The following is a discussion and analysis of the Company's results of operations for the three and nine months ended September 30, 2009 compared with the three and nine months ended September 30, 2008, and also a discussion of the Company's financial condition as of September 30, 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 estimating 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.

Generally, it is the Company's policy to communicate events that may have a material adverse impact on the Company's operations or financial position, including property and casualty catastrophic events and material losses in the investment portfolio, in a timely manner through a public announcement. It is also the Company's policy not to make public announcements regarding events that are believed have no material impact on the Company's results of operations or financial position based on management's current estimates and available information, other than through regularly scheduled calls, press releases or filings.

Results of Operations

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



                                                      Three Months Ended            Nine Months Ended
                                                         September 30,                September 30,
(in millions)                                         2009           2008          2009           2008
Gross written premiums                              $   505.8       $ 477.7      $ 1,573.9      $ 1,221.9

Earned premiums                                     $   347.2       $ 322.8      $ 1,062.8      $   803.4
Net investment income                                    31.9          38.8          113.1          113.4
Fee income                                                4.0           8.2            6.3           10.2
Realized investment and other gains (losses), net         0.7         (18.4 )        (20.3 )        (18.3 )

Total revenue                                       $   383.8       $ 351.4      $ 1,161.9      $   908.7

Income (loss) before income taxes                   $    37.4       $  (6.4 )    $    91.3      $    64.5
Provision for income taxes                                9.8           2.4           14.8           13.4

Net income (loss)                                   $    27.6       $  (8.8 )    $    76.5      $    51.1

Loss ratio                                               60.0 %        70.8 %         60.7 %         65.3 %
Expense ratio                                            38.6 %        35.4 %         36.2 %         35.8 %

Combined ratio                                           98.6 %       106.2 %         96.9 %        101.1 %

The increase in consolidated gross written and earned premiums for the three and nine months ended September 30, 2009 as compared to the same periods in 2008 was primarily attributable to the operations of Argo International (acquired effective May 31, 2008), and to a reduction in ceded premiums under a quota share reinsurance contract within the Excess and Surplus Lines segment. Earned premiums resulting from Argo International were $95.6 million and $320.8 million for the three and nine months ended September 30, 2009, respectively, compared to $80.4 million and $111.7 million for the same periods in 2008. Earned premiums within the Excess and Surplus lines segment for the three and nine months ended September 30, 2008 were reduced by $11.1 million and $44.6 million, respectively, for earned premiums ceded under a quota share reinsurance contract that was terminated in 2008. Earned premiums for the three and nine months ended September 30, 2008 were reduced by $3.4 million for net reinstatement premiums related to property catastrophe reinsurance contracts. Most of the Company's product lines have experienced increased competition and/or reduced rates during 2009, with the exception of Argo Re where property catastrophe pricing has increased relative to 2008.

Consolidated net investment income decreased for the three and nine months ended September 30, 2009 as compared to the same periods in 2008 due to lower investment yields partially offset by higher invested asset balances resulting from positive cash flows from operations. Additionally, included in consolidated net investment income for the nine months ended September 30, 2009 was $4.5 million in interest received from the state of California related to a tax settlement. Total invested assets at September 30, 2009 and 2008 were $4,087.0 million and $3,770.5 million, respectively, net of $230.0 million and $239.1 million of invested assets attributable to Argo International's trade capital providers.

Consolidated fee income represents commissions and other fees earned by the Company for 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 and profit commission from managing third party capital for certain syndicates at Lloyd's. Consolidated fee income was $4.0 million and $6.3 million for the three and nine months ended September 30, 2009, compared to $8.2 million and $10.2 million for the same periods in 2008. The decline in fee income was principally the result of reduced profit commissions due to the decline in operating profits in the International Specialty segment.

Consolidated realized investment and other gains, net, for the three months ended September 30, 2009 were $0.7 million compared to $18.4 million realized loss for the same period in 2008. Consolidated realized investment and other losses, net, for the nine months ended September 30, 2009 was $20.3 million compared to $18.3 million for the same period in 2008. Included in realized investment losses for the three and nine months ended September 30, 2009 were $8.8 million and $36.6 million, respectively, of realized loss due to the recognition of other-than-temporary impairments, compared to $20.1 million and $29.1 million for the same periods in 2008. Included in the other-than-temporary-impairment charge for the three and nine months ended September 30, 2009 was $7.4 million and $13.4 million of foreign currency exchange loss on securities the Company intends to sell or has subsequently has sold. If individual securities are determined to have an other-than-temporary impairment, the security is written down to its fair value. Partially offsetting these realized losses for the nine months ended September 30, 2008 was a realized gain on the sale of PXRE Reinsurance Company of $2.3 million (which closed in the first quarter of 2008) and realized gains from the sale of securities totaling $8.4 million.

Consolidated losses and loss adjustment expenses were $208.3 million and $644.6 million for the three and nine months ended September 30, 2009, respectively, compared to $228.4 million and $524.7 million for the same period in 2008. The consolidated loss ratios for the three and nine months ended September 30, 2009 were 60.0% and 60.7%, respectively, compared to 70.8% and 65.3% for the same periods in 2008. Included in losses and loss adjustment expenses for the three and nine months ended September 30, 2008 was $56.5 million in losses resulting from hurricanes Gustav and Ike. Included in losses and loss adjustment expenses for the nine months ended September 30, 2009 was $10.0 million in net unfavorable 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 nine months ended September 30, 2009:

                               Net Reserves at                        Percent of Net
                                December 31,       Net Reserve         Reserves by
  (in millions)                     2008           Development       Line of Business
  General liability           $           909.9   $        (9.0 )                -1.0 %
  Workers compensation                    465.4            (0.7 )                -0.2 %
  Commercial multi-peril                  190.2             5.4                   2.8 %
  Commercial auto liability               145.7             7.3                   5.0 %
  Special property                         19.0             0.8                   4.2 %
  Auto physical damage                     10.0            (4.1 )               -41.0 %
  Argo International                      239.5            24.4                  10.2 %
  Argo Re                                  30.0            (6.7 )               -22.3 %
  PXRE Legacy                              97.6            (8.5 )                -8.7 %
  All other lines                           8.3             1.1                  13.2 %

  Total all lines             $         2,115.6   $        10.0                   0.5 %

The net unfavorable development (for the nine months ended September 30, 2009) as related to total net reserves for losses and loss adjustment expenses as of December 31, 2008 represents $10.0 million or less than 1.0% of total reserves outstanding at December 31, 2008. The favorable development in the auto physical damage line of business resulted from better than expected loss frequency and severity. The unfavorable reserve development for the commercial auto liability line was primarily attributable to increased frequency and severity. The general liability line of business had $16.6 million favorable prior accident year loss development primarily within the Excess and Surplus Lines and Commercial Specialty segments, partially offset by $7.6 million of unfavorable reserve development in the Run-off Lines segment, primarily for certain asbestos and environmental claims. The revised reserve estimates for the Argo International net loss reserves developed unfavorably by $24.4 million primarily driven by the property binder book of business written in prior accident years. The unfavorable development recognized related to Argo International was partially offset by $22.8 million of additional estimated ultimate premium within the same property binder book of business. The revised estimate for the PXRE Legacy net loss reserves developed favorably by $8.5 million, with $2.2 million representing a reforecast of the 2005 hurricane losses. Argo Re reserves had favorable development of $6.7 million, with $3.2 million representing a reforecast of hurricane Ike losses.

In determining appropriate reserve levels as of September 30, 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, actuarial reviews relied to a large extent on the paid and incurred Bornhuetter-Ferguson methodologies. 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 September 30, 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.

The Company's loss reserve estimates gradually blend in the results from other methodologies over time. For general liability, more credibility is assigned to methods that rely more heavily on the Company's actual paid and reported loss experience as the accident year matures. For property business where losses are reported and settled more quickly, more credibility is assigned to methods that rely more heavily on the Company's actual paid and reported loss experience at an earlier point of maturity.

While prior accident years' net reserves for losses and loss adjustment expenses for some lines of business have developed favorably in recent periods, 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. Since accident year 2007, pricing for the Company's products has been 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 $3,186.9 million (including $235.1 million of reserves attributable to trade capital providers) and $2,987.4 million
(including $187.4 million of reserves attributable to trade capital providers)
as of September 30, 2009 and 2008, respectively. Management has recorded its best estimate of loss reserves as of September 30, 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, insurance and acquisition expenses were $134.1 million and $384.9 million for the three and nine months ended September 30, 2009, respectively, compared to $114.2 million and $287.8 million for the same periods in 2008. Consolidated expense ratios were 38.6% and 36.2% for the three and nine months ended September 30, 2009, respectively, compared to 35.4% and 35.8% for the same periods in 2008. The higher expense ratios for 2009 were primarily attributable to increased commission expense within the Excess and Surplus Lines and International Specialty. Included in the three and nine months ended September 30, 2009 and 2008, was $4.8 million and $5.8 million, respectively, of bad debt expense due to the write-off of reinsurance recoverable balances in the Run-off Lines segment as a result of lost arbitrations.

Consolidated interest expense and other were $9.0 million and $27.3 million for the three and nine months ended September 30, 2009, respectively, compared to $11.9 million and $28.4 million for the same periods in 2008. Consolidated interest expense declined from $8.0 million and $22.2 million for the three and nine months ended September 30, 2008, respectively, to $6.1 million and $19.8 million for the same periods in 2009. The decline in interest expense was the result of more favorable interest rates on the Company's outstanding debt reflecting current market conditions coupled with a $50.0 million reduction in amounts drawn under the Company's revolving credit facility. Included in consolidated interest expense and other for the three and nine months ended September 30, 2009 was $2.9 million and $7.5 million, respectively, of expenses related to the generation of fee income within the Commercial Specialty and International Specialty segments, compared to $3.7 million and $5.7 million for the same

periods in 2008. 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 Lloyd's. The reduction in other expense for the three months ended September 30, 2009 as compared to the same period in 2008 was primarily attributable to the reduction in fee income noted above.

Consolidated foreign currency exchange gain on transactions that are settled in currencies other than U.S. Dollars was $5.0 million for the three months ended September 30, 2009. The foreign currency gain for the three months ended September 30, 2009 was primarily attributable to the movement of non U.S. Dollar net liabilities and foreign exchange rates during the quarter. Consolidated foreign currency exchange loss on transactions that are settled in currencies other than U.S. Dollars was $7.9 million for the nine months ended September 30, 2009. The loss was primarily attributable to the weakening of the U.S. Dollar against the British Pound, the Canadian Dollar and the Euro for business transacted at Argo International.

In June 2009, the Company deemed the value assigned to the trade name of Heritage impaired after an evaluation of the value of the name in the Lloyd's market and the subsequent renaming of Heritage to Argo International. The expense recognized as a result of this impairment was $5.9 million, which represented the unamortized balance as of the impairment date.

Consolidated provision for income taxes was $9.8 million and $2.4 million for the three months ended September 30, 2009 and 2008, respectively. Consolidated provision for income taxes was $14.8 million and $13.4 million for the nine months ended September 30, 2009 and 2008, respectively. Included in the consolidated provision for income taxes for the nine months ended September 30, 2009 was a $5.6 million tax refund received from the state of California due to a favorable tax settlement. Offsetting this tax refund was $6.3 million in tax expense from Argo Financial Holding (Ireland) Ltd to the Internal Revenue Service for withholding on dividends received from Argo Group US. The consolidated provision for income taxes for the nine months ended September 30, 2008 was reduced by $2.6 million for adjustments to the tax liability accounts related to the sale of PXRE Reinsurance Company and a $3.7 million reduction to the deferred tax asset valuation allowance. The consolidated income tax provision for the periods in 2009 and 2008 represents the income tax expense associated with the Company's operations based on the tax laws of the jurisdictions in which they operate.

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 and nine months ended September 30, 2009 and 2008:

                                                      Three Months Ended             Nine Months Ended
                                                        September 30,                  September 30,
(in millions)                                        2009            2008           2009           2008
Gross written premiums                             $   164.5        $ 176.5       $   486.6       $ 516.9

Earned premiums                                    $   138.4        $ 131.4       $   403.9       $ 392.5
Losses and loss adjustment expenses                     91.6           84.4           253.4         242.9
Underwriting, acquisition and insurance expense         47.2           43.4           136.2         129.5

Underwriting (loss) income                              (0.4 )          3.6            14.3          20.1
Net investment income                                   14.8           15.7            49.3          46.5

Income before income taxes                         $    14.4        $  19.3       $    63.6       $  66.6

Loss ratio                                              66.2 %         64.2 %          62.7 %        61.9 %
Expense ratio                                           34.1 %         33.0 %          33.7 %        33.0 %

Combined ratio                                         100.3 %         97.2 %          96.4 %        94.9 %

The increase in earned premiums for the three and nine months ended September 30, 2009 as compared to the same periods in 2008 was primarily attributable to the termination of a ceded quota share reinsurance contract in April 2008. Premiums ceded under this contract reduced earned premiums $11.1 million and $44.6 million for the three and nine months ended September 30, 2008. Earned premiums for the three and nine months ended September 30, 2008 were also reduced by $4.3 million of reinstatement premiums related to property catastrophe reinsurance contracts. 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 and nine months ended September 30, 2009 as compared to the same periods in 2008. Additionally, the Excess and Surplus Lines segment has experienced a shift in both product and policyholder mix, resulting in reduced premium writings.

The Excess and Surplus Lines segment's loss ratios for the three months ended September 30, 2009 and 2008 were 66.2% and 64.2%, respectively. Included in losses and loss adjustment expenses for the three months ended September 30, 2009 was $1.4 million of favorable development on prior accident years primarily in the casualty and professional lines. Additionally, $1.5 million in additional losses were recorded for the 2009 accident year for higher than expected losses primarily in the professional liability and property lines. Included in losses and loss adjustment expenses for the three months ended September 30, 2008 was $12.6 million in losses resulting from hurricanes Gustav and Ike. Offsetting these losses was $12.5 million of favorable loss reserve development for prior accident years primarily driven by favorable reserve development of $7.4 million relating to property lines for the 2006 and 2007 accident years, and $4.4 million for casualty lines of business for the 2003 through 2005 accident years.

Losses and loss adjustment expenses for the nine months ended September 30, 2009 and 2008 resulted in loss ratios of 62.7% and 61.9%, respectively. Included in losses and loss adjustment expenses for the nine months ended September 30, 2009 was $9.7 million in favorable loss reserve development on prior accident years within the casualty, professional liability and property lines. Losses and loss adjustment expenses for the nine months ended September 30, 2008 included the hurricane losses noted above, $6.1 million of other storm losses and $3.9 million of fire and other property losses. Included in losses and loss adjustment expenses for the nine months ended September 30, 2008 was favorable development on prior accident years of $22.6 million, primarily driven by property lines for the 2006 and 2007 accident years and other liability occurrence lines related to accident years 2001 through 2005. Loss reserves for the Excess and Surplus lines segment were $1,334.1 million and $1,223.9 million at September 30, 2009 and 2008, respectively.

Underwriting, insurance and acquisition expenses for the three months ended September 30, 2009 and 2008 resulted in expense ratios of 34.1% and 33.0%, respectively. The increase in the expense ratio was attributable to increased contingent commission expense in 2009 due to the lack of catastrophe losses and to a reduction in the deferral of acquisition expenses due to declining premium volumes. The expense ratio for the nine months ended September 30, 2009 was 33.7% compared to 33.0% for the same period in 2008. The increase in the expense ratio in 2009 as compared to 2008 was attributable to the increased contingent commissions, the reduction in the deferral of acquisition expenses and to increased expenses in the first quarter of 2009 associated with a 2008 acquisition.

The decline in net investment income for the three months ended September 30, 2009 as compared to the same period in 2008 was due to reduced yields. The increase in investment income for the nine months ended September 30, 2009, as . . .