The following is a discussion and analysis of the Company's results of operations for the three months ended March 31, 2009 compared with the three months ended March 31, 2008, and also a discussion of the Company's financial condition as of March 31, 2009. This discussion and analysis should be read in conjunction with the attached unaudited interim Consolidated Financial Statements and notes thereto and Argo Group's Annual Report on Form 10-K for the year ended December 31, 2008 filed with the Securities and Exchange Commission on March 2, 2009, including the audited Consolidated Financial Statements and notes thereto.

Forward Looking Statements

Management's Discussion and Analysis of Financial Condition and Results of Operations, Quantitative and Qualitative Disclosures About Market Risk and the accompanying Consolidated Financial Statements (including the notes thereto) may contain "forward looking statements," which are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The forward looking statements are based on the Company's current expectations and beliefs concerning future developments and their potential effects on the Company. There can be no assurance that actual developments will be those anticipated by the Company. Actual results may differ materially as a result of significant risks and uncertainties, including non-receipt of expected payments, the capital markets and their effect on investment income and the fair value of the investment portfolio, development of claims and the effect on loss reserves, accuracy in projecting loss reserves, the impact of competition and pricing environments, changes in the demand for the Company's products, the effect of general economic conditions, adverse state and federal legislation and regulations, government investigations into industry practices, developments relating to existing agreements, heightened competition, changes in pricing environments and changes in asset valuations. For a more detailed discussion of risks and uncertainties, see the Company's public filings made with the Securities and Exchange Commission. The Company undertakes no obligation to publicly update any forward-looking statements.

Results of Operations

The following is a comparison of selected data from the Company's operations:



                                                           Three Months Ended
                                                                March 31
     (in millions)                                          2009          2008
     Gross written premiums                              $    496.1      $ 346.6

     Earned premiums                                     $    343.4      $ 218.7
     Net investment income                                     39.3         38.1
     Fee income                                                 0.2           -
     Realized investment and other gains (losses), net        (11.8 )        1.3

     Total revenue                                       $    371.1      $ 258.1

     Income before income taxes                                31.4         41.3
     Provision for income taxes                                 4.4          4.4

     Net income                                          $     27.0      $  36.9

     Loss ratio                                                59.2 %       60.1 %
     Expense ratio                                             37.1 %       35.8 %

     Combined ratio                                            96.3 %       95.9 %

Consolidated earned premiums increased $124.7 million, from $218.7 million for the three months ended March 31, 2008 to $343.4 million for the same period in 2009. The increase was primarily attributable to earned premiums in the International Specialty segment, which was acquired in the second quarter of 2008. Heritage contributed earned premiums of $100.0 million for the three months ended March 31, 2009. Earned premiums for the Reinsurance segment increased $6.1 million for the three months ended March 31, 2009 as compared to 2008 primarily due to increased earned premiums at Argo Re. Additionally, earned premiums for the Commercial Specialty segment increased $10.4 million, primarily due to growth in the public entity products.

Consolidated net investment income increased for the three months ended March 31, 2009 as compared to the same period in 2008 due to higher invested asset balances resulting from positive cash flows from operations and due to invested assets acquired in the Heritage transaction. Total invested assets at March 31, 2009 were $3,812.4 million; net of $242.7 million of invested assets attributable to Heritage's Trade Capital providers. Total invested assets as of March 31, 2008 were $3,525.4 million.

Consolidated fee income represents commissions and other fees earned by the Company for the non-risk bearing activities. Fee income is generated by the Commercial Specialty segment as a result of business placed with other insurance companies. In addition, the International Specialty segment generates fee income from managing third party capital for certain syndicates at Lloyds. Consolidated fee income was $0.2 million for the three months ended March 31, 2009.

Consolidated realized investment and other losses, net, for the three months ended March 31, 2009 were $11.8 million, compared to a realized gain of $1.3 million for the same period ended 2008. The Company regularly evaluates its investment portfolio for indications of other-than-temporary impairments. If individual securities are determined to be other-than-temporarily impaired, the security is written down to its fair value. Included in consolidated gross realized investment losses for the three months ended March 31, 2009 were write-downs of $14.1 million from the recognition of other-than-temporary impairments on certain investment securities. The other-than-temporary impairment was primarily attributable to $8.4 million of impairment within the equity portfolio and $5.7 million within the fixed maturity portfolio, including certain sub-prime holdings. Included in consolidated gross realized investment losses for the three months ended March 31, 2008 were write-downs of $6.7 million from the recognition of other-than-temporary impairments on certain equity and fixed maturity securities. Realized gains from the sale of various investment securities totaled $2.3 million for the three month ended March 31, 2009, compared to $8.0 million for the same period ended 2008. Included in realized gains for the three months ended March 31, 2008 was a $2.3 million gain on the sale of PXRE Reinsurance Company, which closed in March 2008.

Consolidated losses and loss adjustment expenses were $203.2 million and $131.6 million for the three months ended March 31, 2009 and 2008, respectively. The consolidated loss ratio for the three months ended March 31, 2009 was 59.2%, compared to 60.1% for the same period in 2008. Included in losses and loss adjustment expenses for the three months ended March 31, 2009 was $0.9 million in net favorable loss reserve development on prior accident years. The following table summarizes the reserve development as respects to prior year loss reserves by line of business for the quarter ended March 31, 2009:

                                Net Reserves at                       Percent of Net
                                 December 31,       Net Reserve        Reserves by
   (in millions)                     2008           Development      Line of Business
   General liability           $           909.9   $         1.7                  0.2 %
   Workers compensation                    465.4             1.1                  0.2 %
   Commercial multi-peril                  190.2             3.0                  1.6 %
   Commercial auto liability               145.7             1.1                  0.8 %
   Special property                         19.0             0.3                  1.6 %
   Auto physical damage                     10.0            (3.1 )              -31.0 %
   Heritage                                239.5              -                   0.0 %
   Argo Re                                  30.0            (2.8 )               -9.3 %
   PXRE Legacy                              97.6            (1.9 )               -1.9 %
   All other lines                           8.3            (0.3 )               -3.6 %

   Total all lines             $         2,115.6   $        (0.9 )                0.0 %

The favorable development as related to total net reserves for loss and loss adjustment expenses as of December 31, 2008 represents $0.9 million or less than 0.1% of total reserves outstanding at December 31, 2008. Aside from the favorable development in the auto physical damage line of business, resulting from better than expected loss frequency and severity, there were no material reserve movements by line of business. The revised estimate for the PXRE Legacy net loss reserves developed favorably by $1.9 million, and Argo Re reserves had favorable development of $2.8 million, with $1.7 million representing a reforecast of Hurricane Ike losses. The general liability line of business had $1.7 million unfavorable prior accident year loss development due to the strengthening of reserves for certain asbestos and environmental claims, offset by favorable loss experience from the Excess and Surplus lines segment.

Included in losses and loss adjustment expense for the three months ended March 31, 2008 was $6.7 million of favorable loss reserve development on prior accident years primarily in the Excess and Surplus Lines and Commercial Specialty segments.

In determining appropriate reserve levels as of March 31, 2009, the Company maintained the same general processes and disciplines that were used to set reserves at prior reporting dates. No changes in key assumptions were made to estimate the reserves since the last reporting date; however, the maturation of claims since the last analysis provided a basis to assign greater credibility to emerged loss development patterns. Consistent with prior reserve valuations, actuarial estimates were refined to assign alternate weights to the different loss forecasting methodologies in order to respond to any emerging trends in the paid and reported loss data. These modifications to the analysis varied depending on whether the line of business was short-tailed or long-tailed and also varied by accident year.

When determining reserve levels, the Company recognizes that there are several factors that present challenges and uncertainties to the estimation of loss reserves. Examples of these uncertainties include growth over the last several years in both the Excess and Surplus Lines and Commercial Specialty segments, and changes to the reinsurance structure. The Company's net retained losses vary by product and they have generally increased over time. To properly recognize these uncertainties, both internal and independent actuarial reviews relied, to a large extent on the paid and incurred Bornhuetter-Ferguson methodologies, which generally produce higher projections of ultimate losses than the other methods. Compared with other actuarial methodologies, the paid and incurred Bornhuetter-Ferguson methods assigned the smallest weight to actual reported loss experience, with the greatest weighting assigned to an expected or planned loss ratio. The expected or planned loss ratio has typically been determined using various assumptions pertaining to prospective loss frequency and loss severity. In setting reserves at March 31, 2009, the Company continued to rely most heavily on the paid and incurred Bornhuetter-Ferguson methods; however certain additional weighting was assigned to other actuarial methods to recognize the most current trends emerging in paid and reported loss data.

For general liability business, the Company increased its premium volume significantly from 2002 through 2006. This growth occurred in both the Excess and Surplus Lines and Commercial Specialty segments. The premium increases derived from both organic growth and acquisitions. In setting loss reserves, internal and external actuaries assumed that the new business may not perform as well as renewal business and that prior year loss development patterns may not be representative of future loss emergence. The actuarial assumption that new business may not perform as well as renewal business is primarily predicated on the basis that the new insurance company offers a lower price or better terms and conditions than the incumbent carrier. Further, the incumbent carrier has the benefit of historical experience and loss characteristics of the insured. Thus, the actuarial methods utilizing the assumption that new business would generate a higher loss ratio were assigned more weight. The Company's loss reserve estimates gradually blend in the results from other methodologies over time. For general liability estimates, more credibility is assigned to the Company's own loss experience approximately 60 to 72 months after the beginning of an accident year. Over the course of time, the Company has recognized that the new business growth from 2002 through 2006 exhibited similar underwriting and profitability characteristics as the Company's renewal book. Further review and analysis of the data in the first quarter of 2009 suggested that favorable loss experience on the new business growth continued to emerge in the first quarter of 2009. Thus the Company reduced its ultimate loss estimates for general liability lines of business for the 2006 and prior accident years.

Another factor that was considered in setting loss reserves at March 31, 2009 was the impact of the Company's reinsurance protection. The Company's excess of loss reinsurance coverage has varied by product. For most general liability products, the net per occurrence retention increased from $250,000 to $500,000 on September 1, 2002 and then to $1,000,000 on October 1, 2006. When loss reserves were initially established, the Company expected a greater number of large claims in the $250,000 excess of $250,000 layer of coverage. In 2006 and again in 2007, after a review of reported large loss activity, the Company began to recognize that the increased retention in the $250,000 excess of $250,000 layer did not have as material an impact on net retained losses as had originally been contemplated. Furthermore, the decision to increase net retentions had a favorable effect on net loss ratios. In the first quarter of 2009, as part of the Company's internal actuarial review of reserves, the Company continued to observe lower than expected large loss activity in the $250,000 excess of $250,000 layer of coverage and further reduced its loss estimates for the 2003 through 2006 accident years.

For property business, the Company's loss reserve estimates also blend in the results from other actuarial methodologies over time. In contrast to general liability estimates, more credibility is assigned to the Company's loss experience approximately 24 to 36 months after the beginning of an accident year, where loss reporting and claims closing patterns settle more quickly. The Company's loss experience receives partial weighting in the estimates 12 to 24 months after the beginning of the accident year. As respects to the loss reserves related to PXRE, the nature of reinsurance (including retro business) requires a longer maturation period. As such, the Company recognized favorable loss experience for the 2005 and 2006 accident years in 2007. Likewise, during 2008, the Company recognized favorable loss experience deriving from the 2006 and 2007 accident years.

While prior accident years' net reserves for losses and loss adjustment expenses for some lines of business have developed favorably during 2007 and 2008, this does not infer that more recent accident years' reserves also will develop favorably; pricing, reinsurance costs, the legal environment, general economic conditions and many other factors impact management's ultimate loss estimates. For accident years 2007 and 2008, pricing for our products was under significant competition and management's expectation is that profitability for certain lines of business decreased accordingly as loss costs have not decreased proportionately.

Consolidated loss reserves were $3,062.0 million (including $193.7 million of reserves attributable to Heritage's Trade Capital providers) and $2,447.0 million as of March 31, 2009 and 2008, respectively. Management has recorded its best estimate of loss reserves as of March 31, 2009 based on current known facts and circumstances. Due to the significant uncertainties inherent in the estimation of loss reserves, there can be no assurance that future loss development, favorable or unfavorable, will not occur.

Consolidated underwriting, acquisition and insurance expenses increased to $127.3 million for the three months ended March 31, 2009 as compared to $78.2 million for the same period in 2008. The consolidated expense ratios were 37.1% and 35.8% for the three months ended March 31, 2009 and 2008, respectively. The increase in the expense ratio for 2009 as compared to 2008 was primarily attributable to the International Specialty segment which incurs a higher expense ratio compared to the other segments. The International Specialty segment's expense ratio for the three months ended March 31, 2009 increased the Company's consolidated expense ratio by approximately 1.5 points.

Consolidated interest expense and other were $9.2 million and $7.0 million for the three months ended March 31, 2009 and 2008, respectively. Consolidated interest expense was $7.0 million for the three months ended March 31, 2009, including $1.2 million of interest expense on the other indebtedness acquired from Heritage. Interest expense for the three months ended March 31, 2008 was $7.2 million. The decline in interest expense excluding Heritage was due to more favorable interest rates on the Company's subordinated debt reflecting current market conditions. Foreign currency exchange loss on transactions that are settled in currencies other than U.S. Dollars was $0.1 million for the three months ended March 31, 2009, compared to a gain of $0.3 million for the same period ended 2008. Included in consolidated interest expense and other for the three months ended March 31, 2009 was $2.0 million in expense related to the generation of fee income within the Commercial Specialty and International Specialty segments.

Consolidated provisions for income taxes were $4.4 million for each of the periods ended March 31, 2009 and 2008. The Company's effective tax rate for the three months ended March 31, 2009 and 2008 were 14.7% and 10.7%, respectively. The Company's effective tax rate is subject to variability depending on the income produced in the jurisdictions in which the Company operates. The effective tax rate for the three months ended March 31, 2008 was favorably impacted by the reversal of the valuation allowance related to the net operating loss of PXRE Corporation.

Segment Results

The Company is primarily engaged in writing property and casualty insurance and reinsurance. The Company has four ongoing reporting segments: Excess and Surplus Lines, Commercial Specialty, Reinsurance and International Specialty. Additionally, the Company has a Run-off Lines segment for products that it no longer writes.

In evaluating the operating performance of its segments, the Company focuses on core underwriting and investing results before consideration of realized gains or losses from the sales of investments. Management excludes realized investment gains and losses from segment results, as decisions regarding the sales of investments are made at the corporate level. Although this measure of profit
(loss) does not replace net income (loss) computed in accordance with GAAP as a measure of profitability, management utilizes this measure of profit (loss) to focus its reporting segments on generating operating income.

Excess and Surplus Lines. The following table summarizes the results of operations for the Excess and Surplus Lines segment for the three months ended March 31, 2009 and 2008:

                                                          Three Months Ended
                                                               March 31
      (in millions)                                        2009          2008
      Gross written premiums                            $    146.1      $ 160.1

      Earned premiums                                   $    132.4      $ 128.5
      Losses and loss adjustment expenses                     79.7         74.2
      Underwriting, acquisition and insurance expense         46.4         43.0

      Underwriting income                                      6.3         11.3
      Net investment income                                   17.7         15.6

      Income before income taxes                        $     24.0      $  26.9

      Loss ratio                                              60.2 %       57.7 %
      Expense ratio                                           34.9 %       33.5 %

      Combined ratio                                          95.1 %       91.2 %

The increase in earned premiums for the three months ended March 31, 2009 as compared to the same period in 2008 was primarily attributable to the termination of a ceded quota share reinsurance contract in April 2008. Earned premiums ceded under this contract were $17.9 million for the three months ended March 31, 2008. The decline in gross written premiums was primarily due to market conditions. The excess and surplus lines market place continues to experience increased competition, from both other excess and surplus lines carriers as well as the standard markets, which has led to lower rates and business shifting to the standard markets. Pricing in the Excess and Surplus Lines segment has declined moderately for the three months ended March 31, 2009 as compared to the same period in 2008. The number of policies written during the three months ended March 31, 2009 has declined slightly as compared to the same period ended 2008 while the average policy size for the three months ended March 31, 2009 declined slightly compared to the same period ended 2008.

Losses and loss adjustment expenses for the three months ended March 31, 2009 resulted in a loss ratio of 60.2%, compared to 57.7% for the same period in 2008. Included in losses and loss adjustment expense for the three months ended March 31, 2009 was $5.4 million in favorable loss reserve development on prior accident years, primarily attributable to the professional liability, property and excess casualty lines. Partially offsetting this favorable development was $2.0 million of unfavorable loss reserve development on prior accident years within the primary casualty lines and due to the settlement of a large claim. Included in losses and loss adjustment expenses for the three months ended March 31, 2008 was $5.1 million in favorable loss reserve development for the 2004 and prior accident years, primarily within the liability lines of business. Loss reserves for the Excess and Surplus Lines segment were $1,285.8 million and $1,134.0 million as of March 31, 2009 and 2008, respectively.

The increase in the expense ratio to 34.9% for the three months ended March 31, 2009 as compared to 33.5% for the same period ended 2008 was attributable to rate declines and reduced premium volumes.

Investment income increased to $17.7 million for the three months ended March 31, 2009 from $15.6 million for the same period in 2008. The increase was primarily attributable to an increase in the invested asset balance, due to positive cash flows. Net invested assets were $1,619.5 million as of March 31, 2009, compared to $1,439.7 million as of March 31, 2008.

Commercial Specialty. The following table summarizes the results of operations for the Commercial Specialty segment (formerly known as the Select Markets segment) for the three months ended March 31, 2009 and 2008:

                                                          Three Months Ended
                                                               March 31
      (in millions)                                        2009          2008
      Gross written premiums                            $    111.0      $ 137.3

      Earned premiums                                   $     92.5      $  82.1
      Losses and loss adjustment expenses                     58.3         53.3
      Underwriting, acquisition and insurance expense         26.3         23.0

      Underwriting income                                      7.9          5.8
      Net investment income                                    8.2          7.3
      Fee income                                               0.5           -
      Other expenses                                           0.9           -

      Income before income taxes                        $     15.7      $  13.1

      Loss ratio                                              63.0 %       65.0 %
      Expense ratio                                           28.4 %       28.1 %

      Combined ratio                                          91.4 %       93.1 %

The increase in earned premiums for the three months ended March 31, 2009 as compared to the same period in 2008 was primarily attributable to growth within the public entity products lines due to an acquisition in the first quarter of 2008. Earned premiums for the public entity products increased from $24.9 million for the three months ended March 31, 2008 to $31.0 million for the same period in 2009. Increased gross written premiums in the specialty programs and surety lines comprised the remaining growth in earned premiums for the three months ended March 31, 2009 as compared to the same period in 2008. Gross written premiums for the three months ended March 31, 2008 included $14.7 million resulting from the renewal of a large account which was not renewed in 2009. In addition, 2009 experienced reduced premiums associated with the state funds program.

Losses and loss adjustment expenses for the three months ended March 31, 2009 resulted in a loss ratio of 63.0%, compared to 65.0% for the same period in 2008. The decline in the loss ratio in 2009 as compared to 2008 was primarily due to $1.5 million in additional reserves recorded in the three months ended March 31, 2008 for the 2008 accident year due to higher than expected losses in the public entity products, primarily in the casualty and automobile physical damage product lines. Included in losses and loss

adjustment expenses for the three months ended March 31, 2008 was $1.6 million in favorable loss reserve development in the property lines for the 2007 accident year. Partially offsetting the favorable loss reserve development was unfavorable loss reserve development for the automobile physical damage lines for the 2007 accident year. Loss reserves for the Commercial Specialty segment were $577.8 million and $501.2 million as of March 31, 2009 and 2008, respectively.

The expense ratios for the three months ended March 31, 2009 and 2008 were 28.4% and 28.1%, respectively. The increase in the expense ratio was primarily attributable to reduced ceding commissions received on the state fund programs due to lower premium volumes.

. . .