Interim Results

31st Aug 2006 07:43

Lancashire Holdings Limited31 August 2006 Hamilton, Bermuda, 31 August 2006 Lancashire Holdings Limited Unaudited interim consolidated financial statements for the 6 month period to 30 June 2006 This disclosure should be read in conjunction with Lancashire Holdings Limited'sprior announcement of interim results for the six month period ended 30 June2006 on 7 August 2006. On receipt of an opinion review letter from auditors, Ernst & Young, Lancashiretoday discloses its full unaudited interim consolidated financial statements forthe six month period 30 June 2006, including the consolidated income statement,the consolidated balance sheet, the consolidated cash flow statement and thestatement of accounting policies. There is no material change in the results for the six month period ended 30June 2006 from the prior announcement on 7 August 2006. consolidated income statement for the period ended june 30, 2006 notes 2006 2005 $m $m gross premiums written 316.3 2.6outwards reinsurance premiums (71.0) -net premiums written 245.3 2.6change in unearned premiums (241.4) (2.6)change in unearned premiums on premium ceded 60.4 -net premiums earned 64.3 -net investment income 3 24.2 2.1net realised gains (losses) 3 (3.4)net foreign exchange gains (losses) (1.1) 0.3total net revenue 84.0 2.4insurance losses and loss adjustment expenses 7.4 -insurance losses and loss adjustment expenses recoverable - -net insurance losses 7.4 -insurance acquisition expenses 4 7.6 -other operating expenses 5,6 24.2 10.0total expenses 39.2 10.0 results of operating activities 44.8 (7.6)finance costs 5.5 4.0profit (loss) before tax 39.3 (11.6)tax 8 - -profit (loss) for the period attributable to equity shareholders 39.3 (11.6) earnings per sharebasic 23 $0.20 $(0.24)diluted 23 $0.20 $(0.24) consolidated balance sheet as at june 30, 2006 notes 2006 2005 $m $massetscash and cash equivalents 9 215.0 1,072.4accrued interest receivable 13 7.9 2.0investments- fixed income securities 10 866.5 -- equity securities 10 86.9 -reinsurance assets- unearned premium on premium ceded 12 60.4 -deferred acquisition costs 14 29.7 0.5other receivables 13 80.6 0.3inwards premium receivable from insureds and cedants 13 165.0 2.1investment in associate 11 20.0 -property, plant and equipment 17 0.6 0.4total assets 1,532.6 1,077.7 liabilitiesinsurance contracts- losses and loss adjustment expenses 12 7.4 -- unearned premiums 12 244.0 2.6amounts payable to reinsurers 12, 15 32.0 -deferred acquisition costs ceded 16 5.6 -other payables 15 124.7 2.2accrued interest payable 18 0.5 0.4long-term debt 18 127.1 125.4total liabilities 541.3 130.6 shareholders' equityshare capital 20 97.9 97.9share premium 871.4 860.8fair value and other reserves 3 (5.7) -retained earnings (deficit) 27.7 (11.6)total shareholders' equity attributable to equity shareholders 991.3 947.1total liabilities and shareholders' equity 1,532.6 1,077.7 consolidated statement of changes in equity for the six months ended june 30, 2006 fair value retained share share and other (deficit) notes capital premium reserves earnings total $m $m $m $m $m balance as at october 12, 2005 (date of - - - - - -incorporation)loss for the period - - - (11.6) (11.6)total recognised income for the period - - - (11.6) (11.6)issue of share capital 20 97.9 880.7 - - 978.6equity offering expenses - (58.6) - - (58.6)formation expenses - (36.1) - - (36.1)warrant issues - founders & sponsor 21 - 66.4 - - 66.4warrant issues - management 6 - 8.4 - - 8.4balance as at december 31, 2005 97.9 860.8 - (11.6) 947.1profit for the period - - - 39.3 39.3change in investment unrealised gains (losses) 3 - - (5.7) - (5.7)total recognised income for the period - - (5.7) 39.3 33.6warrant issues - management & performance 6 - 9.8 - - 9.8options issues - management 6 - 0.8 - - 0.8balance as at june 30, 2006 97.9 871.4 (5.7) 27.7 991.3 consolidated cash flow statement for the six months ended june 30, 2006 2006 2005 notes $m $m cash flows from operating activities profit (loss) before interest income and expense 19.4 (13.3) interest income 25.0 2.1 interest expense (5.1) (0.4) employee benefits expense 5 10.6 8.4 foreign exchange 1.1 (0.3) realised (gains) losses on investments 3 3.4 - accrued interest receivable (5.9) (2.0) unearned premium on premium ceded (60.4) - deferred acquisition costs (29.2) (0.5) other receivables (80.3) (0.3) inwards premium receivable from insureds and cedants (162.6) (2.1) losses and loss adjustment expenses 7.4 - unearned premiums 241.4 2.6 amounts payable to reinsurers 32.0 - deferred acquisition costs ceded 5.6 - other payables 122.4 1.3 accrued interest payable 0.1 0.4 net cash flows from (used in) operating activities 124.9 (4.1) cash flows from investing activities purchase of property, plant and equipment 17 (0.3) (0.4) investment in associates 11 (20.0) - purchase of debt securities (1,531.2) - purchase of equity securities (85.5) - proceeds on maturity and disposal of debt securities 653.1 - proceeds on disposal of equity securities 1.3 - net cash flows used in investing activities (982.6) (0.4) cash flows from financing activities proceeds from issue of share capital - 978.6 transaction costs from issue of share capital - (12.2) formation expenses - (15.2) proceeds from issue of long-term debt - 125.7 net cash flows from financing activities - 1,076.9 net (decrease) increase in cash and cash equivalents (857.7) 1,072.4 cash and cash equivalents at beginning of period 1,072.4 - effect of exchange rate fluctuations on cash and cash equivalents 0.3 - cash and cash equivalents at end of period 215.0 1,072.4 accounting policies for the six months ended june 30, 2006 summary of significant accounting policies The basis of preparation, consolidation principles and significant accountingpolicies adopted in the preparation of Lancashire Holdings Limited ("LHL") andits subsidiaries' (collectively "the Group") interim consolidated financialstatements are set out below. The interim consolidated financial statements forthe six months ended June 30, 2006 have not been audited. basis of preparation Given the significant development in the Group's business from the last auditedconsolidated financial statements, condensed interim consolidated financialstatements have not been presented. As management's preference is to sharethese developments with shareholders and other users, the Group's interimconsolidated financial statements are prepared in accordance with accountingprinciples generally accepted under International Financial Reporting Standards("IFRS") endorsed by the European Commission. Subsequent interim periodstatements may be prepared in accordance with IAS 34: Interim FinancialReporting. Where IFRS is silent, as it is in respect of the measurement of insuranceproducts, the IFRS framework allows reference to another comprehensive body ofaccounting principles. In such instances, management determine appropriatemeasurement bases, to provide the most useful information to users of theinterim consolidated financial statements, using their judgment and consideringthe accounting principles generally accepted in the United States ("US GAAP"). Comparative figures have been presented for the period from October 12, 2005,the date of incorporation, to December 31, 2005, as the Group was not inexistence at June 30, 2005. The new IFRS 7, Financial Instruments Disclosure, which has been issued but isnot yet effective, has not been applied. IFRS 7 is not expected to have amaterial impact on the results reported in the interim consolidated financialstatements. The interim consolidated balance sheet of the Group is presented in order ofdecreasing liquidity. use of estimates The preparation of financial statements in conformity with IFRS requiresmanagement to make estimates and assumptions that affect the reported anddisclosed amounts at the balance sheet date and the reported and disclosedamounts of revenues and expenses during the reporting period. Actual resultsmay differ materially from the estimates made. basis of consolidation i. subsidiaries The Group's interim consolidated financial statements include the assets,liabilities, equity, revenues, expenses and cash flows of Lancashire HoldingsLimited and its subsidiaries. A subsidiary is an entity in which the Groupowns, directly or indirectly, more than 50% of the voting power of an entity orotherwise has the power to govern the operating and financial policies. Theresults of subsidiaries acquired are included in the interim consolidatedfinancial statements from the date on which control is transferred to the Group. Intercompany balances, profits and transactions are eliminated. Subsidiaries' accounting policies are consistent with the Group's accountingpolicies. ii. associates Investments in which the Group has significant influence over the operationaland financial policies of the investee, are initially recognised at cost andthereafter accounted for using the equity method. Under this method, the Grouprecords its proportionate share of income or loss from such investments in itsresults of operations for the period. Adjustments are made to associates'accounting policies, where necessary, in order to be consistent with the Group'saccounting policies. foreign currency translation The functional currency for all Group entities is United States ("U.S.")dollars. The interim consolidated financial statements are presented in U.S.dollars. Items included in the financial statements of each of the Group'sentities are measured using the functional currency, which is the currency ofthe primary economic environment in which operations are conducted. Foreign currency transactions are recorded in the functional currency for eachentity using the exchange rates prevailing at the dates of the transactions, orat the average rate for the period when this is a reasonable approximation.Monetary assets and liabilities denominated in foreign currencies are translatedat period end exchange rates. The resulting exchange differences on translationare recorded in the interim consolidated income statement. Non-monetary assetsand liabilities carried at historical cost denominated in a foreign currency aretranslated at historic rates. Non-monetary assets and liabilities carried atfair value denominated in a foreign currency are translated at the exchange rateat the date the fair value was determined, with resulting exchange differencesrecorded in the fair value reserves in shareholders' equity. insurance contracts i. classification Insurance contracts are those contracts that transfer significant insurance riskat the inception of the contract. Contracts that do not transfer significantinsurance risk are accounted for as investment contracts. Insurance risk istransferred when an insurer agrees to compensate a policyholder if a specifieduncertain future event adversely affects the policyholder. ii. premiums and acquisitions costs Premiums are first recognised as written at the date that the contract is bound. The Group writes both excess of loss and pro-rata contracts. For the majorityof excess of loss contracts, written premium is recorded based on the minimumand deposit or flat premium, as defined in the contract. Subsequent adjustmentsto the minimum and deposit premium are recognised in the period in which theyare determined. For pro-rata contracts and excess of loss contracts where nodeposit is specified in the contract, written premium is recognised based onestimates of ultimate premiums provided by the insureds or ceding companies.Initial estimates of written premium are recognised in the period in which theunderlying risks incept. Subsequent adjustments, based on reports of actualpremium by the insureds or ceding companies, or revisions in estimates, arerecorded in the period in which they are determined. Premiums are earned ratably over the term of the underlying risk period of thereinsurance contract, except where the period of risk differs significantly fromthe contract period. In these circumstances, premiums are recognised over theperiod of risk in proportion to the amount of insurance protection provided.The portion of the premium related to the unexpired portion of the risk periodis reflected in unearned premium. Where contract terms require the reinstatement of coverage after a cedingcompany's loss, the mandatory reinstatement premiums are recorded as writtenpremium when the loss event occurs. Inwards premiums receivable from insureds and cedants are recorded net ofcommissions, brokerage, premium taxes and other levies on premiums. Thesebalances are reviewed for impairment, with any impairment loss recognised inincome in the period in which they are determined. Acquisition costs represent commissions, brokerage and other variable costs thatrelate directly to the securing of new contracts and the renewing of existingcontracts. They are deferred over the period in which the related premiums areearned, to the extent they are recoverable out of future revenue margins. Allother acquisition costs are recognised as an expense when incurred. iii. outwards reinsurance Outwards reinsurance premiums comprise the cost of reinsurance contracts enteredinto. Outwards reinsurance premiums are accounted for in the period in whichthe underlying risks incept. The provision for reinsurers' share of unearnedpremiums represents that part of reinsurance premiums written which is estimatedto be earned in future financial periods. Unearned reinsurance commissions arerecognised as a liability using the same principles. Any amounts recoverablefrom reinsurers are estimated using the same methodology as the underlyinglosses. The Group monitors the credit worthiness of its reinsurers on an ongoing basisand assesses any reinsurance assets for impairment, with any impairment lossrecognised in income in the period in which it is determined. iv. losses Losses comprise losses and loss adjustment expenses paid in the period andchanges in the provision for outstanding losses, including the provision forlosses incurred but not reported ("IBNR") and related expenses. Losses and lossadjustment expenses are charged to income as they are incurred and are mainlyexternal costs related to the negotiation and settlement of claims. A significant portion of the Group's business is property catastrophe and otherclasses with high attachment points of coverage. Reserving for losses in suchprograms is inherently complicated in that losses in excess of the attachmentlevel of the Group's policies are characterised by high severity and lowfrequency and other factors which could vary significantly as losses aresettled. This limits the volume of industry loss experience available fromwhich to reliably predict ultimate losses following a loss event. In addition,the Group has limited past loss experience due to its short operating history,which increases the inherent uncertainty in estimating ultimate loss levels. Losses and loss adjustment expenses represent the estimated ultimate cost ofsettling all losses and loss adjustment expenses arising from events which haveoccurred up to the balance sheet date, including a provision for IBNR. TheGroup does not discount its liabilities for unpaid losses. Outstanding lossesare initially set on the basis of reports of losses received from third parties. Estimated IBNR reserves consist of a provision for additional development inexcess of case reserves reported by ceding companies or insureds, as well as aprovision for losses which have occurred but which have not yet been reported tous by ceding companies or insureds. IBNR reserves are estimated by managementusing various actuarial methods as well as a combination of our own lossexperience, historical insurance industry loss experience, our underwriters'experience, estimates of pricing adequacy trends, and management's professionaljudgment. The Group's internal actuaries review the reserving assumptions andmethodologies on a quarterly basis and the Group's loss estimates are subject toa semi-annual corroborative review by independent actuaries using generallyaccepted actuarial principles. The estimation of the ultimate liability arising is a complex and judgmentalprocess. It is reasonably possible that uncertainties inherent in the reservingprocess, delays in insureds or ceding companies reporting losses to the Group,together with the potential for unforeseen adverse developments, could lead to amaterial change in losses and loss adjustment expenses. v. liability adequacy tests At each balance sheet date, the Group performs a liability adequacy test usingcurrent best estimates of future cash flows generated by its insurancecontracts, plus any investment income thereon. If, as a result of these tests,the carrying amount of the Group's insurance liabilities is found to beinadequate, the deficiency is charged to the consolidated income statement forthe period initially by writing off deferred acquisition costs and subsequentlyby establishing a provision. cash and cash equivalents Cash and cash equivalents are carried in the interim consolidated balance sheetat cost and includes cash in hand, deposits held on call with banks and othershort-term highly liquid investments with a maturity of three months or less atthe date of purchase. Carrying amounts approximate fair value due to the shortterm nature of the instruments. Interest income earned on cash and cash equivalents is recognised on theeffective interest rate method. The carrying value of accrued interest incomeapproximates fair value due to its short term nature. investments The Group's fixed income and equity investments are classified as available forsale and are carried at fair value. Other investments are recorded at estimatedfair value based on financial information received and other informationavailable to management, including factors restricting the liquidity of theinvestments. Regular way purchases and sales of investments are recognised atfair value less transaction costs on the trade date and are subsequently carriedat fair value. Estimated fair value of quoted investments is determined basedon bid prices from recognised exchanges. Investments are derecognised when theGroup has transferred substantially all of the risks and rewards of ownership.Realised gains and losses are included in income in the period in which theyarise. Unrealised gains and losses from changes in fair value are included inthe fair value reserve in shareholders' equity. On derecognition of aninvestment, previously recorded unrealised gains and losses are removed fromshareholders' equity and included in current period income. Amortisation and accretion of premiums and discounts are calculated using theeffective interest rate method and are recognised in current period netinvestment income. Dividends on equity securities are recorded as revenue onthe date the dividends become payable to the holders of record. The carryingvalue of accrued interest income approximates fair value due to its short termnature. The Group reviews the carrying value of its investments for evidence ofimpairment. An investment is impaired if its carrying value exceeds theestimated recoverable amount and there is objective evidence of impairment tothe asset. Such evidence would include a prolonged decline in fair value belowcost or amortised cost, where other factors do not support a recovery in value. If an impairment is deemed appropriate, the difference between cost oramortised cost and fair value is removed from the fair value reserve inshareholders' equity and charged to current period income. Impairment losses on equity securities are not subsequently reversed. derivative financial instruments Derivatives are recognised at fair value on the date a contract is entered into,the trade date, and are subsequently carried at fair value. Derivativeinstruments with a positive value are recorded as derivative financial assetsand those with a negative value are recorded as derivative financialliabilities. Derivative financial instruments include swap, option, forward and futurecontracts. They derive their value from the underlying instrument and aresubject to the same risks as that underlying instrument, including liquidity,credit and market risk. Fair values are based on exchange quotations, withchanges in the fair value of instruments that do not qualify for hedgeaccounting recognised in current period income. Derivative financial assets and liabilities are offset and the net amountreported in the interim consolidated balance sheet only to the extent there is alegally enforceable right of offset and there is an intention to settle on a netbasis, or to realise the assets and liabilities simultaneously. property, plant and equipment Property, plant and equipment is carried at historical cost, less accumulateddepreciation and any impairment in value. Depreciation is calculated towrite-off the cost over the established useful economic life on a straight-linebasis as follows: IT equipment 33% per annum Office furniture and equipment 33% per annum Leasehold improvements 20% per annum The assets' residual values, useful lives and depreciation methods are reviewedand adjusted if appropriate, at each balance sheet date. An item of property, plant or equipment is derecognised on disposal or when nofuture economic benefits are expected to arise from the continued use of theasset. Gains and losses on the disposal of property, plant and equipment are determinedby comparing proceeds with the carrying amount of the asset, and are included inthe income statement. Costs for repairs and maintenance are charged to theconsolidated income statement as incurred. long term debt Long-term debt is recognised initially at fair value, net of transaction costsincurred. Thereafter it is held at amortised cost, with the amortisationcalculated using the effective interest rate method. leases Rentals payable under operating leases are charged to income on a straight-linebasis over the lease term. employee benefits i. equity compensation plans The Group operates a management warrant plan and an option plan. The fair valueof the equity instrument granted is estimated on the date of grant. The fairvalue is recognised as an expense pro-rata over the vesting period of theinstrument. The total amount to be expensed is determined by reference to thefair value of the awards estimated at the grant date, excluding the impact ofany non-market vesting conditions. At each balance sheet date, the Group revises its estimate of the number ofwarrants and options that are expected to become exercisable. It recognises theimpact of the revision of original estimates, if any, in the consolidated incomestatement, and a corresponding adjustment is made to shareholders' equity overthe remaining vesting period. On vesting or exercise, the differences between the expense charged to theconsolidated income statement and the actual cost to the Group is transferred toretained earnings. Where new shares are issued, the proceeds received arecredited to share capital and share premium. ii. pensions The Group operates a defined contribution plan. On payment of contributions tothe plan there is no further obligation to the Group. Contributions arerecognised as employee benefits in the consolidated income statement in theperiod to which they relate. founder and sponsor warrants The Group issued warrants to certain founding shareholders and a sponsor onlisting. The fair value of the equity instruments granted were estimated on thedate of grant. Warrants issued to founding shareholders were treated as a capital transactionand the associated fair value was credited to the share premium account. Thefair value of warrants issued to the sponsor for assistance with incorporationand other start-up services was credited to the share premium account. Thetotal amount to be credited was determined by reference to the fair value of theawards estimated at the grant date, excluding the impact of any non-marketvesting conditions. taxation Income tax expense represents the sum of the tax currently payable and anydeferred tax. The tax payable is calculated based on taxable profit for theperiod. Taxable profit for the period can differ from that reported in theconsolidated income statement due to certain items which are not tax deductibleor which are deferred to subsequent periods. Deferred tax is recognised on differences between the assets and liabilities inthe consolidated balance sheet and their tax base. Deferred tax assets orliabilities are accounted for using the balance sheet liability method. risk disclosures for the six months ended june, 30 2006 risk disclosures: introduction The Group enters into contracts that directly accept and transfer insurancerisk. This in turn creates exposure for the Group to insurance risk andfinancial risk. The Group's appetite for accepting risk is established by the Board ofDirectors. The management of risks is described below. A. insurance risk The Group underwrites contracts that transfer insurance risk. The Group'sunderwriters assess the likely losses using their experience and knowledge ofpast loss experience and current circumstances. This allows them to estimatethe premium sufficient to meet likely losses and expenses. The Group considersinsurance risk at an individual contract level and at an aggregate portfoliolevel. The Group's exposure in connection with such contracts is, in the eventof insured losses, whether premium will be sufficient to cover the loss paymentsand expenses. The Group underwrites worldwide short tail insurance and reinsurance propertyrisks, including risks exposed to natural catastrophes. The four principalclasses are property, energy, marine and aviation. The Group does not currentlyunderwrite a material amount of casualty business. The level of risk toleranceper class is set by the Board of Directors, who delegate day to dayresponsibility to senior management. A number of controls are deployed to limit the amount of insurance exposureunderwritten: • A business plan is produced annually which targets premium by class • The business plan is monitored and reviewed on an on-going basis • Each authorised class has a pre-determined normal maximum line structure proposed by management and agreed by the Board • The Group has a pre-determined target limit on probabilistic loss of capital for certain catastrophic events • A daily underwriting meeting is held to peer review all risks • Sophisticated pricing models are utilised in the underwriting process, and are updated frequently to latest versions • Computer modeling tools are deployed to simulate catastrophes and resultant losses to the portfolio • Reinsurance is purchased to mitigate losses in peak areas of exposure The Group has established an internal audit function which is independent of theunderwriting process. The head of internal audit reports directly to the AuditCommittee. The internal audit function is required to perform risk reviews onthe underwriting function to ensure compliance with Group policies and requiredprocedures. The Group establishes targets for the maximum proportion of capital, includinglong term debt, that can be lost in a single extreme event. As of June 30,2006, the impact of a 1 in 100 year U.S. hurricane event was 20% of capital,after collection of reinsurance and after payment and collection ofreinstatement premiums. There can be no guarantee that the assumptions andtechniques deployed in calculating this figure are accurate. There could also bean unmodeled loss which exceeds these figures. In addition, a loss with anoccurrence probability of greater than 1 in 100 years could cause a larger lossto capital. The Group commenced underwriting in December 2005, but wrote an insignificantamount of business for the period from incorporation to December 31, 2005.Comparatives have therefore not been presented in the analysis provided insection A: insurance risk. Details of gross premiums written by line of business are provided below for thesix month period ending June 30, 2006: $m % property 129.4 40.9 energy 151.2 47.8 marine 21.7 6.9 aviation 14.0 4.4 total 316.3 100.0 Details of gross premiums written by geographic area of risks insured areprovided below for the six month period ending June 30, 2006: $m % worldwide offshore 111.8 35.3 USA and Canada 79.5 25.1 worldwide (1) 76.2 24.1 worldwide, excluding the US (2) 25.2 8.0 middle east 6.5 2.1 far east 6.1 1.9 others 11.0 3.5 total 316.3 100.0 (1) Worldwide comprises insurance and reinsurance contracts that insure orreinsure risks in more than one geographic area. (2) Worldwide, excluding the U.S. comprises insurance and reinsurance contractsthat insure or reinsure risks in more than one geographic area, but thatspecifically exclude the United States of America and Canada. Sections a to d below describe the risks in each of the four principal classesof business written by the Group. a. property Gross premium written, for the six months through June 30, 2006: $m property retrocession 86.4 property direct and facultative 39.1 terrorism 3.6 property cat excess of loss 0.3 total 129.4 Property retrocession is written on an excess of loss basis through treatyarrangements. Programs are generally written on a pillared basis, with separategeographic zonal limits for risks in the U.S. and Canada and for risks outsidethe U.S. and Canada. The gross limit on exposure to property retrocession risksin 2006 has been limited to $300 million per geographic zone in the aggregate.As at June 30, 2006, the gross exposure is less than $300 million. Reinsurancehas also been purchased to mitigate gross losses in the U.S. and Canada.Property cat excess of loss may be written in a similar manner to propertyretrocession but is not written on a pillared basis. The Group is exposed tolarge catastrophic losses such as wind and earthquake loss from assumingproperty retrocession risks. The Group's appetite and exposure guidelines tolarge losses are set out on page 13. Property direct and facultative is written for the full value of the risk, on aprimary or excess of loss basis. Cover is generally provided to largecommercial enterprises with high value locations. Perils covered are typicallyfire, explosion, flood and business interruption, although catastrophe coversfor wind and earthquake damage may also be given in some cases. Terrorism cover is provided for U.S. and worldwide property risks, but excludesnuclear, chemical and biological coverage in most territories. b. energy Gross premium written, for the six months through June 30, 2006: $m gulf of mexico offshore energy 120.6 worldwide offshore energy 24.4 onshore energy 3.3 other energy 2.9 total 151.2 Energy risks are mostly written on a direct basis. Gulf of Mexico energyprograms cover elemental (natural catastrophe) and non-elemental risks. Thelargest exposure is from hurricanes in the Gulf of Mexico. Exposure to suchevents is controlled and measured through loss modeling but the accuracy of thisexposure analysis is limited by the quality of data and effectiveness of themodeling. It is possible that a catastrophic event exceeds the expected eventloss. The Group's appetite and exposure guidelines to large losses are set outon page 13. Policies have sub-limits on coverage for elemental losses, andsignificant policy restrictions on other areas of cover such as businessinterruption and control of well. Reinsurance protection has been purchased toprotect a portion of loss from elemental energy claims. Non-elemental energyrisks include fire and explosion. Worldwide offshore energy programs are generally for non-elemental risks.Onshore energy risks can include onshore Gulf of Mexico and worldwide energyinstallations and are largely subject to the same loss events as describedabove. Other energy primarily comprises insurance of energy installations underconstruction. c. marine Gross premium written, six months through June 30, 2006 $m marine hull and total loss 5.8 marine P&I clubs 4.7 marine excess of loss 4.3 other marine 6.9 total 21.7 Marine hull and total loss is generally written on a direct basis and coversmarine risks on a worldwide basis primarily for physical damage and loss.Marine P&I is the reinsurance of The International Group of Protection andIndemnity Clubs. Marine excess of loss is generally written on a treaty basis. Other marine includes marine war, which is direct insurance of loss of vesselsfrom war or terrorist attack, and insurance for marine property underconstruction. Marine cargo programs are not normally written. The largestexposure is from physical loss rather than from elemental loss events. d. aviation $m AV 52 14.0 other aviation - total 14.0 Aviation AV52 is written on a direct basis and provides coverage for third partyliability resulting from acts of war or hijack against aircraft. Other aviation business may include aviation hull war risks and industry losswarranty programs in the future, although no such programs had been written byJune 30, 2006. reinsurance The Group, in the normal course of business and in accordance with its riskmanagement practices, seeks to reduce the loss that may arise from events thatcould cause unfavourable underwriting results by entering into reinsurancearrangements. Reinsurance does not relieve the Group of its obligations topolicyholders. Under the Group's reinsurance security policy, reinsurers aregenerally required to be rated A- or better by A.M. Best. The Group considersreinsurers that are not rated or do not fall within the above rating category ona case by case basis, and may require therefore collateral to be posted tosupport obligations. The Group monitors the credit worthiness of its reinsurerson an ongoing basis. The Group purchases excess of loss reinsurance, including industry loss warrantycovers, and proportional reinsurance. To date, the reinsurance purchasedreduces the Group's net exposure to a large natural catastrophe loss in the U.S.which is the Group's largest gross exposure to loss. The Group has notcurrently purchased reinsurance for risks outside the U.S. There is no guarantee that reinsurance coverage will be available to meet allpotential loss circumstances, as it is possible that the cover purchased is notsufficient. Any loss amount which exceeds the program would be retained by theGroup. Some parts of the reinsurance program have limited reinstatementstherefore the number of claims which may be recovered from second or subsequentlosses is limited. insurance liabilities For most insurance and reinsurance companies, the most significant judgment madeby management is the estimation of loss and loss adjustment expense reserves.The estimation of the ultimate liability arising from claims made underinsurance and reinsurance contracts is a critical estimate for the Group. Under generally accepted accounting principles, loss reserves are not permitteduntil the occurrence of an event which may give rise to a claim. As a result,only loss reserves applicable to losses incurred up to the reporting date areestablished, with no allowance for the provision of a contingency reserve toaccount for expected future losses. Claims arising from future catastrophicevents can be expected to require the establishment of substantial reserves fromtime to time. However, loss and loss adjustment expense reserves are maintained to cover theGroup's estimated liability for both reported and unreported claims. Reservingmethodologies that calculate a point estimate for the ultimate losses areutilised, and then a range is developed around the point estimate. The pointestimate represents management's best estimate of ultimate loss and lossadjustment expenses. The Group's internal actuaries review the reservingassumptions and methodologies on a quarterly basis with loss estimates beingsubject to a semi-annual corroborative review by independent actuaries, usinggenerally accepted actuarial principles. The extent of reliance on management judgment in the reserving process differsas to whether the business is insurance or reinsurance, whether it is short-tailor long-tail and as to whether the business is written on an excess of loss oron a pro-rata basis. Over a typical annual period, the Group expects to writeapproximately 70% of programs on a direct basis and 30% as reinsurance.Typically, over 80% of programs are expected to be written on an excess of lossbasis. The Group does not currently write a significant amount of long-tailbusiness. a. insurance versus reinsurance Loss reserve calculations for direct insurance business are not precise in thatthey deal with the inherent uncertainty of future contingent events. Estimatingloss reserves requires management to make assumptions regarding future reportingand development patterns, frequency and severity trends, claims settlementpractices, potential changes in the legal environment and other factors such asinflation. These estimates and judgments are based on numerous factors, and maybe revised as additional experience or other data becomes available or reviewedas new or improved methodologies are developed or as current laws change. Furthermore, as a broker market reinsurer for both excess of loss andproportional contracts, management must rely on loss information reported tobrokers by primary insurers who must estimate their own losses at the policylevel, often based on incomplete and changing information. The informationmanagement receives varies by cedant and may include paid losses, estimated casereserves, and an estimated provision for incurred but not reported losses ("IBNRreserves"). Additionally, reserving practices and the quality of data reportingmay vary among ceding companies which adds further uncertainty to the estimationof the ultimate losses. b. short-tail versus long-tail In general, claims relating to short tail property risks, such as thoseunderwritten by the Group, are reported more promptly by third parties thanthose relating to long tail risks, including the majority of casualty risks.However, the timeliness of reporting can be affected by such factors as thenature of the event causing the loss, the location of the loss, and whether thelosses are from policies in force with primary insurers or with reinsurers. c. excess of loss versus proportional For excess of loss business, management are aided by the fact that each treatyhas a defined limit of liability arising from one event. Once that limit hasbeen reached, there is no further exposure to additional losses from that treatyfor the same event. For proportional treaties, generally an initial estimatedloss and loss expense ratio (the ratio of losses and loss adjustment expensesincurred to premiums earned) is used, based upon information provided by theinsured or ceding company and/or their broker and management's historicalexperience of that treaty, if any, and the estimate is adjusted as actualexperience becomes known. d. time lags There is a time lag inherent in reporting from the original claimant to theprimary insurer to the broker and then to the reinsurer, especially in the caseof excess of loss reinsurance contracts. Also, the combination of low claimfrequency and high severity make the available data more volatile and lessuseful for predicting ultimate losses. In the case of proportional contracts,reliance is placed on an analysis of a contract's historical experience,industry information, and the professional judgment of underwriters inestimating reserves for these contracts. In addition, if available, reliance isplaced partially on ultimate loss ratio forecasts as reported by cedants, whichare normally subject to a quarterly or six month lag. e. uncertainty As a result of the time lag described above, an estimation must be made of IBNRreserves, which consist of a provision for additional development in excess ofthe case reserves reported by ceding companies, as well as a provision forclaims which have occurred but which have not yet been reported by cedingcompanies. Because of the degree of reliance that is necessarily placed onceding companies for claims reporting, the associated time lag, the lowfrequency/high severity nature of much of the business that the Groupunderwrites, and the varying reserving practices among ceding companies, reserveestimates are highly dependent on management judgment and therefore uncertain.During the loss settlement period, which may be years in duration, additionalfacts regarding individual claims and trends often will become known, andcurrent laws and case law may change, with consequent impact on reserving. The claim count on the types of insurance and reinsurance that the Group writes,which are low frequency and high severity in nature, is generally low. For certain catastrophic events there is greater uncertainty underlying theassumptions and associated estimated reserves for losses and loss adjustmentexpenses. Complexity resulting from problems such as policy coverage issues,multiple events affecting one geographic area and the resulting impact on claimsadjusting (including allocation of claims to event and the effect of demandsurge on the cost of building materials and labour) by, and communications from,ceding companies, can cause delays to the timing with which the Group isnotified of changes to loss estimates. In the six months to June 30, 2006, management were not notified or made awareof any losses of a material size. As such, at June 30, 2006 management'sestimates for IBNR represented approximately 100% of total loss reserves. Themajority of the estimate relates to potential claims on non-elemental riskswhere timing delays in cedant reporting may mean losses have occurred whichmanagement were not made aware of by June 30, 2006. B. financial risk disclosures The Group is exposed if proceeds from financial assets are not sufficient tofund obligations arising from its insurance contracts. The Group segments its investment portfolio into two main components: Acategory to meet expected insurance liabilities ("core portfolio") and abalancing category which represents funds in excess of those required to meetexpected insurance liabilities ("surplus portfolio"). The core portfolio needs to be sufficiently liquid to settle claims. The coreportfolio is invested in fixed income securities and cash and cash equivalentsand with a bias towards shorter durations and higher quality assets. The surplus portfolio is invested in fixed income, cash and cash equivalents anda modest amount of equity securities. Currently, the Group does not hold anyalternative investments such as hedge funds. Investment guidelines are established by the Investment Committee of the Boardof Directors. Separate investment guidelines exist for the core portfolio, thesurplus portfolio and the Group's consolidated portfolio. Investment guidelinesset parameters within which investment managers must operate. Importantparameters include guidelines on permissible assets, duration ranges, creditquality, and maturity. Investment guidelines are monitored on a monthly basis. Asset allocation is as follows: june 30, 2006 december 31, 2005 $m $m $m $m $m $m core surplus total core surplus total fixed income securities 434.0 432.5 866.5 - - -equity securities - 86.9 86.9 - - -cash 123.3 91.7 215.0 1,072.4 - 1,072.4total 557.3 611.1 1,168.4 1,072.4 - 1072.4 % % % % % %fixed income securities 37.1 37.0 74.1 - -equity securities - 7.4 7.4 - - -cash 10.6 7.9 18.5 100.0 - 100.0total 47.7 52.3 100.0 100.0 - 100.0 The investment mix of the fixed income portfolio is as follows: june 30, 2006 december 31, 2005 $m $m $m $m $m $m core surplus total core surplus total U.S. treasuries 35.1 57.2 92.3 - - -U.S. government agencies 135.1 36.6 171.7 - - -asset backed securities 72.5 37.3 109.8 - - -mortgage backed securities 82.4 242.5 324.9 - - -corporate bonds 101.1 8.9 160.0 - - -other 7.8 - 7.8 - - -total 434.0 432.5 866.5 - - - % % % % % %U.S. treasuries 4.0 6.6 10.6 - - -U.S. government agencies 15.6 4.2 19.8 - - -asset backed securities 8.4 4.3 12.7 - - -mortgage backed securities 9.5 28.0 37.5 - - -corporate bonds 11.7 6.8 18.5 - - -other 0.9 - 0.9 - - -total 50.1 49.9 100.0 - - - Both the core and surplus fixed income portfolios are managed by two externalinvestment managers with identical mandates. The equity portfolio is managed byone investment manager. The equity portfolio is invested predominantly in U.S.and Canadian securities in a diversified range of sectors. The performance ofthe managers is monitored on an on-going basis. An analysis of the most important components of financial risk is detailed in ato e below. a. valuation risk The Group's net asset value is directly impacted by movements in the value ofinvestments held. Values can be impacted by movements in interest rates, creditratings, economic environment and outlook, and exchange rates. The impact of a 10% fall in the value of the Group's equity portfolio at June30, 2006 would be $8.6 million. Valuation risk in the equity portfolio ismitigated by adopting a deep value strategic approach and by diversifying theportfolio across asset classes and geographic zones. b. interest rate risk The majority of the Group's investments comprise fixed income securities. Thefair value of the Group's fixed income portfolio is inversely correlated tomovements in market interest rates. If market interest rates fall, the fairvalue of the Group's fixed income investments would tend to rise and vice versa. The sensitivity of the price of fixed income securities is indicated by itsduration(1). The greater a security's duration, the greater its percentageprice volatility. The sensitivity of the Group's fixed income portfolio at June 30, 2006 tointerest rate movements is as follows: immediate shift in yield (basis points) % $m 100 -2.6 (22.4)75 -1.9 (16.8)50 -1.3 (11.2)25 -0.7 (5.6)-25 0.7 5.6-50 1.3 11.2-75 1.9 16.8-100 2.6 22.4 The Board limits interest rate risk on its investment portfolio by establishingand monitoring duration ranges within investment guidelines. The duration ofthe fixed income portfolios at June 30, 2006 was 1.59 for the core portfolio and3.59 for the surplus portfolio. ((1)) Duration is the weighted average maturity of a security's cash flows,where the present values of the cash flows serve as the weights. Insurance contract liabilities are not directly sensitive to the level of marketinterest rates, as they are undiscounted and contractually non-interest bearing. The Group has issued long-term debt as described in note 18. The loan notesbear interest at a floating rate plus a fixed margin of 3.7%. The Group issubject to interest rate risk on the coupon payments of the long-term debt. TheGroup has mitigated the interest rate risk by entering into swap contracts asfollows: maturity prepayment interest hedged(2) date date(1) senior loan notes €24 million june 15, 2035 march 15, 2011 50% subordinated loan notes $97 million december 15, 2035 december 15, 2011 50% (1) The subordinated note can be prepaid from 16 December 2005, with a slidingscale redemption price penalty which reduces to zero by 15 December 2011. (2) The Group has entered into swaps to fix the interest rate on 50% of theprincipal through the prepayment dates specified above. The current Euribor interest rate on 50% of the senior loan notes has been fixedat 2.96%. The current LIBOR interest rate on 50% of the subordinated loan noteshas been fixed at 5.33%. The Group remains exposed to interest risk on theportion of the notes which have not been hedged. c. liquidity risk The Group can be exposed to daily calls on its available investment assets,principally from insurance claims. Liquidity risk is the risk that cash may notbe available to pay obligations when they are due without incurring anunreasonable cost. The maturity dates of the Group's fixed income portfolio at June 30, 2006 wereas follows: $m $m $m core surplus total less than one year 3.3 - 3.3between one year and two years 169.3 19.9 189.2between two and three years 55.6 26.4 82.0between three and four years 63.6 29.1 92.7between four and five years 30.5 45.5 76.0over five years 106.0 311.6 417.6 428.3 432.5 860.8 perpetual and non-dated securities 5.7 - 5.7total 434.0 432.5 866.5 Actual maturities may differ from contractual maturities because certainborrowers have the right to call or pre-pay certain obligations with or withoutcall or prepayment penalties. The Board limits liquidity risk in several ways. First, a portion of theinvestment portfolio is segregated for the short term liquidity requirementsarising from insurance obligations. The core portfolio is highly liquid withshort maturity. All core portfolio securities are quoted on major exchanges.Secondly, the Board has established asset allocation and maturity parameterswithin investment guidelines such that the vast majority of the Group'sinvestments are in high quality assets which could be converted into cashpromptly and at minimal expense. d. currency risk The Group currently underwrites out of a single location, Bermuda, however risksare assumed on a worldwide basis. Risks assumed are predominantly denominatedin U.S. dollars. The Group is exposed to currency risk to the extent its assetsare denominated in different currencies to its liabilities. The Group is alsoexposed to non-retranslation risk on non-monetary assets such as unearnedpremiums. At each balance sheet date exchange gains and losses can impact theconsolidated income statement. The Group has hedged the large majority of currency risk by closely matching theU.S. dollar liabilities with U.S. dollar assets. The Group's main foreigncurrency exposure relates to its insurance obligations and the €24 millionsenior notes long-term debt liability. While the unhedged balances are notlarge, in the second half of 2006, the Group expects to more closely hedge thesecurrency exposures by modestly increasing investments in non U.S. dollar assetsor holding larger balances of non U.S. dollar cash. The Group's assets and liabilities, categorised by currency at their translatedcarrying amount was as follows: assets $m $m $m $m $m U.S. $ sterling euro other total cash and cash equivalents 213.2 0.5 1.2 0.1 215.0 accrued interest receivable 7.9 - - - 7.9 investments 953.4 - - - 953.4 unearned premium on premium ceded 60.4 - - - 60.4 deferred acquisition costs 27.6 0.1 1.4 0.6 29.7 other receivables 80.6 - - - 80.6 inwards premium receivable from insureds 147.8 1.1 13.1 3.0 165.0 investment in associate 20.0 - - - 20.0 property, plant and equipment 0.6 - - - 0.6 total assets as at june 30, 2006 1,511.5 1.7 15.7 3.7 1,532.6 liabilities $m $m $m $m $m U.S. $ sterling euro other total losses and loss adjustment expenses 7.1 0.1 0.2 - 7.4 unearned premiums 224.6 1.9 13.8 3.7 244.0 amounts payable to reinsurers 32.0 - - - 32.0 deferred acquisition costs ceded 5.6 - - - 5.6 other payables 124.2 0.2 - 0.3 124.7 accrued interest payable 0.4 - 0.1 - 0.5 long-term debt 97.0 - 30.1 - 127.1 total liabilities as at june 30, 2006 490.9 2.2 44.2 4.0 541.3 assets $m $m $m $m $m U.S. $ sterling euro other total cash and cash equivalents 1,072.4 - - - 1,072.4 accrued interest receivable 2.0 - - - 2.0 investments - - - - - unearned premium on premium ceded - - - - - deferred acquisition costs 0.5 - - - 0.5 other receivables 0.3 - - - 0.3 inwards premium receivable from insureds 2.1 - - - 2.1 investment in associate - - - - - property, plant and equipment 0.4 - - - 0.4 total assets as at december 31, 2005 1,077.7 - - - 1,077.7 liabilities $m $m $m $m $m U.S. $ sterling euro other total losses and loss adjustment expenses - - - - - unearned premiums 2.6 - - - 2.6 amounts payable to reinsurers - - - - - deferred acquisition costs ceded - - - - - other payables 2.2 - - - 2.2 accrued interest payable 0.4 - - - 0.4 long-term debt 97.0 - 28.4 - 125.4 total liabilities as at december 31, 2005 102.2 - 28.4 - 130.6 e. credit risk Credit risk is the risk that a counterparty may fail to pay, or repay, a debt orobligation. The Group is exposed to credit risk on its fixed income investmentportfolio, its inwards premium receivable from insureds and cedants, and on anyamounts recoverable from reinsurers. Credit risk on the fixed income portfolio is managed by establishing investmentguidelines that set parameters on the absolute credit ratings of holdings andthe concentration of holdings within credit rating bandings. The guidelinesalso place limits on the size of investment in a single issuer or class ofissuer. Compliance with guidelines is regularly monitored. Credit risk from reinsurance recoverables is primarily managed by review andapproval of reinsurer security by the Group's reinsurance security committee asdiscussed on page 17. The table below presents an analysis of the Group's major exposures tocounterparty credit risk, based on Standard & Poor's or equivalent rating. Thetable includes amounts due from policyholders and unsettled investment trades.The quality of these receivables is not graded, but based on managementshistorical experience there is limited default risk associated with theseamounts. Outstanding claims, including IBNR, recoverable from reinsurers waszero at June 30, 2006 and December 31, 2005, and therefore has not beenincluded. june 30, 2006 december 31, 2005 $m $m $m $m cash & fixed premium & other cash & fixed premium & other income receivables income receivables AAA 927.3 - 1,072.4 - AA+, AA, AA- 30.2 - - - A+, A, A- 78.9 - - - BBB+, BBB, BBB- 38.7 - - - other 6.4 245.6 - 2.1 1,081.5 245.6 1,072.4 2.1 notes to the accounts for the six months ended june 30, 2006 1. general information The Group is a provider of global property insurance and reinsurance products.LHL was incorporated under the laws of Bermuda on October 12, 2005. LHL islisted on the Alternative Investment Market ("AIM"), a subsidiary market of theLondon Stock Exchange. The registered office of LHL is Clarendon House, 2Church Street, Hamilton HM 11, Bermuda. LHL has three wholly ownedsubsidiaries: Lancashire Insurance Company Limited ("LICL"), LancashireInsurance Holdings (UK) Limited ("LIHUKL") and Lancashire Insurance MarketingServices Limited ("LIMSL"). LICL is the Group's principal operating subsidiaryand was incorporated under the laws of Bermuda as a Class 4 insurer on October28, 2005. LICL provides insurance and reinsurance products to its customers,with an emphasis on property, energy, marine and aviation lines of business.LIMSL is authorised by the United Kingdom Financial Services Authority toundertake insurance mediation activities. LIMSL provides business introductionand other support services to LICL, and was incorporated under the laws of theUnited Kingdom on October 7, 2005. LIHUKL is a holding company for twonon-operating wholly owned subsidiaries. 2. segmental reporting Management and the Board review the Group's business primarily by its four principal classes: property, energy, marine and aviation. Management has therefore deemed these classes to be its business and primary segments for the purposes ofsegmental reporting. Further sub classes of business are underwritten within each primary segment. The Group commencedunderwriting in December 2005, but wrote an insignificant amount of business in the period from incorporation to December 31, 2005. Comparatives have therefore not been presented for segments. revenue and expense by business segment $m $m $m $m $m property energy marine aviation total gross premiums written 129.4 151.2 21.7 14.0 316.3 analysed by geographical segment worldwide offshore - 97.3 14.5 - 111.8 USA and Canada 54.3 25.0 0.2 - 79.5 worldwide including the U.S. 40.8 19.8 1.7 13.9 76.2 worldwide excluding the U.S. 24.8 - 0.4 - 25.2 middle east 1.4 4.6 0.4 0.1 6.5 far east 3.4 0.2 2.5 - 6.1 rest of world 4.7 4.3 2.0 - 11.0 total 129.4 151.2 21.7 14.0 316.3 outwards reinsurance premiums (39.8) (31.2) - - (71.0) change in unearned premiums (91.3) (123.7) (15.5) (10.9) (241.4) change in unearned premiums ceded 32.3 28.1 - - 60.4 insurance losses and loss adjustment expenses (2.1) (3.5) (1.8) - (7.4) insurance acquisition expenses (3.1) (2.9) (1.0) (0.6) (7.6) net underwriting profit 25.4 18.0 3.4 2.5 49.3 $m $m $m $m $m property energy marine aviation total net investment return 20.8 net foreign exchange gains (losses) (1.1) other operating expenses (24.2) finance costs (5.5) profit before tax 39.3 loss ratio 6.9% 14.3% 29.0% 0.0% 11.6% acquisition cost ratio 10.1% 11.9% 16.1% 19.4% 11.8% expense ratio - - - - 37.6% combined ratio 17.0% 26.2% 45.1% 19.4% 61.0% assets and liabilities by business segment assets $m $m $m $m $m property energy marine aviation total attributable to business segments 110.4 123.8 14.6 12.6 261.4 other assets 1,271.2 total assets 1,532.6 liabilities $m $m $m $m $m attributable to business segments 100.7 160.1 17.3 10.9 289.0 other liabilities - - - - 252.3 total liabilities 541.3 total net assets 991.3 The Group's net assets are located primarily in Bermuda. 3. investment return The total investment return for the Group is as follows: 2006 2005 $m $minvestment income - interest on fixed income securities 10.8 - - net amortisation of premium (discount) 0.4 - - interest income on cash and cash equivalents 13.0 2.1 net investment income 24.2 2.1 net realised gains (losses) - fixed income securities (3.4) - net realised gains (losses) (3.4) - unrealised gains (losses) recognised in shareholders' equity - fixed income securities (8.4) - - equity securities 2.7 - net unrealised gains (losses) recognised in shareholders' equity (5.7) - total investment return 15.1 2.1 4. insurance acquisition expenses 2006 2005 $m $m insurance acquisition expenses 31.2 0.5 changes in deferred insurance acquisition expenses (23.6) (0.5) total 7.6 - 5. other operating expenses 2006 2005 $m $m operating expenses unrelated to underwriting 13.6 1.6 equity based compensation 10.6 8.4 total 24.2 10.0 6. employee benefits 2006 2005 $m $m wages and salaries 1.9 0.2 pension costs 0.2 - other benefits 2.4 - equity based compensation 10.6 8.4 total 15.1 8.6 As at June 30, 2006, the Group had 25 (2005 - 4) employees. equity based compensation There are two forms of equity based compensation: warrants and a long termincentive plan. On admission to AIM, warrants to purchase common shares were issued forimmediate allocation to certain members of management or reserved for laterallocation to employees of the Group. There are two forms of warrant:Management Team Ordinary Warrants and Management Team Performance Warrants. All warrants issued to management will expire ten years from the date of issueand will be exercisable at an initial price per share of US$5.00 equal to theprice per share paid by investors in the initial public offering. Settlement isat the discretion of the Group and may be in cash or shares. management team ordinary warrants ("ordinary warrants") Ordinary warrants do not have associated performance criteria. 25% of suchwarrants vested immediately upon issuance. Thereafter, 25% of such warrantswill vest on the first, second and third anniversary of the grant date. On December 16, 2005, ordinary warrants to purchase 12,708,695 common shareswere issued, representing the full allocation of ordinary warrants. management team performance warrants ("performance warrants") Performance warrants vest over a four year period and are dependent on certainperformance criteria with specific measurement dates of December 31, 2007,December 31, 2008 and December 31, 2009. Half of these warrants will vest onlyon achievement of a fully diluted book value per share in comparison to aplanned appreciation threshold of between 70% and 100% at certain dates. Theremaining half of these warrants will vest only on achievement of an IRR incomparison to a planned IRR of between 70% and 100% at certain dates. On 16 December, 2005, performance warrants to purchase 7,625,218 common shareswere issued, representing the full allocation of performance warrants. The fair value of each warrant was estimated on the date of grant using theBlack-Scholes option-pricing model. Assumptions used for valuation of thesegrants were as follows: risk free interest rate of 4.93%; an expected life often years; volatility of 30% being the maximum contractual rate; performancetargets will be met; dividend yield of nil due to contractual dividendprotection; the Group will settle in shares; no forfeitures, other than leaverswhich are assumed to be 10% of total employees, and no dilutive events. Warrants Weighted Number Average Thousands Exercise Price US$ Allocated as at December 31, 2005 14,463 $5.00Allocated during the period 2,567 $5.00Allocated as at June 30, 2006 17,030 $5.00Exercisable at June 30, 2006 and December 31, 2005 2,498 - The fair value of warrants granted for the period ended June 30, 2006 was $2.62(2005 - $2.62) per share. A share-based payment expense of $9.8 million (2005 -$8.4 million) is included in other operating expenses in the interimconsolidated income statement. long term incentive plan ("LTIP") Options may be granted under the LTIP at the discretion of the remunerationcommittee. Options granted under the LTIP are limited to 5% of the common sharecapital in issue at the date of grant. All options issued will expire ten yearsfrom date of issue and the exercise price is equal to or greater than theaverage market value of the shares on the twenty previous trading days prior togrant. 25% of such options vested immediately upon issuance. Thereafter, 25% ofsuch options will vest on the first, second and third anniversary of the grantdate. There are no associated performance criteria. On March 9, 2006, certain members of staff were issued options to purchase2,249,439 common shares. The fair value of each option was estimated on the date of grant using theBlack-Scholes option-pricing model. Assumptions used for valuation of thesegrants were as follows: risk free interest rate of 5.125%; an expected life ofsix years; volatility of 30% being the maximum contractual rate; performancetargets will be met; dividend yield of nil due to contractual dividendprotection; the Group will settle in shares; no forfeitures, other than leaverswhich are assumed to be 10% of total employees, and no dilutive events. Options Weighted Number Average Thousands Exercise Price US$ Granted during the period and outstanding at June 30, 2,249 $5.652006Exercisable at June 30, 2006 - - The fair value of options granted during the period ended June 30, 2006 was$2.27 per share. A share-based payment expense of $0.8 million (2005 - $nil) isincluded in other operating expenses in the interim consolidated incomestatement. 7. results of operating activities Results of operating activities are stated after charging the following amounts: 2006 2005 $m $m depreciation on owned assets 0.1 - operating lease charges 0.2 - auditors remuneration - group audit fees 0.4 0.1 - other services 0.3 0.6 total 1.0 0.7 Fees paid to the Group's auditors for other services are approved by the Group'saudit committee. Such fees comprise the following amounts: 2006 2005 $m $m taxation advice 0.1 - FSA regulatory advice 0.2 - other - 0.6 total 0.3 0.6 8. tax Bermuda The Group has received an undertaking from the Bermuda government exempting itfrom all local income, withholding and capital gains taxes until March 28, 2016. At the present time no such taxes are levied in Bermuda. United States The Group does not consider itself to be engaged in trade or business in theUnited States and, accordingly, does not expect to be subject to United Statestaxation. United Kingdom The UK subsidiaries are subject to normal UK tax on all profits. For the periodended June 30, 2006 there was no corporation tax liability. 9. cash and cash equivalents 2006 2005 $m $m cash at bank and in hand 72.6 12.2 cash equivalents 142.4 1,060.2 total 215.0 1,072.4 Cash equivalents have an original maturity of three months or less. Thecarrying amount of these assets approximates to their fair value. Cash and cash equivalents totaling $10.5 million (2005 - $5.4 million) were ondeposit in various trust accounts for the benefit of policyholders orcounterparties to agreements to cover their credit risk. 10. investments as at june 30, 2006 $m $m $m $m cost or gross gross estimated amortised unrealised unrealised fair cost gain loss value fixed income - U.S. treasuries 93.2 0.1 (1.0) 92.3 - U.S. government agencies 173.1 - (1.4) 171.7 - asset backed securities 110.5 - (0.7) 109.8 - mortgage backed securities 328.1 0.4 (3.6) 324.9 - corporate bonds 162.2 - (2.2) 160.0 - other 7.8 - - 7.8 874.9 0.5 (8.9) 866.5 equity securities 84.2 4.3 (1.6) 86.9 total 959.1 4.8 (10.5) 953.4 Equity securities are generally deemed non-current. Fixed income maturities arepresented in the risk disclosures section. In 2005 the Group's assets were held entirely in cash and cash equivalents.Comparatives for the above table have therefore not been presented. 11. investment in associate On June 15, 2006 the Group made an investment of $20.0 million which representsa 21% interest in Sirocco Holdings Limited ("Sirocco"), a company incorporatedin Bermuda. Sirocco's operating subsidiary, Sirocco Reinsurance Limited ("Sirocco Re"), is authorised as a Class 3 insurer by the Bermuda MonetaryAuthority. Sirocco Re was established to assume Gulf of Mexico energy risks fromthe Group. Sirocco is an unquoted investment and its shares do not trade in anyactive market. Sirocco is carried at $20.0 million, representing management'sbest estimate of fair value at June 30, 2006. 2006 $m as at january 1, 2006 - acquisition 20.0 as at june 30, 2006 20.0 Investments in associates are generally deemed non-current. Key financialinformation for Sirocco for the period ending June 30, 2006 is as follows: $m assets 116.9 liabilities 19.4 revenues 3.1 profit (loss) 2.5 12. insurance contracts and reinsurance assets insurance liabilities $m $m $m losses & loss unearned adjustment premiums expenses total as at october 12, 2005 (date of incorporation) - - - movement in period - 2.6 2.6 exchange adjustments - - - as at december 31, 2005 - 2.6 2.6 movement in period 7.4 241.4 248.8 exchange adjustments - - - as at june 30, 2006 7.4 244.0 251.4 reinsurance assets $m $m $m unearned reinsurance premiums payable total as at october 12, 2005 (date of incorporation) - - - movement in period - - - exchange adjustments - - - as at december, 31 2005 - - -movement in period 60.4 (32.0) 28.4 exchange adjustments - - - as at june 30, 2006 60.4 (32.0) 28.4 Further information on the calculation of loss reserves and the risks associatedwith them is provided in the risk disclosures section, which starts on page 13.The risks associated with general insurance contracts are complex and do notreadily lend themselves to meaningful sensitivity analysis. The impact of anunreported event could lead to a significant increase in our loss reserves.Management believe that the loss reserves established as at June 30, 2006 areadequate, however a 20% increase in unpaid losses would lead to a $1.4m (2005 -$nil) increase in loss reserves. The split of losses and loss adjustments expenses between notified outstandinglosses and losses incurred but not reported is shown below: 2006 2005 $m $m outstanding losses - - losses incurred but not reported 7.4 - losses and loss adjustment expense reserves 7.4 - It is estimated that 100% of the losses and loss adjustment expenses above willsettle in the next 12 months. claims development The development of insurance liabilities is indicative of the Group's ability toestimate the ultimate value of its insurance liabilities. The Group beganwriting insurance and reinsurance business in December 2005. Due to theunderlying risks and lack of known loss events occurring during the period toDecember 31, 2005, the Group does not expect to incur any losses from coverageprovided in 2005. Accordingly, a loss development table has not been included. 13. insurance and other receivables 2006 2005 $m $m inwards premium receivable from insureds and cedants 165.0 2.1 other receivables 80.6 0.3 accrued interest receivable 7.9 2.0 total receivables 253.5 4.4 Other receivables consist primarily of unsettled investment trades. Allreceivables are considered current other than $0.2 million (2005 - $nil) relatedto multi-year contracts. The carrying value approximates fair value due to theshort term nature of the receivables. There are no provisions in place forimpairment or irrecoverable balances. There is no significant concentration ofcredit risk within the Group's receivables. 14. deferred acquisition costs The reconciliation between opening and closing deferred acquisition costs isshown below: $m balance as at october 12, 2005 (date of incorporation) - movement in period 0.5 balance as at december 31, 2005 0.5 movement in period 29.2 balance as at june 30, 2006 29.7 15. reinsurance and other payables 2006 2005 $m $m amounts payable to reinsurers 32.0 - other payables 124.7 2.2 total payables 156.7 2.2 Other payables consist primarily of unsettled investment trades. All payablesare considered current. The carrying value approximates fair value due to theshort-term value of the payables. 16. deferred acquisition costs ceded The reconciliation between opening and closing deferred acquisition costs cededis shown below: $m balance as at october 12, 2005 (date of incorporation) - movement in period - balance as at december 31, 2005 - movement in period 5.6 balance as at june 30, 2006 5.6 17. property, plant and equipment IT equipment $mcost as at october 12, 2005 (date of incorporation) - additions 0.4 as at december 31, 2005 0.4 accumulated depreciation as at october 12, 2005 (date of incorporation) - charge for the period - as at december, 31 2005 0.4 net book value as at october 12, 2005 (date of incorporation) - as at december 31, 2005 0.4 IT equipment $mcost as at january 1, 2006 0.4 additions 0.3 as at june 30, 2006 0.7 accumulated depreciation as at january 1, 2006 - charge for the period 0.1 as at june 30, 2006 0.1 net book value as at january 1,2006 0.4 as at june 30, 2006 0.6 18. long term debt and financing arrangements 2006 2005 $m $m senior loan note of €12.0 million 15.1 14.2 senior loan note of €12.0 million 15.0 14.2 subordinated loan note of $97.0 million 97.0 97.0 carrying value and fair value 127.1 125.4 On December 15, 2005 the Group issued $97 million in aggregate principal amountof subordinated loan notes and €24 million in aggregate principal amount ofsenior loan notes ("long-term debt") at an issue price of $1,000 and €1,000 oftheir principal amounts respectively. The Euro senior loan notes are repayable on June 15, 2035 with a prepaymentoption available from March 15, 2011. Interest on the principal is based on aset margin (3.7%) above Euribor and is payable quarterly. The US dollar subordinated loan notes are repayable on December 15, 2035 with asliding scale redemption price from December 16, 2005. Interest on theprincipal is based on a set margin (3.7%) above Libor and is payable quarterly. The Group is exposed to cash flow interest rate risk and currency risk. Furtherinformation is provided in the risk disclosures section. The interest accrued on the loans payable was $0.5 million (2005 - $0.4 million)at the balance sheet date. Due to the long term nature of the loans and the floating interest rates, thecarrying value approximates fair value. letters of credit As LICL is not an admitted insurer or reinsurer throughout the U.S., the termsof certain contracts require LICL to provide letters of credit to policyholdersas collateral. On May 17, 2006, LICL entered into a syndicated collateralisedthree year credit facility in the amount of $350 million. This facility isavailable for the issue of letters of credit to ceding companies. It alsocontains a $75m loan sub-limit available for general corporate purposes. As atJune 30, 2006 no letters of credit had been issued and there was no outstandingdebt under this facility. 19. derivative financial instruments The Group hedges a portion of its floating rate borrowings using interest rateswaps to transfer floating to fixed rate. These instruments are held at fairvalue through the consolidated income statement. During the period, $nil (2005- $nil) was credited to other income in respect of the interest rate swap. Thenet fair value position to the Group was $nil (2005 - $nil). The Group has theright to net settle this instrument. The next cash settlement due on thisinstrument is negligible (2005 - $nil) and is due on September 15, 2006. 20. share capital authorised ordinary shares of $0.50 each number $m as at december 31, 2005 and june 30, 2006 3,000,000,000 1,500 allocated, called up and fully paid number $m as at october 12, 2005 (date of incorporation) - - shares issued 195,713,902 97.9 as at december 31, 2005 and june 30, 2006 195,713,902 97.9 LHL issued 16,000,000 new shares on October 27, 2005 as part of its initialcapitalisation and launch. On December 9, 2005, LHL's outstanding shares wereconsolidated on a 5:1 basis into 3,200,000 shares. On December 16, 2005, anaggregate of 192,513,902 new shares were issued as part of LHL's privateplacement in the U.S. and initial public offering in the U.K., which includedshares issued on the exercise of an over-allotment option. As a result of allthe shares issued, a total of $978.6 million was raised, $97.9 million of whichis included in share capital and $880.7 million of which was included in sharepremium, net of $19.9 million of offering expenses, formation expenses andwarrants issued to management, founders and a sponsor. 21. warrants and options management management ordinary warrants performance founder sponsor warrants warrants warrants options number number number number number as at october 12, 2005 (dateof incorporation) - - - - -issued 17,791,919 7,625,217 12,708,695 7,625,218 -exercised - - - - -as at december 31, 2005 17,791,919 7,625,217 12,708,695 7,625,218 -issued - - - - 2,249,439 exercised - - - - -as at june 30, 2006 17,791,919 7,625,217 12,708,695 7,625,218 2,249,439 warrants All warrants issued will expire ten years from the date of issue and areexercisable at an initial price per share of US$5.00 equal to the price pershare paid by investors in the initial public offering. Settlement is at thediscretion of the Group and may be in cash or shares. The warrant holder mayelect a cashless exercise. The method of settlement is at the discretion of theGroup and may be in cash or shares. founders The Group's founders provided industry expertise, resources and relationshipsduring the fourth quarter of 2005. For the founders position and consideration,the Group issued warrants to certain founding shareholders to purchase in theaggregate, up to 17,791,919 common shares. These warrants were granted onDecember 12, 2005 and were fully vested and exercisable upon issuance. sponsor In consideration for incorporation services received, warrants have been issuedto Benfield Advisory Limited to purchase 7,625,217 common shares. Thesewarrants were granted on December 16, 2005 and were fully vested and exercisableupon issuance. Management warrants and options are discussed in note 6. 22. lease commitments The Group has payment obligations in respect of operating leases for certainitems of office equipment and office space. Operating lease expenses for theperiod were $0.2 million (2005 - $nil). Lease payments under non-cancellableoperating leases are as follows: 2006 2005 $m $m due in less than one year - - due between one and five years 1.9 - due in more than five years 2.4 - total 4.3 - 23. earnings per share Basic earnings or loss per share amounts are calculated by dividing net profitor loss for the period attributable to shareholders by the weighted averagenumber of common shares outstanding during the year. Diluted earnings or loss per share amounts are calculated by dividing the netprofit or loss attributable to shareholders by the weighted average number ofcommon shares outstanding during the year plus the weighted average number ofcommon shares that would be issued on the conversion of all dilutive potentialcommon shares into common shares. The following reflects the loss and share data used in the basic and dilutedloss per share computations: 2006 2005 $m $m Profit (loss) for the period attributable to shareholders 39.3 (11.6) Number of Number of shares shares Thousands Thousands Basic weighted average number of shares 195,714 48,320Potentially dilutive shares related to share-based compensation 4,195 5,733 Diluted weighted average number of shares 199,909 54,053 Share based payments are only treated as dilutive when their conversion tocommon shares would decrease earnings per share or increase loss per share fromcontinuing operations. In the prior period, incremental shares from the assumedexercising of warrants are not included in calculating the diluted earnings orloss per share as it would drive the loss per share further negative. 24. related party disclosures The interim consolidated financial statements include Lancashire HoldingsLimited and the subsidiaries listed below: Name Domicile Lancashire Insurance Company Limited BermudaLancashire Insurance Marketing Services Limited United KingdomLancashire Holdings Financing Trust I United StatesLancashire Insurance Holdings (UK) Limited United KingdomLancashire Insurance Services (UK) Limited United KingdomLancashire Insurance Services Limited United Kingdom All subsidiaries are wholly owned, either directly or indirectly. The Group has issued loan notes via a trust vehicle - Lancashire HoldingsFinancing Trust I (the "Trust") (see Note 18). The Group has 100% of the votingrights in the Trust, provided that there is no default on the loan notes. Whilethe ability of the Group to influence the actions of the Trust is limited by theTrust Agreement, the Trust was set up by the Group with the sole purpose ofissuing the loan notes. The Trust is in essence controlled by the Group,operates exclusively for the benefit of the Group, and is thereforeconsolidated. key management compensation Remuneration for key management for the period ending June 30, 2006 was asfollows: 2006 2005 $m $m short-term compensation 0.8 - share based compensation 7.5 5.2 total 8.3 5.2 transactions with directors and shareholders Significant shareholders have a representation on the Board of Directors.During the period the Group paid $0.3 million (2005 - $nil) in directors' feesand expenses. A further $0.2 million (2005 - $nil) was paid in respect ofmonitoring fees for significant shareholders pursuant to Monitoring Agreements,the terms of which are as disclosed in the application to list on AIM. transactions with associates During the period the Group ceded $22.2 million (2005 - $nil) of premium toSirocco and received $4.3 million (2005 - $nil) of commission income. transactions with sponsor During the period the Group incurred net brokerage and consulting costs of $4.5million with Benfield Group. 25. non-cash transactions Accrued formation expenses of $nil (2005 - $0.9 million) have been recordeddirectly in shareholders' equity. This amount represents a non-cash transactionand therefore is not included within the change in operational assets andliabilities in the consolidated cashflow statement. 26. statutory requirements and dividend restrictions As a holding company, LHL relies on dividends from its subsidiaries to providecash flow required for debt service and dividends to shareholders. LICL'sability to pay dividends and make capital distributions is subject to certainregulatory restrictions based principally on the amount of LICL's premiumswritten and reserves for losses and loss expenses, subject to an overall minimumsolvency requirement of $100 million. LICL is required to maintain a minimumstatutory liquidity ratio. At June 30, 2006, LICL's statutory capital andsurplus was $1,090.8 million (2005 - $1,069.6 million) and the minimum amount ofstatutory capital and surplus required to be maintained was $100 million.Statutory capital and surplus is different from shareholders' equity due tocertain items that are capitalised under IFRS but expensed, have a differentvaluation basis, or are not admitted under the Bermuda Insurance Act 1978 andrelated Regulations (the "Act"). In addition, LICL is required to maintain a minimum liquidity ratio, wherebyrelevant assets, as defined in the Act, must exceed 75% of relevant liabilities. As at June 30, 2006 and December 31, 2005 the liquidity ratio was met. 27. presentation Certain amounts in the December 31, 2005 consolidated financial statements havebeen re-presented to conform with the current year's presentation and format.These changes in presentation have no effect on the previously reported netloss. 28. subsequent events On July 21, 2006 the UK Financial Services Authority ("FSA") notified the Groupthat it is minded to grant authorisation to a new underwriting company to bebased in London. The Group expects to satisfy the remaining conditions of theFSA approval in due course and commence underwriting shortly thereafter. Thenew underwriting company will be capitalised from existing resources and willnot change the existing Group business plan or lines of business. INDEPENDENT REVIEW REPORT TO THE SHAREHOLDERS LANCASHIRE HOLDINGS LIMITED Introduction We have been instructed by Lancashire Holdings Limited (the "Company") to reviewthe financial information for the six months ended 30 June 2006 which comprisesof the Consolidated Income Statement, Consolidated Balance Sheet, ConsolidatedCash Flow Statement, Consolidated Statement of Changes in Equity and the relatednotes 1 to 28. We have read the other information contained in the interimreport and considered whether it contains any apparent misstatements or materialinconsistencies with the financial information. This report is made solely to the Company having regard to guidance contained inInternational Standard on Review Engagements 2410, "Review of Interim FinancialInformation Performed by the Independent Auditor of the Entity". To the fullestextent permitted by the law, we do not accept or assume responsibility to anyoneother than the Company, for our work, for this report, or for the conclusions wehave formed. Directors' responsibilities The interim report, including the financial information contained therein, isthe responsibility of, and has been approved by, the directors. The directorsare responsible for preparing the interim report as required by the AIM Rulesissued by the London Stock Exchange. Review work performed We conducted our review in accordance with International Standard on ReviewEngagements 2410, "Review of Interim Financial Information Performed by theIndependent Auditor of the Entity". A review consists principally of makingenquiries of management and applying analytical procedures to the financialinformation and underlying financial data, and based thereon, assessing whetherthe accounting policies and presentation have been consistently applied, unlessotherwise disclosed. A review excludes audit procedures such as tests ofcontrols and verification of assets, liabilities and transactions. It issubstantially less in scope than an audit performed in accordance withInternational Standards on Auditing and therefore provides a lower level ofassurance than an audit. Accordingly we do not express an audit opinion on thefinancial information. Review conclusion On the basis of our review we are not aware of any material modifications thatshould be made to the financial information as presented for the six monthsended 30 June 2006. August 2, 2006Chartered Accountants Shareholder information The additional information consisting of the shareholder information anddirectors and advisers has been prepared from the records of the Group. While itdoes not form part of the interim statement, it should be read in conjunctionwith it and with the responsibilities section of the independent review reportthereon. Financial Calendar 2006 Fourth quarter Trading release 2007 February / March Announcement of results for the year ending 31 December 2006 Shareholder enquiries, register and website Please contact us at [email protected] or, for enquiries concerning shareregistration, call our Registrar, Capita IRG (Offshore) Limited on01534-463-2363. The Group's website can be accessed at www.lancashire.bm Directors and Advisers Directors Registered office Robert Spass (Chairman)* Clarendon House Richard Brindle (CEO) 2 Church Street Neil McConachie Hamilton HM 11 Ralf Oelssner* Bermuda William Spiegel* Barry Volpert* Audit Committee Auditors Robert Spass (Chairman) Ernst & Young Ralf Oelssner P.O. Box 463 William Spiegel Hamilton HM HX Bermuda Remuneration Committee Registrar William Spiegel (Chairman) Capita IRG (Offshore) Limited Ralf Oelssner Liberation Square 1/3 The Esplanade Nomination Committee St. Helier Robert Spass (Chairman) Jersey Richard Brindle Barry Volpert Investment Committee Robert Spass (Chairman) Secretary Neil McConachie Gregory Lunn Barry Volpert This information is provided by RNS The company news service from the London Stock Exchange

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Lancashire Holdings