XL Takes $647M Reserve Hit

The new year is still in its infancy, but one familiar scenefrom previous years is already being played out in the insuranceindustrya big reserve charge quickly followed by rating agencyreactions.

Last week, the Bermuda-based XL Capital Ltd. announced it istaking a $647 million after-tax charge for its 2003 fourth quarter.XL said the charge, which follows previously announced claims-auditand regularly scheduled year-end reserve reviews, will largelycover reinsurance losses in its North American operations involvingcontracts sold by NAC Re Corp., a reinsurer that XL bought in1999.

XL had already added some $160 million after tax to its NorthAmerican operations reserves during the 2003 third quarter toaccount for higher-than-expected losses, mostly from new casualtyclaims for 1997-to-2000 underwriting years. Since then, the companyhas been examining further whether it has fully adequate reservesto address these losses.

XL said that because of the new charge, it will issue convertiblesecurities to raise at least $750 million in the first half of2004.

In a conference call with analysts, XL management emphasizedrepeatedly that this reserve addition will finally resolve thecompanys prior-year liability problems. “This concludes a verydifficult chapter for XL. I believe that with these actions taken,we have fully and completely addressed our legacy issues,” said XLChief Executive Officer Brian O'Hara.

There are four major components to XLs overall reservechange.

First, the bulk of the charges are for late-emerging developmentfrom the old NAC Re from the soft market years of 1997 to 2001.“This is concentrated primarily in the more problematic businesslines: directors and officers and medical malpractice reinsurancetreaties,” Mr. O'Hara said.

Second, a regularly scheduled reinsurance year-end review of allother reserves, excluding the Sept. 11 terrorism event, resulted inthe recognition of $62 million of casualty and professional-lineslosses from late 1990s to 2001, XL noted.

Third, a regularly scheduled year-end review of XL insurancesegments reserves resulted in $150 million of prior-yeardevelopment, mostly related to Bermuda-based professionallines.

Fourth, XL also had some favorable reserve development toannounce. Due to the high degree of participation by World TradeCenter claimants in the Sept. 11 victim compensation fund process,which ended last month, XL said it was able to take down its Sept.11-related reinsurance reserves by $181 million.

Mr. O'Hara remarked that XL is now in a position to move forwardwithout its legacy burden. “This review is not the only thing goingon at XL. We have a strong momentum in our current business flowinginto 2004,” he said. “I am looking forward to leading XL to astellar 2004 and beyond.”

However, some analysts told National Underwriter thatthey were still surprised by the magnitude of the charge. “It waslarger than we had anticipated, cumulatively for the year,” saidRobert DeRose, analyst at the Oldwick, N.J.-based A.M. BestCompany. The agency has downgraded all debt ratings of XL Capital,and also placed its “A-plus” financial strength ratings for XLCapital and its affiliated companies under review with “negative”implications.

“We have taken a rating action on XL group because charges werehigher than we had anticipated,” added Karole Barkley, analyst atthe New York-based Standard & Poor's Ratings Services, whichalso cut its XL ratings. S&Ps ratings actions include cuttingits counterparty-credit and financial-strength ratings on coreoperating companies to “double-A-minus” from “double-A,” as well aslowering its counterparty-credit rating on XL Capital to “A” from“A-plus” and removing it from the CreditWatch status.

Moody's Investors Service in New York cut ratings of XL Capitalssenior unsecured debt to “A2″ from “A1,” as well as insurancefinancial strength ratings for members of the XL ReinsuranceAmericas intercompany pool and XL Re, to “Aa3″ from “Aa2.” Theoutlooks for all rated members of the XL Capital group are nowstable.

Reproduced from National Underwriter Edition, January 16, 2004.Copyright 2004 by The National Underwriter Company in the serialpublication. All rights reserved.Copyright in this article as anindependent work may be held by the author.