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 the quarterly period ended: June 30, 2008

OR

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

For the transition period from                      to                     

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD

Bermuda		98-0481737
(State or Other Jurisdiction of		(I.R.S. Employer
Incorporation or Organization)		Identification No.)

27 Richmond Road, Pembroke HM 08, Bermuda
(Address of Principal Executive Offices and Zip Code)

(441) 278-5400
(Registrant’s Telephone Number, Including Area Code)

     Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ   No o

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

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

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o   No þ

     The number of outstanding common shares, par value $0.03 per share, of Allied World Assurance Company Holdings, Ltd as of August 4, 2008 was 48,978,591.

 

 

PART I

Item 1. Financial Statements.

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
as of June 30, 2008 and December 31, 2007
(Expressed in thousands of United States dollars, except share and per share amounts)

		As of				As of
		June 30,				December 31,
		2008				2007
ASSETS:
Fixed maturity investments available for sale, at fair value (amortized cost: 2008: $5,685,111; 2007: $5,595,943)		$	5,733,523			$	5,707,143
Other invested assets available for sale, at fair value (cost: 2008: $81,241; 2007: $291,458)			77,444				322,144
Other invested assets, at fair value			192,661				—
Total investments			6,003,628				6,029,287
Cash and cash equivalents			439,933				202,582
Restricted cash			84,492				67,886
Securities lending collateral			190,960				147,241
Insurance balances receivable			432,468				304,499
Prepaid reinsurance			193,005				163,836
Reinsurance recoverable			778,578				682,765
Accrued investment income			54,735				55,763
Deferred acquisition costs			126,995				108,295
Goodwill and other intangible assets			19,450				3,920
Balances receivable on sale of investments			96,801				84,998
Net deferred tax assets			2,032				4,881
Other assets			45,519				43,155
Total assets		$	8,468,596			$	7,899,108
LIABILITIES:
Reserve for losses and loss expenses		$	4,164,220			$	3,919,772
Unearned premiums			945,126				811,083
Unearned ceding commissions			32,356				28,831
Reinsurance balances payable			120,888				67,175
Securities lending payable			190,960				147,241
Balances due on purchase of investments			107,054				141,462
Senior notes			498,738				498,682
Accounts payable and accrued liabilities			31,208				45,020
Total liabilities		$	6,090,550			$	5,659,266
SHAREHOLDERS’ EQUITY:
Common shares, par value $0.03 per share, issued and outstanding 2008: 48,977,635 shares and 2007: 48,741,927 shares			1,469				1,462
Additional paid-in capital			1,298,375				1,281,832
Retained earnings			1,039,154				820,334
Accumulated other comprehensive income: net unrealized gains on investments, net of tax			39,048				136,214
Total shareholders’ equity			2,378,046				2,239,842
Total liabilities and shareholders’ equity		$	8,468,596			$	7,899,108

See accompanying notes to the unaudited condensed consolidated financial statements.

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME
for the three and six months ended June 30, 2008 and 2007
(Expressed in thousands of United States dollars, except share and per share amounts)

		Three Months Ended								Six Months Ended
		June  30,								June 30,
		2008				2007				2008				2007
REVENUES:
Gross premiums written		$	446,784			$	530,549			$	843,657			$	968,955
Premiums ceded			(126,534	)			(143,962	)			(196,835	)			(224,524	)
Net premiums written			320,250				386,587				646,822				744,431
Change in unearned premiums			(51,374	)			(83,468	)			(104,874	)			(154,746	)
Net premiums earned			268,876				303,119				541,948				589,685
Net investment income			72,345				73,937				149,276				146,585
Net realized investment losses			(4,393	)			(1,481	)			(928	)			(7,965	)
			336,828				375,575				690,296				728,305
EXPENSES:
Net losses and loss expenses			178,084				176,225				321,581				342,220
Acquisition costs			26,265				31,872				53,105				61,068
General and administrative expenses			46,380				34,432				89,651				67,635
Interest expense			9,513				9,482				19,023				18,856
Foreign exchange (gain) loss			(399	)			532				77				564
			259,843				252,543				483,437				490,343
Income before income taxes			76,985				123,032				206,859				237,962
Income tax (recovery) expense			(2,220	)			(255	)			(3,291	)			754
NET INCOME			79,205				123,287				210,150				237,208
Other comprehensive loss
Unrealized losses on investments arising during the period net of applicable deferred income tax recovery for three months 2008: $493; 2007: $1,475; and six months 2008: $242; 2007: $2,292			(101,589	)			(58,625	)			(59,966	)			(40,092	)
Reclassification adjustment for net realized losses (gains) included in net income			5,012				1,481				(10,938	)			7,965
Other comprehensive loss			(96,577	)			(57,144	)			(70,904	)			(32,127	)
COMPREHENSIVE (LOSS) INCOME		$	(17,372	)		$	66,143			$	139,246			$	205,081
PER SHARE DATA
Basic earnings per share		$	1.62			$	2.04			$	4.33			$	3.95
Diluted earnings per share		$	1.56			$	1.96			$	4.12			$	3.81
Weighted average common shares outstanding			48,897,931				60,397,591				48,585,015				60,028,523
Weighted average common shares and common share equivalents outstanding			50,873,712				62,874,235				51,013,633				62,277,010
Dividends declared per share		$	0.18			$	0.15			$	0.36			$	0.30

See accompanying notes to the unaudited condensed consolidated financial statements.

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
for the six months ended June 30, 2008 and 2007
(Expressed in thousands of United States dollars)

										Accumulated
						Additional				Other
						Paid-in				Comprehensive				Retained
		Share Capital				Capital				Income				Earnings				Total
December 31, 2007		$	1,462			$	1,281,832			$	136,214			$	820,334			$	2,239,842
Cumulative effect adjustment upon adoption of FAS 159			—				—				(26,262	)			26,262				—
Net income			—				—				—				210,150				210,150
Dividends			—				—				—				(17,592	)			(17,592	)
Other comprehensive loss			—				—				(70,904	)			—				(70,904	)
Stock compensation			7				16,543				—				—				16,550
June 30, 2008		$	1,469			$	1,298,375			$	39,048			$	1,039,154			$	2,378,046

										Accumulated
						Additional				Other
						Paid-in				Comprehensive				Retained
		Share Capital				Capital				Income (Loss)				Earnings				Total
December 31, 2006		$	1,809			$	1,822,607			$	6,464			$	389,204			$	2,220,084
Net income			—				—				—				237,208				237,208
Dividends			—				—				—				(18,112	)			(18,112	)
Other comprehensive loss			—				—				(32,127	)			—				(32,127	)
Stock compensation			3				11,130				—				—				11,133
June 30, 2007		$	1,812			$	1,833,737			$	(25,663	)		$	608,300			$	2,418,186

See accompanying notes to the unaudited condensed consolidated financial statements.

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
for the six months ended June 30, 2008 and 2007
(Expressed in thousands of United States dollars)

		Six Months Ended
		June 30,
		2008				2007
CASH FLOWS PROVIDED BY OPERATING ACTIVITIES:
Net income		$	210,150			$	237,208
Adjustments to reconcile net income to cash provided by operating activities:
Net realized gains on sales of investments			(48,215	)			(4,358	)
Impairment charges for other-than-temporary impairments on investments			37,277				12,323
Change in fair value of hedge fund investments			11,866				—
Amortization of premiums net of accrual of discounts on fixed maturities			(3,787	)			(1,970	)
Amortization and depreciation of fixed assets			4,518				3,992
Amortization of discount and expenses on senior notes			225				210
Stock compensation expense			13,625				11,763
Insurance balances receivable			(127,969	)			(146,351	)
Prepaid reinsurance			(29,169	)			(49,803	)
Reinsurance recoverable			(95,813	)			9,907
Accrued investment income			1,028				(5,243	)
Deferred acquisition costs			(18,700	)			(31,042	)
Net deferred tax assets			3,091				1,231
Other assets			(3,416	)			(6,199	)
Reserve for losses and loss expenses			244,448				106,683
Unearned premiums			134,043				204,550
Unearned ceding commissions			3,525				11,698
Reinsurance balances payable			53,713				40,132
Accounts payable and accrued liabilities			(13,812	)			(5,619	)
Net cash provided by operating activities			376,628				389,112
CASH FLOWS USED IN INVESTING ACTIVITIES:
Purchases of fixed maturity investments			(1,866,738	)			(1,797,082	)
Purchases of other invested assets			(34,461	)			(4,882	)
Sales of fixed maturity investments			1,738,412				1,203,750
Sales of other invested assets			102,869				48,967
Net cash used for acquisition			(44,052	)			—
Changes in securities lending collateral received			(43,719	)			(198,775	)
Purchase of fixed assets			(3,643	)			(4,651	)
Change in restricted cash			(16,606	)			86,327
Net cash used in investing activities			(167,938	)			(666,346	)
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES:
Dividends paid			(17,592	)			(18,112	)
Proceeds from the exercise of stock options			2,582				—
Changes in securities lending collateral			43,719				198,775
Net cash provided by financing activities			28,709				180,663
Effect of exchange rate changes on foreign currency cash			(48	)			325
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS			237,351				(96,246	)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD			202,582				366,817
CASH AND CASH EQUIVALENTS, END OF PERIOD		$	439,933			$	270,571
Supplemental disclosure of cash flow information:
— Cash paid for income taxes		$	5,238			$	2,808
— Cash paid for interest expense			18,750				19,271
Supplemental disclosure of non-cash flow information:
— Change in balance receivable on sale of investments			(11,803	)			(36,544	)
— Change in balance payable on purchase of investments			(34,408	)			21

See accompanying notes to the unaudited condensed consolidated financial statements.

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands of United States dollars, except share, per share and percentage information)

1.  GENERAL

     Allied World Assurance Company Holdings, Ltd (“Holdings”) was incorporated in Bermuda on November 13, 2001. Holdings, through its wholly-owned subsidiaries (collectively, the “Company”), provides property and casualty insurance and reinsurance on a worldwide basis through operations in Bermuda, the United States, Ireland and the United Kingdom.

2.  BASIS OF PREPARATION AND CONSOLIDATION

     These unaudited condensed consolidated financial statements include the accounts of Holdings and its subsidiaries and have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and with Article 10 of Regulation S-X as promulgated by the U.S. Securities and Exchange Commission (“SEC”). Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, these unaudited condensed consolidated financial statements reflect all adjustments that are normal and recurring in nature and necessary for a fair presentation of financial position and results of operations as of the end of and for the periods presented. The results of operations for any interim period are not necessarily indicative of the results for a full year.

     The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The significant estimates reflected in the Company’s financial statements include, but are not limited to:

	•		The premium estimates for certain reinsurance agreements,
	•		Recoverability of deferred acquisition costs,
	•		The reserve for losses and loss expenses,
	•		Valuation of ceded reinsurance recoverables,
	•		Valuation of financial instruments, and
	•		Determination of other-than-temporary impairment of investments.

     Intercompany accounts and transactions have been eliminated on consolidation, and all entities meeting consolidation requirements have been included in the consolidation. Certain immaterial reclassifications in the unaudited condensed consolidated statements of cash flows have been made to the prior period’s amounts to conform to the current period’s presentation.

     These unaudited condensed consolidated financial statements, including these notes, should be read in conjunction with the Company’s audited consolidated financials statements, and related notes thereto, included in the Company’s Annual Report on Form  10-K for the year ended December 31, 2007.

3.  NEW ACCOUNTING PRONOUNCEMENTS

     In February 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“FAS”) No. 159 “The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115” (“FAS 159”). FAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. This statement is expected to expand the use of fair value measurement, which is consistent with the FASB’s long-term measurement objectives for accounting for financial instruments. The fair value option will permit all entities to choose to measure eligible items at fair value at specified election dates. An entity shall record unrealized gains and losses on items for which the fair value option has been elected through net income in the statement of operations at each subsequent reporting date. The Company adopted FAS 159 as of January 1, 2008. See Note 7 “Fair Value of Financial Instruments” regarding the Company’s adoption of FAS 159.

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands of United States dollars, except share, per share and percentage information)

     In September 2006, the FASB issued FAS No. 157 “Fair Value Measurements” (“FAS 157”). This statement defines fair value, establishes a framework for measuring fair value under U.S. GAAP, and expands disclosures about fair value measurements. FAS 157 applies under other accounting pronouncements that require or permit fair value measurements. FAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company adopted FAS 157 as of January 1, 2008. See Note 7 “Fair Value of Financial Instruments” regarding the Company’s adoption of FAS 157.

     In December 2007, the FASB issued FAS No. 141(R) “Business Combinations” (“FAS 141(R)”). FAS 141(R) replaces FAS No. 141 “Business Combinations” (“FAS 141”), but retains the fundamental requirements in FAS 141 that the acquisition method of accounting be used for all business combinations and for an acquirer to be identified for each business combination. FAS 141(R) requires an acquirer to recognize the assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of that date. FAS 141(R) also requires acquisition-related costs to be recognized separately from the acquisition, requires assets acquired and liabilities assumed arising from contractual contingencies to be recognized at their acquisition-date fair values and requires goodwill to be recognized as the excess of the consideration transferred plus the fair value of any noncontrolling interest in the acquiree at the acquisition date over the fair values of the identifiable net assets acquired. FAS 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008 (January 1, 2009 for calendar year-end companies). The Company is currently evaluating the provisions of FAS 141(R) and its potential impact on future financial statements.

     In December 2007, the FASB issued FAS No. 160 “Noncontrolling Interests in Consolidated Financial Statements – an amendment of ARB No. 51” (“FAS 160”). FAS 160 amends ARB No. 51 to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. FAS 160 clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. FAS 160 requires consolidated net income to be reported at the amounts that include the amounts attributable to both the parent and the noncontrolling interest. This statement also establishes a method of accounting for changes in a parent’s ownership interest in a subsidiary that do not result in deconsolidation and for changes in a parent’s ownership interest in a subsidiary that does result in deconsolidation. FAS 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008 (January 1, 2009 for calendar year-end companies). The presentation and disclosure requirements of FAS 160 shall be applied retrospectively for all periods presented. The Company is currently evaluating the provisions of FAS 160 and its potential impact on future financial statements.

     In March 2008, the FASB issued FAS No. 161 “Disclosures about Derivative Instruments and Hedging Activities – an amendment of FASB Statement No. 133” (“FAS 161”). FAS 161 requires enhanced interim and annual disclosures about an entity’s derivative and hedging activities including how and why the entity uses derivative instruments, how the entity accounts for its derivatives under FAS Statement No. 133 (“Accounting for Derivative Instruments and Hedging Activities”), and how derivative instruments and related hedged items affect the entity’s financial position, financial performance and cash flows. FAS 161 is effective for fiscal years and interim periods beginning after November 15, 2008 (January 1, 2009 for calendar year-end companies). The Company is currently evaluating the provisions of FAS 161 and its potential impact on future financial statements.

     In May 2008, the FASB issued FAS No. 162 “The Hierarchy of Generally Accepted Accounting Principles” (“FAS 162”). FAS 162 identifies the sources of accounting principles and the framework for selecting principles to be used in the preparation of financial statements of entities that are presented in conformity with U.S. GAAP. The current U.S. GAAP hierarchy is found in auditing literature and is focused on the auditor rather than the entity. FAS 162 shall be effective 60 days after the SEC’s approval of the Public Accounting Oversight Board amendments to AU Section 411 “The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles”. The Company does not anticipate any impact on future financial statements due to the adoption of FAS 162.

     In May 2008, the FASB issued FAS No. 163 “Accounting for Financial Guarantee Insurance Contracts – an Interpretation of FASB Statement No. 60” (“FAS 163”). FAS 163 clarifies how FAS 60 “Accounting and Reporting by Insurance Enterprises” applies to financial guarantee insurance contracts, including the recognition and measurement of premium revenue and claim liabilities. FAS 163 also requires expanded disclosures about financial guarantee insurance contracts. FAS 163 is effective for fiscal years beginning after December 15, 2008 (January 1, 2009 for calendar year-end companies), and interim periods within those fiscal years. The Company currently does not provide financial guarantee insurance, and as such does not anticipate any impact on future financial statements due to the adoption of FAS 163.

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands of United States dollars, except share, per share and percentage information)

4.  ACQUISITION OF FINIAL INSURANCE COMPANY

     In November 2007, Allied World Assurance Holdings (U.S.) Inc. entered into an agreement to purchase all of the outstanding stock of Finial Insurance Company (formerly known as Converium Insurance (North America) Inc.) from Finial Reinsurance Company, an affiliate of Berkshire Hathaway Inc. Finial Insurance Company was renamed Allied World Reinsurance Company, is currently licensed to write insurance and reinsurance in 49 states and the District of Columbia and has been used to launch the Company’s new reinsurance operations in the United States. This transaction closed on February 29, 2008 for a purchase price of $12,000 plus the Finial Insurance Company’s policyholders’ surplus of $47,082 and an adjustment for the difference between the fair values of investments acquired under U.S. GAAP and statutory reporting of $300. The total purchase price of $59,382 was paid in cash from existing resources. As a part of the acquisition, the Company recorded $12,000 of intangible assets with indefinite lives for the value of the insurance and reinsurance licenses acquired. The remaining assets and liabilities acquired were principally comprised of bonds, at fair value, of $31,690, cash of $15,330, other assets of $1,176, deferred tax liabilities of $4,344 and a reserve for losses and loss expenses of $104,914, of which 100% were recorded as “reinsurance recoverable” as the entire reserve for losses and loss expenses is ceded to National Indemnity Company, an affiliate of Berkshire Hathaway Inc. The Company also recognized goodwill of $3,530 related to this acquisition, which is included in “goodwill and other intangible assets” in the unaudited condensed consolidated balance sheets.

5.  INVESTMENTS

     The amortized cost, gross unrealized gains, gross unrealized losses and fair value of total investments by category as of June 30, 2008 and December 31, 2007 are as follows:

						Gross				Gross
						Unrealized				Unrealized
		Cost				Gains				Losses				Fair Value
June 30, 2008
U.S. government and government agencies		$	2,046,132			$	45,292			$	(914	)		$	2,090,510
Non-U.S. government and government agencies			113,526				18,197				(398	)			131,325
Corporate			1,368,520				6,799				(13,318	)			1,362,001
States, municipalities and political subdivisions			63,409				—				—				63,409
Mortgage backed			1,969,844				15,298				(22,998	)			1,962,144
Asset backed			123,680				524				(70	)			124,134
Total fixed maturity investments, available for sale			5,685,111				86,110				(37,698	)			5,733,523
Hedge funds			192,661				—				—				192,661
Global high-yield bond fund			81,241				—				(3,797	)			77,444
		$	5,959,013			$	86,110			$	(41,495	)		$	6,003,628
December 31, 2007
U.S. government and government agencies		$	1,987,577			$	65,653			$	(6	)		$	2,053,224
Non-U.S. government and government agencies			100,440				18,694				(291	)			118,843
Corporate			1,248,338				10,114				(5,835	)			1,252,617
Mortgage backed			2,095,561				22,880				(902	)			2,117,539
Asset backed			164,027				897				(4	)			164,920
Total fixed maturity investments, available for sale			5,595,943				118,238				(7,038	)			5,707,143
Hedge funds			215,173				27,250				(988	)			241,435
Global high-yield bond fund			75,125				4,424				—				79,549
Other invested asset			1,160				—				—				1,160
		$	5,887,401			$	149,912			$	(8,026	)		$	6,029,287

     Due to the adoption of FAS 159 as of January 1, 2008, the Company’s investment in hedge funds is included in “other invested assets, at fair value” on the unaudited condensed consolidated balance sheet. As of June 30, 2008, the Company’s investment in the global high-yield bond fund is included in “other invested assets available for sale, at fair value” on the unaudited condensed consolidated balance sheet. As of December 31, 2007, the Company’s investment in hedge funds, the global high-yield bond fund and other invested assets were included in “other invested assets available for sale, at fair value” on the unaudited condensed consolidated balance sheet.

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands of United States dollars, except share, per share and percentage information)

     On a quarterly basis, the Company reviews the carrying value of its investments to determine if a decline in value is considered to be other than temporary. This review involves consideration of several factors including: (i) the significance of the decline in value and the resulting unrealized loss position; (ii) the time period for which there has been a significant decline in value; (iii) an analysis of the issuer of the investment, including its liquidity, business prospects and overall financial position; and (iv) the Company’s intent and ability to hold the investment for a sufficient period of time for the value to recover. The identification of potentially impaired investments involves significant management judgment that includes the determination of their fair value and the assessment of whether any decline in value is other than temporary. If the decline in value is determined to be other than temporary, then the Company records a realized loss in the consolidated statements of operations and comprehensive income in the period that it is determined.

     As of June 30, 2008, the Company’s investment portfolio had gross unrealized losses of $41,495, that were primarily the result of increases in market interest rates during 2008 for fixed maturity investments with similar duration to our fixed maturity investments, which caused the market price of our fixed maturity investments to decrease. Following the Company’s review of the securities in its investment portfolio, 124 and 207 securities were considered to be other-than-temporarily impaired for the three and six months ended June 30, 2008, respectively. Consequently, the Company recorded an other-than-temporary impairment charge of $25,907 and $37,277 within “net realized investment losses” on the unaudited condensed consolidated statements of operations and comprehensive income for the three and six months ended June 30, 2008, respectively. The declines in market value of these securities were primarily due to the write-down of residential and commercial mortgage-backed securities due to the widening of credit spreads caused by the continued decline in the U.S. housing market. All of the residential and commercial mortgage-backed securities written down were AAA rated securities. Given the current market environment for mortgage-backed securities, it is difficult to determine when recovery will occur and as such the Company recorded an other-than-temporary charge. Also included in the other-than-temporary impairment charge during the three months ended June 30, 2008 was a write-down of $1,000 related to the Company’s investment in bonds issued by a commercial bank and a write down of $1,160 of the other invested asset. The Company performed an analysis of the issuers, including their liquidity, business prospects and overall financial position and concluded that an other-than-temporary charge should be recognized.

     During the three and six months ended June 30, 2007, 73 and 375 securities were considered to be other-than-temporarily impaired and as a result the Company recorded an other-than-temporary impairment charge of $2,941 and $12,323, within “net realized investment losses” on the unaudited condensed consolidated statements of operations and comprehensive income for the three and six months ended June 30, 2007, respectively.

     During 2007, the Company submitted a redemption notice to sell its shares in the Goldman Sachs Global Equity Opportunities Fund, plc. The Company sold its shares on February 29, 2008 and recognized a loss on the sale of $278, which is included in “net realized investment losses” in the unaudited condensed consolidated statements of operations and comprehensive income for the six months ended June 30, 2008.

     On June 30, 2007, the Company sold its shares in the Goldman Sachs Liquid Trading Opportunities Fund Offshore, Ltd. (the “LTO Fund”). The gain on the sale amounted to $484, which has been included in “net realized investment losses” in the unaudited condensed consolidated statements of operations and comprehensive income for the three and six months ended June 30, 2007.

6. DEBT AND FINANCING ARRANGEMENTS

     On July 21, 2006, the Company issued $500,000 aggregate principal amount of 7.50% Senior Notes due August 1, 2016 (“Senior Notes”), with interest on the Senior Notes payable on August 1 and February 1 of each year, commencing on February 1, 2007. The Senior Notes were offered by the underwriters at a price of 99.71% of their principal amount, providing an effective yield to investors of 7.54%. The Company used a portion of the proceeds from the Senior Notes to repay the outstanding amount of its then existing credit agreement as well as to provide additional capital to its subsidiaries and for other general corporate purposes.

     The Senior Notes can be redeemed by the Company prior to maturity subject to payment of a “make-whole” premium. The Company has no current expectations of calling the Senior Notes prior to maturity. The Senior Notes contain certain covenants that include: (i) limitations on liens on stock of designated subsidiaries; (ii) limitation as to the disposition of stock of designated subsidiaries; and (iii) limitations on mergers, amalgamations, consolidations or sale of assets. The Company was in compliance with all covenants related to its Senior Notes as of June 30, 2008 and December 31, 2007.

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands of United States dollars, except share, per share and percentage information)

     Events of default include: (i) the default in the payment of any interest or principal on any outstanding notes, and the continuance of such default for a period of 30 days; (ii) the default in the performance, or breach, of any of the covenants in the indenture (other than a covenant added solely for the benefit of another series of debt securities) and continuance of such default or breach for a period of 60 days after the Company has received written notice specifying such default or breach; and (iii) certain events of bankruptcy, insolvency or reorganization. Where an event of default occurs and is continuing, either the trustee of the Senior Notes or the holders of not less than 25% in principal amount of the Senior Notes may have the right to declare that all unpaid principal amounts and accrued interest then outstanding be due and payable immediately.

     In March 2007, the Company entered into a collateralized $750,000 amended letter of credit facility (the “Credit Facility”) with Citibank Europe plc. The Credit Facility will be used to issue standby letters of credit.

     In November 2007, the Company entered into a $800,000 five-year senior credit facility (the “Facility”) with a syndication of lenders. The Facility consists of a $400,000 secured letter of credit facility for the issuance of standby letters of credit (the “Secured Facility”) and a $400,000 unsecured facility for the making of revolving loans and for the issuance of standby letters of credit (the “Unsecured Facility”). Both the Secured Facility and the Unsecured Facility have options to increase the aggregate commitments by up to $200,000, subject to approval of the lenders. The Facility will be used for general corporate purposes and to issue standby letters of credit. The Facility contains representations, warranties and covenants customary for similar bank loan facilities, including a covenant to maintain a ratio of consolidated indebtedness to total capitalization as of the last day of each fiscal quarter or fiscal year of not greater than 0.35 to 1.0 and a covenant under the Unsecured Facility to maintain a certain consolidated net worth. In addition, each material insurance subsidiary must maintain a financial strength rating from A.M. Best Company of at least A- under the Unsecured Facility and of at least B++ under the Secured Facility. The Company is in compliance with all covenants under the Facility as of June 30, 2008 and December 31, 2007.

     The Company currently has access to up to $1,550,000 in letters of credit under the two letter of credit facilities described above. These facilities are used to provide security to reinsureds and are collateralized by the Company, at least to the extent of letters of credit outstanding at any given time. As of June 30, 2008 and December 31, 2007, there were outstanding letters of credit totaling $887,018 and $922,206, respectively, under the two facilities. Collateral committed to support the letter of credit facilities was $1,188,937 as of June 30, 2008, compared to $1,170,731 as of December 31, 2007.

          At this time, the Company uses trust accounts primarily to meet security requirements for inter-company and certain related-party reinsurance transactions. The Company also has cash and cash equivalents and investments on deposit with various state or government insurance departments or pledged in favor of ceding companies in order to comply with relevant insurance regulations. As of June 30, 2008, total trust account deposits were $735,807 compared to $802,737 as of December 31, 2007.

7. FAIR VALUE OF FINANCIAL INSTRUMENTS

     The Company adopted FAS 159 as of January 1, 2008, and has elected the fair value option for its hedge fund investments, which are classified as “other invested assets, at fair value” in the unaudited condensed consolidated balance sheets. At the time of adoption, the fair value and carrying value of the hedge fund investments were $241,435 and the net unrealized gain was $26,262. These funds are comprised of liquid portfolios that have no fixed maturity with the objective of achieving current income and capital appreciation. The Company has elected the fair value option for its hedge fund investments as the Company believes that recognizing changes in the fair value of the hedge funds in the consolidated statements of operations and comprehensive income each period better reflects the results of the Company’s investment in the hedge funds rather than recognizing changes in fair value in accumulated other comprehensive income.

     Upon adoption of FAS 159, the Company reclassified the net unrealized gain related to the hedge funds of $26,262 from “accumulated other comprehensive income” and recorded a cumulative-effect adjustment in “retained earnings”. There was no net deferred tax liability associated with the net unrealized gain as the hedge fund investments are held by Holdings’ Bermuda insurance subsidiary, which pays no income tax. Any subsequent change in unrealized gain or loss of “other invested assets, at fair value” will be recognized in the consolidated statements of operations and comprehensive income and included in net realized investment gains or losses. Prior to the adoption of FAS 159 any change in unrealized gain or loss was included in “accumulated other comprehensive income” in the unaudited condensed consolidated balance sheet. The net gain recognized for the change in fair value of the hedge fund investments in the unaudited condensed consolidated statements of operations and comprehensive income during the three months ended June 30, 2008 was $621. The net loss recognized for the change in fair value of the hedge fund investments in the

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands of United States dollars, except share, per share and percentage information)

unaudited condensed consolidated statements of operations and comprehensive income during the six months ended June 30, 2008 was $11,866.

     The Company adopted FAS 157 as of January 1, 2008. This statement defines fair value and establishes a framework for measuring fair value under U.S. GAAP. FAS 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. FAS 157 also established a three-level valuation hierarchy for disclosure of fair value measurements. The valuation hierarchy is based upon whether the inputs to the valuation of an asset or liability are observable or unobservable in the market at the measurement date, with quoted market prices being the highest level (Level 1) and unobservable inputs being the lowest level (Level 3). A fair value measurement will fall within the level of the hierarchy based on the input that is significant to determining such measurement. The three levels are defined as follows:

	•		Level 1: Observable inputs to the valuation methodology that are quoted prices (unadjusted) for identical assets or liabilities in active markets.
	•		Level 2: Observable inputs to the valuation methodology other than quoted market prices (unadjusted) for identical assets or liabilities in active markets. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical assets in markets that are not active and inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the asset or liability.
	•		Level 3: Inputs to the valuation methodology that are unobservable for the asset or liability.

     The following table shows the fair value of the Company’s financial instruments and where in the FAS 157 fair value hierarchy the fair value measurements are included as of June 30, 2008.

										Fair value measurement using:
										Quoted prices
										in active
										markets for				Significant other				Significant
		Carrying				Total fair				identical assets				observable inputs				unobservable
		amount				value				(Level 1)				(Level 2)				inputs (Level 3)
U.S. government and government agencies		$	2,090,510			$	2,090,510			$	957,331			$	1,133,179			$
Non-U.S. government and government agencies			131,325				131,325								131,325
Corporate			1,362,001				1,362,001								1,362,001
States, municipalities and political subdivisions			63,409				63,409								63,409
Mortgage backed			1,962,144				1,962,144								1,962,144
Asset backed			124,134				124,134								124,134
Total fixed maturity investments, available for sale			5,733,523				5,733,523
Total other invested assets, available for sale			77,444				77,444								77,444
Total other invested assets, fair value			192,661				192,661												192,661
Total investments			6,003,628				6,003,628
Senior notes			498,738				474,700								474,700

     The following describes the valuation techniques used by the Company to determine the fair value of financial instruments held as of June 30, 2008.

     U.S. government and U.S. government agencies: Comprised primarily of bonds issued by the U.S. Treasury, the Federal Home Loan Bank, the Federal Home Loan Mortgage Corporation and the Federal National Mortgage Association. The fair values of the Company’s U.S. government securities are based on quoted market prices in active markets, and are included in the Level 1 fair value hierarchy. The Company believes the market for U.S. Treasury securities is an actively traded market given the high level of daily trading volume. The fair values of U.S. government agency securities are priced using the spread above the risk-free yield curve. As

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands of United States dollars, except share, per share and percentage information)

the yields for the risk-free yield curve are observable market inputs, the fair values of U.S. government agency securities are included in the Level 2 fair value hierarchy.

     Non-U.S. government and government agencies: Comprised of fixed income obligations of non-U.S. governmental entities. The fair values of these securities are based on broker-dealer quotes, and are included in the Level 2 fair value hierarchy.

     Corporate: Comprised of bonds issued by corporations that on acquisition are rated BBB-/Baa3 or higher provided that, in aggregate, corporate bonds with ratings of BBB-/Baa3 do not constitute more than 5% of the market value of the Company’s fixed income securities and are diversified across a wide range of issuers and industries. The fair values of corporate bonds that are short-term are priced using spread above the London Interbank Offering Rate yield curve, and the fair value of corporate bonds that are long-term are priced using the spread above the risk-free yield curve. The spreads are sourced from dealer quotes, trade prices and the new issue market. As the inputs used to price corporate bonds are observable market inputs, the fair values of corporate bonds are included in the Level 2 fair value hierarchy.

     States, municipalities and political subdivisions: Comprised of fixed income obligations of U.S. domiciled state and municipality entities. The fair values of these securities are based on broker-dealer quotes and the new issue market, and are included in the Level 2 fair value hierarchy.

     Mortgage-backed: Principally comprised of AAA-rated pools of residential and commercial mortgages originated by both agency (such as the Federal National Mortgage Association) and non-agency originators. The fair values of mortgage-backed securities originated by U.S. government agencies and non-U.S. government agencies are based on a pricing model that incorporates prepayment speeds and spreads to determine appropriate average life of mortgage-backed securities. The spreads are sourced from dealer quotes, trade prices and the new issue market. As the inputs used to price the mortgage-backed securities are observable market inputs, the fair values of these securities are included in the Level 2 fair value hierarchy.

     Asset-backed: Comprised of primarily AAA-rated bonds backed by pools of automobile loan receivables, home equity loans and credit card receivables originated by a variety of financial institutions. The fair values of asset-backed securities are priced using prepayment speed and spread inputs that are sourced from the new issue market. As the inputs used to price the asset-backed securities are observable market inputs, the fair values of these securities are included in the Level 2 fair value hierarchy.

     Other invested assets available for sale: Comprised of an open-end global high-yield bond fund that invests in non-investment grade bonds issued by various issuers and industries. The fair value of the global high-yield bond fund is based on the net asset value as reported by the fund manager. The net asset value is an observable input as it is quoted on a market exchange on a daily basis. The fair value of the global high-yield bond fund is included in the Level 2 fair value hierarchy.

     Other invested assets, at fair value: Comprised of several hedge funds with objectives to seek attractive long-term returns with lower volatility by investing in a range of diversified investment strategies. The fair values of the hedge funds are based on the net asset value of the funds as reported by the fund manager less a liquidity discount where hedge fund investments contain lock-up provisions that prevent immediate dissolution. The Company considers these lock-up provisions to be obligations that market participants would assign a value to in determining the price of these hedge funds, and as such have considered these obligations in determining the fair value measurement of the related hedge funds. The liquidity discount was estimated by calculating the value of a protective put over the lock-up period. The protective put measures the risk of holding a restricted asset over a certain time period. The Company used the Black-Scholes option-pricing model to estimate the value of the protective put for each hedge fund. The aggregate liquidity discount recognized during the three and six months ended June 30, 2008 was $54 and $269, respectively. The net asset value and the liquidity discount are significant unobservable inputs, and as such the fair values of the Company’s hedge funds are included in the Level 3 fair value hierarchy.

     Senior notes: The fair value of the senior notes is based on the price as published by Bloomberg, which was 94.94% of their principal amount, providing an effective yield of 8.37% as of June 30, 2008. The fair value of the senior notes is included in the Level 2 fair value hierarchy.

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands of United States dollars, except share, per share and percentage information)

     The following is a reconciliation of the beginning and ending balance of financial instruments using significant unobservable inputs (Level 3) for the three and six months ended June 30, 2008.

		Fair value measurement using significant
		unobservable inputs (Level 3):
		hedge funds
		Three months ended				Six months ended
		June 30, 2008				June 30, 2008
Opening balance		$	191,195			$	241,435
Total gains or losses included in earnings:
Realized gains			4,884				6,113
Change in fair value of hedge fund investments			621				(11,866	)
Purchases or sales			(4,039	)			(43,021	)
Transfers in and/or out of Level 3			—				—
Ending balance, June 30, 2008		$	192,661			$	192,661

8. INCOME TAXES

     Certain subsidiaries of Holdings file U.S. federal income tax returns and various U.S. state income tax returns, as well as income tax returns in the U.K. and Ireland. The tax years open to examination by the U.S. Internal Revenue Service for the U.S. subsidiaries are the fiscal years from 2004 to the present. The tax years open to examination by the Inland Revenue for the U.K. branches are fiscal years from 2004 to the present. The tax years open to examination by Irish Revenue Commissioners for the Irish subsidiaries are the fiscal years from 2003 to the present. To the best of the Company’s knowledge, there are no examinations pending by the U.S. Internal Revenue Service, the Inland Revenue or the Irish Revenue Commissioners.

     Management has deemed all material tax provisions to have a greater than 50% likelihood of being sustained based on technical merits if challenged. The Company has not recorded any interest or penalties during the three and six months ended June 30, 2008 and 2007 and has not accrued any payment of interest and penalties as of June 30, 2008 and December 31, 2007.

     The Company does not expect any material unrecognized tax benefits within 12 months of January 1, 2008.

9. SHAREHOLDERS’ EQUITY

a) Authorized shares

     The authorized share capital of Holdings as of June 30, 2008 and December 31, 2007 was $10,000.

     The issued share capital consists of the following:

		June 30, 2008				December 31, 2007
Common shares issued and fully paid, par value $0.03 per share			48,977,635				48,741,927
Share capital at end of period		$	1,469			$	1,462

     As of June 30, 2008, there were outstanding 35,250,977 voting common shares and 13,726,658 non-voting common shares.

b) Dividends

     In February 2008, the Company declared a quarterly dividend of $0.18 per common share payable on April 3, 2008 to shareholders of record on March 18, 2008. The total dividend paid amounted to $8,788. In May 2008, the Company declared a quarterly dividend of $0.18 per common share, payable on June 12, 2008 to shareholders of record on May 27, 2008. The total dividend paid amounted to $8,804.

     In March 2007, the Company declared a quarterly dividend of $0.15 per common share payable on April 5, 2007 to shareholders of record on March 20, 2007. The total dividend payable amounted to $9,052. In May 2007, the Company declared a quarterly

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands of United States dollars, except share, per share and percentage information)

dividend of $0.15 per common share that was paid on June 14, 2007 to shareholders of record on May 29, 2007. The total dividend paid amounted to $9,060.

10. EMPLOYEE BENEFIT PLANS

a) Employee option plan

     In 2001, the Company implemented the Allied World Assurance Company Holdings, Ltd Second Amended and Restated 2001 Employee Stock Option Plan (the “Plan”). Under the Plan, up to 4,000,000 common shares of Holdings may be issued. Holdings has filed a registration statement on Form S-8 under the Securities Act of 1933, as amended, to register common shares issued or reserved for issuance under the Plan. These options are exercisable in certain limited conditions, expire after 10 years, and generally vest pro-rata over four years from the date of grant. The exercise price of options issued are determined by the compensation committee of the Board of Directors but shall not be less than 100% of the fair market value of the common shares of Holdings on the date the option award is granted.

		Six months ended June 30, 2008
						Weighted Average
		Options				Exercise Price
Outstanding at beginning of period			1,223,875			$	31.03
Granted			270,300				43.15
Exercised			(90,081	)			27.39
Forfeited			(7,252	)			37.79
Outstanding at end of period			1,396,842			$	33.57

     Assumptions used in the option-pricing model for the options granted during the six months ended June 30, 2008:

		Options granted during
		the six months ended
		June 30, 2008
Expected term of option		6.25 years
Weighted average risk-free interest rate		2.52%
Expected volatility		23.46%
Dividend yield		1.66%
Weighted average fair value on grant date		$9.78

     There is limited historical data available for the Company to base the expected term of the options. As these options are considered to have standard characteristics, the Company has used the simplified method to determine the expected life as set forth in the SEC’s Staff Accounting Bulletins 107 and 110. Likewise, as the Company became a public company in July 2006, there is limited historical data available on which to base the volatility of its common shares. As such, the Company used the average of five volatility statistics from comparable companies, as well as the Company’s volatility, in order to derive the volatility value above. The Company has assumed a forfeiture rate of 4.91% in determining the compensation expense over the service period.

     Compensation expense of $632 and $627 relating to the options has been recognized in “general and administrative expenses” in the Company’s unaudited condensed consolidated statements of operations and comprehensive income for the three months ended June 30, 2008 and 2007, respectively. Compensation expense of $1,180 and $1,316 relating to the options has been recognized in “general and administrative expenses” in the Company’s unaudited condensed consolidated statements of operations and comprehensive income for the six months ended June 30, 2008 and 2007, respectively. As of June 30, 2008 and December 31, 2007, the Company recorded in “additional paid-in capital” on the unaudited condensed consolidated balance sheets amounts of $15,941 and $11,840, respectively, in connection with all options granted.

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands of United States dollars, except share, per share and percentage information)

b) Stock incentive plan

     In 2004, the Company implemented the Allied World Assurance Company Holdings, Ltd Second Amended and Restated 2004 Stock Incentive Plan (the “Stock Incentive Plan”). The Stock Incentive Plan provides for grants of restricted stock, restricted stock units (“RSUs”), dividend equivalent rights and other equity-based awards. A total of 2,000,000 common shares may be issued under the Stock Incentive Plan. To date only RSUs have been granted. These RSUs generally vest pro-rata over four years from the date of grant or in the fourth or fifth year from the original grant date.

		Six months ended June 30, 2008
						Weighted Average
						Grant Date Fair
		RSUs				Value
Outstanding RSUs at beginning of period			820,890			$	36.09
RSUs granted			242,979				43.23
RSUs fully vested			(139,664	)			37.27
RSUs forfeited			(31,210	)			36.13
Outstanding RSUs at end of period			892,995			$	37.85

     Compensation expense of $2,276 and $1,859 relating to the issuance of the RSUs has been recognized in “general and administrative expenses” in the Company’s unaudited condensed consolidated statements of operations and comprehensive income for the three months ended June 30, 2008 and 2007, respectively. Compensation expense of $3,752 and $3,846 relating to the issuance of the RSUs has been recognized in “general and administrative expenses” in the Company’s unaudited condensed consolidated statements of operations and comprehensive income for the six months ended June 30, 2008 and 2007, respectively. The compensation expense for the RSUs is based on the fair market value of Holdings’ common shares at the time of grant. The Company has assumed a forfeiture rate of 4.30% in determining the compensation expense over the service period. As of June 30, 2008 and December 31, 2007, the Company has recorded $16,013 and $12,337, respectively, in “additional paid-in capital” on the unaudited condensed consolidated balance sheets in connection with the RSUs awarded.

c) Long-term incentive plan

     In 2006, the Company implemented the Allied World Assurance Company Holdings, Ltd Long-Term Incentive Plan (“LTIP “), which provides for performance based equity awards to key employees in order to promote the long-term growth and profitability of the Company. Each award represents the right to receive a number of common shares in the future, based upon the achievement of established performance criteria during the applicable performance period. A total of 2,000,000 common shares may be issued under the LTIP. The awards granted in 2008 will generally vest after the fiscal year ending December 31, 2010, or in the fourth or fifth year from the original grant date, subject to the achievement of the performance conditions and terms of the LTIP.

		Six months ended June 30, 2008
						Weighted Average
						Grant Date Fair
		LTIP				Value
Outstanding LTIP awards at beginning of period			590,834			$	40.09
LTIP awards granted			507,152				43.27
LTIP awards subjected to accelerated vesting			(11,667	)			34.00
LTIP awards forfeited			(20,000	)			43.40
Outstanding LTIP awards at end of period			1,066,319			$	41.61

     Compensation expense of $4,563 and $2,960 relating to the LTIP has been recognized in “general and administrative expenses” in the Company’s unaudited condensed consolidated statements of operations and comprehensive income for the three months ended June 30, 2008 and 2007, respectively. Compensation expense of $8,693 and $6,601 relating to the LTIP has been recognized in “general and administrative expenses” in the Company’s unaudited condensed consolidated statements of operations and comprehensive income for the six months ended June 30, 2008 and 2007, respectively. The compensation expense for the LTIP is based on the fair market value of Holdings’ common shares at the time of grant. As of June 30, 2008 and December 31, 2007, the

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands of United States dollars, except share, per share and percentage information)

Company has recorded $25,079 and $16,403, respectively, in “additional paid-in capital” on the unaudited condensed consolidated balance sheets in connection with the LTIP awards.

     In calculating the compensation expense, and in the determination of share equivalents for the purpose of calculating diluted earnings per share, it is estimated for the LTIP awards granted in 2006 and 2007 that the maximum performance goals as set by the LTIP are likely to be achieved over the performance period. For the LTIP awards granted in 2008 it is estimated that the target performance goals as set by the LTIP are likely to be achieved over the performance period. Based on the target performance goals the LTIP awards granted in 2008 are expensed at 100% of the fair market value of Holdings’ common shares on the date of grant. The expense is recognized over the performance period.

     The following table shows the stock compensation expense relating to the stock options, RSUs and LTIP awards for the three and six months ended June 30, 2008 and 2007.

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2008				2007				2008				2007
Stock options		$	632			$	627			$	1,180			$	1,316
RSUs			2,276				1,859				3,752				3,846
LTIP			4,563				2,960				8,693				6,601
Total stock compensation expense		$	7,471			$	5,446			$	13,625			$	11,763

11. EARNINGS PER SHARE

     The following table sets forth the comparison of basic and diluted earnings per share:

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2008				2007				2008				2007
Basic earnings per share
Net income		$	79,205			$	123,287			$	210,150			$	237,208
Weighted average common shares outstanding			48,897,931				60,397,591				48,585,015				60,028,523
Basic earnings per share		$	1.62			$	2.04			$	4.33			$	3.95

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2008				2007				2008				2007
Diluted earnings per share
Net income		$	79,205			$	123,287			$	210,150			$	237,208
Weighted average common shares outstanding			48,897,931				60,397,591				48,585,015				60,028,523
Share equivalents:
Warrants and options			1,125,506				1,833,078				1,436,960				1,651,842
Restricted stock units			327,128				340,305				391,518				351,913
LTIP awards			523,147				303,261				600,140				244,732
Weighted average common shares and common share equivalents outstanding — diluted			50,873,712				62,874,235				51,013,633				62,277,010
Diluted earnings per share		$	1.56			$	1.96			$	4.12			$	3.81

     For the three-month period ended June 30, 2008, a weighted average of 493,533 employee stock options were considered antidilutive and were therefore excluded from the calculation of the diluted earnings per share. For the six-month period ended June 30, 2008, a weighted average of 28,000 employee stock options were considered antidilutive and were therefore excluded from the calculation of the diluted earnings per share.

     For the three-month period ended June 30, 2007, a weighted average of 6,500 employee stock options were considered antidilutive and were therefore excluded from the calculation of the diluted earnings per share. For the six-month period ended June 30, 2007, a weighted average of 3,250 employee stock options were considered antidilutive and were therefore excluded from the calculation of the diluted earnings per share.

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands of United States dollars, except share, per share and percentage information)

12. SEGMENT INFORMATION

     The determination of reportable segments is based on how senior management monitors the Company’s underwriting operations. The Company measures the results of its underwriting operations under three major business categories, namely property insurance, casualty insurance and reinsurance. All product lines fall within these classifications.

     The property segment provides direct coverage of physical property and energy-related risks. These risks generally relate to tangible assets and are considered “short-tail” in that the time from a claim being advised to the date when the claim is settled is relatively short. The casualty segment provides direct coverage of general liability risks, professional liability risks and healthcare risks. Such risks are “long-tail” in nature since the emergence and settlement of a claim can take place many years after the policy period has expired. The reinsurance segment includes any reinsurance of other companies in the insurance and reinsurance industries. The Company writes reinsurance on both a treaty and facultative basis.

     Responsibility and accountability for the results of underwriting operations are assigned by major line of business on a worldwide basis. Because the Company does not manage its assets by segment, investment income, interest expense and total assets are not allocated to individual reportable segments.

     Management measures results for each segment on the basis of the “loss and loss expense ratio”, “acquisition cost ratio”, “general and administrative expense ratio” and the “combined ratio”. The “loss and loss expense ratio” is derived by dividing net losses and loss expenses by net premiums earned. The “acquisition cost ratio” is derived by dividing acquisition costs by net premiums earned. The “general and administrative expense ratio” is derived by dividing general and administrative expenses by net premiums earned. The “combined ratio” is the sum of the loss and loss expense ratio, the acquisition cost ratio and the general and administrative expense ratio.

     The following table provides a summary of the segment results for the three and six months ended June 30, 2008 and 2007.

Three Months Ended June 30, 2008		Property				Casualty				Reinsurance				Total
Gross premiums written		$	131,973			$	178,212			$	136,599			$	446,784
Net premiums written			54,289				129,335				136,626				320,250
Net premiums earned			44,164				105,604				119,108				268,876
Net losses and loss expenses			(62,593	)			(41,764	)			(73,727	)			(178,084	)
Acquisition costs			2,976				(5,229	)			(24,012	)			(26,265	)
General and administrative expenses			(10,963	)			(24,286	)			(11,131	)			(46,380	)
Underwriting (loss) income			(26,416	)			34,325				10,238				18,147
Net investment income															72,345
Net realized investment losses															(4,393	)
Interest expense															(9,513	)
Foreign exchange gain															399
Income before income taxes														$	76,985
Loss and loss expense ratio			141.7	%			39.5	%			61.9	%			66.2	%
Acquisition cost ratio			(6.7	)%			5.0	%			20.2	%			9.8	%
General and administrative expense ratio			24.8	%			23.0	%			9.3	%			17.2	%
Combined ratio			159.8	%			67.5	%			91.4	%			93.2	%

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands of United States dollars, except share, per share and percentage information)

Three Months Ended June 30, 2007		Property				Casualty				Reinsurance				Total
Gross premiums written		$	156,463			$	188,091			$	185,995			$	530,549
Net premiums written			58,947				141,620				186,020				386,587
Net premiums earned			48,318				123,715				131,086				303,119
Net losses and loss expenses			(34,149	)			(60,908	)			(81,168	)			(176,225	)
Acquisition costs			(105	)			(5,033	)			(26,734	)			(31,872	)
General and administrative expenses			(8,163	)			(16,711	)			(9,558	)			(34,432	)
Underwriting income			5,901				41,063				13,626				60,590
Net investment income															73,937
Net realized investment losses															(1,481	)
Interest expense															(9,482	)
Foreign exchange loss															(532	)
Income before income taxes														$	123,032
Loss and loss expense ratio			70.7	%			49.2	%			61.9	%			58.1	%
Acquisition cost ratio			0.2	%			4.1	%			20.4	%			10.5	%
General and administrative expense ratio			16.9	%			13.5	%			7.3	%			11.4	%
Combined ratio			87.8	%			66.8	%			89.6	%			80.0	%

Six Months Ended June 30, 2008		Property				Casualty				Reinsurance				Total
Gross premiums written		$	218,033			$	299,274			$	326,350			$	843,657
Net premiums written			100,886				219,970				325,966				646,822
Net premiums earned			87,745				214,718				239,485				541,948
Net losses and loss expenses			(77,340	)			(114,879	)			(129,362	)			(321,581	)
Acquisition costs			2,427				(8,499	)			(47,033	)			(53,105	)
General and administrative expenses			(21,457	)			(47,994	)			(20,200	)			(89,651	)
Underwriting (loss) income			(8,625	)			43,346				42,890				77,611
Net investment income															149,276
Net realized investment losses															(928	)
Interest expense															(19,023	)
Foreign exchange loss															(77	)
Income before income taxes														$	206,859
Loss and loss expense ratio			88.1	%			53.5	%			54.0	%			59.3	%
Acquisition cost ratio			(2.8	)%			4.0	%			19.6	%			9.8	%
General and administrative expense ratio			24.5	%			22.4	%			8.4	%			16.5	%
Combined ratio			109.8	%			79.9	%			82.0	%			85.6	%

Six Months Ended June 30, 2007		Property				Casualty				Reinsurance				Total
Gross premiums written		$	258,328			$	313,280			$	397,347			$	968,955
Net premiums written			105,079				242,265				397,087				744,431
Net premiums earned			92,809				248,124				248,752				589,685
Net losses and loss expenses			(41,014	)			(151,275	)			(149,931	)			(342,220	)
Acquisition costs			(437	)			(11,071	)			(49,560	)			(61,068	)
General and administrative expenses			(15,920	)			(32,018	)			(19,697	)			(67,635	)
Underwriting income			35,438				53,760				29,564				118,762
Net investment income															146,585
Net realized investment losses															(7,965	)
Interest expense															(18,856	)
Foreign exchange loss															(564	)
Income before income taxes														$	237,962
Loss and loss expense ratio			44.2	%			61.0	%			60.3	%			58.0	%
Acquisition cost ratio			0.4	%			4.4	%			19.9	%			10.4	%
General and administrative expense ratio			17.2	%			12.9	%			7.9	%			11.5	%
Combined ratio			61.8	%			78.3	%			88.1	%			79.9	%

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands of United States dollars, except share, per share and percentage information)

     The following table shows an analysis of the Company’s net premiums written by geographic location of the Company’s subsidiaries for the three and six months ended June 30, 2008 and 2007. All inter-company premiums have been eliminated.

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2008				2007				2008				2007
Bermuda		$	191,022			$	302,480			$	454,564			$	593,082
United States			79,238				34,203				102,358				57,113
Europe			49,990				49,904				89,900				94,236
Total net premiums written		$	320,250			$	386,587			$	646,822			$	744,431

13. COMMITMENTS AND SUBSEQUENT EVENTS

     Holdings entered into a definitive agreement and plan of merger (the “Merger Agreement”) on June 27, 2008 with Allied World Merger Company, a newly formed Delaware corporation and an indirect wholly-owned subsidiary of the Company (“Merger Sub”), and Darwin Professional Underwriters, Inc. (“Darwin”), a Delaware corporation. The Merger Agreement provides for the merger of Merger Sub with and into Darwin, with Darwin continuing as the surviving corporation and an indirect wholly-owned subsidiary of Holdings. Darwin offers a wide array of specialty and primary professional lines coverages, including a healthcare professional liability franchise and a niche errors and omissions division.

     Pursuant to the terms of the Merger Agreement, stockholders of Darwin will be entitled to receive $32.00 in cash for each share of Darwin common stock in exchange for 100% of their interests in Darwin. Also, each outstanding Darwin stock option will fully vest and be converted into an amount in cash equal to (i) the excess, if any, of $32.00 over the exercise price per share of the stock option, multiplied by (ii) the total number of shares of Darwin common stock subject to the stock option. In addition, each outstanding Darwin restricted share will fully vest and be converted into the right to receive $32.00 in cash per restricted share, and each outstanding director share unit will be converted into the right to receive $32.00 in cash per share unit. The total cash consideration to be paid by the Company will be approximately $550,000. The $32.00 per share purchase price is subject to a downward adjustment in the event that certain representations by Darwin in the Merger Agreement with respect to its capitalization are breached and, as a result of such breach, the aggregate consideration payable by the Company in the merger is increased by more than $1,000. The transaction is expected to be completed during the fourth quarter of 2008 subject to customary closing conditions, including regulatory approvals. The transaction will be accounted for as a purchase. Under the purchase method of accounting for a business combination, the assets and liabilities of Darwin will be recorded at their fair values on the acquisition date.

     On August 7, 2008, the Company declared a quarterly dividend of $0.18 per common share, payable on September 11, 2008 to shareholders of record on August 26, 2008.

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

     The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes included elsewhere in this Form 10-Q. References in this Form 10-Q to the terms “we,” “us,” “our,” “the company” or other similar terms mean the consolidated operations of Allied World Assurance Company Holdings, Ltd and its subsidiaries, unless the context requires otherwise. References in this Form 10-Q to the term “Holdings” means Allied World Assurance Company Holdings, Ltd only.

Note on Forward-Looking Statement

     This Form 10-Q and other publicly available documents may include, and our officers and representatives may from time to time make, projections concerning financial information and statements concerning future economic performance and events, plans and objectives relating to management, operations, products and services, and assumptions underlying these projections and statements. These projections and statements are forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995 and are not historical facts but instead represent only our belief regarding future events, many of which, by their nature, are inherently uncertain and outside our control. These projections and statements may address, among other things, our strategy for growth, product development, financial results and reserves. Actual results and financial condition may differ, possibly materially, from these projections and statements and therefore you should not place undue reliance on them. Factors that could cause our actual results to differ, possibly materially, from those in the specific projections and statements are discussed throughout this Management’s Discussion and Analysis of Financial Condition and Results of Operations and in “Risk Factors” in Item 1A. of Part I of our 2007 Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission (“SEC”) on February 29, 2008. We are under no obligation (and expressly disclaim any such obligation) to update or revise any forward-looking statement that may be made from time to time, whether as a result of new information, future developments or otherwise.

Overview

Our Business

     We write a diversified portfolio of property and casualty insurance and reinsurance lines of business internationally through our subsidiaries or branches based in Bermuda, the United States, Ireland and the United Kingdom. We manage our business through three operating segments: property, casualty and reinsurance. As of June 30, 2008, we had $8.5 billion of total assets, $2.4 billion of shareholders’ equity and $2.9 billion of total capital, which includes shareholders’ equity and senior notes.

     During the year ended December 31, 2007, we experienced rate declines from increased competition across all of our operating segments. This trend of increased competition and decreasing rates has continued during the six months ended June 30, 2008, and we expect this trend to continue during the remainder of 2008. Given this trend, we continue to be selective in the policies and reinsurance contracts we underwrite. Our consolidated gross premiums written decreased $83.7 million, or 15.8%, for the three months ended June 30, 2008 compared to the three months ended June 30, 2007. Our consolidated gross premiums decreased $125.3 million, or 12.9%, for the six months ended June 30, 2008 compared to the six months ended June 30, 2007. Our net income for the three months ended June 30, 2008 decreased $44.1 million, or 35.8%, to $79.2 million compared to $123.3 million for the three months ended June 30, 2007. During the three months ended June 30, 2008, we were negatively impacted by net losses and loss expenses recognized of $41.0 million related to both the floods in the U.S. Midwest and a gas pipeline explosion in Australia. Our net income for the six months ended June 30, 2008 decreased $27.0 million, or 11.4%, to $210.2 million compared to $237.2 million for the six months ended June 30, 2007.

Recent Developments

     On June 27, 2008, we entered into a definitive merger agreement to acquire Darwin Professional Underwriters, Inc. (“Darwin”). Darwin offers healthcare professional liability, errors and omissions and other specialty and primary professional liability coverages. Darwin had total gross premiums written for the year ended December 31, 2007 of $280.3 million, which would have represented, on a pro-forma basis, approximately 16% of our total gross premiums written for the year ended December 31, 2007. Under the terms of the merger agreement, stockholders of Darwin will be entitled to receive $32.00 per share in cash for each share of Darwin common stock in exchange for 100% of their interests in Darwin. Also, each outstanding Darwin stock option will fully vest and be converted into an amount in cash equal to (i) the excess, if any, of $32.00 over the exercise price per share of the stock option, multiplied by (ii) the total number of shares of Darwin common stock subject to the stock option. In addition, each outstanding Darwin restricted share

will fully vest and be converted into the right to receive $32.00 in cash per restricted share, and each outstanding director share unit will be converted into the right to receive $32.00 in cash per share unit. The total cash consideration to be paid by us will be approximately $550 million. The $32.00 per share purchase price is subject to a downward adjustment in the event that certain representations by Darwin in the merger agreement with respect to its capitalization are breached and, as a result of such breach, the aggregate consideration payable by us in the merger is increased by more than $1 million. The transaction is expected to be completed during the fourth quarter of 2008 subject to customary closing conditions, including regulatory approvals. The transaction will be accounted for as a purchase. Under the purchase method of accounting for a business combination, the assets and liabilities of Darwin will be recorded at their fair values on the acquisition date.

Relevant Factors

Revenues

     We derive our revenues primarily from premiums on our insurance policies and reinsurance contracts, net of any reinsurance or retrocessional coverage purchased. Insurance and reinsurance premiums are a function of the amounts and types of policies and contracts we write, as well as prevailing market prices. Our prices are determined before our ultimate costs, which may extend far into the future, are known. In addition, our revenues include income generated from our investment portfolio, consisting of net investment income and net realized gains or losses. Investment income is principally derived from interest and dividends earned on investments, partially offset by investment management fees and fees paid to our custodian bank. Net realized gains or losses include (1) net realized investment gains or losses from the sale of investments, (2) write-downs related to declines in the market value of securities on our available for sale portfolio that were considered to be other than temporary and (3) the change in the fair value of investments that we mark-to-market in the consolidated statements of operations and comprehensive income.

Expenses

     Our expenses consist largely of net losses and loss expenses, acquisition costs and general and administrative expenses. Net losses and loss expenses incurred are comprised of three main components:

	•		losses paid, which are actual cash payments to insureds or losses payable to insureds, net of recoveries from reinsurers;
	•		outstanding loss or case reserves, which represent management’s best estimate of the likely settlement amount for known claims, less the portion that can be recovered from reinsurers; and
	•		reserves for losses incurred but not reported, or “IBNR”, which are reserves established by us for claims that are not yet reported but can reasonably be expected to have occurred based on industry information, management’s experience and/or actuarial evaluation. The portion recoverable from reinsurers is deducted from the gross estimated loss.

     Acquisition costs are comprised of commissions, brokerage fees and insurance taxes. Commissions and brokerage fees are usually calculated as a percentage of premiums and depend on the market and line of business. Acquisition costs are reported after (1) deducting commissions received on ceded reinsurance, (2) deducting the part of acquisition costs relating to unearned premiums and (3) including the amortization of previously deferred acquisition costs.

     General and administrative expenses include personnel expenses including stock-based compensation charges, rent expense, professional fees, information technology costs and other general operating expenses. We are experiencing increases in general and administrative expenses resulting from additional staff, increased stock-based compensation expense, increased rent expense for our U.S. offices, increased professional fees and additional amortization expense for building-related and infrastructure expenditures. We believe this trend will continue during the remainder of 2008 as we continue to hire additional staff and build our infrastructure.

Ratios

     Management measures results for each segment on the basis of the “loss and loss expense ratio,” “acquisition cost ratio,” “general and administrative expense ratio,” “expense ratio” and the “combined ratio.” Because we do not manage our assets by segment, investment income, interest expense and total assets are not allocated to individual reportable segments. General and administrative expenses are allocated to segments based on various factors, including staff count and each segment’s proportional share of gross premiums written. The “loss and loss expense ratio” is derived by dividing net losses and loss expenses by net premiums earned. The “acquisition cost ratio” is derived by dividing acquisition costs by net premiums earned. The “general and administrative expense ratio” is derived by dividing general and administrative expenses by net premiums earned. The “expense ratio” is the sum of the acquisition cost ratio and the general and administrative expense ratio. The “combined ratio” is the sum of the loss and loss expense ratio, the acquisition cost ratio and the general and administrative expense ratio.

Critical Accounting Policies

     It is important to understand our accounting policies in order to understand our financial position and results of operations. Our unaudited condensed consolidated financial statements reflect determinations that are inherently subjective in nature and require management to make assumptions and best estimates to determine the reported values. If events or other factors cause actual results to differ materially from management’s underlying assumptions or estimates, there could be a material adverse effect on our financial condition or results of operations. We believe that some of the more critical judgments in the areas of accounting estimates and assumptions that affect our financial condition and results of operations are related to reserves for losses and loss expenses, reinsurance recoverables, premiums and acquisition costs, valuation of financial instruments and other-than-temporary impairment of investments. For a detailed discussion of our critical accounting policies please refer to our Annual Report on Form 10-K for the year ended December 31, 2007 filed with the SEC. There were no material changes in the application of our critical accounting estimates subsequent to that report, except as discussed below related to the valuation of financial instruments.

Fair Value of Financial Instruments

     Under existing accounting principles generally accepted in the United States (“U.S. GAAP”), we are required to recognize certain assets at their fair value in our condensed consolidated balance sheets. This includes our fixed maturity investments, global high-yield bond fund and hedge funds. Fair value, as defined in Financial Accounting Standard No. 157 “Fair Value Measurements” (“FAS 157”), is 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. FAS 157 also established a three-level valuation hierarchy for disclosure of fair value measurements. The valuation hierarchy is based upon whether the inputs to the valuation of an asset or liability are observable or unobservable in the market at the measurement date, with quoted market prices being the highest level (Level 1) and unobservable inputs being the lowest level (Level 3). A fair value measurement will fall within the level of the hierarchy based on the input that is significant to determining such measurement. The three levels are defined as follows:

	•		Level 1: Observable inputs to the valuation methodology that are quoted prices (unadjusted) for identical assets or liabilities in active markets.
	•		Level 2: Observable inputs to the valuation methodology other than quoted market prices (unadjusted) for identical assets or liabilities in active markets. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical assets in markets that are not active and inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the asset or liability.
	•		Level 3: Inputs to the valuation methodology that are unobservable for the asset or liability.

     At each measurement date, we estimate the fair value of the financial instruments using various valuation techniques. We utilize, to the extent available, quoted market prices in active markets or observable market inputs in estimating the fair value of our financial instruments. When quoted market prices or observable market inputs are not available, we utilize valuation techniques that rely on unobservable inputs to estimate the fair value of financial instruments. The following describes the valuation techniques used by us to determine the fair value of financial instruments held as of June 30, 2008 and what level within the FAS 157 fair value hierarchy the valuation technique resides.

     U.S. government and U.S. government agencies: Comprised primarily of bonds issued by the U.S. Treasury, the Federal Home Loan Bank, the Federal Home Loan Mortgage Corporation and the Federal National Mortgage Association. The fair values of U.S. government securities are based on quoted market prices in active markets, and are included in the Level 1 fair value hierarchy. We believe the market for U.S. Treasury securities is an actively traded market given the high level of daily trading volume. The fair values of U.S. government agency securities are priced using the spread above the risk-free yield curve. As the yields for the risk-free yield curve are observable market inputs, the fair values of U.S. government agency securities are included in the Level 2 fair value hierarchy.

     Non-U.S. government and government agencies: Comprised of fixed income obligations of non-U.S. governmental entities. The fair values of these securities are based on broker-dealer quotes, and are included in the Level 2 fair value hierarchy.

     Corporate: Comprised of bonds issued by corporations that on acquisition are rated BBB-/Baa3 or higher provided that, in aggregate, corporate bonds with ratings of BBB-/Baa3 do not constitute more than 5% of the market value of our fixed income securities, and are diversified across a wide range of issuers and industries. The fair values of corporate bonds that are short-term are

priced using spread above the London Interbank Offering Rate yield curve, and the fair value of corporate bonds that are long-term are priced using the spread above the risk-free yield curve. The spreads are sourced from dealer quotes, trade prices and the new issue market. As the inputs used to price corporate bonds are observable market inputs, the fair values of corporate bonds are included in the Level 2 fair value hierarchy.

     States, municipalities and political subdivisions: Comprised of fixed income obligations of U.S. domiciled state and municipality entities. The fair values of these securities are based on broker-dealer quotes and the new issue market, and are included in the Level 2 fair value hierarchy.

     Mortgage-backed: Principally comprised of AAA-rated pools of residential and commercial mortgages originated by both agency (such as the Federal National Mortgage Association) and non-agency originators. The fair values of mortgage-backed securities originated by U.S. government agencies and non-U.S. government agencies are based on a pricing model that incorporates prepayment speeds and spreads to determine appropriate average life of mortgage-backed securities. The spreads are sourced from dealer quotes, trade prices and the new issue market. As the inputs used to price the mortgage-backed securities are observable market inputs, the fair values of these securities are included in the Level 2 fair value hierarchy.

     Asset-backed: Comprised of primarily AAA-rated bonds backed by pools of automobile loan receivables, home equity loans and credit card receivables originated by a variety of financial institutions. The fair values of asset-backed securities are priced using prepayment speed and spread inputs that are sourced from the new issue market. As the inputs used to price the asset-backed securities are observable market inputs, the fair values of these securities are included in the Level 2 fair value hierarchy.

     Other invested assets available for sale: Comprised of an open-end global high-yield bond fund that invests in non-investment grade bonds issued by various issuers and industries. The fair value of the global high-yield bond fund is based on the net asset value as reported by the fund manager. The net asset value is an observable input as it is quoted on a market exchange on a daily basis. The fair value of the global high-yield bond fund is included in the Level 2 fair value hierarchy.

     Other invested assets, at fair value: Comprised of several hedge funds with objectives to seek attractive long-term returns with lower volatility by investing in a range of diversified investment strategies. The fair values of the hedge funds are based on the net asset value of the funds as reported by the fund manager less a liquidity discount where hedge fund investments contain lock-up provisions that prevent immediate dissolution. We consider these lock-up provisions to be obligations that market participants would assign a value to in determining the price of these hedge funds, and as such have considered these obligations in determining the fair value measurement of the related hedge funds. The liquidity discount was estimated by calculating the value of a protective put over the lock-up period. The protective put measures the risk of holding a restricted asset over a certain time period. We used the Black-Scholes option-pricing model to estimate the value of the protective put for each hedge fund. The aggregate liquidity discount recorded during the three and six months ended June 30, 2008 was $0.1 million and $0.3 million, respectively. The net asset value and the liquidity discount are significant unobservable inputs, and as such the fair values of the hedge funds are included in the Level 3 fair value hierarchy. Our hedge funds are the only assets that have significant Level 3 inputs in determining fair value. The hedge funds represent 3.2% of our total investments.

     There have been no material changes to any of our valuation techniques from what those used as of December 31, 2007. Since fair valuing a financial instrument is an estimate of what a willing buyer would pay for our asset if we sold it, we will not know the ultimate value of our financial instruments until they are sold. We believe the valuation techniques utilized provide us with the best estimate of the price that would be received to sell our assets in an orderly transaction between participants at the measurement date.

Results of Operations

     The following table sets forth our selected consolidated statement of operations data for each of the periods indicated.

		Three Months								Six Months
		Ended June 30,								Ended June 30,
		2008				2007				2008				2007
		($ in millions)
Gross premiums written		$	446.8			$	530.5			$	843.7			$	969.0
Net premiums written		$	320.3			$	386.6			$	646.8			$	744.4
Net premiums earned			268.9				303.1				541.9				589.7
Net investment income			72.4				73.9				149.3				146.6
Net realized investment losses			(4.4	)			(1.5	)			(0.9	)			(8.0	)
		$	336.9			$	375.5			$	690.3			$	728.3
Net losses and loss expenses		$	178.1			$	176.2			$	321.6			$	342.2
Acquisition costs			26.3				31.9				53.1				61.1
General and administrative expenses			46.4				34.4				89.6				67.6
Interest expense			9.5				9.5				19.0				18.9
Foreign exchange (gain) loss			(0.4	)			0.5				0.1				0.5
		$	259.9			$	252.5			$	483.4			$	490.3
Income before income taxes		$	77.0			$	123.0			$	206.9			$	238.0
Income tax (recovery) expense			(2.2	)			(0.3	)			(3.3	)			0.8
Net income		$	79.2			$	123.3			$	210.2			$	237.2
Ratios
Loss and loss expense ratio			66.2	%			58.1	%			59.3	%			58.0	%
Acquisition cost ratio			9.8				10.5				9.8				10.4
General and administrative expense ratio			17.2				11.4				16.5				11.5
Expense ratio			27.0				21.9				26.3				21.9
Combined ratio			93.2				80.0				85.6				79.9