S&P, A.M. Best React to XL Reserve Announcement

January 15, 2004

Both A.M. Best and Standard & Poor’s Ratings Services reacted to XL Capital Group’s announcement yesterday that its aggregate reserve additions in 2003 would be around $908 million pretax ($694 million in the fourth quarter). (See IJ Web site Jan.13)

Best lowered all of the debt ratings of XL Capital Ltd. (Cayman Islands), affecting approximately $2.4 billion of securities issued or guaranteed by XL Capital Ltd. and its affiliates. It also placed the “A+” (Superior) financial strength ratings of XL Capital Group (Hamilton, Bermuda) and its affiliated companies “under review with negative implications,” and assigned a negative outlook.

S&P lowered its counterparty credit and financial strength ratings on the core operating companies of XL Capital Group to ‘AA-‘ from ‘AA’ and removed them from CreditWatch. It also lowered its counterparty credit rating on XL Capital Ltd. to ‘A’ from ‘A+’ and removed it from CreditWatch.

In a related action S&P lowered its counterparty credit and financial strength ratings on the subsidiaries of XL Group, which had not been on CreditWatch, to ‘AA-‘ from ‘AA,’ “because these companies are considered core to the group.” S&P said “The outlook on all these companies is stable,” and noted that the rating action does not affect the ‘AAA’ financial strength ratings on XL Capital Assurance Inc. and XL Financial Assurance Ltd.”

Best said that “cumulatively, these reserve charges have exceeded A.M. Best’s expectation and have caused the company’s risk- adjusted capital to fall below levels required for its current financial strength ratings.” It noted, however that XL plans to “raise additional capital during the first half of 2004 to replenish its capital base.”

S&P emphasized the preponderant role that the “development related to NAC Re business, casualty lines from 1996-2001 on which XL has seen recent (September 2003) adverse claims trends,” has played. It noted that the reserve increases were “$385 million in 2002, $253 million in 2001, and $61 million in 2000, the bulk of which is related to NAC Re business casualty lines from 1996-2001.”

S&P indicated that the fourth-quarter additions of $694 million, which includes $563 million of reserve additions within XL Reinsurance America (NAC Re), as well as $162 million of additions at other reinsurance operations, and $150 million of reserve additions for XL Insurance segment, were somewhat “offset by $181 million of reserve redundancies recognized on Sept. 11, 2001-related aviation liability risks.”

S&P said that although it “continues to treat the subsidiaries of XL America Inc. as core to the XL Capital Group (based on the quota share arrangement to XL Re Ltd. and continued capital support from the group to replenish losses), the rating action on the group reflects a reassessment of operating performance and reserving policies in view of the adverse reserve development.” S&P added that it “believes XL Capital’s consolidated operating performance is more appropriate for the lower rating, notwithstanding good prospects for 2004. ROR for 2003 is estimated to fall below 5 percent.”

Best described the downgrade of the debt securities as reflecting “the declining trend in XL Capital’s fixed charge coverage ratios over the last three years and the anticipation of elevated debt to capital leverage ratios following the completion of the 2004 capital injection plan.”

It noted, however, that it “expects XL Capital’s leverage and coverages to improve as projected earnings increase shareholders’ equity and holding company liquidity. XL Capital’s ratings will remain under review with negative implications until additional capital has been successfully raised in sufficient amounts to place risk-adjusted capitalization well within the Superior level, supportive of its current financial strength ratings.”

Best warned, however, that “should this not be accomplished within a reasonable timeframe, it is likely that the current financial strength ratings will be downgraded to the ‘Excellent’ level.”

S&P noted the following “Major rating factors:” On the positive side were XL’s “Very strong capital adequacy; Strong global presence; Strong management and Increased financial leverage and reduced coverage.” On the negative side were its “Persistent adverse reserve development and Below-market operating profitability.”

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