XL Capital Placed on Rating Watch Negative by Fitch

Fitch Ratings has placed several ratings of XL Capital Ltd (XL) on Rating Watch Negative, including XL’s ‘A’ long term issuer rating, and the ‘AA’ insurer financial strength rating of lead (re)insurance companies XL Insurance (Bermuda) Ltd. and XL Re Ltd.

The actions follow XL’s announcement that it was entering into an independent valuation process with Winterthur Swiss Insurance Co. (Winterthur) regarding settlement of a reserve seasoning agreement related to XL’s July 2001 purchase of Winterthur International.

The Winterthur International acquisition greatly expanded XL’s position in the large commercial property casualty insurance market. Due to the long tail nature of the reserves acquired with Winterthur International, the purchase agreement included a reserve seasoning agreement that indemnified XL to June 30, 2004 from adverse loss reserve development over a three year period on the book of business in force at the date of purchase. The related adverse reserve development is significantly higher than what was anticipated at the acquisition date.

As settlement discussions have thus far proven unsuccessful, the amount of reserve seasoning will now be determined by an independent valuation process. Fitch’s understanding of the process is that both sides will submit their estimated valuation with supporting information and analysis regarding ultimate loss experience to a designated independent actuary. The independent actuary will complete their own actuarial valuation based on this information.

XL has indicated that their submission would result in a net payable to XL of approximately $1.45 billion, while Winterthur’s submission would result in a net payable to XL of approximately $541 million. The final seasoned reserve amount is determined through a ‘baseball-type’ process in which the actual final seasoned reserve amount is whichever of XL’s or Winterthur’s submitted number is closest to the ultimate loss valuation determined by the independent actuary.

Although it is difficult to predict, it will likely take several quarters for the independent actuary to make a decision. While XL has completed extensive analysis supported by outside actuarial and claims experts to derive its estimates, there is the possibility that the independent actuary may not rule in their favor.

If XL is unsuccessful in the independent actuary valuation process, the company could face a $900 million net pre-tax charge from a reduced recoverable from Winterthur. In this event, Fitch would review XL’s capital position and any plans to replenish capital from this potential charge, including retained earnings from operations, and consider the ratings on Rating Watch for a downgrade at that time, most likely by one notch.

If XL is successful in the process, Fitch is likely to affirm the ratings at the current level and remove them from Rating Watch Negative.

XL is a Bermuda-headquartered holding company with subsidiaries providing insurance, reinsurance and specialty financial products and services on a worldwide basis. The company reported consolidated GAAP assets of $49 billion and shareholders equity of approximately $7.7 billion at Dec. 31, 2004.

XL reported net income of $1.2 billion and an underwriting combined ratio of 96% for the full year 2004. This compares with net income of $371.7 million and a combined ratio of 102.6% in 2003. XL’s 2004 results included pre-tax losses of approximately $590 million related to losses from the third quarter hurricanes in the U.S. and the fourth quarter south Asian tsunami. XL’s 2003 results included third and fourth quarter pre-tax loss reserve increases totaling $878 million, primarily related to North American casualty reinsurance business.

Fitch noted that the placement of XL Capital Ltd. (XL) on Rating Watch Negative today has no current effect on the ‘AAA’ insurer financial strength (IFS) ratings of XL Capital Assurance (XLCA) and XL Financial Assurance (XLFA). XLCA and XLFA are the monoline financial guaranty subsidiaries of XL. The Rating Outlook for XLCA and XLFA remains Stable.

Fitch noted that should the ratings of parent XL ultimately be downgraded, this may place downward pressure on the financial flexibility afforded to XLCA and XLFA via its parent relationship. XLCA and XLFA has historically been reliant on capital contributions from XL to support business growth.

That being said, Fitch is confident that management of XLCA and XLFA have the willingness and commitment to manage their capital position within the boundaries necessary to maintain their ‘AAA’ IFS ratings without further reliance on capital infusions from XL. These parameters are particularly relevant while XL’s rating is on Rating Watch.