixed income
securities valued at $207.9 million and $203.6 million at December
31, 2005 and 2004, respectively. During 2005 and 2004, we paid $0.2
million and $0.1 million, respectively, in investment management fees
to this entity. We also have entered into an agreement with an
entity owned by our Chairman and Chief Executive Officer, who is also
a Director, pursuant to which we rent equipment and facilities to
provide transportation services to our employees, our Directors and
our clients. We provide our own employees to operate the equipment
and pay all expenses related to its operation. We paid rentals of
$1.1 million in 2005, $1.0 million in 2004 and $1.2 million in 2003.
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In 2004, we owned an interest in a company at a level that the company qualified as a related
party. That interest has now been reduced below the qualifying amount. In 2004, we recorded
$3.2 million of other operating income related to this company and ceded $9.1 million of
written premium to and assumed $61.5 million of written premium from this company.At December 31, 2005 and 2004, we accrued $32.3 million and $35.9 million, respectively, for
amounts owed to former owners of businesses we acquired, who now are officers of certain of
our subsidiaries. These accruals represent amounts due under the terms of various acquisition
agreements. We paid $35.1 million in 2005, $41.0 million in 2004 and $15.2 million in 2003
related to such agreements.We own equity interests ranging from 20% to 31% in three companies for which we use the equity
method of accounting. During 2005, we acquired the remaining interest in two other companies
we owned a minority interest in and included 100% of their earnings in our consolidated
financial statements beginning on the effective date of the acquisitions. We recorded gross
written premium from business originating at the five companies (until the acquisition date
for the two companies that are now subsidiaries) of $40.2 million in 2005, $21.7 million in
2004 and $2.1 million in 2003. During 2005 and 2004, we also ceded written premium of $8.0
million and $5.6 million, respectively, to one of these companies under a quota share
reinsurance agreement.(15)
    
    STATUTORY INFORMATIONOur insurance companies file financial statements prepared in
accordance with statutory accounting practices prescribed or
permitted by domestic or foreign insurance regulatory authorities.
The differences between statutory financial statements and financial
statements prepared in accordance with generally accepted accounting
principles vary between domestic and foreign jurisdictions.Statutory policyholders surplus and net income, after intercompany
eliminations, included in those companies respective filings with
regulatory authorities were as follows:
 2005
    
    
    2004
    
    
    2003Statutory policyholders surplus
    
    $
    1,110,268
    
    
    $
    844,851
    
    
    $
    591,889Statutory net income
    
    
    112,231
    
    
    
    85,843
    
    
    
    54,784
 The 2005 statutory net income was reduced $58.2 million due to the 2005 hurricanes and $20.3
million due to commutations. The 2004 statutory net income was reduced $21.5 million due to
the 2004 hurricanes. The 2003 statutory net income was reduced $18.7 million due to a
commutation.The statutory surplus of each of our insurance companies is significantly in excess of
regulatory risk-based capital requirements.
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(16)
    
    SUPPLEMENTAL INFORMATIONSupplemental cash flow information was as follows:
 2005
    
    
    2004
    
    
    2003Cash received from commutations
    
    $
    180,789
    
    
    $
    79,462
    
    
    $
    48,983Income taxes paid
    
    
    78,309
    
    
    
    112,392
    
    
    
    70,573Interest paid
    
    
    6,168
    
    
    
    7,219
    
    
    
    6,174Dividends declared but not paid at year end
    
    
    8,310
    
    
    
    5,783
    
    
    
    4,800
 The unrealized gain or loss on securities available for sale, deferred taxes related thereto
and the issuance of our common stock for the purchase of subsidiaries are non-cash
transactions that have been included as direct increases or decreases in our consolidated
shareholders equity.(17)
    
    QUARTERLY FINANCIAL DATA (UNAUDITED)The quarterly financial data has been restated for the adjustments discussed in Note 2.
 Fourth quarter 2005
    
    
    Fourth quarter 2004As
    
    
    
    
    
    
    
    
    
    
    Aspreviously
    
    
    
    
    
    
    
    
    
    
    previouslyreported
    
    
    Adjustments
    
    
    As restated
    
    
    reported
    
    
    Adjustments
    
    
    As restatedTotal revenue
    
    $
    447,796
    
    
    $
    (201
    )
    
    $
    447,595
    
    
    $
    365,669
    
    
    $
    1,388
    
    
    $
    367,057Net earnings
    
    $
    66,534
    
    
    $
    (1,498
    )
    
    $
    65,036
    
    
    $
    56,239
    
    
    $
    1,079
    
    
    $
    57,318Basic earnings per share data:Earnings per share
    
    $
    0.62
    
    
    $
    (0.02
    )
    
    $
    0.60
    
    
    $
    0.57
    
    
    $
    0.01
    
    
    $
    0.58Weighted average shares outstanding
    
    
    107,970
    
    
    
    
    
    
    
    107,970
    
    
    
    98,799
    
    
    
    
    
    
    
    98,799Diluted earnings per share data:Earnings per share
    
    $
    0.59
    
    
    $
    (0.02
    )
    
    $
    0.57
    
    
    $
    0.56
    
    
    $
    0.01
    
    
    $
    0.57Weighted average shares outstanding
    
    
    113,566
    
    
    
    
    
    
    
    113,566
    
    
    
    100,254
    
    
    
    
    
    
    
    100,254
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Third quarter 2005
    
    
    Third quarter 2004As
    
    
    
    
    
    
    
    
    
    
    Aspreviously
    
    
    
    
    
    
    
    
    
    
    previouslyreported
    
    
    Adjustments
    
    
    As restated
    
    
    reported
    
    
    Adjustments
    
    
    As restatedTotal revenue
    
    $
    412,031
    
    
    $
    
    
    
    $
    412,031
    
    
    $
    322,197
    
    
    $
    65
    
    
    $
    322,262Net earnings
    
    $
    7,950
    
    
    $
    (538
    )
    
    $
    7,412
    
    
    $
    15,803
    
    
    $
    (337
    )
    
    $
    15,466Basic earnings per share data:Earnings per share
    
    $
    0.08
    
    
    $
    (0.01
    )
    
    $
    0.07
    
    
    $
    0.16
    
    
    $
    
    
    
    $
    0.16Weighted average shares outstanding
    
    
    105,623
    
    
    
    
    
    
    
    105,623
    
    
    
    97,019
    
    
    
    
    
    
    
    97,019Diluted earnings per share data:Earnings per share
    
    $
    0.07
    
    
    $
    
    
    
    $
    0.07
    
    
    $
    0.16
    
    
    $
    
    
    
    $
    0.16Weighted average shares outstanding
    
    
    109,818
    
    
    
    
    
    
    
    109,818
    
    
    
    98,409
    
    
    
    
    
    
    
    98,409
 Second quarter 2005
    
    
    Second quarter 2004As
    
    
    
    
    
    
    
    
    
    
    Aspreviously
    
    
    
    
    
    
    
    
    
    
    previouslyreported
    
    
    Adjustments
    
    
    As restated
    
    
    reported
    
    
    Adjustments
    
    
    As restatedTotal revenue
    
    $
    404,837
    
    
    $
    
    
    
    $
    404,837
    
    
    $
    317,270
    
    
    $
    335
    
    
    $
    317,605Net earnings
    
    $
    64,058
    
    
    $
    (702
    )
    
    $
    63,356
    
    
    $
    46,415
    
    
    $
    (641
    )
    
    $
    45,774Basic earnings per share data:Earnings per share
    
    $
    0.61
    
    
    $
    (0.01
    )
    
    $
    0.60
    
    
    $
    0.48
    
    
    $
    (0.01
    )
    
    $
    0.47Weighted average shares outstanding
    
    
    104,962
    
    
    
    
    
    
    
    104,962
    
    
    
    96,807
    
    
    
    
    
    
    
    96,807Diluted earnings per share data:Earnings per share
    
    $
    0.59
    
    
    $
    
    
    
    $
    0.59
    
    
    $
    0.47
    
    
    $
    (0.01
    )
    
    $
    0.46Weighted average shares outstanding
    
    
    108,269
    
    
    
    
    
    
    
    108,269
    
    
    
    98,690
    
    
    
    
    
    
    
    98,690
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First quarter 2005
    
    
    First quarter 2004As
    
    
    
    
    
    
    
    
    
    
    Aspreviously
    
    
    
    
    
    
    
    
    
    
    previouslyreported
    
    
    Adjustments
    
    
    As restated
    
    
    reported
    
    
    Adjustments
    
    
    As restatedTotal revenue
    
    $
    379,678
    
    
    $
    (1,453
    )
    
    $
    378,225
    
    
    $
    278,018
    
    
    $
    (335
    )
    
    $
    277,683Net earnings
    
    $
    57,318
    
    
    $
    (1,930
    )
    
    $
    55,388
    
    
    $
    44,568
    
    
    $
    (427
    )
    
    $
    44,141Basic earnings per share data:Earnings per share
    
    $
    0.56
    
    
    $
    (0.02
    )
    
    $
    0.54
    
    
    $
    0.46
    
    
    $
    
    
    
    $
    0.46Weighted average shares outstanding
    
    
    103,241
    
    
    
    
    
    
    
    103,241
    
    
    
    96,374
    
    
    
    
    
    
    
    96,374Diluted earnings per share data:Earnings per share
    
    $
    0.54
    
    
    $
    (0.02
    )
    
    $
    0.52
    
    
    $
    0.45
    
    
    $
    
    
    
    $
    0.45Weighted average shares outstanding
    
    
    105,734
    
    
    
    
    
    
    
    105,734
    
    
    
    98,126
    
    
    
    
    
    
    
    98,126
 During the fourth and third quarters of 2005, losses from the 2005 hurricanes reduced net earnings $9.9 million and $48.3
million, respectively. Also in the third quarter of 2005, we recorded a $16.9 million after-tax loss due to a
commutation. During the third quarter of 2004, losses from the 2004 hurricanes decreased net earnings $35.7 million.
During the fourth quarter of 2004, we reduced the hurricane reserves by $14.2 million after-tax based on our assessment
of new and additional claim information, and also strengthened our
reserves for discontinued lines by a similar amount.The sum of earnings per share for the quarters may not equal the annual amounts due to rounding.
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(18)
    
    SUBSEQUENT EVENTSBased on the Special Committees voluntary independent investigation of our past practices
related to granting stock options, we determined that the price on the actual measurement date
for a number of our stock option grants during the period 1997 through 2005 and into 2006 did
not correspond to the price on the stated grant date and that certain option grants were
retroactively repriced. The investigation was conducted with the help of a law firm that was
not previously involved with our stock option plans and procedures. The SEC has commenced an
informal inquiry. In connection with its inquiry, we received a document request from the
SEC. We intend to fully cooperate with the informal inquiry. We are unable to predict the
outcome of or the future costs related to the informal inquiry.On October 30, 2006, we received a registered letter from U.S. Bank, as trustee for the
holders of our 2.00% Convertible Notes due 2021, 1.30% Convertible Notes due 2023 and 2.00%
Convertible Exchange Notes due 2021, stating that U.S. Bank, as trustee, had not received our
consolidated financial statements for the quarter ended June 30, 2006. If we do not file our
Quarterly Report on Form 10-Q for the quarter ended June 30, 2006 with the SEC and deliver the
report to the trustee within sixty days from the date notice was
received from the trustee, such
failure to file and deliver will be considered an Event of Default under the indenture
governing the notes. If an Event of Default were to occur under the indentures for any
series of the notes, the trustee or holders of at least 25% of the aggregate principal of such
series then outstanding could declare all the unpaid principal on such series of notes then
outstanding to be immediately due and payable. Likewise, we have not timely delivered our
Form 10-Qs for the quarters ended June 30 and September 30, 2006 as required by the terms of
our Revolving Loan Facility. The banks that are a party to the agreement waived certain
Defaults or Events of Default until January 31, 2007. In addition, our restatement of our
prior year financial statements might be considered an Event of Default, which has been
waived until January 31, 2007 under our Revolving Loan Facility. Our failure to comply with
the covenants in the indentures for our convertible notes and our Revolving Loan Facility in
the future could have a material adverse effect on our stock price, business and financial
condition if we would not have available funds at that time to repay any defaulted debt. A
default and acceleration under the indentures for our convertible notes and loan agreement may
also trigger cross-acceleration under our other debt instruments.In
December 2006, our existing Revolving Loan Facility was increased by
$100.0 million to $300.0 million. Pursuant
to the terms of the agreement, the Company can borrow up to $25
million in addition to what is currently borrowed for working capital
purposes. However, the full unfunded amount of the facility would be
available to pay any potential convertible note conversion or put.
 F-58




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In April 2006, we were named as a defendant in a complaint related to insurance marketing and
producer compensation practices. The lawsuit was filed in Federal District Court in Georgia
by a number of corporate plaintiffs against approximately 100 insurance entity defendants.
The suit has been transferred to the multi-district litigation proceeding pending in the
United States District Court for the District of New Jersey for coordinated or consolidated
pre-trial proceedings with suits previously transferred that appear to the court to involve
common questions of fact. The complaint alleges violations of Federal antitrust law, the
Racketeering Influence and Corrupt Organization Act and various state anti-fraud laws. The
lawsuit seeks unspecified damages. We are vigorously contesting this action.The Financial Accounting Standards Board (FASB) has issued FASB Interpretation (FIN) No. 48,
Accounting for Uncertainty in Income Taxes. Effective January 1, 2007, FIN 48 clarifies the
accounting for uncertain income tax positions. We are currently reviewing the requirements of
FIN 48 to determine the effect it will have on our consolidated financial statements.The FASB issued SFAS No. 157, Fair Value
Measurements (SFAS 157), which clarified the
definition of fair value, establishes a framework for measuring fair value in generally
accepted accounting principles, and expands disclosures about fair value measurement. SFAS
157 does not require any new fair value measurements and eliminates inconsistencies in
guidance found in various prior accounting pronouncements. SFAS 157 will be effective for us
on January 1, 2008. We are currently assessing whether the adoption of SFAS 157 will have an
impact on our consolidated financial statements.The Securities and Exchange Commission has issued Staff Accounting Bulletin (SAB) No.108,
Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current
Year Financial Statements. SAB 108 establishes a standard approach for quantifying the
materiality of errors to current and prior period financial statements. SAB 108s guidelines
must be applied in the fourth quarter, and adjustments, if any, will be recorded either by
restating prior year financial statements or recording a cumulative effect adjustment as of
January 1, 2006. We believe the requirements of SAB 108 will
have no effect on our consolidated financial statements.
 F-59




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SCHEDULE 1
 HCC INSURANCE HOLDINGS, INC.
 SUMMARY OF INVESTMENTS
OTHER THAN INVESTMENTS IN RELATED PARTIES
(in thousands)
 December 31, 2005Column A
    
    Column B
    
    
    Column C
    
    
    Column DAmount at whichshown in theType of investment
    
    Cost
    
    
    Value
    
    
    balance sheetFixed maturities:Bonds  United States government and government
agencies and authorities
    
    $
    90,404
    
    
    $
    89,724
    
    
    $
    89,724Bonds  states, municipalities and political
subdivisions
    
    
    418,179
    
    
    
    418,873
    
    
    
    418,873Bonds  special revenue
    
    
    720,320
    
    
    
    723,101
    
    
    
    723,101Bonds  corporate
    
    
    381,917
    
    
    
    375,582
    
    
    
    375,582Asset-backed and mortgage-backed securities
    
    
    361,456
    
    
    
    355,372
    
    
    
    355,372Bonds  foreign
    
    
    304,863
    
    
    
    305,972
    
    
    
    305,972Total fixed maturities
    
    
    2,277,139
    
    
    
    2,268,624
    
    
    
    2,268,624Equity securities:Common stocks  banks, trusts and insurance companies
    
    
    28,766
    
    
    $
    36,926
    
    
    
    36,926Common stocks  industrial, miscellaneous and all other
    
    
    40,764
    
    
    
    36,095
    
    
    
    36,095Non-redeemable preferred stocks
    
    
    1,033
    
    
    
    1,013
    
    
    
    1,013Total equity securities
    
    
    70,563
    
    
    $
    74,034
    
    
    
    74,034Short-term investments
    
    
    839,581
    
    
    
    
    
    
    
    839,581Other investments
    
    
    74,334
    
    
    
    
    
    
    
    75,189Total investments
    
    $
    3,261,617
    
    
    
    
    
    
    $
    3,257,428
 S - 1




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##### Table of Contents



SCHEDULE 2
 HCC INSURANCE HOLDINGS, INC.
 CONDENSED FINANCIAL INFORMATION OF REGISTRANT
 BALANCE SHEETS
(in thousands)
 
 December 31,2005
    
    
    2004(As restated)
    
    
    (As restated)ASSETSFixed income securities, at fair value (amortized cost: 2005 
$31,023;
2004  $33,749)
    
    $
    30,622
    
    
    $
    33,716Cash
    
    
    3,610
    
    
    
    2,242Short-term investments
    
    
    38,182
    
    
    
    31,006Investment in subsidiaries
    
    
    1,790,774
    
    
    
    1,391,415Intercompany loans to subsidiaries for acquisitions
    
    
    184,706
    
    
    
    194,919Receivable from subsidiaries
    
    
    37,364
    
    
    
    39,997Other assets
    
    
    14,056
    
    
    
    11,867Total assets
    
    $
    2,099,314
    
    
    $
    1,705,162LIABILITIES AND SHAREHOLDERS EQUITYPayable to subsidiaries
    
    $
    85,821
    
    
    $
    55,151Notes payable
    
    
    297,400
    
    
    
    297,442Deferred Federal income tax
    
    
    13,548
    
    
    
    6,468Accounts payable and accrued liabilities
    
    
    12,110
    
    
    
    20,603Total liabilities
    
    
    408,879
    
    
    
    379,664Total shareholders equity
    
    
    1,690,435
    
    
    
    1,325,498Total liabilities and shareholders equity
    
    $
    2,099,314
    
    
    $
    1,705,162
  S - 2




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SCHEDULE 2
 HCC INSURANCE HOLDINGS, INC.
 CONDENSED FINANCIAL INFORMATION OF REGISTRANT
 STATEMENTS OF EARNINGS
(in thousands)
 
 Years ended December 31,2005
    
    
    2004
    
    
    2003(As restated)
    
    
    (As restated)
    
    
    (As restated)Equity in earnings of subsidiaries
    
    $
    188,202
    
    
    $
    165,712
    
    
    $
    141,319Interest income from subsidiaries
    
    
    6,799
    
    
    
    6,531
    
    
    
    6,827Net investment income
    
    
    2,082
    
    
    
    994
    
    
    
    953Other operating income
    
    
    525
    
    
    
    
    
    
    
    2,481Total revenue
    
    
    197,608
    
    
    
    173,237
    
    
    
    151,580Interest expense
    
    
    6,552
    
    
    
    6,733
    
    
    
    6,296Other operating expense
    
    
    3,404
    
    
    
    2,858
    
    
    
    1,781Total expense
    
    
    9,956
    
    
    
    9,591
    
    
    
    8,077Earnings before income tax expense
    
    
    187,652
    
    
    
    163,646
    
    
    
    143,503Income tax expense (benefit)
    
    
    (3,540
    )
    
    
    947
    
    
    
    1,476Net earnings
    
    $
    191,192
    
    
    $
    162,699
    
    
    $
    142,027
  S - 3




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SCHEDULE 2
 HCC INSURANCE HOLDINGS, INC.
 CONDENSED FINANCIAL INFORMATION OF REGISTRANT
 STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
 
 Years ended December 31,2005
    
    
    2004
    
    
    2003(As restated)
    
    
    (As restated)
    
    
    (As restated)Net earnings
    
    $
    191,192
    
    
    $
    162,699
    
    
    $
    142,027Other comprehensive income (loss):Investment gains (losses):Gains (losses) during the year, net of income tax charge
(benefit) of $(129) in 2005 and $12 in 2004
    
    
    (239
    )
    
    
    21
    
    
    
    Consolidated subsidiaries investment
gains (losses) during the year, net of income
tax charge (benefit) of $(2,817) in 2005,
$6,079 in 2004 and $(1,048) in 2003
    
    
    (4,018
    )
    
    
    10,934
    
    
    
    (1,962
    )Less consolidated subsidiaries reclassification
adjustment for gains included in
net earnings, net of income tax charge of
$2,479 in 2005, $2,433 in 2004 and $184 in 2003
    
    
    (4,605
    )
    
    
    (4,518
    )
    
    
    (343
    )Foreign currency translation adjustment
    
    
    (9,699
    )
    
    
    6,287
    
    
    
    6,451Other comprehensive income (loss)
    
    
    (18,561
    )
    
    
    12,724
    
    
    
    4,146Comprehensive income
    
    $
    172,631
    
    
    $
    175,423
    
    
    $
    146,173
  S - 4




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SCHEDULE 2
 HCC INSURANCE HOLDINGS, INC.
 CONDENSED FINANCIAL INFORMATION OF REGISTRANT
 STATEMENTS OF CASH FLOWS
(in thousands)
 
 Years ended December 31,2005
    
    
    2004
    
    
    2003(As restated)
    
    
    (As restated)
    
    
    (As restated)Cash flows from operating activities:Net earnings
    
    $
    191,192
    
    
    $
    162,699
    
    
    $
    142,027Adjustments to reconcile net earnings to net cash
provided by operating activities:Undistributed net income of subsidiaries
    
    
    (116,122
    )
    
    
    (133,916
    )
    
    
    (119,419
    )Change in accrued interest receivable added to
intercompany loan balances
    
    
    (6,712
    )
    
    
    (6,544
    )
    
    
    (6,317
    )Change in accounts payable and accrued liabilities
    
    
    (10,999
    )
    
    
    (660
    )
    
    
    10,022Tax benefit from exercise of stock options
    
    
    6,168
    
    
    
    2,969
    
    
    
    1,811Other, net
    
    
    (4,754
    )
    
    
    4,680
    
    
    
    3,331Cash provided by operating activities
    
    
    58,773
    
    
    
    29,228
    
    
    
    31,455Cash flows from investing activities:Cash contributions to subsidiaries
    
    
    (162,872
    )
    
    
    (107,000
    )
    
    
    (51,364
    )Payments for purchase of subsidiaries, net of cash
received
    
    
    (98,829
    )
    
    
    (48,975
    )
    
    
    (11,624
    )Change in short-term investments
    
    
    (7,176
    )
    
    
    29,817
    
    
    
    (55,986
    )Sales and maturities of fixed income securities
    
    
    6,200
    
    
    
    
    
    
    
    Cost of securities acquired
    
    
    (3,400
    )
    
    
    (33,679
    )
    
    
    Change in receivable/payable from subsidiaries
    
    
    33,303
    
    
    
    43,295
    
    
    
    (14,008
    )Intercompany loans to subsidiaries for acquisitions
    
    
    (39,685
    )
    
    
    (62,523
    )
    
    
    (26,838
    )Payments on intercompany loans to subsidiaries
    
    
    56,610
    
    
    
    54,694
    
    
    
    54,674Cash used by investing activities
    
    
    (215,849
    )
    
    
    (124,371
    )
    
    
    (105,146
    )Cash flows from financing activities:Proceeds from note payable, net of costs
    
    
    36,000
    
    
    
    29,000
    
    
    
    178,000Payments on notes payable
    
    
    (36,015
    )
    
    
    (29,009
    )
    
    
    (107,003
    )Sale of common stock, net of costs
    
    
    186,103
    
    
    
    116,776
    
    
    
    20,279Dividends paid
    
    
    (27,644
    )
    
    
    (19,984
    )
    
    
    (17,039
    )Cash provided by financing activities
    
    
    158,444
    
    
    
    96,783
    
    
    
    74,237Net increase in cash
    
    
    1,368
    
    
    
    1,640
    
    
    
    546Cash at beginning of year
    
    
    2,242
    
    
    
    602
    
    
    
    56Cash at end of year
    
    $
    3,610
    
    
    $
    2,242
    
    
    $
    602
  S - 5




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##### Table of Contents



HCC INSURANCE HOLDINGS, INC.
 CONDENSED FINANCIAL INFORMATION OF REGISTRANT
 NOTES TO CONDENSED FINANCIAL INFORMATION
 (1)
    
    The accompanying condensed financial information should be read in conjunction with the
consolidated financial statements and the related notes thereto of HCC Insurance Holdings,
Inc. and Subsidiaries. Investments in subsidiaries are accounted for using the equity method.
Certain amounts in the 2004 and 2003 condensed financial information have been reclassified
to conform with the 2005 presentation. Such reclassifications had no effect on shareholders
equity, net earnings or cash flows.The restatement adjustments discussed in Note 2 in the consolidated financial statements related to
mis-priced options were recorded at a subsidiary of HCC Insurance Holdings. Accordingly,
these entries are reflected in the condensed financial information as adjustments to equity in
earnings of subsidiaries on the condensed income statement and investment in subsidiaries on
the condense balance sheet. The condensed financial information also reflects other minor
adjustments that were made as part of the restatement.(2)
    
    Intercompany loans to subsidiaries are demand notes issued primarily to fund the cash portion
of acquisitions. They bear interest at a rate set by management, which approximates the
interest rate charged for similar debt. At December 31, 2005, the interest rate on
intercompany loans was 6.0%.(3)
    
    Other income for 2003 includes a one-time foreign currency transaction gain of $1.3 million
in settlement of an advance to an unaffiliated entity and income from a strategic investment.
 S - 6




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##### Table of Contents



SCHEDULE 3
 HCC INSURANCE HOLDINGS, INC.
 SUPPLEMENTARY INSURANCE INFORMATION
(in thousands)
 Column A
    
    Column B
    
    
    Column C
    
    
    Column D
    
    
    Column F
    
    
    Column G
    
    
    Column H
    
    
    Column I
    
    
    Column J
    
    
    Column K(1)
    
    
    (1)
    
    
    
    
    
    
    (2)
    
    
    
    
    
    
    
    
    
    
    (3)December 31,
    
    
    Years ended December 31,Deferred
    
    
    Future policy
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Benefits, claims,policy
    
    
    benefits, losses,
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    losses and
    
    
    Amortization of
    
    
    Otheracquisition
    
    
    claims and loss
    
    
    Unearned
    
    
    Premium
    
    
    Net investment
    
    
    settlement
    
    
    deferred policy
    
    
    operating
    
    
    PremiumSegments
    
    costs
    
    
    expenses
    
    
    premiums
    
    
    revenue
    
    
    income
    
    
    expenses
    
    
    acquisition costs
    
    
    expenses
    
    
    written2005
    
    (As restated)
    
    (As restated)
    
    
    
    
    
    
    
    
    
    
    
    
    
    (As restated)
    
    (As restated)
    
    (As restated)Insurance Company
    
    $
    88,367
    
    
    $
    2,887,135
    
    
    $
    807,109
    
    
    $
    1,369,988
    
    
    $
    88,397
    
    
    $
    919,697
    
    
    $
    261,708
    
    
    $
    84,838
    
    
    $
    1,501,224Agency
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,437
    
    
    
    
    
    
    
    
    
    
    
    84,107Other Operations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    794
    
    
    
    
    
    
    
    
    
    
    
    1,732Corporate
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,223
    
    
    
    
    
    
    
    
    
    
    
    10,313Total
    
    $
    88,367
    
    
    $
    2,887,135
    
    
    $
    807,109
    
    
    $
    1,369,988
    
    
    $
    98,851
    
    
    $
    919,697
    
    
    $
    261,708
    
    
    $
    180,990
    
    
    $
    1,501,2242004Insurance Company
    
    $
    45,719
    
    
    $
    2,163,826
    
    
    $
    741,706
    
    
    $
    1,010,692
    
    
    $
    59,073
    
    
    $
    645,230
    
    
    $
    222,323
    
    
    $
    67,138
    
    
    $
    1,105,519Agency
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,559
    
    
    
    
    
    
    
    
    
    
    
    91,617Other Operations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,236
    
    
    
    
    
    
    
    
    
    
    
    1,416Corporate
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,017
    
    
    
    
    
    
    
    
    
    
    
    7,874Total
    
    $
    45,719
    
    
    $
    2,163,826
    
    
    $
    741,706
    
    
    $
    1,010,692
    
    
    $
    64,885
    
    
    $
    645,230
    
    
    $
    222,323
    
    
    $
    168,045
    
    
    $
    1,105,5192003Insurance Company
    
    $
    18,814
    
    
    $
    1,602,861
    
    
    $
    592,311
    
    
    $
    738,272
    
    
    $
    42,345
    
    
    $
    488,000
    
    
    $
    137,212
    
    
    $
    55,814
    
    
    $
    865,502Agency
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,796
    
    
    
    
    
    
    
    
    
    
    
    75,691Other Operations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    224
    
    
    
    
    
    
    
    
    
    
    
    2,242Corporate
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    970
    
    
    
    
    
    
    
    
    
    
    
    10,827Total
    
    $
    18,814
    
    
    $
    1,602,861
    
    
    $
    592,311
    
    
    $
    738,272
    
    
    $
    47,335
    
    
    $
    488,000
    
    
    $
    137,212
    
    
    $
    144,574
    
    
    $
    865,502
 (1)
    
    Columns C and D are shown ignoring the effects of reinsurance.(2)
    
    Net investment income was allocated to the subsidiary, and therefore the segment, on
which the related investment asset was recorded.(3)
    
    Other operating expenses is after all corporate expense allocations have been charged or
credited to the individual segments.
  S - 7




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##### Table of Contents



SCHEDULE 4
 HCC INSURANCE HOLDINGS, INC.
 REINSURANCE
(in thousands)
 Column A
    
    Column B
    
    
    Column C
    
    
    Column D
    
    
    Column E
    
    
    Column FAssumed from
    
    
    
    
    
    
    Percent ofCeded to other
    
    
    other
    
    
    
    
    
    
    amountPrimary amount
    
    
    companies
    
    
    companies
    
    
    Net amount
    
    
    assumed to netYear ended December 31, 2005Life insurance in force
    
    $
    1,359,529
    
    
    $
    404,228
    
    
    $
    
    
    
    $
    955,301
    
    
    
    %Earned premium:Property and liability insurance
    
    $
    1,116,713
    
    
    $
    546,275
    
    
    $
    266,651
    
    
    $
    837,089
    
    
    
    32%Accident and health insurance
    
    
    577,733
    
    
    
    71,127
    
    
    
    26,293
    
    
    
    532,899
    
    
    
    5%Total
    
    $
    1,694,446
    
    
    $
    617,402
    
    
    $
    292,944
    
    
    $
    1,369,988
    
    
    
    21%Year ended December 31, 2004Life insurance in force
    
    $
    1,498,559
    
    
    $
    435,808
    
    
    $
    
    
    
    $
    1,062,751
    
    
    
    %Earned premium:Property and liability insurance
    
    $
    968,444
    
    
    $
    615,780
    
    
    $
    274,124
    
    
    $
    626,788
    
    
    
    44%Accident and health insurance
    
    
    589,362
    
    
    
    233,830
    
    
    
    28,372
    
    
    
    383,904
    
    
    
    7%Total
    
    $
    1,557,806
    
    
    $
    849,610
    
    
    $
    302,496
    
    
    $
    1,010,692
    
    
    
    30%Year ended December 31, 2003Life insurance in force
    
    $
    1,443,611
    
    
    $
    481,870
    
    
    $
    
    
    
    $
    961,741
    
    
    
    %Earned premium:Property and liability insurance
    
    $
    651,893
    
    
    $
    454,294
    
    
    $
    205,165
    
    
    $
    402,764
    
    
    
    51%Accident and health insurance
    
    
    537,463
    
    
    
    294,505
    
    
    
    92,550
    
    
    
    335,508
    
    
    
    28%Total
    
    $
    1,189,356
    
    
    $
    748,799
    
    
    $
    297,715
    
    
    $
    738,272
    
    
    
    40%
 S - 8




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##### Table of Contents



SCHEDULE 5
 HCC INSURANCE HOLDINGS, INC.
 VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
 2005
    
    
    2004
    
    
    2003Reserve for uncollectible reinsurance:Balance at beginning of year
    
    $
    20,425
    
    
    $
    14,991
    
    
    $
    7,142Provision charged to expense
    
    
    5,750
    
    
    
    6,616
    
    
    
    7,671Reclassification to indemnification liability
    
    
    (9,000
    )
    
    
    
    
    
    
    Amounts (written off) recovered
    
    
    (5,034
    )
    
    
    (1,182
    )
    
    
    178Balance at end of year
    
    $
    12,141
    
    
    $
    20,425
    
    
    $
    14,991Allowance for doubtful accounts:Balance at beginning of year
    
    $
    4,911
    
    
    $
    2,549
    
    
    $
    2,279Acquisition of subsidiaries
    
    
    
    
    
    
    1,931
    
    
    
    13Provision charged to expense
    
    
    1,917
    
    
    
    546
    
    
    
    167Amounts (written off) recovered and other
    
    
    566
    
    
    
    (115
    )
    
    
    90Balance at end of year
    
    $
    7,394
    
    
    $
    4,911
    
    
    $
    2,549
 S - 9




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##### Table of Contents



(Items denoted by a letter are incorporated by reference to
other documents previously filed with the Securities and
Exchange Commission as set forth at the end of this index.
Items not denoted by a letter are being filed herewith.)
 ExhibitNumberA3.1
    
    -Restated Certificate of Incorporation and
Amendment of Certificate of Incorporation of HCC
Insurance Holdings, Inc., filed with the Delaware
Secretary of State on July 23, 1996 and May 21, 1998, respectively.B3.2
    
    -Bylaws of HCC Insurance Holdings, Inc., as amended.B4.1
    
    -Specimen of Common Stock Certificate, $1.00 par value, of HCC Insurance Holdings, Inc.C4.2
    
    -Indenture dated August 23, 2001 between HCC Insurance Holdings, Inc. and
First Union National Bank related to Debt Securities (Senior Debt).C4.3
    
    -First Supplemental Indenture dated August 23, 2001 between HCC Insurance
Holdings, Inc. and First Union National Bank related to 2.00% Convertible Notes Due 2021.D4.4
    
    -Second Supplemental Indenture dated March 28, 2003 between HCC Insurance Holdings, Inc. and Wachovia Bank,
National Association (as successor to First Union National Bank) related to 1.30% Convertible Notes Due 2023.E4.5
    
    -First Amendment to Second Supplemental Indenture dated December 22, 2004 between HCC Insurance Holdings, Inc.
and Wachovia Bank, National Association related to 1.30% Convertible Notes Due 2023.F4.6
    
    -Third Supplemental Indenture dated November 23, 2004 between HCC Insurance Holdings, Inc. and Wachovia
Bank, National Association related to 2.00% Convertible Notes Due 2021.G10.1
    
    -Loan Agreement ($200,000,000 Revolving Loan Facility) dated at November 24, 2004 among HCC Insurance
Holdings, Inc.; Wells Fargo Bank, National Association; Southwest Bank of Texas, N.A.; Citibank, N.A.; Royal
Bank of Scotland and Bank of New York.H10.2
    
    -HCC Insurance Holdings, Inc. 1995 Flexible Incentive Plan, as amended and restated.H10.3
    
    -HCC Insurance Holdings, Inc. 1997 Flexible Incentive Plan, as amended and restated.H10.4
    
    -HCC Insurance Holdings, Inc. 1996 Nonemployee Director Stock Option Plan, as amended and restated.I10.5
    
    -HCC Insurance Holdings, Inc. 2001 Flexible Incentive Plan, as amended and restated.




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##### Table of Contents







|        |  |                                                                                                                                            |  | 
|------- |  | ------------------------------------------------------------------------------------------------------------------------------------------ |  | 
|Exhibit |  |                                                                                                                                           
|Number  |  |                                                                                                                                           
|J10.6   |  | -Form of Incentive Stock Option Agreement under the HCC Insurance Holdings, Inc. 2001 Flexible Incentive Plan.                            
|        |  |                                                                                                                                            |  | 
|K10.7   |  | -HCC Insurance Holdings, Inc. 2004 Flexible Incentive Plan.                                                                               
|        |  |                                                                                                                                            |  | 
|F10.8   |  | -Form of Incentive Stock Option Agreement under the HCC Insurance Holdings, Inc. 2004 Incentive Plan.                                     
|        |  |                                                                                                                                            |  | 
|F10.9   |  | -Amended and Restated Employment Agreement effective at November 10, 2004, between HCC Insurance
Holdings, Inc. and Stephen L. Way.       
|        |  |                                                                                                                                            |  | 
|L10.10  |  | -HCC Insurance Holdings, Inc. nonqualified deferred compensation plan for Stephen L. Way effective January 1, 2003.                       
|        |  |                                                                                                                                            |  | 
|M10.11  |  | -Employment Agreement effective at March 1, 2005, between HCC Insurance Holdings, Inc. and Craig J. Kelbel.                               
|        |  |                                                                                                                                            |  | 
|J10.12  |  | -Employment Agreement effective at June 3, 2002, between HCC Insurance Holdings, Inc. and Michael J. Schell.                              
|        |  |                                                                                                                                            |  | 
|N10.13  |  | -Employment Agreement effective at January 1, 2002, between HCC Insurance Holdings, Inc. and Edward H. Ellis, Jr.                         
|        |  |                                                                                                                                            |  | 
|P10.14  |  | -Consulting Agreement and Resignation effective as of November 17, 2006 by and between HCC Insurance
Holdings, Inc. and Stephen L. Way.   
|        |  |                                                                                                                                            |  | 
|Q10.15  |  | -Separation Agreement and Release effective as of November 17, 2006 by and between HCC Insurance
Holdings, Inc. and Christopher L. Martin.
|        |  |                                                                                                                                            |  | 
|12      |  | -Statement Regarding Computation of Ratios.                                                                                               
|        |  |                                                                                                                                            |  | 
|O 14    |  | -Form of HCC Insurance Holdings, Inc. Code of Ethics Statement by Chief Executive Officer and Senior
Financial Officers.                  
|        |  |                                                                                                                                            |  | 
|O 21    |  | -Subsidiaries of HCC Insurance Holdings, Inc.                                                                                             
|        |  |                                                                                                                                            |  | 
|24      |  | -Powers of Attorney.                                                                                                                      
|        |  |                                                                                                                                            |  | 
|31.1    |  | -Certification by Chief Executive Officer.                                                                                                
|        |  |                                                                                                                                            |  | 
|31.2    |  | -Certification by Chief Financial Officer.                                                                                                
|        |  |                                                                                                                                            |  | 
|32.1    |  | -Certification with respect to Annual Report of HCC Insurance Holdings, Inc.                                                              






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##### Table of Contents



A
    
    Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.s
Registration Statement on Form S-8 (Registration No. 333-61687) filed August 17, 1998.B
    
    Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.s
Registration Statement on Form S-1 (Registration No. 33-48737) filed October 27, 1992.C
    
    Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.s
Form 8-K dated August 19, 2001.D
    
    Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.s Form 8-K dated March 25, 2003.E
    
    Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.s Form 8-K dated December 22, 2004.F
    
    Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.s Form 10-K for the year ended December 31, 2004.G
    
    Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.s Form 8-K filed December 1, 2004.H
    
    Incorporated by reference to Exhibits to HCC Insurance Holdings, Inc.s Form 10-K for the year ended December 31, 1999.I
    
    Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.s Definitive Proxy Statement for the May 22, 2002 Annual Meeting of Shareholders filed April 26, 2002.J
    
    Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.s Form 10-K for the year ended December 31, 2002.K
    
    Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.s Definitive Proxy Statement for
the May 13, 2004 Annual Meeting of Shareholders filed April 16, 2004.L
    
    Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.s Form 10-K for the year ended December 31, 2003.M
    
    Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.s Form 10-Q for the quarter ended March 31, 2005.N
    
    Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.s Form 10-K for the year ended December 31, 2001.O
    
    Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.s Form 10-K for the year ended December 31, 2005.P
    
    Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.s Form 8-K dated November 17, 2006.Q
    
    Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.s Form 8-K dated November 28, 2006.