UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(MARK ONE)

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

		FOR QUARTERLY PERIOD ENDED MARCH 31, 2011

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD

		FROM                      TO

COMMISSION FILE NUMBER 1-9371

ALLEGHANY CORPORATION

EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER

DELAWARE

51-0283071

7 TIMES SQUARE TOWER, 17TH FLOOR, NY, NY 10036

212-752-1356

NOT APPLICABLE

INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS.

YES þ		NO o

INDICATE BY CHECK MARK WHETHER THE REGISTRANT HAS SUBMITTED ELECTRONICALLY AND POSTED ON ITS CORPORATE WEB SITE, IF ANY, EVERY INTERACTIVE DATA FILE REQUIRED TO BE SUBMITTED AND POSTED PURSUANT TO RULE 405 OF REGULATION S-T (SECTION 232.405 OF THIS CHAPTER) DURING THE PRECEDING 12 MONTHS (OR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS REQUIRED TO SUBMIT AND POST SUCH FILES).

YES þ		NO o

INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS A LARGE ACCELERATED FILER, AN ACCELERATED FILER, OR A NON-ACCELERATED FILER. SEE DEFINITION OF ACCELERATED FILER AND LARGE ACCELERATED FILER IN RULE 12b-2 OF THE EXCHANGE ACT. (CHECK ONE):

INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS A SHELL COMPANY (AS DEFINED IN RULE 12b-2 OF THE EXCHANGE ACT).

YES o		NO þ

INDICATE THE NUMBER OF SHARES OUTSTANDING OF EACH OF THE ISSUER’S CLASSES OF COMMON STOCK, AS OF THE LAST PRACTICABLE DATE.

 

 

Part I. FINANCIAL INFORMATION

Item 1. Financial Statements.

ALLEGHANY CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets

		March 31,				December 31,
		2011				2010
		(in thousands, except
		share amounts)
		(unaudited)
Assets
Investments
Available-for-sale securities at fair value:
Equity securities (cost: 2011 — $1,284,686; 2010 — $1,310,009)		$	1,598,682			$	1,500,686
Debt securities (amortized cost: 2011 — $2,783,146; 2010 — $2,778,117)			2,831,302				2,832,411
Short-term investments			246,072				264,811
			4,676,056				4,597,908
Other invested assets			204,634				207,294
Total investments			4,880,690				4,805,202
Cash			64,881				76,741
Premium balances receivable			144,251				128,075
Reinsurance recoverables			867,777				873,295
Ceded unearned premium reserves			137,684				144,065
Deferred acquisition costs			65,814				67,692
Property and equipment at cost, net of accumulated depreciation and amortization			20,189				19,504
Goodwill and other intangibles, net of amortization			141,474				142,312
Net deferred tax assets			17,714				77,147
Other assets			189,525				97,666
		$	6,529,999			$	6,431,699
Liabilities and Stockholders’ Equity
Loss and loss adjustment expenses		$	2,290,226			$	2,328,742
Unearned premiums			503,105				523,927
Senior Notes			298,952				298,923
Reinsurance payable			44,353				41,500
Current taxes payable			2,557				3,220
Other liabilities			338,824				326,519
Total liabilities			3,478,017				3,522,831
Common stock (shares authorized: 2011 and 2010 — 22,000,000; issued and outstanding 2011 — 9,300,143; 2010 — 9,300,448)			9,118				9,118
Contributed capital			928,251				928,816
Accumulated other comprehensive income			241,866				170,262
Treasury stock, at cost (2011 — 364,793 shares; 2010 — 351,532 shares)			(103,926	)			(99,686	)
Retained earnings			1,976,673				1,900,358
Total stockholders’ equity			3,051,982				2,908,868
		$	6,529,999			$	6,431,699

See accompanying Notes to Unaudited Consolidated Financial Statements.

ALLEGHANY CORPORATION AND SUBSIDIARIES
Consolidated Statements of Earnings and Comprehensive Income
(unaudited)

		Three Months Ended March 31,
		2011				2010
		(in thousands, except
		per share amounts)
Revenues
Net premiums earned		$	180,980			$	194,700
Net investment income			31,579				31,429
Net realized capital gains			34,692				26,467
Other than temporary impairment losses			—				(1,077	)
Other income			885				133
Total revenues			248,136				251,652
Costs and expenses
Loss and loss adjustment expenses			71,022				96,627
Commissions, brokerage and other underwriting expenses			66,528				66,356
Other operating expenses			10,246				8,851
Corporate administration			6,379				5,234
Interest expense			4,452				219
Total costs and expenses			158,627				177,287
Earnings before income taxes			89,509				74,365
Income taxes			18,169				16,196
Net earnings		$	71,340			$	58,169
Other comprehensive income
Change in unrealized gains (losses), net of deferred taxes		$	99,262			$	29,818
Less: reclassification for net realized capital gains and other than temporary impairment losses, net of taxes			(22,550	)			(16,504	)
Other			(129	)			49
Comprehensive income		$	147,923			$	71,532
Basic earnings per share*		$	7.99			$	6.31
Diluted earnings per share*		$	7.97			$	6.25

See accompanying Notes to Unaudited Consolidated Financial Statements.

ALLEGHANY CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(unaudited)

		Three Months Ended March 31,
		2011				2010
		(in thousands)
Cash flows from operating activities
Net earnings		$	71,340			$	58,169
Adjustments to reconcile net earnings to net cash provided by operating activities:
Depreciation and amortization			6,775				10,587
Net realized capital (gains) losses			(34,692	)			(26,467	)
Other than temporary impairment losses			—				1,077
(Increase) decrease in other assets			(73,953	)			(2,705	)
(Increase) decrease in reinsurance receivable, net of reinsurance payable			8,371				7,644
(Increase) decrease in premium balances receivable			(16,176	)			(6,303	)
(Increase) decrease in ceded unearned premium reserves			6,381				8,511
(Increase) decrease in deferred acquisition costs			1,878				3,130
Increase (decrease) in other liabilities and current taxes			(14,126	)			(21,744	)
Increase (decrease) in unearned premiums			(20,822	)			(33,097	)
Increase (decrease) in loss and loss adjustment expenses			(38,516	)			(41,653	)
Net adjustments			(174,880	)			(101,020	)
Net cash (used in) provided by operating activities			(103,540	)			(42,851	)
Cash flows from investing activities
Purchase of investments			(399,118	)			(480,229	)
Sales of investments			421,330				440,116
Maturities of investments			58,647				59,564
Purchases of property and equipment			(2,584	)			(1,389	)
Net change in short-term investments			18,753				58,208
Other, net			652				(2,828	)
Net cash (used in) provided by investing activities			97,680				73,442
Cash flows from financing activities
Treasury stock acquisitions			(6,402	)			(7,517	)
Other, net			402				175
Net cash (used in) provided by financing activities			(6,000	)			(7,342	)
Net cash increase (decrease) in cash			(11,860	)			23,249
Cash at beginning of period			76,741				32,526
Cash at end of period		$	64,881			$	55,775
Supplemental disclosures of cash flow information
Cash paid during the period for:
Interest		$	8,203			$	—
Income taxes paid (refunds received)		$	260			$	2,453

See accompanying Notes to Unaudited Consolidated Financial Statements.

ALLEGHANY CORPORATION AND SUBSIDIARIES

Notes to Unaudited Consolidated Financial Statements

1. Principles of Financial Statement Presentation

     This report should be read in conjunction with the Annual Report on Form 10-K for the year ended December 31, 2010 (the “2010 10-K”) of Alleghany Corporation (“Alleghany”).

     Alleghany, a Delaware corporation, which together with its subsidiaries is referred to as “Alleghany” unless the context otherwise requires, is engaged in the property and casualty and surety insurance business through its wholly-owned subsidiary Alleghany Insurance Holdings LLC (“AIHL”). AIHL’s insurance business is conducted through its wholly-owned subsidiaries RSUI Group, Inc. (“RSUI”), Capitol Transamerica Corporation and Platte River Insurance Company (collectively “CATA”), and Pacific Compensation Corporation (“PCC”). AIHL Re LLC (“AIHL Re”), a captive reinsurance subsidiary of AIHL, has in the past provided reinsurance to Alleghany operating units and affiliates. Alleghany’s equity investments, including those held by AIHL’s insurance operating units, are managed primarily by Alleghany Capital Partners LLC, an indirect, wholly-owned subsidiary of Alleghany. Alleghany also owns and manages properties in the Sacramento, California region through its subsidiary Alleghany Properties Holdings LLC (“Alleghany Properties”). In addition, Alleghany owns approximately 33 percent of the outstanding shares of common stock of Homesite Group Incorporated (“Homesite”), a national, full-service, mono-line provider of homeowners insurance, and approximately 38 percent of ORX Exploration, Inc. (“ORX”), a regional oil and gas exploration and production company. Alleghany also makes strategic investments in operating companies and conducts other activities at the parent level.

     The financial statements contained in this Quarterly Report on Form 10-Q are unaudited, but reflect all adjustments which, in the opinion of management, are necessary to a fair statement of results of the interim periods covered thereby. All adjustments are of a normal and recurring nature except as described herein.

     The accompanying unaudited consolidated financial statements include the results of Alleghany and its wholly-owned and majority-owned subsidiaries, and have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). All significant inter-company balances and transactions have been eliminated in consolidation.

     The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those reported results to the extent that those estimates and assumptions prove to be inaccurate.

     Certain prior year amounts have been reclassified to conform to the 2011 presentation.

2. Recent Accounting Standards

Recently Adopted

     In July 2010, the Financial Accounting Standards Board (“FASB”) issued guidance that provides for additional financial statement disclosure regarding financing receivables, including the credit quality and allowance for credit losses associated with such assets. This guidance is generally effective for interim and annual periods beginning after December 15, 2010, with certain disclosures effective for interim and annual periods ending on or after December 31, 2010. Alleghany fully adopted this guidance in the 2011 first quarter, and the implementation did not have any impact on its results of operations and financial condition.

Future Application of Accounting Standards

     In October 2010, the FASB issued guidance that provides additional clarification for costs associated with acquiring or renewing insurance contracts. This guidance states that only incremental, direct costs associated with the successful acquisition of a new or renewal insurance contract may be capitalized as deferred acquisition costs. Furthermore, such costs: (i) must be essential to the contract transaction; (ii) would not have been incurred had the contract transaction not occurred; and (iii) must be related directly to the acquisition activities involving underwriting, policy issuance and processing, medical and inspection, and sales force contract selling. Advertising costs should be included in deferred acquisition costs only if the capitalization criteria in separate “direct-response” advertising guidance within GAAP are met. All other acquisition-related costs and other expenses should be charged to expense as incurred. This guidance is effective for interim and annual periods beginning after December 15, 2011, with early adoption permitted (but only at the beginning of an entity’s annual reporting period). Alleghany will adopt this guidance in the 2012 first quarter, and Alleghany does not currently believe that the implementation will have a material impact on its results of operations and financial condition.

3. Earnings Per Share of Common Stock

     The following is a reconciliation of the income and share data used in the basic and diluted earnings per share computations for the three months ended March 31, 2011 and 2010 (in millions, except share amounts):

		2011				2010
Net earnings		$	71.3			$	58.2
Effect of dilutive securities			(0.1	)			(0.5	)
Income available to common stockholders for diluted earnings per share		$	71.2			$	57.7
Weighted average shares outstanding applicable to basic earnings per share			8,928,807				9,213,252
Effect of dilutive securities			7,161				10,427
Adjusted weighted average shares outstanding applicable to diluted earnings per share			8,935,968				9,223,679

     Contingently issuable shares of 45,579 and 40,398 were potentially available during the 2011 and 2010 first quarters, respectively, but were not included in the computations of diluted earnings per share because the impact was anti-dilutive to the earnings per share calculation.

     Earnings per share by quarter may not equal the amount for the full year due to the timing of treasury stock purchases and rounding.

4. Commitments and Contingencies

     (a) Leases

     Alleghany leases certain facilities, furniture and equipment under long-term lease agreements.

     (b) Litigation

     Alleghany’s subsidiaries are parties to pending litigation and claims in connection with the ordinary course of their businesses. Each such subsidiary makes provisions for estimated losses to be incurred in such litigation and claims, including legal costs. In the opinion of management, such provisions were adequate as of March 31, 2011.

     (c) Asbestos and Environmental Impairment Exposure

     AIHL’s reserves for unpaid loss and loss adjustment expenses include $14.0 million of gross reserves and $13.9 million of net reserves as of March 31, 2011, and $14.1 million of gross reserves and $14.0 million of net reserves as of December 31, 2010, for asbestos and environmental impairment claims that arose from reinsurance assumed by a subsidiary of CATA between 1969 and 1976. This subsidiary exited such business in 1976. Additional information concerning CATA’s asbestos and environmental exposure can be found in Note 13 to the Notes to the Consolidated Financial Statements set forth in Item 8 of the 2010 10-K.

     (d) Indemnification Obligations

     On July 14, 2005, Alleghany completed the sale of its world-wide industrial minerals business, World Minerals, Inc. (“World Minerals”), to Imerys USA, Inc. (the “Purchaser”), a wholly-owned subsidiary of Imerys, S.A., pursuant to a Stock Purchase Agreement, dated as of May 19, 2005, by and among the Purchaser, Imerys, S.A. and Alleghany (the “Stock Purchase Agreement”). Pursuant to the Stock Purchase Agreement, Alleghany undertook certain indemnification obligations, including a general indemnification for breaches of representations and warranties set forth in the Stock Purchase Agreement (the “Contract Indemnification”) and a special indemnification (the “Products Liability Indemnification”) related to products liability claims arising from events that occurred during pre-closing periods, including the period of Alleghany ownership (the “Alleghany Period”).

     The Products Liability Indemnification is divided into two parts, the first relating to products liability claims arising in respect of events occurring during the period prior to Alleghany’s acquisition of the World Minerals business from Johns Manville Corporation, Inc., formerly known as Manville Sales Corporation (“Manville”), in July 1991 (the “Manville Period”), and the second relating to products liability claims arising in respect of events occurring during the period of Alleghany ownership.

     Under the terms of the Stock Purchase Agreement, Alleghany will provide indemnification at a rate of 100 percent for the first $100.0 million of losses arising from products liability claims relating to the Manville Period and at a rate of 50 percent for the next $100.0 million of such losses, so that Alleghany’s maximum indemnification obligation in respect of products liability claims relating to the Manville Period is $150.0 million. This indemnification obligation in respect of Manville Period products liability claims will expire on July 31, 2016. The Stock Purchase Agreement states that it is the intention of the parties that, with regard to losses incurred in respect of products liability claims relating to the Manville Period, recovery should first be sought from Manville, and that Alleghany’s indemnification obligation in respect of products liability claims relating to the Manville Period is intended to indemnify the Purchaser for such losses which are not recovered from Manville within a reasonable period of time after recovery is sought from Manville. In connection with World Minerals’ acquisition of the assets of the industrial minerals business of Manville in 1991, Manville agreed to indemnify World Minerals for certain products liability claims, in respect of products of the industrial minerals business manufactured during the Manville Period, asserted against World Minerals through July 31, 2006. In June 2006, Manville agreed to extend its indemnification for such claims asserted against World Minerals through July 31, 2009. Notwithstanding the expiration of the Manville indemnity on July 31, 2009, World Minerals did not, as part of its 1991 acquisition of the assets of Manville’s industrial minerals business assets, assume liability for product liability claims to the extent that such claims relate, in whole or in part, to the Manville Period, and Manville should continue to be responsible for such claims. The Stock Purchase Agreement provides that Alleghany has no responsibility for products liability claims arising in respect of events occurring after the closing, and that any products liability claims involving both pre-closing and post-closing periods will be apportioned on an equitable basis.

     With respect to the Contract Indemnification, substantially all of the representations and warranties to which the Contract Indemnification applies survived until July 14, 2007, with the exception of certain representations and warranties such as those related to environmental, real estate and tax matters, which survive for longer periods and generally, except for tax and certain other matters, apply only to aggregate losses in excess of $2.5 million, up to a maximum of approximately $123.0 million.

     Additional information concerning the Products Liability Indemnification and Contract Indemnification can be found in Note 13 to the Notes to the Consolidated Financial Statements set forth in Item 8 of the 2010 10-K.

     Based on Alleghany’s historical experience and other analyses, in July 2005, Alleghany established a $0.6 million reserve in connection with the Products Liability Indemnification for the Alleghany Period. Such reserve was approximately $0.2 million at both March 31, 2011 and December 31, 2010.

     (e) Equity Holdings Concentration

     As of March 31, 2011 and December 31, 2010, Alleghany had a concentration of market risk in its available-for-sale equity securities portfolio with respect to certain energy sector businesses of $1,084.0 million and $1,004.8 million, respectively. Of the $1,084.0 million, $673.0 million represents Alleghany’s ownership of common stock of Exxon Mobil Corporation.

5. Segments of Business

     Information related to Alleghany’s reportable segment is shown in the table below. Property and casualty and surety insurance operations are conducted by AIHL through its insurance operating units RSUI, CATA and PCC. In addition, AIHL Re is a wholly-owned subsidiary of AIHL that has in the past provided reinsurance to Alleghany’s insurance operating units and affiliates.

     Alleghany’s reportable segment is reported in a manner consistent with the way management evaluates the businesses. As such, insurance underwriting activities are evaluated separately from investment activities. Net realized capital gains and other-than-temporary impairment losses are not considered relevant in evaluating investment performance on an annual basis. Segment accounting policies are described in Note 1 to the Notes to the Consolidated Financial Statements set forth in Item 8 of the 2010 10-K.

     The primary components of “corporate activities” are Alleghany Properties, Alleghany’s investments in Homesite and ORX and strategic investments and other activities at the parent level.

		Three Months Ended
		March 31,
		2011				2010
		(in millions)
Revenues:
AIHL insurance group:
Net premiums earned
RSUI		$	141.6			$	150.3
CATA			39.3				40.6
PCC			0.1				3.8
			181.0				194.7
Net investment income			30.2				33.4
Net realized capital gains			34.7				22.7
Other than temporary impairment losses (1)			—				(1.1	)
Other income			0.1				0.1
Total insurance group			246.0				249.8
Corporate activities:
Net investment income (2)			1.4				(1.9	)
Net realized capital gains			—				3.8
Other than temporary impairment losses			—				—
Other income			0.7				—
Total		$	248.1			$	251.7
Earnings before income taxes:
AIHL insurance group:
Underwriting profit (loss) (3)
RSUI		$	49.0			$	36.8
CATA			0.7				0.3
PCC			(6.3	)			(5.4	)
			43.4				31.7
Net investment income			30.2				33.4
Net realized capital gains			34.7				22.7
Other than temporary impairment losses (1)			—				(1.1	)
Other income, less other expenses			(9.7	)			(8.4	)
Total insurance group			98.6				78.3
Corporate activities:
Net investment income (2)			1.4				(1.9	)
Net realized capital gains			—				3.8
Other than temporary impairment losses			—				—
Other income			0.7				—
Corporate administration and other expenses			6.8				5.7
Interest expense			4.4				0.1
Total		$	89.5			$	74.4

6. Reinsurance

     As discussed in the 2010 10-K, RSUI reinsures its property lines of business through a program consisting of surplus share treaties, facultative placements, per risk and catastrophe excess of loss treaties. RSUI’s catastrophe reinsurance program (which covers catastrophe risks including, among others, windstorms and earthquakes) and per risk reinsurance program run on an annual basis from May 1 to the following April 30 and thus expired on April 30, 2011. RSUI placed all of its catastrophe reinsurance program for the 2011-2012 period, and the new program is similar to the expired program. The new reinsurance program provides coverage in two layers for $400.0 million of losses in excess of a $100.0 million net retention after application of the surplus share treaties, facultative reinsurance and per risk covers. The first layer provides coverage for $100.0 million of losses, before a 47.0 percent co-participation by RSUI (compared with a 33.0 percent co-participation under the expired program), in excess of the $100.0 million net retention, and the second layer provides coverage for $300.0 million of losses, before a 5 percent co-participation by RSUI, in excess of $200.0 million. In addition, RSUI’s property per risk reinsurance program for the 2011-2012 period provides RSUI with coverage for $90.0 million of losses, before a 10.0 percent co-participation by RSUI, in excess of a $10.0 million net retention per risk after application of the surplus share treaties and facultative reinsurance. As discussed in Note 5(a) to the Notes to the Consolidated Financial Statements set forth in Item 8 of the 2010 10-K, RSUI reinsures its other lines of business through quota share treaties, except for professional liability and binding authority lines where RSUI retains all of such business.

7. Investments

     (a) Fair Value

     The estimated carrying values and fair values of Alleghany’s consolidated financial instruments as of March 31, 2011 and December 31, 2010 were as follows (in millions):

		March 31, 2011								December 31, 2010
		Carrying				Fair				Carrying				Fair
		Value				Value				Value				Value
Assets
Investments (excluding equity method investments)*		$	4,702.2			$	4,702.2			$	4,622.7			$	4,622.7
Liabilities
Senior Notes**		$	299.0			$	302.4			$	298.9			$	291.8

     GAAP defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value measurements are not adjusted for transaction costs. In addition, GAAP has a three-tiered hierarchy for inputs used in management’s determination of fair value of financial instruments that emphasizes the use of observable inputs over the use of unobservable inputs by requiring that the observable inputs be used when available. Observable inputs are market participant assumptions based on market data obtained from sources independent of the reporting entity. Unobservable inputs are the reporting entity’s own assumptions about market participant assumptions based on the best information available under the circumstances. In assessing the appropriateness of using observable inputs in making its fair value determinations, Alleghany considers whether the market for a particular security is “active” or not based on all the relevant facts and circumstances. For example, Alleghany may consider a market to be inactive if there are relatively few recent transactions or if there is a significant decrease in market volume. Furthermore, Alleghany considers whether observable transactions are “orderly” or not. Alleghany does not consider a transaction to be orderly if there is evidence of a forced liquidation or other distressed condition, and as such, little or no weight is given to that transaction as an indicator of fair value.

     The hierarchy is broken down into three levels based on the reliability of inputs as follows:

	•		“Level 1” — Valuations are based on unadjusted quoted prices in active markets for identical, unrestricted assets. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these assets does not involve any meaningful degree of judgment. An active market is defined as a market where transactions for the financial instrument occur with sufficient frequency and volume to provide pricing information on an ongoing basis. Alleghany’s Level 1 assets generally include publicly traded common stocks and debt securities issued directly by the U.S. Government, where Alleghany’s valuations are based on quoted market prices.
	•		“Level 2” — Valuations are based on quoted market prices where such markets are not deemed to be sufficiently “active.” In such circumstances, additional valuation metrics will be used which involve direct or indirect observable market inputs. Alleghany’s Level 2 assets generally include preferred stocks and debt securities other than debt issued directly by the U.S. Government. Alleghany’s Level 2 liabilities include the Senior Notes. Substantially all of the determinations of value in this category are based on a single quote from third-party dealers and pricing services. As Alleghany generally does not make any adjustments thereto, such quote typically constitutes the sole input in its determination of the fair value of these types of securities. In developing a quote, such third parties will use the terms of the security and market-based inputs. Terms of the security include coupon, maturity date, and any special provisions that may, for example, enable the investor, at its election, to redeem the security prior to its scheduled maturity date. Market-based inputs include the level of interest rates applicable to comparable securities in the market place and current credit rating(s) of the security. Such quotes are generally non-binding.
	•		“Level 3” — Valuations are based on inputs that are unobservable and significant to the overall fair value measurement. Valuation under Level 3 generally involves a significant degree of judgment on the part of Alleghany. Alleghany’s Level 3 assets are primarily limited to partnership investments. Net asset value quotes from the third-party general partner of the entity in which such investment is held, which will often be based on unobservable market inputs, constitute the primary input in Alleghany’s determination of the fair value of such assets.

     Alleghany validates the reasonableness of its fair value determinations for Level 2 securities by testing the methodology of the relevant third-party dealer or pricing service that provides the quotes upon which the fair value determinations are made. Alleghany tests the methodology by comparing such quotes with prices from executed market trades when such trades occur. Alleghany discusses with the relevant third-party dealer or pricing service any identified material discrepancy between the quote derived from its methodology and the executed market trade in order to resolve the discrepancy. Alleghany uses the quote from the third-party dealer or pricing service unless Alleghany determines that the methodology used to produce such quote is not in compliance with GAAP. In addition to such procedures, Alleghany also compares the aggregate amount of the fair value for such Level 2 securities with the aggregate fair value provided by a third-party financial institution. Furthermore, Alleghany reviews the reasonableness of its classification of securities within the three-tiered hierarchy to ensure that the classification is consistent with GAAP.

     The estimated fair values of Alleghany’s financial instruments as of March 31, 2011 and December 31, 2010 allocated among the three levels set forth above were as follows (in millions):

		Level 1				Level 2				Level 3				Total
As of March 31, 2011
Equity securities:
Common stock(1)		$	1,598.7			$	—			$	—			$	1,598.7
Preferred stock			—				—				—				—
Debt securities:
U.S. Government obligations			275.9				30.5				—				306.4
Mortgage and asset-backed securities(2)			—				952.0				—				952.0
States, municipalities and political subdivision bonds			—				1,033.0				—				1,033.0
Foreign bonds			—				117.7				—				117.7
Corporate bonds and other			—				422.2				—				422.2
			275.9				2,555.4				—				2,831.3
Short-term investments			146.8				99.3				—				246.1
Other invested assets(3)			—				—				26.1				26.1
Investments (excluding equity method investments)		$	2,021.4			$	2,654.7			$	26.1			$	4,702.2
Senior Notes		$	—			$	302.4			$	—			$	302.4
As of December 31, 2010
Equity securities:
Common stock(1)		$	1,500.7			$	—			$	—			$	1,500.7
Preferred stock			—				—				—				—
Debt securities:
U.S. Government obligations			307.3				30.5				—				337.8
Mortgage and asset-backed securities(2)			—				866.5				—				866.5
States, municipalities and political subdivision bonds			—				1,068.5				—				1,068.5
Foreign bonds			—				114.2				—				114.2
Corporate bonds and other			—				445.4				—				445.4
			307.3				2,525.1				—				2.832.4
Short-term investments			86.4				178.4				—				264.8
Other invested assets(3)			—				—				24.8				24.8
Investments (excluding equity method investments)		$	1,894.4			$	2,703.5			$	24.8			$	4,622.7
Senior Notes		$	—			$	291.8			$	—			$	291.8

     (b) Available-For-Sale Securities

     Available-for-sale securities as of March 31, 2011 and December 31, 2010 are summarized as follows (in millions):

		Amortized				Gross				Gross
		Cost				Unrealized				Unrealized				Fair
		or Cost				Gains				Losses				Value
As of March 31, 2011
Equity securities:
Common stock(1)		$	1,284.7			$	316.1			$	(2.1	)		$	1,598.7
Preferred stock			—				—				—				—
Debt securities:
U.S. Government obligations			304.0				3.8				(1.4	)			306.4
Mortgage and asset-backed securities(2)			928.7				29.2				(5.9	)			952.0
States, municipalities and political subdivision bonds			1,023.4				22.8				(13.2	)			1,033.0
Foreign bonds			116.5				2.2				(1.0	)			117.7
Corporate bonds and other			410.5				13.6				(1.9	)			422.2
			2,783.1				71.6				(23.4	)			2,831.3
Short-term investments			246.1				—				—				246.1
		$	4,313.9			$	387.7			$	(25.5	)		$	4,676.1
Industry Segment
AIHL insurance group		$	3,758.3			$	268.0			$	(25.5	)		$	4,000.8
Corporate activities			555.6				119.7				—				675.3
		$	4,313.9			$	387.7			$	(25.5	)		$	4,676.1

		Amortized				Gross				Gross
		Cost				Unrealized				Unrealized				Fair
		or Cost				Gains				Losses				Value
As of December 31, 2010
Equity securities:
Common stock(1)		$	1,310.0			$	196.3			$	(5.6	)		$	1,500.7
Preferred stock			—				—				—				—
Debt securities:
U.S. Government obligations			334.4				4.6				(1.2	)			337.8
Mortgage and asset-backed securities(2)			841.0				31.8				(6.3	)			866.5
States, municipalities and political subdivision bonds			1,058.1				25.4				(15.0	)			1,068.5
Foreign bonds			112.7				2.4				(0.9	)			114.2
Corporate bonds and other			431.9				14.9				(1.4	)			445.4
			2,778.1				79.1				(24.8	)			2,832.4
Short-term investments			264.8				—				—				264.8
		$	4,352.9			$	275.4			$	(30.4	)		$	4,597.9
Industry Segment
AIHL insurance group		$	3,760.3			$	232.7			$	(30.4	)		$	3,962.6
Corporate activities			592.6				42.7				—				635.3
		$	4,352.9			$	275.4			$	(30.4	)		$	4,597.9

     The amortized cost and estimated fair value of debt securities as of March 31, 2011 by contractual maturity are shown below (in millions). Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

		Amortized				Fair
		Cost				Value
Short-term investments due in one year or less		$	246.1			$	246.1
Mortgage and asset-backed securities			928.7				952.0
Debt securities
One year or less			217.2				219.5
Over one through five years			650.8				669.8
Over five through ten years			543.2				553.0
Over ten years			443.2				437.0
Equity securities			1,284.7				1,598.7
		$	4,313.9			$	4,676.1

     The proceeds from sales of available-for-sale securities were $421.3 million and $440.1 million for the three months ended March 31, 2011 and 2010, respectively. The amounts of gross realized capital gains and gross realized capital losses of available-for-sale securities (primarily, equity securities) for the three months ended March 31, 2011 and March 31, 2010 were:

		Three Months
		Ended March 31,
		2011				2010
		(in millions)
Gross realized gains		$	40.9			$	27.1
Gross realized losses			(6.2	)			(0.6	)
Net realized gains		$	34.7			$	26.5

     The gross loss amounts exclude other-than-temporary impairment losses, as discussed below. Realized gains and losses on investments are determined in accordance with the specific identification method.

     (c) Other-Than-Temporary-Impairment Losses

     Alleghany holds it equity and debt securities as available for sale, and as such, these securities are recorded at fair value. Alleghany continually monitors the difference between cost and the estimated fair value of its investments, which involves uncertainty as to whether declines in value are temporary in nature. If a decline in the value of a particular investment is deemed temporary, Alleghany records the decline as an unrealized loss in stockholders’ equity. If the decline is deemed to be other than temporary, Alleghany writes it down to the carrying value of the investment and records an other-than-temporary impairment loss on its statement of earnings, regardless of whether Alleghany continues to hold the applicable security. In addition, under GAAP, any portion of such decline that relates to debt securities that is believed to arise from factors other than credit is recorded as a component of other comprehensive income.

     Management’s assessment of a decline in value initially involves an evaluation of all securities that are in an unrealized loss position, regardless of the duration or severity of the loss, as of the applicable balance sheet date. Such initial review consists primarily of assessing whether:

	(i)		there has been a negative news event with respect to the issuer of any such security (irrespective of the duration or severity of its loss) that could indicate the existence of an other-than-temporary impairment;
	(ii)		Alleghany has the ability and intent to hold an equity security for a period of time sufficient to allow for an anticipated recovery (generally considered to be less than one year from the balance sheet date); and
	(iii)		it is more likely than not that Alleghany will sell a debt security before recovery of its amortized cost basis.

     To the extent that an equity security in an unrealized loss position is not impaired based on the initial review described above, Alleghany then further evaluates such equity security and deems it to be other-than-temporarily impaired if its decline in fair value has existed for twelve months or more or if its decline in fair value from its cost is greater than 50 percent, absent compelling evidence to the contrary.

     Alleghany then evaluates all remaining equity securities that are in an unrealized loss position the cost of which:

	(i)		exceeds their fair value by 20 percent or more as of the balance sheet date; or
	(ii)		has exceeded their fair value continuously for six (6) months or more preceding the balance sheet date.

This evaluation takes into account quantitative and qualitative factors in determining whether such securities are other-than-temporarily impaired including:

	•		market valuation metrics associated with the equity security (e.g., dividend yield and price-to-earnings ratio);
	•		current views on the equity security, as expressed by either Alleghany’s internal stock analysts and/or by independent stock analysts or rating agencies; and
	•		discrete credit or news events associated with a specific company, such as negative news releases and rating agency downgrades with respect to the issuer of the investment.

     To the extent that a debt security that is in an unrealized loss position is not impaired based on the initial review described above, Alleghany will consider a debt security to be impaired when it believes it to be probable that Alleghany will not be able to collect all amounts due under the security’s contractual terms.

     Alleghany may ultimately record a realized loss after having originally concluded that the decline in value was temporary. Risks and uncertainties are inherent in the methodology Alleghany uses to assess other-than-temporary declines in value. Risks and uncertainties could include, but are not limited to, incorrect assumptions about financial condition, liquidity or future prospects, inadequacy of any underlying collateral, and unfavorable changes in economic or social conditions, interest rates or credit ratings.

     There were no other-than-temporary impairment losses for the three months ended March 31, 2011. Other-than-temporary impairment losses for the three months ended March 31, 2010 reflect $1.1 million of unrealized losses that were deemed to be other-than-temporary and, as such, were required to be charged against earnings. All of the $1.1 million of other-than-temporary impairment losses related to equity holdings. The determination that unrealized losses on such securities were other-than-temporary was primarily based on the severity and duration of the declines in fair value of such securities relative to their cost as of the balance sheet date.

     After adjusting the cost basis of securities for the recognition of other-than-temporary impairment losses, the gross unrealized investment losses for debt and equity securities as of March 31, 2011 were deemed to be temporary, based on, among other things:

	•		the duration of time and the relative magnitude to which fair values of these investments has been below cost was not indicative of an other-than-temporary impairment loss (for example, no equity security was in a continuous unrealized loss position for twelve months or more as of March 31, 2011);
	•		the absence of compelling evidence that would cause Alleghany to call into question the financial condition or near-term prospects of the issuer of the investment; and
	•		Alleghany’s ability and intent to hold the investment for a period of time sufficient to allow for any anticipated recovery.

     Such gross unrealized investment losses and related fair value for debt securities and equity securities as of March 31, 2011 and December 31, 2010, were as follows (in millions):

		2011								2010
						Gross								Gross
		Fair				Unrealized				Fair				Unrealized
		Value				Losses				Value				Losses
Debt securities:
U.S. Government obligations
Less than 12 months		$	69.5			$	1.4			$	49.7			$	1.2
More than 12 months			—				—				—				—
Mortgage and asset-backed securities
Less than 12 months			282.6				3.0				170.8				2.8
More than 12 months			34.2				2.9				39.5				3.5
States, municipalities and political subdivision bonds
Less than 12 months			337.8				12.6				349.1				14.4
More than 12 months			6.7				0.6				7.7				0.6
Foreign bonds
Less than 12 months			43.4				1.0				45.2				0.9
More than 12 months			—				—				—				—
Corporate bonds and other
Less than 12 months			67.9				1.9				63.1				1.4
More than 12 months			—				—				—				—
Total debt securities
Less than 12 months			801.2				19.9				677.9				20.7
More than 12 months			40.9				3.5				47.2				4.1
Equity securities — Common Stock
Less than 12 months			76.1				2.1				139.5				5.6
More than 12 months			—				—				—				—
Equity securities — Preferred Stock
Less than 12 months			—				—				—				—
More than 12 months			—				—				—				—
Total temporarily impaired securities
Less than 12 months			877.3				22.0				817.4				26.3
More than 12 months			40.9				3.5				47.2				4.1
Total		$	918.2			$	25.5			$	864.6			$	30.4

     As of March 31, 2011, Alleghany held a total of 226 debt and equity securities that were in an unrealized loss position, of which 14 securities, all debt securities, were in an unrealized loss position continuously for 12 months or more. Of the debt securities that were in an unrealized loss position, all were mortgage and asset-backed securities, and states, municipalities and political subdivision bonds. As of March 31, 2011, substantially all of Alleghany’s debt securities were rated investment grade. As of March 31, 2011, non-income producing invested assets were insignificant.

8. Income Taxes

     As of March 31, 2011, Alleghany believes there were no material uncertain tax positions that would require disclosure under GAAP.

     The effective tax rate on earnings before income taxes was 20.3 percent for the first three months of 2011, compared with 21.8 percent for the corresponding 2010 period. The lower effective tax rate in 2011 primarily reflects the impact of higher dividends received deductions in the first three months of 2011, partially offset by the absence of a permanent tax benefit significant in the 2010 period, which related to a finalization of Alleghany’s unused foreign tax credits arising from its prior ownership of World Minerals which was sold on July 14, 2005.

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

     References to the “Company,” “Alleghany,” “we,” “us,” and “our” in Items 2, 3 and 4 of Part I, as well as in Part II, of this Quarterly Report on Form 10-Q, or “this Form 10-Q,” refer to Alleghany Corporation and its consolidated subsidiaries unless the context otherwise requires. In addition, unless the context otherwise requires, references to

	•		“AIHL” are to our insurance holding company subsidiary Alleghany Insurance Holdings LLC,
	•		“RSUI” are to our subsidiary RSUI Group, Inc. and its subsidiaries,
	•		“CATA” are to our subsidiary Capitol Transamerica Corporation and its subsidiaries, and also include the operations and results of Platte River Insurance Company, or “Platte River,” unless the context otherwise requires,
	•		“PCC” are to our subsidiary Pacific Compensation Corporation,
	•		“AIHL Re” are to our subsidiary AIHL Re LLC, and
	•		“Alleghany Properties” are to our subsidiary Alleghany Properties Holdings LLC and its subsidiaries.

Cautionary Statement Regarding Forward-Looking Information

     “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Quantitative and Qualitative Disclosures About Market Risk” contain disclosures which are forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements include all statements that do not relate solely to historical or current facts, and can be identified by the use of words such as “may,” “will,” “expect,” “project,” “estimate,” “anticipate,” “plan,” “believe,” “potential,” “should,” “continue” or the negative versions of those words or other comparable words. These forward-looking statements are based upon our current plans or expectations and are subject to a number of uncertainties and risks that could significantly affect current plans, anticipated actions and our future financial condition and results. These statements are not guarantees of future performance, and we have no specific intention to update these statements. The uncertainties and risks include, but are not limited to,

	•		significant weather-related or other natural or human-made catastrophes and disasters;
	•		the cyclical nature of the property and casualty insurance industry;
	•		adverse loss development for events insured by our insurance operating units in either the current year or prior years;
	•		changes in market prices of our significant equity investments and changes in value of our debt securities portfolio;
	•		the long-tail and potentially volatile nature of certain casualty lines of business written by our insurance operating units;
	•		the cost and availability of reinsurance;
	•		exposure to terrorist acts;
	•		the willingness and ability of our insurance operating units’ reinsurers to pay reinsurance recoverables owed to our insurance operating units;
	•		changes in the ratings assigned to our insurance operating units;
	•		claims development and the process of estimating reserves;
	•		legal and regulatory changes, including the new federal financial regulatory reform of the insurance industry established by the Dodd-Frank Wall Street Reform and Consumer Protection Act;
	•		the uncertain nature of damage theories and loss amounts; and

•

increases in the levels of risk retention by our insurance operating units.

     Additional risks and uncertainties include general economic and political conditions, including the effects of a prolonged U.S. or global economic downturn or recession; changes in costs; variations in political, economic or other factors; risks relating to conducting operations in a competitive environment; effects of acquisition and disposition activities, inflation rates or recessionary or expansive trends; changes in interest rates; extended labor disruptions, civil unrest or other external factors over which we have no control; and changes in our plans, strategies, objectives, expectations, or intentions, which may happen at any time at our discretion. As a consequence, current plans, anticipated actions and future financial condition and results may differ from those expressed in any forward-looking statements made by us or on our behalf.

Critical Accounting Estimates

     The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, or “GAAP,” requires us to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period covered by the financial statements. Critical accounting estimates are defined as those estimates that are important to the presentation of our financial condition and results of operations and require us to exercise significant judgment.

     We review our critical accounting estimates and assumptions quarterly. These reviews include evaluating the adequacy of reserves for unpaid loss and loss adjustment expenses, or “LAE,” and reinsurance, analyzing the recoverability of deferred tax assets, assessing goodwill for impairment and evaluating our investment portfolio for other-than-temporary declines in estimated fair value. Actual results may differ from the estimates used in preparing the financial statements.

     Readers are encouraged to review our Report on Form 10-K for the year ended December 31, 2010, or the “2010 10-K,” for a more complete description of our critical accounting estimates.

Consolidated Results of Operations

     The following discussion and analysis presents a review of our results for the three months ended March 31, 2011 and 2010. You should read this review in conjunction with the unaudited consolidated financial statements and other data presented in this Form 10-Q as well as “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors” contained in our 2010 10-K. Our results for the first three months of 2011 are not indicative of operating results in future periods.

Overview

     We are engaged, through AIHL and its subsidiaries, primarily in the property and casualty and surety insurance business. We also own and manage properties in the Sacramento, California region through our subsidiary Alleghany Properties and seek out strategic investments and conduct other activities at the parent level. Primarily through our wholly-owned subsidiary, Alleghany Capital Partners, we manage our public equity investments, including those held by our insurance operating units, as well as conduct equity investment and non-insurance acquisition research. Strategic investments currently include an approximately 33 percent ownership of the outstanding shares of common stock of Homesite Group Incorporated, or “Homesite,” a national, full-service, mono-line provider of homeowners insurance, and approximately 38 percent ownership of ORX Exploration, Inc., or “ORX,” a regional oil and gas exploration and production company. Our primary sources of revenues and earnings are our insurance operations and investments.

     The profitability of our insurance operating units, and as a result, our profitability, is primarily impacted by the adequacy of premium rates, level of catastrophe losses, investment returns, intensity of competition and the cost of reinsurance. The adequacy of premium rates is affected mainly by the severity and frequency of claims, which are influenced by many factors, including natural disasters, regulatory measures and court decisions that define and expand the extent of coverage, and the effects of economic inflation on the amount of compensation due for injuries or losses. The ultimate adequacy of premium rates is not known with certainty at the time property and casualty insurance policies are issued because premiums are determined before claims are reported.

     Catastrophe losses, or the absence thereof, can have a significant impact on our results. For example, RSUI’s pre-tax catastrophe losses, net of reinsurance, were $31.0 million for 2010, $6.7 million for 2009 and $97.9 million for 2008 (primarily reflecting net losses from 2008 third quarter Hurricanes Ike, Gustav and Dolly). The incidence and severity of catastrophes in any short period of

time are inherently unpredictable. Catastrophes can cause losses in a variety of our property and casualty lines of business, and most of our past catastrophe-related claims have resulted from severe hurricanes. Longer-term natural catastrophe trends may be changing due to climate change, a phenomenon that has been associated with extreme weather events linked to rising temperatures, and includes effects on global weather patterns, sea, land and air temperatures, sea levels, rain and snow. Climate change, to the extent it produces rising temperatures and changes in weather patterns, could impact the frequency or severity of weather events such as hurricanes. To the extent climate change increases the frequency and severity of such weather events, our insurance operating units, particularly RSUI, may face increased claims, particularly with respect to properties located in coastal areas. Our insurance operating units take certain measures to mitigate against the frequency and severity of such events by giving consideration to these risks in their underwriting and pricing decisions and through the purchase of reinsurance.

     As of March 31, 2011, we had consolidated total investments of approximately $4.9 billion, of which approximately $2.8 billion was invested in debt securities and approximately $1.6 billion was invested in equity securities. Net realized capital gains, other-than-temporary impairment losses and net investment income related to such investment assets are subject to market conditions and management investment decisions and as a result can have a significant impact on our results. In the 2011 first quarter, net realized capital gains were $34.7 million, compared with $26.5 million in the corresponding 2010 period, and there were no other-than-temporary impairment losses in the 2011 first quarter, compared with $1.1 million in the corresponding 2010 period.

     The profitability of our insurance operating units is also impacted by competition generally and price competition in particular. Historically, the performance of the property and casualty insurance industry has tended to fluctuate in cyclical periods of price competition and excess underwriting capacity followed by periods of high premium rates and shortages of underwriting capacity. Although an individual insurance company’s performance is dependent on its own specific business characteristics, the profitability of most property and casualty insurance companies tends to follow this cyclical market pattern. In the past few years, our insurance operating units have faced increasing competition as a result of an increased flow of capital into the insurance industry, with both new entrants and existing insurers seeking to gain market share. This has resulted in decreased premium rates and less favorable contract terms and conditions. In particular, RSUI and CATA’s specialty lines of business increasingly encounter competition from the standard market. We expect to continue to face strong competition in these and the other lines of business of our insurance operating units, and our insurance operating units may continue to experience decreases in premium rates and/or premium volume and less favorable contract terms and conditions.

     As part of their overall risk and capacity management strategy, our insurance operating units purchase reinsurance for certain amounts of risk underwritten by them, especially catastrophe risks. The reinsurance programs purchased by our insurance operating units are generally subject to annual renewal. Market conditions beyond the control of our insurance operating units determine the availability and cost of the reinsurance protection they purchase, which may affect the level of business written and thus their profitability.

     The following table summarizes our consolidated revenues, costs and expenses and earnings.

		Three Months Ended
		March 31,
		2011				2010
		(in millions)
Revenues
Net premiums earned		$	181.0			$	194.7
Net investment income			31.6				31.4
Net realized capital gains			34.7				26.5
Other than temporary impairment losses			—				(1.1	)
Other income			0.8				0.2
Total revenues		$	248.1			$	251.7
Costs and expenses
Loss and loss adjustment expenses		$	71.0			$	96.6
Commissions, brokerage and other underwriting expenses			66.6				66.4
Other operating expenses			10.2				8.9
Corporate administration			6.4				5.2
Interest expense			4.4				0.2
Total costs and expenses		$	158.6			$	177.3
Earnings before income taxes		$	89.5			$	74.4
Income taxes			18.2				16.2
Net earnings		$	71.3			$	58.2
Revenues:
AIHL		$	246.0			$	249.8
Corporate activities*			2.1				1.9
Earnings (loss) before income taxes:
AIHL		$	98.6			$	78.3
Corporate activities*			(9.1	)			(3.9	)

     Our earnings before income taxes in the 2011 first quarter increased from the corresponding 2010 period, primarily reflecting lower loss and LAE and higher net realized capital gains, partially offset by a decline in net premiums earned and higher interest expense. Net realized capital gains in the first quarter of 2011 and 2010 relate primarily to sales of certain equity securities, some of which had their cost basis reduced in earlier periods for the recognition of unrealized losses through other-than-temporary impairment losses. The decrease in loss and LAE and net premiums earned reflects the impact of continuing competition at RSUI and CATA. The decrease in loss and LAE also reflects a $15.8 million release of prior year reserves at RSUI, compared with a net $7.5 million increase in the 2010 period. Interest expense in the 2011 first quarter relates primarily to interest on our $300.0 million of 5.625% Senior Notes due on September 15, 2020, or “Senior Notes,” which were issued on September 20, 2010.

     The effective tax rate on earnings before income taxes was 20.3 percent for the first three months of 2011, compared with 21.8 percent for the corresponding 2010 period. The lower effective tax rate in 2011 primarily reflects the impact of higher dividends received deductions in the first three months of 2011, partially offset by the absence of a permanent tax benefit significant in the 2010 period, which related to a finalization of our unused foreign tax credits arising from its prior ownership of World Minerals which was sold on July 14, 2005.

AIHL Operating Results

AIHL Operating Unit Pre-Tax Results

		RSUI				CATA				PCC				AIHL
						(in millions, except ratios)
Three months ended March 31, 2011
Gross premiums written		$	212.2			$	37.6			$	0.4			$	250.2
Net premiums written			130.8				35.4				0.4				166.6
Net premiums earned (1)		$	141.6			$	39.3			$	0.1			$	181.0
Loss and loss adjustment expenses			51.2				19.1				0.7				71.0
Commission, brokerage and other underwriting expenses (2)			41.4				19.5				5.7				66.6
Underwriting profit (loss) (3)		$	49.0			$	0.7			$	(6.3	)		$	43.4
Net investment income (1)															30.2
Net realized capital gains (1)															34.7
Other than temporary impairment losses (1)															—
Other income (1)															0.1
Other expenses (2)															9.8
Earnings before income taxes														$	98.6
Loss ratio (4)			36.2	%			48.5	%			762.5	%			39.2	%
Expense ratio (5)			29.2	%			49.7	%			5857.3	%			36.8	%
Combined ratio (6)			65.4	%			98.2	%			6619.8	%			76.0	%
Three months ended March 31, 2010
Gross premiums written		$	222.0			$	40.6			$	2.4			$	265.0
Net premiums written			130.3				38.2				2.3				170.8
Net premiums earned (1)		$	150.3			$	40.6			$	3.8			$	194.7
Loss and loss adjustment expenses			72.8				21.0				2.8				96.6
Commission, brokerage and other underwriting expenses (2)			40.7				19.3				6.4				66.4
Underwriting profit (loss) (3)		$	36.8			$	0.3			$	(5.4	)		$	31.7
Net investment income (1)															33.4
Net realized capital gains (1)															22.7
Other than temporary impairment losses (1)															(1.1	)
Other income (1)															0.1
Other expenses (2)															8.5
Earnings before income taxes														$	78.3
Loss ratio (4)			48.5	%			51.6	%			74.2	%			49.6	%
Expense ratio (5)			27.1	%			47.6	%			166.3	%			34.1	%
Combined ratio (6)			75.6	%			99.2	%			240.5	%			83.7	%

     Discussion of individual AIHL operating unit results follows, and AIHL investment results are discussed below under “AIHL Investment Results.”

RSUI

     The decrease in gross premiums written by RSUI in the 2011 first quarter from the corresponding 2010 period primarily reflects the impact of reduced exposures of RSUI’s customers and continuing and increasing competition, particularly in RSUI’s property and, to a lesser extent, umbrella/excess lines of business, partially offset by growth in RSUI’s binding authority business and assumed premium writings from international insurance carriers. RSUI’s net premiums earned decreased in the 2011 first quarter from the corresponding 2010 period primarily due to the decline in gross premiums written, partially offset by a decrease in ceded premiums written associated primarily with RSUI’s property line of business.

     The decrease in loss and LAE in the 2011 first quarter from the corresponding period in 2010 primarily reflects a net $15.8 million release of prior year reserves in the 2011 first quarter, compared with a net $7.5 million increase of prior year reserves in the 2010 first quarter. The decrease in loss and LAE also reflects the impact of lower net premiums earned in the 2011 first quarter. Net catastrophe losses were minimal in both the 2011 and 2010 first quarters.

     The $15.8 million net release of prior year reserves in the 2011 first quarter relates primarily to the umbrella/excess, general liability and professional liability lines of business, primarily for the 2004 through 2008 accident years, and reflects favorable loss emergence compared with loss emergence patterns assumed in earlier periods for such lines of business. Specifically, cumulative losses for such lines of business, which include both loss payments and case reserves, in respect of prior accident years were expected to be higher through March 31, 2011 than the actual cumulative losses through that date. The amount of lower cumulative losses, expressed as a percentage of carried loss and LAE reserves at the beginning of the year, was 3.5 percent. Such reduction did not impact the assumptions used in estimating RSUI’s loss and LAE liabilities for its umbrella/excess, general liability, professional liability lines of business earned in the 2011 first quarter. The net $7.5 million increase in loss reserves in the 2010 first quarter resulted from an increase in estimated ultimate 2007 accident year losses for the directors and officers, or “D&O,” liability line of business, reflecting, in part, unfavorable loss emergence on certain sub-prime mortgage industry claims.

     The increase in RSUI’s underwriting profit in the 2011 first quarter from the corresponding 2010 period primarily reflects a decrease in loss and LAE, partially offset by the decrease in net premiums earned.

     In general, rates at RSUI in the first quarter of 2011, compared with the comparable period in 2010, reflect overall industry trends of downward pricing as a result of increased competition.

     As discussed in the 2010 10-K, RSUI reinsures its property lines of business through a program consisting of surplus share treaties, facultative placements, per risk and catastrophe excess of loss treaties. RSUI’s catastrophe reinsurance program (which covers catastrophe risks including, among others, windstorms and earthquakes) and per risk reinsurance program run on an annual basis from May 1 to the following April 30 and thus expired on April 30, 2011. RSUI placed all of its catastrophe reinsurance program for the 2011-2012 period, and the new program is similar to the expired program. The new reinsurance program provides coverage in two layers for $400.0 million of losses in excess of a $100.0 million net retention after application of the surplus share treaties, facultative reinsurance and per risk covers. The first layer provides coverage for $100.0 million of losses, before a 47.0 percent co-participation by RSUI (compared with a 33.0 percent co-participation under the expired program), in excess of the $100.0 million net retention, and the second layer provides coverage for $300.0 million of losses, before a 5 percent co-participation by RSUI, in excess of $200.0 million. In addition, RSUI’s property per risk reinsurance program for the 2011-2012 period provides RSUI with coverage for $90.0 million of losses, before a 10.0 percent co-participation by RSUI, in excess of a $10.0 million net retention per risk after application of the surplus share treaties and facultative reinsurance. As discussed in Note 5(a) to the Notes to the Consolidated Financial Statements set forth in Item 8 of the 2010 10-K, RSUI reinsures its other lines of business through quota share treaties, except for professional liability and binding authority lines where RSUI retains all of such business.

CATA

     CATA’s gross premiums written decreased in the 2011 first quarter from the corresponding 2010 period, primarily reflecting continuing price competition in CATA’s property and casualty lines of business, including in excess and surplus markets, partially offset by higher gross premiums written in CATA’s commercial surety line of business. The decrease in CATA’s property and casualty lines of business also reflected reduced writings of certain specialty classes of business through a program administrator in connection with a program where notice of termination of such program has been given. CATA’s net premiums earned in the 2011

first quarter decreased from the corresponding 2010 period, reflecting the decrease in gross premiums written, partially offset by an increase in net premiums earned in CATA’s miscellaneous errors and omissions liability line of business.

     The decrease in loss and LAE in the 2011 first quarter from the corresponding 2010 period primarily reflects a higher amount of prior year reserve releases in the 2011 first quarter compared with the corresponding 2010 period, and the impact of lower net premiums earned in the 2011 first quarter.

     During the 2011 first quarter, CATA had a net prior year reserve release of $1.7 million, compared with a net prior year reserve release of $0.8 million in the 2010 first quarter. The $1.7 million reserve release primarily relates to favorable development on the property line of business from the 2010 accident year and, to a lesser extent, a prior year reserve release in the casualty lines of business from older accident years, reflecting favorable loss emergence compared with loss emergence patterns assumed in earlier periods for such lines of business. The $1.7 million net release did not impact the assumptions used in estimating CATA’s loss and LAE liabilities for business earned in the first quarter of 2011. The $0.8 million reserve release in the 2010 first quarter was primarily related to casualty prior accident year reserves.

     The decrease in loss and LAE, partially offset by the decrease in net premiums earned, was the primary cause for the modest increase in CATA’s underwriting profit in the 2011 first quarter from the corresponding 2010 period.

     In general, rates at CATA in the first three months of 2011, compared with the corresponding 2010 period, reflect overall industry trends of downward pricing as a result of increased competition.

PCC

     Commencing August 1, 2009, PCC ceased soliciting new or renewal business on a direct basis due to its determination that it was unable to write business at rates it deemed adequate due to the difficult state of the California workers’ compensation market and took corresponding expense reduction steps, including staff reductions, in light of such determination. Effective April 12, 2010, as part of a strategic repositioning effort, PCC changed its name from Employers Direct Corporation, changed the name of Pacific Compensation Insurance Company from Employers Direct Insurance Company, and took steps to emerge as a brokerage carrier at such time as it determines rates are adequate. In the first three months of 2011, PCC began writing a modest amount of new business through brokers.

     PCC reported underwriting losses of $6.3 million and $5.4 million for the first three months of 2011 and 2010, respectively. The underwriting losses primarily reflect a lack of premiums earned for the reasons described above (particularly with respect to the first three months of 2011), combined with PCC’s ongoing staffing and related expenses.

AIHL Investment Results

     Following is information relating to AIHL’s investment results.

		Three Months
		Ended March 31,
		2011				2010
		(in millions)
Net investment income		$	30.2			$	33.4
Net realized capital gains		$	34.7			$	22.7
Other than temporary impairment losses		$	—			$	(1.1	)

     Net Investment Income. The decrease in AIHL’s net investment income in the 2011 first quarter from the corresponding 2010 period is due principally to the lack of equity-method partnership income in the first quarter of 2011 as such partnerships were dissolved in the 2010 third quarter, and the impact of ongoing negative cash flow at PCC, partially offset by higher dividend income.

     Net Realized Capital Gains. Net realized capital gains in the first quarter of 2011 and 2010 relate primarily to sales of certain equity securities in the energy sector, some of which had their cost basis reduced in earlier periods for the recognition of unrealized losses through other-than-temporary impairment losses. Net realized capital gains in the first quarter of 2011 also included the sales of certain equity securities in the defense sector.

     Other-Than-Temporary Impairment Losses. There were no other-than-temporary impairment losses for the three months ended March 31, 2011. Other-than-temporary impairment losses for the three months ended March 31, 2010 reflect $1.1 million of unrealized losses that were deemed to be other-than-temporary and, as such, are required to be charged against earnings. All of the $1.1 million of other-than-temporary impairment losses related to equity holdings. The determination that unrealized losses on such securities were other-than-temporary was primarily based on the severity and duration of the declines in fair value of such securities relative to their cost as of the balance sheet date.

     After adjusting the cost basis of securities for the recognition of other-than-temporary impairment losses, the gross unrealized investment losses for debt and equity securities as of March 31, 2011 were deemed to be temporary, based on, among other things:

	•		the duration of time and the relative magnitude to which fair values of these investments has been below cost was not indicative of an other-than-temporary impairment loss (for example, no equity security was in a continuous unrealized loss position for twelve months or more as of March 31, 2011);
	•		the absence of compelling evidence that would cause us to call into question the financial condition or near-term prospects of the issuer of the investment; and
	•		our ability and intent to hold the investment for a period of time sufficient to allow for any anticipated recovery.

     See Note 7 to the Notes to the Unaudited Consolidated Financial Statements set forth in Item 1 of this Form 10-Q for further details concerning gross unrealized investment losses for debt and equity securities as of March 31, 2011.

Corporate Activities Operating Results

     The following table summarizes corporate activities’ results (in millions):

		Three Months
		Ended March 31,
		2011				2010
Net investment income		$	1.4			$	(1.9	)
Net realized capital gains			—				3.8
Other than temporary impairment losses			—				—
Other income			0.7				—
Total revenues		$	2.1			$	1.9
Corporate administration and other expenses			6.8				5.7
Interest expense			4.4				0.1
(Loss) before income taxes		$	(9.1	)		$	(3.9	)

     Losses for corporate activities in the first quarter of 2011 generally reflect corporate administration, interest and other expenses, partially offset by net investment income. Losses for corporate activities in the first quarter of 2010 generally reflect corporate administration and other expenses, partially offset by net realized capital gains. The increase in loss before income taxes in the 2011 first quarter from the corresponding 2010 period primarily reflects a lack of net realized capital gains in the first three months of 2011 and substantially higher interest expense, partially offset by an increase in net investment income. Interest expense in the 2011 first quarter relates primarily to interest on our Senior Notes, which were issued on September 20, 2010 (see Note 7 to the Notes to the Consolidated Financial Statements set forth in Item 8 of the 2010 10-K for further details). The increase in net investment income for the first quarter of 2011 compared with the corresponding period in 2010 was primarily due to higher dividend income and lower equity in losses of Homesite and ORX. For the three months ended March 31, 2011 and 2010, net investment income included $0.5 million and $1.8 million, respectively, of our equity in losses of Homesite, and $1.0 million and $2.4 million, respectively, of our equity in losses of ORX.

Reserve Review Process

     AIHL’s insurance operating units periodically analyze, at least quarterly, liabilities for unpaid loss and LAE established in prior years and adjust their expected ultimate cost, where necessary, to reflect positive or negative development in loss experience and new information, including, for certain catastrophic events, revised industry estimates of the magnitude of a catastrophe. Adjustments to previously recorded liabilities for unpaid loss and LAE, both positive and negative, are reflected in our financial results in the periods in which these adjustments are made and are referred to as prior year reserve development. The following table presents the reserves established in connection with the loss and LAE of AIHL’s insurance operating units on a gross and net basis by line of business. These reserve amounts represent the accumulation of estimates of ultimate loss (including for incurred but not reported loss) and LAE.

																		Workers’
		Property				Casualty(1)				CMP(2)				Surety				Comp(3)				All Other(4)				Total
										(dollars in millions)
March 31, 2011
Gross loss and LAE reserves		$	118.1			$	1,889.9			$	60.8			$	18.5			$	171.7			$	31.2			$	2,290.2
Reinsurance recoverables on unpaid losses			(43.1	)			(768.2	)			(0.2	)			(0.1	)			(10.9	)			(17.2	)			(839.7	)
Net loss and LAE reserves		$	75.0			$	1,121.7			$	60.6			$	18.4			$	160.8			$	14.0			$	1,450.5
December 31, 2010
Gross loss and LAE reserves		$	150.1			$	1,883.6			$	58.9			$	17.1			$	186.7			$	32.3			$	2,328.7
Reinsurance recoverables on unpaid losses			(52.0	)			(765.2	)			(1.0	)			(0.1	)			(10.9	)			(18.2	)			(847.4	)
Net loss and LAE reserves		$	98.1			$	1,118.4			$	57.9			$	17.0			$	175.8			$	14.1			$	1,481.3