Best Affirms XL Ratings; Comments

May 29, 2007

A.M. Best Co. has affirmed the financial strength rating (FSR) of “A+” (Superior) and the issuer credit ratings (ICR) of “aa-“of Bermuda-based XL Capital Ltd’s operating subsidiaries. Best also affirmed the ICR of “a-” and the existing debt ratings of “a-” on senior debt, “bbb+” on subordinated debt and “bbb” on preferred shares of XL Capital.

In the Group’s life sector, Best affirmed the FSR of “A” (Excellent) and ICR of “a” of XL Re Life America Inc., headquartered in Simsbury, Conn. However, Best has downgraded the FSR to “A” (Excellent) from “A+” (Superior) and the ICR to “a” from “aa-” of XL Life Insurance and Annuity Company (XLLIAC) of Schaumburg, Ill. Best also downgraded to “a” from “aa-” the rating of the funding agreement-backed securities (FABS) program established by XLLIAC and the debt ratings to “a” from “aa-” on the outstanding notes issued under the program. The outlook for all the ratings is stable.

The affirmation of XL’s ratings reflect its “record earnings reported for 2006, with consolidated net income of $1.763 billion as the group’s diversified portfolio of risks and lack of catastrophe activity enabled it to nearly recoup the $1.970 billion in pre-tax net losses incurred related to the 2005 natural catastrophes.”

Best indicated that a growth in asset value is also “enhancing net income,” which has increased the contribution of net investment income to operating results. Best indicated even though “market conditions are softening within the global reinsurance industry,” it considers XL to be “well positioned to manage the current underwriting cycle, albeit at potentially reduced operating margins given rate softening and increased global capacity.”

As far as rebuilding its capital base is concerned, Best pointed out that in 2007, XL raised capital totaling $1.325 billion, “including a $1.0 billion preferred security issuance, the proceeds from which are to be used primarily for the purchase of approximately $830 million of XL Capital’s Class A ordinary shares.” It also issued a $325 million senior note offering, “which together with available cash, was used to retire $825 million in senior notes due in 2009, which comprised part of the equity security units of XL Capital that settled in May 2007. In connection with the settlement of the forward purchase contract portion of the equity security units in May 2007, XL Capital received $825 million.”

Best maintains confidence in XL’s ability “to maintain solid financial flexibility with strong access to both debt and equity markets.” XL’s market capitalization “remains above its book value and well above its tangible book value,” Best noted. The rating agency also said it expects XL “to maintain financial leverage as measured by debt and preferred-to-total capital below 30 percent and to maintain fixed charge coverage in the mid to upper single-digit range.”

Best’s analysis went on to cite the heightened concern with good risk management and the steps XL has undertaken to implement through measures designed to “reduce its susceptibility to shock losses through discontinuing some of its catastrophe-related programs and through certain other arrangements.

Best cited XL’s agreement with Cyrus Re that began in 2006 through which XL “retroceded 50 percent of its property catastrophe premiums to Cyrus Re to reduce volatility while, at the same time, improving the quality of the its risk-adjusted returns.” The rating agency also took note of XL’s “securities issuance agreement and the excess of loss reinsurance agreement entered into by certain of its insurance and reinsurance subsidiaries with Stoneheath Re.” Best described the “net effect” of these initiatives as essentially creating “a contingent put option in the amount of $350 million in the aggregate. The agreements provide XL Capital’s operating subsidiaries with a reinsurance collateral account in support of certain covered perils named in the reinsurance agreement.”

Best explained its downgrade of XLLIAC as reflecting “the announced discontinuance of new business and the continued run off of its existing liabilities. Through its $4 billion global medium-term note (GMTN) program, XLLIAC Global Funding, a Delaware statutory trust, issued various series of notes to certain institutional investors on a private placement basis.

“Each series of notes is secured by one or more funding agreements issued by XLLIAC, which is domiciled under the laws of Illinois. The performance of all obligations under the reinsurance program is guaranteed by a core subsidiary of XL Capital. In the event of an insolvency of an Illinois domestic insurance company, claims under funding agreements would be treated pari passu with life insurance policy and annuity claims. Thus, the ICR of the FABS program reflects A.M. Best’s belief that all investors in the GMTN program are exposed to the inherent credit, liquidity and business risks of the sponsoring insurance company, XLLIAC.”

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