The following is a discussion and analysis of the financial condition and results of operations for the three and nine months ended September 30, 2009 of Endurance Specialty Holdings Ltd. ("Endurance Holdings") and its wholly-owned subsidiaries (collectively, the "Company"). This discussion and analysis should be read in conjunction with the unaudited condensed consolidated financial statements and related notes contained in this Quarterly Report on Form 10-Q (this "Form 10-Q") as well as the audited consolidated financial statements and related notes for the fiscal year ended December 31, 2008, the discussions of critical accounting policies and the qualitative and quantitative disclosure about market risk contained in Endurance Holdings' Annual Report on Form 10-K for the fiscal year ended December 31, 2008 as amended on May 8, 2009 (the "2008 Annual Report on Form 10-K").
Some of the information contained in this discussion and analysis or set forth elsewhere in this Form 10-Q, including information with respect to the Company's plans and strategy for its business, includes forward-looking statements that involve risk and uncertainties. Please see the section "Cautionary Statement Regarding Forward-Looking Statements" below for more information on factors that could cause actual results to differ materially from the results described in or implied by any forward-looking statements contained in this discussion and analysis. You should review the "Risk Factors" set forth in the 2008 Annual Report on Form 10-K for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained herein. Overview
Endurance Holdings was organized as a Bermuda holding company on June 27, 2002 and has the following wholly-owned operating subsidiaries:
• Endurance Specialty Insurance Ltd. ("Endurance Bermuda"), domiciled in Bermuda with branch offices in Zurich and Singapore;

• Endurance Worldwide Insurance Limited ("Endurance U.K."), domiciled in England;

• Endurance Reinsurance Corporation of America ("Endurance U.S. Reinsurance"), domiciled in Delaware;

• Endurance American Insurance Company ("Endurance American"), domiciled in Delaware;

• Endurance American Specialty Insurance Company ("Endurance American Specialty"), domiciled in Delaware;

• Endurance Risk Solutions Assurance Co. ("Endurance Risk Solutions"), domiciled in Delaware; and

• American Agri-Business Insurance Company and ARMtech Insurance Services, Inc. (collectively "ARMtech"), both domiciled in Texas.

The Company writes specialty lines of property and casualty insurance and reinsurance on a global basis and seeks to create a portfolio of specialty lines of business that are profitable and have limited correlation with one another. The Company's portfolio of specialty lines of business is organized into two business segments, Insurance and Reinsurance.

In the Insurance segment, the Company writes property, casualty, healthcare liability, workers' compensation, agriculture and professional lines insurance. In the Reinsurance segment, the Company writes casualty, property, catastrophe, agriculture, aerospace and marine and surety and other specialty reinsurance. The Company's Insurance and Reinsurance segments both include property related coverages which provide insurance or reinsurance of an insurable interest in tangible property for property loss, damage or loss of use. In addition, the Company's Insurance and Reinsurance segments include various casualty insurance and reinsurance coverages, which are primarily concerned with the losses caused by injuries to third parties, i.e., not the insured, or to property owned by third parties and the legal liability imposed on the insured resulting from such injuries.
Application of Critical Accounting Estimates The Company's condensed consolidated financial statements are based on the selection of accounting policies and the application of significant accounting estimates, which require management to make significant estimates and assumptions. The Company believes that some of the more critical judgments in the areas of accounting estimates and assumptions that affect its financial condition and results of operations are related to reserves for losses and loss expenses, valuation of investments, the recognition of premiums written and ceded and the recognition of contingencies. For a detailed discussion of the Company's critical accounting estimates, please refer to the 2008 Annual Report on Form 10-K. There were no material changes in the application of the Company's critical accounting estimates subsequent to that report with the exception of changes to the Company's method of applying its critical accounting estimates related to its invested assets as required by new accounting guidance and described below. Management has discussed the application of these critical accounting estimates with the Company's Board of Directors and the Audit Committee of the Board of Directors.
Investments. The Company currently classifies all of its fixed income investments, which consist of fixed maturity investments, short term investments and preferred equity securities, as "available for sale" and, accordingly, they are carried at estimated fair value, with related net unrealized gains or losses excluded from earnings and included in shareholders' equity as a component of accumulated other comprehensive income. The Company determines the fair value of its fixed income investments in accordance with current accounting guidance, which defines fair value and establishes a fair value hierarchy based on inputs to the various valuation techniques used for each fair value measurement. The use of valuation techniques for any given investment requires a significant amount of judgment and consideration of factors specific to the underlying investment. Fair value measurements determined by the Company seek to maximize observable inputs and minimize the use of unobservable inputs. Current accounting guidance establishes three levels as follows:
Level 1: Unadjusted quoted prices in active markets for identical assets or liabilities.
Level 2: Quoted prices for similar assets in markets that are active, quoted prices for identical or similar assets in markets that are not active or inputs that are observable either directly or indirectly. Level 2 inputs include quoted prices for similar assets or liabilities other than quoted prices in Level 1; quoted prices in markets that are not active; or other inputs that are observable or can be derived principally from or corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3: Unobservable inputs that are supported by little or no market activity and are significant to the fair value of the assets or liabilities. Unobservable inputs reflect the Company's own views about the assumptions that market participants would use in pricing the asset or liability. Level 3 assets and liabilities include financial instruments whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

The Company determines the estimated fair value of each individual security utilizing the highest level inputs available.
The Company uses quoted values and other data provided by nationally recognized independent pricing sources as inputs into its process for determining fair values of its fixed income investments. The Company obtains multiple prices for its securities where available. Pricing sources used in pricing the Company's fixed income investments at September 30, 2009 were as follows:

                            Pricing services     14.2 %
                            Index providers      51.5 %
                            Broker/dealers       34.3 %

Pricing Services and Index Providers. Pricing services, including index providers, provide pricing for less-complex, liquid securities based on market quotations in active markets. For securities that do not trade on a listed exchange, these pricing services may use a matrix pricing consisting of observable market inputs to estimate the fair value of a security. These observable market inputs include: reported trades, benchmark yields, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data, and industry and economic factors. Additionally, pricing services may use a valuation model such as an option adjusted spread model commonly used for estimating fair values of mortgage-backed and asset-backed securities. At September 30, 2009, the Company has not adjusted any pricing provided by independent pricing services and index providers and have classified all such securities as Level 2.
Broker/Dealers. Generally, the Company obtains quotes directly from broker/dealers who are active in the corresponding markets when prices are unavailable from independent pricing services or index providers. Broker/dealer quotes may also be used if the pricing from pricing services or index providers is not reflective of current market levels, as detected by our pricing control tolerance procedures. Generally, broker/dealers value securities through their trading desks based on observable market inputs. Their pricing methodologies include mapping securities based on trade data, bids or offers, observed spreads and performance on newly issued securities. They may also establish pricing through observing secondary trading of similar securities. Quotes from broker/dealers are all non-binding. At September 30, 2009, the Company has not adjusted any pricing provided by broker/dealers and has classified all such securities as Level 2.

As described above, independent pricing services, index providers and broker/dealers have their own method for determining the fair value of securities. As such, prices provided by independent pricing services, index providers and independent broker quotes can vary widely, even for the same security, and may have a material effect on the estimated fair values of the Company's securities. If the Company determines that there has been a significant decrease in the volume and level of trading activity for the securities in relation to the normal market activity for such security (or similar securities), then transactions or quoted prices may not accurately reflect fair value and, if there is evidence that the transaction for the security is not orderly, the Company may place less weight on the transaction price as an indicator of fair value. To validate the techniques or models used by pricing sources, the Company's review process includes, but is not limited to:
(i) quantitative analysis (e.g., comparing the quarterly return for each managed portfolio to its target benchmark, with significant differences identified and investigated);

(ii) initial and ongoing evaluation of methodologies used by outside parties to calculate fair value; and

(iii) comparing the fair value estimates to its knowledge of the current market.

Based on the above review, the Company will challenge any prices for a security, which are not considered representative of fair value.
The Company's available for sale investments are comprised of a variety of different securities, which are grouped based on the valuation technique and inputs used in their valuation. The valuation of current issue U.S. government securities is generally based on Level 1 inputs, which use the market approach valuation technique. The valuation of the Company's other available for sale investments, including non-current U.S. government and agency securities, U.S. state, municipal and foreign government securities, corporate debt, U.S. agency and non-agency residential and commercial mortgage-backed securities, asset-backed securities, short term investments and preferred equity securities generally incorporate significant Level 2 inputs using the market and income approach techniques. Level 3 includes any available for sale investments that use unobservable inputs, which will vary from period to period.
For mortgage-backed and other asset-backed debt securities, fair value includes estimates regarding prepayment assumptions, which are based on current market conditions. Amortized cost in relation to these securities is calculated using a constant effective yield based on anticipated prepayments and the estimated economic life of the security. When actual prepayments differ significantly from anticipated prepayments, the effective yield is recalculated to reflect actual payments to date. For the majority of these securities, changes in estimated yield are recorded on a retrospective basis, resulting in future cash flows determining current book value.
Other than Temporary Impairment. Following a determination of fair value, the Company reviews its fixed income investments to determine whether any declines in the fair value below the amortized cost basis of its fixed income investments are other-than-temporary.
If the Company determines that a decision to sell the security has been made or that it is more likely than not that the Company will be required to sell the security, the Company deems the security to be other-than-temporarily impaired and writes down the value to fair value, thereby establishing a new cost basis. The amount of the write-down is recognized in earnings as an other-than-temporary impairment ("OTTI") loss.

For the remaining fixed income securities in an unrealized loss position for which a decision to sell has not been made and it is more likely that the Company will not be required to sell, the Company performs additional reviews to determine whether the investment will recover its amortized cost. Analysis and reviews performed to determine if the amortized cost of the Company's fixed income securities is likely to be recovered include the following actions, among others, depending on the type of security being reviewed or tested:
• Analysis to determine cash flow projections under base and stressed case scenarios using historical information to determine significant inputs such as expected default rates, delinquency rates, foreclosure costs, etc.;

• Review of credit ratings, expected loss tables by ratings, default rated securities, sector weaknesses and business prospects;

• Review of information obtained from asset managers, credit agencies and industry reports or other publicly available information;

• Review of the time period in which there has been a significant decline in value; and

• Review of the payment structure of the security, whether scheduled interest and principal payments have been made, current levels of subordination and any guarantees, if applicable.

If the amortized cost of the Company's fixed income securities is, based upon the judgment of management, unlikely to be recovered, the Company writes down the investment by the amount representing the credit related portion of the decline in value, thereby establishing a new cost basis. The amount of the write-down is recognized in earnings as an OTTI loss. The new cost basis is not changed for subsequent recoveries in fair value.
To the extent the Company determines that the amortized cost of the Company's fixed income securities is likely to be recovered and related to other factors (such as interest rates, market conditions, etc.) and not due to credit related factors, that remaining non-credit portion of the unrealized loss is recorded as a part of accumulated other comprehensive income in the shareholders' equity section of the Company's balance sheet.
Other Investments. Other investments are accounted for using the equity method of accounting whereby the initial investment is recorded at cost. The carrying value of these investments are increased or decreased to reflect the Company's share of income or loss, which is included in net investment income, and are decreased for dividends. Due to the timing of the delivery of the final valuations reported by the managers of certain of our alternative funds, our investments in those alternative funds are estimated based on the most recently available information including period end valuation statements, period end estimates, or, in some cases, prior month or quarter valuation statements.

Consolidated results of operations - for the three month periods ended September 30, 2009 and 2008
Results of operations for the three months ended September 30, 2009 and 2008 were as follows:

                                                              Three Months Ended
                                                     September 30,           September 30,
                                                          2009                   2008             Change(1)
                                                        (U.S. dollars in thousands, except for ratios)
Revenues
Gross premiums written                             $          469,622       $       624,144            (24.8 %)
Ceded premiums written                                        (72,956 )            (130,121 )          (43.9 %)

Net premiums written                                          396,666               494,023            (19.7 %)

Net premiums earned                                           426,754               509,629            (16.3 %)
Net investment income                                          71,559                27,410            161.1 %
Net realized gains (losses) on investment sales                 1,396                (7,574 )             NM (2)
Net impairment losses recognized in earnings                     (497 )             (22,495 )          (97.8 %)
Other underwriting income (loss)                                    5                (2,712 )             NM (2)

Total revenues                                                499,217               504,258             (1.0 %)


Expenses
Losses and loss expenses                                      211,683               445,501            (52.5 %)
Acquisition expenses                                           63,026                70,598            (10.7 %)
General and administrative expenses                            64,436                57,771             11.5 %
Amortization of intangibles                                     2,588                 2,588                -
Net foreign exchange (gains) losses                            (2,963 )              15,477               NM (2)
Interest expense                                                7,540                 7,535              0.1 %
Income tax (benefit) expense                                     (935 )               4,180               NM (2)


Net income (loss)                                  $          153,842       $       (99,392 )             NM (2)


Net loss ratio                                                   49.6 %                87.4 %          (37.8 )
Acquisition expense ratio                                        14.8 %                13.8 %            1.0
General and administrative expense ratio                         15.1 %                11.4 %            3.7

Combined ratio                                                   79.5 %               112.6 %          (33.1 )

(1) With respect to ratios, changes show increase or decrease in percentage points.

(2) Not meaningful

Premiums
Gross premiums written in the three months ended September 30, 2009 were $469.6 million, a decrease of $154.5 million, or 24.8%, compared to the same period in 2008. Net premiums written in the three months ended September 30, 2009 were $396.7 million, a decrease of $97.3 million, or 19.7% compared to the same period in 2008. The change in net premiums written was driven by the following factors:
• Declines in net premiums written in the agriculture line of the Insurance segment due to lower commodity prices;

• Declines in net premiums written in the workers' compensation and property lines of the Insurance segment, as a result of the Company's exit from the California workers' compensation and U.K. property insurance markets in the first quarter of 2009. These lines contributed $43.4 million to net premiums written during the same period in 2008;

• Absence of $21.4 million of reinstatement premiums in the catastrophe line of the Reinsurance segment which were recorded in the third quarter of 2008 as a result of Hurricanes Ike and Gustav; and

• Growth in the professional lines, casualty and healthcare liability lines of the Insurance segment resulting from expanded underwriting capabilities and increased market penetration.

Net premiums earned for the three months ended September 30, 2009 were $426.8 million, a decrease of $82.8 million, or 16.3% from the third quarter of 2008 principally driven by the decline in net premiums written. Net Investment Income
Endurance's net investment income of $71.6 million represents an increase of 161.1% or $44.1 million for the quarter ended September 30, 2009 as compared to the same period in 2008. Net investment income during the third quarter of 2009 included net gains of $30.4 million on its alternative investments and high yield loan funds, included in other investments, as compared to a loss of $32.8 million in the third quarter of 2008. Investment income generated from the Company's fixed income securities, which consist of fixed maturity investments, short term investments and preferred equity securities, decreased by $19.1 million in comparison to the same period in 2008 due to lower reinvestment rates during the current period and a higher allocation of the Company's investment portfolio to cash and cash equivalents and shorter duration securities. Investment expenses for the third quarter of 2009, including investment management fees, were $2.7 million, which was generally consistent with the same period in 2008.
The annualized net earned yield and total return on the investment portfolio for the three months ended September 30, 2009 and 2008 as well as the market yield and portfolio duration as of September 30, 2009 and 2008 were as follows:

                                                      Three Months Ended
                                              September 30,         September 30,
                                                  2009                  2008
   Annualized net earned yield(1)                       4.98 %                1.95 %
   Total return on investment portfolio(2)              3.66 %               (2.15 %)
   Market yield(3)                                      3.08 %                5.62 %
   Portfolio duration(4)                                2.27                  3.17

(1) The actual net earned income from the investment portfolio after adjusting for expenses and accretion and amortization from the purchase price divided by the average book value of assets.

(2) Includes realized and unrealized gains and losses.

(3) The internal rate of return of the investment portfolio based on the given market price or the single discount rate that equates a security price (inclusive of accrued interest) for the portfolio with its projected cash flows. Excludes other investments and operating cash.

(4) Includes only cash and cash equivalents and fixed income investments managed by the Company's internal and external investment managers. Excludes other investments and operating cash.

During the third quarter of 2009, the yield on the benchmark five year U.S. Treasury bond fluctuated within a 60 basis points range, with a high of 2.82% and a low of 2.22%. Trading activity in the Company's portfolio included a reduction of cash equivalents, foreign government securities, agency and non-agency residential mortgages and an increase in asset-backed securities, U.S. government guaranteed corporate securities and corporate securities from prior periods. The duration of the Company's fixed income investments has decreased compared to September 30, 2008 primarily due to the increased allocation to short term investments and the purchase of shorter duration government guaranteed corporate securities. Investment Portfolio Composition
As of September 30, 2009, the Company continued to maintain an investment portfolio with an average credit rating of AAA. At September 30, 2009, the Company's fixed income investments consisted of both mortgaged-backed and asset-backed securities, which comprised 35.0% of total invested assets, including pending securities transactions, fixed maturity investments, short term investments, preferred equity, cash and cash equivalents and other investments. The Company, along with its investment managers, monitors the nature and type of assets underlying these types of securities. At September 30, 2009, the Company's portfolio held no sub-prime mortgage exposure, and the Company's Alt-A exposure represented 1.42% of the Company's fixed income investments. Of the Company's Alt-A exposure, 83.2% are fixed rate securities. In the third quarter of 2009, the Company's investment portfolio experienced rating downgrades on securities with fair values of $260.1 million and amortized costs of $287.4 million as of September 30, 2009, primarily within its non-agency residential mortgage-backed securities holdings. Net Realized Gains (Losses) on Investment Sales The Company's investment portfolio is managed to preserve capital and liquidity while generating income and growth in book value. The portfolio is adjusted and rebalanced to meet the Company's objectives, resulting in the realization of net gains or losses which are dependent on movements in financial markets and interest rates and the timing of investment sales. Proceeds from sales of investments classified as available for sale during the three months ended September 30, 2009 were $337.9 million compared to $1,145.0 million during the three months ended September 30, 2008. Net realized investment gains (losses) on investment sales for the three months ended September 30, 2009 and 2008 were as follows:

                                                          Three Months Ended
                                                   September 30,       September 30,
                                                       2009                2008
                                                      (U.S. dollars in thousands)
Gross realized gains on investment sales          $        11,219     $         6,557
Gross realized losses on investment sales                  (9,823 )           (14,131 )

Net realized gains (losses) on investment sales   $         1,396     $        (7,574 )

. . .