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, 2010

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

(Exact Name of Registrant as Specified in Its Charter)

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o

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

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

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

     The number of outstanding common shares, par value $0.03 per share, of Allied World Assurance Company Holdings, Ltd as of August 2, 2010 was 48,873,660.

 

 

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
as of June 30, 2010 and December 31, 2009
(Expressed in thousands of United States dollars, except share and per share amounts)

		As of				As of
		June 30,				December 31,
		2010				2009
ASSETS
Fixed maturity investments available for sale, at fair value (amortized cost: 2010: $2,602,000; 2009: $4,260,844)		$	2,755,934			$	4,427,072
Fixed maturity investments trading, at fair value			4,275,893				2,544,322
Other invested assets trading, at fair value			388,761				184,869
Total investments			7,420,588				7,156,263
Cash and cash equivalents			442,689				292,188
Restricted cash			101,206				87,563
Insurance balances receivable			552,330				395,621
Prepaid reinsurance			202,107				186,610
Reinsurance recoverable			932,435				919,991
Accrued investment income			46,105				53,046
Net deferred acquisition costs			103,286				87,821
Goodwill			268,376				268,376
Intangible assets			58,576				60,359
Balances receivable on sale of investments			24,318				55,854
Net deferred tax assets			14,170				21,895
Other assets			48,182				67,566
Total assets		$	10,214,368			$	9,653,153
LIABILITIES
Reserve for losses and loss expenses		$	4,920,435			$	4,761,772
Unearned premiums			1,069,956				928,619
Reinsurance balances payable			137,790				102,837
Balances due on purchases of investments			50,425				55,670
Senior notes			498,984				498,919
Accounts payable and accrued liabilities			68,235				92,041
Total liabilities		$	6,745,825			$	6,439,858
SHAREHOLDERS’ EQUITY
Common shares, par value $0.03 per share (2010: 50,488,342; 2009: 49,734,487 shares issued and 2010: 49,407,301; 2009: 49,734,487 shares outstanding)		$	1,515			$	1,492
Additional paid-in capital			1,378,262				1,359,934
Treasury shares, at cost (2010: 1,081,041; 2009: nil)			(49,089	)			—
Accumulated other comprehensive income: net unrealized gains on investments, net of tax			138,245				149,849
Retained earnings			1,999,610				1,702,020
Total shareholders’ equity		$	3,468,543			$	3,213,295
Total liabilities and shareholders’ equity		$	10,214,368			$	9,653,153

See accompanying notes to the 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, 2010 and 2009
(Expressed in thousands of United States dollars, except share and per share amounts)

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2010				2009				2010				2009
REVENUES:
Gross premiums written		$	493,847			$	492,782			$	998,010			$	972,379
Premiums ceded			(124,052	)			(131,344	)			(194,923	)			(205,903	)
Net premiums written			369,795				361,438				803,087				766,476
Change in unearned premiums			(30,871	)			(27,770	)			(125,839	)			(108,836	)
Net premiums earned			338,924				333,668				677,248				657,640
Net investment income			65,594				76,537				134,496				154,391
Net realized investment gains			94,933				5,093				172,420				41,695
Net impairment charges recognized in earnings:
Total other-than-temporary impairment charges			—				(16,225	)			(168	)			(58,188	)
Portion of loss recognized in other comprehensive income, before taxes			—				10,751				—				10,751
Net impairment charges recognized in earnings			—				(5,474	)			(168	)			(47,437	)
Other income			616				369				913				835
			500,067				410,193				984,909				807,124
EXPENSES:
Net losses and loss expenses			188,722				177,719				420,876				326,216
Acquisition costs			37,938				36,963				78,722				74,091
General and administrative expenses			68,089				61,495				131,552				118,860
Amortization and impairment of intangible assets			891				1,065				1,783				2,130
Interest expense			9,531				9,522				19,059				19,969
Foreign exchange loss (gain)			559				(1,222	)			1,635				(387	)
			305,730				285,542				653,627				540,879
Income before income taxes			194,337				124,651				331,282				266,245
Income tax expense			10,378				10,981				13,583				21,167
NET INCOME			183,959				113,670				317,699				245,078
Other comprehensive (loss) income:
Unrealized gains on investments arising during the period net of applicable deferred income tax expense for the three months 2010: $(471); 2009: $(1,822); and six months 2010: $(690); 2009: $(441)			63,852				140,209				101,322				76,149
Portion of other-than-temporary impairment losses recognized in other comprehensive income, net of applicable deferred income tax for the three months and six months ended June 30, 2010 nil; 2009: nil			—				(10,751	)			—				(10,751	)
Reclassification adjustment for net realized investment (gains) losses included in net income, net of applicable income tax			(67,891	)			7,856				(112,926	)			14,487
Other comprehensive (loss) income			(4,039	)			137,314				(11,604	)			79,885
COMPREHENSIVE INCOME		$	179,920			$	250,984			$	306,095			$	324,963
PER SHARE DATA
Basic earnings per share		$	3.66			$	2.30			$	6.34			$	4.96
Diluted earnings per share		$	3.47			$	2.22			$	5.98			$	4.79
Weighted average common shares outstanding			50,222,974				49,523,459				50,123,945				49,386,549
Weighted average common shares and common share equivalents outstanding			52,974,410				51,257,887				53,086,708				51,215,808
Dividends declared per share		$	0.20			$	0.18			$	0.40			$	0.36

See accompanying notes to the consolidated financial statements.

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
for the six months ended June 30, 2010 and 2009
(Expressed in thousands of United States dollars)

														Accumulated
						Additional								Other
						Paid-in				Treasury				Comprehensive				Retained
		Share Capital				Capital				Shares				Income				Earnings				Total
December 31, 2009		$	1,492			$	1,359,934			$	—			$	149,849			$	1,702,020			$	3,213,295
Net income			—				—				—				—				317,699				317,699
Dividends			—				—				—				—				(20,109	)			(20,109	)
Other comprehensive loss:
Net unrealized losses, net of deferred income tax			—				—				—				(11,604	)			—				(11,604	)
Portion of other-than-temporary impairment losses recognized in other comprehensive income, net of deferred income tax			—				—				—				—				—				—
Total other comprehensive loss			—				—				—				(11,604	)			—				(11,604	)
Stock compensation			23				18,328				—				—				—				18,351
Share repurchase			—				—				(49,089	)			—				—				(49,089	)
June 30, 2010		$	1,515			$	1,378,262			$	(49,089	)		$	138,245			$	1,999,610			$	3,468,543

										Accumulated
						Additional				Other
						Paid-in				Comprehensive				Retained
		Share Capital				Capital				Income				Earnings				Total
December 31, 2008		$	1,471			$	1,314,785			$	105,632			$	994,974			$	2,416,862
Cumulative effect adjustment upon adoption of ASC 320-10-651, net of deferred taxes			—				—				(136,848	)			136,848				—
Net income			—				—				—				245,078				245,078
Dividends			—				—				—				(17,828	)			(17,828	)
Other comprehensive income:
Unrealized gains			—				—				90,636				—				90,636
Portion of other-than-temporary impairment losses recognized in other comprehensive income, net of deferred income tax			—				—				(10,751	)			—				(10,751	)
Total other comprehensive income			—				—				79,885				—				79,885
Stock compensation			15				17,415				—				—				17,430
June 30, 2009		$	1,486			$	1,332,200			$	48,669			$	1,359,072			$	2,741,427

See accompanying notes to the consolidated financial statements.

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
for the six months ended June 30, 2010 and 2009
(Expressed in thousands of United States dollars)

		Six Months Ended
		June 30,
		2010				2009
CASH FLOWS PROVIDED BY OPERATING ACTIVITIES:
Net income		$	317,699			$	245,078
Adjustments to reconcile net income to cash provided by operating activities:
Net realized gains on sales of investments			(113,151	)			(34,311	)
Mark to market adjustments			(59,269	)			(7,384	)
Net impairment charges recognized in earnings			168				47,437
Stock compensation expense			17,454				16,560
Insurance balances receivable			(156,709	)			(73,832	)
Prepaid reinsurance			(15,497	)			(27,531	)
Reinsurance recoverable			(12,444	)			(21,402	)
Accrued investment income			6,941				(5,980	)
Net deferred acquisition costs			(15,465	)			(10,422	)
Net deferred tax assets			8,415				(8,783	)
Other assets			22,318				(1,353	)
Reserve for losses and loss expenses			158,663				136,899
Unearned premiums			141,337				136,368
Reinsurance balances payable			34,953				37,819
Accounts payable and accrued liabilities			(23,806	)			(24,263	)
Other items, net			(6,005	)			(2,518	)
Net cash provided by operating activities			305,602				402,382
CASH FLOWS USED IN INVESTING ACTIVITIES:
Purchases of fixed maturity investments — available for sale			(113,118	)			(5,379,219	)
Purchases of fixed maturity investments — trading			(6,927,637	)			(234,049	)
Purchases of other invested assets			(203,011	)			(125,376	)
Sales of fixed maturity investments — available for sale			1,827,800				5,297,600
Sales of fixed maturity investments — trading			5,344,007				357
Sales of other invested assets			3,155				134,386
Changes in securities lending collateral received			—				171,026
Purchases of fixed assets			(5,213	)			(3,072	)
Change in restricted cash			(13,643	)			(8,636	)
Net cash used in investing activities			(87,660	)			(146,983	)
CASH FLOWS USED IN FINANCING ACTIVITIES:
Dividends paid			(20,109	)			(17,828	)
Proceeds from the exercise of stock options			3,576				2,228
Share repurchase			(49,089	)			—
Repayment of syndicated loan			—				(243,750	)
Changes in securities lending collateral			—				(177,010	)
Net cash used in financing activities			(65,622	)			(436,360	)
Effect of exchange rate changes on foreign currency cash			(1,819	)			801
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS			150,501				(180,160	)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR			292,188				655,828
CASH AND CASH EQUIVALENTS, END OF YEAR		$	442,689			$	475,668
Supplemental disclosure of cash flow information:
— Cash paid for income taxes		$	4,386			$	37,878
— Cash paid for interest expense			18,750				20,365

See accompanying notes to the 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, percentage and ratio 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, Europe, Hong Kong and Singapore.

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 outstanding losses and loss expenses,
	•		Valuation of ceded reinsurance recoverables,
	•		Determination of impairment of goodwill and other intangible assets,
	•		Valuation of financial instruments, and
	•		Determination of other-than-temporary impairment of investments.

     Inter-company 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 operations and comprehensive income (“consolidated income statements”) and consolidated statements of cash flows and notes to the unaudited condensed consolidated financial statements have been made to prior years’ amounts to conform to the current year’s presentation.

     These unaudited condensed consolidated financial statements, including these notes, should be read in conjunction with the Company’s audited consolidated financial statements, and related notes thereto, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.

3. NEW ACCOUNTING PRONOUNCEMENTS

     In January 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) 2010-06 “Fair Value Measurements and Disclosures” (“ASU 2010-06”). ASU 2010-06 updated section ASC 820-10 to require a greater level of disaggregated information and more robust disclosure about valuation techniques and inputs to fair value measurements. ASU 2010-06 is effective for interim and annual reporting periods beginning after December 15, 2009, with the exception of the disclosures about purchases, sales, issuances and settlements in the roll forward of activity in Level 3 fair value measures which are effective for interim and annual reporting periods beginning after December 15, 2010. See Note 6 “Fair Value of Financial Instruments” for the Company’s disclosures about the fair value of financial instruments.

     In March 2010, the FASB issued ASU 2010-11 “Derivatives and Hedging: Scope Exception Related to Embedded Credit

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

Derivatives” (“ASU 2010-11”). ASU 2010-11 clarifies the type of embedded credit derivative that is exempt from embedded derivative bifurcation requirements, specifically one that is related only to the subordination of one financial instrument to another. ASU 2010-11 is effective for interim and annual periods beginning after June 15, 2010. As permitted under the transitional provisions of ASU 2010-11, effective July 1, 2010 the Company has elected the fair value option for any investment in a beneficial interest in a securitized asset. As a result, the Company elected the fair value option for all of its mortgage-backed and asset-backed securities held as of June 30, 2010. On July 1, 2010, the Company reclassified net unrealized gains of $42,402 from “accumulated other comprehensive income” to “retained earnings”. As a result of the fair value election, any changes in fair value of the mortgage-backed and asset-backed securities will be recognized in “net realized investment gains (losses)” on the consolidated income statement. On July 1, 2010, these investments, which totaled $968,825 as of June 30, 2010, were classified as “fixed maturity investments trading, at fair value” on the consolidated balance sheet.

4. INVESTMENTS

a) Available for Sale Securities

     The amortized cost, gross unrealized gains, unrealized losses, other-than-temporary-impairment charges (“OTTI”) recorded through other comprehensive income (“OCI”) and fair value of the Company’s available for sale investments by category as of June 30, 2010 and December 31, 2009 are as follows:

						Gross
						Unrealized				Unrealized
		Cost				Gains				Losses				OTTI OCI				Fair Value
June 30, 2010
U.S. Government and Government agencies		$	197,602			$	13,662			$	(8	)		$	—			$	211,256
Non-U.S. Government and Government agencies			135,790				10,055				(5,239	)			—				140,606
States, municipalities and political subdivisions			145,495				14,550				—				—				160,045
Corporate debt:
Financial institutions			337,266				15,609				(2,378	)			—				350,497
Industrials			691,159				49,728				(9	)			—				740,878
Utilities			168,265				15,562				—				—				183,827
Residential mortgage-backed:
Non-agency residential			151,416				6,306				(6,759	)			(563	)			150,400
Agency residential			551,635				32,508				(68	)			—				584,075
Commercial mortgage-backed			157,464				8,715				—				—				166,179
Asset-backed			65,908				2,345				(82	)			—				68,171
Total fixed maturity investments, available for sale		$	2,602,000			$	169,040			$	(14,543	)		$	(563	)		$	2,755,934
December 31, 2009
U.S. Government and Government agencies		$	689,858			$	34,831			$	(1,389	)		$	—			$	723,300
Non-U.S. Government and Government agencies			271,528				13,752				(1,590	)			—				283,690
States, municipalities and political subdivisions			210,315				17,429				(336	)			—				227,408
Corporate debt:
Financial institutions			684,386				27,695				(1,751	)			—				710,330
Industrials			879,905				46,489				(184	)			—				926,210
Utilities			143,773				10,479				—				—				154,252
Residential mortgage-backed:
Non-agency residential			172,000				4,206				(11,517	)			(1,856	)			162,833
Agency residential			708,652				28,882				(1,095	)			—				736,439
Commercial mortgage-backed			406,236				6,482				(7,915	)			—				404,803
Asset-backed			94,191				3,762				(146	)			—				97,807
Total fixed maturity investments, available for sale		$	4,260,844			$	194,007			$	(25,923	)		$	(1,856	)		$	4,427,072

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

b) Trading Securities

     Securities accounted for at fair value with changes in fair value recognized in the consolidated income statements by category as of June 30, 2010 and December 31, 2009 are as follows:

		June 30, 2010				December 31, 2009
U.S. Government and Government agencies		$	1,558,731			$	655,266
Non-U.S. Government and Government agencies			246,180				227,310
States, municipalities and political subdivisions			88,965				15,810
Corporate debt
Financial institutions			687,744				590,130
Industrials			359,285				191,729
Utilities			69,802				11,934
Residential mortgage-backed
Non-agency residential			256,130				259,055
Agency residential			377,748				139,858
Commercial mortgage-backed			29,545				18,266
Asset-backed			601,763				434,964
Total fixed maturity investments, trading			4,275,893				2,544,322
Hedge funds			319,592				184,725
Equity securities			69,169				144
Total		$	4,664,654			$	2,729,191

c) Contractual Maturity Dates

     The contractual maturity dates of fixed maturity investments (available for sale and trading) as of June 30, 2010 are as follows:

		Amortized Cost				Fair Value
Due within one year		$	396,310			$	399,476
Due after one year through five years			3,593,575				3,676,074
Due after five years through ten years			596,166				611,326
Due after ten years			100,233				110,940
Mortgage-backed			1,523,938				1,564,077
Asset-backed			667,671				669,934
		$	6,877,893			$	7,031,827

     Expected maturities may differ from contractual maturities because borrowers may have the right to prepay obligations with or without prepayment penalties.

d) Other Invested Assets

     As of June 30, 2010, the Company held sixteen hedge fund investments with a total fair value of $319,592, which comprised 4.0% of the total fair value of its investments and cash and cash equivalents and are summarized as follows by type of investment strategy:

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

										Long				Short
Hedge Fund		Fair Value as of				Unfunded				Exposure(1)				Exposure(2)				Gross				Net
Type		June 30, 2010				Commitments				(% of funded)				(% of funded)				Exposure(3)				Exposure(4)
Secondary private equity funds		$	17,464			$	43,319				100	%			0	%			100	%			100	%
Distressed			68,310				42,660				68	%			13	%			81	%			55	%
Equity long/short			76,205				—				61	%			36	%			97	%			25	%
Multi-strategy			107,744				—				92	%			50	%			142	%			42	%
Event driven			49,869				—				90	%			52	%			142	%			38	%
Total		$	319,592

	•		Secondary private equity funds: These funds buy limited partnership interests from existing limited partners of primary private equity funds. As owners of private equity funds seek liquidity, they can sell their existing investments, plus any remaining commitment, to secondary market participants. The Company has invested in two secondary private equity funds to purchase those primary limited partnership interests. The fair values of the investments in this class have been estimated using the net asset value per share of the investments. These funds cannot be redeemed because the investments include restrictions that do not allow for redemption until termination of the fund. The remaining restriction period for these funds ranges from seven to eight years.
	•		Distressed funds: In distressed debt investing, managers take positions in the debt of companies experiencing significant financial difficulties, including bankruptcy, or in certain positions of the capital structure of structured securities. The manager relies on the fundamental analysis of these securities, including the claims on the assets and the likely return to bondholders. The fair values of the funds in this class have been estimated using the net asset value per share of the funds. The Company has invested in five distressed funds, four of which (representing approximately 34% of the value of the funds in this class) are not currently eligible for redemption due to imposed lock-up periods with remaining periods ranging from eighteen months to seven years. Funds representing approximately 43% of the value of the funds in this class are currently eligible for quarterly redemption with a 65-day notification period, subject to redemption limitations. Funds representing approximately 23% of the value of the funds in this class are currently eligible for quarterly redemption with a 45-day notification period and redemption fee if redeemed prior to January 2012.
	•		Equity long/short funds: In equity long/short funds, managers take long positions in companies they deem to be undervalued and short positions in companies they deem to be overvalued. Long/short managers may invest in countries, regions or sectors and vary by their use of leverage and target net long position. The fair values of the funds in this class have been estimated using the net asset value per share of the funds. The Company has invested in three equity long/short funds, two of which (representing approximately 69% of the value of the funds in this class) are not currently eligible for redemption due to imposed lock-up periods with remaining periods ranging from two to six months, at which time the funds will be eligible for quarterly redemption with a 60-day notification period. The third fund, representing approximately 31% of the value of the funds in this class, is currently eligible for quarterly redemption with a 30-day notification period or monthly redemption with a 30-day notification period and redemption fee.
	•		Multi-strategy funds: These funds may utilize many strategies employed by specialized funds including distressed investing, equity long/short, merger arbitrage, convertible arbitrage, fixed income arbitrage and macro trading. The fair values of the funds in this class have been estimated using the net asset value per share of the funds. The Company has invested in four multi-strategy funds. Funds representing approximately 24% of the value of the funds in this class currently are not eligible for

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

redemption due to imposed lock-up periods with remaining periods of approximately eight months. Funds representing approximately 29% of the value of the funds in this class are currently eligible for quarterly redemption with a 60-day notification period. Funds representing approximately 23% of the value of the funds in this class are currently eligible for quarterly redemption with a 45-day notification period and redemption fee if redeemed prior to December 2010. Funds representing approximately 24% of the value of the funds in this class are not eligible for redemption due to a seven month lock-up period.

•

Event driven funds: Event driven strategies seek to deploy capital into specific securities whose returns are affected by a specific event that affects the value of one or more securities of a company. Returns for such securities are linked primarily to the specific outcome of the events and not by the overall direction of the bond or stock markets. Examples could include mergers and acquisitions (arbitrage), corporate restructurings and spin-offs and capital structure arbitrage. The fair values of the funds in this class have been estimated using the net asset value per share of the funds. The Company has invested in two event driven funds. Approximately 50% of the value of the funds is not currently eligible for redemption due to an imposed two year lock-up period. The remaining 50% of the value of the funds in this class is currently eligible for quarterly redemption, but is subject to redemption fees and limitations.

     Two of the Company’s hedge funds, a multi-strategy fund and an event driven fund, had long exposure greater than 100% of the funds’ net asset value (indicating explicit leverage of 122% and 120%, respectively as of June 30, 2010). None of the other funds in which the Company invests have used explicit leverage as of June 30, 2010.

     In addition, the Company has committed $50,000 and $25,000 for two new hedge funds, respectively.

e) Net Investment Income

		For the Three Months Ended								For the Six Months Ended
		June 30,								June 30,
		2010				2009				2010				2009
Fixed maturities and other investments		$	67,552			$	76,703			$	138,650			$	155,581
Other invested assets			940				880				1,246				1,487
Cash and cash equivalents			111				561				163				1,187
Expenses			(3,009	)			(1,607	)			(5,563	)			(3,864	)
Net investment income		$	65,594			$	76,537			$	134,496			$	154,391

f) Components of Realized Gains and Losses

     Components of realized gains for the three and six months ended June 30, 2010 and 2009 are summarized in the following table:

		For the Three Months Ended								For the Six Months Ended
		June 30,								June 30,
		2010				2009				2010				2009
Gross realized gains on sale of securities		$	78,572			$	46,618			$	130,239			$	94,272
Gross realized losses on sale of securities			(6,724	)			(49,001	)			(13,130	)			(59,961	)
Treasury yield hedge			(3,958	)			—				(3,958	)			—
Mark-to-market changes: debt securities trading			32,746				(428	)			60,477				(428	)
Mark-to-market changes: hedge funds and equity securities			(5,703	)			7,904			$	(1,208	)			7,812
Net realized investment gains		$	94,933			$	5,093			$	172,420			$	41,695
Proceeds from sale of available for sale securities		$	539,449			$	1,942,811			$	1,846,074			$	5,365,294
Proceeds from sale of trading securities		$	4,081,800			$	10,717			$	5,297,353			$	67,405

     The Company recognized a realized loss of $3,958 related to a U.S. treasury yield hedge transaction that was purchased in May 2010 and terminated in June 2010.

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

g) Pledged Assets

     As of June 30, 2010 and December 31, 2009, $391,355 and $323,681, respectively, of cash and cash equivalents and investments were on deposit with various state or government insurance departments or pledged in favor of ceding companies in order to comply with relevant insurance regulations. In addition, the Company has set up trust accounts to meet security requirements for inter-company reinsurance transactions. These trusts contained assets of $994,455 and $701,843 as of June 30, 2010 and December 31, 2009, respectively, and are included in fixed maturity investments.

     The Company also has facilities available for the issuance of letters of credit collateralized against the Company’s investment portfolio. The collateralized portion of these facilities is up to $1,300,000 as of June 30, 2010 and December 31, 2009. See Note 7 “Debt and Financing Arrangements” for details on the facilities.

     The following table shows the Company’s trust accounts on deposit, as well as outstanding and remaining letters of credit facilities, and the collateral committed to support the letters of credit facilities as of June 30, 2010 and December 31, 2009:

		As of				As of
		June 30,				December 31,
		2010				2009
Total trust accounts on deposit		$	1,385,810			$	1,025,524
Total letters of credit facilities:
Citibank Europe plc			900,000				900,000
Credit Facility			800,000				800,000
Total letters of credit facilities			1,700,000				1,700,000
Total letters of credit facilities outstanding:
Citibank Europe plc			765,241				794,609
Credit Facility			206,452				376,658
Total letters of credit facilities outstanding			971,693				1,171,267
Total letters of credit facilities remaining:
Citibank Europe plc			134,759				105,391
Credit Facility			593,548				423,342
Total letters of credit facilities remaining			728,307				528,733
Collateral committed to support the letter of credit facilities		$	1,223,194			$	1,208,359

     Total trust accounts on deposit includes available for sale securities, trading securities and cash and cash equivalents. The fair values of the combined total cash and cash equivalents and investments held under trust were $2,609,004 and $2,233,883 as of June 30, 2010 and December 31, 2009, respectively. Of the total letters of credit facilities outstanding as of June 30, 2010 and December 31, 2009, $8,025 and $263,297 was used to meet security requirements for inter-company transactions and the remaining letter of credit facilities outstanding of $963,668 and $907,970 was used for third-party ceding companies, respectively. Trust accounts were substituted for inter-company letters of credit during 2010.

h) Analysis of Unrealized Losses

     The Company’s primary investment objective is the preservation of capital. Although the Company has been successful in meeting this objective, shifts in interest rates and credit spreads affecting valuation can temporarily place some investments in an unrealized loss position.

     The following table summarizes the market value of those investments in an unrealized loss position for periods less than and greater than 12 months as of June 30, 2010 and December 31, 2009:

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

		June 30, 2010												December 31, 2009
		Gross Fair				Unrealized								Gross Fair				Unrealized
		Value				Loss				OTTI OCI				Value				Loss				OTTI OCI
Less than 12 months
U.S. Government and Government agencies		$	6,769			$	(3	)		$	—			$	112,349			$	(1,367	)		$	—
Non-U.S. Government and Government agencies			40,871				(4,519	)			—				40,450				(1,079	)			—
States, municipalities and political subdivisions			—				—				—				7,637				(336	)			—
Corporate debt
Financial institutions			15,746				(1,298	)			—				45,697				(560	)			—
Industrials			1,067				(9	)			—				18,409				(184	)			—
Residential mortgage-backed
Non-agency residential			9,615				(568	)			—				82,544				(8,797	)			(1,527	)
Agency residential			3,546				(15	)			—				70,525				(1,057	)			—
Commercial mortgage-backed			128				—				—				56,396				(511	)			—
Asset-backed			14,301				(21	)			—				8,516				(120	)			—
		$	92,043			$	(6,433	)		$	—			$	442,523			$	(14,011	)		$	(1,527	)
More than 12 months
U.S. Government and Government agencies		$	284			$	(5	)		$	—			$	271			$	(22	)		$	—
Non-U.S. Government and Government agencies			2,685			$	(721	)		$	—				3,700				(511	)			—
Corporate debt
Financial institutions			42,685				(1,080	)			—				23,462				(1,191	)			—
Residential mortgage-backed
Non-agency residential			85,978				(6,191	)			(563	)			27,265				(2,720	)			(329	)
Agency residential			959				(52	)			—				214				(38	)			—
Commercial mortgage-backed			—				—				—				149,074				(7,404	)			—
Asset-backed			2,212				(61	)			—				419				(26	)			—
		$	134,803			$	(8,110	)		$	(563	)		$	204,405			$	(11,912	)		$	(329	)
		$	226,846			$	(14,543	)		$	(563	)		$	646,928			$	(25,923	)		$	(1,856	)

     As of June 30, 2010 and December 31, 2009, there were approximately 64 and 159 securities, respectively, in an unrealized loss position. The gross unrealized loss of $14,543 as of June 30, 2010 was primarily the result of widening credit spreads related to increases in market risk premium and reduced market liquidity since the acquisition of these securities. The decrease in the gross unrealized loss from December 31, 2009 to June 30, 2010 is primarily due to selling available for sale debt securities and reinvesting proceeds in trading debt securities thereby reducing unrealized gains/losses recognized in accumulated other comprehensive income.

i) Other-than-temporary impairment charges

     Following the Company’s review of the securities in the investment portfolio during the three and six months ended June 30, 2010, nil and one mortgage-backed security, respectively, was considered to be other-than-temporarily impaired due to the present value of the expected cash flows being lower than the amortized cost. The $168 of OTTI during the six months ended June 30, 2010 was recognized through earnings due to credit related losses.

     For the mortgage-backed security for which OTTI was recognized due to credit loss during the six months ended June 30, 2010, the significant inputs utilized to determine a credit loss were the estimated frequency and severity of losses of the underlying mortgages that comprise the mortgage-backed security. The frequency of losses was measured as the credit default rate, which includes such factors such as loan-to-value ratios and credit scores of borrowers. The severity of losses includes such factors as trends in overall housing prices and house prices that are obtained at foreclosure. The frequency and severity inputs were used in projecting

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

the future cash flows of the mortgage backed security. For the security in which we recognized an OTTI due to credit loss the credit default rate was 10.3% and the severity rate was 49.0%.

     The following table summarizes the amounts related to credit losses on debt securities for which a portion of the OTTI was recognized in other comprehensive income in the consolidated income statements for the three and six months ended June 30, 2010, and the three months ended June 30, 2009:

		For the Three Months				For the Six Months				For the Three Months
		Ended June 30, 2010				Ended June 30, 2010				Ended June 30, 2009
Beginning balance of credit losses		$	1,264			$	1,096			$	7,140
Additions for credit loss for which OTTI was not previously recognized			—				168				3,167
Reductions for securities sold during the period (realized)			—				—				—
Reductions for OTTI previously recognized due to intent to sell			—				—				—
Additions resulting from the increase in credit losses			—				—				2,307
Reductions resulting from the improvement in expected cash flows			—				—				—
Ending balance of credit losses		$	1,264			$	1,264			$	12,614

     Following the Company’s review of the securities in the investment portfolio during the six months ended June 30, 2009, seven securities (six mortgage-backed securities and one corporate bond) were considered to be other-than-temporarily impaired due to the present value of the expected cash flows being lower than the amortized cost. Of the $58,188 recognized as OTTI, $5,474 was recognized through earnings due to credit related losses, $41,963 was recognized through earnings for those securities in an unrealized loss position where the Company’s investment managers had the discretion to sell and $10,751 was recognized in “accumulated other comprehensive income” in the unaudited condensed consolidated balance sheets.

     The Company uses currency forward contracts to manage currency exposure, which are the only derivative instruments used for risk management purposes. The U.S. dollar is the Company’s reporting currency and the functional currency of its operating subsidiaries. The Company enters into insurance and reinsurance contracts where the premiums receivable and losses payable are denominated in currencies other than the U.S. dollar. In addition, the Company maintains a portion of its investments and liabilities in currencies other than the U.S. dollar, primarily the Canadian dollar, Euro and British Sterling. For liabilities incurred in currencies other than U.S. dollars, U.S. dollars are converted to the currency of the loss at the time of claim payment. As a result, the Company has an exposure to foreign currency risk resulting from fluctuations in exchange rates. The Company has developed a hedging strategy using currency forward contracts to minimize the potential loss of value caused by currency fluctuations. These currency forward contracts are not designated as hedges and accordingly are carried at fair value on the consolidated balance sheets as a part of “other assets” or “accounts payable and accrued liabilities,” with the corresponding realized and unrealized gains and losses included in “foreign exchange loss” in the unaudited condensed consolidated statements of operations and comprehensive income. The fair value of our currency forward contracts as of June 30, 2010 and December 31, 2009 was a net payable of $2,216 and $1,650, respectively, and was included in “accounts payable and accrued expenses” in the unaudited condensed consolidated balance sheet.

     In accordance with U.S. GAAP, fair value is defined 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. There is 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

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

			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 fair value hierarchy the fair value measurements are included as of June 30, 2010.

										Fair value measurement using:
										Quoted prices
										in active								Significant
										markets for				Significant other				unobservable
		Carrying				Total fair				identical assets				observable inputs				inputs
		amount				value				(Level 1)				(Level 2)				(Level 3)
Available for sale securities:
U.S. Government and Government agencies		$	211,256			$	211,256			$	145,662			$	65,594			$	—
Non-U.S. Government and Government agencies			140,606				140,606				—				140,606				—
States, municipalities and political subdivisions			160,045				160,045				—				160,045				—
Corporate debt			1,275,202				1,275,202				—				1,275,202				—
Mortgage-backed			900,654				900,654				—				771,490				129,164
Asset-backed			68,171				68,171				—				65,087				3,084
Total available for sale fixed maturity investments			2,755,934				2,755,934
Trading securities:
U.S. Government and Government agencies		$	1,558,731			$	1,558,731			$	1,431,132			$	127,599			$	—
Non-U.S. Government and Government agencies			246,180				246,180				—				246,180				—
States, municipalities and political subdivisions			88,965				88,965				—				88,965				—
Corporate debt			1,116,831				1,116,831				—				1,116,831				—
Mortgage-backed			663,423				663,423				—				513,798				149,625
Asset-backed			601,763				601,763				—				501,292				100,471
Total trading fixed maturity investments			4,275,893				4,275,893
Total fixed maturity investments			7,031,827				7,031,827
Hedge funds			319,592				319,592				—				—				319,592
Equity securities			69,169				69,169				69,169				—				—
Total investments			7,420,588				7,420,588
Senior notes			498,984				547,500				—				547,500				—

     The following describes the valuation techniques used by the Company to determine the fair value of financial instruments held as of June 30, 2010.

     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 the yields for the risk-free yield curve and the spreads for these securities 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 prices obtained from international indices and 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 prices obtained from the new issue market, and are 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, percentage and ratio information)

     Corporate debt: Comprised of bonds issued by corporations that 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 Offered 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 broker-dealers, trade prices and the new issue market. As the significant 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.

     Mortgage-backed: Primarily comprised of pools of residential and commercial mortgages originated by both U.S. government agencies (such as the Federal National Mortgage Association) and non-U.S. government 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 broker-dealers, trade prices and the new issue market. As the significant 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, unless the significant inputs used to price the mortgage-backed securities are broker-dealer quotes and the Company is not able to determine if those quotes are based on observable market inputs, in which case the fair value is included in the Level 3 hierarchy.

     Asset-backed: Principally comprised of bonds backed by pools of automobile loan receivables, home equity loans, credit card receivables and collateralized loan obligations 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 significant 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, unless the significant inputs used to price the asset-backed securities are broker-dealer quotes and the Company is not able to determine if those quotes are based on observable market inputs, in which case the fair value is included in the Level 3 hierarchy.

     Hedge funds: Comprised of hedge funds invested in a range of diversified strategies. In accordance with U.S. GAAP, the fair values of the hedge funds are based on the net asset value of the funds as reported by the fund manager, which is not considered an observable input, and as such, the fair values of those hedge funds are included in the Level 3 fair value hierarchy.

     Equity securities: The fair value of the equity securities are prices from market exchanges and therefore included in the Level 1 fair value hierarchy.

     Senior notes: The fair value of the senior notes is based on trades as reported in Bloomberg, which was 109.5% of their principal amount, providing an effective yield of 5.63% as of June 30, 2010. The fair value of the senior notes is included in the Level 2 fair value hierarchy.

     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, 2010.

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, LTD
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

		Fair value measurement using significant
		unobservable inputs (Level 3):
		Hedge funds				Mortgage-backed				Asset-backed
Three Months Ended June 30, 2010
Opening balance		$	242,135			$	233,667			$	36,532
Total realized and unrealized gains included in net income			1,742				9,703				79
Total realized and unrealized losses included in net income			(2,906	)			(6,987	)			(279	)
Change in unrealized gains included in OCI			—				1,639				9
Change in unrealized losses included in OCI			—				(205	)			—
Purchases			78,621				96,089				28,868
Sales			—				(47,560	)			(2,058	)
Transfers into Level 3			—				2,286				50,641
Transfers out of Level 3			—				(9,843	)			(10,237	)
Ending balance		$	319,592			$	278,789			$	103,555
Three Months Ended June 30, 2009
Opening balance		$	120,708			$	—			$	—
Total gains included in net income:
Realized losses			(824	)			—				—
Change in fair value of investments			5,395				—				—
Purchases or sales			7,281				—				—
Transfers in and/or out of Level 3			—				—				—
Ending balance		$	132,560			$	—			$	—
Six Months Ended June 30, 2010
Opening balance		$	184,725			$	253,979			$	104,871
Total realized and unrealized gains included in net income			6,584				18,084				634
Total realized and unrealized losses included in net income			(3,386	)			(7,098	)			(209	)
Change in unrealized gains included in OCI			—				5,084				51
Change in unrealized losses included in OCI			—				(447	)			(6	)
Purchases			131,669				120,943				51,181
Sales			—				(119,228	)			(5,246	)
Transfers into Level 3			—				48,731				50,739
Transfers out of Level 3			—				(41,259	)			(98,460	)
Ending balance		$	319,592			$	278,789			$	103,555
Six Months Ended June 30, 2009
Opening balance		$	48,573			$	—			$	—
Total gains included in net income:
Realized losses			(2,575	)			—				—
Change in fair value of investments			7,962				—				—
Purchases or sales			78,600				—				—
Transfers in and/or out of Level 3			—				—				—
Ending balance		$	132,560			$	—			$	—