Fitch Downgrades Avalon Re; On Rating Watch Negative

March 23, 2006

Fitch Ratings announced that it has downgraded the class B and C variable-rate notes of Avalon Re Ltd. and placed all of the notes in classes A, B and C on Rating Watch Negative. “The class B variable-rate notes were downgraded to ‘BB’ from ‘BB+’ while the class C variable-rate notes were downgraded to ‘CCC-‘ from ‘B-‘,” said the bulletin. The rating actions affect $405 million of Avalon Re variable-rate notes.

Fitch explained: “The “downgrades follow release of a quarterly loss report indicating that Oil Casualty Insurance Ltd. (OCIL), a Bermuda-based insurer, has recorded a full limit loss due to an oil spill by one of its policyholders as the result of damage to an oil storage tank from hurricane Katrina. Avalon Re reinsures OCIL on an excess of loss basis.

“The reserve recorded by OCIL has not been ceded to Avalon Re and does not result in a current loss of principal or interest to note holders. The class C, B and A note holders are exposed to the third, fourth and fifth loss, respectively, occurring within the three-year risk period. The downgrades reflect the change in expected loss to each of the classes of notes that results from a first loss having been recorded with approximately 26 months left in the risk period.

“Fitch placed the three classes of notes on Rating Watch Negative because there is a reasonable possibility that a second loss to OCIL may have occurred. Two of OCIL’s policyholders are partners in a joint venture that operates a portion of the Buncefield fuel storage terminal in the UK. The Buncefield fuel storage terminal exploded in December 2005, causing injuries and property damage to third parties. However, Fitch emphasizes that an investigation into the cause of the explosion is ongoing and it is not yet known who, if anyone, is responsible for the explosion.”

Fitch said it “expects to monitor OCIL’s insurance losses as they develop. If insurance losses develop such that Fitch believes the probability of a loss to holders of the variable-rate notes had increased materially, Fitch may downgrade the notes. Due to the indemnity risk structure of the notes and the long-term nature of liability claims, Fitch expects that it may be several months before it OCIL’s losses, if any, can be quantified.”

The rating agency also noted that “Avalon Re is a Cayman Islands-domiciled insurance company formed solely to issue the variable-rate notes, enter into a reinsurance contract with OCIL, and to conduct activities related to the notes’ issuance. The variable-rate notes are insurance-linked securities that will suffer a loss of principal if OCIL’s aggregate insured losses exceed a specified threshold that varies by note class.”

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