Edgar Filing: Allied World Assurance Co Holdings, AG

Form 10-Q

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, 2012

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

For the transition period from to

Commission file number: 001-32938

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

(Exact Name of Registrant as Specified in Its Charter)

Switzerland

98-0681223

(State or Other Jurisdiction of

Incorporation or Organization)

(I.R.S. Employer

Identification No.)

Lindenstrasse 8

6340 Baar

Zug, Switzerland

(Address of Principal Executive Offices and Zip Code)

41-41-768-1080

(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 ¨

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 ¨

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 ¨	Non-accelerated filer ¨	Smaller reporting company ¨
		(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 ¨ No þ

As of July 30, 2012, 35,773,639 common shares were outstanding.

TABLE OF CONTENTS


PART I FINANCIAL INFORMATION

Item 1.	Financial Statements	1

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	30

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	64

Item 4.	Controls and Procedures	66

PART II

Item 1.	Legal Proceedings	67

Item 1A.	Risk Factors	67

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	67

Item 3.	Defaults Upon Senior Securities	67

Item 4.	Mine Safety Disclosures	67

Item 5.	Other Information	67

Item 6.	Exhibits	68

SIGNATURES		69

EXHIBIT INDEX

-i-

PART I

FINANCIAL INFORMATION

Item 1. Financial Statements.

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

as of June 30, 2012 and December 31, 2011

(Expressed in thousands of United States dollars, except share and per share amounts)


	As of June 30, 2012			As of December 31, 2011
ASSETS:
Fixed maturity investments available for sale, at fair value (amortized cost: 2012: $28,038; 2011: $226,397)	$	30,214		$	244,016
Fixed maturity investments trading, at fair value (amortized cost: 2012: $6,705,210; 2011: $6,207,991)		6,796,109			6,254,686
Equity securities trading, at fair value (cost: 2012: $419,366; 2011: $356,370)		454,205			367,483
Other invested assets trading, at fair value		520,890			540,409

Total investments		7,801,418			7,406,594
Cash and cash equivalents		864,450			633,996
Restricted cash		239,376			82,608
Insurance balances receivable		845,663			652,158
Prepaid reinsurance		259,289			226,721
Reinsurance recoverable		1,073,612			1,002,919
Accrued investment income		30,117			38,263
Net deferred acquisition costs		129,818			100,334
Goodwill		268,376			268,376
Intangible assets		52,631			53,898
Balances receivable on sale of investments		635,727			580,443
Net deferred tax assets		28,477			22,646
Other assets		48,697			53,202

Total assets	$	12,277,651		$	11,122,158

LIABILITIES:
Reserve for losses and loss expenses	$	5,377,518		$	5,225,143
Unearned premiums		1,363,006			1,078,412
Reinsurance balances payable		128,306			124,539
Balances due on purchases of investments		1,220,246			616,728
Senior notes		798,080			797,949
Dividends payable		—			14,302
Accounts payable and accrued liabilities		106,594			116,063

Total liabilities	$	8,993,750		$	7,973,136

SHAREHOLDERS’ EQUITY:
Common shares: 2012: par value CHF 13.69 per share and 2011: par value CHF 14.03 per share (2012: 40,003,642; 2011: 40,003,642 shares issued and 2012: 35,942,964; 2011: 37,742,131 shares outstanding)		543,452			557,153
Additional paid-in capital		52,815			78,225
Treasury shares, at cost (2012: 4,060,678; 2011: 2,261,511)		(264,037	)		(136,590	)
Retained earnings		2,950,257			2,635,750
Accumulated other comprehensive income: net unrealized gains on investments, net of tax		1,414			14,484

Total shareholders’ equity		3,283,901			3,149,022

Total liabilities and shareholders’ equity	$	12,277,651		$	11,122,158

See accompanying notes to the consolidated financial statements.

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE INCOME

for the three and six months ended June 30, 2012 and 2011

(Expressed in thousands of United States dollars, except share and per share amounts)


	Three Months Ended June 30,						Six Months Ended June 30,
	2012			2011			2012			2011
REVENUES:
Gross premiums written	$	646,870		$	519,598		$	1,327,799		$	1,080,286
Premiums ceded		(152,160	)		(123,795	)		(244,136	)		(203,612	)

Net premiums written		494,710			395,803			1,083,663			876,674
Change in unearned premiums		(64,963	)		(40,496	)		(252,026	)		(186,491	)

Net premiums earned		429,747			355,307			831,637			690,183
Net investment income		42,451			52,368			89,660			102,576
Net realized investment gains		8,663			58,878			142,244			109,254

		480,861			466,553			1,063,541			902,013

EXPENSES:
Net losses and loss expenses		240,380			235,813			465,582			540,265
Acquisition costs		51,588			42,971			98,726			81,053
General and administrative expenses		73,979			67,201			144,345			135,157
Amortization and impairment of intangible assets		634			766			1,267			1,533
Interest expense		14,001			13,745			27,757			27,487
Foreign exchange (gain) loss		(1,019	)		1,184			(1,100	)		742

		379,563			361,680			736,577			786,237

Income before income taxes		101,298			104,873			326,964			115,776
Income tax expense		4,947			11,073			12,457			13,356

NET INCOME		96,351			93,800			314,507			102,420

Other comprehensive loss:
Unrealized gains on investments arising during the period net of applicable deferred income tax (benefit) expense for the three months ended June 30, 2012: ($68); 2011:$1,461 and six months ended June 30, 2012:($96); 2011: $2,425		231			13,680			179			5,636
Reclassification adjustment for net realized investment gains included in net income, net of applicable income tax		(1,142	)		(23,548	)		(13,249	)		(39,676	)

Other comprehensive loss		(911	)		(9,868	)		(13,070	)		(34,040	)

COMPREHENSIVE INCOME	$	95,440		$	83,932		$	301,437		$	68,380

PER SHARE DATA
Basic earnings per share	$	2.66		$	2.45		$	8.56		$	2.69
Diluted earnings per share	$	2.59		$	2.36		$	8.41		$	2.57
Weighted average common shares outstanding		36,288,596			38,346,489			36,746,881			38,061,724
Weighted average common shares and common share equivalents outstanding		37,189,722			39,800,753			37,395,559			39,873,418
Dividends paid per share	$	0.375		$	—		$	0.750		$	—

See accompanying notes to the consolidated financial statements.

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

for the six months ended June 30, 2012 and 2011

(Expressed in thousands of United States dollars)


	Share Capital			Additional Paid-in Capital			Treasury Shares			Accumulated Other Comprehensive Income			Retained Earnings		Total
December 31, 2011	$	557,153		$	78,225		$	(136,590	)	$	14,484		$	2,635,750	$	3,149,022
Net income		—			—			—			—			314,507		314,507
Dividends — par value reduction		(13,701	)		—			—			—			—		(13,701	)
Other comprehensive loss		—			—			—			(13,070	)		—		(13,070	)
Stock compensation		—			(25,410	)		32,011			—			—		6,601
Share repurchases		—			—			(159,458	)		—			—		(159,458	)

June 30, 2012	$	543,452		$	52,815		$	(264,037	)	$	1,414		$	2,950,257	$	3,283,901


December 31, 2010	$	600,055		$	170,239		$	(112,811	)	$	57,135		$	2,361,202	$	3,075,820
Net income		—			—			—			—			102,420		102,420
Other comprehensive loss		—			—			—			(34,040	)		—		(34,040	)
Stock compensation		—			(34,582	)		48,419			—			—		13,837
Share repurchase		—			—			(60,000	)		—			—		(60,000	)
Repurchase of founder warrants		—			(53,620	)		—			—			—		(53,620	)

June 30, 2011	$	600,055		$	82,037		$	(124,392	)	$	23,095		$	2,463,622	$	3,044,417

See accompanying notes to the consolidated financial statements.

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

for the six months ended June 30, 2012 and 2011

(Expressed in thousands of United States dollars)


	Six Months Ended June 30,
	2012			2011
CASH FLOWS PROVIDED BY OPERATING ACTIVITIES:
Net income	$	314,507		$	102,420
Adjustments to reconcile net income to cash provided by operating activities:
Net realized gains on sales of investments		(46,834	)		(52,906	)
Mark to market adjustments		(94,732	)		(77,318	)
Stock compensation expense		9,294			12,112
Changes in:
Reserve for losses and loss expenses, net of reinsurance recoverables		81,682			285,753
Unearned premiums, net of prepaid reinsurance		252,026			186,491
Insurance balances receivable		(193,505	)		(123,075	)
Reinsurance balances payable		3,767			32,929
Net deferred acquisition costs		(29,484	)		(15,280	)
Net deferred tax assets		(3,458	)		2,339
Accounts payable and accrued liabilities		(19,978	)		(18,629	)
Other items, net		28,488			27,010

Net cash provided by operating activities		301,773			361,846

CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES:
Purchases of available for sale securities		—			(352	)
Purchases of trading securities		(4,005,352	)		(4,194,787	)
Purchases of other invested assets		(17,778	)		(240,410	)
Sales of available for sale securities		214,015			560,794
Sales of trading securities		3,959,204			3,540,053
Sales of other invested assets		108,759			36,067
Purchases of fixed assets		(879	)		(2,316	)
Change in restricted cash		(156,768	)		29,520

Net cash provided by (used in) investing activities		101,201			(271,431	)

CASH FLOWS USED IN FINANCING ACTIVITIES:
Dividends paid — partial par value reduction		(28,003	)		—
Proceeds from the exercise of stock options		6,697			4,824
Share repurchases		(148,949	)		(60,000	)
Repurchase of founder warrants		—			(53,620	)

Net cash used in financing activities		(170,255	)		(108,796	)

Effect of exchange rate changes on foreign currency cash		(2,265	)		2,190
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		230,454			(16,191	)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD		633,996			756,995

CASH AND CASH EQUIVALENTS, END OF PERIOD	$	864,450		$	740,804

Supplemental disclosure of cash flow information:
— Cash paid for income taxes	$	8,257		$	433
— Cash paid for interest expense	$	27,000		$	27,000

See accompanying notes to the consolidated financial statements.

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

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, AG, a Swiss holding company (“Allied World Switzerland”), 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 the Company 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, and

•

Valuation of financial instruments.

Intercompany accounts and transactions have been eliminated on consolidation and all entities meeting consolidation requirements have been included in the consolidation.

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, 2011.

3. NEW ACCOUNTING PRONOUNCEMENTS

In October 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2010-26, “Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts” (“ASU 2010-26”). ASU 2010-26 clarifies what costs associated with acquiring or renewing insurance contracts can be deferred and amortized over the coverage period. Under the revised guidance of ASU 2010-26, incremental direct costs that result directly from and are essential to the insurance contract and would not have been incurred had the insurance contract not been written are costs that may be capitalized, including costs relating to activities specifically performed by the Company such as underwriting, policy issuance and processing. The Company adopted ASU 2010-26 retrospectively on January 1, 2012. The adoption of ASU 2010-26 did not have an impact on consolidated shareholders’ equity or net income as the Company had not previously capitalized costs that did not meet the requirement for capitalization of the revised standard.

In May 2011, the FASB issued ASU 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs” (“ASU 2011-04”). ASU 2011-04 provides a consistent meaning for the term “fair value” between the FASB and International Accounting Standards Board and establishes common requirements for measuring and disclosing information related thereto. The Company adopted ASU 2011-04 prospectively on January 1, 2012. The adoption of ASU 2011-04

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

did not have an impact on consolidated shareholders’ equity or net income or the Company’s fair value measurements. Refer to Note 6 for the Company’s related disclosures.

In June 2011, the FASB issued ASU 2011-05, “Presentation of Comprehensive Income” (“ASU 2011-05”). ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in shareholders’ equity, requires consecutive presentation of the statement of net income and other comprehensive income, and requires the presentation of reclassification adjustments on the face of the financial statements from other comprehensive income to net income. In December 2011, ASU 2011-05 was updated by ASU 2011-12, “Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05” (“ASU 2011-12”) to defer the presentation requirements of reclassification adjustments required by ASU 2011-05. The Company adopted ASU 2011-05 on January 1, 2012. The adoption of ASU 2011-05 and the related updates from ASU 2011-12 did not have an impact on the presentation of the financial statements.

In September 2011, the FASB issued ASU 2011-08, “Testing Goodwill for Impairment” (“ASU 2011-08”). ASU 2011-08 simplifies how goodwill is tested for impairment by permitting entities to assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. The results of the qualitative assessment will determine if an entity needs to proceed with the two-step goodwill impairment test. ASU 2011-08 is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. The Company adopted ASU 2011-08 on January 1, 2012. The adoption of ASU 2011-08 did not have an impact on consolidated shareholders’ equity or net income.

4. INVESTMENTS

a) Available for Sale Securities

The amortized cost, gross unrealized gains, gross unrealized losses and fair value of the Company’s available for sale investments by category are as follows:


	Amortized Cost		Unrealized Gains		Unrealized Losses			Fair Value
June 30, 2012
U.S. Government and Government agencies	$	28,038	$	2,176	$	—		$	30,214

Total fixed maturity investments, available for sale	$	28,038	$	2,176	$	—		$	30,214

December 31, 2011
U.S. Government and Government agencies	$	31,309	$	2,321	$	—		$	33,630
States, municipalities and political subdivisions		29,128		4,351		—			33,479
Corporate debt:
Financial institutions		17,431		348		(292	)		17,487
Industrials		73,539		4,268		—			77,807
Utilities		74,990		6,623		—			81,613

Total fixed maturity investments, available for sale	$	226,397	$	17,911	$	(292	)	$	244,016

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

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 unaudited condensed consolidated statements of operations and comprehensive income (loss) (“consolidated income statements”) by category are as follows:


	June 30, 2012				December 31, 2011
	Fair Value		Amortized Cost		Fair Value		Amortized Cost
U.S. Government and Government agencies	$	1,715,141	$	1,701,706	$	1,278,265	$	1,263,948
Non-U.S. Government and Government agencies		315,493		309,350		256,756		251,784
States, municipalities and political subdivisions		39,741		38,584		133,902		128,633
Corporate debt:
Financial institutions		961,728		946,999		1,161,904		1,174,308
Industrials		1,019,043		1,013,026		987,006		974,731
Utilities		58,173		56,718		105,564		103,262
Residential mortgage-backed:
Non-agency residential		298,355		283,739		302,827		314,077
Agency residential		1,710,596		1,686,022		1,183,893		1,156,913
Commercial mortgage-backed		260,420		252,193		331,371		326,697
Asset-backed		417,419		416,873		513,198		513,638

Total fixed maturity investments, trading	$	6,796,109	$	6,705,210	$	6,254,686	$	6,207,991


	June 30, 2012				December 31, 2011
	Fair Value		Original Cost		Fair Value		Original Cost
Equity securities	$	454,205	$	419,366	$	367,483	$	356,370
Other invested assets⁽¹⁾		520,890		487,938		540,409		529,851

	$	975,095	$	907,304	$	907,892	$	886,221

(1)	Within the Company’s financial statements and footnotes “other invested assets” include the Company’s investments in both hedge funds and private equity funds.

c) Contractual Maturity Dates

The contractual maturity dates of available for sale fixed maturity investments are as follows:


	June 30, 2012
	Amortized Cost		Fair Value
Due within one year	$	7,001	$	7,056
Due after one year through five years		16,958		18,111
Due after five years through ten years		1,077		1,180
Due after ten years		3,002		3,867

	$	28,038	$	30,214

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

Included in other invested assets are the Company’s hedge fund and private equity investments. As of the balance sheet date, the Company held interests in 22 funds with a total fair value of $520,890, which comprised 5.8% of the total fair value of its investments and cash and cash equivalents. The fair values of these assets have been estimated using the net asset value per share of the funds.

In general, the Company has invested in hedge funds that require at least 30 days’ notice of redemption, and may be redeemed on a monthly, quarterly, semi-annual, annual or longer basis, depending on the fund. Certain hedge funds have lock-up periods ranging from 1 to 3 years from initial investment. A lock-up period refers to the initial amount of time an investor is contractually required to invest before having the ability to redeem. Funds that provide for periodic redemptions may, depending on the funds’ governing documents, have the ability to deny or delay a redemption request, called a “gate.” The fund may implement this restriction because the aggregate amount of redemption requests as of a particular date exceeds a specified level, generally ranging from 15% to 25% of the fund’s net assets. The gate is a method for executing an orderly redemption process that allows for redemption requests to be

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

executed in a timely manner to reduce the possibility of adversely affecting the remaining investors in the fund. Typically, the imposition of a gate delays a portion of the requested redemption, with the remaining portion settled in cash sometime after the redemption date. Certain funds may impose a redemption fee on early redemptions. Interests in private equity funds cannot be redeemed because the investments include restrictions that do not allow for redemption until termination of the fund.

Details regarding the redemption characteristics of the other invested assets portfolio as of June 30, 2012 were as follows:


Fund Type	Fair Value as of June 30, 2012		Investments with Redemption Restrictions		Estimated Remaining Restriction Period		Investments without Redemption Restrictions		Redemption Frequency⁽¹⁾		Redemption Notice Period⁽¹⁾		Unfunded Commitments
Private equity (primary and secondary)	$	78,199	$	78,199		4 - 10 Years	$	—					$	167,013
Mezzanine debt		21,756		21,756		10 Years		—						94,022
Distressed		9,559		9,559		<6 Years		—						8,699

Total private equity		109,514		109,514				—						269,734

Distressed		41,131		1,042		<2 Years		40,089		Quarterly		45 - 65 Days		—
Equity long/short		165,482		—				165,482		Quarterly		30 - 60 Days		—
Multi-strategy		136,160		25,830		<2 Years		110,330		Quarterly		45 - 90 Days		—
Event driven		68,603		—				68,603		Annual		45 - 60 Days		—

Total hedge funds		411,376		26,872				384,504						—

Total other invested assets	$	520,890	$	136,386			$	384,504					$	269,734

(1)	The redemption frequency and notice periods only apply to the investments without redemption restrictions.

•

Private equity funds: Primary funds may invest in companies and general partnership interests. Secondary 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. These funds cannot be redeemed because the investments include restrictions that do not allow for redemption until termination of the fund.

•

Mezzanine debt funds: Mezzanine debt funds invest primarily in privately negotiated mezzanine investments. The funds’ strategies will focus primarily on providing capital to upper middle market and middle market companies, and private equity sponsors, in connection with leveraged buyouts, mergers and acquisitions, recapitalizations, growth financings and other corporate transactions. The most common position in the capital structure will be between the senior secured debt holder and the equity; however, the funds will utilize a flexible approach when structuring investments, which may include secured debt, subordinated debt, preferred stock and/or private equity. These funds cannot be redeemed because the investments include restrictions that do not allow for redemption until termination of the fund.

•

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. Certain funds cannot be redeemed because the investments include restrictions that do not allow for redemption until termination of the fund.

•

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.

•

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.

•

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.

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

e) Net Investment Income


	Three Months Ended June 30,						Six Months Ended June 30,
	2012			2011			2012			2011
Fixed maturity investments	$	37,219		$	50,648		$	84,105		$	101,594
Equity securities and other invested assets		8,644			5,015			12,718			7,211
Cash and cash equivalents		550			127			1,157			445
Expenses		(3,962	)		(3,422	)		(8,320	)		(6,674	)

Net investment income	$	42,451		$	52,368		$	89,660		$	102,576

f) Components of Realized Gains and Losses


	Three Months Ended June 30,						Six Months Ended June 30,
	2012			2011			2012			2011
Gross realized gains on sale of invested assets	$	52,775		$	34,611		$	91,944		$	78,168
Gross realized losses on sale of invested assets		(14,762	)		(3,330	)		(36,669	)		(25,262	)
Net realized and unrealized (losses) gains on derivatives		(5,914	)		(10,040	)		770			(15,536	)
Mark-to-market changes:
Debt securities, trading		(24,287	)		31,872			44,203			45,336
Other invested assets and equity securities		851			5,765			41,996			26,548

Net realized investment gains	$	8,663		$	58,878		$	142,244		$	109,254

Proceeds from sale of available for sale securities	$	14,308		$	202,671		$	213,716		$	546,191

g) Pledged Assets

As of June 30, 2012 and December 31, 2011, $2,161,733 and $2,029,138, respectively, of cash and cash equivalents and investments were deposited, pledged or held in trust accounts in favor of ceding companies and other counterparties or government authorities to comply with reinsurance contract provisions and insurance laws.

In addition, as of June 30, 2012 and December 31, 2011, a further $1,270,757 and $1,044,236, respectively, of cash and cash equivalents and investments were pledged as collateral for the Company’s letter of credit facility. See Note 11 to these Condensed Consolidated Financial Statements and Note 9 to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 for details on the credit facility.

h) Analysis of Unrealized Losses

The following table summarizes the market value of those available for sale investments in an unrealized loss position for periods less than and greater than 12 months:


	June 30, 2012				December 31, 2011
	Gross Fair Value		Unrealized Loss		Gross Fair Value		Unrealized Loss
Less than 12 months
Corporate debt:
Financial institutions	$	—	$	—	$	9,440	$	(292	)

Total fixed maturity investments, available for sale	$	—	$	—	$	9,440	$	(292	)

As of June 30, 2012 and December 31, 2011, there were nil and three securities, respectively, in an unrealized loss position.

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

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, 2012 and 2011, no securities were considered to be other-than-temporarily impaired.

5. DERIVATIVE INSTRUMENTS

As of June 30, 2012 and December 31, 2011, none of the Company’s derivatives were designated as hedges. The following table summarizes information on the location and amounts of derivative fair values in the unaudited condensed consolidated balance sheets (“consolidated balance sheets”):


	June 30, 2012								December 31, 2011
	Asset Derivative Notional Amount		Asset Derivative Fair Value		Liability Derivative Notional Amount		Liability Derivative Fair Value		Asset Derivative Notional Amount		Asset Derivative Fair Value		Liability Derivative Notional Amount		Liability Derivative Fair Value
Derivatives not designated as hedging instruments
Put options⁽¹⁾	$	—	$	—	$	—	$	—	$	4,461	$	336	$	—	$	—
Foreign exchange contracts⁽²⁾		113,828		1,964		217,588		4,317		91,162		2,030		339,533		8,934
Interest rate futures⁽²⁾		197,000		943		216,700		265		680,650		977		292,000		3,467

Total derivatives	$	310,828	$	2,907	$	434,288	$	4,582	$	776,273	$	3,343	$	631,533	$	12,401

(1)	Asset and liability derivatives relating to the put options are classified within “equity securities trading, at fair value” on the consolidated balance sheets.

(2)	All other asset and liability derivatives are classified within “other assets” or “accounts payable and accrued liabilities” on the consolidated balance sheets.

The following table provides the net realized and unrealized gains (losses) on derivatives not designated as hedges recorded in the consolidated income statements:


	Three months ended June 30,						Six months ended June 30,
	2012			2011			2012			2011
Foreign exchange contracts	$	(359	)	$	1,345		$	580		$	2,601

Total included in foreign exchange (loss) gain		(359	)		1,345			580			2,601

Put options		—			—			(336	)		—
Foreign exchange contracts		4,415			723			2,110			723
Interest rate futures		(10,329	)		(10,763	)		(1,004	)		(16,259	)

Total included in net realized investment gains		(5,914	)		(10,040	)		770			(15,536	)

Total realized and unrealized (losses) gains on derivatives	$	(6,273	)	$	(8,695	)	$	1,350		$	(12,935	)

Derivative Instruments Not Designated as Hedging Instruments

The Company is exposed to foreign currency risk in its investment portfolio. Accordingly, the fair values of the Company’s investment portfolio are partially influenced by the change in foreign exchange rates. The Company entered into foreign currency forward contracts to manage the effect of this foreign currency risk. These foreign currency hedging activities have not been designated as specific hedges for financial reporting purposes.

The Company’s insurance and reinsurance subsidiaries and branches operate in various foreign countries and consequently the Company’s underwriting portfolio is exposed to foreign currency risk. The Company manages foreign currency risk by seeking to match liabilities under the insurance policies and reinsurance contracts that it writes and that are payable in foreign currencies with

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

cash and investments that are denominated in such currencies. When necessary, the Company may also use derivatives to economically hedge un-matched foreign currency exposures, specifically forward contracts and currency options.

The Company also purchases and sells interest rate future contracts to actively manage the duration and yield curve positioning of its fixed income portfolio. Interest rate futures can efficiently increase or decrease the overall duration of the portfolio. Additionally, interest rate future contracts can be utilized to obtain the desired position along the yield curve in order to protect against certain future yield curve shapes.

The Company purchases options to actively manage the Company’s equity portfolio.

6. FAIR VALUE OF FINANCIAL INSTRUMENTS

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 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 the dates indicated below:

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

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:
June 30, 2012	Carrying amount		Total fair value		Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)
Available for sale securities:
U.S. Government and Government agencies	$	30,214	$	30,214	$	30,214	$	—	$	—

Total available for sale fixed maturity investments		30,214		30,214

Trading securities:
U.S. Government and Government agencies	$	1,715,141	$	1,715,141	$	1,231,823	$	483,318	$	—
Non-U.S. Government and Government agencies		315,493		315,493		—		315,493		—
States, municipalities and political subdivisions		39,741		39,741		—		39,741		—
Corporate debt		2,038,944		2,038,944		—		2,038,944		—
Mortgage-backed		2,269,371		2,269,371		—		2,111,412		157,959
Asset-backed		417,419		417,419		—		299,833		117,586

Total trading fixed maturity investments		6,796,109		6,796,109

Total fixed maturity investments		6,826,323		6,826,323

Equity securities		454,205		454,205		454,205		—		—
Other invested assets		520,890		520,890		—		—		520,890

Total investments	$	7,801,418	$	7,801,418	$	1,716,242	$	5,288,741	$	796,435

Derivative assets: ⁽¹⁾
Foreign exchange contracts	$	1,964	$	1,964	$	—	$	1,964	$	—
Interest rate futures		943		943		—		943		—

Derivative liabilities: ⁽¹⁾
Foreign exchange contracts	$	4,317	$	4,317	$	—	$	4,317	$	—
Interest rate futures		265		265		—		265		—

Senior notes	$	798,080	$	890,373	$	—	$	890,373	$	—

(1)	Asset and liability derivatives relating to foreign exchange contracts and interest rate futures are classified within “other assets” or “accounts payable and accrued liabilities” on the consolidated balance sheets.

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

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:
December 31, 2011	Carrying amount		Total fair value		Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)
Available for sale securities:
U.S. Government and Government agencies	$	33,630	$	33,630	$	33,630	$	—	$	—
States, municipalities and political subdivisions		33,479		33,479		—		33,479		—
Corporate debt		176,907		176,907		—		176,907		—

Total available for sale fixed maturity investments		244,016		244,016

Trading securities:
U.S. Government and Government agencies	$	1,278,265	$	1,278,265	$	1,054,003	$	224,262	$	—
Non-U.S. Government and Government agencies		256,756		256,756		—		256,756		—
States, municipalities and political subdivisions		133,902		133,902		—		133,902		—
Corporate debt		2,254,474		2,254,474		—		2,254,474		—
Mortgage-backed		1,818,091		1,818,091		—		1,568,887		249,204
Asset-backed		513,198		513,198		—		418,453		94,745

Total trading fixed maturity investments		6,254,686		6,254,686

Total fixed maturity investments		6,498,702		6,498,702

Equity securities		367,483		367,483		367,483		—		—
Other invested assets		540,409		540,409		—		—		540,409

Total investments	$	7,406,594	$	7,406,594	$	1,455,116	$	5,067,120	$	884,358

Derivative assets: ⁽¹⁾
Foreign exchange contracts	$	2,030	$	2,030	$	—	$	2,030	$	—
Interest rate futures		977		977		—		977		—

Derivative liabilities: ⁽¹⁾
Foreign exchange contracts	$	8,934	$	8,934	$	—	$	8,934	$	—
Interest rate futures		3,467		3,467		—		3,467		—

Senior notes	$	797,949	$	872,731	$	—	$	872,731	$	—

(1)	Asset and liability derivatives relating to foreign exchange contracts and interest rate futures are classified within “other assets” or “accounts payable and accrued liabilities” on the consolidated balance sheets.

The following describes the valuation techniques used by the Company to determine the fair value of financial instruments held as of the balance sheet date.

U.S. Government and 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, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

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.

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 residential and commercial mortgages originated by both U.S. government agencies (such as the Federal National Mortgage Association) and non-U.S. government agencies. 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 or broker-dealer quotes. 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.

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

Other invested assets: Comprised of funds invested in a range of diversified strategies. In accordance with U.S. GAAP, the fair values of the funds are based on the net asset value of the funds as reported by the fund manager that the Company believes is an unobservable input, and as such, the fair values of those funds are included in the Level 3 fair value hierarchy.

Derivative instruments: The fair value of foreign exchange contracts and interest rate futures are priced from quoted market prices for similar exchange-traded derivatives and pricing valuation models that utilize independent market data inputs. The fair value of derivatives are included in the Level 2 fair value hierarchy.

Senior notes: The fair value of the senior notes is based on reported trades. As of June 30, 2012, the 7.50% Senior Notes and 5.50% Senior Notes (each as defined in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011) were traded at 114.6% and 105.8% of their principal amount, providing an effective yield of 3.6% and 4.7%, respectively. The fair value of the senior notes is included in the Level 2 fair value hierarchy.

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

The following is a reconciliation of the beginning and ending balance of financial instruments using significant unobservable inputs (Level 3):


	Fair value measurement using significant unobservable inputs (Level 3):
	Other invested assets			Mortgage-backed			Asset-backed
Three Months Ended June 30, 2012
Opening balance	$	522,065		$	178,374		$	242,394
Realized and unrealized gains (losses) included in net income		(641	)		1,780			(220	)
Purchases		16,728			40,352			23,267
Sales		(17,262	)		(34,755	)		(47,537	)
Transfers into Level 3 from Level 2		—			3,707			8,654
Transfers out of Level 3 into Level 2⁽¹⁾		—			(31,499	)		(108,972	)

Ending balance	$	520,890		$	157,959		$	117,586

Three Months Ended June 30, 2011
Opening balance	$	469,999		$	234,087		$	143,829
Realized and unrealized gains included in net income		814			1,680			494
Purchases		94,290			29,827			32,408
Sales		(2,836	)		(34,329	)		(2,800	)
Transfers into Level 3 from Level 2		—			24,389			20,246
Transfers out of Level 3 into Level 2⁽¹⁾		—			(38,994	)		(80,867	)

Ending balance	$	562,267		$	216,660		$	113,310


	Fair value measurement using significant unobservable inputs (Level 3):
	Other invested assets			Mortgage-backed			Asset-backed
Six Months Ended June 30, 2012
Opening balance	$	540,409		$	249,204		$	94,745
Realized and unrealized gains included in net income		14,882			4,324			904
Purchases		17,778			41,376			31,580
Sales		(52,179	)		(108,165	)		(48,133	)
Transfers into Level 3 from Level 2		—			4,495			55,498
Transfers out of Level 3 into Level 2 ⁽¹⁾		—			(33,275	)		(17,008	)

Ending balance	$	520,890		$	157,959		$	117,586

Six Months Ended June 30, 2011
Opening balance	$	347,632		$	172,558		$	48,707
Realized and unrealized gains included in net income		12,493			3,227			587
Purchases		245,340			62,604			115,417
Sales		(43,198	)		(43,287	)		(3,226	)
Transfers into Level 3 from Level 2		—			86,085			32,801
Transfers out of Level 3 into Level 2 ⁽¹⁾		—			(64,527	)		(80,976	)

Ending balance	$	562,267		$	216,660		$	113,310

(1)	Transfers out of Level 3 are primarily attributable to the availability of market observable information.

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

The Company attempts to verify the significant inputs used by broker-dealers in determining the fair value of the securities priced by them. If the Company could not obtain sufficient information to determine if the broker-dealers were using significant observable inputs, such securities have been transferred to the Level 3 fair value hierarchy. The Company believes the prices obtained from the broker-dealers are the best estimate of fair value of the securities being priced as the broker-dealers are typically involved in the initial pricing of the security, and the Company has compared the price per the broker-dealer to other pricing sources and noted no material differences. The Company recognizes transfers between levels at the end of the reporting period. There were no transfers between Level 1 and Level 2 during the period.

The Company’s external investment accounting service provider receives prices from internationally recognized independent pricing services to measure the fair values of its fixed maturity investments. Pricing sources are evaluated and selected in a manner to ensure that the most reliable sources are used. The independent pricing sources obtain market quotations and actual transaction prices for securities that have quoted prices in active markets. Each pricing service has its own proprietary method for determining the fair value of securities that are not actively traded. In general, these methods involve the use of “matrix pricing” in which the independent pricing service uses observable market inputs, including, but not limited to, reported trades, benchmark yields, broker-dealer quotes, interest rates, prepayment speeds, default rates and such other inputs as are available from market sources to determine a reasonable fair value.

All of the Company’s securities classified as Level 3, other than investments in other invested assets, are valued based on unadjusted broker-dealer quotes. This includes less liquid securities such as lower quality asset-backed securities, commercial mortgage-backed securities, and residential mortgage-backed securities. The primary valuation inputs include monthly payment information, the probability of default, loss severity rates and estimated prepayment rates. Significant changes in these inputs in isolation would result in a significantly lower or higher fair value measurement. In general, a change in the assumption of the probability of default is accompanied by a directionally similar change in the assumption used for the loss severity in an event of default and prepayment rates.

The Company records the unadjusted price provided and validates this price through a process that, includes, but is not limited to monthly and/or quarterly: (i) comparison of prices between two independent sources, with significant differences requiring additional price sources; (ii) quantitative analysis (e.g., comparing the quarterly return for each managed portfolio to their target benchmark, with significant differences identified and investigated); (iii) evaluation of methodologies used by external parties to calculate fair value, including a review of the inputs used for pricing; (iv) comparing the price to the Company’s knowledge of the current investment market; and (v) back-testing, which includes randomly selecting purchased or sold securities and comparing the executed prices to the fair value estimates from the pricing service. In addition to internal controls, management relies on the effectiveness of the valuation controls in place at the Company’s external investment accounting service provider (supported by a Statement on Standards for Attestation Engagements No. 16 report) in conjunction with regular discussion and analysis of the investment portfolio’s structure and performance.

7. RESERVE FOR LOSSES AND LOSS EXPENSES

The reserve for losses and loss expenses consists of the following:


	June 30, 2012		December 31, 2011
Outstanding loss reserves	$	1,431,802	$	1,366,466
Reserves for losses incurred but not reported		3,945,716		3,858,677

Reserve for losses and loss expenses	$	5,377,518	$	5,225,143

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

The table below is a reconciliation of the beginning and ending liability for unpaid losses and loss expenses. Losses incurred and paid are reflected net of reinsurance recoverables.


	Three Months Ended June 30,						Six Months Ended June 30,
	2012			2011			2012			2011
Gross liability at beginning of period	$	5,331,418		$	5,100,643		$	5,225,143		$	4,879,188
Reinsurance recoverable at beginning of period		(1,056,780	)		(975,523	)		(1,002,919	)		(927,588	)

Net liability at beginning of period		4,274,638			4,125,120			4,222,224			3,951,600

Net losses incurred related to:
Commutation of variable-rated reinsurance contracts		—			11,529			—			11,529
Current year		282,302			279,513			546,986			628,315
Prior years		(41,922	)		(55,229	)		(81,404	)		(99,579	)

Total incurred		240,380			235,813			465,582			540,265

Net paid losses related to:
Current year		18,226			19,579			19,840			21,279
Prior years		186,891			109,238			362,411			243,596

Total paid		205,117			128,817			382,251			264,875

Foreign exchange revaluation		(5,995	)		5,237			(1,649	)		10,363

Net liability at end of period		4,303,906			4,237,353			4,303,906			4,237,353
Reinsurance recoverable at end of period		1,073,612			1,013,951			1,073,612			1,013,951

Gross liability at end of period	$	5,377,518		$	5,251,304		$	5,377,518		$	5,251,304

For the three months ended June 30, 2012, the Company had net favorable reserve development in each of its segments due to actual loss emergence being lower than initially expected. The majority of the net favorable reserve development was recognized by each segment in the 2004 through 2009 loss years across most lines of business.

For the six months ended June 30, 2012, the Company had net favorable reserve development in each of its segments due to actual loss emergence being lower than initially expected. The majority of the net favorable reserve development was recognized in the international insurance and reinsurance segments in the 2004 through 2008 loss years.

During the three and six months ended June 30, 2011, the Company commuted certain variable-rated reinsurance contracts that have swing-rated provisions, reducing ceded losses by $11,529 in accordance with the terms of the contracts resulting in a net gain of $865.

For the three months ended June 30, 2011, the Company had net favorable reserve development in each of its segments due to actual loss emergence being lower than initially expected. The majority of the net favorable reserve development was recognized in the reinsurance segment related to the 2004 through 2007 loss years for casualty reinsurance lines and in the international insurance segment related to the 2004 through 2007 loss years for casualty lines of business.

For the six months ended June 30, 2011, the Company had net favorable reserve development in its international and reinsurance segments due to actual loss emergence being lower than initially expected. The majority of the net favorable reserve development was recognized in the international insurance and reinsurance segments in the 2004 through 2007 loss years related to casualty insurance and reinsurance lines of business. The Company had net unfavorable reserve development in its U.S. insurance segment due to actual loss emergence being higher than initially expected. The majority of the net unfavorable reserve development was recognized in the 2006 through 2010 loss years related to the professional liability line of business.

While the Company has experienced favorable development in its insurance and reinsurance lines, there is no assurance that conditions and trends that have affected the development of liabilities in the past will continue. It is not appropriate to extrapolate future redundancies based on prior years’ development. The methodology of estimating loss reserves is periodically reviewed to ensure that the key assumptions used in the actuarial models continue to be appropriate.

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

8. INCOME TAXES

Under Swiss law, a resident company is subject to income tax at the federal, cantonal and communal levels that is levied on net income. Income attributable to permanent establishments or real estate located abroad is excluded from the Swiss tax base. Allied World Switzerland is a holding company and, therefore, is exempt from cantonal and communal income tax. As a result, Allied World Switzerland is subject to Swiss income tax only at the federal level. Allied World Switzerland is a resident of the Canton of Zug and, as such, is subject to an annual cantonal and communal capital tax on the taxable equity of Allied World Switzerland in Switzerland. Allied World Switzerland has a Swiss operating company resident in the Canton of Zug. The operating company is subject to federal, cantonal and communal income tax and to annual cantonal and communal capital tax.

Under current Bermuda law, Allied World Assurance Company Holdings, Ltd (“Allied World Bermuda”) and its Bermuda subsidiaries are not required to pay taxes in Bermuda on either income or capital gains. Allied World Bermuda and Allied World Assurance Company, Ltd have received an assurance from the Bermuda Minister of Finance under the Exempted Undertakings Tax Protection Act 1966 of Bermuda, that in the event of any such taxes being imposed, Allied World Bermuda and Allied World Assurance Company, Ltd will be exempted until March 2035.

Certain subsidiaries of Allied World Switzerland file U.S. federal income tax returns and various U.S. state income tax returns, as well as income tax returns in the United Kingdom, Ireland, Switzerland, Hong Kong and Singapore. To the best of the Company’s knowledge, there are no income tax examinations pending by any tax authority.

Management has deemed all material tax positions to have a greater than 50% likelihood of being sustained based on technical merits if challenged. The Company does not expect any material unrecognized tax benefits within 12 months of January 2012.

9. SHAREHOLDERS’ EQUITY

a) Authorized shares

The issued share capital consists of the following:


	June 30, 2012		December 31, 2011
Common shares issued and fully paid, 2012: CHF 13.69 per share; 2011: CHF 14.03 per share		40,003,642		40,003,642

Share capital at end of period	$	543,452	$	557,153


	Six Months Ended June 30, 2012
Total shares issued at beginning and end of period		40,003,642

Treasury shares issued at beginning of period		2,261,511
Shares repurchased		2,336,187
Shares issued out of treasury		(537,020	)

Total treasury shares at end of period		4,060,678

Total shares outstanding at end of period		35,942,964

As of June 30, 2012, there were outstanding 35,942,964 voting common shares and nil non-voting common shares.

Effective July 30, 2012, the Company cancelled 2,326,900 voting shares and 173,100 non-voting shares held in treasury, upon completing a required filing with the Swiss Commercial Register in Zug.

As of June 30, 2012, Allied World Switzerland’s articles of association authorized its board of directors to increase the share capital by a maximum amount of 20% of the share capital registered in the commercial register up to CHF 102,685 or 7,500,728 voting shares, and create conditional capital of 5,200,000 voting shares.

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

b) Share Warrants

In conjunction with the private placement offering at the formation of Allied World Bermuda, Allied World Bermuda granted warrant agreements to certain founding shareholders to acquire up to 5,500,000 common shares at an exercise price of $34.20 per share. These warrants were exercisable in certain limited conditions, including a public offering of common shares. All warrants granted were repurchased by the Company.

In February 2011, the Company repurchased the last outstanding warrant owned by American International Group, Inc. (“AIG”) in a privately negotiated transaction. The warrant entitled AIG to purchase 2,000,000 of the Company’s common shares for $34.20 per share. The Company repurchased the warrant for an aggregate purchase price of $53,620. The repurchase of the warrant was recognized as a reduction in “additional paid-in capital” on the consolidated balance sheets. The repurchase was executed separately from the share repurchase program discussed in Note 9(d) below. After this repurchase, AIG has no warrants remaining and no other disclosed equity interest in the Company.

c) Dividends

Under Swiss law, distributions to shareholders may be paid only if the Company has sufficient distributable profits from previous fiscal years, or if the Company has freely distributable reserves, each as presented on the audited stand-alone statutory balance sheet. Distributions to shareholders out of the share and participation capital may be made by way of a capital reduction in the form of a reduction to par value to achieve a similar result as the payment of a dividend.

On May 5, 2011, the shareholders approved the Company’s proposal to pay cash dividends in the form of a distribution by way of par value reductions. The aggregate reduction amount was paid to shareholders in quarterly installments of $0.375 per share, with the last of such quarterly dividend payments being made on April 6, 2012 to shareholders of record in the amount of $13,795.

On May 3, 2012, the shareholders approved the Company’s proposal to pay cash dividends in the form of a distribution by way of par value reductions. The aggregate reduction amount is expected to be paid to shareholders in quarterly installments of $0.375 per share. The Company expects to distribute such dividends in August 2012, September 2012, December 2012 and March 2013.

d) Share repurchase

In May 2012, the Company established a new share repurchase program in order to repurchase up to $500 million of its common shares. Repurchases may be effected from time to time through open market purchases, privately negotiated transactions, tender offers or otherwise. The timing, form and amount of the share repurchases under the program will depend on a variety of factors, including market conditions, the Company’s capital position, legal requirements and other factors. Shares repurchased have been classified as “Treasury shares, at cost” on the consolidated balance sheets. The Company will issue shares out of treasury principally related to the Company’s employee benefit plans. Under the terms of this new share repurchase program, common shares repurchased shall be designated for cancellation and shall be cancelled upon shareholder approval. The Company’s share repurchases were as follows:


	Three Months Ended June 30,				Six Months Ended June 30,
	2012		2011		2012		2011
Common shares repurchased		905,383		—		2,336,187		969,163
Total cost of shares repurchased	$	66,435	$	—	$	159,458	$	60,000
Average price per share	$	73.38	$	—	$	68.26	$	61.91

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

10. EARNINGS PER SHARE

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


	Three Months Ended June 30,				Six Months Ended June 30,
	2012		2011		2012		2011
Basic earnings per share:
Net income	$	96,351	$	93,800	$	314,507	$	102,420
Weighted average common shares outstanding		36,288,596		38,346,489		36,746,881		38,061,724

Basic earnings per share	$	2.66	$	2.45	$	8.56	$	2.69


	Three Months Ended June 30,				Six Months Ended June 30,
	2012		2011		2012		2011
Diluted earnings per share:
Net income	$	96,351	$	93,800	$	314,507	$	102,420
Weighted average common shares outstanding		36,288,596		38,346,489		36,746,881		38,061,724
Share equivalents:
Warrants and options		440,811		333,837		413,702		503,529
RSUs and long-term incentive plan (“LTIP”) awards		460,315		1,120,427		234,976		1,308,165

Weighted average common shares and common share equivalents outstanding — diluted		37,189,722		39,800,753		37,395,559		39,873,418

Diluted earnings per share	$	2.59	$	2.36	$	8.41	$	2.57

For the three months ended June 30, 2012 and 2011, a weighted average of 337,153 and 662,835 employee stock options and restricted stock units (“RSUs”) were considered anti-dilutive and were therefore excluded from the calculation of the diluted earnings per share, respectively.

For the six months ended June 30, 2012 and 2011, a weighted average of 343,726 and 687,713 employee stock options and RSUs were considered anti-dilutive and were therefore excluded from the calculation of the diluted earnings per share, respectively.

11. CREDIT AGREEMENTS

In the normal course of its operations, the Company enters into agreements with financial institutions to obtain secured and unsecured credit facilities.

On June 7, 2012, Allied World Bermuda amended its existing secured credit facility. The amended $450,000 four-year secured credit facility (the “Amended Secured Credit Facility”) is primarily used for the issuance of standby letters of credit to support obligations in connection with the insurance and reinsurance business of Allied World Bermuda and its subsidiaries. A portion of the facility may also be used for revolving loans for general corporate and working capital purposes, up to a maximum of $150,000. Allied World Bermuda may request that existing lenders under the Amended Secured Credit Facility make additional commitments from time to time, up to $150,000, subject to approval by the lenders. The Amended Secured Credit Facility contains representations, warranties and covenants customary for similar bank loan facilities, including certain covenants that, among other things, require the Company to maintain a certain leverage ratio and financial strength rating.

On June 7, 2012, upon entering into the Amended Secured Credit Facility, Allied World Bermuda terminated its $400,000 unsecured facility.

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

12. SEGMENT INFORMATION

The determination of reportable segments is based on how senior management monitors the Company’s underwriting operations. Management monitors the performance of its direct underwriting operations based on the geographic location of the Company’s offices, the markets and customers served and the type of accounts written. The Company is currently organized into three operating segments: U.S. insurance, international insurance and reinsurance. All product lines fall within these classifications.

The U.S. insurance segment includes the Company’s direct specialty insurance operations in the United States. This segment provides both direct property and specialty casualty insurance primarily to non-Fortune 1000 North American domiciled accounts. The international insurance segment includes the Company’s direct insurance operations in Bermuda, Europe, Singapore and Hong Kong. This segment provides both direct property and casualty insurance primarily to Fortune 1000 North American domiciled accounts and non-North American domiciled accounts. The reinsurance segment includes the Company’s reinsurance operations in the U.S., Bermuda, Europe and Asia. This segment provides reinsurance of property, general casualty, professional liability, specialty lines and property catastrophe coverages written by insurance companies. The Company presently writes reinsurance on both a treaty and a facultative basis, targeting several niche reinsurance markets.

Responsibility and accountability for the results of underwriting operations are assigned by major line of business within each segment. Because the Company does not manage its 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.

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.”

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

The following tables provide a summary of the segment results:


Three Months Ended June 30, 2012	U.S. Insurance			International Insurance			Reinsurance			Total
Gross premiums written	$	265,974		$	183,593		$	197,303		$	646,870
Net premiums written		196,661			111,342			186,707			494,710
Net premiums earned		162,785			82,605			184,357			429,747
Net losses and loss expenses		(103,074	)		(22,233	)		(115,073	)		(240,380	)
Acquisition costs		(21,250	)		582			(30,920	)		(51,588	)
General and administrative expenses		(34,730	)		(21,648	)		(17,601	)		(73,979	)

Underwriting income		3,731			39,306			20,763			63,800
Net investment income											42,451
Net realized investment gains											8,663
Amortization and impairment of intangible assets											(634	)
Interest expense											(14,001	)
Foreign exchange gain											1,019

Income before income taxes										$	101,298


Loss and loss expense ratio		63.3	%		26.9	%		53.0	%		55.9	%
Acquisition cost ratio		13.1	%		(0.7	%)		16.4	%		12.0	%
General and administrative expense ratio		21.3	%		26.2	%		10.0	%		17.2	%

Combined ratio		97.7	%		52.4	%		79.4	%		85.1	%


Three Months Ended June 30, 2011	U.S. Insurance			International Insurance			Reinsurance			Total
Gross premiums written	$	226,738		$	178,593		$	114,267		$	519,598
Net premiums written		172,887			108,985			113,931			395,803
Net premiums earned		145,857			79,956			129,494			355,307
Net losses and loss expenses		(92,595	)		(72,082	)		(71,136	)		(235,813	)
Acquisition costs		(18,876	)		747			(24,842	)		(42,971	)
General and administrative expenses		(31,253	)		(20,653	)		(15,295	)		(67,201	)

Underwriting income (loss)		3,133			(12,032	)		18,221			9,322
Net investment income											52,368
Net realized investment gains											58,878
Amortization and impairment of intangible assets											(766	)
Interest expense											(13,745	)
Foreign exchange loss											(1,184	)

Income before income taxes										$	104,873


Loss and loss expense ratio		63.5	%		90.2	%		54.9	%		66.4	%
Acquisition cost ratio		12.9	%		(0.9	%)		19.2	%		12.1	%
General and administrative expense ratio		21.4	%		25.8	%		11.8	%		18.9	%

Combined ratio		97.8	%		115.1	%		85.9	%		97.4	%

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)


Six Months Ended June 30, 2012	U.S. Insurance			International Insurance			Reinsurance			Total
Gross premiums written	$	470,185		$	297,183		$	560,431		$	1,327,799
Net premiums written		350,507			183,951			549,205			1,083,663
Net premiums earned		316,143			162,476			353,018			831,637
Net losses and loss expenses		(200,778	)		(60,333	)		(204,471	)		(465,582	)
Acquisition costs		(41,222	)		1,110			(58,614	)		(98,726	)
General and administrative expenses		(65,774	)		(44,049	)		(34,522	)		(144,345	)

Underwriting income		8,369			59,204			55,411			122,984
Net investment income											89,660
Net realized investment gains											142,244
Amortization and impairment of intangible assets											(1,267	)
Interest expense											(27,757	)
Foreign exchange gain											1,100

Income before income taxes											326,964


Loss and loss expense ratio		63.5	%		37.1	%		57.9	%		56.0	%
Acquisition cost ratio		13.0	%		(0.7	%)		16.6	%		11.9	%
General and administrative expense ratio		20.8	%		27.1	%		9.8	%		17.3	%

Combined ratio		97.3	%		63.5	%		84.3	%		85.2	%


Six Months Ended June 30, 2011	U.S. Insurance			International Insurance			Reinsurance			Total
Gross premiums written	$	410,040		$	289,918		$	380,328		$	1,080,286
Net premiums written		312,789			183,895			379,990			876,674
Net premiums earned		281,338			156,246			252,599			690,183
Net losses and loss expenses		(208,426	)		(143,266	)		(188,573	)		(540,265	)
Acquisition costs		(36,978	)		2,603			(46,678	)		(81,053	)
General and administrative expenses		(62,052	)		(41,381	)		(31,724	)		(135,157	)

Underwriting loss		(26,118	)		(25,798	)		(14,376	)		(66,292	)
Net investment income											102,576
Net realized investment gains											109,254
Amortization and impairment of intangible assets											(1,533	)
Interest expense											(27,487	)
Foreign exchange loss											(742	)

Income before income taxes										$	115,776


Loss and loss expense ratio		74.1	%		91.7	%		74.7	%		78.3	%
Acquisition cost ratio		13.1	%		(1.7	%)		18.5	%		11.7	%
General and administrative expense ratio		22.1	%		26.5	%		12.6	%		19.6	%

Combined ratio		109.3	%		116.5	%		105.8	%		109.6	%

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

The following table shows an analysis of the Company’s gross premiums written by geographic location of the Company’s subsidiaries. All intercompany premiums have been eliminated.


	Three Months Ended June 30,				Six Months Ended June 30,
	2012		2011		2012		2011
United States	$	349,577	$	269,193	$	738,548	$	575,824
Bermuda		193,195		177,850		375,358		348,318
Europe		60,008		58,209		135,384		122,288
Singapore		40,128		10,331		69,311		25,567
Hong Kong		3,962		4,015		9,198		8,289

Total gross premiums written	$	646,870	$	519,598	$	1,327,799	$	1,080,286

13. COMMITMENTS AND CONTINGENCIES

In April 2006, a complaint entitled New Cingular Wireless Headquarters, LLC et al. v. Marsh & McLennan Companies, Inc., et al. was filed against numerous brokers and 78 insurers including Allied World Assurance Company, Ltd. Plaintiffs allege that the broker defendants used a variety of illegal schemes and anti-competitive practices that resulted in the plaintiffs either paying more for insurance products or receiving less beneficial terms than the competitive market would have produced. Plaintiffs seek equitable and legal remedies, including injunctive relief, consequential and punitive damages, treble damages and attorneys’ fees. Due to various pending procedural matters, the litigation has not progressed beyond the discovery phase. While it is not possible to predict the outcome of the litigation, the Company does not believe that the outcome will have a material effect on its operations or financial position.

The Company, in common with the insurance industry in general, is subject to litigation and arbitration in the normal course of its business. These legal proceedings generally relate to claims asserted by or against the Company in the ordinary course of insurance or reinsurance operations; estimated amounts payable under such proceedings are included in the reserve for losses and loss expenses in the Company’s consolidated balance sheets. As of June 30, 2012, the Company was not a party to any material legal proceedings arising outside the ordinary course of business that is expected by management to have a material adverse effect on the Company’s results of operations and financial condition and liquidity.

14. CONDENSED CONSOLIDATED GUARANTOR FINANCIAL STATEMENTS

The following tables present unaudited condensed consolidating financial information as of June 30, 2012 and December 31, 2011 and for the three and six months ended June 30, 2012 and 2011 for Allied World Switzerland (the “Parent Guarantor”) and Allied World Bermuda (the “Subsidiary Issuer”). The Subsidiary Issuer is a direct 100% owned subsidiary of the Parent Guarantor. Investments in subsidiaries are accounted for by the Parent Guarantor under the equity method for purposes of the supplemental consolidating presentation. Earnings of subsidiaries are reflected in the Parent Guarantor’s investment accounts and earnings. The Parent Guarantor fully and unconditionally guarantees the senior notes issued by the Subsidiary Issuer.

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

Unaudited Condensed Consolidating Balance Sheet:


As of June 30, 2012	Allied World Switzerland (Parent Guarantor)			Allied World Bermuda (Subsidiary Issuer)			Other Allied World Subsidiaries		Consolidating Adjustments			Allied World Switzerland Consolidated
ASSETS:
Investments	$	—		$	—		$	7,801,418	$	—		$	7,801,418
Cash and cash equivalents		24,319			19,212			820,919		—			864,450
Insurance balances receivable		—			—			845,663		—			845,663
Reinsurance recoverable		—			—			1,073,612		—			1,073,612
Net deferred acquisition costs		—			—			129,818		—			129,818
Goodwill and intangible assets		—			—			321,007		—			321,007
Balances receivable on sale of investments		—			—			635,727		—			635,727
Investments in subsidiaries		3,283,286			4,220,504			—		(7,503,790	)		—
Due (to) from subsidiaries		(4,457	)		(7,361	)		11,818		—			—
Other assets		880			6,817			598,259		—			605,956

Total assets	$	3,304,028		$	4,239,172		$	12,238,241	$	(7,503,790	)	$	12,277,651

LIABILITIES:
Reserve for losses and loss expenses	$	—		$	—		$	5,377,518	$	—		$	5,377,518
Unearned premiums		—			—			1,363,006		—			1,363,006
Reinsurance balances payable		—			—			128,306		—			128,306
Balances due on purchases of investments		—			—			1,220,246		—			1,220,246
Senior notes		—			798,080			—		—			798,080
Other liabilities		20,127			17,972			68,495		—			106,594

Total liabilities		20,127			816,052			8,157,571		—			8,993,750

Total shareholders’ equity		3,283,901			3,423,120			4,080,670		(7,503,790	)		3,283,901

Total liabilities and shareholders’ equity	$	3,304,028		$	4,239,172		$	12,238,241	$	(7,503,790	)	$	12,277,651


As of December 31, 2011	Allied World Switzerland (Parent Guarantor)			Allied World Bermuda (Subsidiary Issuer)			Other Allied World Subsidiaries		Consolidating Adjustments			Allied World Switzerland Consolidated
ASSETS:
Investments	$	—		$	—		$	7,406,594	$	—		$	7,406,594
Cash and cash equivalents		112,672			8,886			512,438		—			633,996
Insurance balances receivable		—			—			652,158		—			652,158
Reinsurance recoverable		—			—			1,002,919		—			1,002,919
Net deferred acquisition costs		—			—			100,334		—			100,334
Goodwill and intangible assets		—			—			322,274		—			322,274
Balances receivable on sale of investments		—			—			580,443		—			580,443
Investments in subsidiaries		3,064,066			3,964,585			—		(7,028,651	)		—
Due (to) from subsidiaries		(4,853	)		(6,769	)		11,622		—			—
Other assets		1,504			6,367			415,569		—			423,440

Total assets	$	3,173,389		$	3,973,069		$	11,004,351	$	(7,028,651	)	$	11,122,158

LIABILITIES:
Reserve for losses and loss expenses	$	—		$	—		$	5,225,143	$	—		$	5,225,143
Unearned premiums		—			—			1,078,412		—			1,078,412
Reinsurance balances payable		—			—			124,539		—			124,539
Balances due on purchases of investments		—			—			616,728		—			616,728
Senior notes		—			797,949			—		—			797,949
Other liabilities		24,367			17,688			88,310		—			130,365

Total liabilities		24,367			815,637			7,133,132		—			7,973,136

Total shareholders’ equity		3,149,022			3,157,432			3,871,219		(7,028,651	)		3,149,022

Total liabilities and shareholders’ equity	$	3,173,389		$	3,973,069		$	11,004,351	$	(7,028,651	)	$	11,122,158

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

Unaudited Condensed Consolidating Income Statement:


Three months ended June 30, 2012	Allied World Switzerland (Parent Guarantor)			Allied World Bermuda (Subsidiary Issuer)			Other Allied World Subsidiaries			Consolidating Adjustments			Allied World Switzerland Consolidated
Net premiums earned	$	—		$	—		$	429,747		$	—		$	429,747
Net investment income		5			8			42,438			—			42,451
Net realized investment losses		—			—			8,663			—			8,663
Net losses and loss expenses		—			—			(240,380	)		—			(240,380	)
Acquisition costs		—			—			(51,588	)		—			(51,588	)
General and administrative expenses		(4,278	)		(1,302	)		(68,399	)		—			(73,979	)
Amortization of intangible assets		—			—			(634	)		—			(634	)
Interest expense		—			(14,001	)		—			—			(14,001	)
Foreign exchange gain (loss)		460			(42	)		601			—			1,019
Income tax (expense) benefit		(373	)		—			(4,574	)		—			(4,947	)
Equity in earnings of consolidated subsidiaries		100,537			115,102			—			(215,639	)		—

NET INCOME (LOSS)	$	96,351		$	99,765		$	115,874		$	(215,639	)	$	96,351

Unrealized gains on investments arising during the period net of applicable deferred income tax expense of $68		—			—			231			—			231
Reclassification adjustment for net realized investment gains included in net income, net of applicable income tax		—			—			(1,142	)		—			(1,142	)

Other comprehensive loss		—			—			(911	)		—			(911	)

COMPREHENSIVE INCOME (LOSS)	$	96,351		$	99,765		$	114,963		$	(215,639	)	$	95,440


Three months ended June 30, 2011	Allied World Switzerland (Parent Guarantor)			Allied World Bermuda (Subsidiary Issuer)			Other Allied World Subsidiaries			Consolidating Adjustments			Allied World Switzerland Consolidated
Net premiums earned	$	—		$	—		$	355,307		$	—		$	355,307
Net investment income		15			8			52,345			—			52,368
Net realized investment gains		—			—			58,878			—			58,878
Net losses and loss expenses		—			—			(235,813	)		—			(235,813	)
Acquisition costs		—			—			(42,971	)		—			(42,971	)
General and administrative expenses		(4,746	)		(1,483	)		(60,972	)		—			(67,201	)
Amortization of intangible assets		—			—			(766	)		—			(766	)
Interest expense		—			(13,745	)		—			—			(13,745	)
Foreign exchange gain (loss)		(3	)		17			(1,198	)		—			(1,184	)
Income tax (expense) benefit		—			—			(11,073	)		—			(11,073	)
Equity in earnings of consolidated subsidiaries		98,534			114,496			—			(213,030	)		—

NET INCOME (LOSS)	$	93,800		$	99,293		$	113,737		$	(213,030	)	$	93,800

Unrealized gains on investments arising during the period net of applicable deferred income tax expense of $1,461		—			—			13,680			—			13,680
Reclassification adjustment for net realized investment gains included in net income, net of applicable income tax		—			—			(23,548	)		—			(23,548	)

Other comprehensive loss		—			—			(9,868	)		—			(9,868	)

COMPREHENSIVE INCOME (LOSS)	$	93,800		$	99,293		$	103,869		$	(213,030	)	$	83,932

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)


Six Months Ended June 30, 2012	Allied World Switzerland (Parent Guarantor)			Allied World Bermuda (Subsidiary Issuer)			Other Allied World Subsidiaries			Consolidating Adjustments			Allied World Switzerland Consolidated
Net premiums earned	$	—		$	—		$	831,637		$	—		$	831,637
Net investment income		14			11			89,635			—			89,660
Net realized investment losses		—			—			142,244			—			142,244
Net losses and loss expenses		—			—			(465,582	)		—			(465,582	)
Acquisition costs		—			—			(98,726	)		—			(98,726	)
General and administrative expenses		(8,234	)		(2,454	)		(133,657	)		—			(144,345	)
Amortization and impairment of intangible assets		—			—			(1,267	)		—			(1,267	)
Interest expense		—			(27,757	)		—			—			(27,757	)
Foreign exchange loss (gain)		549			(67	)		618			—			1,100
Income tax (expense) benefit		71			—			(12,528	)		—			(12,457	)
Equity in earnings of consolidated subsidiaries		322,107			349,409			—			(671,516	)		—

NET INCOME (LOSS)	$	314,507		$	319,142		$	352,374		$	(671,516	)	$	314,507

Unrealized gains on investments arising during the period net of applicable deferred income tax expense of $96		—			—			179			—			179
Reclassification adjustment for net realized investment gains included in net income, net of applicable income tax		—			—			(13,249	)		—			(13,249	)

Other comprehensive loss		—			—			(13,070	)		—			(13,070	)

COMPREHENSIVE INCOME (LOSS)	$	314,507		$	319,142		$	339,304		$	(671,516	)	$	301,437


Six Months Ended June 30, 2011	Allied World Switzerland (Parent Guarantor)			Allied World Bermuda (Subsidiary Issuer)			Other Allied World Subsidiaries			Consolidating Adjustments			Allied World Switzerland Consolidated
Net premiums earned	$	—		$	—		$	690,183		$	—		$	690,183
Net investment income		45			22			102,509			—			102,576
Net realized investment gains		—			—			109,254			—			109,254
Net losses and loss expenses		—			—			(540,265	)		—			(540,265	)
Acquisition costs		—			—			(81,053	)		—			(81,053	)
General and administrative expenses		(5,810	)		(4,229	)		(125,118	)		—			(135,157	)
Amortization of intangible assets		—			—			(1,533	)		—			(1,533	)
Interest expense		—			(27,487	)		—			—			(27,487	)

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