S&P Lowers XL and Operating Companies Ratings; Outlook Negative

December 16, 2008

Standard & Poor’s Ratings Services has lowered its counterparty credit and financial strength ratings on XL Capital Ltd.’s core operating companies to ‘A’ from ‘A+’. S&P also lowered its counterparty credit rating on XL to ‘BBB+’ from ‘A-‘, and indicated that the “outlook on all these companies is negative.”

Credit analyst Steven Ader explained: “These rating actions reflect our belief that XL’s prospective competitive position and resulting underwriting performance have diminished because of perceived franchise issues stemming from a string of material earnings and capital charges over the past several years.

“Although XL remedied many of these issues this past summer, the material deterioration in the unrealized position of XL’s investment portfolio in the third quarter has again pressured XL’s market presence.”

S&P added that in accord with its analysis, “the rating action incorporates our belief that renewal activity will be modestly below historical norms, with a more substantive reduction in new business opportunities. This would hamper prospective underwriting performance, which, though strong, is inconsistent with what we typically expect for the prior rating. Notwithstanding XL’s strong liquidity position, its financial flexibility, in our opinion, is a weakness to the rating.”

Moreover, S&P indicated that, “although we are comfortable with XL’s investment-impairment process and believe that XL’s strong liquidity position ($7.2 billion in cash and short-term investments as of Sept. 30, 2008) supports the intent to hold these securities to recovery, further deterioration in economic conditions (as experienced so far the fourth quarter) will result in additional unrealized losses and economic impairments. Although XL continues to actively reduce the volatility of its portfolio, the rating action reflects our belief that prospective realized investment losses will largely offset operating income through 2009.”

However, S&P described XL’s capitalization as “strong,” and noted that it “reflects our comfort in XL’s detailed and comprehensive investment-impairment process, supplemented by the application of Standard & Poor’s derived default factors by rating level and vintage for certain classes of structured assets. Accordingly, the assessment is strong despite a quantitative calculation that was modestly below the rating level when incorporating projected unrealized losses as of Nov. 30, 2008. We believe that capital adequacy will remain strong for the foreseeable future.”

S&P continued: “XL’s management team has undertaken several initiatives structured to simplify and refocus XL’s operations on its strongly performing property/casualty insurance and reinsurance operations while materially reducing noncore risks, including investments and financial lines exposure. These initiatives–in combination with an enhanced focus on enterprise risk management (ERM), which we view as adequate–markedly reduce the potential for unexpected material charges outside of the investment portfolio.

“We expect that XL’s continued enhancement of its ERM, especially strategic and operational risk, will materially reduce the potential for unexpected losses. Although additional realized losses in the investment portfolio are likely because of continued economic uncertainty, these losses will be offset by continued strong underwriting performance.”

Ader indicated: “If, in the next two years, ERM continues to develop, additional investment losses fail to materialize, and no negative surprises arise that dampen consolidated results, we could revise the outlook to stable. However, if more unexpected adverse events occur (such as unexpected additional realized investment losses, large underwriting losses, or large operational related risk), if the company does not meet our financial tolerance levels, or if there is inadequate progress related to XL’s ERM, another downgrade would most likely result.”

Source: Standard & Poor’s – www.standardandpoors.com

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