10-K

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2004

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____ to _____
Commission file number 1-10804

XL CAPITAL LTD

(Exact name of registrant as specified in its charter)

Cayman Islands	98-0191089
(State or other jurisdiction of	(I.R.S. Employer Identification No.)
incorporation or organization)
XL House, One Bermudiana Road,	(441) 292-8515
Hamilton, Bermuda HM 11	(Registrant’s telephone number, including area code)
(Address of principal executive offices and zip code)

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

Title of each class	Name of each exchange on which registered
Class A Ordinary Shares, Par Value $0.01 per Share	New York Stock Exchange, Inc.
Series A 8.00% Preference Ordinary Shares, Par Value $0.01 per Share	New York Stock Exchange, Inc.
Series B 7.625% Preference Ordinary Shares, Par Value $0.01 per Share	New York Stock Exchange, Inc.
6.50% Equity Security Units	New York Stock Exchange, Inc.

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
None

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [  ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X]

Indicate by check mark whether the registrant is an accelerated filer as defined in Rule 12b-2 of the Act.
Yes [X]   No [  ]

The aggregate market value of the voting common equity of the registrant held by non-affiliates of the registrant on March 1, 2005 was approximately $10.4 billion computed upon the basis of the closing sales price of the Class A Ordinary Shares on that date. For purposes of this computation, ordinary shares held by directors and officers of the registrant have been excluded. Such exclusion is not intended, nor shall it be deemed, to be an admission that such persons are affiliates of the registrant.

As of March 1, 2005, there were outstanding 139,031,341 Class A Ordinary Shares, $0.01 par value per share, of the registrant.

Documents Incorporated by Reference

The Registrant’s Definitive Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report relating to the annual meeting of ordinary shareholders to be held on April 29, 2005 is incorporated by reference into Part III of this Form 10-K.

XL CAPITAL LTD

TABLE OF CONTENTS

PART I

		Page
Item 1.	Business	1
Item 2.	Properties	29
Item 3.	Legal Proceedings	29
Item 4.	Submission of Matters to a Vote of Security Holders	31

PART II

Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	33
Item 6.	Selected Financial Data	35
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	37
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	84
Item 8.	Financial Statements and Supplementary Data	93
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	162
Item 9A.	Controls and Procedures	162
Item 9B.	Other Information	163

PART III

Item 10.	Directors and Executive Officers of the Registrant	164
Item 11.	Executive Compensation	164
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	164
Item 13.	Certain Relationships and Related Transactions	165
Item 14.	Principal Accountant Fees and Services	165

PART IV

Item 15. Exhibits and Financial Statement Schedules 165

This Annual Report on Form 10-K contains “Forward-Looking Statements” as defined in the Private Securities Litigation Reform Act of 1995. A non-exclusive list of the important factors that could cause actual results to differ materially from those in such Forward-Looking Statements is set forth herein under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Cautionary Note Regarding Forward-Looking Statements.”

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PART I

ITEM 1.BUSINESS

History

XL Capital Ltd, together with its subsidiaries (the “Company” or “XL”), is a leading provider of insurance and reinsurance coverages, and financial products and services to industrial, commercial and professional service firms, insurance companies and other enterprises on a worldwide basis. XL Capital Ltd was incorporated with limited liability under the Cayman Islands Companies Act on March 16, 1998, as EXEL Merger Company. XL Capital Ltd was formed as a result of the merger of EXEL Limited and Mid Ocean Limited on August 7, 1998, and the Company was named EXEL Limited on that date.

EXEL Limited and Mid Ocean are companies that were incorporated in the Cayman Islands in 1986 and 1992, respectively. At a special general meeting held on February 1, 1999, the shareholders of the Company approved a resolution changing the name of the Company to XL Capital Ltd.

On June 18, 1999, XL Capital Ltd merged with NAC Re Corp. (“NAC”), a Delaware corporation organized in 1985, in a stock merger. This merger was accounted for as a pooling of interests under U.S. generally accepted accounting principles (“GAAP”). Following the merger, the Company changed its fiscal year end from November 30 to December 31 as a conforming pooling adjustment.

On July 25, 2001, the Company acquired certain Winterthur International insurance operations (“Winterthur International”) to extend its predominantly North American based large corporate insurance business globally. This was an all-cash transaction preliminarily valued at approximately $405.6 million which was based on audited financial statements as at December 31, 2000 for the business being acquired, and was subject to adjustment based on the audited June 30, 2001 financial statements of Winterthur International. In December 2003, the Company reached an agreement with the Winterthur Swiss Insurance Company (the “Seller”) as to the final purchase price, which was $330.2 million. As a result $75.4 million in cash was returned to the Company.

In connection with its acquisition of Winterthur International, the Company has recorded an unsecured reinsurance recoverable from the Seller of $1.45 billion at December 31, 2004 related to certain contractual arrangements with the sale and purchase agreement, as amended (“SPA”). The Seller is currently rated “A-” by S&P. The Seller provides the Company with post-closing protection determined as of June 30, 2004 with respect to, among other things, adverse development of net loss and unearned premium reserves relating to the acquired Winterthur International business (“Winterthur Business”). This protection is based upon net loss experience and development over a three-year, post-closing seasoning period based on actual loss development experience, collectible reinsurance and certain other factors set forth in the SPA. The SPA includes a process for determining the amount due from the Seller by an independent actuarial process whereby the independent actuary develops a value of the seasoned net reserves. The actual final seasoned amount will be the submission that is closest to the number developed by the independent actuary.

As the Company and the Seller were unable to come to an agreement, the Company submitted to the Seller notice to trigger the independent actuarial process as contemplated by the SPA. On February 3, 2005, both the Company and the Seller made submissions for the independent actuarial process. The Company’s submission would result in a net payable to the Company of approximately $1.45 billion in aggregate and the Seller’s submission would result in a net payable to the Company of $541 million in aggregate. Approximately $855 million of the total $909 million difference between the Seller and the Company relates to seasoned losses, the remainder relates to premium seasoning. Upon completion of the independent actuarial process, the Company will be entitled to a lump sum payment.

Results of operations of Winterthur International have been included from July 1, 2001, the date from which the economic interest was transferred to the Company.

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Effective January 1, 2002, the Company increased its shareholding in Le Mans Ré from 49% to 67% in order to expand its international reinsurance operations. Due to certain contractual arrangements between the Company and Les Mutuelles du Mans Assurances Group (“MMA”) (the other Le Mans Ré shareholder), MMA did not have any economic interest in the earnings of Le Mans Ré with effect from January 1, 2002 and accordingly, no minority interest was recorded since that date. On September 3, 2003, the Company exercised its option to buy the remaining 33% from MMA for approximately $161 million in cash and changed the name of Le Mans Ré to XL Re Europe. XL Re Europe underwrites a worldwide portfolio comprising most classes of property and casualty reinsurance business, together with a select portfolio of life reinsurance business. See further information under Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 8, Note 5(a) to the Consolidated Financial Statements.

Segments

The Company operates through three business segments: Insurance, Reinsurance and Financial Products and Services. These business segments were determined in accordance with Statement of Financial Accounting Standard (“FAS”) No. 131, “Disclosures about Segments of an Enterprise and Related Information” (“FAS 131”).

The following table sets forth an analysis of gross premiums written by segment for the years ended December 31, 2004, 2003 and 2002. Additional financial information about the Company’s segments, including financial information about geographic areas, is included in Item 8, Note 3 to the Consolidated Financial Statements.

	2004		2003		2002
	Gross		Gross		Gross
Year ended December 31	Premiums	Percentage	Premiums	Percentage	Premiums
(U.S. dollars in millions)	Written	Change	Written	Change	Written
Insurance – General	$5,956,978	14.1%	$5,221,316	15.0%	$4,539,186
Reinsurance – General	3,420,570	0.5%	3,402,764	7.2%	3,174,819
Reinsurance – Life and Annuity	1,343,507	99.6%	673,027	(32.9)%	1,003,154
Financial Products & Services – Financial	276,079	(12.1)%	313,916	57.0%	199,913
Financial Products & Services – Life and Annuity	94,597	(0.5)%	95,062	37.6%	69,094

Insurance Operations

General

The Company provides commercial property and casualty insurance products on a global basis. Products generally provide tailored coverages for complex corporate risks and are divided into two categories: risk management products and specialty lines products.

Risk management products comprise global property and casualty insurance programs for large multinational companies and institutions and include umbrella liability, product recall, U.S. workers’ compensation, property catastrophe and primary master property and liability coverages. Risk management products generally provide large capacity on a primary, quota share or excess of loss basis. Risk management products are targeted to large worldwide companies in major industry groups including aerospace, automotive, consumer products, pharmaceutical, pulp and paper, high technology, telecommunications, transportation and basic metals. In North America, excess casualty business written is generally long tail, umbrella and high layer excess business, meaning that the Company’s liability attaches after large deductibles, including self insurance or insurance from other companies. Primary casualty programs (including workers’ compensation) generally require customers to take large deductibles or self-insured retentions. Outside of North America, excess casualty business is also written on a primary basis. Policies are written on an occurrence, claims-made and occurrence reported basis. The Company’s property business written is primarily short tail in nature and written on both a primary and excess of loss basis. Property business written includes exposures to man-made and natural disasters, and generally, loss experience is characterized as low frequency and high severity. This may result in volatility in the Company’s results of operations, financial condition and liquidity. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

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Specialty lines products include professional liability insurance, environmental liability insurance, political risk insurance, aviation and satellite insurance, marine and offshore energy insurance, surety, specie, equine, and other insurance coverages including program business.

Professional liability insurance includes directors’ and officers’ liability, errors and omissions liability and employment practices liability coverages. Policies are written on both a primary and excess of loss basis. Directors’ and officers’ coverage includes primary and excess directors’ and officers’ liability, employment practices liability, company securities and private company directors’ and officers’ liability. Products are targeted at a variety of different sized companies, with a heavy concentration on small to medium-sized firms when written on a primary basis. Employment practices liability is written primarily for very large corporations and covers those firms for legal liability in regard to the treatment of employees. Errors and omissions coverage is written on a primary and excess basis. Errors and omissions insurance written on a primary basis is targeted to small to medium-sized firms and coverage is provided for various professional exposures, including, but not limited to, insurance brokers, consultants, architects and engineers, lawyers and real estate agents.

Environmental liability products include pollution and remediation legal liability, general and project-specific pollution and professional liability, commercial general property redevelopment and contractor’s pollution liability. Business is written for both single and multiple years on a primary or excess of loss, claims-made or, less frequently, occurrence basis. Targeted industries include chemical facilities, environmental service firms, contractors, healthcare facilities, manufacturing facilities, real estate redevelopment, transportation and construction. The Company also offers commercial general liability and automobile liability insurance to environmental businesses.

Political risk insurance generally covers risks arising from expropriation, currency inconvertibility, contract frustration, non-payment and war on land or political violence (including terrorism) in developing regions of the world. Political risk insurance is typically provided to financial institutions, equity investors, exporters, importers, export credit agencies and multilateral agencies in connection with investments and contracts in emerging market countries.

Aviation and satellite products include comprehensive airline hull and liability, airport liability, aviation manufacturers’ product liability, aviation ground handler liability, large aircraft hull and liability, corporate non-owned aircraft liability, space third party liability and satellite risk including damage or malfunction during ascent to orbit and continual operation, and aviation war. Aviation liability and physical damage coverage is offered for large aviation risks on a proportional basis, while smaller general aviation risks are offered on a primary basis. Satellite risks are generally written on a proportional basis. The target markets for aviation and satellite products include airlines, aviation product manufacturers, aircraft service firms, general aviation operators and telecommunications firms.

Marine and offshore energy, specie and equine insurance are also provided by the Company. Marine and energy coverage includes marine hull and machinery, marine war, marine excess liability, cargo and offshore energy insurance. Specie products are highly specialized classes of insurance for the protection of fine arts and other high value items. Equine products specialize in providing bloodstock, livestock and fish farm insurance.

Business is also written on a broad range of surety products and services throughout North America, with a focus on contract, commercial and international trade surety bonds, targeting all segments of the construction marketplace. Surety products include bid, performance, payment, maintenance and supply bonds, commercial surety bonds, U.S. customs and international trade surety bonds, license bonds, permit bonds, court bonds, public official bonds and other miscellaneous bonds.

The Company’s program business specializes in insurance coverages for distinct market segments in North America, including program administrators and managing general agents who operate in a specialized market niche and have unique industry backgrounds or specialized underwriting capabilities. Products encompass automobile extended warranty, intellectual property and trademark infringement, small commercial property catastrophe and other property and casualty coverages.

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The excess nature of many of the Company’s insurance products, coupled with historically large policy limits, results in a book of business that can have losses characterized as low frequency and high severity. As a result, large losses, though infrequent, can have a significant impact on the Company’s results of operations, financial condition and liquidity. The Company attempts to mitigate this risk by, among other things, using strict underwriting guidelines and various reinsurance arrangements, discussed below.

See also “– Risk Management” for further information.

The U.S. Terrorism Risk Insurance Act of 2002 (“TRIA”) became effective on November 26, 2002 and is a three-year federal program effective through 2005. TRIA voided in force terrorism exclusions as of November 26, 2002 for certified terrorism acts (i.e., those arising from international, not domestic, acts) on all TRIA specified property and casualty business. TRIA requires covered insurers to make coverage available for certified acts of terrorism on all new and renewal policies issued after TRIA was enacted. TRIA allows the Company to assess a premium charge for terrorism coverage and, if the policyholder declines the coverage or fails to pay the buy-back premium, certified acts of terrorism may then be excluded from the policy, subject, however, to state specific requirements. Terrorism coverage cannot be excluded from workers’ compensation policies. Subject to a premium-based deductible and provided that the Company has otherwise complied with all the requirements as specified in TRIA, for each year this program is in effect, the Company is eligible for reimbursement by the Federal Government for 90% of its covered terrorism related losses arising from a certified terrorist attack. Entitlement to such reimbursement ends once the aggregated insured losses for the entire insurance industry exceed $100 billion in a single program year. Once this $100 billion loss threshold has been reached for any program year, any insurer covered under TRIA that has met its deductible will not be responsible for any further loss payments in that program year.

The Company had, prior to the passage of TRIA, underwritten exposures under certain insurance policies that included coverage for terrorism. The passage of TRIA has required the Company to make a mandatory offer of “Certified” terrorism coverage with respect to all of its TRIA covered insurance policies. In addition, the Company underwrites a number of policies providing terrorism coverage that are not subject to TRIA.

To date, the U.S. Congress has not extended TRIA beyond the end of 2005. Terrorism-related losses that occur after January 1, 2006 which are covered by policies issued during 2005 may not, therefore, be reimbursable under TRIA. If TRIA is not renewed or similar legislation passed, it will create an increase in the risk to the Company of large losses related to terrorist acts committed after January 1, 2006 which are covered by policies issued during 2005. Under current legislation, the Company must provide certain terrorism coverages as described above. Policies issued during 2005 will likely extend into 2006 and are subject to these mandated coverages, even if TRIA reinsurance programs has expired before the end of the policy period.

Non-U.S. Terrorism

The Company provides coverage for terrorism under casualty policies on a case by case basis, except with respect to workers’ compensation policies on which no terrorism exclusion of any type is permitted. However, the Company generally does not provide significant limits of coverage for terrorism under first party property policies outside of the U.S. unless required to do so by local law and/or protected by a national terrorism risk pool. Various countries have enacted legislation to provide insurance coverage for terrorism occurring within their borders, to protect registered property, and to protect citizens traveling abroad. The legislation typically requires registered direct insurers to provide terrorism coverage for specified coverage lines and then permits them to cede the risk to a national risk pool. The Company has subsidiaries that participate in terrorism risk pools in various jurisdictions, including Australia, France, Spain, The Netherlands and the United Kingdom.

Underwriting

The Company underwrites and prices most risks individually following a review of the exposure and in accordance with the Company’s underwriting guidelines. Most of the Company’s insurance operations have underwriting

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guidelines that are industry-specific. The Company seeks to control its exposure on an individual insurance contract through terms and conditions, policy limits and sub-limits, attachment points, and facultative and treaty reinsurance arrangements on certain types of risks.

The Company’s underwriters generally evaluate each industry category and sub-groups within each category. Premiums are set and adjusted for an insured based, in large part, on the industry group in which the insured is placed and the insured’s perceived risk relative to the other risks in that group. Rates may vary significantly according to the industry group of the insured as well as the insured’s risk relative to the group. The Company’s rating methodology for individual insureds seeks to set premiums in accordance with claims potential as measured by past experience and future expectations, the attachment point and amount of underlying insurance, the nature and scope of the insured’s operations, including the industry group in which the insured operates, exposures to loss, natural hazard exposures, risk management quality and other specific risk factors relevant in the judgment of the Company’s underwriters to the type of business being written.

Underwriting and loss experience is reviewed regularly for loss trends, emerging exposures, changes in the regulatory or legal environment as well as the efficacy of policy terms and conditions.

As the Company’s insurance products are primarily specialized coverages, underwriting guidelines and policy forms differ by product offering as well as by legal jurisdiction. Liability insurance is written on both a primary and excess of loss basis, on occurrence, occurrence reported and claims-made policy forms. Occurrence reported policies typically cover occurrences causing unexpected and unintended personal injury or property damage to third parties arising from events or conditions that commence at or subsequent to an inception date, or retroactive date, if applicable (but not prior to January 1, 1986), and prior to the expiration of the policy provided that proper notice is given during the term of the policy or the discovery period. Traditional occurrence coverage is also available for restricted classes of risk and is generally written on a follow-form basis where the policy adopts the terms, conditions and exclusions of the underlying policy. Property insurance risks are written on a lead or follow-form basis that usually provides coverage for all risks of physical damage and business interruption. Maximum limits are generally subject to sub-limits for coverage in critical earthquake zones, where the Company seeks to limit its liability in these areas.

Reinsurance Ceded

In certain cases, the risks assumed by the Company are partially reinsured with third party reinsurers. Reinsurance ceded varies by location and line of business based on a number of factors, including market conditions. The benefits of ceding risks to other reinsurers include reducing exposure on individual risks, protecting against catastrophic risks and maintaining acceptable capital ratios and enabling the writing of additional business. Reinsurance ceded does not legally discharge the Company from its liabilities to the original policyholder in respect of the risk being reinsured.

The Company uses reinsurance to support the underwriting and retention guidelines of each of its subsidiaries as well as to control the aggregate exposure of the Company to a particular risk or class of risks. Reinsurance is purchased at several levels ranging from reinsurance of risks assumed on individual contracts to reinsurance covering the aggregate exposure of a portfolio at policies issued by groups of companies. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Premiums

Premium rates and underwriting terms and conditions for all lines of business written vary by jurisdiction principally due to local market conditions, competitor product offerings and legal requirements.

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The following table is an analysis of the insurance segment’s gross premiums written, net premiums written and net premiums earned from general operations, by line of business for the year ended December 31, 2004:

	Gross	Net	Net
	Premiums	Premiums	Premiums
(U.S. dollars in thousands)	Written	Written	Earned
General Operations:
Professional liability	$1,624,387	$1,457,842	$1,361,013
Casualty insurance	1,659,992	1,153,576	1,001,376
Property catastrophe	107,609	57,240	40,713
Other property	916,465	612,822	594,867
Marine, energy, aviation and satellite	1,178,289	920,882	889,170
Accident and health	14,401	9,066	11,235
Other (1)	455,835	215,091	184,779
Total	$5,956,978	$4,426,519	$4,083,153

(1) Other includes political risk, surety, bonding, warranty and other lines.

Additional discussion and financial information about the insurance segment is set forth in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 8, Note 3 to the Consolidated Financial Statements.

Competition

The Company competes globally in the property and casualty markets. Its competitors include the following companies and their affiliates: The ACE Group of Companies (“ACE”); American International Group, Inc. (“AIG”); Hartford Financial Services (“Hartford”); Lloyd’s of London Syndicates (“Lloyd’s”); Munchener Ruckversicherungs-Gesellschaft Aktiengesellschaft (“Munich Re”); Swiss Reinsurance Company (“Swiss Re”); The Chubb Corporation (“Chubb”); St. Paul/Travelers; and Zurich Financial Services Group (“Zurich”).

The Company’s major geographical markets for its property and casualty insurance operations are North America, Europe and Bermuda. The Company’s main competitors in each of these markets include the following:

North America – AIG, ACE, Chubb, Zurich, St. Paul/Travelers, CNA Financial Corporation, Hartford, Factory Mutual Insurance Company, Liberty Mutual Group and Lloyd’s.

Europe – Allianz Aktiengesellschaft, AIG, Zurich, AXA, Munich Re, ACE, Lloyd’s and Swiss Re.

Bermuda – ACE, Allied World Assurance Company, Axis Capital Group, Max Re Ltd., Endurance Specialty Insurance Ltd (“Endurance”), Arch Capital Group Ltd and Starr Excess Liability Insurance Co Ltd.

See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Executive Overview” for further discussion.

Marketing and Distribution

Clients (insureds) are referred to the Company through a large number of international, national and regional brokers, acting as their agents, and captive managers who receive from the insured or ceding company a set fee or brokerage commission usually equal to a percentage of gross premiums. In the past, the Company has also entered into contingent commission arrangements with some intermediaries that provide for the payment of additional commissions based on such variables as production of new and renewal business or the retention of business. In general, the Company has no implied or explicit commitments to accept business from any particular broker and neither brokers nor any other third party have the authority to bind the Company, except in the case where underwriting authority

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may be delegated contractually to selected program administrators. Such administrators are subject to a due diligence financial and operational review prior to any such delegation of authority and ongoing reviews and audits are carried out as deemed necessary by the Company to assure the continuing integrity of underwriting and related business operations. See Item 8, Note 18(a) to the Consolidated Financial Statements for information on the Company’s major brokers.

Claims Administration

Claims management for the insurance operations includes the review of initial loss reports, administration of claims databases, generation of appropriate responses to claims reports, identification and handling of coverage issues, determination of whether further investigation is required and, where appropriate, retention of claims counsel, establishment of case reserves, payment of claims, and notification to reinsurers. With respect to the establishment of case reserves, when the Company is notified of insured losses, claims personnel record a case reserve as appropriate for the estimated amount of the exposure at that time. The estimate reflects the judgment of claims personnel based on general reserving practices, the experience and knowledge of such personnel regarding the nature of the specific claim and, where appropriate, advice of counsel. Reserves are also established to provide for the estimated expense of settling claims, including legal and other fees and the general expenses of administering the claims adjustment process.

Claims in respect of business written by the Company’s Lloyd’s syndicates are primarily notified by various central market bureaus. Where a syndicate is a “leading” syndicate on a Lloyd’s policy, its underwriters and claims adjusters will deal with the broker or insured on behalf of itself and the following market for any particular claim. This may involve appointing attorneys or loss adjusters. The claims bureaux and the leading syndicate advise movement in loss reserves to all syndicates participating on the risk. The Company’s claims department may adjust the case reserves it records from those advised by the bureaux as deemed necessary.

Certain of the Company’s product lines have arrangements with third party administrators (“TPAs”) to provide claim handling services to the Company. These agreements spell out the duties of the TPA, limits of authority and various procedures that are required. These arrangements are also subject to audit review by the Company’s claim departments.

Reinsurance Operations

General

The Company provides casualty, property, property catastrophe, marine, aviation, accident and health, and other specialty reinsurance and life products on a global basis with business being written on both a proportional and non-proportional basis. Business written on a non-proportional basis generally includes an indemnification of the ceding company for a portion of the losses on policies in excess of a specified loss amount. For business written on a proportional or “quota share” basis, the Company receives an agreed percentage of the premium and is liable for the same percentage of the incurred losses. The ceding company receives a commission based upon premiums ceded and may also, under certain circumstances, receive a profit commission. Reinsurance may be written on a treaty or facultative basis.

The Company’s casualty reinsurance includes general liability, professional liability, automobile and workers’ compensation. Professional liability includes directors’ and officers’, employment practices, medical malpractice, and environmental liability. Casualty lines are written as treaties or programs on both a proportional and a non-proportional basis as well as individual risk business written on a facultative basis. The treaty business includes clash programs which cover a number of underlying policies involved in one occurrence or a judgment above an underlying policy’s limit, before suffering a loss. The treaty business is mainly written through reinsurance intermediaries while the individual risk business is mostly marketed directly to the ceding companies.

The Company’s property business, primarily short-tail in nature, is written on both a treaty and facultative basis and includes property catastrophe, property excess of loss and property proportional. A significant portion of the property business underwritten consists of large aggregate exposures to man-made and natural disasters and, generally,

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loss experience is characterized as low frequency and high severity. This may result in volatility in the Company’s results of operations, financial condition and liquidity. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

The Company seeks to manage its reinsurance exposures to catastrophic events by limiting the amount of exposure in each geographic or peril zone worldwide, underwriting in excess of varying attachment points and requiring that its property catastrophe contracts provide for aggregate limits. The Company also seeks to protect its aggregate exposures by peril and zone through the purchase of reinsurance programs. See “– Risk Management” for further information.

The Company’s property catastrophe reinsurance account is generally “all risk” in nature. As a result, the Company is exposed to losses from sources as diverse as hurricanes and other windstorms, earthquakes, freezing, riots, floods, industrial explosions, fires, and many other potential disasters. In accordance with market practice, the Company’s policies generally exclude certain risks such as war, nuclear contamination or radiation. Following the terrorist attacks at the World Trade Center in New York City, in Washington, D.C. and in Pennsylvania on September 11, 2001 (collectively, “the September 11 event”), terrorism cover, including nuclear, biological and chemical, has also excluded in many territories and classes. The Company’s predominant exposure under such coverage is to property damage.

Property catastrophe reinsurance provides coverage on an excess of loss basis when aggregate losses and loss adjustment expenses from a single occurrence of a covered event exceed the attachment point specified in the policy. Some of the Company’s property catastrophe contracts limit coverage to one occurrence in any single policy year, but most contracts generally enable one reinstatement to be purchased by the reinsured.

The Company also writes property risk excess of loss reinsurance. Property risk excess of loss reinsurance covers a loss to the reinsured on a single risk of the type reinsured rather than to aggregate losses for all covered risks on a specific peril, as is the case with catastrophe reinsurance. The Company’s property proportional account includes reinsurance of direct property insurance. The Company seeks to limit the catastrophe exposure from its proportional business through extensive use of occurrence and cession limits.

Other specialty reinsurance products include energy, fidelity, surety and political risk.

The Company had, prior to the passing of TRIA, underwritten reinsurance exposures in the U.S. that included terrorism coverage. Since the passage of TRIA in the U.S., the Company has underwritten a very limited number of stand-alone terrorism coverage policies in addition to coverage included within non-stand-alone policies. In the U.S., the Company generally excludes coverage included under TRIA in addition to nuclear, biological and chemical (“NBC”) acts from the main catastrophe exposed policies. In other cases, both within and outside the U.S., the Company generally relies on either a terrorism exclusion clause, which does not include personal lines, excluding NBC, or a similar clause that excludes terrorism completely.

The Company’s accident and health products include accidental death, medical, hospital indemnity and income protection coverage.

The Company underwrites a small portfolio of contracts covering political risk and trade credit. Exposure is assumed from a limited number of trade credit contracts and through Lloyd’s quota shares. In addition, there are run off exposures from discontinued writings in the Company’s marine portfolio.

The Company’s reinsurance segment also writes life reinsurance primarily in respect of European lives. This includes term assurances, group life, critical illness cover, immediate annuities and disability income business. The majority of the business written is on a proportional basis. The Company has also written a few large contracts comprising portfolios of closed blocks of U.K. and European annuities. In relation to certain of these contracts, the Company receives cash and investment assets at the inception of the contract relating to future policy benefit reserves assumed. These contracts are long term in nature where the expected claims payout period can span thirty to forty years.

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Underwriting

Underwriting risks for the general and life reinsurance business are evaluated using a number of factors including, but not limited to, the type and layer of risk to be assumed, the actuarial evaluation of premium adequacy, the cedent’s underwriting and claims experience, the cedent’s financial condition and claims paying rating, the exposure and/or experience with the cedent, and the line of business to be reinsured.

Other factors assessed by the Company include the reputation of the proposed cedent, the geographic area in which the cedent does business and its market share, a detailed evaluation of catastrophe and risk exposures, and historical loss data for the cedent where available and for the industry as a whole in the relevant regions, in order to compare the cedent’s historical loss experience to industry averages. On-site underwriting reviews are performed where it is deemed necessary to determine the quality of a current or prospective cedent’s underwriting operations.

For property catastrophe reinsurance business, the Company’s underwriting guidelines generally limit the amount of exposure it will directly underwrite for any one reinsured and the amount of the aggregate exposure to catastrophic losses in any one geographic zone. The Company believes that it has defined geographic and peril zones such that a single occurrence, for example an earthquake or hurricane, should not affect more than one peril zone. While the exposure to multiple zones is considered remote for events such as a hurricane, the Company does manage its aggregates for such a scenario where the Company considers it appropriate to do so. The definition of the Company’s peril zones is subject to periodic review. The Company also generally seeks an attachment point for its property catastrophe reinsurance at a level that is high enough to produce a low frequency of loss. The Company seeks to limit its aggregate exposure in the proportional business through extensive use of occurrence and cession limits.

Reinsurance Retroceded

The Company uses third party reinsurance to support the underwriting and retention guidelines of each reinsurance subsidiary as well as to seek to limit the aggregate exposure of the Company to a particular risk or class of risks. Reinsurance is purchased at several levels ranging from reinsurance of risks assumed on individual contracts to reinsurance covering the aggregate exposures. The benefits of ceding risks to other reinsurers include reducing exposure on individual risks, protecting against catastrophic risks, maintaining acceptable capital ratios and enabling the writing of additional business. Reinsurance ceded does not legally discharge the Company from its liabilities in respect of the risk being reinsured. Reinsurance ceded varies by location and line of business based on factors including, among others, market conditions.

In May 2004, a three-year program that commenced in May 2001 for a significant portion of the Company’s global property catastrophe exposures expired. This program, at inception, contained provisions that provided for a return of premium in the event of no losses being ceded to the program and conversely provided for additional premiums in the event that losses exceeded specific limits within the treaties. Following the September 11 event, these provisions were fully invoked in 2001 with the additional premiums being booked in 2001. As a result, the program for the 2002/3 and 2003/4 coverage period was essentially similar to a traditional agreement with a fixed premium and aggregate limit, consistent with the original terms of the treaty. A full review of the Company’s property catastrophe exposures was completed in the spring of 2004 to optimize the economics against the management of such risks. A traditional program incepting between May and July and renewing annually was put in place to cover these exposures. The new covers give protection in various layers and excess of varying attachment points according to territorial exposure. The Company has co-reinsurance retentions within this program.

The Company’s casualty reinsurance program covers multiple claims arising from two or more risks from a single occurrence or event. In 2003, the Company purchased casualty contingency cover of $22.5 million excess of $7.5 million per occurrence and also further protected the casualty book within a multi-line basket cover with limits of $20 million excess of $30 million per occurrence and this protection was renewed in 2004. There is additional clash cover purchased for the Company’s London and Sydney based portfolios, also on an occurrence basis, for limits of $15 million excess of $15 million. This layer was renewed in October with limits of $25 million excess of $20 million and now covers all business written out of the Company’s London and Sydney branches as well as XL Re Europe. The

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Company also buys specific reinsurance on its marine and aviation portfolios to manage its net exposures in these classes. The Company has not purchased retrocession coverage attaching during 2004 that has limited risk transfer terms. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 8, Note 10 to the Consolidated Financial Statements for further information.

Premiums

The following table is an analysis of the reinsurance segment’s gross premiums written, net premiums written and net premiums earned from general and life and annuity operations, by line of business for the year ended December 31, 2004:

	Gross	Net	Net
	Premiums	Premiums	Premiums
(U.S. dollars in thousands)	Written	Written	Earned
General Operations:
Professional liability	$ 405,077	$ 399,450	$ 375,582
Casualty	940,197	867,046	871,155
Property catastrophe	377,132	317,424	304,057
Other property	1,059,353	726,548	783,502
Marine, energy, aviation and satellite	248,779	192,827	204,500
Accident and health	38,285	37,716	42,706
Other (1)	351,747	299,644	317,894
Total general operations	3,420,570	2,840,655	2,899,396
Life and annuity operations	1,343,507	1,308,634	1,310,986
Total	$4,764,077	$4,149,289	$4,210,382

(1) Other includes political risk, surety, bonding, warranty and other lines.

Additional discussion and financial information about the reinsurance segment is set forth in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 8, Note 3 to the Consolidated Financial Statements.

Competition

The Company competes globally in the property and casualty markets. Its competitors include the following companies and their affiliates: ACE Tempest Reinsurance, Ltd (“Tempest”); Lloyd’s; Munich Re; St. Paul/Travelers; Swiss Re; PartnerRe Ltd; ERC; Transatlantic Reinsurance Company (“Transatlantic Re”); and Zurich.

The Company’s major geographical markets for its property and casualty general reinsurance operations are North America, Europe and Bermuda. The main competitors in each of these markets include the following:

North America – General Re Corporation, American Re Corporation, Swiss Re America Corporation, Transatlantic Re, Everest Re Group Ltd, GE Reinsurance Corp., Endurance, ERC and PartnerRe Ltd.

Europe – Munich Re, Swiss Re, Lloyd’s, General Cologne Re, SCOR Reinsurance Company, PartnerRe Ltd and ERC Frankona.

Bermuda – ACE Tempest Reinsurance Ltd, AXIS Specialty Limited, Arch Reinsurance Limited, Renaissance Reinsurance Limited, Montpelier Reinsurance Ltd, Platinum Underwriters Bermuda Ltd and Partner Reinsurance Company Ltd.

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The Company’s major geographical market for its life reinsurance operations is Europe and the main competitors in this market include Reinsurance Group of America, Inc., Munich Re, ERC, General Cologne Re, Swiss Re and Hannover Life Re.

See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Executive Overview” for further discussion

Marketing and Distribution

See Insurance Operations – “Marketing and Distribution” and Item 8, Note 18(a) to the Consolidated Financial Statements for information in the Company’s marketing and distribution procedures and information on the Company’s major brokers. In addition, for life reinsurance operations the majority of business is written directly with the ceding company rather than through a broker.

Claims Administration

Claims management for the reinsurance operations includes the receipt of loss notifications, review and approval of claims through a claims approval process, establishment of loss reserves and approval of loss payments. Case reserves for reported claims are generally established based on reports received from ceding companies with additional case reserves being established when deemed appropriate. Additionally, claims audits are conducted for specific claims and claims procedures at the offices of selected ceding companies.

Financial Products and Services Operations

General

The Company provides insurance, reinsurance, and derivative products for complex financial risks, including financial guaranty insurance and reinsurance, weather and energy risk management products and institutional life products. Each of these transactions is unique and tailored to the specific needs of the insured or user. With the exception of weather and energy risk management transactions, these are typically multi-year transactions.

Financial guaranty insurance and reinsurance generally guarantees payments of interest and principal on an issuer’s obligations when due. Obligations that are guaranteed or enhanced by the Company range in duration and premiums are received either on an installment basis or up front. Financial guaranties written in credit default swap form provide coverage for losses upon the occurrence of specified credit events set forth in the swap documentation.

The Company classifies the financial guaranty policies underwritten in four broad categories: asset-backed structured finance, public finance obligations, essential infrastructure project finance transactions and future flow obligations. Each category contains risks and structures that are unique to the underlying obligation. Asset-backed obligations insured or reinsured by the Company are generally issued in structured transactions backed by pools of assets of specified types, such as residential mortgages, auto loans and other consumer receivables, equipment leases and corporate debt obligations, having an ascertainable cash flow or market value. Public finance obligations insured or reinsured consist mainly of general or special obligations of state and local governments, supported by the issuer’s ability to charge taxes or fees for specified services or projects. Essential infrastructure project finance obligations underwritten by the Company include projects such as bridges, toll roads, airports and power plants. Future flow obligations are backed by receivables from the future sales of commodities or the processing of payments received by financial institutions.

The Company’s weather and energy risk management products are customized solutions designed to assist corporate customers, often energy companies and utilities, to manage their financial exposure to variations in underlying weather conditions and related energy markets. Weather risk management contracts generally average one season (five months) in duration. The Company uses the capital markets to hedge portions of these risks written. In 2004, the Company expanded its contingent risk business by offering a dual trigger temperature-contingent natural gas product,

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designed to protect end-users of natural gas from price volatility due to extreme changes in temperature. The Company also continued to grow its contingent power generator outage insurance business. The outage insurance product protects utilities so that in the event of a generator failure, the cost of purchasing replacement electricity above a previously established strike price in the power markets is covered. The Company utilizes markets in electricity power derivatives to partially hedge a portion of its exposure to substantial price spikes in electricity. The outage insurance component of the product is underwritten on an actual experience basis and is not hedged. In 2003, the energy group established and traded financial gas positions in the U.S. natural gas markets but during 2004, the Company exited this business. In 2005, the primary focus will be on customer oriented transactions.

In December 2002, the Company’s institutional life platform assumed, through novation, certain blocks of U.S. based term life mortality reinsurance business from one of the Company’s insurance affiliates. This business is in a runoff status and is currently managed separately from the life business written in the reinsurance segment in terms of the nature of the business and location of the risk. In 2005, the Company expects to continue to expand its structured, financially orientated life reinsurance business.

In 2004, the Company expanded its sales of funding agreements and continued to grow its municipal-based guaranteed investment contract business. Funding agreements are investment contracts sold to institutional investors. The Company sells funding agreements either directly to qualified institutional buyers or to special purpose entities which, in turn, issue medium term notes to fixed income investors. Municipal guaranteed reinvestment contracts are customized financial products that offer a guaranteed investment return to the purchaser, generally a municipal entity that raises funds for a particular project and invests such funds pending their drawdown to complete the project.

Underwriting

The Company has underwriting guidelines for the various products and asset classes comprising the credit enhancement business, which include single and aggregate risk limitations on specified exposures. A credit committee provides final underwriting approval. The Company’s underwriting policy is to credit enhance obligations and exposures that would otherwise be rated in lower investment grade categories. The Company’s other activities may occasionally structure and underwrite non-investment grade risks.

For the weather and energy business, the Company has seasonal value at risk (“VaR”) limits for weather and electricity generator outage exposures.

Individual funding agreements are issued in the context of the overall cash flow structure of the asset/liability portfolio, taking into consideration the impact of each new funding agreement offering on the overall risk position of the Company.

With respect to life reinsurance, the Company focuses on the underwriting practices of the ceding companies to set reinsurance premiums that, in conjunction with the expected mortality for the blocks of business, can be expected to produce a return that meets the Company’s desired rate of return for this type of business. All life reinsurance transactions are modeled for several scenarios of changing assumptions and presented to a committee for review and approval.

With respect to the municipal reinvestment contract business, the Company underwrites the cash flow risks associated with each contract and continually monitors each contract’s performance. The Company utilizes underwriting guidelines to assess risks and internal cash flow and asset liability models to price each contract. The Company focuses on reinvestment opportunities associated with municipal bond issuers.

Reinsurance Ceded

Similar to the Company as a whole, the financial products and services operations utilize outwards reinsurance for single risk and portfolio management purposes. The Company has retroceded risks on a facultative basis to third party reinsurers to provide greater flexibility to manage large single risks and reduce concentrations in specific bond sectors or geographic regions. For the weather and energy risk management business, the Company more often uses

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derivatives rather than reinsurance to hedge or mitigate its primary exposure, but will use reinsurance as well, if deemed appropriate.

Premiums

The following table is an analysis of the financial products and services segment’s gross premiums written, net premiums written and net premiums earned from financial and life and annuity operations for the year ended December 31, 2004:

	Gross	Net	Net
	Premiums	Premiums	Premiums
(U.S. dollars in thousands)	Written	Written	Earned
Financial operations	$276,079	$255,524	$161,285
Life and annuity operations	94,597	94,713	94,713
Total	$370,676	$350,237	$255,998

Additional discussion and financial information about the financial products and services segment is set forth in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 8, Note 3 to the Consolidated Financial Statements.

Competition

The principal competitors in the municipal and asset-backed insured markets include other triple-A rated and, to a lesser extent, double-A rated monoline financial guarantors and multiline insurance companies and banks. Triple-A monoline insurers include MBIA Inc. (“MBIA”), Ambac Financial Group, Inc. (“Ambac”), Financial Guaranty Insurance Company (“FGIC”) and Financial Security Assurance Holdings Ltd (“FSA”). There are also many means by which issuers may borrow money without using third party credit enhancement. For example, structured financings may be executed by issuing senior and subordinated tranches of debt that effectively substitute for third party enhancement. Additionally, issuers may raise debt financing by issuing corporate debt or by borrowing from banks. Such alternatives effectively constitute a form of competition for financial guaranty insurance companies.

With respect to the Company’s weather and energy risk management business, competition is encountered in both the U.S. and on a worldwide basis from companies within the energy, insurance and, to an increasing extent, the financial services sector. Among the principal competitive factors affecting the Company’s weather and energy business are its financial strength ratings, its capability in originating, marketing, structuring and executing innovative products and services, its relative pricing and its ability and willingness to hedge all or a portion of such risks.

With respect to the Company’s municipal guaranteed reinvestment contract business, competitors include financial institutions in the banking, investment banking, life insurance and financial guaranty industries. These include Aegon, AIG, Bayerische Landesbank (“BLB”), Caisse des Depots et Consignations, FSA and MBIA.

Marketing and Distribution

Marketing of the Company’s financial guaranty business is targeted based on the type and stage of completion of the transaction. Targeted parties include investment bankers, issuers of and investors in credit-enhanced transactions and concessionaires in certain transactions. Other financial guaranty insurers or reinsurers or other counterparties may also be a source of new business, particularly on the reinsurance side.

With respect to the Company’s weather and energy risk management business, new clients are acquired through direct marketing but may also be referred through a number of brokers who receive a fee that is based on the size of the transaction. The Company’s main clients are in the energy and financial services sector.

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Guaranteed investment or municipal reinvestment contract business is mainly originated through specialized brokers. Funding agreements are typically sold through and distributed by investment banks.

Claims Administration

Claims management for the financial guaranty business includes the identification of potential claims through systematic surveillance of the insured portfolio, the establishment of reserves for losses that are both probable and estimable, the accounting for loss adjustment expenses, the receipt of claims, the approval of claim payments and the notification to reinsurers. Surveillance also involves proactive efforts to prevent or mitigate potential claims once they are identified. If a claim is paid, recoveries will be sought based on the security pledged under the policy.

Claims management for the life and annuity business includes the tracking of claims from periodic communication provided by ceding companies, followed up with a monthly and quarterly reporting from each ceding company. These reports are the basis of the claims review procedures, payment authorization and approval processes, reserving for future policy benefits and the notification of claims to reinsurers.

With respect to the Company’s weather and energy business, claims management includes the identification of potential claims through review of underlying weather conditions and unit outages within the insured portfolio, the establishment of reserves for losses that are probable and estimable, loss adjustment expenses, the receipt of claims, the approval of claim payments and the notification of claims to reinsurers.

XL Financial Solutions

The Company’s XL Financial Solutions operations (“XLFS”) function globally as an internal joint venture among the Company’s three underwriting segments. The group provides a wide range of structured financial products and alternative risk transfer transactions, including property and casualty insurance and reinsurance, asset backed securitizations and business enterprise risk transactions. Most transactions originated through XLFS have multi-year exposures, with many transactions having durations in excess of ten years. Generally, the underlying nature of the transaction determines the business segment in which it is written. Up to and including 2003, property and casualty business written is included in the insurance segment or the reinsurance segment, depending upon whether the customer is a reinsurance company or other type of entity, respectively. In addition, from 2003 certain financial market risk transactions that were structured in derivative form as well as guaranteed investment contracts were reallocated from the insurance and reinsurance segments to the financial products and services segment.

Geographic Areas

See Item 8, Notes 3 and 24 to the Consolidated Financial Statements.

Risk Management

The Company seeks to identify, assess, monitor and manage its market, credit, underwriting, operational and legal risks in accordance with defined policies and procedures. The Company’s senior management takes an active role in the risk management process and has developed and implemented policies and procedures that require specific administrative and business functions to assist in the identification, assessment and control of various risks pertaining to the Company’s businesses. The Company has a Risk Management Committee which acts to ensure major risks are being managed with an “enterprise wide” perspective. Due to the changing nature of the global marketplace, the Company’s risk management policies, procedures and methodologies are constantly evolving and are subject to ongoing review and modification. Senior management provides regular updates on major risk exposures to the Audit Committee of the Board of Directors. See Item 7A, “Quantitative and Qualitative Disclosures About Market Risk” for further discussion.

Aggregate exposures to potential catastrophic events, including natural catastrophes are managed at an entity level and also at the corporate level. In addition to internal controls designed to mitigate the Company’s exposure to a

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specific event or class of business, the Company maintains various reinsurance programs that help protect the Company against foreseeable catastrophic and other types of risks.

Under its reinsurance security policy, the Company seeks to cede business to reinsurers generally rated “A” or better by Standard & Poor’s, a division of The McGraw-Hill Companies, Inc. (“S&P”), or, in the case of Lloyd’s syndicates, “B+” from Moody’s Investors Service, Inc. (“Moody’s”). The Company’s Chief Risk Officer considers reinsurers that are not rated or do not fall within the above rating categories and may grant exceptions to the Company’s general policy on a case-by-case basis.

See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 8, Note 10 to the Consolidated Financial Statements for further information.

As part of risk management, the Company also has several credit committees and underwriting/transaction committees that meet regularly to review the terms and conditions of certain proposed new transactions.

Unpaid Losses and Loss Expenses

Certain aspects of the Company’s business have loss experience characterized as low frequency and high severity. This may result in volatility in the Company’s results of operations, financial condition and liquidity.

Loss reserves are established due to the significant periods of time that may lapse between the occurrence, reporting and payment of a loss. To recognize liabilities for unpaid losses and loss expenses, the Company estimates future amounts needed to pay claims and related expenses with respect to insured events. The Company’s reserving practices and the establishment of any particular reserve reflect management’s judgment concerning sound financial practice and do not represent any admission of liability with respect to any claim. Unpaid losses and loss expense reserves are established for reported claims (“case reserves”) and incurred but not reported (“IBNR”) claims.

The nature of the Company’s high excess of loss liability and catastrophe business can result in loss payments that are both irregular and significant. Similarly, adjustments to reserves for individual years can be irregular and significant. Such adjustments are part of the normal course of business for the Company. Conditions and trends that have affected development of liabilities in the past may not necessarily occur in the future. Accordingly, it is inappropriate to extrapolate future redundancies or deficiencies based upon historical experience. See generally, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Cautionary Note Regarding Forward-Looking Statements.”

The tables below present the development of unpaid loss and loss expense reserves related to the Company’s general and financial operations on both a net and gross basis. The cumulative redundancy (deficiency) calculated on a net basis differs from that calculated on a gross basis. As different reinsurance programs cover different underwriting years, net and gross loss experience will not develop proportionately. The top line of the tables shows the estimated liability, net of reinsurance recoveries, as at the year end balance sheet date for each of the indicated years. This represents the estimated amounts of losses and loss expenses, including IBNR, arising in the current and all prior years that are unpaid at the year end balance sheet date of the indicated year. The tables show the re-estimated amount of the previously recorded reserve liability based on experience as of the year end balance sheet date of each succeeding year. The estimate changes as more information becomes known about the frequency and severity of claims for individual years. The cumulative redundancy (deficiency) represents the aggregate change with respect to that liability originally estimated. The lower portion of the first table also reflects the cumulative paid losses relating to these reserves. Conditions and trends that have affected development of liabilities in the past may not necessarily occur in the future. Accordingly, it may not be appropriate to extrapolate redundancies or deficiencies into the future, based on the tables below. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Cautionary Note Regarding Forward-Looking Statements.”

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Analysis of Consolidated Loss and Loss Expense Reserve Development
Net of Reinsurance Recoveries

(U.S. dollars in millions)	1994	1995	1996	1997	1998	1999	2000	2001	2002	2003	2004
ESTIMATED LIABILITY FOR UNPAID       LOSSES AND LOSS EXPENSES,       NET OF REINSURANCE RECOVERABLES	$2,482	$2,899	$3,166	$3,609	$4,303	$4,537	$4,328	$7,173	$8,395	$10,782	$12,882
LIABILITY RE-ESTIMATED AS OF:
One year later	2,455	2,885	2,843	3,354	4,016	4,142	4,503	7,573	9,332	11,050
Two years later	2,383	2,546	2,704	3,038	3,564	4,085	4,463	8,445	9,723
Three years later	2,190	2,445	2,407	2,737	3,580	4,120	5,239	8,822
Four years later	2,085	2,214	2,227	2,658	3,461	4,624	5,415
Five years later	1,927	2,050	2,144	2,505	3,742	4,747
Six years later	1,819	2,010	2,026	2,663	3,774
Seven years later	1,823	1,915	2,115	2,704
Eight years later	1,758	1,983	2,146
Nine years later	1,803	1,981
Ten years later	1,832
CUMULATIVE REDUNDANCY       (DEFICIENCY) (1)	650	918	1,020	905	529	(210)	(1,087)	(1,649)	(1,328)	(268)
CUMULATIVE PAID LOSSES, NET OF       REINSURANCE RECOVERIES, AS OF:
One year later	$ 317	$ 445	$ 234	$ 458	$ 812	$1,252	$1,184	$2,011	$2,526	$1,904
Two years later	709	667	576	932	1,594	1,828	1,920	3,984	3,721
Three years later	921	934	932	1,404	1,928	2,306	2,683	4,703
Four years later	1,110	1,143	1,235	1,525	2,249	2,824	3,038
Five years later	1,199	1,356	1,313	1,732	2,555	3,035
Six years later	1,328	1,408	1,466	1,903	2,741
Seven years later	1,365	1,485	1,603	2,085
Eight years later	1,429	1,601	1,749
Nine years later	1,553	1,674
Ten years later	1,604

(1) See Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for further discussion.

Analysis of Consolidated Loss and Loss Expense Reserve Development
Gross of Reinsurance Recoverables

(U.S. dollars in millions)	1994	1995	1996	1997	1998	1999	2000	2001	2002	2003	2004
ESTIMATED GROSS LIABILITY FOR UNPAID       LOSSES AND LOSS EXPENSES	$2,760	$3,238	$3,623	$3,972	$4,897	$5,369	$5,668	$11,807	$13,203	$16,559	$19,598
LIABILITY RE-ESTIMATED AS OF:
One year later	2,764	3,244	3,221	3,763	4,735	5,266	6,118	12,352	15,068	18,192
Two years later	2,721	2,872	3,164	3,496	4,352	5,147	6,105	14,003	16,771
Three years later	2,494	2,793	2,902	3,243	4,316	5,176	6,909	15,377
Four years later	2,414	2,572	2,753	3,139	4,232	5,663	7,086
Five years later	2,268	2,415	2,663	2,979	4,508	5,798
Six years later	2,165	2,379	2,564	3,132	4,568
Seven years later	2,177	2,327	2,650	3,181
Eight years later	2,154	2,393	2,673
Nine years later	2,197	2,379
Ten years later	2,219
CUMULATIVE REDUNDANCY       (DEFICIENCY)	541	859	950	791	329	(429)	(1,418)	(3,570)	(3,568)	(1,633)

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The following table presents an analysis of paid, unpaid and incurred losses and loss expenses for the Company’s general and financial operations and a reconciliation of beginning and ending unpaid losses and loss expenses for the years indicated:

Reconciliation of Unpaid Losses and Loss Expenses

(U.S. dollars in thousands)	2004	2003	2002
Unpaid losses and loss expenses at beginning of year	$16,558,788	$13,202,736	$11,806,745
Unpaid losses and loss expenses recoverable	(5,776,410)	(4,807,317)	(4,633,693)
Net unpaid losses and loss expenses at beginning of year	10,782,378	8,395,419	7,173,052
Increase (decrease) in net losses and loss expenses incurred in respect       of losses occurring in:
Current year	4,596,346	3,673,321	2,927,297
Prior years	267,594	937,285	400,018
Total net incurred losses and loss expenses	4,863,940	4,610,606	3,327,315
Exchange rate effects	309,768	394,121	552,173
Net loss reserves acquired	–	199,164	189,710
Less net losses and loss expenses paid in respect of losses occurring in:
Current year	1,170,699	291,104	836,102
Prior years	1,903,790	2,525,828	2,010,729
Total net paid losses	3,074,489	2,816,932	2,846,831
Net unpaid losses and loss expenses at end of year	12,881,597	10,782,378	8,395,419
Unpaid losses and loss expenses recoverable	6,716,934	5,776,410	4,807,317
Unpaid losses and loss expenses at end of year	$19,598,531	$16,558,788	$13,202,736

The Company’s net unpaid loss and loss expense reserves broken down by operating segment at December 31, 2004 and 2003 was as follows:

(U.S. dollars in millions)	December 31, 2004	December 31, 2003
Insurance	$ 7,036	$ 5,849
Reinsurance	5,726	4,871
Financial products and services	120	62
Net unpaid loss and loss expense reserves	$12,882	$10,782

Current year net losses incurred

Current year net losses incurred in 2004 increased from 2003 due primarily to growth in the Company’s general insurance and reinsurance operations combined with catastrophic hurricane activity in 2004. There was a relatively low level of catastrophic events affecting the Company in both 2003 and 2002.

The 2004 Atlantic hurricane season resulted in four insured hurricane losses aggregating to the largest seasonal loss in history and had a substantial impact on the results of the Company for the year. For the four hurricane losses, the Company estimated net losses incurred of $516.6 million, net of reinsurance recoverables, based on preliminary reports and estimates of loss and damage.

Current year net losses incurred in 2003 increased over 2002 primarily due to general growth of the Company’s operations.

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Prior year net losses incurred

The following tables present the development of the Company’s gross and net, loss and loss expense reserves for its general and financial operations. The tables also show the estimated reserves at the beginning of each fiscal year and the favorable or adverse development (prior year development) of those reserves during such fiscal year.

Gross (U.S. dollars in millions)	2004	2003	2002
Unpaid losses and loss expense reserves at the beginning of the year	$16,559	$13,203	$11,807
Net adverse development of those reserves during the year	1,633	1,865	545
Unpaid losses and loss expense reserves re-estimated one year later	$18,192	$15,068	$12,352
Net (U.S. dollars in millions)	2004	2003	2002
Unpaid losses and loss expense reserves at the beginning of the year	$10,782	$8,395	$7,173
Net adverse development of those reserves during the year	268	937	400
Unpaid losses and loss expense reserves re-estimated one year later	$11,050	$9,332	$7,573

As different reinsurance programs cover different underwriting years, contracts and lines of business, net and gross loss experience do not develop proportionately.

Prior year incurred losses for the years prior to 1998 were driven primarily by the Company’s high layer casualty insurance loss reserves. As previously discussed, the nature of this business can result in losses that are both irregular and significant. The basis for establishing IBNR for these lines was previously more judgmental due to the lack of industry data available. Consequently, the Company estimated loss reserves through actuarial models based upon its own experience, which by definition had its own inherent limitations. The Company commenced writing this type of business in 1986 and experienced a low number of losses in the first few years. Over time, the amount of data has increased, providing a larger statistical base for estimating reserves. Redundancies in prior year loss reserves have occurred where loss experience has developed more favorably than expected.

The following table presents the net adverse (favorable) prior year loss development of the Company’s loss and loss expense reserves for its general and financial operations by each operating segment for each of the years indicated:

(U.S. dollars in millions)	2004	2003	2002
Insurance Segment	$292	$153	$ 28
Reinsurance Segment	(24)	799	385
Financial Products and Services Segment	–	(15)	(13)
Total	$268	$937	$400

See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 8, Note 9 to the Consolidated Financial Statements for further information regarding the developments in prior year loss reserve estimates for each of the years indicated within each of the Company’s operating segments.

Net loss reserves acquired

There were no net loss reserves acquired in 2004.

Net loss reserves acquired in 2003 of $199.2 million included $85.2 million related to the Company’s Lloyd’s operation in connection with the closure of the Lloyd’s 2000 underwriting year where reserves and cash were transferred to the Company’s Lloyd’s Syndicates. The Company did not provide 100% of the Syndicate capacity for the 2000 underwriting year. In addition, $114.0 million related to the settlement of the purchase price for the acquisition

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of the Winterthur International operations in December 2003. In connection with the settlement, the Company updated the fair value of the net assets acquired as of this date and reduced the estimated amount of unpaid losses recoverable from the Seller under the SPA. See Item 8, Note 5(b) to the Consolidated Financial Statements for further information.

Net loss reserves acquired in 2002 related primarily to Le Mans Ré ($376.2 million) consolidated as a subsidiary with effect from January 1, 2002. This was partially offset by the return by the Company to the Seller of the accident and health business related to the Winterthur International acquisition in June 2002 of approximately $190.0 million.

Exchange rate effects

Exchange rate effects on net loss reserves in each of the three years ended December 31, 2004 related to the global operations of the Company where several operations have a functional currency that is not the U.S. dollar. The reduction in the value of the U.S. dollar during each of these three years mainly compared to the Swiss franc, U.K. sterling and the Euro has given rise to translation and revaluation exchange movements of $309.8 million, $394.1 million and $552.2 million in 2004, 2003 and 2002, respectively.

Net paid losses

Total net paid losses were $3.1 billion in 2004 and $2.8 billion in each of 2002 and 2003. The increase in paid losses in 2004 relates to both the increase in business over the last several years and the payments associated with the Atlantic hurricane losses. The Company wrote more business in 2003 than in 2002, however, the amount of net paid losses did not increase from the previous year primarily due to a relatively low level of catastrophe losses in 2003 together with the increase in casualty business written which typically has a longer period over which losses are reported and paid as compared to property business.

The increase in paid losses in 2003 and 2002, related primarily to prior years, is due mainly to payments relating to loss reserves associated with the Winterthur International acquisition, the longer tail casualty business written by the Company and, to a lesser extent, the September 11 event. At December 31, 2004, the Company had paid approximately 66% of its estimated ultimate net losses relating to the September 11 event. Unpaid claims remain due to the size and complexity of the claims and also that approximately 50% of the Company’s ultimate incurred losses related to the reinsurance segment, where there is an inherent lag between the timing of a loss event and when it is reported by the ceding company to the Company. See Item 8, Note 9 to the Consolidated Financial Statements.

Other loss related information

The Company’s net incurred losses and loss expenses included actual and estimates of potential non-recoveries from reinsurers. As at December 31, 2004 and 2003, the reserve for potential non-recoveries from reinsurers was $278.7 million and $108.0 million, respectively.

Except for certain workers’ compensation and long-term disability liabilities, the Company does not discount its unpaid losses and loss expenses. The Company utilizes tabular reserving for workers’ compensation and long-term disability unpaid losses that are considered fixed and determinable, and discounts such losses using an interest rate of 5% (2003: 5%). The interest rate approximates the average yield to maturity on specific fixed income investments that support these liabilities. The Company decreased the interest rate in 2003 from 7% to 5% in line with the then current investment yields on this portfolio. The effect of the decrease in the interest rate resulted in an increase in loss reserves of approximately $35.0 million in 2003. The amount of the discount credit included in net losses and loss expenses incurred was $22.6 million in 2002. The tabular reserving methodology results in applying uniform and consistent criteria for establishing expected future indemnity and medical payments (including an explicit factor for inflation) and the use of mortality tables to determine expected payment periods. Tabular unpaid losses and loss expenses, net of reinsurance, at December 31, 2004 and 2003 were $578.6 million and $538.8 million, respectively. The related discounted unpaid losses and loss expenses were $290.0 million and $263.8 million as of December 31, 2004 and 2003, respectively.

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Investments

Investment structure and strategy

The Company’s investment operations are managed centrally by the Company’s investment department, which also provides certain investment advice and support for the rest of the Company’s operations. The Finance Committee of the Board of Directors approves the Company’s overall investment policy and guidelines and reviews the implementation of the investment strategy on a regular basis.

The primary objectives of the investment strategy are to support the liabilities arising from the operations of the Company, generate stable investment income and to build book value for the Company over the longer term. The strategy strives to maximize investment returns while taking into account market and credit risk. Market risk is due to interest rate variability and exposure to foreign denominated currencies, which the Company seeks to manage through asset/liability management, and due to the allocation to risk assets, including global equity securities, which the Company seeks to manage through diversification. Credit risk arises from investments in fixed income securities and is managed with aggregate and portfolio limits.

The Company’s overall investment portfolio is structured to take into account a number of variables including local regulatory requirements, business needs, collateral management and risk tolerance. At December 31, 2004 and 2003, total investments and cash, less payable for investments purchased, was $32.1 billion and $25.1 billion, respectively.

Functionally, the Company’s investment portfolio is divided into four principle components. The largest component is the general account asset/liability portfolio supporting property and casualty and financial guaranty liabilities, which was approximately $18.1 billion and $14.6 billion at December 31, 2004 and 2003, respectively. The key focus for this component is asset and liability management and it is used to provide liquidity to settle claims arising from the Company’s general and financial operations. The asset/liability portfolio is made up entirely of investment grade fixed income securities.

The second component of the investment portfolio is the structured and spread product portfolio, which was approximately $9.7 billion and $6.6 billion at December 31, 2004 and 2003, respectively. This portfolio consists of highly structured actively managed investment portfolios that support specific insurance and reinsurance transactions, e.g., deposit liability and future policy benefit reserves. Many of these transactions have underlying liabilities that pay out over many years. As a result, asset and liability management is also a key focus for this portfolio.

The third component of the investment portfolio is the risk asset portfolio, which was approximately $3.9 billion and $3.5 billion at December 31, 2004 and 2003, respectively. The Company utilizes a risk budgeting framework for the dynamic risk and asset allocation of the risk asset portfolio. The risk asset portfolio is that portion of the Company’s surplus that is invested in risk assets to generate growth in the Company’s book value over the longer term with the efficient utilization of risk. The fundamental premise of the risk budgeting methodology for the risk asset portfolio is to maximize expected returns for a given level of risk. The risk asset portfolio currently includes four core diversified total return strategy portfolios incorporating: (i) alternative investment strategies; (ii) high yield fixed income; (iii) public equities; and (iv) private investments, which include private equity and mezzanine funds and non-rated tranches of collateralized debt obligations.

The Company sets specific constraints during the risk allocation process that reflect the Company’s overall tolerance for risk, including guidelines on the level of VaR of the risk asset portfolio, stress testing and a maximum drawdown level attributable to the alternative investment portfolio. These levels are approved by the Finance Committee of the Company’s Board of Directors annually. In addition, each of the core risk asset portfolios is subject to specific investment guidelines that are also approved by the Finance Committee of the Company’s Board of Directors. These guidelines address the investment parameters and risk associated with each portfolio. The Company monitors the total risk and return of the risk asset portfolio and the four strategy portfolios to ensure compliance with the risk target guidelines as approved.

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The alternative investment portfolio, part of the risk asset portfolio, is a highly diversified portfolio of investments in limited partnerships and similar investment vehicles, with each fund pursuing absolute return investment mandates. These are typically investing in one or more of the traditional asset classes including equities, fixed income, credit, currency and commodity markets, and similar investment vehicles. For the majority of the portfolio, the Company owns minority investment interests that are accounted for under the equity method and are included in the Consolidated Balance Sheet under “Investments in affiliates.” The investment objective of the alternative investment portfolio is to attain a high risk-adjusted total return while maintaining a low level of correlation to the traditional asset classes and realizing a low volatility. This portfolio was $1.7 billion and $1.4 billion at December 31, 2004 and 2003, respectively.

The fourth component of the Company’s total investment portfolio, valued at $0.4 billion and $0.4 billion as at December 31, 2004 and 2003, respectively, was related to insurance and financial affiliates and investments in investment management companies. At December 31, 2004, the Company owned minority stakes in eight independent investment management companies. These ownership stakes are part of the Company’s asset management strategy, pursuant to which the Company seeks to develop relationships with specialty investment management organizations, generally acquiring an equity interest in the business. In these investments, the Company seeks to achieve strong returns on capital while accessing the investment expertise of professionals to help manage portions of the Company’s investment assets. In addition, the Company is active in the relationships with these affiliate managers, seeking to benefit from the intellectual capital in ways that will enhance the Company’s overall financial performance and achieve broader strategic goals.

Where the Company maintains significant influence over the decisions of the investment management organization, through such board representation or through certain voting and/or consent rights, the Company’s proportionate share of the income or loss from these companies is reported as net income from operating affiliates. The Company’s existing affiliate managers manage or sponsor over 40 different investment products, providing institutional and high net worth investors access to a broad range of asset classes and investment strategies. It is a strategic objective of the Company to continue to expand the diversification of investment products offered by its affiliates by assisting existing affiliates in launching new products and new lines of business as well as by making additional ownership stake investments in other specialty asset managers. See Item 8, Note 6 to the Consolidated Financial Statements.

Implementation of investment strategy

Although the Company’s investment department is responsible for implementation of the investment strategy, the day to day management of the investment portfolio is outsourced to investment management service providers. External investment managers are selected and monitored using a disciplined due diligence process. Each investment manager may manage one or more portfolios and is governed by a detailed set of investment guidelines, including overall objectives, risk parameters, and diversification requirements that fall within the overall guidelines discussed above. Compliance with investment guidelines is monitored on a regular basis by the investment department.

Investment performance

See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for discussion of the Company’s investment performance.

Credit ratings, duration and maturity profile

It is the Company’s policy to operate the aggregate fixed income portfolio with a minimum weighted average credit rating of “Aa3/AA-.” The aggregate credit rating is determined based on the market value weighted average credit rating using a linear credit rating scale similar to that used by Moody’s. The highest credit rated fixed income securities are held within the asset/liability and structured product portfolios. Sub-investment grade (high yield) fixed income securities are held within the risk asset portfolio. The weighted average credit rating of the fixed income portfolio was “Aa2/AA” at December 31, 2004 and 2003.

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The Company did not have an aggregate investment in a single entity, other than the U.S. Government, in excess of 10% of shareholders’ equity at December 31, 2004 or 2003.

The aggregate duration of the fixed income portfolio is managed relative to liabilities. Duration measures bond price volatility and is an indicator of the sensitivity of the price of a bond (or a portfolio of bonds) to changes in interest rates, assuming a parallel change in the yield curve reflecting the percentage change in price for a 100 basis point change in yield. Management believes that the duration of the fixed income portfolio is the best single measure of interest rate risk and the table below summarizes the weighted average duration in years of the main components of the fixed income portfolio at December 31, 2004 and 2003:

	2004	2003
Asset/Liability portfolio:
General Account	3.3	3.4
Structured and Spread Products	6.5	7.5
Total Fixed Income portfolio	4.4	4.7

The maturity profile of the fixed income portfolio is a function of the maturity profile of liabilities and, to a lesser extent, the maturity profile of common fixed income benchmarks. For further information on the maturity profile of the fixed income portfolio see Item 8, Note 6 to the Consolidated Financial Statements.

Ratings

The Company’s ability to underwrite business is dependent upon the quality of its claims paying and financial strength ratings as evaluated by independent agencies.

In February 2005, Fitch placed the Company’s financial strength and claims paying ratings on Rating Watch Negative and Moody’s confirmed the Company’s ratings and changed the outlooks to Negative.

In January 2004, several of the internationally recognized rating agencies lowered the financial strength ratings of the Company’s principal insurance and reinsurance subsidiaries and pools following the announcement by the Company of an increase in prior period loss reserves in the fourth quarter of 2003. See “Unpaid Losses and Loss Expenses” above and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for further discussion. There can be no assurance that any such ratings will be retained for any period of time or that they will not be qualified, suspended, revised downward or withdrawn entirely by such rating agencies.

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The following are the current financial strength and claims paying ratings from internationally recognized rating agencies in relation to the Company’s principal insurance and reinsurance subsidiaries and pools:

Rating	Agency’s description		Agency’s rating
agency	of rating	Rating	definition	Ranking of Rating
Standard &	“A current opinion of the	AA–	“Very strong”	The “AA” grouping is the
Poor’s	financial security characteristics	(Outlook	financial security	second highest out of nine main
	of an insurance organization	Stable)	characteristics.	ratings. Main ratings from AA
	with respect to its ability to pay			to CCC are subdivided into
	under its insurance policies and			three subcategories: “+”
	contracts in accordance with			indicating the high end of the
	their terms.”			main rating; no modifier,
				indicating the mid range of the
				main rating; and “-” indicating
				the lower end of the main rating.
Fitch	“An assessment of the financial	AA	“Very strong”	The “AA” rating is the second
	strength of an insurance	(Ratings	capacity to meet	highest out of twelve ratings
	organization, and its capacity to	Watch	policyholder and	categories. AA insurers are
	meet senior obligations to	Negative)	contract	viewed as possessing very
	policyholders and contract		obligations.	strong capacity to meet
	holders on a timely basis.”			policyholder and contract
				obligations. “+” or “-” may be
				appended to a rating to indicate
				the relative position of a credit
				within the rating category.

A ratings outlook assesses potential long term direction, with a time horizon up to 3 years. Ratings are placed on Rating Watch to notify investors that there is a reasonable probability of a rating change and the likely direction of such change. These are designated as “Positive”, indicating a potential upgrade, “Negative”, for a potential downgrade, or “Evolving”, if ratings may be raised, lowered or maintained. Rating Watch is typically resolved over a relatively short period.

Rating	Agency’s description		Agency’s rating
agency	of rating	Rating	definition	Ranking of Rating
A.M. Best	“An opinion of an insurer’s	A+ u	“Superior” ability to	The “A+” grouping is the
	financial strength and ability	Negative	meet its obligations	second highest ratings category
	to meet ongoing obligations to		to policyholders.	out of ten. It is assigned to
	policyholders.”			companies that have, in A.M.
				Best’s opinion, a superior ability
				to meet their ongoing

Ratings with the “u” modifier (for “Under Review”) are event-driven (positive, negative or developing) and are assigned to a company whose Best’s Rating opinion is under review and may be subject to change in the near-term, generally 6 months.

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Rating	Agency’s description		Agency’s rating
agency	of rating	Rating	definition	Ranking of Rating
Moody’s	An opinion of “the ability of	Aa2 (except	“Excellent”	The “Aa” grouping is the
	insurance companies to repay	members of	financial security.	second highest out of nine
	punctually senior policyholder	the XL		rating categories. Each rating
	claims and obligations.”	America Pool,		category is subdivided into
		XL Re Ltd and		three subcategories. Moody’s
		the newly rated		appends numerical modifiers 1,
		XL Life		2, and 3 to each generic rating
		Insurance and		classification from Aa through
		Annuity		Caa. Numeric modifiers are
		Company, which		used to refer to the ranking
		are rated Aa3.)		within a group – with 1 being
				the highest and 3 being the
				lowest.

The following were the current financial strength and claims paying ratings from internationally recognized rating agencies in relation to the Company’s principal insurance and reinsurance subsidiaries and pools as at December 31, 2003:

Rating	Agency’s description		Agency’s rating
agency	of rating	Rating	definition	Ranking of Rating
Standard &	“A current opinion of the	AA	“Very strong”	This is the second highest out of
Poor’s	financial security characteristics		financial security	nine main ratings. Main ratings
	of an insurance organization		characteristics.	from AA to CCC are subdivided
	with respect to its ability to pay			into three subcategories: “+”,
	under its insurance policies			indicating the high end of the
	and contracts in accordance			main rating; no modifier,
	with their terms.”			indicating the mid range of the
				main rating; and “-”, indicating
				the lower end of the main
				rating.
Fitch	“An assessment of the financial	AA	“Very strong”	The “AA” rating is the second
	strength of an insurance	(Ratings	capacity to meet	highest of twelve ratings categories.
	organization, and its capacity to	Watch	policyholder and	AA insurers are viewed as
	meet senior obligations to	Negative)	contract obligations.	possessing very strong capacity to
	policyholders and contract			meet policyholder and contract
	holders on a timely basis.”			obligations. “+” and “-” may be
				appended to a rating to indicate
				the relative positive of a credit
				within the rating category.

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Rating	Agency’s description		Agency’s rating
agency	of rating	Rating	definition	Ranking of Rating
A.M. Best	“An opinion of an insurer’s	A+	“Superior”	This is the second highest out of
	financial strength and ability to		ability to meet its	fifteen ratings.
	meet ongoing obligations to		obligations to
	policyholders.”		policyholders
Moody’s	An opinion of “the ability of	Aa2	“Excellent”	The “Aa” grouping is the
	insurance companies to repay		financial security.	second highest out of nine
	punctually senior policyholder			rating categories. Each rating
	claims and obligations.”			category is subdivided into
				three subcategories. Moody’s
				appends numerical modifiers 1,
				2, and 3 to each generic rating
				classification from Aa through
				Caa. Numeric modifiers are
				used to refer to the ranking
				within a group – with 1 being
				the highest and 3 being the
				lowest.

The following are the financial strength ratings from internationally recognized rating agencies currently and as of December 31, 2004 in relation to the Company’s principal financial guaranty insurance and reinsurance subsidiaries:

Rating	Agency’s description		Agency’s rating
agency	of rating	Rating	definition	Ranking of Rating
Standard &	“A current opinion of the	AAA	“Extremely strong”	This is the highest out of nine
Poor’s	financial security characteristics		financial security	main ratings groupings.
	of an insurance organization		characteristics.
	with respect to its ability to pay
	under its insurance policies and
	contracts in accordance with
	their terms.”
Moody’s	An opinion of “the ability of	Aaa	“Exceptional”	This is the highest out of nine
	insurance companies to repay	financial security.	main ratings categories.
	punctually senior policyholder
	claims and obligation.”
Fitch	“An assessment of the financial	AAA	“Exceptionally	This is the highest out of twelve
	strength of an insurance		strong” capacity	main ratings categories.
	organization, and its capacity to		to meet policyholder
	meet senior obligations to		and contract
	policyholders and contract		obligations.

In addition, XL Capital Ltd currently has the following long term debt ratings: “A-” (review with negative implications) from A.M. Best, “A” (negative) from Standard and Poor’s, “A2” (stable) from Moody’s and “A” (stable) from Fitch.

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The Company believes that the primary users of ratings include commercial and investment banks, policyholders, brokers, ceding companies and investors.

Tax Matters

See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 8, Note 23 to the Consolidated Financial Statements.

Regulation

The Company’s operations are subject to regulation and supervision in each of the jurisdictions where they are domiciled and licensed to conduct business. Generally, regulatory authorities can have broad supervisory and administrative powers over such matters as licenses, management, standards of solvency, material transactions between affiliates, premium rates, policy forms, investments, security deposits, methods of accounting, form and content of financial statements, reserves for unpaid losses and loss adjustment expenses, reinsurance, minimum capital and surplus requirements, dividends and other distributions to shareholders, periodic examinations and annual and other report filings. In general, such regulation is for the protection of policyholders rather than shareholders. The Company believes that it is in compliance with all applicable laws and regulations pertaining to its business that would have a material effect on its financial position in the event of non-compliance.

Bermuda Operations

The Insurance Act 1978 of Bermuda and related regulations, as amended (the “Act”), regulates the Company’s operating subsidiaries in Bermuda, and it provides that no person may carry on any insurance business in or from within Bermuda unless registered as an insurer by the Bermuda Monetary Authority (the “Authority”) under the Act. Insurance as well as reinsurance is regulated under the Act.

The Act imposes on Bermuda insurance companies, solvency and liquidity standards, certain restrictions on the declaration and payment of dividends and distributions, certain restrictions on the reduction of statutory capital, auditing and reporting requirements, and grants the Authority powers to supervise, investigate and intervene in the affairs of insurance companies. Significant requirements include the appointment of an independent auditor, the appointment of a loss reserve specialist and the filing of the Annual Statutory Financial Return with the Authority. The Supervisor of Insurance is the chief administrative officer under the Act.

Under the Bermuda Companies Act 1981, as amended, a Bermuda company may not declare or pay a dividend or make a distribution out of contributed surplus if there are reasonable grounds for believing that: (a) the company is, or would after the payment be, unable to pay its liabilities as they become due; or (b) the realizable value of the company’s assets would thereby be less than the aggregate of its liabilities and its issued share capital and share premium accounts.

United States

Within the United States, the Company’s insurance and reinsurance subsidiaries are subject to regulation and supervision by their respective states of incorporation or organization and by other jurisdictions in which they do business. The methods of regulation vary, but in general have their source in statutes that delegate regulatory and supervisory powers to an insurance official. The regulation and supervision relate primarily to approval of policy forms and rates, the standards of solvency that must be met and maintained, including risk-based capital measurements, material transactions between an insurer and its affiliates, the licensing of insurers and their agents, the nature of and limitations on the amount of certain investments, restrictions on the size of risks that may be insured under a single policy, deposits of securities for the benefit of policyholders, methods of accounting, periodic examinations of the affairs of insurance companies, the form and content of reports of financial condition required to be filed, and reserves for unearned premiums, losses and other purposes. In general, such regulation is for the protection of policyholders rather than shareholders.

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Regulations generally require insurance and reinsurance companies to furnish information to their domestic state insurance department concerning activities that may materially affect the operations, management or financial condition and solvency of the company. Regulations vary from state to state but generally require that each primary insurance company obtain a license from the department of insurance of a state to conduct business in that state. A reinsurance company is not generally required to have an insurance license to reinsure a U.S. ceding company. However, for a U.S. ceding company to obtain financial statement credit for reinsurance ceded, the reinsurer must obtain an insurance license or accredited status from the cedant’s state of domicile or must post collateral to support the liabilities ceded. In addition, regulations for reinsurers vary somewhat from primary insurers in that the form and rate of reinsurance contracts are not subject to regulator approval.

The Company’s U.S. insurance subsidiaries are required to file detailed annual and, in most states, quarterly reports with state insurance regulators in each of the states in which they are licensed. Such annual and quarterly reports are required to be prepared on a calendar year basis. In addition, the U.S. insurance subsidiaries’ operations and accounts are subject to financial condition and market conduct examination at regular intervals by state regulators. The respective reports filed in accordance with applicable insurance regulations with respect to the most recent periodic examinations of the U.S. insurance subsidiaries contained no material adverse findings.

Statutory surplus is an important measure utilized by the regulators and rating agencies to assess the Company’s U.S. insurance subsidiaries’ ability to support business operations and provide dividend capacity. The Company’s U.S. insurance subsidiaries are subject to various state statutory and regulatory restrictions that limit the amount of dividends that may be paid from earned surplus without prior approval from regulatory authorities. These restrictions differ by state, but are generally based on a calculation of the lesser of 10% of statutory surplus or 100% of net investment income.

Most states have implemented laws that establish standards for current, as well as continued, state accreditation. In addition, the National Association of Insurance Commissioners promulgated and all states have adopted Risk-Based Capital (“RBC”) standards for property and casualty companies and life insurance companies as a means of monitoring certain aspects affecting the overall financial condition of insurance companies. RBC is designed to measure the adequacy of an insurer’s statutory surplus in relation to the risks inherent in its business. The RBC Model Law provides for four incremental levels of regulatory attention for insurers whose surplus is below the calculated RBC target. These levels of attention range in severity from requiring the insurer to submit a plan for corrective action to actually placing the insurer under regulatory control. The Company’s current RBC ratios for its U.S. subsidiaries are satisfactory and such ratios are not expected to result in any adverse regulatory action. The Company is not aware of any actions.

While the federal government does not directly regulate the insurance business (other than for flood, nuclear and reinsurance of losses from terrorism), federal legislation and administrative policies can affect the insurance industry. In addition, legislation has been introduced from time to time in recent years that, if enacted, could result in the federal government assuming a more direct role in the regulation of the insurance industry, primarily as respects federal licensing in lieu of state licensing.

European Union

Financial services including insurance, reinsurance, securities and Lloyd’s in the United Kingdom are regulated by the Financial Services Authority (“FSA”). The FSA’s Handbook of Rules and Guidance (the “FSA Rules”) covers all aspects of regulation including capital adequacy, financial and non-financial reporting and certain activities of U.K.-regulated firms. The Company’s subsidiaries carrying out regulated activities in the U.K. comply with the FSA Rules. The Company’s Lloyd’s managing agency, its managed syndicates and its associated Corporate Capital Vehicles are subject to additional requirements of the Council of Lloyd’s franchise.

FSA regulations also impact on the Company as “controller”(an FSA defined term) in its U.K.-regulated subsidiaries. Through the FSA’s Approved Persons regime, certain employees and Directors are subject to regulation by the FSA and certain employees are individually registered at Lloyd’s.

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Subsidiaries in Ireland, Hungary and France are regulated in those jurisdictions. The Company’s network of offices in the European Union consists mainly of branches of U.K. and Irish companies that are principally regulated under European Directives from their home states, the U.K. and Ireland rather than by each individual jurisdiction.

International Operations

A substantial portion of the Company’s general insurance business and a majority of its life insurance business is carried on in foreign countries. The degree of regulation in foreign jurisdictions can vary. Generally, the Company’s subsidiaries must satisfy local regulatory requirements. Licenses issued by foreign authorities to subsidiaries of the Company are subject to modification or revocation for cause by such authorities. The Company’s subsidiaries could be prevented, for cause, from conducting business in certain of the jurisdictions where they currently operate. While each country imposes licensing, solvency, auditing and financial reporting requirements, the type and extent of the requirements differ substantially. Key areas where countries may differ include: i) the filing of financial reports to be filed; ii) limitations on the requirement to use local intermediaries; iii) the use of reinsurance; iv) the scope of any regulation of policy forms and rates; and v) the type and frequency of regulatory examinations.

In addition to these requirements, the Company’s foreign operations are also regulated in various jurisdictions with respect to currency, amount and type of security deposits, amount and type of reserves, amount and type of local investment and the share of profits to be returned to policyholders on participating policies. Certain countries have established reinsurance institutions, wholly or partially owned by the state, to which admitted insurers are obligated to cede a portion of their business on terms which do not always allow foreign insurers full compensation.

For further information see Item 8, Note 24 to the Consolidated Financial Statements.

Employees

At December 31, 2004, the Company employed approximately 3,527 employees. At that date, 40 of the Company’s employees were known by the Company to be represented by unions, approximately 400 employees were represented by workers’ councils and 446 of the Company’s employees were subject to collective bargaining agreements. The Company believes that it has a good relationship with its employees.

Available Information

The public can read and copy any materials the Company files with the U.S. Securities and Exchange Commission (“SEC”) at the SEC’s Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. The public can obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers, including the Company, that file electronically with the SEC. The address of the SEC’s website is http://www.sec.gov.

The Company’s Internet website address is http://www.xlcapital.com. The information contained on the Company’s website is not incorporated by reference into this annual report on Form 10-K or any other of the Company’s documents filed with or furnished to the SEC.

The Company makes available free of charge, including through the Company’s Internet website, the Company’s annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC.

The Company adopted Corporate Governance Guidelines, as well as written charters for each of the Audit Committee, the Compensation Committee, the Finance Committee, and the Nominating and Governance Committee of the Board of Directors, as well as a Code of Ethics for Senior Financial Officers, a Code of Business Conduct & Ethics for employees and a related Compliance Program. Each of these documents is posted on the Company’s website at http://www.xlcapital.com, and each is available in print to any shareholder who requests it by writing to us at Investor Relations Department, XL Capital Ltd, XL House, One Bermudiana Road, Hamilton HM 11, Bermuda.

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ITEM 2. PROPERTIES

The Company operates in the United States, Bermuda, Europe and various other locations around the world. In 1997, the Company acquired commercial real estate in Hamilton, Bermuda for the purpose of securing long-term office space for its worldwide headquarters. The development was completed in April 2001. The total cost of this development, including land, was approximately $126.6 million.

In July 2003, the Company acquired new offices at 70 Gracechurch Street, London, which have become the Company’s new London headquarters. The acquisition was made through a purchase, sale and leaseback transaction. The move to the new offices was completed in 2004 and consolidated the Company’s London businesses in one location. The Company has recorded a capital lease asset and liability of approximately $150.0 million related to this transaction.

The majority of all other office facilities throughout the world that are occupied by the Company and its subsidiaries are leased.

Total rent expense for the years ended December 31, 2004, 2003 and 2002 was approximately $31.4 million, $42.3 million and $30.4 million, respectively. See Item 8, Note 18(d) to the Consolidated Financial Statements for discussion of the Company’s lease commitments for real property.

ITEM 3.LEGAL PROCEEDINGS

On March 17, 2004, certain current and former directors and officers of the Company were named as defendants in a putative “shareholder derivative complaint” (Marilyn Clark, Derivatively on Behalf of XL Capital Ltd v. Brian O’Hara et al.) filed in Connecticut Superior Court by a California shareholder (the “Action”). The Company was named as a nominal defendant. The complaint alleged several causes of action including breach of fiduciary duty, abuse of control, gross mismanagement, waste of corporate assets and unjust enrichment during the time period “from November 2001 to the present” (the “Relevant Period”). The Action alleged that the Company maintained inadequate loss reserves for its NAC Re subsidiary (now known as XL Reinsurance America Inc.) during the Relevant Period and that, as a consequence, the Company’s earnings and assets were materially overstated. On June 10, 2004, the Company filed a motion to dismiss the plaintiff’s claim. Thereafter, the plaintiff moved to withdraw the complaint in this Action and, on September 29, 2004, the Court approved the plaintiff’s motion.

On June 21, 2004, a consolidated and amended class action complaint (the “Amended Complaint”) was served on the Company and certain of its present and former directors and officers as defendants in a putative class action (Malin et al. v. XL Capital Ltd et al.) filed in United States District Court, District of Connecticut (the “Malin Action”). The Malin Action purports to be on behalf of purchasers of the Company’s common stock between November 1, 2001 and October 16, 2003, and alleges claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10(b)-5 promulgated thereunder (“Securities Laws”). The Amended Complaint alleges that the defendants violated the Securities Laws by, among other things, failing to disclose in various public and shareholder and investor reports and other communications the alleged inadequacy of the Company’s loss reserves for its NAC Re subsidiary (now known as XL Reinsurance America, Inc.) and that, as a consequence, the Company’s earnings and assets were materially overstated. Defendant’s filed a motion to dismiss the Amended Complaint which motion is pending before the Court. There has been no discovery in the Malin Action. The Company and the defendant present and former officers and directors intend to vigorously defend the claims asserted against them.

On June 17, 2004, William Kronenberg, III, Frank A. Piliero and David M. Rosenberg (together, the “Claimants”) commenced an arbitration against the Company before the American Arbitration Association (“AAA”) in New York, New York. The Claimants and the Company were parties to a stock purchase agreement dated June 1, 1999, pursuant to which the Company acquired the outstanding capital stock of ECS, Inc (the “Stock Purchase Agreement”). In their AAA arbitration demand, the Claimants assert claims of fraud and deceitful conduct, negligent misrepresentation, and breach of contract and a covenant of good faith and fair dealing, all relating to the allegation that the Company failed to make certain contingent payments allegedly due to the Claimants under the Stock

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Purchase Agreement. Claimants seek $85 million (the maximum amount payable under the contingent payment provision at issue), plus punitive damages, interest, costs and attorneys’ fees. On July 30, 2004, the Company filed an Answering Statement and Motion to Stay or Dismiss the AAA arbitration. On April 13, 2004, the Company commenced a separate arbitration procedure, as provided in the Stock Purchase Agreement, but the Claimants have refused to participate in this procedure. On July 15, 2004, the Company filed a petition in the United States District Court for the Southern District of New York, seeking an order of the Court compelling the Claimants to arbitrate the dispute pursuant to those procedures and staying or dismissing the AAA arbitration. On September 19, 2004, the District Court denied the Company’s petition. On October 22, 2004, the Company filed an appeal of the District Court’s decision with the United States Court of Appeals for the Second Circuit. The AAA arbitration is proceeding. The Company intends to vigorously defend against the Claimants’ claims.

On July 15, 2003, the Company and Messrs. Esposito and O’Hara were named in a Consolidated Amended Class Action Complaint (the “Amended Complaint”) filed by certain shareholders of Annuity and Life Re (Holdings), Ltd. (“ANR”) against ANR and certain present and former officers and directors of ANR in the United States District Court for the District of Connecticut seeking unspecified money damages on behalf of purchasers of ANR stock. Schnall v. Annuity and Life Re (Holdings), Ltd., Civil Action No. 02-CV-2133 (GLG) (the “Schnall Action”). The plaintiffs claim that the defendants violated certain provisions of the United States securities laws by making (or being responsible as alleged controlling persons for) various alleged material misstatements and omissions in public filings and press releases of ANR. On July 19, 2004, an agreement in principle was reached with the plaintiffs to settle the Schnall Action. The settlement is without any admission of liability or wrongdoing and includes a nominal cash payment by the Company. After notice to the class of the proposed settlement, on January 21, 2005, a hearing was held before Judge Ellen Bree Burns of the United States District Court for the District of Connecticut and the Judge approved the settlement by written order.

The Company is also subject to litigation and arbitration in the normal course of its business. These lawsuits and arbitrations principally involve claims on policies of insurance and contracts of reinsurance and are typical for the Company and for the property and casualty insurance and reinsurance industry in general. Such legal proceedings are considered in connection with the Company’s loss and loss expense reserves. Reserves in varying amounts may or may not be established in respect of particular claims proceedings based on many factors, including the legal merits thereof. In addition to claims litigation, the Company and its subsidiaries are subject to lawsuits in the normal course of business that do not arise from or directly relate to claims on policies of insurance or contracts of reinsurance.

The Company believes that the ultimate outcome of all outstanding litigation and arbitration will not have a material adverse effect on its consolidated financial condition, future operating results and/or liquidity, although an adverse resolution of a number of these items could have a material adverse effect on the Company’s results of operations in a particular fiscal quarter or year.

Although not a litigation or arbitration, the Company has entered into a binding independent actuarial valuation process relating to the Company’s acquisition of Winterthur International in July 2001. This process is further described in Item 8, note 18(a) to the Consolidated Financial Statements and Item 7, “Managements Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources.”

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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of ordinary shareholders during the fourth quarter of the fiscal year covered by this report.

Executive Officers of the Company

The table below sets forth the names, ages and titles of the persons who were the executive officers of the Company for the year ended December 31, 2004:

Name	Age	Position
Brian M. O’Hara	56	President, Chief Executive Officer and Director
Fiona E. Luck	47	Executive Vice President, Global Head of Corporate Services and Assistant
		Secretary
Jerry M. de St. Paer	63	Executive Vice President, Chief Financial Officer, Treasurer and Assistant
		Secretary
Charles F. Barr	55	Executive Vice President and General Counsel
Christopher V. Greetham	60	Executive Vice President and Chief Investment Officer
Clive R. Tobin	55	Executive Vice President of the Company and Chief Executive of Insurance
		Operations
Henry C.V. Keeling	49	Executive Vice President of the Company and Chief Executive of
		Reinsurance Operations and Global Head of Business Services
Paul S. Giordano	42	Executive Vice President of the Company and Chief Executive of Financial
		Products and Services Operations
Anthony G. Beale	62	Senior Vice President, Head of Global Human Resources
Willi Suter	61	Executive Vice President, International Strategic Development

Brian M. O’Hara has been President and Chief Executive Officer of the Company since 1994 and a Director of the Company since 1986, having previously served as Vice Chairman of the Company from 1987. He is Chairman of XL Insurance (Bermuda) Ltd and XL Re Ltd and was Chief Executive Officer of XL Insurance (Bermuda) Ltd until 1998, having previously served as Chairman, President and Chief Executive Officer from 1994, President and Chief Executive Officer from 1992 and as President and Chief Operating Officer from 1986.

Fiona E. Luck has been Executive Vice President and Global Head of Corporate Services since November 2004 and Assistant Secretary since January 2002. From 1999 to 2004, Ms. Luck was Executive Vice President of Group Operations of the Company. Ms. Luck was previously employed at ACE Bermuda as Executive Vice President from 1998, and Senior Vice President from 1997. From 1992 to 1997, Ms. Luck was the Managing Director of the Marsh & McLennan Global Broking office in Bermuda.

Jerry M. de St. Paer has been Executive Vice President and Chief Financial Officer of the Company since February 2001. Mr. de St. Paer was appointed Treasurer and Assistant Secretary of the Company in January 2002. Mr. de St. Paer was previously Managing Director of Hudson International Advisors in New York. Prior to forming Hudson International in 1998, he served as Managing Director, Insurance at J.P. Morgan & Company, Inc. Mr. de St. Paer was previously employed at The Equitable (now AXA Financial Advisors), from 1986 until 1997, serving most recently as Senior Executive Vice President and Chief Financial Officer of The Equitable and as Executive Vice President of Strategic Studies and Development of the AXA Group.

Charles F. Barr has been Executive Vice President and General Counsel of the Company since November 2004, having previously served as General Counsel of X.L. America, Inc. from 2002. Before joining the Company, Mr. Barr

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was General Counsel of Benfield Blanch from 2000 to 2002. Mr. Barr was previously Senior Vice President, Secretary and General Counsel of General Re Corporation from 1994 to 2000 and Assistant General Counsel from 1989 to 1994. Prior to that he was Senior Vice President and General Counsel of General Accident Insurance Company of America from 1987 to 1989.

Christopher V. Greetham has been Executive Vice President of the Company since December 1998 and has served as Chief Investment Officer of the Company since 1996. Prior to joining the Company, Mr. Greetham served as Senior Vice President and Chief Financial Officer of OIL Insurance Ltd from 1982 to 1996 and as Vice President of Bankers Trust Company from 1975 to 1982.

Clive R. Tobin has been Executive Vice President and Chief Executive of Insurance Operations since April 2004. Mr. Tobin was President and Chief Executive of XL Winterthur International from February 2002, having previously served as Deputy Chief Executive and Chief Underwriting Officer of XL Winterthur International following the Company’s acquisition of the risk management business from Credit Suisse in 2001, and President and Chief Executive of XL Insurance (Bermuda) Ltd since July 1999. From 1995 to 1999, Mr. Tobin held a variety of senior management positions at XL. Prior to joining XL in 1995, Mr. Tobin served as President of Rockefeller Insurance Company and Acadia Risk Management Services, Inc., in New York. From 1979 to 1986, Mr. Tobin served as Vice President of Risk Management Services for Marsh & McLennan, Inc.

Henry C.V. Keeling has been Executive Vice President of the Company and Chief Executive Officer of XL Re Ltd since August 1998 and Global Head of Business Services since November 2004. He was appointed Chief Executive of Reinsurance Operations in July 2000. Mr. Keeling was President and Chief Operating and Underwriting Officer of Mid Ocean Re (now known as XL Re Ltd) from 1992 to 1998. He previously served as a director of Taylor Clayton (Underwriting Agencies) Ltd and deputy underwriter for syndicate 51 at Lloyd’s from 1984 through 1992.

Paul S. Giordano has been Executive Vice President and Chief Executive of Financial Products and Services since November 2004. Mr. Giordano served as General Counsel of the Company from January 1997 to November 2004. Mr. Giordano was associated with Cleary, Gottlieb, Steen & Hamilton and Clifford Chance in New York and London prior to joining the Company.

Anthony G. Beale has been Senor Vice President, Head of Global Human Resources since he joined the Company in September 2000. Mr Beale was Managing Director at Santander Investment Securities from 1997 to 1999. Mr. Beale previously served as Managing Director of J.P. Morgan until 1997.

Willi Suter has been Executive Vice President, International Strategic Development since February 2002. Mr. Suter was Chief Executive Officer at XL Winterthur International from 2001 to 2002. Prior to joining the Company Mr. Suter was Chairman and Chief Executive Officer of Winterthur International.

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PART II

ITEM 5.MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER  PURCHASES OF
            EQUITY SECURITIES

The Company’s Class A ordinary shares, $0.01 par value, are listed on the New York Stock Exchange under the symbol “XL”.

The following table sets forth the high, low and closing sales prices per share of the Company’s Class A ordinary shares per fiscal quarter, as reported on the New York Stock Exchange Composite Tape.

	High	Low	Close
2004:
1st Quarter	$81.54	$72.44	$76.04
2nd Quarter	79.55	73.92	75.46
3rd Quarter	75.99	68.87	73.99
4th Quarter	79.56	67.62	77.65
2003:
1st Quarter	$83.55	$64.57	$70.78
2nd Quarter	88.00	72.58	83.00
3rd Quarter	83.92	72.83	77.44
4th Quarter	79.83	68.11	77.55

Each Class A ordinary share has one vote, except if, and so long as, the Controlled Shares (defined below) of any person constitute ten percent (10%) or more of the issued Class A ordinary shares, the voting rights with respect to the Controlled Shares owned by such person are limited, in the aggregate, to a voting power of approximately 10%, pursuant to a formula specified in the Articles of Association. “Controlled Shares” includes, among other things, all Class A ordinary shares which such person is deemed to beneficially own directly, indirectly or constructively (within the meaning of Section 13(d)(3) of the Securities Exchange Act of 1934 or Section 958 of the Internal Revenue Code of 1986, as amended).

The number of record holders of Class A ordinary shares as of December 31, 2004 was 485. This figure does not represent the actual number of beneficial owners of the Company’s Class A ordinary shares because such shares are frequently held in “street name” by securities dealers and others for the benefit of individual owners who may vote the shares.

In 2004, four regular quarterly dividends were paid at $0.49 per share to all ordinary shareholders of record as of March 8, June 7, September 6 and December 6. In 2003, four regular quarterly dividends were paid at $0.48 per share to all ordinary shareholders of record as of March 10, June 9, September 8 and December 8.

The declaration and payment of future dividends by the Company will be at the discretion of the Board of Directors and will depend upon many factors, including the Company’s earnings, financial condition, business needs, capital and surplus requirements of the Company’s operating subsidiaries and regulatory and contractual restrictions.

As a holding company, the Company’s principal source of income is dividends or other statutorily permissible payments from its subsidiaries. The ability to pay such dividends is limited by the applicable laws and regulations of the various countries that the Company operates in, including Bermuda, the United States and the U.K., and those of the Society of Lloyd’s, and certain contractual provisions. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 8, Note 24 to the Consolidated Financial Statements for further discussion.

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Rights to purchase Class A ordinary shares (“Rights”) were distributed as a dividend at the rate of one Right for each Class A ordinary share held of record as of the close of business on October 31, 1998. Each Right entitles holders of Class A ordinary shares to buy one ordinary share at an exercise price of $350. The Rights would be exercisable, and would detach from the Class A ordinary shares, only if a person or group were to acquire 20% or more of the Company’s outstanding Class A ordinary shares, or were to announce a tender or exchange offer that, if consummated, would result in a person or group beneficially owning 20% or more of Class A ordinary shares. Upon a person or group without prior approval of the Board acquiring 20% or more of Class A ordinary shares, each Right would entitle the holder (other than such an acquiring person or group) to purchase Class A ordinary shares (or, in certain circumstances, Class A ordinary shares of the acquiring person) with a value of twice the Rights exercise price upon payment of the Rights exercise price. The Company will be entitled to redeem the Rights at $0.01 per Right at any time until the close of business on the tenth day after the Rights become exercisable. The Rights will expire at the close of business on September 30, 2008, and do not initially have a fair value. The Company has initially reserved 119,073,878 Class A ordinary shares being authorized and unissued for issue upon exercise of Rights.

Information concerning securities authorized for issuance under equity compensation plans appears in Part III, Item 12, “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.”

Purchases of Equity Securities by the Issuer and Affiliate Purchases

The following table provides information about purchases by the Company during the quarter ended December 31, 2004 of equity securities that are registered by the Company pursuant to Section 12 of the Exchange Act:

			Total Number	Approximate Dollar
			Of Shares	Value of Shares
			Purchases as	that May Yet Be
			Part of	Purchased Under
	Total Number	Average Price	Publicly	the Plans
	of Shares	Paid	Announced Plans	or Programs
Period	Purchased (1)	per share (2)	or Programs	(3)
October	1,224	73.65	___	$135.4 million
November	—	—	___	$135.4 million
December	2,338	79.56	___	$135.4 million
Total	3,562	77.53	___	$135.4 million

(1)	All of the shares included in each period were purchased in connection with the vesting of restricted shares granted under the Company’s restricted stock plan. All of these purchases were made in connection with satisfying tax withholding obligations of those employees. These shares were not purchased as part of the Company’s publicly announced share repurchase program.
(2)	The price paid per share is the closing price of the shares on the vesting date.
(3)	On January 9, 2000, the Board of Directors previously authorized a $500.0 million share repurchase program. The Company did not repurchase any equity securities under the program during the year ended December 31, 2004. As of December 31, 2004 the Company could repurchase up to approximately $135.4 million of the Company’s equity securities under the Company’s share repurchase program.

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ITEM 6. SELECTED FINANCIAL DATA

The selected consolidated financial data below is based upon the Company’s fiscal year end of December 31. The selected consolidated financial data should be read in conjunction with the Consolidated Financial Statements and the Notes thereto presented under Item 8.

	2004(1)	2003(1)	2002(1)	2001	2000
(U.S. dollars in thousands, except share and per share amounts and ratios)
Income Statement Data:
Net premiums earned – general operations	$6,982,549	$6,081,033	$4,899,073	$2,730,420	$2,011,525
Net premiums earned – financial operations	161,285	139,622	67,745	37,113	23,715
Net premiums earned – life operations	1,405,699	748,495	1,022,992	695,595	–
Net investment income	995,036	779,558	734,535	610,528	580,946
Net realized gains (losses) on investments	246,547	120,195	(214,160)	(93,237)	45,090
Net realized and unrealized
gains (losses) on derivative instruments	78,019	(27,542)	(51,761)	11,768	21,405
Net income from investment affiliates (2)(7)	124,008	119,200	54,143	75,590	55,289
Fee income and other	35,317	41,745	54,963	18,247	(1,131)
Net losses and loss expenses incurred –
general operations	4,790,885	4,576,856	3,329,049	2,890,076	1,426,443
Net losses and loss expenses incurred –
financial operations	73,055	33,750	(1,732)	15,155	6,116
Claims and policy benefits – life operations	1,500,128	818,894	1,069,456	698,675	–
Acquisition costs, operating expenses
and exchange gains and losses	2,277,321	1,926,393	1,549,440	1,073,903	743,067
Interest expense	259,075	199,407	168,086	113,272	70,593
Amortization of intangible assets	15,827	4,637	6,187	58,569	58,597
Income (loss) before minority interests,
net income from operating affiliates
and income tax expense	1,112,169	442,369	447,046	(763,626)	432,023
Preference share dividends	40,321	40,321	9,620	–	–
Net income (loss) available to ordinary shareholders	1,126,292	371,658	395,951	(576,135)	506,352
Per Share Data:
Net income (loss) per ordinary share – basic (3)	$ 8.17	$ 2.71	$ 2.92	$ (4.55)	$ 4.07
Net income (loss) per ordinary share – diluted (3)	$ 8.13	$ 2.69	$ 2.88	$ (4.55)	$ 4.03
Weighted average ordinary shares
Outstanding – diluted (3)	138,582	138,187	137,388	126,676	125,697
Cash dividends per ordinary share	$1.96	$1.92	$1.88	$1.84	$1.80

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	2004(1)	2003(1)	2002(1)	2001(1)	2000
(U.S. dollars in thousands, except share and per share amounts and ratios)
Balance Sheet Data:
Total investments available for sale	$27,823,828	$20,775,256	$16,059,733	$12,429,845	$9,501,548
Cash and cash equivalents	2,304,303	2,829,627	3,670,460	2,239,419	995,495
Investments in affiliates	1,936,852	1,903,341	1,750,005	1,113,344	792,723
Unpaid losses and loss expenses recoverable	6,740,519	5,779,997	5,012,655	4,633,693	1,339,767
Premiums receivable	3,838,228	3,487,322	3,592,713	2,182,348	1,119,723
Total assets	49,014,632	41,190,721	35,760,014	28,338,574	17,006,978
Unpaid losses and loss expenses	19,598,531	16,558,788	13,202,736	11,806,745	5,667,833
Unearned premiums	5,191,368	4,729,989	4,028,299	2,636,428	1,741,393
Notes payable and debt	2,721,431	1,905,483	1,877,957	1,604,877	450,032
Shareholders’ equity	7,738,695	6,936,915	6,569,589	5,437,184	5,573,668
Book value per ordinary share	$51.98	$46.74	$44.48	$40.35	$44.58
Operating Ratios:
Loss and loss expense ratio (4)	68.6%	75.3%	68.0%	105.8%	70.9%
Underwriting expense ratio (5)	27.4%	27.3%	29.0%	33.9%	35.3%
Combined ratio (6)	96.0%	102.6%	97.0%	139.7%	106.2%

(1)	Results for all periods subsequent to July 1, 2001 include the results of Winterthur International, which was acquired with effect from this date. The results also include the consolidation of XL Re Europe, which has been accounted for as a subsidiary with effect from January 1, 2002. In the years ended December 31, 2001 and 2000, the Company’s share of net income of Le Mans Ré (now known as XL Re Europe) was included in equity in net income of operating affiliates. The Company’s net income for the years ended December 31, 2003, 2002 and 2001 was impacted by the September 11 event. The effect of all of these items should be considered when making period to period comparisons of the Company’s results of operations and financial condition and liquidity. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for further discussion and analysis.
(2)	Net income from investment affiliates in 2003 includes income on the alternative investment portfolio for eleven months ended November 30, 2003 as compared to twelve months in prior years. The fair market values of certain of these alternative investments often take longer to obtain as compared to the other of the Company’s investments and therefore are unavailable at the time of the close.
(3)	Net income per ordinary share is based on the basic and diluted weighted average number of Class A ordinary shares and ordinary share equivalents outstanding for each period. Net loss per ordinary share is based on the basic weighted average number of ordinary shares outstanding.
(4)	The loss and loss expense ratio is calculated by dividing the losses and loss expenses incurred by the net premiums earned for general insurance and reinsurance operations.
(5)	The underwriting expense ratio is the sum of acquisition expenses and operating expenses for general insurance and reinsurance operations divided by net premiums earned for general insurance and reinsurance operations. See Item 8, Note 3 to the Consolidated Financial Statements for further information.
(6)	The combined ratio is the sum of the loss and loss expense ratio and the underwriting expense ratio. A combined ratio under 100% represents an underwriting profit and over 100% represents an underwriting loss.
(7)	Certain reclassifications to prior period information have been made to conform to current year presentation.

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contains forward-looking statements which involve inherent risks and uncertainties. Statements that are not historical facts, including statements about the Company’s beliefs and expectations, are forward looking-statements. These statements are based upon current plans, estimates and expectations. Actual results may differ materially from those projected in such forward-looking statements, and therefore undue reliance should not be placed on them. See “Cautionary Note Regarding Forward-Looking Statements” for a list of additional factors that could cause actual results to differ materially from those contained in any forward-looking statement.

This discussion and analysis should be read in conjunction with the audited Consolidated Financial Statements and Notes thereto presented under Item 8.

Certain aspects of the Company’s business have loss experience characterized as low frequency and high severity. This may result in volatility in both the Company’s results of operations and financial condition.

Executive Overview

The Company operates on a global basis primarily in the property and casualty industry and, to a lesser extent, the financial services industry. The Company serves the insurance, reinsurance and financial services needs of institutional or corporate clients, typically the global equivalent of the Fortune 2000. The Company operates in markets where the Company believes its underwriting expertise and financial strength represent a relative advantage. The Company does not operate in any retail markets.

The property and casualty insurance and reinsurance markets have historically been cyclical, meaning that based on market conditions, there have been periods where premium rates are high and policy terms and conditions are more favorable (a “hard market”) to the Company and there have been periods where premium rates decline and policy terms and conditions are less favorable (a “soft market”) to the Company. This has been driven primarily by competition in the marketplace, the supply of capital in the industry, investment yields and the frequency and severity of loss events. Management’s goal is to build long-term shareholder value by capitalizing on current opportunities and managing through any potential downward cycles by reducing its property and casualty book of business and exposures if and when rates deteriorate to unprofitable levels for the Company. As part of its long-term strategy, the Company also looks to its financial products and services segment to provide a diversified stream of earnings that are not directly tied to the property and casualty cycle. In this regard, the Company’s financial guaranty operations have substantially achieved relative trading parity with its peers.

The Company has grown through acquisition activity and development of new business opportunities. Acquisitions included Global Capital Underwriting Ltd in 1996, Mid Ocean Limited in 1998, ECS, Inc. and NAC Re Corp. in 1999, Winterthur International in 2001 and Le Mans Ré in 2002. All acquisitions have supported the Company’s strategic plan to develop a global platform in insurance and reinsurance. Recent business developments include XL Capital Assurance Inc. and XL Financial Assurance Ltd., the Company’s financial guaranty primary and reinsurance guarantors, XL Weather & Energy and XL Life & Annuity. As a result of these combined developments, the Company now competes as an integrated global business with more than 3,500 employees in 29 countries.

The Company earns its revenue primarily from net premiums written and earned. Premium rates in the property and casualty industry began to increase in 2001 following five years of poor underwriting performance in the industry. These price increases were further compounded by the September 11 event. In the three years ended December 31, 2003, the Company experienced pricing increases and improved terms and conditions across most of the lines of business it writes. These generally, across-the-board price increases were unprecedented meaning that, in the past, pricing increases and more favorable terms and conditions were not experienced across all of the Company’s product lines at one point in any one cycle.

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Property and casualty market conditions overall remain attractive although price competition continued to increase throughout 2004, most notably in regards to property and professional lines. Accordingly, the Company continued to focus on disciplined risk selection. Based on continued solid demand and the benefits of price increases and improved terms achieved over the last several years’ renewals, the Company believes that overall business in the insurance and reinsurance markets was adequately priced. In relation to insurance and reinsurance, with respect to current market conditions and January 1, 2005 renewals, the Company has seen competitive pressures continue. The impact of the 2004 storm season, the backdrop of continued emergence of adverse development related to the market of the late 1990’s and concerns about reinsurer financial strength, all served to reinforce a sense of discipline in the market. Marine rates were flat to down 10%, energy rates were up 10 to 15% reflecting the substantial impact of Hurricane Ivan. Casualty rates appear to have remained flat on average. In accordance with this increasingly competitive market environment, the Company’s expectation is for flat earned premium growth for full year 2005, with insurance flat to up low-single digits and reinsurance flat to down low single-digits.

The Company also generates revenue from investment activities through returns on its investment portfolio. The Company’s current investment strategy seeks to support the liabilities arising from the operations of the Company, generate investment income and build book value over the longer term. During 2004, interest rates in the U.S. increased moderately and the yield on the benchmark 5-year treasury rose from 3.25% to 3.61%. Interest rates declined in the U.K., where the yield on the benchmark 5-yr Gilt fell from 4.60% to 4.49% and in the Euro-zone, where the yield on the benchmark 5-yr German Bund fell from 3.50% to 3.03%.

For the three years up to December 31, 2003, there were declines in interest rates that negatively impacted the Company’s net investment income. The Company expects net investment income to rise in 2005 supported by positive cash flow from operations and anticipated moderate increases in market interest rates.

In 2004, the Company generated net realized gains from both its equity and fixed income portfolios reflecting the overall performance of capital markets and the deterioration of the U.S. dollar relative to foreign currencies. In 2003, the Company generated net realized gains from both its equity and fixed income portfolios reflecting the overall improvement in capital markets and narrowing of credit spreads.

The Company’s profitability in any given period is based upon its premium and investment revenues as noted above, less net losses incurred and expenses. Net losses incurred are based upon claims paid and changes to unpaid loss reserves. Unpaid loss reserves are estimated by the Company and include both reported loss reserves and reserves for losses incurred but not reported. The Company’s results for 2004 were significantly impacted by the catastrophe activity in the year which resulted in $591.2 million in estimated net loss and loss expenses, combined with adverse prior year development in certain lines of the Company’s insurance segment. See further information below. The Company’s results for 2003 and 2002 were negatively impacted by an increase to reserves established in prior years primarily relating to its North American casualty reinsurance business written in the 1997 through 2001 underwriting years. In the third quarter of 2003, the Company received reported claims that were in excess of the Company’s expected claims and the Company increased loss reserves by $184.0 million and began an extensive claims audit review of its ceding companies for this book of business. Upon completion of this claims audit review as well as the Company’s scheduled annual reserve review, the Company increased loss reserves by $694 million in the fourth quarter of 2003. This increase was net of a $197 million release of reserves relating to the September 11 event. See further information under “Reinsurance – General Operations” below.

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Financial measures

The following are some of the financial measures management considers important in evaluating the Company’s operating performance in the Company’s general operations:

(U.S. dollars in thousands, except ratios and per share amounts)	2004	2003	2002
Underwriting profit (loss) – general operations	$349,308	$ (84,117)	$274,701
Combined ratio – general operations	96.0%	102.6%	97.0%
Investment income – general operations	$661,535	$588,428	$617,122
Book value per ordinary share	$ 51.98	$ 46.74	$ 44.48
Return on average ordinary shareholders’ equity	16.5%	6.0%	6.9%

Underwriting profit (loss) – general operations

One way that the Company evaluates the performance of its insurance and reinsurance general operations is the underwriting profit or loss. The Company does not measure performance based on the amount of gross premiums written. Underwriting profit or loss is calculated from premiums earned and fee income, less net losses incurred and expenses related to the underwriting activities. As noted above, the Company’s underwriting profit and loss for the last three years have been negatively impacted by net losses incurred from catastrophic losses and adverse development of prior year loss reserves. Partially offsetting this has been the increase in premium rates and favorable underwriting terms and conditions during 2002 and 2003. Any changes to loss reserves affect the calculation of underwriting profit or loss but most often do not directly affect the Company’s cash flow in the same period. See further discussion below. Barring any unusual catastrophic loss events, the Company expects to produce an underwriting profit in 2005.

Combined ratio – general operations

The combined ratio for general operations is used by the Company and many other insurance and reinsurance companies as another measure of underwriting profitability. The combined ratio is calculated from the net losses incurred and underwriting expenses as a ratio of the net premiums earned for the Company’s general insurance and reinsurance operations. A combined ratio of less than 100% indicates an underwriting profit and over 100% indicates an underwriting loss. Changes in the Company’s combined ratio for the last three years have been negatively impacted by the net losses incurred, related to 2004 catastrophe activity and prior period development in all three years. The improvement in 2004 was primarily a result of the severity of the prior period development in 2003 offset by the catastrophe losses noted in 2004.

Net investment income – general operations

Net investment income from its general operations is an important measure which affects the Company’s overall profitability. The largest liability of the Company relates to its unpaid loss reserves and the Company’s investment portfolio provides liquidity for claims settlements of these reserves as they become due, and thus a significant part of the portfolio is in fixed income securities. Net investment income is affected both by the size of the portfolio and the level of market interest rates. In 2004 U.S. interest rates increased moderately while interest rates in the U.K. and Euro-zone declined. The size of the portfolio is also impacted by cash flow generated from operations which has been positive during the last three years and which the Company currently expects to be positive in 2005.

Book value per ordinary share

Management also views the change in the Company’s book value per ordinary share as an additional measure of the Company’s performance. Book value per share is calculated by dividing ordinary shareholders’ equity by the number of outstanding ordinary shares at any period end. Book value per ordinary share is affected primarily by the Company’s net income and also any changes in the net unrealized gains and losses on its investment portfolio. The Company’s book value per ordinary share increased in 2004 primarily as a result of an increase in net income com-

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bined with an increase in the net unrealized gains on the investment portfolio. The increase in unrealized gains on the Company’s fixed income portfolio was primarily a result of the foreign exchange benefits for non-U.S. dollar investments partially offset by a moderate increase in interest rates in the U.S.

Return on average ordinary shareholders’ equity

Return on average ordinary shareholder’s equity (“ROE”) is a widely used measure of any company’s profitability. It is calculated by dividing the net income for any period by the average of the opening and closing ordinary shareholders’ equity. The Company establishes minimum target ROE’s for its total operations, segments and lines of business. If the Company’s minimum ROE targets over the longer term are not met with respect to any line of business, the Company seeks to exit these lines. In addition, the Company’s compensation of its senior officers is significantly dependant on the achievement of the Company’s performance goals to enhance shareholder value as measured by ROE. The Company’s ROE’s for the last three years have been mainly affected by its general operations’ underwriting results and investment income. In addition to those items, in 2004 the Company had realized gains from investments and derivatives of $324 million which contributed 5.1% to the ROE.

Other Key Focuses of Management

Winterthur International Net Reserve Seasoning

Management continues to focus on the settlement and collection of certain post-closing balances under the sale and purchase agreement, as amended (“SPA”) and other contractual agreements, related to the 2001 acquisition of the Winterthur International operations from Winterthur Swiss Insurance Company. For further information, see “Unpaid losses and loss expenses recoverable” Item 8, Note 5(b) to the Consolidated Financial Statements.

Ratings and Capital Management

Management continues to focus heavily on the Company’s financial strength and claims paying ratings because the Company’s ability to write business is dependent upon the quality of these ratings. Management seeks to maintain strong financial strength and claims paying ratings, relative to its competitors. In January 2004, several internationally recognized agencies lowered their financial strength ratings at the Company’s principle insurance and reinsurance subsidiaries and pools following the announcement that the Company increased prior period reserves in the fourth quarter of 2003. In February 2005, Fitch placed the Company’s financial strength and claims paying ratings on Rating Watch Negative and Moody’s confirmed the Company’s ratings and changed the outlooks to Negative.

Collateral Management

Another important matter on which management is focused (and which also affects the Company’s ability to underwrite business) is the availability of collateral. Collateral includes letters of credit, insurance trusts and other credit facilities required to provide security to cedants (which are companies who reinsure their liabilities to the Company), particularly as required by state insurance regulation in the U.S. and at Lloyds, and also to provide the Company with liquidity as required. These facilities are provided to the Company from commercial banks and generally are renewed every year. The Company has also utilized “off balance sheet” transactions in order to obtain more collateral capacity (these transactions are described below under “Variable Interest Entities and Other Off Balance Sheet Arrangements”). As the Company writes more business, its collateral requirements will increase. A key challenge for management is to ensure that sufficient collateral capacity is available as to not hinder future writing of business.

Liquidity and cash flow

As a property and casualty company, the Company must ensure that it has sufficient funds to settle claims promptly, especially in the event of a major catastrophic event. Management is focused on making sure that liquidity requirements are supported by both having lines of credit facilities available to the Company as well as the

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Company’s general investment portfolio of which the majority is in high grade fixed income securities. The Company has had significant positive cash flow from operations in the three years ended December 31, 2004 generated from its underwriting activities (premiums less claim and expense settlements) as well as the receipt of investment income on its portfolio. The Company expects cash flow from operations to be strong in 2005.

Results of Operations

The following table presents an analysis of the Company’s net income available to ordinary shareholders and other financial measures (described below) for the years ended December 31, 2004, 2003 and 2002:

(U.S. dollars in thousands, except share and per share amounts)	2004	2003	2002
Net income available to ordinary shareholders	$1,126,292	$371,658	$395,951
Earnings per ordinary share – basic	$8.17	$2.71	$2.92
Earnings per ordinary share – diluted	$8.13	$2.69	$2.88
Weighted average number of ordinary shares and ordinary
share equivalents – basic	137,903	136,906	135,636
Weighted average number of ordinary shares and ordinary
share equivalents – diluted	138,582	138,187	137,388

The Company’s net income and other financial measures as shown above for the three years ended December 31, 2004 have been affected, among other things, by the following significant items:

1) Significant large catastrophe activity in 2004 (Florida hurricanes and the Tsunami in South Asia);

2) Net adverse prior year loss development in general insurance and reinsurance operations;

3) Growing asset base and positive performance from investments in affiliates;

4) A favorable underwriting environment in 2002 and 2003 with increased competition in 2004;

5) Other than temporary declines in investments in 2002 and 2003.

1. Significant large catastrophe activity in 2004. (Florida hurricanes and the Tsunami in South Asia)

The 2004 Atlantic hurricane season resulted in four insured hurricane losses aggregating to the largest seasonal loss in history and had a substantial impact on the results of the Company for 2004. The following table sets forth the impact of Hurricanes Frances, Charley, Ivan and Jeanne as well as the Tsunami in South Asia on the Company’s statement of operations for 2004 by operating segment. The Company estimated net hurricane losses and loss expenses incurred of $516.6 million net of reinsurance recoverables, based on preliminary reports and estimates of loss and damage. In addition, the Company incurred net losses and loss expenses of $74.6 million in 2004 as a result of the earthquake and the subsequent Tsunami that struck South Asia on December 26, 2004. The bulk of expected claims relate to property exposure, with personal accident and marine exposures also affected.

While these are management’s best estimates at this time, they could change as more information becomes available. In estimating the impact of these catastrophes on the Company, premium payments required to reinstate reinsurance policies have been accrued. Premiums from insureds required to reinstate their insurance or reinsurance coverage with the Company have also been accrued in the estimate.

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	(U.S. dollars in millions, except ratios and per share amounts)	Insurance	Reinsurance	Total
Operating Data:
Net reinstatement premiums earned:
	Charley	$ –	$ 7.7	$ 7.7
	Frances	–	3.5	3.5
	Ivan	(12.2)	(6.5)	(18.7)
	Jeanne	–	2.7	2.7
	South Asia Tsunami	–	–	–
	Total net premiums earned	$(12.2)	$ 7.4	(4.8)
Gross losses and loss expenses:
	Charley	$ 72.8	$ 85.5	$158.3
	Frances	93.4	83.2	176.6
	Ivan	168.4	186.5	354.9
	Jeanne	37.6	49.5	87.1
	South Asia Tsunami	50.0	24.6	74.6
	Total gross losses and loss expenses	$422.2	$429.3	$851.5
Losses and loss expenses recoverable:
	Charley	$ 16.9	$ 10.8	$ 27.7
	Frances	21.9	10.2	32.1
	Ivan	77.7	111.5	189.2
	Jeanne	7.4	3.9	11.3
	South Asia Tsunami	–	–	–
	Total losses and losses expense recoveries	$123.9	$136.4	$260.3
Underwriting loss		$310.5	$285.5	$596.0
Income tax benefit				$ 37.7
Net loss				$558.3
Loss ratio impact for the year ended December 31, 2004		7.5%	10.0%	8.5%
Combined ratio impact for the year ended December 31, 2004		7.6%	10.0%	8.4%

2. Net adverse prior year loss development

Net adverse prior year loss development occurs when there is an increase to loss reserves recorded at the beginning of the year, resulting from actual or reported loss development for prior years exceeding expected loss development. The net adverse prior year loss development in 2004 related to the Company’s general insurance operations most notably in the casualty and professional lines of business.

During 2004, the Company’s net adverse prior year development of $268 million was a result of increases in reported insurance case reserves for excess professional liability, excess casualty liability and specialty lines within the insurance segment offset by net prior year releases in the reinsurance segment. These increases in reported insurance case reserves exceeded the Company’s expected losses based on historical patterns of loss development. Strengthening of $144 million in professional lines was caused by few large directors’ and officers’ claims in pre-2002 business, and increases in errors and omissions reserves were caused by claims related to large accounting firms and to insurance/reinsurance brokers. For specialty lines, strengthening of $135 million was caused by reported loss increases in discontinued programs business with workers’ compensation exposure, environmental related coverages, and Lloyd’s; as well as high severity claims on the surety book.

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The net adverse prior period loss development in the years ended December 31, 2003 and 2002 related primarily to the Company’s general reinsurance operations and principally to losses on business written in the 1997 through 2001 underwriting years in the Company’s U.S. casualty reinsurance business. In the third quarter of 2003, the Company experienced a significant increase in claims reported that was in excess of the Company’s expected loss development based on historical reporting patterns and recorded an increase to reserves of $184 million related to this book of business. As a result of this increase, the Company began a detailed claims audit review of the cedents contributing to this increase and the lines of business affected were primarily directors’ and officers’, errors and omissions, medical malpractice, commercial umbrella and general liability. Upon completion of this claims audit review, the Company increased case and IBNR reserves relating to this book of business for a total of $663 million in the fourth quarter of 2003. The Company monitors actual against expected reported claims on an ongoing basis. To the extent that actual experience on loss reserves differs significantly for this, or any other line of business, the Company would again expand its normal and ongoing cedant review program accordingly.

See further discussion under “Critical Accounting Policies and Estimates” and under “– Segments-Reinsurance” below.

3. Growing asset base and positive performance from investments in affiliates.

Net investment income was $995 million in 2004 as compared to $779.6 million in 2003 due primarily to a higher investment base. The investment portfolio increased due to positive operating cash flows and growth in structured and spread balances, combined with capital raising activities. In addition, net realized gains produced by the investment portfolio and the equity earnings from the Company’s affiliates also contributed positively to the year. Net realized gains on investments were $246.5 million in 2004 compared to $120.2 million in 2003. Net income from investment affiliates was $124.0 million in 2004 compared to $119.2 million in 2003. Net income from operating affiliates (including insurance, financial and investment manager affiliates) was $147.4 million in 2004 compared to $8.9 million in 2003. Earnings from operating affiliates during 2004 included $102.1 million of income in connection with the sales of Admiral Group Ltd and Pareto Partners and its affiliated companies.

4. A favorable underwriting environment in 2003 and 2002 with increased competition in 2004.

As noted above, competition increased in 2004 in most lines of business resulting in some pricing reductions and general softening of the market. In the two years ended December 31, 2003 and 2002, the Company had experienced pricing increases and improved terms and conditions across most of the lines of business it writes. This is discussed further within the segments below.

5. Other than temporary declines in investments in 2003 and 2002.

The Company realized losses on securities in its investment portfolio due to declines in fair value determined to be other than temporary of $6.4 million, $130.7 million and $251.5 million for the years ended December 31, 2004, 2003 and 2002, respectively.

The general economy in the U.S. and the investment markets improved in 2004 relative to 2003. For example, Moody’s reported that 57 issuers defaulted in 2004 as compared with 77 issuers in 2003. The Company experienced better default experience than the Moody’s default data would have indicated. As a percentage of the total fixed income portfolio, the write down for other than temporary declines was negligible in 2004 as compared with 0.6% in 2003 and 1.4% in 2002.

See the discussion of other than temporary declines in investments within “Critical Accounting Policies and Estimates” and “Investment Activities” below.

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Critical Accounting Policies and Estimates

The following are considered to be the Company’s critical accounting policies and estimates due to the judgments and uncertainties affecting the application of these policies and/or the likelihood that materially different amounts would be reported under different conditions or using different assumptions. If actual events differ significantly from the underlying assumptions or estimates applied for any or all of the accounting policies (either individually or in the aggregate), there could be a material adverse effect on the Company’s results of operations, financial condition and liquidity. These critical accounting policies have been discussed by management with the Audit Committee of the Company’s Board of Directors.

Other significant accounting policies are nevertheless important to an understanding of the Company’s Consolidated Financial Statements. Policies such as those related to revenue recognition, financial instruments and consolidation require difficult judgments on complex matters that are often subject to multiple sources of authoritative guidance. See Item 8, Note 2 to the Consolidated Financial Statements.

1) Unpaid Losses and Loss Expenses and Unpaid Loss and Loss Expenses Recoverable

As the Company earns premiums for the underwriting risks it assumes, it also establishes an estimate of the expected ultimate losses related to the premium. Loss reserves or unpaid losses and loss expenses are established due to the significant periods of time that may lapse between the occurrence, reporting and settlement of a loss. The process of establishing reserves for unpaid property and casualty claims can be complex and is subject to considerable variability as it requires the use of informed estimates and judgments. These estimates and judgments are based on numerous factors, and may be revised as additional experience and other data become available and are reviewed, as new or improved methodologies are developed or as current laws change. Loss reserves include:

a) Case reserves – reserves for reported losses and loss expenses that have not yet been settled and,

b) Losses incurred but not reported (“IBNR”).

At December 31, 2004 and 2003, the Company’s total gross reserves for unpaid losses and loss expenses were $19.6 billion and $16.6 billion, respectively, of which $9.5 billion and $8.4 billion related to case reserves for reported claims and $10.1 billion and $8.2 billion for IBNR reserves, respectively.

Case reserves for the Company’s general operations are established by management based on amounts reported from insureds or ceding companies and consultation with legal counsel, and represent the estimated ultimate cost of events or conditions that have been reported to or specifically identified by the Company. The method of establishing case reserves for reported claims differs among the Company’s operations.

With respect to the Company’s insurance operations, the Company is notified of insured losses and records a case reserve for the estimated amount of the settlement, if any. The estimate reflects the judgment of claims personnel based on general reserving practices, the experience and knowledge of such personnel regarding the nature of the specific claim and, where appropriate, advice of legal counsel. Reserves are also established to provide for the estimated expense of settling claims, including legal and other fees and the general expenses of administering the claims adjustment process. With respect to the Company’s reinsurance general operations, case reserves for reported claims are generally established based on reports received from ceding companies. Additional case reserves may be established by the Company to reflect the estimated ultimate cost of a loss. With respect to the Company’s financial products and services financial operations, financial guaranty claims incurred on policies written on an insurance basis are established consistent with the Company’s insurance operations and financial guaranty claims incurred on policies written on a reinsurance basis are established consistent with the Company’s reinsurance operations.

IBNR reserves relate mainly to the Company’s insurance and reinsurance casualty business. IBNR reserves are calculated by the Company’s actuaries using several standard actuarial methodologies including paid and incurred loss development, the Bornhuetter-Ferguson incurred loss method and frequency and severity approaches.

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IBNR reserves are calculated by the Company’s actuaries using standard actuarial methodologies as discussed above. Prior to the year ended December 31, 2003, the outcomes of the Company’s actuarial reviews, consistent with historical practice, provided either (i) a single point reserve estimate or (ii) a range of reserve estimates from which the Company selected a best estimate. Since the year ended December 31, 2003, the Company adopted a methodology that provided a single point reserve estimate separately for each line of business and also a range of possible outcomes across each single point reserve estimate. This is discussed further below. As a result, reserve ranges disclosed previously are not comparable to the reserve ranges disclosed herein.

While the proportion of unpaid loss and loss expenses represented by IBNR is sensitive to a number of factors, the most significant ones have historically been accelerating business growth and changes in business mix. Other factors which have affected the ratio in the past include; additions to prior period reserves, catastrophic occurrences, settlement of large claims and changes in claims settlement patterns.

The ratio of IBNR to total reserves has increased in recent years due to the growth of casualty business written over that period. The ratio of IBNR to total reserves is higher for more recent years’ business because these immature years have relatively fewer claims reported and, as a result, a higher proportion of claims reserves are based on experience in respect of incurred but not reported losses. As each prior year of business matures and claims become known, the ratio of IBNR to total reserves will typically decline, all other factors remaining constant. Since the Company has experienced rapid premium volume growth in recent years, the ratio of IBNR to total reserves has increased because the Company’s aggregate exposure has become relatively less mature. Conversely, in a situation of declining premium volume, this ratio will typically decline, all other factors remaining constant. The Company writes insurance and reinsurance business in many different lines. Typically, the ratio of IBNR to total reserves is greater for casualty lines (which are longer tail in nature) than for property lines due to the policy forms utilized and timing of loss reporting. In recent years, casualty lines have increased as a proportion of the Company’s business when compared to property lines (which are shorter tail in nature).

The single point reserve estimate is generally management’s best estimate, which the Company considers to be one that has an equal likelihood of developing a redundancy or deficiency as the loss experience matures, and this amount is recorded. The Company’s actuaries utilize one set of assumptions in determining its single point estimate which include loss development factors, loss ratios, reported claim frequency and severity. These reviews and documentation are completed in accordance with professional actuarial standards appropriate to the jurisdictions where the business is written. The selected assumptions reflect the actuary’s judgment based on historical data and experience combined with information concerning current underwriting, economic, judicial, regulatory and other influences on ultimate claim settlements.

Loss and loss expenses are charged to income as they are incurred. These charges include loss and loss expense payments and any changes in case and IBNR reserves. During the loss settlement period, additional facts regarding claims are reported. As these additional facts are reported, it may be necessary to increase or decrease the unpaid losses and loss expense reserves. The actual final liability may be significantly different than prior estimates.

The Company’s net unpaid loss and loss expense general and financial reserves broken down by operating segment at December 31, 2004 and 2003 were as follows:

(U.S. dollars in millions)	2004	2003
Insurance	$ 7,036	$ 5,849
Reinsurance	5,726	4,871
Financial products and services	120	62
Net unpaid loss and loss expense reserves	$12,882	$10,782

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The following table shows the recorded estimate and the high and low ends of the range of reserves for each of the lines of business noted above at December 31, 2004:

(U.S. dollars in millions)	Recorded	High	Low
Casualty insurance	$ 4,715	$5,316	$4,135
Casualty reinsurance	3,717	4,217	3,244
Property catastrophe	312	380	250
Other property	1,242	1,428	1,067
Marine and aviation reinsurance and insurance	1,184	1,350	1,027
Other (1)	1,313	1,457	1,126
Total	12,483
Financial Operations	120
Provision for potential non recoveries	279
Total	$12,882

(1) Other consists of several products, including accident and health, political risk, surety and bonding.

Actual development of recorded reserves as of December 31, 2003 during 2004 was within the estimated reserve range.

As shown in the table above and as previously noted, for the year ended December 31, 2004 the Company developed a methodology for calculating reserve ranges around its single point reserve estimates for all its lines of business. Similar to VAR (Value At Risk) models commonly used to evaluate risk, the Company modeled a statistical distribution of potential reserve outcomes over a one year run-off period. The Company used the modeled statistical distribution to calculate an 80% confidence interval for the potential reserve outcomes over this one year run-off period. The high and low end points of the ranges set forth in the above table are such that there is a 10% modeled probability that the reserve will develop higher than the high point and a 10% modeled probability that the reserve will develop lower than the low point.

The development of a reserve range models the uncertainty of the claim environment as well as the limited predictive power of past loss data. These uncertainties and limitations are not specific to the Company. The ranges represent an estimate of the range of possible outcomes over a one year development period. A range of possible outcomes should not be confused with a range of best estimates. The range of best estimates will generally be much narrower than the range of possible outcomes as it will reflect reasonable actuarial and management best estimates of the expected reserve.

Reserve volatility was analyzed for each line of business within each of the reinsurance and insurance segments’ general operations using the Company’s historical data supplemented by industry data. These ranges were then aggregated to the lines of business shown above taking into account correlation between lines of business based on a study of the Company’s historical data supplemented by industry data. The practical result of the correlation approach to aggregation is that the ranges by line of business disclosed above are narrower than the sum of the ranges of the individual lines of business. Similarly, the range for the Company’s total reserves in the aggregate is narrower than the sum of the ranges for the lines of business disclosed above.

The Company is not aware that there is a generally accepted model to perform the reserve range analysis described above and other models may also be employed to develop ranges.

The Company does not calculate a range for its total net unpaid loss and loss expense reserves as it would not be appropriate to add the ranges for each line of business to obtain a range around the Company’s total reserves because this would not reflect the diversification effects across the Company’s various lines of business. The diversification effects result from the fact that losses across the Company’s different lines of business are not completely correlated.

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The Company writes both “short-tail” and “long tail” lines of business. “Short-tail’ and “long-tail” describe the time between the receipt of the premium from a policy and the final settlement of any loss incurred under such policy. Short-tail lines include property catastrophe, other property and certain marine and aviation lines where, on average, the settlement period may be up to 24 months. Long-tail lines, on the other hand, include the Company’s casualty business in which claims may take up to 30 years to be reported and settled. The increase in the time associated with ultimate settlement of a claim is directly related to an increase in the amount of judgment required to establish loss reserves, especially IBNR reserves.

See further discussion under “– Segments” below for prior year development of loss reserves.

The Company’s three types of reserve exposure with the longest tails are:

(1) high layer excess casualty insurance;

(2) casualty reinsurance; and

(3) discontinued asbestos and long-tail environmental business.

Certain aspects of the Company’s casualty operations complicate the actuarial process for establishing reserves. Certain casualty business written by the Company’s insurance operations is high layer excess casualty business, meaning that the Company’s liability attaches after large deductibles including self insurance or insurance from sources other than the Company. The Company commenced writing this type of business in 1986 and issued policies in forms that were different from traditional policies used by the industry at that time. Initially, there was a lack of industry data available for this type of business. Consequently, the basis for establishing loss reserves by the Company for this type of business was largely judgmental and based upon the Company’s own reported loss experience which was used as basis for determining ultimate losses, and therefore IBNR reserves. Over time, the amount of available historical loss experience data has increased. As a result, the Company has obtained a larger statistical base to assist in establishing reserves for these excess casualty insurance claims.

High layer excess casualty insurance claims typically involve claims relating to (i) a “shock loss” such as an explosion or transportation accident causing severe damage to persons and/or property over a short period of time, (ii) a “non-shock” loss where a large number of claimants are exposed to injurious conditions over a longer period of time, such as exposure to chemicals or pharmaceuticals or (iii) a professional liability loss such as a medical malpractice claim. In each case, these claims are ultimately settled following extensive negotiations and legal proceedings. This process can typically take 5 to 15 years following the date of loss.

Reinsurance operations by their nature add further complications to the reserving process, particularly for casualty business written, in that there is an inherent lag in the timing and reporting of a loss event from an insured or ceding company to the reinsurer. This reporting lag creates an even longer period of time between the policy inception and when a claim is finally settled. As a result, more judgment is required to establish reserves for ultimate claims in the Company’s reinsurance operations.

In the Company’s reinsurance general operations, case reserves for reported claims are generally established based on reports received from ceding companies. Additional case reserves may be established by the Company to reflect the estimated ultimate cost of a loss.

Casualty reinsurance business involves reserving methods that generally include historical aggregated claim information as reported by ceding companies, combined with the results of claims and underwriting reviews of a sample of the ceding company’s claims and underwriting files. Therefore, the Company does not always receive detailed claim information for this line of business.

Discontinued asbestos and long-tail environment business had been previously written by NAC Re (now known as XL Reinsurance America Inc), prior to its acquisition by the Company.

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Except for certain workers’ compensation and long-term disability liabilities, the Company does not discount its unpaid losses and loss expenses. The Company utilizes tabular reserving for workers’ compensation and long-term disability unpaid losses that are considered fixed and determinable, and discounts such losses using an interest rate of 5% at December 31, 2004 and 2003. The interest rate approximates the average yield to maturity on specific fixed income investments that support these liabilities. A 1% reduction in the interest rate would increase unpaid loss and loss expense reserves and net incurred loss and loss expenses by approximately $25.7 million and $24.0 million at December 31, 2004 and 2003, respectively, based on the current estimated amount and payout of the liabilities. See Item 8, Note 9 to the Consolidated Financial Statements.

Financial Guaranty Loss Reserving

The Company is aware of the SEC’s recent review of the loss reserving practices in the financial guaranty industry. The Company recognizes that there is diversity in practice among financial guaranty insurers and reinsurers with respect to their accounting policies. Current accounting literature, specifically FASB Statement of Financial Accounting Standards No. 60 “Accounting and Reporting by Insurance Enterprises” (“FAS 60”) and FASB Statement of Financial Accounting Standards No. 97 “Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments” (“FAS 97”), do not specifically address the unique characteristics of financial guaranty insurance contracts. Consequently, the accounting principles applied by the industry have evolved over time and incorporate the concepts of both short-duration and long-duration contracts accounting under the provisions of FAS 60 and FAS 97. It is the Company’s understanding that the SEC has requested that the FASB review this matter and provide guidance for the accounting of financial guaranty insurance contracts. The Company will continue its loss reserving methodology as noted in Note 2 (k) to the Consolidated Financial Statements until further guidance is provided by the SEC or the FASB. The Company had net reserves for financial guaranty insurance contracts of $120.2 million and $62.0 million at December 31, 2004 and 2003, respectively.

Unpaid losses and loss expenses recoverable

The recognition of unpaid losses and loss expenses recoverable requires two key judgments. The first judgment involves the Company’s estimation of the amount of gross IBNR to be ceded to reinsurers. Ceded IBNR is generally developed as part of the Company’s loss reserving process and consequently, its estimation is subject to similar risks and uncertainties as the estimation of gross IBNR (see Critical Accounting Policies and Estimates – Unpaid losses and loss expenses and unpaid loss and loss expense recoverable). The second judgment involves the Company’s estimate of the amount of the reinsurance recoverable balance that the Company will ultimately be unable to recover from related reinsurers due to insolvency, contractual dispute, or for other reasons. Amounts estimated to be uncollectible are reflected in a bad debt provision that reduces the reinsurance recoverable balance and shareholders’ equity. Changes in the bad debt provision are reflected in net income. Due to the size of the gross losses arising from the September 11 event and its effect on the reinsurance industry, the Company, in addition to its normal review process, further analyzed the recoverability of these assets. In addition to the potential effect of the non-recoverability of these assets from reinsurers disputing claims, the reinsurance market in general has experienced significant capital erosion as a result of underwriting and investment losses. Accordingly, there is greater uncertainty regarding recoverability due to the reinsurers’ ability to pay. See “Financial Condition and Liquidity” and Item 8, Note 10 to the Consolidated Financial Statements for further information.

Included in unpaid loss and loss expenses recoverable at December 31, 2004 is an unsecured reinsurance recoverable from Winterthur Swiss Insurance Company (the “Seller”) of $1.45 billion, related to certain contractual arrangements with the sale and purchase agreement, as amended (“SPA”) from the Company’s acquisition of Winterthur International in July 2001. The Seller is currently rated “A-” by S&P. The Seller provides the Company with post-closing protection determined as of June 30, 2004 with respect to, among other things, adverse development of net loss and unearned premium reserves relating to the acquired Winterthur International business (“Winterthur Business”). This protection is based upon net loss experience and development over a three-year, post-closing season-

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ing period based on actual loss development experience, collectible reinsurance and certain other factors set forth in the SPA. The SPA includes a process for determining the amount due from the Seller by an independent actuarial process whereby the independent actuary develops a value of the seasoned net reserves. The actual final seasoned amount will be the submission that is closest to the number developed by the independent actuary.

As the Company and the Seller were unable to come to an agreement, the Company submitted to the Seller notice to trigger the independent actuarial process as contemplated by the SPA. On February 3, 2005, both the Company and the Seller made submissions for the independent actuarial process. The Company’s submission would result in a net payable to the Company of approximately $1.45 billion in aggregate and the Seller’s submission would result in a net payable to the Company of $541 million in aggregate. At the completion of the independent actuarial process, the Company will be entitled to a lump sum payment.

In addition, the Seller provides protection to the Company with respect to third party reinsurance receivables and recoverables related to the Winterthur Business which are $2.0 billion in the aggregate as of December 31, 2004. There are two levels of protection from the Seller for these balances:

1. At the time of this transaction, the Company entered into a liquidity facility with the Seller. At the time of the payment of the net reserve seasoned amount, the Company has the right to repay up to the balances outstanding on this facility by assignment to the Seller of an equal amount of receivables relating to reinsurance recoverables selected by the Company. The payable balance related to this facility is included within Other liabilities on the Company’s balance sheet at December 31, 2004 and amounted to approximately $281 million at that date.

2. Under two retrocession agreements the Company has reinsurance protection on the remaining portion of reinsurance recoverables with respect to incurred losses seasoned as of June 30, 2004 to the extent that the Company does not receive payment of such amounts from applicable reinsurers with one agreement providing a limit of $1.3 billion for the insurance written in the period to June 30, 2001 and the other agreement providing a limit of $1.3 billion for the insurance written in the period to December 31, 2000.

At December 31, 2004, certain reinsurers responsible for some portions of the reinsurance of the Winterthur Business have raised issues as to whether amounts claimed are due and the resolution of those discussions is also currently ongoing.

The Company may record a loss in future periods if any or all of the following occur:

(i)     The Seller’s submission is closer to the valuation developed by the independent actuary and, as such, the Seller’s submission is the actual final seasoned amount;

(ii)     There is deterioration of the net losses from what is reported in the Company’s December 31, 2004 financial statements;

(iii)     The Company is unable to make full recovery of the reinsurance recoverables related to the Winterthur Business, either from third parties or from the Seller under the additional protections; or

(iv)     Any amount due from the Seller proves to be uncollectible from the Seller for any reason.

2) Future Policy Benefit Reserves

Future policy benefit reserves relate to the Company’s life operations and are estimated using assumptions for investment yields, mortality, expenses and provisions for adverse loss deviation. Uncertainties related to interest rate volatility and mortality experience make it difficult to project and value the ultimate benefit payments.

Most of the Company’s future policy benefit reserves relate to annuity portfolio reinsurance contracts under which the Company makes annuity payments throughout the term of the contract for a specified portfolio of policies.

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For certain of these contracts, a single premium is paid at inception of the contract by way of a transfer of cash and investments to the Company.

The reserving methodology for these annuity portfolio reinsurance contracts is described in FAS 60 as amended by FAS 97. These contracts subject the Company to risks arising from policyholder mortality over a period that extends beyond the periods in which premiums are collected. Liabilities for future policy benefit reserves are established in accordance with the provisions of FAS 60.

Claims and expenses for individual policies within these annuity reinsurance contracts are projected over the lifetime of the contract to calculate a net present value of future cash flows. Assumptions for each element of the basis (mortality, expenses and interest) are determined at the issue of the contract and these assumptions are locked-in throughout the term of the contract unless a premium deficiency exists. The assumptions are best estimate assumptions plus provisions for adverse deviations on the key risk elements (i.e., mortality and interest). Provisions for adverse deviation are sufficient to cover reasonable deviations from the best estimate outcome of the contract. As the experience on the contracts emerges, the assumptions are reviewed. This occurs at least annually and includes both an analysis of experience and review of likely future experience. If such review would produce reserves in excess of those currently held then lock-in assumptions will be revised and a loss recognized. During the years ended December 31, 2004, 2003, and 2002, there were no adjustments to the locked-in assumptions for any of these contracts.

The future policy benefit reserves for these annuity portfolio reinsurance contracts amounted to $3.9 billion and $2.7 billion at December 31, 2004 and 2003, respectively. The Company holds the investment assets backing these liabilities. These investments are primarily fixed income securities with maturities that closely match the expected claims settlement profile. A 0.1% decrease in the investment yield assumption would result in a $36 million increase in the value of future claims related to annuity portfolio reinsurance.

As stated above, the future policy benefit reserves include provisions for adverse deviation in excess of best estimate assumptions that amounted to approximately $145 million and $125 million at December 31, 2004 and 2003, respectively. The future policy benefit reserves would only be increased if these provisions for adverse deviation became insufficient in the light of emerging claims experience. The present value of future claims would increase by approximately $13 million if mortality rates were to decrease by 1% in all future years, relative to the reserving assumptions.

The Company also provides reinsurance of disability income protection. The future policy benefit reserves for these contracts amounted to $86 million and $89 million at December 31, 2004 and 2003, respectively. Future policy benefit reserves are established in accordance with the provisions of FAS 60, including the lock-in of “padded” assumptions at inception with periodic review against experience. The liabilities relate to in-force blocks of business, comprising underlying insurance policies that provide an income if the policyholder becomes sick or disabled. The liabilities are therefore driven mainly by the rates at which policyholders become sick (where sickness is defined by the policy conditions) and by the rates at which these policyholders recover or die. A 1% increase in the incidence rate would increase the value of future claims by approximately $0.1 million, while a decrease in the termination rate would increase the value of future claims by approximately $0.4 million.

The Company also provides reinsurance of term assurance and critical illness policies. The future policy benefit reserves for these contracts amounted to $41 million and $15 million at December 31, 2004 and 2003, respectively. Future policy benefit reserves are established in accordance with the provisions of FAS 60, including the lock-in of “padded” assumptions at inception with periodic review against experience.

The liabilities relate to in-force blocks of business, comprising underlying insurance policies that provide mainly lump sum benefits if the policyholder dies or becomes sick. For term assurance, the liabilities are therefore driven by the rates of mortality and for critical illness cover, the liabilities are driven predominantly by the rates at which policyholders become sick (where sickness is defined by the treaty conditions), i.e., the morbidity rates. A 1% increase in the mortality rate relative to the reserving assumption would increase the value of future claims by approximately $0.4 million, while a 1% increase in the morbidity rate would increase the value of future claims by approximately $0.4 million.

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The term assurance and critical illness treaties have been written using a variety of structures, some of which incur acquisition costs during an initial period. For such treaties, a deferred acquisition cost (“DAC”) asset has been established and an increase in future lapse rates could impact the recoverability of such costs from future premiums. The recoverability will also be influenced by the impact of lapses on future claims. An increase in the annual lapse rates by 1% could lead to a 5%-10% reduction in future margins available for amortizing the DAC asset.

Following a review of lapse experience, the locked-in assumptions were revised in respect of one contract during the year ended December 31, 2004. The overall affect of using the revised assumptions was a reduction in income of $0.4 million.

3) Deposit Liabilities

The Company’s deposit liabilities at December 31, 2004 reflect obligations assumed under funding agreements, municipal guaranteed reinvestment contracts, payment undertaking agreements and certain structured insurance and reinsurance agreements. For each of these contracts, the Company establishes a deposit liability equal to the net cash received at inception. Each deposit liability accrues at a rate equal to the internal rate of return of the payment receipts and obligations due during the life of the agreement. Where the timing and or amount of future payments are uncertain, cash flows reflecting the Company’s actuarially determined best estimates are utilized. The ultimate size of underlying losses, the impact of the contractual limits upon settlement of such losses, and the impact of the underlying loss settlement process on the timing of payments are considered as appropriate. Where uncertainty is present, an increase in the ultimate claims cost or accelerated claims settlement would potentially lead to an increase in the deposit liability accretion rate or lead to incurred losses if significant. The Company has not had any significant change in these assumptions during the last three years ended December 31, 2004. The interest expense reported due to the accretion of deposit liabilities associated with structured insurance and reinsurance contracts was $59.4 million, $92.9 million and $65.9 million for the years ended December 31, 2004, 2003 and 2002, respectively. For some of the Company’s deposit liabilities the accretion rate is recorded at its contractual maximum level. For all other contracts, a 1% increase in the average accretion rate would result in an increase in deposit liabilities and interest expense by $14.1 million on an annualized basis.

4) Derivative Instruments

The Company conducts activities in three main types of derivative instruments: credit derivatives, weather and energy derivatives and investment related derivative instruments. The estimate of fair value for credit derivatives and weather and energy derivatives requires management’s judgment. These two activities are discussed below:

a) Credit Derivatives

The Company enters into credit derivatives in connection with its financial guaranty business and the Company intends to hold these contracts to maturity. In determining fair value, management differentiates between investment and non-investment grade exposures and models them separately. Management estimates fair value for investment grade exposures by monitoring changes in credit quality and selecting appropriate market indices to determine credit spread movements over the life of the contracts. The determination of the credit spread movements is the basis for calculating the fair value. For credit derivatives that are non-investment grade and therefore do not have a readily determinable market value, the Company uses an alternative fair value methodology. The fair value is determined using a cash flow model developed by the Company and is dependent upon a number of factors, including changes in interest rates, future default rates, credit spreads, changes in credit quality, future expected recovery rates and other market factors. Installment premiums are also considered in the determination of discounted net cash flows. Other elements of the change in fair value are based upon pricing established at the inception of the contract. Changes in fair value are unrealized as the credit derivatives are not traded to realize this value. See Item 7A, “Quantitative and Qualitative Disclosures About Market Risk” for sensitivity analysis.

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b) Weather and Energy Derivatives

The fair value of weather and energy derivatives is determined through the use of quoted market prices where available. Where quoted market prices are unavailable, the fair value is estimated using available market data and internal pricing models using consistent statistical methodologies. Estimating fair value of instruments which do not have quoted market prices requires management’s judgment in determining amounts which could reasonably be expected to be received from, or paid to, a third party in settlement of the contracts. The amounts could be materially different from the amounts that might be realized in an actual sale transaction. Fair values are subject to change in the near-term and reflect management’s best estimate based on various factors including, but not limited to, actual and forecasted weather conditions, changes in commodity prices, changes in interest rates and other market factors. See Item 7A, “Quantitative and Qualitative Disclosures About Market Risk” for sensitivity analysis.

5) Other Than Temporary Declines In Investments

The Company’s process for identifying declines in the fair value of investments that are other than temporary involves consideration of several factors. These factors include (i) the time period during which there has been a significant decline in value, (ii) an analysis of the liquidity, business prospects and financial condition of the issuer, (iii) the significance of the decline, (iv) an analysis of the collateral structure and other credit support, as applicable, of the securities in question and (v) the Company’s intent and ability to hold the investment for a sufficient period of time for the value to recover. Where the Company’s analysis of the above factors results in the Company’s conclusion that declines in fair values are other than temporary, the cost of the security is written down to fair value and the previously unrealized loss is therefore realized in the period such determination is made.

With respect to securities where the decline in value is determined to be temporary and the security’s value is not written down, a subsequent decision may be made to sell that security and realize a loss. Subsequent decisions on security sales are made within the context of overall risk monitoring, changing information, market conditions generally and assessing value relative to other comparable securities. Day to day management of the Company’s investment portfolio is outsourced to third party investment managers. While these investment managers may, at a given point in time, believe that the preferred course of action is to hold securities with unrealized losses that are considered temporary until such losses are recovered, the dynamic nature of the portfolio management may result in a subsequent decision to sell the security and realize the loss, based upon a change in market and other factors described above. The Company believes that subsequent decisions to sell such securities are consistent with the classification of the Company’s portfolio as available for sale.

As mentioned above, the Company considers its intent and ability to hold a security until the value recovers as part of the process of evaluating whether a security with an unrealized loss represents an other than temporary decline. However, this factor on its own does not dictate whether or not the Company recognizes an impairment charge. The Company believes its ability to hold such securities is supported by positive and sufficient cash flow from its operations and from maturities within its investment portfolio in order to meet its claims payment obligations arising from its underwriting operations without selling such investments. In this regard, cash flow from operating activities was $4.4 billion and $3.4 billion in 2004 and 2003, respectively.

There are risks and uncertainties associated with determining whether declines in the fair value of investments are other than temporary. These include subsequent significant changes in general economic conditions as well as specific business conditions affecting particular issuers, subjective assessment of issue-specific factors (seniority of claims, collateral value, etc.), future financial market effects, stability of foreign governments and economies, future rating agency actions and significant disclosure of accounting, fraud or corporate governance issues that may adversely affect certain investments. In addition, significant assumptions and management judgment are involved in determining if the decline is other than temporary. If management determines that a decline in fair value is temporary then a security’s value is not written down at that time. However, there are potential effects upon the Company’s future earnings and financial position should management later conclude that some of the current declines in the fair value of the investments are other than temporary declines. See “– Investment Activities – Unrealized losses on investments” for further information.

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6) Income Taxes

The Company utilizes the asset and liability method of accounting for income taxes. Under this method, deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The Company has capitalized net operating tax losses of $186 million and $225.2 million against which a valuation allowance of $68.5 million and $18.3 million at December 31, 2004 and 2003, respectively, has been established. The deferral of benefits from tax losses is evaluated based upon management’s estimates of the future profitability of the Company’s taxable entities based on current forecasts and the period for which losses may be carried forward. A valuation allowance may have to be established for any portion of a deferred tax asset that management believes will not be realized. Should the future income of these entities fall below expectations, a further valuation allowance would have to be established, which could be significant. In addition, if any further losses are generated by these entities, these losses may not be tax effected.

Effective as of January 1, 2004, XL Re America Inc (“XLRA”), a subsidiary of the Company, entered into an adverse development reinsurance treaty with another reinsurance subsidiary of the Company. The treaty related to the 1985 through (and including) 2000 underwriting years covering any adverse development on reserves calculated as of December 31, 2003 between January 1, 2004 and December 31, 2005. The treaty has a limit of $500 million and will limit future loss development at XLRA relating to these underwriting years. Any commutation of this treaty requires the prior approval of the New York Department of Insurance. There is no impact of this treaty on the consolidated financial statements of the Company, however, as part of management’s continuing evaluation of its deferred tax asset, the treaty is critical in evaluating the future income position of the U.S. group of companies. Management believes that the treaty will protect the U.S. group from unexpected prior loss development. Absent unexpected loss development from the 2000 and prior underwriting years, management has concluded that there is sufficient positive evidence of future profitability in the U.S. and that a valuation allowance as a charge against the deferred tax asset is not required at this time.

See further information under “– Other Revenues and Expenses” and Item 8, Note 23 to the Consolidated Financial Statements.

7) Intangible Assets

Intangible assets are carried at or below estimated fair value. There are many assumptions and estimates underlying the fair value calculation. Principally, the Company identifies the business entity that the intangible asset is attributed to, reviews historical and forecasted performance and other underlying factors affecting such analysis, including market conditions, premium rates and loss trends. Other assumptions used could produce a significantly different result which may result in a change in the value of the intangible asset and related amortization charge in the Consolidated Statement of Income. Based on the current expectations of profitability, an impairment charge would only be recognized in the event of a significant decline in the expected profitability of those operations where such intangible assets are applicable. At December 31, 2004, intangible assets were $1.8 billion of which approximately $1.38 billion and $450 million related to the Company’s reinsurance and insurance segments, respectively. See “– Other Revenue and Expenses” for further information.

8) Variable Interest Entities

The Company utilizes variable interest entities both directly and indirectly or not in the ordinary course of business. The Company must assess consolidation of variable interest entities based on whether the Company is the primary beneficiary of the entity. The company that absorbs a majority of the expected losses or residual rewards of the entity is deemed to be the primary beneficiary and is therefore required to consolidate the entity. The determination of expected losses and expected residual returns requires the Company to estimate the expected cash flows of the entities and measure the expected variability of these cash flows. The use of different assumptions to determine the expected cash flows and variability could affect the Company’s determination of the primary beneficiary. The assumptions used

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to determine the expected cash flows depend on the type of structure and the nature of the Company’s variable interest. The Company has made assumptions primarily regarding default rates, the timing of defaults and recovery rates to estimate these expected cash flows of the variable interest entities that it utilizes.

9) Reinsurance Premium Estimates

The company writes business on both an excess of loss and proportional basis. In the case of excess of loss contracts, the subject written premium is generally outlined within the treaty and the Company receives a minimum and/or deposit premium on a quarterly basis which is normally followed by an adjustment premium based on the ultimate subject premium for the contract. The Company estimates the premium written on the basis of the expected subject premium and regularly reviews this against actual quarterly statements to revise the estimate based on the information provided by the cedant.

On proportional contracts, written premiums are estimated to expected ultimate premiums based on information provided by the ceding companies. An estimate of premium is recorded at the inception of the contract. When the actual premium is reported by the ceding company, normally on a quarterly basis, it may be materially higher or lower than the estimate. Adjustments arising from the reporting of actual premium by the ceding companies are recorded in the period in which they are determined.

Written premiums on excess of loss contracts are earned in accordance with the loss occurring period defined within the treaty; normally 12 months following inception of the contract. Written premiums on proportional contracts are earned over the risk periods of the underlying policies issues and renewed, normally 24 months. For both excess of loss and proportional contracts, the earned premium is recognized ratably over the earning period, namely 12 – 24 months. The portion of the premium related to the unexpired portion of the policy at the end of any reporting period is reflected in unearned premiums.

Reinsurance operations by their nature add further complications in that generally the ultimate premium due under a specific contract will not be known at the time the contract is entered into. As a result, more judgment and ongoing monitoring is required to establish premiums written and earned in the Company’s reinsurance operations.

Reinstatement premiums are recognized at the time a loss event occurs where coverage limits for the remaining life of the contract are reinstated under pre-defined contract terms and are fully earned when recognized. Accrual of reinstatement premiums is based on the Company’s estimate of loss and loss adjustment expense reserves, which involves management judgment as described below.

Segments

The Company is organized into three underwriting segments – insurance, reinsurance, and financial products and services – and a corporate segment, which includes the investment operations of the Company. See Item 1 and Item 8, Note 3 to the Consolidated Financial Statements for further information.

The Company’s business is conducted on a global basis where several of its subsidiaries operate in foreign currencies which are the base currency of that entity. Under U.S. GAAP, revenues and expenses of those operations are translated into the U.S. dollar at average exchange rates during the year and assets and liabilities at exchange rates at the end of the year. In the three years ended December 31, 2004 with the decline in value of the U.S. dollar against several currencies, including U.K. sterling, Swiss franc and the Euro, this has resulted in revenues and expenses translated into higher U.S. dollar values. This should be considered when making period to period comparisons.

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Insurance

The following table summarizes the underwriting profit for this segment:

		% Change		% Change
(U.S. dollars in thousands)	2004	04 vs 03	2003	03 vs 02	2002
General:
Gross premiums written	$5,956,978	14.1%	$5,221,316	15.0%	$4,539,186
Net premiums written	4,426,519	18.8%	3,725,208	16.1%	3,207,292
Net premiums earned	$4,083,153	12.2%	$3,640,330	28.5%	$2,832,298
Fee income and other	24,229	77.2%	13,670	(62.8)%	36,717
Net losses and loss expenses	2,869,114	20.6%	2,379,499	34.3%	1,771,982
Acquisition costs	542,827	0.1%	542,149	13.3%	478,548
Operating expenses	535,443	29.8%	412,540	8.3%	380,901
Foreign exchange (gains)	(9,911)	(26.1)%	(7,858)	NM	(56,515)
Underwriting profit	$ 169,909	(48.1)%	$ 327,670	11.4%	$ 294,099

NM = Not Meaningful

Gross and net premiums written increased by 14.1% and 18.8%, respectively, for the year ended December 31, 2004 compared with the year ended December 31, 2003. These increases were primarily due to new business in the casualty and professional lines, multi year contracts written in the year and favorable foreign exchange movements. The most significant growth was due to new business product offerings in the areas of primary casualty, specialty professional and property catastrophe risks. The new insurance initiatives added, in total, approximately $280.0 million to gross premiums written for the year. The strengthening of the U.K. sterling and the Euro against the U.S. dollar, as compared to 2003, accounted for approximately $173.0 million of the increase in gross premiums written in the year. Partially offsetting the growth in gross and net premiums written in 2004 were rate reductions in most property and professional lines as well as growing rate pressures on most casualty lines. Net premiums written have grown by a larger percentage than gross premiums written primarily as a result of ceded reinsurance commutations related to professional lines.

Increases in gross and net premiums written in 2003 as compared to 2002 were due to significant price increases across most lines of business, partially offset by the non-renewal of certain workers’ compensation and Lloyd’s international programs.

Net premiums earned increased in each of the three years ended December 31, 2004, 2003 and 2002 due to the increases in net premium written in the current and prior years, as noted above. Growth in net premiums earned in 2004 and 2003 were partially offset by several non-renewed portfolios as the earned premium impact of the non-renewed business lags behind the written premium impact. Combined casualty and professional liability insurance net premiums earned increased from $1.36 billion in 2002 to $1.96 billion in 2003 to $2.36 billion in 2004.

Fee income and other increased in 2004 as compared to 2003 primarily due to the income recorded on the sale of property in London, combined with fees generated by the Company’s professional lines start up businesses for administration of third party portfolios. Fee income and other decreased in 2003 as compared to 2002 primarily due to $21.0 million of contingent income received in the fourth quarter of 2002 that related to a sale in 1999 of the motor business written by the Company’s Lloyd’s syndicates. In addition, at the end of 2002, the Company discontinued certain consulting and administration services related to the Winterthur International operations for employee benefit plans of unrelated companies.

Exchange gains in each of the last three years were primarily due to a decline in the value of the U.S. dollar against U.K. sterling, Euro and Swiss franc in those operations that have those currencies as their functional currency and are exposed to net monetary liabilities denominated in U.S. dollars. The gain in 2003 was partially reduced by a hedge put in place by the Company in February 2003 to cover part of its exposure to a U.K. sterling reinsurance recoverable balance.

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The decrease in the underwriting profit in 2004 as compared with 2003 and the increases in 2003 as compared with 2002 were also reflective of the combined ratios, as shown below. The following table presents the ratios for the insurance segment for each of the three years ended December 31:

	2004	2003	2002
Loss and loss expense ratio	70.3%	65.4%	62.6%
Underwriting expense ratio	26.4%	26.2%	30.3%
Combined ratio	96.7%	91.6%	92.9%

The loss and loss expense ratio includes net losses incurred for both the current year and any adverse or favorable prior year development of loss and loss reserves held at the beginning of the year.

The loss and loss expense ratio for the insurance segment for the year ended December 31, 2004 increased compared with the year ended December 31, 2003 primarily due to net hurricane losses of $248.3 million in the property and marine lines combined with prior year reserve strengthening as discussed below, and losses and loss expenses related to the tsunami in South Asia. Losses due to hurricanes Charley, Frances, Ivan and Jeanne combined with the South Asia Tsunami increased the loss ratio for the year by 7.5%.

The loss ratio was higher in 2003 as compared to 2002 due primarily to an increase in the net adverse development of prior year loss reserves which was partially offset by a relatively lower level of current year loss activity and the positive effect of continued pricing increases and improved terms and conditions across most lines written.

The following tables present the prior year adverse or favorable development of the Company’s gross and net loss and loss expense reserves for its insurance operations:

Gross (U.S. dollars in millions)	2004	2003	2002
Unpaid losses and loss expense reserves at the       beginning of the year	$10,225	$8,103	$7,834
Net adverse development of those reserves during the year	1,674	1,055	54
Unpaid losses and loss expense reserves re-estimated       one year later	$11,899	$9,158	$7,888
Net (U.S. dollars in millions)	2004	2003	2002
Unpaid losses and loss expense reserves at the       beginning of the year	$5,849	$4,771	$4,680
Net adverse development of those reserves       during the year	292	153	28
Unpaid losses and loss expense reserves re-estimated       one year later	$6,141	$4,924	$4,708

The Company did not change its methodology or key assumptions used in 2004, 2003 or 2002 to determine ultimate loss reserves for any line of insurance business written.

During 2004, the Segment’s net adverse development of $292 million was driven primarily by increases in reported case reserves for excess professional liability, excess casualty liability and specialty lines. These increases in reported case reserves exceeded the Company’s expected losses based on historical patterns of loss development. Strengthening of $122 million in professional lines was caused by a few large directors’ and officers’ claims in pre-2002 business, while increases in errors and omisions reserves were caused by loss related to large accounting firms and insurance and reinsurance brokers. For specialty lines, strengthening of $152 million was caused by reported loss

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increases in discontinued programs business with workers compensation exposure, environmental related coverages, certain Lloyd’s business and high severity claims on the surety book.

During 2003, the Company’s net adverse prior year development of $153 million was due primarily to increases in previously reported case reserves for excess professional liability lines of $143 million for the underwriting years 1997 through 2001. These increases in reported case reserves exceeded the Company’s expected losses based on historical patterns of loss development. Specifically, the increase related to reported case reserves for directors’ and officers’ and errors and omissions coverages. During 2003, there was an increase in the amount of litigation related to certain losses.

During 2004 and 2003, the Company’s net adverse development of its gross reserves greatly exceeded its net reserve adverse development due principally to an increase in prior year reserves related to Winterthur International. The Company has protection with respect to any adverse loss or premium development related to the acquired Winterthur International operations with effect from July 1, 2001 under the SPA with the Seller, and has recorded a recoverable of the same amount. See – Liquidity and Capital Resources and Item 8, Note 5(b) to the Consolidated Financial Statements for further information.

During 2002, the Company’s net adverse prior year development of $28 million was comprised of an increase in loss reserves of $73 million relating to the September 11 event which was partially offset by a net decrease in the other reserves of $45 million.

In 2002, the increase in the estimate of the ultimate losses relating to the September 11 event of $73 million related primarily to the accident and health business written in the Company’s Lloyd’s operations. The Company had originally recorded ultimate losses for the September 11 event in the insurance segment of $318 million in 2001 based on management’s best estimate at that time. This best estimate was based on an analysis which had been performed to attempt to identify all possible claims and to analyze the magnitude of the potential loss. The increase in the loss reserves occurred in the second quarter of 2002 after the Company received additional information from policyholders with regard to claims relating to their insured employee casualties, including estimates of benefits payable under U.S. workers’ compensation statutes.

During 2002, the Company decreased the estimate of other reserves at the beginning of 2002 by a net amount of $45 million, consisting of a decrease in reserves relating to the excess casualty insurance business of $114 million partially offset by increases in prior year reserves for satellite lines of $30 million and other casualty insurance lines of $39 million. Estimated ultimate loss reserves were reduced for excess casualty insurance based upon lower than expected actual reported loss experience for business written in years 1997 and prior. A lack of available industry data resulted in more actuarial judgment being involved in establishing IBNR loss reserves for this line of business in the earlier years, as mentioned above under “Critical Accounting Policies and Estimates” – Unpaid losses and loss expenses and unpaid loss and loss expenses recoverable. Estimated loss reserves were then regularly updated to take into account actual claims reported. The adverse development experienced in the satellite lines was due to several satellite malfunctions which caused an increase in actual reported loss activity that was greater than expected. The adverse development for the other casualty lines was for business written in 1999 through 2001. In these years, premium rates for casualty business had declined due to competitive market pressures and in 2002, there was an increase in the size of claims reported that was higher than expected.

There is no assurance that conditions and trends that have affected the development of liabilities in the past will continue. Accordingly, it may not be appropriate to extrapolate future redundancies or deficiencies based on the Company’s historical results.

The underwriting expense ratio for the year ended December 31, 2004 compared to the same period in 2003 increased slightly. The decrease in the acquisition expense ratio of 1.6 points (13.3% as compared to 14.9%) was offset by an increase in the operating expense ratio of 1.8 points (13.1% as compared to 11.3%). The reduction in the acquisition expense ratio was due primarily to a change in the mix of business earned compared to the same period in the prior year and changes in the commission structure with certain brokers. The increase in the operating expense

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ratio was due primarily to the increased costs associated with supporting new business growth in the segment operations globally, including start up operations, an allocation of certain corporate expenses to the insurance segment and the impact of foreign exchange movements.

The decrease in the underwriting expense ratio in 2003 from 2002 was due to a reduction in the acquisition expense ratio of 2.0% (14.9% as compared to 16.9%) and a reduction in the operating expense ratio of 2.1% (11.3% as compared to 13.4%). The reduction in the acquisition expense ratio was due primarily to lower commission and brokerage costs in a favorable underwriting market on certain lines of business and where there has been a change in the mix of business earned. The reduction in the operating expense ratio was due to the growth in net premiums earned where the amount of net premiums earned was increased more than the amount of increase in operating expenses, which was due primarily to the growth in the insurance segment operations.

Reinsurance

Reinsurance – General Operations

The following table summarizes the underwriting results for the general operations of this segment:

		% Change		% Change
(U.S. dollars in thousands)	2004	04 vs 03	2003	03 vs 02	2002
Gross premiums written	$3,420,570	0.5%	$3,402,764	7.2%	$3,174,819
Net premiums written	$2,840,655	0.5%	$2,827,072	10.2%	$2,564,334
Net premiums earned	$2,899,396	18.8%	$2,440,703	18.1%	$2,066,775
Fee income and other	7,623	(69.8)%	25,240	125.3%	11,201
Net losses and loss expenses	1,921,771	(12.5)%	2,197,357	41.1%	1,557,065
Acquisition costs	639,799	15.2%	555,431	22.3%	454,300
Operating expenses	194,995	28.9%	151,332	37.8%	109,796
Foreign exchange (gains)	(28,945)	9.7%	(26,390)	10.9%	(23,787)
Underwriting profit (loss)	$ 179,399	NM	$ (411,787)	NM	$ (19,398)

Gross premiums written increased slightly for the year ended December 31, 2004 as compared to 2003. Most lines of business remained relatively flat as a result of rate decreases being offset by selective new premium volume growth. Casualty rates have remained stronger than the shorter tail lines of business. The high frequency of catastrophic events prompted some stabilization of rates in the property catastrophe business most impacted by the losses, namely in Florida, in the latter half of the year. In addition, the increasingly competitive market has resulted in the non-renewal of certain Latin American property programs. Favorable foreign exchange movements also contributed $107.3 million to the growth in gross premiums written. Net premiums written reflect the above gross changes, together with higher retentions, offset by the effects of retrocessional reinstatement premiums and growth in certain large proportional programs that are largely retroceded.

Gross premiums written increased 7.2% in 2003 as compared to 2002 due mainly to new business written and increases in premium rates, primarily in casualty. These increases were partially offset by some cancellations in treaty renewals in 2003 and also a reduction of $18.0 million in 2003 attributable to reinstatement premiums related to the release of loss reserves for the September 11 event, discussed further below.

Net premiums earned in 2004 increased 18.8% as compared to 2003 and net premiums earned in 2003 increased 18.1% as compared to 2002 due primarily to the earning of net written premium growth over the last several years, most notably in casualty and professional lines of business. Net premiums earned for casualty and professional reinsurance lines combined were $1.2 billion in 2004 as compared to $971.2 million in 2003 and $792.6 in 2002.

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The following table presents the underwriting ratios for this segment:

	2004	2003	2002
Loss and loss expense ratio	66.3%	90.0%	75.3%
Underwriting expense ratio	28.8%	29.0%	27.3%
Combined ratio	95.1%	119.0%	102.6%

The loss and loss expense ratio includes net losses incurred for both the current year and any adverse or favorable prior year development of loss reserves held at the beginning of the year.

The decrease in the loss and loss expense ratio for the year ended December 31, 2004 compared to 2003 was primarily due to the fact that 2003 included significant adverse prior period development related to the Company’s North American casualty business. See further discussion below. The segment experienced losses in 2004 resulting from hurricanes Charley, Frances, Ivan and Jeanne, from which the segment incurred a combined $268.3 million of net losses and loss expenses. In addition, the segment incurred net losses and loss expenses of $24.6 million as a result of the earthquake and tsunami in South Asia. These large catastrophe losses contributed 10.0% to the segment loss ratio for the year ended December 31, 2004. Catastrophe losses were partially offset by lower than expected incurred loss development in the year relating to shorter tail lines prior underwriting years and price improvements on earned premiums from prior periods.

The loss and loss expense ratio increased in 2003 as compared to 2002 due primarily to net adverse development of prior year loss reserves related to the Company’s North American casualty business written during the 1997 through 2001 underwriting years. See further discussion below.

The following tables present the adverse prior year development of the Company’s gross and net loss and loss expense reserves for its reinsurance general operations:

Gross
(U.S. dollars in millions)	2004	2003	2002
Unpaid losses and loss expense reserves at the       beginning of the year	$6,270	$5,062	$3,947
Net (favorable) adverse development of those reserves       during the year	(32)	821	504
Unpaid losses and loss expense reserves re-estimated       one year later	$6,238	$5,883	$4,451
Net
(U.S. dollars in millions)	2004	2003	2002
Unpaid losses and loss expense reserves at the       beginning of the year	$4,871	$3,588	$2,467
Net (favorable) adverse development of those reserves       during the year	(24)	799	385
Unpaid losses and loss expense reserves re-estimated       one year later	$4,847	$4,387	$2,852

During 2004, net prior year reserves across the reinsurance segment developed favorably by $24 million. Releases of $144 million in the property, aviation, marine and other lines of business were partially offset by strengthening of casualty and accident and health reserves amounting to approximately $122 million. Property catastrophe and property other reserve releases totaled approximately $101 million net related primarily to the 2002 and 2003 underwriting years where loss experience has been exceptionally good for the property line. The strengthening of casualty reserves totaled $77 million and related most significantly to professional liability reserves which were strengthened

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by $32 million for Enron, Worldcom and Laddering claims. The accident & health reserve strengthening of $45 million relates to a portfolio of business underwritten by certain of the Company’s Lloyds syndicates.

During 2003, the Company increased its estimated reserves related to its reinsurance segment (excluding the September 11 event) by $996 million, of which approximately $877 million related primarily to the Company’s North American reinsurance operations for casualty business underwritten during the 1997 through 2001 underwriting years. The main lines of business affected by this adverse development included general liability, medical malpractice, professional and surety lines. This adverse development was due to competitive market pressures on pricing during these underwriting years combined with an increase in the number and size of claims reported in recent years as a result of increases in court filings, corporate scandals, rising tort costs and settlement awards. Prior year reserves also developed adversely on certain other casualty business written in the 1998 through 2001 underwriting years outside of North America. These exposures were affected by trends similar to those as described above for the North American casualty reinsurance operations. The casualty exposures underwritten in these entities were much less than those of the North American operations, so the impact on the prior year reserves was relatively smaller.

In the fourth quarter of 2003, the Company reduced aviation loss reserves related to the September 11 event by $197 million. This reduction in reserves was due to higher than expected levels of participation (97%) in the September 11 Victim Compensation Fund, a no-fault compensation scheme funded by the U.S. government, which closed on December 22, 2003. This resulted in a reduction of the estimated ultimate losses by the Company for this event.

In the second quarter of 2002, the segment increased its estimated loss reserves for the September 11 event by $127 million due primarily to higher than originally estimated business interruption losses and exposure to potential claims by the Lloyd’s Central Guaranty Fund. The increase followed an analysis of additional new information received from the Company’s ceding companies with regard to their increased estimates of claims relating to their exposures to the September 11 event. Due to the size and complexity of the loss and the time lag in ceding companies reporting the information to the segment, establishing reserves for this loss within a short time period was difficult.

The increase in estimate for all other reinsurance reserves in 2002 of $258 million also related principally to losses on business written in 1997 through (and including) 2000 in the Company’s U.S. casualty reinsurance business and for asbestos losses on business written prior to 1985.

The segment’s reserving process includes a continuing evaluation of the potential impact on unpaid liabilities from exposure to asbestos and environmental claims, including related loss adjustment expenses. Liabilities are established to cover both known and incurred but not reported claims.

A reconciliation of the opening and closing unpaid losses and loss expenses related to asbestos and environmental exposure claims related to business written prior to 1986 for the years indicated is as follows:

Year Ended December 31
(U.S. dollars in thousands)	2004	2003	2002
Net unpaid losses and loss expenses at beginning of year	$ 60,525	$ 66,130	$ 33,152
Net incurred losses and loss expenses	—	(1,000)	35,870
Less net paid losses and loss expenses	3,125	4,605	2,892
Net decrease in unpaid losses and loss expenses	(3,125)	(5,605)	(32,978)
Net unpaid losses and loss expenses at end of year	57,400	60,525	66,130
Unpaid losses and loss expenses recoverable at end of year	82,922	86,576	92,167
Gross unpaid losses and loss expenses at end of year	$140,322	$147,100	$158,297

Incurred but not reported losses, net of reinsurance, included in the above table was $22.5 million at December 31, 2004, $27.0 million at December 31, 2003 and $33.1 million at December 31, 2002. Unpaid losses recoverable are net of potential uncollectible amounts.

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The Company utilizes industry standard asbestos and environmental claims models to estimate its ultimate liability for these exposures.

The Company reviews its actual reported loss experience for asbestos and environmental claims for its 1985 and prior exposures annually. The actual loss experience was consistent with assumptions established, and, therefore, there was no adverse prior year development of the Company’s asbestos and environmental reserves in 2003 or 2004. The reserves for these exposures represented less than 1% of the Company’s total unpaid loss and loss expense reserves at December 31, 2004.

The Company believes it has made reasonable provision for its asbestos and environmental exposures and is unaware of any specific issues that would significantly affect its estimate for loss and loss expenses. For further information see Item 8, Note 9 to the Consolidated Financial Statements.

The decrease in the underwriting expense ratio for the year ended December 31, 2004 as compared with 2003 was primarily due to a decrease in acquisition cost ratio driven by reduced profit commissions as a result of the year’s catastrophic losses. This decrease was partially offset by an increase in the operating expense ratio resulting from additional allocations of corporate expenses as well as the adverse impact of foreign exchange and the continued build up of the European reinsurance platform. The increase in the underwriting expense ratio in 2003 as compared with 2002 was due to an increase in the acquisition expense ratio of 0.8% and operating expense ratio of 0.9%. The increase in the acquisition expense ratio was due primarily to higher ceding company profit commissions payable and a change in the mix of net premiums earned. The operating expense ratio increased due primarily to a reduction of operating expenses in 2002 of approximately $8.0 million in recognition of a curtailment gain on a Company pension plan in the U.S.

Exchange gains in 2004 and 2003 were mainly attributable to a decline in the value of the U.S. dollar against U.K. sterling and the Euro in Bermuda based operations that write business globally.

Reinsurance – Life and Annuity Operations

The following table summarizes the net income from life and annuity operations of this segment:

		% Change		% Change
(U.S. dollars in thousands)	2004	04 vs 03	2003	03 vs 02	2002
Gross premiums written	$1,343,507	99.6%	$ 673,027	(32.9)%	$1,003,154
Net premiums written	1,308,634	99.5%	655,986	(33.0)%	979,825
Net premiums earned	$1,310,986	97.3%	$ 664,612	(32.2)%	$ 980,387
Fee income and other	93	NM	599	NM	2
Claims and policy benefits	1,403,710	87.0%	750,663	(27.0)%	1,027,981
Acquisition costs	42,587	28.7%	33,090	157.7%	12,839
Operating expenses	16,697	85.1%	9,019	54.3%	5,844
Net investment income	204,637	47.0%	139,241	52.3%	91,451
Foreign exchange gains	(1,340)	NM	(4,371)	NM	–
Net income	$ 54,062	NM	$ 16,051	(36.2)%	$ 25,176

Life and annuity gross and net premiums written, net premiums earned and claims and policy benefits in each of the three years ended December 31, 2004, 2003 and 2002 included the assumption of the following long duration annuity portfolios:

1. Second and fourth quarters of 2004 - two large U.K. portfolio contracts, representing $995 million in net premiums earned and related claims and policy benefits.

2. Fourth quarter of 2003 – two portfolios, one U.K. and one European, for a total of approximately $395.5 million in net premiums earned and related claims and policy benefits.

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3. Third quarter of 2002 – one U.K. portfolio of approximately $762.7 million in net premiums earned and related claims and policy benefits.

The Company acquired cash and investment assets related to the future policy benefit reserves assumed at inception of these large contracts. While the Company expects to write more of these contracts, the frequency of these transactions will likely continue to be irregular.

Excluding these large contracts, net premiums earned in life and annuity reinsurance increased in 2004 compared with 2003 and 2003 compared with 2002 as the Company expanded its life and annuity reinsurance operations in Europe combined with additional regular premium term assurance contracts written in 2003 which generated further premiums written in 2004.

Acquisition costs, operating expenses and net investment income have increased in line with the expansion of this business. Net investment income is included in the calculation of net income from life and annuity operations as it relates to income earned on portfolios of separately identified and managed life investment assets and other allocated assets. The accretion of the related future policy benefit reserves is included in claims and policy benefits.

Financial Products and Services

Financial Products and Services – Financial Operations

The following table summarizes the underwriting results for this segment:

		% Change		% Change
(U.S. dollars in thousands)	2004	04 vs 03	2003	03 vs 02	2002
Gross premiums written	$276,079	(12.1)%	$313,916	57.0%	$199,913
Net premiums written	255,524	(14.6)%	299,240	68.3%	177,794
Net premiums earned	$161,285	15.5%	$139,622	106.1%	$ 67,745
Fee income and other	2,787	40.1%	1,990	(71.7)%	7,043
Net losses and loss expenses	73,055	116.5%	33,750	NM	(1,732)
Acquisition costs	18,670	(2.1)%	19,066	97.7%	9,644
Operating expenses	73,955	47.5%	50,147	16.4%	43,068
Foreign exchange (gains) losses	(482)	NM	–	NM	8
Underwriting profit (loss)	$ (1,126)	NM	$ 38,649	62.4%	$ 23,800
Investment income – financial guarantee	40,780	75.2%	23,273	(10.4)%	25,962
Net realized and unrealized gains on weather       and energy derivative instruments	1,997	81.1%	1,103	(93.3)%	16,607
Operating expenses – weather and energy	25,020	14.6%	21,837	46.8%	14,875
Equity in net income of financial affiliates	12,622	(66.0)%	37,108	NM	5,166
Minority interest	8,708	(23.8)%	11,424	9.6%	10,424
Net realized and unrealized gains (losses) on credit       derivatives (1)	52,897	NM	(25,787)	(44.1)%	(46,137)
Net contribution from financial operations	$ 73,442	78.8%	$ 41,085	NM	$ 99

(1) In 2003, the Company reclassified all credit derivatives from the general operations insurance segment into the financial products and services segment. Prior period information has been reclassified to conform to current year presentation. There was no net income impact of this change in presentation.

Gross and net premiums written primarily relate to the financial guaranty line of business and reflect premiums received and accrued for in the period and do not include the present value of future cash receipts expected from installment premium policies written in the period. Decreases in gross and net premiums written of 12.1% and 14.6%, respectively, in the year ended December 31, 2004, as compared to the same period in 2003, were primarily due to the combination of conscious underwriting discipline during generally weaker market conditions and a smaller amount of

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large upfront premium contracts written. Market conditions are being driven by credit spread compression, higher interest rates, increased competition and reduced public financing. Gross and net premiums written increased in 2003 compared to 2002 reflecting an increase in the volume of insured debt obligations, enhanced market penetration by the Company’s financial guaranty platform, and expansion of the platform into the public finance market.

Net premiums earned also primarily relate to the financial guaranty line of business. Premiums written on such business are earned over the life of the insured debt obligations based on par amount of risk outstanding. Accordingly, as the in force business grows, so will the level of premiums earned from period to period. The increase in net premiums earned in 2004, as compared to the prior year, is primarily due to growth in the financial guaranty in force book of business, in conjunction with the acceleration of $23.3 million in premium earnings associated with an insured project financing structure on which a full limit loss was recognized during the year (see discussion below regarding “Net losses and expenses” for further details). This increase was partially offset by the impact in earned premiums in 2003 related to the refunding of certain insured structures and certain short term contract enhancements not repeated in 2004. The increase in net premiums earned in 2003 as compared to 2002 was primarily due the growth in the financial guaranty in force book of business Premiums earned do not include premiums from the issuance of credit default swaps, which are derivative contracts. Such contracts are reported at fair value and changes therein are included in “Net realized and unrealized gains (losses) on credit derivatives” (see discussion below regarding “Net realized and unrealized gains (losses) on credit derivatives” for further details).

Net losses and loss expenses include current year net losses incurred and adverse or favorable development of prior year net loss and loss expenses reserves. Net losses and loss expenses in 2004 increased by 116.5% compared to 2003. The increase was primarily the result of a provision for losses of approximately $41.7 million, representing the present value of a $50.0 million loss relating to the subordinate layer of an insured project financing structure, as well as a net increase in reserves resulting from the growth in the financial guaranty in force business. Management continues to monitor its loss exposures and will revise its loss estimates as necessary, as additional information becomes available.

The Company commenced writing financial guaranty business in 1998 and had relied entirely upon industry data to establish reserves until the end of 2001. In 2002, the Company refined its assumptions to take into account its actual historical loss experience and revised its estimated claim reporting pattern. The Company uses this expected loss reporting pattern, combined with changes in known losses, to determine the prior year development amount. Using the new methodology developed in 2002, actual reported loss development was less than expected in 2004 and 2003, resulting in a release of prior period reserves of $10.5 million and $15 million. In 2002, reported losses for this business were also less than expected and the refinement in assumptions resulted in a decrease in the estimate of reserves for prior years of $13 million.

In the year ended December 31, 2004 acquisition costs decreased compared with the prior year reflecting a change in the average life of the financial guaranty in force book of business over which such costs are expensed. Acquisition costs increased in 2003 as compared to 2002 in line with the growth of the business.

Operating expenses increased in 2004 as compared to 2003, and in 2003 as compared to 2002, due to the investment in segment infrastructure over the last year as well as an increase in the allocation of certain corporate expenses.

Net investment income related to the financial guaranty business increased in 2004, as compared to 2003, due to the larger investment portfolio created by growth in premium receipts and a $100.0 million capital infusion to this business in the fourth quarter of 2003. Net investment income related to the financial guaranty business decreased in 2003, as compared to 2002, due primarily to a decline in general market interest rates.

The net realized and unrealized positions on weather and energy risk management derivative instruments resulted in a small gain for the years ended December 31, 2004 and 2003. The gain in 2004 was the result of gains in the weather portfolio due to warm temperatures late in the year, partially offset by losses due to higher than expected temperature volatility in the first half of the year and costs associated with exiting natural gas positions. During 2004

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the positions and activities in the gas area were significantly reduced, those in the weather area have been increased slightly, and new contingent risk products were introduced.

Net income from financial affiliates decreased in 2004, as compared to 2003, due primarily to the Company’s investment in Primus Guaranty Ltd. Primus specializes in providing credit risk protection through credit derivatives. Primus had a mark-to-market adjustment in the year which was less favorable than that recorded in the 2003. This decrease was partially offset by income from the sale of a portion of the Company’s investment in Primus, in connection with its Initial Public Offering. Net income from financial affiliates increased in 2003, as compared to 2002, due primarily to increased earnings from the Company’s investment in Primus. These increased earnings were due to a significant narrowing of credit spreads in the second and third quarters of 2003 relative to spreads when the protection was originally sold.

The decrease in minority interest in 2004, as compared to 2003, reflects the fact that the minority interest holder’s return on investment is contractually capped. The minority interest relates to an equity position in XL Financial Assurance Ltd., which is held by a third party. The increase in minority interest in 2003, as compared to 2002 was due to an increase in the profitability of XL Financial Assurance Ltd.

The Company’s credit derivative transactions relate primarily to financial guaranty coverage that is written in swap form and pertain to tranches of collateralized debt obligations and asset backed securities. The net realized and unrealized gains during the year ended December 31, 2004 relate to the fair value adjustments for transactions written in derivative form, as well as the premiums earned associated with these transactions. These gains, which were mainly unrealized, related to the improvement of credit quality for certain credit pools and were partially offset by several individual credit events in the year. During 2003 and 2002, the opposite conditions existed and the fair value change was negative. The Company continues to monitor its credit exposures and adjust the fair value of these derivatives as required.

Financial Products and Services – Life and Annuity Operations

The following table summarizes the net income from life and annuity operations of this segment:

		% Change		% Change
(U.S. dollars in thousands)	2004	04 vs 03	2003	03 vs 02	2002
Gross premiums written	$94,597	(0.5)%	$95,062	37.6%	$69,094
Net premiums written	94,713	12.9%	83,883	91.6%	43,779
Net premiums earned	$94,713	12.9%	$83,883	96.9%	$42,605
Fee income and other	585	137.8%	246	NM	–
Claims and policy benefits	96,418	41.3%	68,231	64.5%	41,475
Acquisition costs	20,981	20.2%	17,450	NM	–
Operating expenses	10,376	31.9%	7,866	NM	404
Net investment income	88,090	NM	28,616	NM	–
Interest expense	54,454	NM	12,168	NM	–
Net income	$ 1,159	(83.5)%	$ 7,030	NM	$ 726

Gross and net premiums earned, claims and policy benefit reserves and acquisition costs relate to certain blocks of U.S based term life mortality reinsurance business written that were novated to the Company from an insurance affiliate in December 2002. During the quarter ended September 30, 2003, the Company exercised its right and terminated a retrocession agreement of certain of these exposures which led to the significant increase in net premiums earned and claims and policy benefits in 2004 compared to 2003. In 2004, approximately $7.0 million in additional claims and policy benefit reserves were recorded related to this block of business due to adverse claim experience.

Net investment income and interest expense relate to municipal reinvestment contracts and funding agreement transactions. The increase in investment income and the related interest expense were due to the initiation of the fund-

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ing agreements in the second quarter of 2003 combined with increases in the average balances outstanding related to the book of municipal reinvestment contracts. The balances outstanding for funding agreements and municipal reinvestment contracts increased from $0.6 billion and $1.5 billion, respectively, as at December 31, 2003 to $1.1 billion and $2.6 billion, respectively, as at December 31, 2004.

Investment Activities

The following table illustrates the change in net investment income from general operations, net income from investment affiliates, net realized gains and losses on investments and net realized and unrealized gains and losses on investment derivatives for each of the three years ended December 31, 2004.

		% Change		% Change
(U.S. dollars in thousands)	2004	04 vs 03	2003	03 vs 02	2002
Net investment income – general operations	$661,535	12.4%	$588,428	(4.6)%	$617,122
Net income from investment affiliates (1)	124,008	4.0%	119,200	120.2%	54,143
Net realized gains (losses) on investments	246,547	105.1%	120,195	NM	(214,160)
Net realized and unrealized gains (losses) on       investment derivative instruments (2)	23,125	NM	(2,858)	NM	(22,231)

(1)	Net income from investment affiliates in 2004 reflects the twelve months to November 30, 2004, as compared to the eleven months ended November 30, 2003 in 2003 and the twelve months ended December 31, 2002 in 2002. The Company records the investment affiliates on a one month lag in order for the Company to meet the accelerated filing deadlines as specified by the SEC.
(2)	For a summary of realized and unrealized gains and losses on all derivative instruments, see Item 8, Note 14 to the Consolidated Financial Statements.

Net investment income related to general operations increased in 2004 as compared to 2003 primarily due to growth in the investment base, as well as moderate increases in the yield of the portfolio.

The Company’s total investments available for sale and cash and cash equivalents less net pending payable for investments purchased was $29.9 billion at December 31, 2004 as compared to $23.1 billion at December 31, 2003. This increase of $6.8 billion includes (i) cash flow from operations of $4.4 billion and (ii) cash flow of $1.5 billion from spread product transactions. The annualized effective yield of the total investment portfolio was 3.8% for 2004 as compared to 3.5% for 2003, a 0.3% increase. The increase in the effective yield of the total investment portfolio was primarily due to general interest rate increases in the U.S., and the growth in assets invested in non-U.S. markets, particularly the United Kingdom, where investment grade yields are generally higher than in the U.S.

Net investment income related to general operations decreased in 2003 as compared to 2002 primarily due to the market decline in yields and the shorter duration of the investment portfolio, partially offset by growth in the investment base.

The Company’s total investments available for sale and cash and cash equivalents less net pending payable for investments purchased was $23.1 billion at December 31, 2003 as compared to $18.1 billion at December 31, 2002. This increase of $5.0 billion includes (i) cash flow from operations of $3.4 billion and (ii) cash flow of $1.5 billion from spread product transactions. The annualized effective yield of the total investment portfolio was 3.5% for 2003 as compared to 4.3% for 2002, a 0.8% decrease.

It is expected that net investment income in 2005 will increase due to projected increases in investments resulting from expected positive operating cash flow and growth in structured and spread balances, as well as anticipated increases in market yields on reinvestment of existing assets and investment of new cash flows. However, actual market changes in interest rates could offset or supplement the effects of cash flow. See further discussion in “Liquidity and Capital Resources.”

Net income from investment affiliates includes earnings from the Company’s investments in closed-end investment funds and partnerships and similar vehicles. Net income from investment affiliates increased in 2004 as compared to 2003 primarily due to an increase in the size of the alternative investment portfolio. Net income from investment affiliates increased significantly in 2003 as compared to 2002 due mainly to the strong

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performance of certain of the Company’s investment funds, particularly in the second and fourth quarters of 2003 as compared to lower overall returns on these funds in 2002. In addition, as noted above, income on the alternative investment portfolio was for an eleven month period in 2003 as compared to a twelve months period in 2002.

Investment Performance

The Company manages its investment grade fixed income securities using an asset/liability management framework. Due to the unique nature of the underlying liabilities, customized benchmarks are used to measure investment performance and comparison to standard market indices is not meaningful. However, the risk asset portfolios managed by the Company may be compared to appropriate market indices. Investment performance is not monitored for certain assets primarily consisting of operating cash and special regulatory deposits. The following is a summary of the investment portfolio returns for each of the two years ended December 31, 2004 and 2003 of the general account asset/liability portfolio, structured and spread product portfolio and risk asset
portfolios.

	2004	2003
	(1)	(1)
General Account Asset/Liability Portfolio
USD fixed income portfolio	3.5%	10.0%
Non USD fixed income portfolio	10.0%	15.2%
Structured and Spread Product Portfolio
USD fixed income portfolio	4.8%	5.3%
Non USD fixed income portfolio	9.1%	7.4%
Risk Asset Portfolio
Alternative portfolio (2)	8.2%	8.6%
Equity portfolio	18.0%	41.1%
High-Yield fixed income portfolio	6.9%	25.6%

(1)	Portfolio returns are calculated by dividing the sum of the net investment income, realized gains (loss) and unrealized gains, (loss) by the daily weighted average market value of each portfolio.
(2)	Performance on the alternative portolio in 2004 reflects the 12 months to November 30, 2004, as compared to the 11 months ended November 30, 2003 in 2003.

Net realized gains and losses on investments and other than temporary declines in the value of investments

The Company’s investment portfolio is classified as available for sale. Realized investment gains and losses occur through the normal turnover of the Company’s investment portfolio. Realized investment losses include impairment charges relating to declines in value of securities that are considered to be other than temporary. See “– Critical Accounting Policies and Estimates” for further information.

In 2004, net realized gains on investments were $246.5 million which includes $265.9 million of gross realized losses on fixed income and $48.8 million of gross realized losses on equity securities. Gross realized losses in 2004 included $6.4 million of provisions for declines in fair value considered to be other than temporary. In the United States there was a general reduction in the level of corporate defaults. For example, Moody’s Investor Service (“Moody’s”) reported that 57 issuers defaulted in 2004 as compared with 77 issuers in 2003 and 141 issuers in 2002. The Company’s exposure to these defaults was even more limited in 2004 resulting in a significant reduction in the write down for other than temporary declines. Of the write-downs in 2004, 50% related to credit impairments within the airlines industry. As a percentage of the total fixed income portfolio, the write down for other than temporary declines was negligible in 2004 as compared with 0.6% in 2003 and 1.6% in 2002.

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In 2003, net realized gains on investments were $120.2 million which included $344.8 million of gross realized losses on fixed income and $162.5 million of gross realized losses on equity securities. Gross realized losses in 2003 included $130.7 million of provisions for declines in fair value considered to be other than temporary. The general economy in the United States and the investment markets improved in 2003 relative to 2002.

During the year ended 2002, the Company had net realized losses on investments of $214.2 million. This included gross realized losses on fixed income and equity securities of $526.3 million and $160.1 million, respectively. Gross and net realized losses in 2002 included $251.5 million of provisions for declines in fair value considered to be other than temporary. Of the total provisions, $144.3 million related to fixed income securities, $77.8 million to equity securities and $29.4 million to other investments. Approximately 44% of the declines in fair value in 2002 of fixed income and equity securities considered to be other than temporary related to the communications sector, including Worldcom Inc. and Adelphia Communication Corp. in the second quarter of 2002. In addition, approximately $41.0 million of gross realized losses related to sales of Worldcom Inc. and Adelphia Communication Corp.

The significant circumstances that contributed to the realized losses in 2002 included the high level of distress and default in the telecommunications sector, the Enron Corp. bankruptcy and a general rise in corporate defaults across other sectors in response to the general economic decline in the United States and elsewhere.

With respect to those investment securities that were sold at a loss during the year ended December 31, 2004 the following is an analysis of the period of time that those securities had been in a continual unrealized loss position, the amount of the realized loss recorded in the Company’s results of operations as of the sale date and the amount of the impairment charge taken in the year:

Length of time in a continual unrealized loss position	Fixed Income	Equity
(U.S. dollars in thousands)	Securities	Securities
Less than 6 months	$220,127	$37,893
At least 6 months but less than 12 months	22,686	5,688
At least 12 months but less than 2 years	11,877	3,342
At least 2 years	7,020	–
Total gross realized loss from sales	261,710	46,923
Impairment charges for declines in value considered to be
other than temporary	4,144	1,870
Total gross realized loss	$265,854	$48,793

With respect to those securities that were sold at a loss during the year ended December 31, 2003 the following is an analysis of the period of time that those securities had been in a continual unrealized loss position, the amount of the realized loss recorded in the Company’s results of operations as of the sale date and the amount of the impairment charge taken in the year:

Length of time in a continual unrealized loss position	Fixed Income	Equity
(U.S. dollars in thousands)	Securities	Securities
Less than 6 months	$242,220	$ 94,151
At least 6 months but less than 12 months	13,347	9,502
At least 12 months but less than 2 years	20,614	4,444
At least 2 years	245	253
Total gross realized loss from sales	276,426	108,350
Impairment charges for declines in value considered to be
other than temporary	68,405	54,206
Total gross realized loss	$344,831	$162,556

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The Company’s process for identifying declines in the fair value of investments that are other than temporary involves consideration of several factors as discussed under “Critical Accounting Policies and Estimates.”

During the year ended December 31, 2004, the Company realized losses of $18.9 million and $3.3 million upon the sale of fixed income securities and equity securities, respectively, that had been in an unrealized loss position for greater than twelve months. During the year ended December 31, 2003, the Company realized losses of $20.9 million and $4.7 million upon the sale of fixed income securities and equity securities, respectively, that had been in an unrealized loss position for greater than twelve months. During the year ended December 31, 2002, the Company realized a loss of $38.4 million and $7.2 million upon the sale of fixed income securities and equity securities, respectively, that had been in an unrealized loss position for greater than twelve months. The decisions to sell these securities were made by the Company’s investment managers based upon a change in market conditions and other factors (these decisions were independent of the Company’s previously stated intent and ability to hold such securities).

Net realized and unrealized gains on investment derivatives result from the Company’s investment strategy to economically hedge against interest and foreign exchange risk within the investment portfolio. See Item 7A. “Quantitative and Qualitative Disclosures About Market Risk,” and “–Liquidity and Capital Resources” for a more detailed analysis.

Unrealized losses on investments

At December 31, 2004, there were $119.7 million of gross unrealized losses on fixed-income and short-term investments, and $7.2 million of gross unrealized losses on equity securities. At December 31, 2003, there were $120.0 million of gross unrealized losses on fixed income and short-term investments, and $6.2 million of gross unrealized losses on equity securities. These losses include securities below investment grade as discussed below.

The information shown below about the unrealized losses on the Company’s investments at December 31, 2004 concerns the potential effect upon future earnings and financial position should management later conclude that some of the current declines in the fair value of these investments are other than temporary declines.

The following is an analysis of the length of each of those investment securities at December 31, 2004 and 2003 had been in a continual unrealized loss position:

		Amount of	Amount of
Type of Securities	Length of time in a continual	unrealized loss at	unrealized loss at
(U.S. dollars in thousands)	unrealized loss position	December 31, 2004	December 31, 2003
Fixed Income and Short-Term	Less than six months	$ 43,383	$ 32,514
	At least 6 months but less than 12 months	46,613	82,647
	At least 12 months but less than 2 years	29,453	4,355
	At least 2 years but less than 3 years	217	517
	At least 3 years but less than 4 years	–	23
	Total	$119,666	$120,056
Equities	Less than six months	$ 3,067	$ 4,830
	At least 6 months but less than 12 months	2,287	911
	At least 12 months but less than 2 years	1,862	440
	At least 2 years but less than 3 years	–	49
	Total	$ 7,216	$ 6,230

At December 31, 2004, the total gross unrealized losses represented approximately 5,100 fixed income securities out of a total of approximately 15,300, and approximately 200 equity securities out of a total of approximately 1,600. At December 31, 2003, the total gross unrealized losses represented approximately 3,400 fixed income securities out of a total of approximately 14,300 and approximately 300 equity securities out of a total of approximately 1,800.

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As discussed under Item 1, “Investments - Investment Structure and Strategy,” the Company operates a risk asset portfolio that includes high yield (below investment grade) fixed income securities. These securities are more sensitive to credit risk than investment grade securities. At December 31, 2004, approximately 4.6% of the Company’s fixed income investment portfolio was invested in securities which were below investment grade or not rated. Approximately 5.8% of the unrealized losses in the Company’s fixed income securities portfolio at December 31, 2004, related to securities that were below investment grade or not rated. At December 31, 2003, approximately 5.4% of the Company’s fixed income investment portfolio was invested in securities which were below investment grade or not rated. Approximately 8.8% of the unrealized losses in the Company’s fixed income securities portfolio at December 31, 2003 related to securities that were below investment grade or not rated.

The following is an analysis of how long each of these below investment grade and unrated securities had been in a continual unrealized loss position at the date indicated.

	Amount of	Amount of
Length of time in a continual unrealized loss position	unrealized loss at	unrealized loss at
(U.S. dollars in thousands)	December 31, 2004	December 31, 2003
Less than six months	$4,768	$ 756
At least 6 months but less than 12 months	1,764	5,722
At least 12 months but less than 2 years	358	1,447
At least 2 years but less than 3 years	106	517
Total	$6,996	$8,442

Of the gross unrealized investment losses on the fixed income and short term investments portfolio at December 31, 2004 of $119.7 million, approximately $45.2 million related to corporate fixed income securities. Within the corporate fixed income securities, approximately 43.8% of the losses were in the financial sector, 11.0% in the communications sector, 8.4% in the utilities sector, 8.2% in the consumer, non-cyclical sector and 7.1% in the consumer cyclical sector. No other sector was greater than 5%. The largest individual unrealized loss in the fixed income portfolio was $4.9 million. Approximately 20 equity securities held by the Company with total unrealized losses of approximately $2.0 million at December 31, 2004 were in a continual unrealized loss position for at least 12 months. The largest individual unrealized loss in the equity portfolio was $1.0 million.

Of the gross unrealized investment losses on the fixed income and short term investments portfolio at December 31, 2003 of $120.0 million, approximately $61.2 million related to corporate fixed income securities. Within the corporate fixed income securities, approximately 36.9% of the losses were in the financial sector, 16.6% in asset backed securities, 10.1% in the communications sector, 8.1% in the utilities sector, 7.2% in the consumer non-cyclical sector, 5.7% in the basic materials sector, and 5.0% in the consumer cyclical sector. No other sector was greater than 5%. The largest unrealized loss in the fixed income portfolio was $8.7 million. All other individual fixed income security unrealized losses were less than $5.0 million Approximately 29 equity securities held by the Company with total unrealized losses of approximately $0.5 million at December 31, 2003 were in a continual unrealized loss position for at least 12 months. The largest individual unrealized loss in the equity portfolio was $0.2 million.

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At December 31, 2004 and 2003, the following was the maturity profile of the fixed income securities (excluding short term) that were in a gross unrealized loss position:

Maturity profile in years of fixed income	Amount of	Amount of
securities in a continual unrealized loss position	unrealized loss at	unrealized loss at
(U.S. dollars in thousands)	December 31, 2004	December 31, 2003
At least 1 year but less than 5 years remaining	$ 35,880	$ 19,867
At least 5 years but less than 10 years remaining	19,220	33,722
More than 10 years but less than 20 years remaining	11,908	22,742
At least 20 years or more remaining	6,665	20,776
Mortgage and asset backed securities	41,176	21,656
Total	$114,849	$118,763

Other Revenues and Expenses

The following table sets forth other revenues and expenses of the general operations of the Company for each of the three years ended December 31, 2004:

		% Change		% Change
(U.S. dollars in thousands)	2004	04 vs 03	2003	03 vs 02	2002
Net income from operating affiliates	147,357	NM	8,923	(16.0)%	10,623
Amortization of intangible assets	15,827	NM	4,637	(25.1)%	6,187
Corporate operating expenses	196,649	35.5%	145,085	21.4%	119,515
Interest expense	204,627	9.3%	187,239	11.4%	168,086
Minority interest	(321)	(85.1)%	(2,160)	NM	2,947
Income tax expense	84,526	NM	30,049	32.7%	22,647

In 2004, the increase in net income from operating affiliates included strong performance by the Company’s investment management affiliates combined with income of $66.7 million on the sale of the Company’s investment in the Admiral Group Ltd. and $35.4 million of income from the sale of the Company’s stake in Pareto Partners and its affiliated companies, as well as strong growth in assets managed by these minority-owned managers. In 2003, net income from investment manager affiliates increased due to growth in assets managed by these minority-owned managers.

Net income from operating affiliates in 2003 included an other than temporary decline of $40.9 million in the value of the Company’s investment in ANR. The investment was written down to its fair value of $2.2 million at March 31, 2003.

Net income from operating affiliates in 2002 also included a loss of approximately $22.7 million relating to ANR. This loss included a write down of the goodwill component of the Company’s investment of $13.3 million in the fourth quarter of 2002 due to a significant decline in the book value of ANR.

Amortization of intangible assets increased in 2004 as compared to 2003 due primarily to the acquisition of a book of business related to XL Re Europe at the end of 2003. Amortization of intangible assets decreased in 2003 as compared to 2002 due primarily to a reduction in the expense related to intangible assets related to the acquisition of XL Re Europe.

Corporate operating expenses in 2004 increased 36.0% compared to 2003 due to the continued build out of the Company’s global infrastructure and personnel in developing its network of shared service organizations to support operations in certain locations, costs related to compliance with the Sarbanes-Oxley Act, and adverse foreign exchange impacts. Corporate operating expenses increased 21.4% in 2003 compared to 2002 due primarily to the continued build-out of the Company’s global infrastructure in developing a network of shared service organizations to

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support operations in certain locations, new costs related to the Company’s global branding campaign and $5.6 million of stock option expenses associated with the adoption of FAS 123 as amended by FAS 148. See Item 8 Note 2 to the Consolidated Financial Statements for more information.

Interest expense includes costs related to the Company’s debt and collateral facilities as well as deposit liability accretion. In 2004, interest expense has increased primarily as a result of the additional interest related to the senior notes issued in March, August and November of 2004, partially offset by the reduced interest as a result of the redemption of the Liquid Yield Option Notes (“LYONs”) and Zero Coupon Convertible Debentures (“CARZ”) during the year. In 2003, interest expense for debt and collateral facilities was $94.3 million as compared to $102.2 million in 2002. This decrease was due to the inclusion of amortization of debt issuance expenses in 2002 related to the issue of the CARZ and the LYONs. See “Liquidity and Capital Resources” for more information. In 2003, interest expense related to the accretion of deposit liabilities was $92.9 million as compared to $65.9 million due to new deposit liability contracts written in 2003.

The change in the Company’s income taxes in each of the three years ended December 31, 2004 principally reflects the effects of changes in the profitability of the U.S. operations for each year. The deferral of tax losses is evaluated based upon the future profitability of the Company’s taxable entities and, under current projections, the Company anticipates using this asset by 2007. The Company’s net deferred tax asset at December 31, 2004 was $288.6 million, which consists primarily of net operating losses generated by subsidiaries in the U.S. and U.K. Should the taxable income of these entities fall below expectations, a further valuation allowance may have to be established which could be significant. In addition, if any further losses are generated by these entities, these losses may not be tax effected. See “Critical Accounting Policies and Estimates” and Item 8, Note 23 to the Consolidated Financial Statements.

Investments

The primary objective of the investment strategy is to support the liabilities arising from the operations of the Company, generate stable investment income and to build book value for the Company over the longer term. The strategy strives to maximize investment returns while taking into account market and credit risk. The Company’s overall investment portfolio is structured to take into account a number of variables including local regulatory requirements, business needs, collateral management and risk tolerance.

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At December 31, 2004 and 2003, total investments and cash and cash equivalents were $32.1 billion and $25.1 billion, respectively. The following table summarizes the composition of the Company’s invested assets at December 31, 2004 and 2003:

	Market Value	Percent of	Market Value	Percent of
(U.S. dollars in thousands)	2004	Total	2003	Total
Cash and cash equivalents	$ 2,304,303	7.2%	$ 2,829,627	11.2%
Net payable for investments purchased	(273,535)	(0.9)%	(523,077)	(2.1)%
Fixed maturities
U.S. Government and Government agency	$ 4,112,075	12.7%	$ 2,267,154	9.0%
Corporate	11,349,847	35.4%	10,336,912	41.1%
Mortgage and asset-backed securities	6,928,558	21.6%	3,707,910	14.8%
U.S. States and political subdivisions
of the States	63,056	0.2%	38,722	0.2%
Non-U.S. Sovereign Government	2,646,658	8.3%	3,143,658	12.5%
Total fixed maturities	$25,100,194	78.2%	$19,494,356	77.6%
Short-term investments	1,760,714	5.5%	697,450	2.8%
Total equity securities	962,920	3.0%	583,450	2.3%
Investments in affiliates	1,936,852	6.0%	1,903,341	7.6%
Other investments	305,160	1.0%	142,567	0.6%
Total investments and cash and
cash equivalents	$32,096,608	100%	$25,127,714	100%

The Company reviews on a regular basis its corporate debt concentration, credit quality and compliance with established guidelines. At December 31, 2004 and 2003, the average credit quality of the Company’s total fixed income portfolio was “AA.” Approximately 58% of the fixed income portfolio was rated AAA by one or more of the principal ratings agencies. Approximately 4.6% was below investment grade or not rated.

Unpaid Losses and Loss Expenses

Unpaid losses and loss expenses include reserves on the Company’s general and financial operations and relates primarily to the casualty insurance and reinsurance business written by the Company. The balance was $19.6 billion at December 31, 2004 which is an increase of $3.0 billion from December 31, 2003. The increase was due primarily to new business earned in the year, together with an increase in reserves for net adverse development in 2004 of $1.6 billion of prior period loss reserves principally related to the book of business purchased from Winterthur Swiss Insurance Company in 2001 which is covered by the SPA. See Item 8, Note 5(b) to the Consolidated Financial Statements for further discussion.

The table below represents a reconciliation of the Company’s unpaid losses and loss expenses for the year ended December 31, 2004:

	Gross unpaid	Unpaid losses and	Net unpaid losses
	losses and loss	loss expenses	and loss
(U.S. dollars in thousands)	expenses	recoverable	expenses
Balance at December 31, 2003	$16,558,788	$5,776,410	$10,782,378
Losses and loss expenses incurred	7,830,132	2,966,193	4,863,940
Losses and loss expenses paid/recovered	4,926,421	1,851,932	3,074,489
Other (including foreign exchange revaluation)	136,032	(173,737)	309,768
Balance at December 31, 2004	$19,598,531	$6,716,934	$12,881,597

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While the Company reviews the adequacy of established reserves for unpaid losses and loss expenses regularly, no assurance can be given that actual claims made and payments related thereto will not be in excess of the amounts reserved. In the future if such reserves develop adversely, such deficiency would have a negative impact on future results of operations. See Item 1, “Unpaid Losses and Loss Expenses.” “Critical Accounting Policies and Estimates” and Item 8, Note 9 to the Consolidated Financial Statements for further discussion.

Unpaid Losses and Loss Expenses Recoverable and Reinsurance Balances Receivable

In the normal course of business, the Company seeks to reduce the potential amount of loss arising from claims events by reinsuring certain levels of risk assumed in various areas of exposure with other insurers or reinsurers. While reinsurance agreements are designed to limit the Company’s losses from large exposures and permit recovery of a portion of direct unpaid losses, reinsurance does not relieve the Company of its ultimate liability to the Company’s insureds. Accordingly, the losses and loss expense reserves on the balance sheet represent the Company’s total unpaid gross losses. Unpaid losses and loss expense recoverable relates to estimated reinsurance recoveries on the unpaid loss and loss expense reserves.

Unpaid losses and loss expense recoverables were $6.7 billion and $5.8 billion at December 31, 2004 and 2003, respectively. At December 31, 2004 and 2003, reinsurance balances receivable were $1.1 billion and $1.4 billion respectively. The table below presents the Company’s net reinsurance recoverable at December 31, 2004 and 2003.

	December 31,	December 31,
(U.S. dollars in thousands)	2004	2003
Reinsurance balances receivable	$ 1,097,709	$ 1,369,331
Bad debt reserve on reinsurance balances receivable	(1,970)	(9,845)
Reinsurance recoverable on future policy benefits	23,585	3,587
Reinsurance recoverable on unpaid losses and loss expenses recoverable	6,995,643	5,883,970
Bad debt reserve on unpaid losses and loss expenses - recoverable	(278,709)	(107,560)
Net paid and unpaid losses and loss expenses recoverable and
reinsurance balances receivable	$ 7,836,258	$ 7,139,483

The Company has credit risk should any of its reinsurers be unable to settle amounts due. Of the $78 billion total unpaid losses and loss expenses recoverable and reinsurance balances receivable at December 31, 2004, no individual reinsurer accounted for 10% or more of the total. The Company is the beneficiary of letters of credit, trust accounts and funds withheld in the aggregate amount of $1.6 billion at December 31, 2004, collateralizing reinsurance recoverables with respect to certain reinsurers. The provision for uncollectible reinsurance is required principally due to the failure of reinsurers to indemnify the Company primarily because of disputes under reinsurance contracts and insolvencies. As at December 31, 2004 and 2003, the Company had a reserve for potential non-recoveries from reinsurers of $278.7 million and $107.6 million, respectively.

Included in unpaid loss and loss expenses recoverable at December 31, 2004 is an unsecured reinsurance recoverable from Winterthur Swiss Insurance Company (the “Seller”) of $1.45 billion, related to certain contractual arrangements in the sale and purchase agreement, as amended (“SPA”) relating to the Company’s acquisition of Winterthur International in July 2001. The Seller is currently rated “A-” by S&P. The Seller provides the Company with post-closing protection determined as of June 30, 2004 with respect to, among other things, adverse development of incurred losses and premium balances relating to the acquired Winterthur International business (“Winterthur Business”). This protection is based upon net loss experience and development over a three-year, post-closing seasoning period based on actual loss development experience, collectible reinsurance and certain other factors set forth in the SPA. The SPA includes an independent actuarial process for determining the net amount due to the Company from the Seller. In the process, each of the Company and the Seller submits their respective net reserves and seasoned premium amounts. The independent actuary develops its own value of the seasoned net reserves and seasoned premium amounts and the actual final seasoned amount would be, in each case, the submission that is closest to the number developed by the independent actuary.

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As the Company and the Seller were unable to come to an agreement, the Company submitted to the Seller notice to trigger the independent actuarial process as contemplated by the SPA. On February 3, 2005, both the Company and the Seller made submissions for the independent actuarial process. The Company’s submissions would result in a net payable to the Company of approximately $1.45 billion in aggregate and the Seller’s submissions would result in a net payable to the Company of $541 million in aggregate. Approximately $855 million of the total $909 million dollar difference between the Seller and the Company relates to seasoned losses, the remainder relates to premium seasoning At the completion of the independent actuarial process, the Company will be entitled to a lump sum payment.

In addition, the Seller provides protection to the Company with respect to third party reinsurance receivables and recoverables related to the Winterthur Business which are $2.0 billion in the aggregate as of December 31, 2004. There are two levels of protection from the Seller for these balances:

1. At the time of the Winterthur International acquisition, the Seller provided to the Company a liquidity facility. At the time of the payment of the net reserve seasoned amount, the Company has the right to repay up to the balances outstanding on this facility by assignment to the Seller of an equal amount of receivables relating to reinsurance recoverables selected by the Company. The payable balance related to this facility is included within Other liabilities on the Company’s balance sheet at December 31, 2004 and amounted to approximately $281 million at that date.

2. Under two retrocession agreements the Company has reinsurance protection on the remaining portion of reinsurance recoverables with respect to incurred losses seasoned as of June 30, 2004 to the extent that the Company does not receive payment of such amounts from applicable reinsurers with one agreement providing a limit of $1.3 billion for the insurance written in the period to June 30, 2001 and the other agreement providing a limit of $1.3 billion for the insurance written in the period to December 31, 2000.

At December 31, 2004, certain reinsurers responsible for some portions of the reinsurance of the acquired Winterthur Business have raised issues as to whether amounts claimed are due and the resolution of those discussions is also currently ongoing.

The Company may record a loss in future periods if any or some of the following occur:

(i)     A submission of the Seller is closer to the valuation developed by the independent actuary;

(ii)     There is deterioration of the net reserves and premium balances, relating to the Winterthur Business, from what is reported in the Company’s December 31, 2004 financial statements;

(iii)     The Company is unable to make full recovery of the reinsurance recoverables related to the Winterthur Business, either from third parties or from the Seller under the additional protections; or

(iv)     Any amount due from the Seller proves to be uncollectible from the Seller for any reason.

Excluding the recoverable from the Seller described above, approximately 69% of the total unpaid loss and loss expense recoverable and reinsurance balances receivable (excluding collateral held) outstanding at December 31, 2004 were due from reinsurers rated “A” or better by S&P. The following is an analysis of the total recoverable and reinsurance balances receivable at December 31, 2004 by reinsurers owing more than 3% of such total:

	Standard and
Name of reinsurer	Poor’s rating	% of total
Employers Reinsurance Corp.	A+/Watch Negative	8.4%
Lloyd’s Syndicates	A/Stable	6.7%
Munich Reinsurance Co.	A+/Stable	5.9%
Swiss Reinsurance Co.	AA/Negative	4.9%
Transatlantic Reinsurance Company	AA/Stable	3.0%

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Liquidity and Capital Resources

As a holding company, the Company’s assets consist primarily of its investments in subsidiaries, and the Company’s future cash flows depend upon the availability of dividends or other statutorily permissible payments from its subsidiaries. The ability to pay such dividends is limited by the applicable laws and regulations of the various countries in which the Company operates, including, among others, Bermuda, the United States, Ireland, Switzerland, the United Kingdom, and those of the Society of Lloyd’s and certain contractual provisions. See Item 8, Note 24 to the Consolidated Financial Statements for further discussion. No assurance can be given that the Company or its subsidiaries will be permitted to pay dividends in the future.

Liquidity

Certain business written by the Company has loss experience generally characterized as having low frequency and high severity. This may result in volatility in both the Company’s results and operational cash flows.

See Item 8 – “Consolidated Statement of Cash Flows.” There are three main sources of cash flows for the Company – those provided by operations, investing activities and financing activities.

Cash Flow provided by Operations

Cash flow from operations is derived from two main sources:

1)     The receipt of investment income on the Company’s total investment portfolio; and

2)     The net receipt of premiums less claims and expenses related to its underwriting activities in general, life and financial operations.

Cash flow from operations was $4.4 billion in 2004 as compared to $3.4 billion in 2003. This increase in 2004 is due to an increase in the receipt of investment income in line with the growth of the investment portfolio together with an increase in net cash received from underwriting activities.

Net cash received from underwriting activities is comprised of receipt of premiums, minus payment of claims and operating and acquisition costs. Premiums and acquisition expenses are settled based on terms of trade as stipulated by an underwriting contract, and generally are received within the first year of inception of a policy when the premium is written, but can be up to three years on certain reinsurance business assumed. Operating expenses are generally paid within a year of being incurred. Claims on the other hand, especially for casualty business, may take a much longer time before they are reported and ultimately settled and this is why the Company establishes reserves for unpaid losses and loss expenses. Therefore, the amount of claims paid in any one year is not necessarily related to the amount of net losses incurred as reported in the consolidated statement of income.

During 2004, 2003 and 2002, the total amounts of net losses paid for the general operations were $3.1 billion, $2.8 billion and $2.8 billion, respectively, whereas the amount of net losses incurred was $4.9 billion, $4.6 billion and $3.3 billion, respectively. The difference between net incurred and paid losses in 2004 is primarily due to adverse development in the insurance segment and the hurricane losses, many of which are not yet paid. The difference between net incurred and paid losses in 2003 is due primarily to the prior period adverse development on the Company’s North American casualty reinsurance book as described above, where the Company increased reserves by $877 million. The payout of the Company’s casualty reserves at December 31, 2004 could be as long as a thirty year period. Property claims are generally reported and settled within a much shorter period, usually up to three years. Cumulative net losses paid by the Company for the September 11 event at December 31, 2004 were $512 million, or approximately 66% of the total net incurred losses of $775 million.

Cash Flow used in Investing Activities

Generally, positive cash flow from operations and financing activities is invested in the Company’s portfolio, including affiliates or acquisition of subsidiaries. In 2004, in addition to purchases and sales of the Company’s total investment portfolio, the Company sold its interests in Admiral Group Ltd and Pareto Partners and its affiliated companies for $66.7 million and $45.1 million respectively.

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In 2003, in addition to purchases and sales of the Company’s total investment portfolio, the Company had the following significant investment cash flows:

1)     In September 2003, the Company exercised its option and settled the related Euro liability to purchase the remaining 33% ownership of Le Mans Ré, now known as XL Re Europe, for approximately $161 million. See Item 8; Note 5(a) to the Consolidated Financial Statements for further information.

2)     In December 2003, the Company received $75.4 million relating to the settlement of the purchase price for Winterthur International. See Item 8; Note 5(b) to the Consolidated Financial Statements for further information.

3)     In July 2003, the Company acquired new offices in London for its London headquarters. The acquisition was by a purchase, sale and leaseback transaction resulting in net cash received of $45.3 million, which was recorded as a deferred liability at December 31, 2003. The Company also recorded a capitalized lease asset and liability of approximately $150.0 million related to this transaction and there were no significant capital expenditures for leasehold improvements during 2003.

Cash Flow provided by Financing Activities

Cash flows related to financing activities include the payment of dividends, share related transactions, the issue or repayment of debt and deposit liability transactions. In 2004 and 2003, the Company received $1.5 billion and $1.5 billion of net cash relating to new deposit liability contracts. In 2004, dividends were $270.5 million for ordinary shares and $40.3 million for preferred shares.

In connection with the acquisition of Winterthur International, a limited recourse receivables financing facility previously available to these operations from the Seller was made available to the Company. The balance outstanding at December 31, 2004 and 2003 was approximately $ 281.0 million and $223.0 million, respectively, and is included in Other Liabilities in the Consolidated Balance Sheet.

In addition, in 2004 and 2003 the Company executed a number of debt and equity transactions which affect the cash flow from financing activities described below in Capital Resources.

Capital Resources

In addition to ordinary share capital, the Company depends on external sources of financing to support its underwriting activities in the form of:

a.     debt,

b.     preference shares, and,

c.     contingent capital,

d.     letters of credit facilities and other sources of collateral

In particular, the Company requires, among other things:

• Sufficient capital to maintain its financial strength, claims paying and debt ratings, as issued by several ratings agencies, at a level considered necessary by management to enable the Company’s key operating subsidiaries to compete.

• Sufficient capital to enable its underwriting subsidiaries to meet the capital adequacy tests performed by statutory agencies in the U.S., the U.K., and other key markets.

• Letters of credit and other forms of collateral that are required by the Company’s non-U.S. operating companies that are “non-admitted” under U.S. state insurance regulations. The Company also uses letters of credit to support its operations at Lloyd’s.

• Revolving credit to meet short-term liquidity needs.

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Certain of the Company’s credit facilities will expire in 2005. The following risks are associated with the Company’s requirement to renew these facilities during 2005:

• The credit available from banks may be reduced resulting in the Company’s need to pledge its investment portfolio to customers. This could result in a lower investment yield.

• The volume of business that the Company’s non-admitted subsidiaries are able to transact could be reduced if the Company is unable to renew its letter of credit facilities at an appropriate amount.

Continued consolidation within the banking industry may result in the aggregate amount of credit provided to the Company being reduced. The Company attempts to mitigate this risk by identifying and/or selecting additional banks that can participate in the credit facilities upon renewal.

a) Debt

At December 31, 2004, banks and investors provided the Company and its subsidiaries with $3.4 billion of debt capacity, of which $2.7 billion was utilized by the Company. These facilities consist of:

• Revolving credit facilities (“revolvers”) of $660 million in aggregate. These revolvers (and their predecessor facilities) were not utilized during 2004 or 2003. The revolvers are components of a $2.0 billion 3-year facility, a $1 billion 364-day facility, and a $100 million 364-day facility. At December 31, 2003, the Company had a single $2.5 billion 364-day facility. These facilities are provided on an unsecured basis by a syndicate of banks (the $2.0 billion and $1.0 billion facilities) or on a bilateral basis in the case of the $100 million facility. The revolvers can be utilized to provide cash at any time until the facilities expire. The Company anticipates that the 364-day facilities will be renewed for a further year in 2005, however, the size of the facilities and the price terms will depend on market conditions in the period leading up to the renewal.

• Senior Unsecured Notes of approximately $2.7 billion. These notes require the Company to pay a fixed rate of interest during their lives. There are six outstanding issues of senior unsecured notes:

• $100 million senior notes due November 2005 with a fixed coupon of 7.15%. The security is publicly traded.

• $255 million senior notes due April 2011 with a fixed coupon of 6.58%. This transaction was privately placed. The security is not traded on a public exchange.

• $600 million senior notes due January 2012 with a fixed coupon of 6.5%. The security is publicly traded. The notes were issued at $99.469 and gross proceeds were $596.8 million. Related expenses of the offering amounted to $7.9 million.

• $600 million senior notes due September 2014 with a fixed coupon of 5.25%. The security is publicly traded. The notes were issued in two tranches of $300 million aggregate principal amount each – one tranche at 99.432% and the other at 98.419%. Aggregate gross proceeds were $593.6 million. Related expenses of the offering amounted to $4 million.

• $350 million senior notes due November 2024 with a fixed coupon of 6.375%. The security is publicly traded. The notes were issued at 100.000% and gross proceeds were $350 million. Related expenses of the offering amounted to $2 million.

• $825 million of senior notes due May 2009 with a fixed coupon of 2.53%. These securities are a component of Equity Security Units (“Units”) that are publicly traded. In addition to the coupon paid on the senior notes, contract adjustment payments of 3.97% per annum are paid on forward purchase contracts for the Company’s common shares for a total distribution of 6.50% per annum. The purchase contracts mature in 2007, and the senior notes mature in 2009. In May 2007, the senior notes will be remarketed whereby the interest rate will be reset in order to generate sufficient remarketing proceeds to satisfy the Unit holders’ obligations under the purchase contract.

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The following tables present the Company’s debt under outstanding securities and lenders’ commitments as at December 31, 2004:

				Payments Due by Period
Notes Payable and Debt			Year of	Less than	1 to 3	4 to 5	After 5
(U.S. dollars in thousands)	Commitment	In Use	Expiry	1 Year	Years	Years	Years
364-day and 3-year revolvers	$ 660,000	$ –	2005/7	$ –	$ –	$ –	$ –
7.15% Senior Notes	100,000	100,000	2005	–	100,000	–	–
2.53% Senior Notes	825,000	825,000	2009	–	–	825,000	–
6.58% Guaranteed Senior Notes	255,000	255,000	2011	–	–	–	255,000
6.50% Guaranteed Senior Notes	597,761	597,761	2012	–	–	–	600,000
5.25% Senior Notes	593,670	593,670	2014	–	–	–	600,000
6.375% Senior Notes	350,000	350,000	2024	–	–	–	350,000
Total	$3,381,431	$2,721,431		$ –	$100,000	$825,000	$1,805,000

“Commitment” and “In Use” data represent December 31, 2004 accreted values. “After 5 years” data represent ultimate redemption values.

b) Preferred shares

In 2002, the Company issued preferred shares as follows:

• Series A Preferred In August 2002, the Company issued 9.2 million of 8% Series A preference ordinary shares (“Series A preference shares”). Gross proceeds were $230.0 million and related expenses were $7.2 million. Upon dissolution of the Company, the holders of the Series A preference shares are entitled to receive a liquidation preference of $25 per share, plus accrued dividends. Dividends on the preference Shares are cumulative from the date of original issuance and are payable when declared. The Company may redeem the Series A preference shares on or after August 14, 2007, at a redemption price of $25 per share. The Company may, under certain circumstances, redeem the Series A preference shares before August 14, 2007 at specified redemption prices, plus accrued dividends. These circumstances include an amalgamation, consolidation or other similar transaction involving the Company in which the Series A preferred shares are entitled to a class vote ($26 per share redemption price), or a change in tax laws that requires the Company to pay additional amounts with respect to the Series A preference shares ($25 per share redemption price). The proceeds were used for general corporate purposes.

• Series B Preferred In November 2002, the Company issued 11.5 million of 7 5/8% Series B preference ordinary shares (“Series B preference shares”). Gross proceeds were $287.5 million and related expenses were $9.1 million. Upon dissolution of the Company, the holders of the Series B preference shares are entitled to receive a liquidation preference of $25 per share, plus accrued dividends. Dividends on the preference shares are cumulative from the date of original issuance and are payable when declared. The Company may redeem the Series B preference ordinary shares on or after November 18, 2007, at a redemption price of $25 per share. The Company may, under certain circumstances, redeem the B preference shares before November 18, 2007 at specified redemption prices, plus accrued dividends. These circumstances include an amalgamation, consolidation or other similar transaction involving the Company in which the Series B preferred shares are entitled to a class vote ($26 per share redemption price), or a change in tax laws that requires the Company to pay additional amounts with respect to the Series B preference shares ($25 per share redemption price). The proceeds were used for general corporate purposes.

c) Contingent Capital

In addition to funded debt transactions, the Company and a majority-owned subsidiary, (XL Financial Assurance Ltd. (“XLFA”)) have entered into contingent capital transactions. No up-front proceeds were received by the Company or XLFA under these transactions, however, in the event that the associated irrevocable put option

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agreements are exercised, proceeds previously raised from investors from the issuance of pass-through trust securities would be received in return for the issuance of preferred shares.

On December 10, 2004, XLFA entered into a put option agreement and an asset trust expense reimbursement agreement with Twin Reefs Asset Trust (the “Asset Trust”). The put option agreement provides XLFA with the irrevocable right to require the Asset Trust at any time and from time to time to purchase XLFA’s non-cumulative perpetual Series B Preferred Shares with an aggregate liquidation preference of up to $200 million. There is no limit to the number of times that XLFA may exercise the put option, redeem the Series B Preferred Shares from the Asset Trust and exercise the put option again. XLFA is obligated to reimburse the Asset Trust for certain fees and ordinary expenses. To the extent that any Series B Preferred Shares are put to the Asset Trust and remain outstanding, a corresponding portion of such fees and ordinary expenses will be payable by XLFA pursuant to the asset trust expense reimbursement agreement. The put option agreement is perpetual but would terminate on delivery of notice by XLFA on or after December 9, 2009, or under certain defined circumstances, such as the failure of XLFA to pay the put option premium when due or bankruptcy. The premium payable by XLFA is the sum of certain trustee and investment managers expenses, the distribution of income paid to holders of the pass-through trust securities, less the investment yield on the eligible assets purchased using the proceeds originally raised from the issuance of the pass-through securities.

In July 2003, the Company entered into a contingent capital transaction with an aggregate value of $500.0 million. This transaction provides the Company with an insurance trust that provides the Company with statutory relief under state insurance regulations in the U.S. Under the terms of this facility, the Company has acquired an irrevocable put option to issue preference ordinary shares into a trust in return for proceeds raised from investors. This put option may be exercised by the Company at any time. In addition, the Company may be required to issue preference ordinary shares to the trust under certain circumstances, including, but not limited to, the non-payment of the put option premium and a ratings downgrade of the Company. In connection with this transaction, the fair value of the put premiums and other related costs, in total of $111.9 million was transferred from “Additional paid in capital” to a deferred liability which was established (included with “Other liabilities”) in the consolidated balance sheet at December 31, 2003. The Company amortizes this liability that resulted in an interest expense of approximately $3.5 million in 2004 and $2.0 million in 2003.

d) Letter of Credit Facilities and other sources of collateral

At December 31, 2004, the Company had eight letter of credit facilities in place with total availability of $4.4 billion, of which $3.0 billion was utilized.

				Amount of Commitment Expiration per period
Other Commercial Commitments			Year of	Less than	1 to 3	4 to 5	After 5
(U.S. dollars in thousands)	Commitment	In Use	Expiry	1 Year	Years	Years	Years
7 Letter of credit facilities (1)	$2,371,167	$1,141,192	2005	$2,371,167	$ –	$ –	$ –
1 Letter of credit facility (1)	$2,000,000	$1,850,484	2007	$ –	$2,000,000	$ –	$ –
8	$4,371,167	$2,991,676		$2,371,167	$2,000,000	$ –	$ –

(1) Of the total letter of credit facilities above, $660 million is also included in the revolvers under notes payable and debt

The facilities are provided on a syndicated and bilateral basis from commercial banks and are scheduled for renewal during 2005 and 2007.

It is anticipated that the commercial facilities will be renewed on expiry but such renewals are subject to the availability of credit from banks utilized by the Company. In the event that such credit support is insufficient, the Company could be required to provide alternative security to cedents. This could take the form of insurance trusts supported by the Company’s investment portfolio or funds withheld (amounts retained by ceding companies to collateralize loss or premium reserves) using the Company’s cash resources. The value of letters of credit required is driven by, among other things, loss development of existing reserves, the payment pattern of such reserves, the expansion of business written by the Company and the loss experience of such business. In addition to letters of credit, the Company has established insurance trusts in the U.S. that provide cedents with statutory relief required under state insurance regulation in the U.S.

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The Company reviews current and projected collateral requirements on a regular basis, as well as new sources of collateral. Management’s objective is to maintain an excess amount of collateral sources over expected uses. The Company also reviews its liquidity needs on a regular basis.

The following letter of credit facilities were originated or renewed during 2004:

• During 2004, the Company renewed a $200 million unsecured bilateral letter of credit facility that was fully utilized throughout 2004 and at December 31, 2004.

• In September 2004, the Company created a new $100 million unsecured bilateral credit facility that was unutilized during 2004 and at December 31, 2004. Of the aggregate amount of $100 million, $60 million is available as revolving credit and up to $100 million is available in the form of letters of credit, with the combined total not to exceed $100 million.

• In June 2004, the Company replaced its principal revolving credit and letter of credit facility that had amounted to $2.5 billion with two facilities – one $2.0 billion facility with a tenor of 3 years and a $1.0 billion facility with a tenor of 364 days. Of the aggregate amount of $3.0 billion, $600 million is available as revolving credit and up to $3.0 billion is available in the form of letters of credit, with the combined total not to exceed $3.0 billion. As at December 31, 2004 approximately $1.9 billion of the 3-year facility was in use in the form of letters of credit while the 364-day facility was unutilized at that date.

• In November 2004, the Company renewed its unsecured syndicated letter of credit facility that supports its operations at Lloyd’s. The renewed facility is denominated in U.K. sterling and was increased in size from £400 million at December 31, 2003, to £450 million (approximately $863 million) at December 31, 2004.

In addition to the letter of credit facilities described above, the Company has the following facility:

• $500 million commercial paper-based facility. In February 2003, the Company entered into an aggregate of $300.0 million of commercial paper-based credit facilities (the “Credit Facilities”). These facilities were increased to $500.0 million in June 2003. The proceeds of advances under the Credit Facilities were used to fund a trust account to collateralize the reinsurance obligations of the Company under an inter-company quota share reinsurance agreement. The Company could face additional obligations under the Credit Facilities prior to the stated maturity of February 25, 2008, if certain events were to occur, including, but not limited to the Company’s insolvency, withdrawal of assets from the Regulation 114 trust by the ceding company, the downgrade of the Company’s credit ratings below certain specified levels, or the failure of the agent to have a first priority perfected security interest in the collateral posted by the Company. At maturity, the Company will be obligated to make payments in an amount equal to the principal and accrued interest outstanding under the Credit Facilities. The issued securities and the Company’s repayment obligations are recorded as a net balance on the Company’s balance sheet.

Cross-Default and Other Provisions in Debt Documents

The following describes certain terms of the documents referred to below. All documents referred to below have been filed with the SEC and should be referred to for an assessment of the complete contractual obligations of the Company.

In general, all of the Company’s bank facilities, indentures and other documents relating to the Company’s outstanding indebtedness, including the Credit Facilities discussed above (collectively, the “Company’s Debt Documents”), contain cross default provisions to each other and the Company’s Debt Documents contain affirmative covenants. These covenants provide for, among other things, minimum required ratings of the Company’s insurance and reinsurance operating subsidiaries (other than its AAA financial guaranty companies) and the level of secured indebtedness in the future. In addition, generally each of the Company’s Debt Documents provide for an event of default in the event of a change of control of the Company or some events involving bankruptcy, insolvency or reorganization of the Company. The Company’s credit facilities and the 6.58% Guaranteed Senior Notes also contain minimum consolidated net worth covenants.

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Under the Company’s credit facilities and ten-year private placement notes described above, in the event that the Company fails to maintain a financial strength rating of at least A from A.M. Best or the Company’s insurance and reinsurance rated operating subsidiaries (other than its AAA financial guaranty companies) fail to maintain a rating of at least A from S&P, an event of default would occur.

The 6.5% Guaranteed Senior Notes indentures contains a cross default provision. In general, in the event that the Company defaults in the payment of indebtedness in the amount of $50.0 million or more, an event of default would be triggered under the Guaranteed Senior Notes indentures. Given that all of the Company’s Debt Documents contain cross default provisions, this may result in all holders declaring such debt due and payable and an acceleration of all debt due under those documents. If this were to occur, the Company may not have funds sufficient at that time to repay any or all of such indebtedness.

In addition, the Company’s unsecured Lloyd’s letter of credit facility provides that, in the event that the Company’s insurance and reinsurance rated operating subsidiaries in Bermuda fall below A. The facility would then be required to be fully secured by the Company, at which time the Company would be required to either (i) provide an amount in cash to cover an amount equal to the aggregate letters of credit outstanding at that time or (ii) deposit assets in trust securing 105% of the aggregate letters of credit outstanding at that time. If this were to occur, the Company may not be able to provide the collateral required in order to maintain this facility.

See Item 8, Note 13 to the Consolidated Financial Statements for further information.

Long Term Contractual Obligations

The following table presents the Company’s long term contractual obligations and related payments as at December 31, 2004, due by period. This table excludes further commitments of $49.1 million to the Company’s investment managers, related investment funds, certain limited partnerships, insurance affiliates, collateralized debt/equity investments and letter of credit facilities of $3.5 billion. See Item 8, Note 14 and Note 18 to the Consolidated Financial Statements set forth in the Company’s Form 10-K for the year ended December 31, 2003 for further information.

Contractual Obligations		Less than	1 to	3 to	More than
(U.S. dollars in thousands)	Total	1 year	3 years	5 years	5 years
Long-term debt obligations	$ 2,730,000	$ –	$ 100,000	$ 825,000	$ 1,805,000
Interest in long term debt	1,226,853	136,720	260,928	247,883	581,322
Contingent capital facilities	104,550	12,300	24,600	24,600	43,050
Equity Units	81,882	32,753	49,129	–	–
Capital lease obligations	369,500	11,747	24,381	25,616	307,756
Operating lease obligations	258,217	33,925	60,614	47,028	116,650
Deposit liabilities (1)	7,787,028	1,050,998	2,443,650	968,100	3,324,280
Future policy benefits (3)	7,858,210	546,053	630,956	640,000	6,041,201
Unpaid losses and loss expenses (2)	19,893,631	6,535,077	6,648,085	2,783,864	3,926,605
Total	$40,309,871	$8,359,573	$10,242,343	$5,562,091	$16,145,864

(1)

Deposit liabilities on the Company’s Consolidated Balance Sheet at December 31, 2004 amounted to $5,725,590. The payment related to these liabilities varies primarily based on interest rates. The ultimate payments associated with these liabilities could differ from the Company’s estimate. See Item 8, Note 11 to the Consolidated Financial Statements for further information.

(2)

The unpaid loss and loss expenses amounted to $19,598,531 on the Company’s Consolidated Balance Sheet at December 31, 2004. The timing and amounts of actual claims payments related to these reserves vary based on many factors including large individual losses, changes in the legal environment, as well as general market conditions. The ultimate amount of the claims payments could differ materially from the Company’s estimated amounts. For information regarding the estimates for unpaid loss and loss expenses as well as factors effecting potential payment patterns of reserves for actual and potential claims related the Company’s different lines of business see “Critical Accounting Policies and Estimates” above. Certain lines of business written by the Company, such as excess casualty, have loss experience characterized as low frequency and high severity. This may result in significant variability in loss payment patterns and, therefore, may impact the related

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	asset/liability investment management process. In order to be in a position, if necessary, to make these payments, the Company’s liquidity requirements are supported by having revolving lines of credit facilities available to the Company and significant reinsurance programs, in addition to the Company’s general high grade fixed income investment portfolio. For information regarding the cash and investments available to pay claims related to these liabilities.
(3)	Future policy benefit reserves on life and annuity business amounted to $4,547,688 on the Company’s Consolidated Balance Sheet at December 31, 2004. Amounts included above include an allowance for future premiums in respect of contracts under which premiums are payable throughout the life of the underlying policy. The value of the discount is also included for those lines of business that have reserves where future claim payments and future premium receipts can be estimated using actuarial principles. The timing and amounts of actual claims payments and premium receipts related to these reserves vary based on the underlying experience of the portfolio. Typical elements of the experience include mortality, morbidity and persistency. The ultimate amount of the claims payments and premium receipts could differ materially from the Company’s estimated amounts.
(4)	Contingent capital facilities related payments include an estimate at the payments due under the past option agreement of $200 per month. Actual payments depend on the return on certain assets and LIBOR.

Variable Interest Entities and Other Off-Balance Sheet Arrangements

The Company utilizes variable interest entities both indirectly and directly in the ordinary course of the Company’s business.

The Company provides various forms of credit enhancement including financial guaranty insurance and reinsurance of structured transactions backed by pools of assets of specified types, municipal obligations supported by the issuers’ ability to charge fees for specified services or projects, and structured single risk based obligations including essential infrastructure projects and obligations backed by receivables from future sales of commodities and other specified services. The obligations related to these transactions are often securitized through variable interest entities. In synthetic transactions, the Company guarantees payment obligations of counterparties including special purpose vehicles under credit derivatives referencing asset portfolios. The Company invests in collateralized debt obligations (“CDOs”), and other investment vehicles that are issued through variable interest entities as part of the Company’s risk asset portfolio.

In 2003, the Company entered into an aggregate of $500.0 million of commercial paper-based credit facilities (the “Credit Facilities”). The proceeds of advances under the Credit Facilities were used to fund a trust account (“Trust”) to collateralize the reinsurance obligations of the Company under an intercompany quota share reinsurance agreement. The issued securities and the Company’s repayment obligations will be recorded as a net balance on the Company’s balance sheet because the Company has a contractual legal right of offset. In the event that in the future the Company were to not have the right to offset such assets (as, for example, would be the case if the assets in the Trust were withdrawn in order to satisfy the Company’s reinsurance obligations or if lender-issued securities could not be held in the Trust because they did not qualify as permitted assets under the trust agreement), then all or a portion of the assets in the Trust and the Company’s repayment obligations under the Credit Facilities would be required to be included as assets and liabilities on a gross basis, respectively, on the Company’s balance sheet. See also “Liquidity and Capital Resources” for more details regarding this off balance sheet collateral arrangement.

In December 2004, XLFA entered into a put option agreement and an asset trust expense reimbursement agreement with the Asset Trust. The put option agreement provides XLFA with the irrevocable right to require the Asset Trust at any time and from time to time to purchase XLFA's non-cumulative perpetual Series B Preferred Shares with an aggregate liquidation preference of up to $200 million. XLFA is obligated to reimburse the Asset Trust for certain fees and ordinary expenses. To the extent that any Series B Preferred Shares are put to the Asset Trust and remain outstanding, a corresponding portion of such fees and ordinary expenses will be payable by XLFA pursuant to the asset trust expense reimbursement agreement. The put option agreement is perpetual but would terminate on delivery of notice by XLFA on or after December 9, 2009, or under certain defined circumstances, such as the failure of XLFA to pay the put option premium when due or bankruptcy. The put option is recorded at fair value with changes in fair value recognized in earnings.

In July 2003, the Company entered into a contingent capital transaction with an aggregate value of $500.0 million. This transaction also provides the Company with an insurance trust that provides the Company with statutory relief under state insurance regulations in the U.S. Under the terms of this facility, the Company has acquired an irrevocable put option to issue preference ordinary shares into a trust in return for proceeds raised from investors. This put option may be exercised by the Company at any time. In addition, the Company may be required to issue preference ordinary shares to the trust under certain circumstances, including, but not limited to, the non-payment of the put option premium and a ratings downgrade of the Company.

The Company has an investment in the junior notes of a collateralized debt obligation (“CDO”). The Company also issued financial guaranties for the senior notes of the CDO. As of December 31, 2004, the CDO had assets of $468.2 million and liabilities of $395.6 million and the Company’s maximum exposure to loss as a result of its financial guaranties and investment in this variable interest entity was approximately $412.3 million. The Company could

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experience a loss in the event that the cash flows relating to the underlying assets are not collected as expected. The Company is not the primary beneficiary of this entity and therefore is not required to consolidate this entity.

Recent Accounting Pronouncements

See Item 8, Note 2 to the Consolidated Financial Statements for a discussion on recent accounting pronouncements.

Cautionary Note Regarding Forward-Looking Statements

The Private Securities Litigation Reform Act of 1995 (“PSLRA”) provides a “safe harbor” for forward-looking statements. Any prospectus, prospectus supplement, the Company’s Annual Report to ordinary shareholders, any proxy statement, any other Form 10-K, Form 10-Q or Form 8-K of the Company or any other written or oral statements made by or on behalf of the Company may include forward-looking statements that reflect the Company’s current views with respect to future events and financial performance. Such statements include forward-looking statements both with respect to the Company in general, and to the insurance, reinsurance and financial products and services sectors in particular (both as to underwriting and investment matters). Statements that include the words “expect”, “intend”, “plan”, “believe”, “project”, “anticipate”, “will”, “may”, and similar statements of a future or forward-looking nature identify forward-looking statements for purposes of the PSLRA or otherwise.

All forward-looking statements address matters that involve risks and uncertainties. Accordingly, there are or will be important factors that could cause actual results to differ materially from those indicated in such statements. The Company believes that these factors include, but are not limited to, the following: (i) the timely and full recoverability of reinsurance placed by the Company with third parties, or other amounts due to the Company, including, without limitation, amounts due to the Company from the Seller in connection with the Company’s acquisition of the Winterthur International operations; (ii) the projected amount of ceded reinsurance recoverables and the ratings and creditworthiness of reinsurers may change; (iii) the size of the Company’s claims relating to the hurricane and tsunami losses described herein may change due to the preliminary nature of some of the reports and estimates of loss and damage to date; (iv) the timing of claims payments being faster or the receipt of reinsurance recoverables being slower than anticipated by the Company; (v) ineffectiveness or obsolescence of the Company’s business strategy due to changes in current or future market conditions; (vi) increased competition on the basis of pricing, capacity, coverage terms or other factors; (vii) greater frequency or severity of claims and loss activity, including as a result of natural or man-made catastrophic events, than the Company’s underwriting, reserving or investment practices anticipate based on historical experience or industry data; (viii) developments in the world’s financial and capital markets that adversely affect the performance of the Company’s investments and the Company’s access to such markets; (ix) the potential impact on the Company from government-mandated insurance coverage for acts of terrorism; (x) the potential impact of variable interest entities or other off-balance sheet arrangements on the Company; (xi) developments in bankruptcy proceedings or other developments related to bankruptcies of companies insofar as they affect property and casualty insurance and reinsurance coverages or claims that the Company may have as a counterparty; (xii) availability of borrowings and letters of credit under the Company’s credit facilities; (xiii) changes in regulation or tax laws applicable to the Company or its subsidiaries, brokers or customers; (xiv) acceptance of the Company’s products and services, including new products and services; (xv) changes in the availability, cost or quality of reinsurance; (xvi) changes in the distribution or placement of risks due to increased consolidation of insurance and reinsurance brokers; (xvii) loss of key personnel; (xviii) the effects of mergers, acquisitions and divestitures; (xix) changes in ratings, rating agency policies or practices; (xx) changes in accounting policies or practices or the application thereof; (xxi) legislative or regulatory developments; (xxii) changes in general economic conditions, including inflation, foreign currency exchange rates and other factors; (xxiii) the effects of business disruption or economic contraction due to war, terrorism or other hostilities; and (xxiv) the other factors set forth in the Company’s other documents on file with the SEC. The foregoing review of important factors should not be construed as exhaustive and should be read in conjunction with the other cautionary statements that are included herein or elsewhere. The Company undertakes no

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obligation to update publicly or revise any forward-looking statement, whether as a result of new information, future developments or otherwise.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The following risk management discussion and the estimated amounts generated from the sensitivity and value-at-risk (“VaR”) analyses presented in this document are forward-looking statements of market risk assuming certain adverse market conditions occur. Actual results in the future may differ materially from these estimated results due to, among other things, actual developments in the global financial markets. The results of analysis used by the Company to assess and mitigate risk should not be considered projections of future events of losses. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Cautionary Note Regarding Forward-Looking Statements.”

The Company enters into derivatives and other financial instruments primarily for risk management purposes. The Company’s derivative transactions can expose the Company to credit derivative risk, weather and energy risk, investment market risk, and foreign currency exchange rate risk. The Company attempts to manage these risks based on guidelines established by senior management. Derivative instruments are carried at fair value with the resulting changes in fair value recognized in income in the period in which they occur.

Credit Derivative Risk

The Company enters into swaps written under International Swaps and Derivatives Association (“ISDA”) forms as an extension of its financial guaranty business. The fair value is determined using models developed by the Company and is dependent upon a number of factors, including changes in interest rates, future default rates, changes in credit quality, future expected recovery rates and other market factors. Other elements of the change in fair value are based upon pricing established at the inception of the contract. A change in the interest, default and recovery rate assumptions indicated below would cause the fair value associated with credit derivatives to decrease as follows:

Assumptions (U.S. dollars in thousands)	% Change	Decrease in Fair Value
Interest rate	1% decrease	$1,779
Default rate	10% increase	$3,648
Recovery rate	10% decrease	$6,583

Weather and Energy Market Risk

The Company offers weather and contingent energy risk management products in insurance or derivative form to end-users, while managing the risks in the over-the-counter and exchange traded derivatives markets or through the use of quota share or excess of loss arrangements.

Fair values for the Company’s natural gas derivative contracts are determined through the use of quoted market prices. As quoted market prices are not widely available in the weather derivative market, management uses available market data and internal pricing models based upon consistent statistical methodologies to estimate fair values. Estimating fair value of instruments which do not have quoted market prices requires management’s judgment in determining amounts which could reasonably be expected to be received from, or paid to, a third party in respect of the contracts. The amounts could be materially different from the amounts that might be realized in an actual sale transaction. Fair values are subject to change in the near-term and reflect management’s best estimate based on various factors including, but not limited to, realized and forecasted weather conditions, changes in interest rates and other market factors.

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The following table summarizes the movement in the fair value of contracts outstanding during the year ended December 31, 2004:

	Unrealized gain
(U.S. dollars in thousands)	(loss)
Fair value of contracts outstanding, beginning of the year	$(11,490)
Option premiums received, net of premiums realized (1)	8,554
Reclassification of settled contracts to realized (2)	51,588
Other changes in fair value (3)	(41,433)
Fair value of contracts outstanding, end of year	$ 7,219

(1)	For the year ended December 31, 2004, the Company collected $34.9 million of paid premiums and realized $43.5 million of premiums on expired transactions for a net decrease in the balance sheet derivative liability of $8.6 million.
(2)	The Company paid $51.6 million to settle derivative positions during the year ended December 31, 2004, resulting in a reclassification of this amount from unrealized to realized and a reduction in the balance sheet derivative liability.
(3)	This represents the effects of changes in commodity prices, the time value of options, and other valuation adjustments of $41.4 million on the Company’s derivative positions, primarily attributable to the hedges of the positions that realized $43.5 million of premiums.

The change in fair value of contracts outstanding at December 31, 2004 as compared to the beginning of the year is primarily due to the settlement of negative fair value positions during the first half of the year.

The following table summarizes the maturity of contracts outstanding at December 31, 2004:

				Greater
Source of Fair Value	Less than			than 5	Total Fair
(U.S. dollars in thousands)	1 Year	1-3 Years	4-5 Years	Years	Value
Prices actively quoted	$ –	$ –	$ –	$ –	$ –
Prices based on models and other       valuation methods	(2,502)	10,229	(508)	–	7,219
Total fair value of contracts outstanding	$(2,502)	$10,229	$(508)	$ –	$7,219

Market risk for the Company’s weather and energy portfolio relates to changes in underlying weather conditions (i.e., changes in climatic variables such as temperature and precipitation) changes in electricity prices, and changes in natural gas prices. The Company has underwritten risks in Asia, Australia, Europe, and North America, with its primary market risk reflected in temperature changes within the United States and Europe.

The Company manages its weather and energy risk portfolio through the employment of a variety of strategies. These include geographical and directional diversification of risk exposures and direct hedging within the capital and reinsurance markets. Risk management is undertaken on a portfolio-wide basis, to maintain a portfolio that the Company believes is well diversified and which remains within the aggregate risk tolerance established by the Company’s senior management.

Value-At-Risk – Related to Weather and Energy Activities

A statistical technique known as Value-at-Risk (VaR) is one of the tools used by management to measure, monitor and review the market risk exposures of the Company’s weather risk, natural gas and electricity price risk management portfolios. The Company’s VaR is calculated at the 99% confidence level.

The Company’s aggregate average, low and high seasonal VaR amounts for its weather risk management portfolio, calculated at a 99% confidence level, during the year ended December 31, 2004, were $173.7 million, $126.5 million and $232.4 million, respectively. The corresponding levels for the weather risk management portfolio during the year ended December 31, 2003, were $137.7 million, $100.1 million and $178.4 million, respectively. The Company calculates its aggregate VaR by summing the VaR amounts for each of its seasonal portfolios. The

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Company’s aggregation methodology yields a conservative aggregate portfolio VaR, given that current weather events and patterns have an immaterial effect on expectations for future seasons and the Company could therefore reduce or eliminate its VaR on future seasons by selling its positions prior to the beginning of a season.

For the natural gas portfolio, VaR is calculated using a one-day holding period. The Company’s average, low and high daily VaR amounts calculated at a 99% confidence level during the year ended December 31, 2004 were nil, nil and, $0.2 million, respectively. The corresponding amounts during the year ended December 31, 2003 were $2.0 million, $0.2 million and $2.9 million, respectively.

For electricity price risk management products, including electricity generation outage products, VaR is calculated using an annual holding period. Management has established an annual VaR limit of $17 million for this book of business. The Company’s average, low and high annual VaR amounts, calculated at a 99% confidence level during the year ended December 31, 2004, were $4.9 million, $2.6 million and $12.8 million, respectively. The corresponding levels during the year ended December 31, 2003 were $2.3 million, $0.8 million, and $5.3 million, respectively.

Since VaR statistics are estimates based on simulations of historical market data, VaR should not be viewed as an absolute, prognostic measurement gauge of future financial performance or as a way for the Company to predict risk. There can be no assurance that the Company’s actual future losses will not exceed its VaR amounts.

Credit Risk – Related to Weather and Energy Activities

The Company is exposed to credit risk, or the risk that counterparties to weather and contingent energy transactions will fail to perform their contractual obligations leading to possible losses. In order to control its risk exposures, the Company has implemented a credit risk control framework centered on a credit management process, credit policies and credit limits developed, enhanced and maintained by a credit officer and a credit committee comprised of senior management. All credit-sensitive transactions are reviewed and approved by the Company’s risk management personnel and/or credit committee and exposures are reviewed with respect to authorized credit limits before the Company enters into weather or contingent energy derivative transactions. To address counterparty risk concerns and to support credit exposures in certain cases, the Company may require that a counterparty provide a guaranty or a letter of credit or post margin or collateral. The Company monitors its credit exposures on a daily basis to ensure adherence to all policies and limits.

Investment Market Risk

The Company’s investment portfolio is managed by external investment professionals under the direction of the Company’s management and generally in accordance with detailed investment guidelines provided and monitored by the Company. Managers are selected directly by the Company on the basis of various criteria, including investment style, track record, performance, internal controls, operational risk, and diversification implications. The vast majority of the Company’s investment portfolio is managed by well established, large institutional investment professionals.

The Company’s investment portfolio consists of exposures to fixed income securities, equities, alternative investments, derivatives, business and other investments and cash. These securities and investments are denominated in both U.S. dollar and foreign currencies.

Through the structure of the Company’s investment portfolio, the Company’s earnings and book value are directly affected by changes in the valuations of the securities and investments held in the investment portfolio. These valuation changes reflect changes in interest rates (e.g., changes in the level, slope and curvature of yield curves, volatility of interest rates, mortgage prepayment speeds and credit spreads), credit quality, equity prices (e.g., changes in prices and volatilities of individual securities, equity baskets and equity indices) and foreign currency exchange rates (e.g., changes in spot prices, forward prices and volatilities of currency rates). Market risk therefore arises due to the uncertainty surrounding the future valuations of these different assets, the factors that impact their values and the impact that this could have on the Company’s earnings.

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The Company seeks to manage the risks of the investment portfolio through a combination of asset class, country, industry and security level diversification and investment manager allocations. These allocation decisions are made relative to the liability profile of the Company and the Company’s surplus. Further, individual security and issuer exposures are controlled and monitored at the investment portfolio level, via specific investment constraints outlined in investment guidelines and agreed with the external investment professionals. Additional constraints are generally agreed with the external investment professionals, which may address exposures to eligible securities, prohibited investments/transactions, credit quality and general concentrations limits.

The Company’s direct use of investment derivatives includes futures, forwards, swaps and option contracts that derive their value from underlying assets, indices, reference rates or a combination of these factors. When investment guidelines allow for the use of derivatives, these can generally only be used for the purpose of managing interest rate risk, foreign exchange risk, credit risk and replicating permitted investments, provided the use of such instruments is incorporated in the overall portfolio duration, spread, convexity and other relevant portfolio metrics. The direct use of derivatives is generally not permitted to economically leverage the portfolio outside of the stated guidelines. Derivatives may also be used to add value to the investment portfolio where market inefficiencies are perceived to exist, to utilize cash holdings to purchase equity indexed derivatives and to adjust the duration of a portfolio of fixed income securities to match the duration of related deposit liabilities.

Investment Value-at-Risk

Central to the Company’s market risk management framework is VaR. VaR is a statistical risk measure, calculating the level of potential losses that could be expected to be exceeded, over a specified holding period and at a given level of confidence, in normal market conditions, due to adverse movements in the investment portfolio’s underlying securities and investments valuations.

The Company calculates the VaR of the investment portfolio using a 1-month time horizon and a 95% level of confidence. This means that, on average, the Company could expect losses greater than predicted by the VaR results 5% of the time, or once every 20 months. The calculation of VaR is performed monthly using a full valuation based on the Monte Carlo approach and it is expressed both in terms of U.S. dollars and as a percentage of the Company’s investment portfolio.

The modeling of the risk of any portfolio, as measured by VaR, involves a number of assumptions and approximations. While the Company believes that its assumptions and approximations are appropriate, there is no uniform industry methodology for calculating VaR. The Company notes that different VaR results can be produced for the same portfolio dependent, not only on the approach used but also on the assumptions employed when implementing the approach.

The VaR approach uses historical data to determine the sensitivity of each of the underlying securities to the risk factors incorporated into the models that are employed in the Monte Carlo simulations. In calculating these sensitivities, greater importance is placed on the more recent data points and information. Since the VaR approach is based on historical positions and market data, VaR results should not be viewed as an absolute and predictive gauge of future financial performance or as a way for the Company to predict risk. There is no assurance that the Company’s actual future losses will not exceed its VaR and the Company expects that 5% of the time the VaR will be exceeded. Additionally, the Company acknowledges the fact that risks associated with abnormal market events can be significantly different from the VaR results and these are by definition not reflected or assessed in the VaR analysis.

The VaR of the investment portfolio at December 31, 2004 was approximately $487.3 million. The VaR of all investment relative derivatives excluding investments in affiliates and other investments was $15.1 million at December 31, 2004.

In instances where the data or time series are insufficient to determine the risk factor sensitivities, the VaR approach uses proxy time series data available for similar instruments. As at December 31, 2004, approximately $12.3 billion (39% of the Company’s investment portfolio at market value) used proxy time series data.

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Approximately $8.7 billion related to various fixed income portfolios, $1.7 billion to alternative investments, $77.5 million to equity portfolios, ($26.2) million to derivatives, $1.6 billion to various cash portfolios and $205 million to private investments. The Company reviews the proxies to ensure that an appropriate data and time series is being used in the calculations and that the proxies used are conservative.

The following two tables show the Company’s average, minimum and maximum VaR in percentage and dollar terms for the total investment portfolio during 2004, based upon the VaR at quarter end dates. The two tables also include the Company’s VaR in percentage and dollar terms, respectively, for the total investment portfolio as at December 31, 2004. The Company’s investment portfolio VaR as at December 31, 2004 is not necessarily indicative of future VaR levels.

				At December 31,
	Average VaR	Minimum VaR	Maximum VaR	2004
	% VaR(1)	% VaR(1)	% VaR(1)	% VaR(1)
Fixed Income	1.86%	1.40%	2.21%	1.47%
Alternatives (2)	0.07%	0.05%	0.09%	0.08%
Equity	0.11%	0.09%	0.15%	0.09%
Private Investments	0.05%	0.04%	0.06%	0.04%
Derivatives	0.04%	0.03%	0.05%	0.05%
Cash Equivalents	0.04%	0.02%	0.08%	0.02%
Total Undiversified VaR (3)	2.17%	1.67%	2.61%	1.75%
Diversification VaR (4)	(0.21)%	NA	NA	(0.19)%
Total Investment Portfolio VaR (5)	1.96%	1.49%	2.36%	1.56%

NA – not applicable

				VaR as at
	Average VaR	Minimum VaR	Maximum VaR	December 31,
	during 2004	during 2004	during 2004	2004
(U.S. dollars in millions)	$VaR(6)	$VaR(6)	$VaR(6)	$VaR(6)
Total Investment Portfolio VaR (5)	540.0	457.1	609.5	487.3

(1)	Based on a 95% confidence level with a one month holding period and expressed as a percentage of the total investment portfolio.
(2)	The majority of the Company’s alternative investment portfolio is accounted for as investments in affiliates. However, for purposes of monitoring and tracking the Company’s total investment market risk, the total alternative investment portfolio is included in these calculations.
(3)	Average Total Undiversified VaR for the year ended December 31, 2004 and Total Undiversified VaR at December 31, 2004 is the summation of the individual VaRs for each of the separate asset classes and, by construction, ignores any and all correlations between the different asset classes. The Total Undiversified VaR therefore ignores diversification benefits that exist in between these different asset classes. Maximum and Minimum Total Undiversified VaR is not necessarily the summation of the individual VaRs for each of the separate asset classes since the Maximum and Minimum VaRs for each of the asset classes and the Maximum and Minimum Total Undiversified VaR do not necessarily refer to the same point in time.
(4)	Diversification VaR equals the difference between the Total Investment Portfolio VaR and the Total Undiversified VaR. As the former explicitly accounts for the correlations and diversification benefits that exist between the actual asset classes and the latter explicitly does not, the difference in the two VaR results is due to the ‘diversification benefits’. These diversification benefits arise due to the risk reduction that occurs when different assets, that are not perfectly correlated, are combined in a portfolio. It will vary over time dependent on: allocations changes; changes in the correlations between the different asset classes; and changes in the general asset class risks. The NA reflects the fact that, since the Minimum and Maximum VaR for the six different asset class portfolios do not refer to the same point in time, and therefore it is not meaningful to calculate the Diversification VaR.
(5)	Total Investment Portfolio VaR is the Company’s investment portfolio VaR based on the prescribed methodology that explicitly accounts for the diversification benefits that occur when each of the allocations to the individual asset classes are included in the investment portfolio.
(6)	Based on a 95% confidence level with a one month holding period, expressed in millions of U.S. Dollars.

The Company’s total investment portfolio VaR is driven by: the size of the overall investment portfolio; the size of the allocations to the different asset classes and securities in the asset classes; the risks associated with each of the asset classes and securities; and the correlations and diversification benefits between each of the asset classes and securities. Changes in any of these variables will have a direct impact on the Company’s VaR.

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The Company’s total undiversified VaR, which ignores any correlation and diversification benefits, at December 31, 2004 was 1.75% compared to a maximum of 2.61% and a minimum of 1.67% during 2004. The Company’s average diversification VaR during 2004 resulted in an average reduction of the Company’s total undiversified VaR of 0.21% and as at December 31, 2004 was 0.19%.

The Company’s total investment portfolio VaR was on average 1.96% during 2004 and as at December 31, 2004, was 1.56%. The Company’s maximum and minimum total investment portfolio VaR during 2004 were 2.36% and 1.49%, respectively. The Company’s largest VaR exposure during 2004 was to fixed income. The average VaR for fixed income was 1.86%, compared to a maximum of 2.21% and a minimum of 1.40%. As at December 31, 2004, the fixed income VaR was 1.47%.

At December 31, 2004, the ranking for the Company’s asset class risk, based on the individual asset class VaRs, was: fixed income; equity; alternative investments; derivatives; private investments; and cash equivalents.

Stress Testing

VaR does not provide the means to estimate the magnitude of the loss in the 5% of occurrences that the Company expects the VaR level to be exceeded. To complement the VaR analysis based on normal market environments, the Company considers the impact on the investment portfolio in several different historical stress periods to analyze the effect of unusual market conditions. The Company establishes certain historical stress test scenarios which are applied to the actual investment portfolio. As these stress tests and estimated gains and losses are based on historical events, they will not necessarily reflect future stress events or gains and losses from such events. The results of the stress test scenarios are reviewed on a regular basis to ensure they are appropriate, based on current shareholders equity, market conditions and the Company’s total risk tolerance.

The table below shows the maximum impact on the Company’s investment portfolio if all events stress tested were to repeat themselves, given the actual investment portfolio’s allocations at quarter end dates during 2004. The Company assumes that no action is taken during the stress period to either liquidate or rebalance the portfolio. The Company believes that this fairly reflects the potential decreased liquidity that is often associated with stressed market environments.

	March 31,	June 30,	September 30,	December 31,
Stress Test	2004	2004	2004	2004
Maximum loss impact on portfolio	(5.6%)	(5.6%)	(5.6%)	(5.7%)
Maximum gain impact on portfolio	18.3%	18.4%	17.9%	18.4%

From the different scenarios that the Company analyzes, the largest downside event risk exposure during 2004 was 5.7%, based on the investment portfolio as at December 31, 2004. The largest upside risk exposure during 2004 was 18.4% as at June 30, 2004 and December 31, 2004.

Given the investment portfolio allocations as at December 31, 2004, the Company would expect to lose approximately 5.7% of the portfolio if the most damaging event stress tested was repeated, all other things held equal. Given the investment portfolio allocations as at December 31, 2004, the Company would expect to gain approximately 18.4% of the portfolio if the most favorable event stress tested was repeated, all other things held equal.

Fixed Income Portfolio

The Company’s fixed income portfolio is exposed to credit and interest rate risk through its portfolio of debt securities, and includes fixed maturities and short-term investments. The fixed income portfolio includes fixed maturities, short-term investments, cash and cash equivalents and net payable for investments purchased.

As at December 31, 2004, the value of the Company’s fixed income portfolio including cash and cash equivalents and net payable for investments purchased was approximately $28.9 billion as compared to approximately $22.5 billion as at December 31, 2003. As at December 31, 2004, the fixed income portfolio consisted of approximately

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89.1% of the total investment portfolio (including cash and cash equivalents, accrued investment income and net payable for investments purchased) as compared to approximately 88.5% as at December 31, 2003.

The Company manages credit risk in the investment portfolio through the credit research performed by the external investment professionals and limitations on the investment portfolio’s exposure to individual credits, as set by the Company. Limits are set for each credit quality rating and are a function of the probability of default and the expected loss in the event of a default. Limits ensure that potential losses from individual defaults should not exceed predetermined levels.

The Company reviews on a regular basis its corporate debt concentration, credit quality and compliance with established credit limits. Any obligor over its credit limits, experiencing financial difficulties, material credit quality deterioration or potentially subject to forthcoming credit quality deterioration is placed on a Watch List for closer monitoring. Where appropriate, exposures are reduced or prevented from increasing.

The table below shows the Company’s fixed income portfolio by credit rating in percentage terms of the Company’s total fixed income exposure (including fixed maturities, short-term investments, cash and cash equivalents and net payable for investments purchased) as at December 31, 2004.

	Total
AAA	58.2%
AA	10.2%
A	16.6%
BBB	10.4%
BB & below	3.9%
NR	0.7%
Total	100.0%

At December 31, 2004 and 2003, the average credit quality of the Company’s total fixed income portfolio was “AA”.

As at December 31, 2004, the top 10 corporate holdings represented approximately 9.9% of the total fixed income portfolio and approximately 45.7% of all corporate holdings. The top 10 corporate holdings listed below utilizes a conservative approach to aggregation as it includes unsecured as well as securitized, credit enhanced and collateralized securities issued by parent companies and their affiliates.

	Percentage of Total
Top 10 Corporate Holdings (2)	Fixed Income Portfolio (1)
JPMorgan Chase & Co	1.9%
Citigroup Inc	1.6%
Bank of America Corporation	1.0%
Bear, Sterns & Co. Inc.	1.0%
Morgan Stanley	0.9%
General Electric Company	0.7%
MBNA Corp	0.7%
General Motors Corporation	0.7%
General Motors Corporation	0.7%
Wachovia Corporation	0.7%
DaimlerChrysler AG	0.7%

(1)

Including fixed maturities, short-term investments, cash and cash equivalents and net payable for investments purchased.

(2)

Corporate holdings include parent and affiliated companies that issue fixed income securities. In many cases a portion of the market value includes Asset Backed or Mortgage Backed securities, which are investments that are securitized, bankruptcy remote entities which have sufficient credit enhancement to provide a longer-term credit rating that is higher than the rating of the unsecured debt of the related company or its corporate securities.

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The Company’s fixed income portfolio is exposed to interest rate risk. Interest rate risk is the price sensitivity of a fixed income security to changes in interest rates. The Company manages interest rate risk within the context of its overall asset liability management strategy by setting duration targets for its investment portfolio in line with the estimated duration of its liabilities, thus mitigating the overall economic effect of interest rate risk. The Company remains nevertheless exposed to accounting interest rate risk since the assets are marked to market, thus subject to market conditions, while liabilities are accrued at a static rate. The hypothetical case of an immediate 100 basis point adverse parallel shift in global bond curves as at December 31, 2004 would decrease the fair value of the Company’s fixed income portfolio by approximately 4.4% or $1.3 billion. Based on historical observations, it is unlikely that all global yield curves would shift in the same direction and at the same time.

In addition, the Company has short-term debt and long-term debt outstanding. Interest rates on short-term debt are LIBOR based. Accordingly, any changes in interest rates will affect interest expense.

Equity Portfolio

As at December 31, 2004, the Company’s equity portfolio, which for financial reporting purposes includes certain fixed income mutual fund investments that do not have the risk characteristics of equity investments, was $963 million as compared to $583 million as at December 31, 2003. As at December 31, 2004, the Company’s allocation to equity securities was approximately 3.0% of the total investment portfolio (including cash and cash equivalents, accrued investment income and net payable for investments purchased) as compared to approximately 2.3% as at December 31, 2003.

As at December 31, 2004, approximately 60% of the equity portfolio was invested in U.S. companies as compared to approximately 62% as at December 31, 2003. As at December 31, 2004, the top ten equity holdings represented approximately 8.0% of the Company’s total equity portfolio as compared to approximately 11.6% as at December 31, 2003.

The Company’s equity portfolio is exposed to price risk. Equity price risk is the potential loss arising from decreases in the market value of equities. An immediate hypothetical 10% change in the value of each equity position would affect the fair value of the portfolio by approximately $96.3 million as at December 31, 2004.

Alternative Investment Portfolio

A portion of the Company’s portfolio is invested in funds that pursue alternative investment strategies, with the investment objective of attaining high risk-adjusted total return whilst maintaining a low level of correlation to the traditional asset classes and realizing a low volatility. Investments within this portfolio are generally fund investments in limited partnerships or similar vehicles, with each fund pursuing absolute return investment mandates, typically investing in one or more of the traditional asset classes including equities, fixed income, credit, currency and commodity markets.

Various strategies can be pursued and the Company classifies each fund allocation into four general style categories. The four styles are: Event driven, which includes strategies that pursue merger arbitrage, distressed and special situations opportunities; Directional/tactical, which includes strategies that pursue long/short equity, managed futures and macro opportunities; Arbitrage, which includes strategies that pursue equity market neutral, fixed income arbitrage and convertible arbitrage opportunities; and Multi-strategy, which includes strategies incorporating aspects of the above.

The Company utilizes additional risk and portfolio management analytics and processes to enhance the overall management and assessment of the alternative investment portfolio. Central to the portfolio and risk management processes is the receipt of information on each of its allocations that is sufficient to assess risks and exposures of the fund allocations and to monitor how the portfolio and associated risk changes over time. The level and frequency of information required by the Company on each investment depends on the type of strategy that a fund pursues; the expected risk profile and types of risk that the fund and underlying securities are exposed to the liquidity of the fund and underlying securities, and the size of the allocation.

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The Company’s alternative investment portfolio had approximately 100 separate investments in different funds at December 31, 2004 with a total exposure of $1.7 billion making up approximately 5.2% of total investments compared to December 31, 2003 where the Company had over 100 separate fund investments with a total exposure of $1.4 billion representing approximately 5.5% of total investments.

At December 31, 2004, the alternative investment style allocation was 42% in Directional/tactical strategies, 25% in Event driven strategies, 25% in Arbitrage strategies, and 8% in Multi-strategy strategies. At December 31, 2003, the Alternative investment style allocation was 35% in Arbitrage strategies, 39% in Directional/tactical strategies and 26% in Event driven strategies.

Private Investment Portfolio

A portion of the Company’s portfolio is invested in limited partnerships and other entities which are not publicly traded. In addition to normal market risks, these positions may also be exposed to liquidity risk, risks related to distressed investments, and risks specific to startup or small companies.

As at December 31, 2004, the Company’s exposure to private investments was approximately $206 million compared to $200 million as at December 31, 2003. As at December 31, 2004, the Company’s exposure to private investments consisted of approximately 0.6% of the total investment portfolio (including cash and cash equivalents, accrued investment income and net payable for investments purchased), as compared to 0.8% as at December 31, 2003.

Bond and Stock Index Futures Exposure

At December 31, 2004, bond and stock index futures outstanding had a net long position of $1.3 billion as compared to a net short position of $376.1 million at December 31, 2003. A 10% appreciation or depreciation of the underlying exposure to these derivative instruments would have resulted in realized gains or realized losses of $129.5 million as at December 31, 2004 and $37.6 million as at December 31, 2003, respectively. The Company may reduce its exposure to these futures through offsetting transactions, including options and forwards.

Foreign Currency Exchange Risk

The Company has exposure to foreign currency exchange rate fluctuations through its operations and in its investment portfolio. The Company’s net foreign currency denominated payable on foreign exchange contracts as at December 31, 2004 was $3.8 million and the net foreign currency denominated receivable was $31.1 million with a net unrealized loss of $11.8 million as at December 31, 2004 and $6.7 million as at December 31, 2003.

Foreign exchange contracts within the investment portfolio are utilized to manage individual portfolio foreign exchange exposures, subject to investment manager guidelines established by management. These contracts are not designated as specific hedges for financial reporting purposes and, therefore, realized and unrealized gains and losses on these contracts are recorded in income in the period in which they occur. These contracts generally have maturities of three months or less.

The Company also attempts to manage the foreign exchange volatility arising on certain transactions denominated in foreign currencies. These include, but are not limited to, premium receivable, reinsurance contracts, claims payable and investments in subsidiaries.

Credit Risk

The Company is exposed to credit risk in the event of non-performance by the other parties to its forward contracts, however the Company does not anticipate non-performance. The difference between the notional principal amounts and the associated market value is the Company’s maximum credit exposure.

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Index to Consolidated Financial Statements and Related Notes	Page
Consolidated Balance Sheets as at December 31, 2004 and 2003	94
Consolidated Statements of Income and Comprehensive Income for the years ended       December 31, 2004, 2003 and 2002	95
Consolidated Statements of Shareholders’ Equity for the years ended       December 31, 2004, 2003 and 2002	96
Consolidated Statements of Cash Flows for the years ended       December 31, 2004, 2003 and 2002	97
Notes to Consolidated Financial Statements for the years ended       December 31, 2004, 2003 and 2002	99

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XL CAPITAL LTD

CONSOLIDATED BALANCE SHEETS AS AT DECEMBER 31, 2004 AND 2003

A S S E T S

(U.S. dollars in thousands, except share amounts)	2004	2003
Investments:
Fixed maturities at fair value (amortized cost: 2004, $24,452,348; 2003, $18,990,670;)	$25,100,194	$19,494,356
Equity securities, at fair value (cost: 2004, $778,117; 2003, $ 473,112)	962,920	583,450
Short-term investments, at fair value (amortized cost: 2004, $1,738,845; 2003, $696,798)	1,760,714	697,450
Total investments available for sale	27,823,828	20,775,256
Investments in affiliates	1,936,852	1,903,341
Other investments	305,160	142,567
Total investments	30,065,840	22,821,164
Cash and cash equivalents	2,304,303	2,829,627
Accrued investment income	326,510	294,615
Deferred acquisition costs	845,422	777,882
Prepaid reinsurance premiums	992,260	977,595
Premiums receivable	3,838,228	3,487,322
Reinsurance balances receivable	1,095,739	1,359,486
Unpaid losses and loss expenses recoverable	6,740,519	5,779,997
Goodwill and other intangible assets	1,827,782	1,845,507
Deferred tax asset, net	288,599	310,077
Other assets	689,430	707,449
Total assets	$49,014,632	$41,190,721
L I A B I L I T I E S  A N D  S H A R E H O L D E R S ’  E Q U I T Y
Liabilities:
Unpaid losses and loss expenses	$19,598,531	$16,558,788
Deposit liabilities	5,725,590	4,050,334
Future policy benefit reserves	4,547,688	3,233,845
Unearned premiums	5,191,368	4,729,989
Notes payable and debt	2,721,431	1,905,483
Reinsurance balances payable	1,565,689	1,525,739
Net payable for investments purchased	273,535	523,077
Other liabilities	1,578,665	1,666,397
Minority interest	73,440	60,154
Total liabilities	$41,275,937	$34,253,806
Commitments and Contingencies
Shareholders’ Equity:
Series A preference ordinary shares, 9,200,000 authorized, par value $0.01
Issued and outstanding: (2004 and 2003, 9,200,000)	$ 92	$ 92
Series B preference ordinary shares, 11,500,000 authorized, par value $0.01       Issued and outstanding: (2004 and 2003, 11,500,000)	115	115
Series C preference ordinary shares, 20,000,000 authorized, par value $0.01       Issued and outstanding: 2004 and 2003, nil.	–	–
Class A ordinary shares, 999,990,000 authorized, par value $0.01       Issued and outstanding: (2004, 138,932,481 , 2003, 137,343,232)	1,389	1,373
Additional paid in capital	3,950,175	3,949,421
Accumulated other comprehensive income	460,273	490,195
Deferred compensation	(69,988)	(46,124)
Retained earnings	3,396,639	2,541,843
Total shareholders’ equity	$ 7,738,695	$ 6,936,915
Total liabilities and shareholders’ equity	$49,014,632	$41,190,721

See accompanying Notes to Consolidated Financial Statements

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XL CAPITAL LTD

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002

(U.S. dollars in thousands, except share and per share amounts)	2004	2003	2002
Revenues:
Net premiums earned – general operations	$ 6,982,549	$6,081,033	$4,899,073
Net premiums earned – life and annuity operations	1,405,699	748,495	1,022,992
Net premiums earned – financial operations	161,285	139,622	67,745
Net investment income	995,036	779,558	734,535
Net realized gains (losses) on investments	246,547	120,195	(214,160)
Net realized and unrealized gains (losses) on
derivative instruments	78,019	(27,542)	(51,761)
Net income from investment affiliates	124,008	119,200	54,143
Fee income and other	35,317	41,745	54,963
Total revenues	$10,028,460	$8,002,306	$6,567,530
Expenses:
Net losses and loss expenses incurred – general             and financial operations	$ 4,863,940	$4,610,606	$3,327,315
Claims and policy benefits – life operations	1,500,128	818,894	1,069,456
Acquisition costs	1,264,864	1,167,186	955,331
Operating expenses	1,053,135	797,826	674,403
Exchange (gains) losses	(40,678)	(38,619)	(80,294)
Interest expense	259,075	199,407	168,086
Amortization of intangible assets	15,827	4,637	6,187
Total expenses	$ 8,916,291	$7,559,937	$6,120,484
Income before minority interest, income tax and equity in net             income of operating affiliates	$ 1,112,169	$ 442,369	$ 447,046
Minority interest in net income of subsidiary	8,387	9,264	13,371
Income tax expense	84,526	30,049	22,647
Net income (loss) from operating affiliates	147,357	8,923	(5,457)
Net income	$ 1,166,613	$411,979	$ 405,571
Preference share dividends	(40,321)	(40,321)	(9,620)
Net income available to ordinary shareholders	$ 1,126,292	$ 371,658	$ 395,951
Net income	$ 1,166,613	$ 411,979	$ 405,571
Change in net unrealized appreciation (depreciation) of investments	149,662	342,232	393,781
Derivative (loss) on cash flow hedge	(6,118)	–	–
Foreign currency translation adjustments	(173,466)	(36,851)	4,046
Comprehensive income	$ 1,136,691	$ 717,360	$ 803,398
Weighted average ordinary shares and ordinary share equivalents       outstanding – basic	137,903	136,906	135,636
Weighted average ordinary shares and ordinary share equivalents       outstanding – diluted	138,582	138,187	137,388
Earnings per ordinary share and ordinary share equivalent – basic	$ 8.17	$ 2.71	$ 2.92
Earnings per ordinary share and ordinary share equivalent – diluted	$ 8.13	$ 2.69	$ 2.88

See accompanying Notes to Consolidated Financial Statements

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XL CAPITAL LTD

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002

(U.S. dollars in thousands)	2004	2003	2002
Series A and B Preference Ordinary Shares:
Balance – beginning of year	$ 207	$ 207	$ –
Issue of shares	–	–	207
Balance – end of year	$ 207	$ 207	$ 207
Ordinary Shares:
Balance – beginning of year	$ 1,373	$ 1,360	$ 1,347
Issue of shares	7	5	2
Exercise of stock options	10	8	11
Repurchase of shares	(1)	–	–
Balance – end of year	$ 1,389	$ 1,373	$ 1,360
Additional paid in capital:
Balance – beginning of year	$3,949,421	$3,979,979	$3,378,549
Issue of shares	59,407	34,103	522,713
Stock option expense	14,575	5,590	–
Exercise of stock options	34,796	42,103	79,364
Repurchase of shares	(3,558)	(424)	(647)
Equity units / debt value	(104,466)	–	–
Contingent capital costs	–	(111,930)	–
Balance – end of year	$3,950,175	$3,949,421	$3,979,979
Accumulated Other Comprehensive Income (Loss):
Balance – beginning of year	$ 490,195	$ 184,814	$ (213,013)
Net change in unrealized gains (losses) on investment portfolio,             net of tax	162,683	345,650	400,404
Net change in unrealized (losses) gains on affiliate             and other investments	(13,021)	(3,418)	(6,623)
Derivative loss on cash flow hedge	(6,118)	–	–
Currency translation adjustments	(173,466)	(36,851)	4,046
Balance – end of year	$ 460,273	$ 490,195	$ 184,814
Deferred Compensation:
Balance – beginning of year	$   (46,124)	$ (31,282)	$ (27,177)
Issue of restricted shares	(52,257)	(32,757)	(18,416)
Amortization	28,393	17,915	14,311
Balance – end of year	$    (69,988)	$ (46,124)	$ (31,282)
Retained Earnings:
Balance – beginning of year	$2,541,843	$2,434,511	$2,297,478
Net income	1,166,613	411,979	405,571
Dividends on Class A ordinary shares	(270,452)	(263,176)	(257,054)
Dividends on Series A and B preference ordinary shares	(40,321)	(40,321)	(9,620)
Repurchase of shares	(1,044)	(1,150)	(1,864)
Balance – end of year	$3,396,639	$2,541,843	$2,434,511
Total shareholders’ equity	$7,738,695	$6,936,915	$6,569,589

See accompanying Notes to Consolidated Financial Statements

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XL CAPITAL LTD

CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002

(U.S. dollars in thousands)	2004	2003	2002
Cash Flows Provided by Operating Activities:
Net income	$ 1,166,613	$ 411,979	$ 405,571
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Net realized (gains) losses on sales of investments	(246,547)	(120,195)	214,160
Net realized and unrealized (gains) losses on derivative instruments	(78,019)	27,542	51,761
Amortization of discounts on fixed maturities	80,740	44,792	(15,715)
Amortization of intangible assets	15,827	4,637	6,187
Amortization of deferred compensation	28,393	17,915	14,311
Accretion of convertible debt	21,775	25,512	24,831
Accretion of deposit liabilities	129,872	105,070	65,884
Equity in net income of investment, and operating affiliates	(271,365)	(128,123)	(48,687)
Unpaid losses and loss expenses	3,039,743	3,356,052	850,566
Unearned premiums	461,379	701,690	1,316,263
Premiums receivable	(350,906)	105,391	(1,337,876)
Unpaid losses and loss expenses recoverable	(960,522)	(881,342)	76,347
Future policy benefit reserves	1,313,843	757,427	1,103,327
Prepaid reinsurance premiums	(14,665)	(20,559)	(102,580)
Reinsurance balances receivable	263,747	(119,516)	68,869
Reinsurance balances payable	39,950	(398,411)	182,861
Deferred acquisition costs	(67,540)	(89,601)	(294,023)
Deferred tax asset	21,478	10,547	102,162
Other	(221,286)	(380,474)	352,226
Total adjustments	$ 3,205,897	$ 3,018,354	$ 2,630,874
Net cash provided by operating activities	$ 4,372,510	$ 3,430,333	$ 3,036,445
Cash Flows Used in Investing Activities:
Proceeds from sale of fixed maturities and short-term investments	$ 23,346,159	$ 27,235,169	$ 44,554,304
Proceeds from redemption of fixed maturities and             short-term investments	3,976,544	11,462,093	3,753,801
Proceeds from sale of equity securities	771,943	1,224,420	754,611
Purchases of fixed maturities and short-term investments	(33,935,293)	(44,732,460)	(50,859,921)
Purchases of equity securities	(805,235)	(909,414)	(531,437)
Investments in affiliates, net of dividends received	88,997	(56,004)	(717,523)
Acquisition of subsidiaries, net of cash acquired	–	(91,470)	(43,143)
Other investments	(34,311)	4,697	34,171
Fixed assets and other	–	(3,338)	(4,509)
Net proceeds from purchase and sale of leasehold property	$ –	$ 45,307	$ –
Net Cash Used in Investing Activities	(6,591,196)	(5,821,000)	(3,059,646)

See accompanying Notes to Consolidated Financial Statements

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XL CAPITAL LTD

CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002 (Continued)

(U.S. dollars in thousands)	2004	2003	2002
Cash Flows Provided by Financing Activities:
Issue of preference shares	$ –	$ –	$ 503,579
Proceeds from exercise of stock options and issue of common shares	41,480	42,113	79,375
Repurchase of common shares	(4,602)	(1,574)	(2,512)
Dividends paid on common shares	(270,452)	(263,176)	(257,054)
Dividends paid on preference shares	(40,321)	(40,321)	(9,620)
Proceeds from notes payable and debt	1,742,317	–	846,814
Repayment of notes payable and debt	(974,384)	–	(600,000)
Deposit liabilities	1,524,022	1,496,285	1,156,285
Net cash flow on securities lending	(324,470)	313,861	(262,913)
Net cash provided by financing activities	1,693,590	1,547,188	1,453,954
Effects of exchange rate changes on foreign currency cash	(228)	2,646	288
(Decrease) increase in cash and cash equivalents	(525,324)	(840,833)	1,431,041
Cash and cash equivalents – beginning of year	2,829,627	3,670,460	2,239,419
Cash and cash equivalents – end of year	$ 2,304,303	$2,829,627	$3,670,460
Net taxes (paid) received	$ (30,861)	$ (3,154)	$ 76,750
Interest paid	$ (79,848)	$ (62,929)	$ (36,820)

See accompanying Notes to Consolidated Financial Statements

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XL CAPITAL LTD

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002

1. History

XL Capital Ltd together with its subsidiaries (the “Company” or “XL”), is a holding company organized under the laws of the Cayman Islands. XL Capital Ltd was incorporated on March 16, 1998, as the successor to EXEL Limited, a Cayman Islands corporation organized in 1986, in connection with EXEL Limited’s merger with Mid Ocean Limited, a Cayman Islands corporation. XL Capital Ltd operated under the name EXEL Limited from completion of the merger until February 1, 1999, when its current name was approved by the requisite vote of the Company’s shareholders. The Company provides insurance and reinsurance coverages and financial products and services to industrial, commercial and professional service firms, insurance companies and other enterprises on a worldwide basis.

Effective January 1, 2002, the Company increased its shareholding in Le Mans Ré from 49% to 67% in order to expand its international reinsurance operations. Due to certain contractual arrangements between the Company and Les Mutuelles du Mans Assurances Group (“MMA”), MMA did not have any economic interest in the earnings of Le Mans Ré with effect from January 1, 2002 and accordingly, no minority interest was recorded from that date. In September 2003, the Company purchased the remaining 33% and Le Mans Ré was renamed “XL Re Europe”. XL Re Europe underwrites a worldwide portfolio comprising most classes of property and casualty reinsurance business, together with a selective portfolio of life reinsurance business. See Note 5 for additional information.

On July 25, 2001, the Company acquired certain Winterthur International insurance operations (“Winterthur International”) to extend its predominantly North American based large corporate business globally. Effective July 1, 2001, the Company’s results include Winterthur International. See Note 5 for additional information. In 2003, the Winterthur International operations changed its name to “XL Global Risk”.

In 1999, XL Capital Ltd merged with NAC Re Corp (“NAC”), a Delaware corporation. NAC was organized in 1985 and wrote property and casualty insurance and reinsurance in the U.S., Canada and Europe.

2. Significant Accounting Policies

(a) Basis of Preparation and Consolidation

These consolidated financial statements include the accounts of the Company and all of its subsidiaries. These consolidated financial statements have been prepared in accordance with U.S. GAAP (“GAAP”). The results include the consolidation of XL Re Europe, accounted for as a subsidiary effective January 1, 2002, described in Note 5(a). In addition, the results also include the acquired certain Winterthur International operations, effective July 1, 2001, under the purchase method of accounting, described in Note 5. All significant intercompany accounts and transactions have been eliminated. Certain amounts in 2003 and 2002 have been reclassified to conform to the current year presentation.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. While management believes that the amounts included in the consolidated financial statements reflect the Company’s best estimates and assumptions, actual results could differ from these estimates.

(b) Premiums and Acquisition Costs

Premiums written are recorded in accordance with the terms of the underlying policies. Reinsurance premiums written are recorded at the inception of the policy and are estimated based upon information received from ceding

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. Significant Accounting Policies (continued)

(b) Premiums and Acquisition Costs (continued)

companies and any subsequent differences arising on such estimates are recorded in the period they are determined. Financial guaranty installment premiums are recorded as premiums written when due.

Premiums are earned on a pro-rata basis over the period the coverage is provided. Financial guaranty insurance premiums are earned pro rata to the amount of risk outstanding over the life of the exposure. Unearned premiums represent the portion of premiums written applicable to the unexpired terms of policies in force. Net premiums earned are presented after deductions for reinsurance ceded, as applicable.

Reinstatement premiums are recognized at the time a loss event occurs where coverage limits for the remaining life of the contract are reinstated under pre-defined contract terms and are earned on a pro-rata basis over the remaining risk period.

Life and annuity premiums from long duration contracts that transfer significant mortality or morbidity risks are recognized as revenue and earned when due from policyholders. Life and annuity premiums from long duration contracts that do not subject the Company to risks arising from policyholder mortality or morbidity are accounted for as investment contracts and presented within deposit liabilities.

Acquisition costs, which vary with and are related to the acquisition of policies, consist primarily of commissions paid to brokers and cedents and certain underwriting costs and are deferred and amortized over the period that the premiums are earned. Acquisition costs are shown net of commissions earned on reinsurance ceded. Future earned premiums, the anticipated losses and other costs (and in the case of a premium deficiency, investment income) related to those premiums, are also considered in determining the level of acquisition costs to be deferred.

(c) Reinsurance

In the normal course of business, the Company seeks to reduce the potential amount of loss arising from claims events by reinsuring certain levels of risk assumed in various areas of exposure with other insurers or reinsurers. Reinsurance premiums ceded are expensed (and any commissions recorded thereon are earned) on a monthly pro-rata basis over the period the reinsurance coverage is provided. Prepaid reinsurance premiums represent the portion of premiums ceded applicable to the unexpired term of policies in force. Reinstatement premiums ceded are recorded at the time a loss event occurs where coverage limits for the remaining life of the contract are reinstated under pre-defined contract terms and are expensed over the remaining risk period. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policy. Provisions are made for estimated unrecoverable reinsurance.

(d) Fee Income and Other

Fee income and other includes fees received for insurance and product structuring services provided and is earned over the service period of the contract. Any adjustments to fees earned or the service period are reflected in income in the period when determined.

(e) Other Than Temporary Declines in Investments

The Company reviews the fair value of its investment portfolio on a periodic basis to identify declines in fair value below the carrying value that are other than temporary. This review involves consideration of several factors including (i) the time period during which there has been a significant decline in fair value below carrying value, (ii)

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2. Significant Accounting Policies (continued)

(e) Other Than Temporary Declines in Investments (continued)

an analysis of the liquidity, business prospects and overall financial condition of the issuer, (iii) the significance of the decline, (iv) an analysis of the collateral structure and other credit support, as applicable, of the securities in question and (v) the Company’s intent and ability to hold the investment for a sufficient period of time for the value to recover. Where the Company concludes that declines in fair values are other than temporary, the cost of the security is written down to fair value below carrying value and the previously unrealized loss is therefore realized in the period such determination is made.

With respect to securities where the decline in value is determined to be temporary and the security’s value is not written down, a subsequent decision may be made to sell that security and realize a loss. Subsequent decisions on security sales are made within the context of overall risk monitoring, changing information, market conditions generally and assessing value relative to other comparable securities.

(f) Derivative Instruments and Weather Derivative Contracts

The Company recognizes all derivatives as either assets or liabilities in the balance sheet and measures those instruments at fair value. Non-exchange traded weather products are recorded at fair value. The changes in fair value of derivatives are shown in the consolidated statement of income as “net realized and unrealized gains and losses on derivative instruments” unless the derivatives are designated as hedging instruments. If the derivatives qualify as hedges, depending on the nature of the hedge, changes in the fair value of the derivatives are either offset against the change in fair value of assets, liabilities or firm commitments through earnings, or recognized in accumulated other comprehensive income until the hedged item is recognized in earnings. Any ineffective portion of a derivative’s change in fair value is recognized immediately in earnings. Changes in fair value of derivatives may create volatility in the Company’s results of operations from period to period.

The Company conducts activities in three main types of instruments: credit derivatives, weather and energy derivatives and investment related derivatives.

Credit derivatives

Credit derivatives are recorded at fair value, which is determined using models developed by the Company and is dependent upon a number of factors, including changes in interest rates, future default rates, credit spreads, changes in credit quality, future expected recovery rates and other market factors. The change resulting from movements in credit and credit quality spreads is unrealized as the credit derivatives are not traded to realize this resultant value.

Weather and Energy derivatives

Fair values for the Company’s natural gas contracts are determined through the use of quoted market prices. As quoted market prices are not widely available in the weather and electricity derivative markets, management uses available market data and internal pricing models based upon consistent statistical methodologies to estimate fair values. Estimating the fair value of instruments which do not have quoted market prices requires management’s judgment in determining amounts which could reasonably be expected to be received from, or paid to, a third party in settlement of the contracts. The amounts could be materially different from the amounts that might be realized in an actual sale transaction. Fair values are subject to change in the near-term and reflect management’s best estimate based on various factors including, but not limited to, actual and forecasted weather conditions, changes in commodity prices, changes in interest rates and other market factors.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. Significant Accounting Policies (continued)

(f) Derivative Instruments and Weather Derivative Contracts (continued)

Investment Related derivatives

The Company uses derivative instruments to manage duration and foreign currency exposure for its investment portfolio.

The Company uses investment derivative instruments, primarily interest rate swaps, to manage the interest rate exposure associated with certain assets and liabilities. All interest rate swaps are recorded at fair value. Changes in the value of derivative instruments designated as fair value hedges are recorded as adjustments to the hedged items to the extent that the hedge is effective. Changes in the value of derivative instruments designated as cash flow hedges are recorded in other comprehensive income to the extent that the hedge is effective. The ineffective portion of both fair value and cash flow hedges are recognized in earnings.

The Company also has investment related derivatives embedded in certain reinsurance contracts. For a particular life reinsurance contract, the Company pays the ceding company a fixed amount equal to the estimated present value of the excess of guaranteed benefit (“GMIB”) over the account balance upon the policyholder’s election to take the income benefit. The fair value of this derivative is determined based on the present value of expected cash flows. In addition, the Company has modified coinsurance and funds withheld reinsurance agreements that provide for a return based on a portfolio of fixed income securities, as such, the agreements contain embedded derivatives. The embedded derivative is bifurcated and recorded at fair value with changes in fair value recognized in earnings.

(g) Total Investments

Investments Available For Sale

Investments that are considered available for sale are carried at fair value. The fair value of investments is based upon quoted market values where available or by reference to broker or underwriter bid indications. The net unrealized appreciation or depreciation on investments, net of tax, is included in “accumulated other comprehensive income (loss)”. Any unrealized depreciation in value considered by management to be other than temporary is charged to income in the period that it is determined.

Short-term investments comprise investments with a maturity equal to or greater than 90 days at the time of purchase but less than one year. Equity securities include investments in open end mutual funds.

All investment transactions are recorded on a trade date basis. Realized gains and losses on sales of equities and fixed income investments are determined on the basis of average cost and amortized cost, respectively. Investment income is recognized when earned and includes interest and dividend income together with the amortization of premium and discount on fixed maturities and short-term investments.

Investment In Affiliates

Investments in which the Company has significant influence over the operating and financial policies of the investee are classified as investments in affiliates on the Company’s balance sheets and are accounted for under the equity method of accounting. Under this method, the Company records its proportionate share of income or loss from such investments in its results for the period. Significant influence is deemed to exist where the Company has an investment of 20% or more in the common stock of a corporation or an investment of 3% or greater in closed end funds, limited partnerships or similar investment vehicles. Significant influence is considered for other strategic investments on a case-by-case basis. The determination of whether an entity is classified as an affiliate for GAAP

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. Significant Accounting Policies (continued)

(g) Total Investments (continued)

accounting purposes may be different from the determination of whether such entity would constitute an affiliate for any other purposes, including regulatory purposes. The income from affiliates is shown separately between income from operating affiliates and net income from investment affiliates. Any decline in value of an affiliate investment considered by management to be other than temporary is charged to income in the period that it is determined.

Other investments

The Company accounts for its other investments which do not have readily determinable market values at estimated fair value as it has no significant influence over these entities. The net unrealized appreciation or depreciation on investments, net of tax, is included in “accumulated other comprehensive income/(loss).” Any unrealized depreciation in value considered by management to be other than temporary is charged to income in the period that it is determined.

Securities lending

The Company engages in a securities lending program whereby certain securities from the Company’s portfolio are loaned to other institutions for short periods of time. The market value of the loaned securities is monitored on a daily basis, with additional collateral obtained or refunded as the market value of the loaned securities changes. The Company’s policy is to require fixed maturities and initial cash collateral equal to between 102% and 105% of the fair value of the loaned securities depending on the class of assets loaned. The Company continues to earn interest on the securities loaned. In addition, the Company shares a portion of the interest earned on the collateral with the lending agent. The securities lending collateral is included in cash and cash equivalents with a corresponding liability related to the Company’s obligation to return the collateral plus interest included in net payable for investments purchased.

(h) Cash Equivalents

Cash equivalents include fixed interest deposits placed with a maturity of under 90 days when purchased.

(i) Foreign Currency Translation

Assets and liabilities of foreign operations whose functional currency is not the U.S. dollar are translated at prevailing year end exchange rates. Revenue and expenses of such foreign operations are translated at average exchange rates during the year. The net effect of the translation adjustments for foreign operations, net of applicable deferred income taxes, is included in “accumulated other comprehensive income (loss).”

Other monetary assets and liabilities denominated in foreign currencies are revalued at the exchange rate in effect at the balance sheet date and revenues and expenses are translated at the exchange rate on the date the transaction occurs with the resulting foreign exchange gains and losses recognized in income.

(j) Intangible Assets

Identifiable intangible assets with finite lives are amortized on a straight-line basis over their estimated useful lives. The Company evaluates the recoverability of its intangible assets whenever changes in circumstances warrant. If it is determined that an impairment exists, the excess of the unamortized balance over the fair value of the intangible asset will be charged to income at that time.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. Significant Accounting Policies (continued)

(j) Intangible Assets (continued)

Intangible assets with an indefinite life and goodwill are no longer amortized with effect from January 1, 2002, in accordance with FAS 142. The Company continues to review the carrying value of goodwill related to all of its investments for any impairment at least annually. If it is determined that an impairment exists, the Company adjusts the carrying value of goodwill to fair value. The impairment charge is recorded in income in the period in which it is determined. See Note 5 for further information.

(k) Losses and Loss Expenses

Unpaid losses and loss expenses includes reserves for reported unpaid losses and loss expenses and for losses incurred but not reported. The reserve for reported unpaid losses and loss expenses for the Company’s general and financial operations is established by management based on amounts reported from insureds or ceding companies, and represents the estimated ultimate cost of events or conditions that have been reported to or specifically identified by the Company.

The reserve for losses incurred but not reported is estimated by management based on loss development patterns determined by reference to the Company’s underwriting practices, the policy form, type of program and historical experience. The Company’s actuaries employ a variety of generally accepted methodologies to determine estimated ultimate loss reserves, including the “Bornhuetter-Ferguson incurred loss method” and frequency and severity approaches.

Certain workers’ compensation, long term disability liabilities and financial guaranty case reserve contracts are considered fixed and determinable and are subject to tabular reserving. Reserves associated with these liabilities are discounted.

For the Company’s financial guaranty reserves, a case basis reserve for unpaid losses and loss adjustment expenses is recorded at the net present value of an estimated loss when, in management’s opinion, the likelihood of a future loss on a particular insured obligation is probable and determinable at a balance sheet date. The Company also maintains an unallocated reserve on its financial guaranty business which is based actuarial reserving analysis. This reserve is available to be applied to new case basis reserves that may be established for claims on current outstanding insured principal and interest in the future. This non-specific reserve is established for expected levels of losses associated with currently insured issues and is based on a portion of premiums earned to date. The Company, on an ongoing basis, monitors these reserves and may periodically adjust such reserves based on the Company’s actual loss experience, its future mix of business, and its view of future economic conditions.

Management believes that the reserves for unpaid losses and loss expenses are sufficient to cover losses that fall within coverages assumed by the Company. However, there can be no assurance that losses will not exceed the Company’s total reserves. The methodology of estimating loss reserves is periodically reviewed to ensure that the assumptions made continue to be appropriate and any adjustments resulting there-from are reflected in income of the year in which the adjustments are made.

(l) Deposit Liabilities

Contracts entered into by the Company with cedants which are not deemed to transfer significant underwriting and/or timing risk are accounted for as deposits, whereby liabilities are initially recorded at an amount equal to the assets received. The Company uses a portfolio rate of return of equivalent duration to the liabilities in determining risk transfer. An initial accretion rate is established based on actuarial estimates whereby the deposit liability is increased to the estimated amount payable over the term of the contract. The deposit accretion rate is the rate of return required

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. Significant Accounting Policies (continued)

(l) Deposit Liabilities (continued)

to fund expected future payment obligations (this is equivalent to the ‘best estimate’ of future cash flows), which are determined actuarially based upon the nature of the underlying indemnifiable losses. Accretion of the liability is recorded as interest expense. The Company periodically reassesses the estimated ultimate liability. Any changes to this liability are reflected as adjustments to interest expense to reflect the cumulative effect of the period the contract has been in force, and by an adjustment to the future accretion rate of the liability over the remaining estimated contract term.

Guaranteed investment contracts are initially recorded at an amount equal to the assets received. The Company may use derivative instruments in order to hedge the Company’s exposure to fluctuations in interest rates related to these contracts. Changes in the fair value of the hedging instrument are recognized in income. The change in the fair value of the hedged item, attributable to the hedged risk, is recorded as an adjustment to the carrying amount of the hedged item and is recognized in income.

(m) Future policy benefit reserves

The Company estimates the present value of future policy benefits related to long duration contracts using assumptions for investment yields, mortality, and expenses, including a provision for adverse deviation.

The assumptions used to determine future policy benefit reserves are best estimate assumptions that are determined at the inception of the contracts and are locked-in throughout the life of the contract unless a premium deficiency develops. As the experience on the contracts emerges, the assumptions are reviewed. If such review would produce reserves in excess of those currently held then the lock-in assumptions will be revised and a claim and policy benefit is recognized at that time.

Certain life insurance and annuity contracts provide the holder with a guaranty that the benefit received upon death will be no less than a minimum prescribed amount. The contracts are accounted for in accordance with SOP 03-1 “Accounting and Reporting by Insurance Enterprises for certain Long-Duration Contracts and for Separate Accounts”, which requires that the best estimate of future experience be combined with actual experience to determine the benefit ratio used to calculate the policy benefit reserve.

(n) Income Taxes

The Company utilizes the asset and liability method of accounting for income taxes. Under this method, deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The deferral of tax losses is evaluated based upon management’s estimates of the future profitability of the Company’s taxable entities based on current forecasts and the period for which losses may be carried forward. A valuation allowance is established for any portion of a deferred tax asset that management believes will not be realized. The Company continues to evaluate income generated in future periods by its subsidiaries in jurisdictions in determining the recoverability of its deferred tax asset. If it is determined that future income generated by these subsidiaries is insufficient to cause the realization of the net operating losses within a reasonable period, a valuation allowance is established at that time.

(o) Stock Plans

The Company accounts for stock compensation plans in accordance with the fair value recognition provisions of FAS 123 “Accounting for Stock-Based Compensation”, This method was adopted as of January 1, 2003 using the prospective method allowed under FAS 148, “Accounting for Stock-Based Compensation – Transition and

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. Significant Accounting Policies (continued)

(o) Stock Plans (continued)

Disclosure” for options and employee stock purchase Plan shares granted subsequent to January 1, 2003. Prior to 2003, the Company accounted for these plans under the disclosure-only provisions of FAS 123 and no stock based employee compensation cost was included in net income as all options granted had an exercise price equal to the market value of the Company’s ordinary shares on the date of grant. Awards under the Company’s stock plans vest over periods ranging from three to four years. If the fair value based method had been applied to all awards since the original effective date of FAS 123, the cost related to employee stock based compensation included in the determination of net income would have been higher. FAS 148 amends FAS 123 by providing alternative methods of transition for a voluntary change to the fair value-based method of accounting for stock-based employee compensation. In addition, FAS 148 amends the disclosure requirements of FAS 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results.

The following table illustrates the net effect on net income and earnings per ordinary share if the fair value method had been applied to all outstanding and unvested awards for each of the three years ended December 31, 2004; 2003 and 2002:

(U.S. dollars in thousands, except per share amounts)	2004	2003	2002
Net income available to ordinary shareholders – as reported	$1,126,292	$371,658	$395,951
Add: Stock based employee compensation expense included in       reported net income, net of related tax.	14,575	5,590	–
Deduct: Total stock based employee compensation expense       determined under fair value based method for all awards       net of related tax effects	(43,404)	(49,473)	(54,331)
Pro forma net income available to ordinary shareholders	$1,097,463	$327,775	$341,620
Earnings (loss) per ordinary share:
Basic – as reported	$ 8.17	$ 2.71	$ 2.92
Basic – pro forma	$ 7.96	$ 2.39	$ 2.52
Diluted – as reported	$ 8.13	$ 2.69	$ 2.88
Diluted – pro forma	$ 7.92	$ 2.37	$ 2.49

(p) Per Share Data

Basic earnings per ordinary share is based on weighted average ordinary shares outstanding and excludes any dilutive effects of options and convertible securities. Diluted earnings per ordinary share assumes the exercise of all dilutive stock options and conversion of convertible securities where the contingency for conversion has occurred or been satisfied.

(q) Fair Value of Financial Instruments

Fair values of investments and derivatives are based on published market values if available, estimates of fair values of similar issues or estimates of fair values determined by the Company. See Notes 2, 6 and 15 for further information.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. Significant Accounting Policies (continued)

(r) Recent Accounting Pronouncements

In April 2004, the FASB issued Staff Position No. FAS 129-1, “Disclosure Requirements under FASB Statement No. 129, Disclosure of Information about Capital Structure, Relating to Contingently Convertible Securities” (“FSP FAS 129-1”). The purpose of FSP FAS 129-1 is to interpret how the disclosure provisions of Statement 129 apply to contingently convertible securities and to their potentially dilutive effects on earnings per share. The Company provided the required disclosures related to its contingently convertible securities that are required by FSP FAS 129-1 in its December 31, 2003 financial statements. The contingently convertible securities have been fully redeemed as of December 31, 2004.

In March 2004, the FASB ratified Emerging Issues Task Force (“EITF”) Issue No. 03-16, “Accounting for Investments in Limited Liability Companies” (the “Issue”). In EITF Abstracts, Topic No. D-46, “Accounting for Limited Partnership Investments,” the SEC staff clarified its view that investments of more than three to five percent are considered to be more than minor and, therefore, should be accounted for using the equity method. Limited liability companies (“LLCs”) have characteristics of both corporations and partnerships, but are dissimilar from both in certain respects. Due to those similarities and differences, diversity in practice exists with respect to accounting for noncontrolling investments in LLCs. This Issue addresses whether an LLC should be viewed as similar to a corporation or similar to a partnership for purposes of determining whether a noncontrolling investment should be accounted for using the cost method or the equity method of accounting. The EITF reached a consensus that an investment in an LLC that maintains a “specific ownership account” for each investor, similar to a partnership capital account structure should be viewed as similar to an investment in a limited partnership for purposes of determining whether a noncontrolling investment in an LLC should be accounted for using the cost method or the equity method. This EITF applies to all investments in LLCs and is effective for reporting periods beginning after June 15, 2004. The adoption of this Issue did not have a material effect on the Company’s financial condition or results of operations.

In June 2004, the FASB issued Staff Position No. FAS 97-1, “Situations in Which Paragraphs 17(b) and 20 of FASB Statement No. 97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses From the Sale of Investments, Permit or Require Accrual of an Unearned Revenue Liability” (“FSP FAS 97-1”). FSP FAS 97-1 clarifies whether it is appropriate to recognize an unearned revenue liability to compensate the insurer for services to be performed over future periods when future profits are expected to decline from the current level, or only when current profits are expected to be followed by future losses (consistent with SOP 03-1). The adoption of this FSP FAS 97-1 did not have a material effect on the Company’s financial condition or results of operations.

EITF Issue No. 02-14, “Whether an Investor Should Apply the Equity Method of Accounting to Investments Other than Common Stock if the Investor Has the Ability to Exercise Significant Influence Over the Operating and Financial Policies of the Investee” (“EITF 02-14”), addresses the issue as to whether the equity method of accounting applies when an investor does not have an investment in voting common stock of an investee but exercises significant influence through other means (such as convertible debt, preferred equity securities, options, warrants and interests in unincorporated entities). In July 2004, the EITF reached a consensus that investors should apply the equity method when they have an investment in either common stock or “in-substance common stock.” The consensus reached in EITF 02-14 was effective for reporting periods beginning after September 15, 2004. The adoption of EITF 02-14 did not have a material effect on the Company’s financial condition or results of operations.

Statement of Position (“SOP”) 03-3, “Accounting for Certain Loans or Debt Securities Acquired in a Transfer” addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an

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2. Significant Accounting Policies (continued)

(r) Recent Accounting Pronouncements (continued)

investor’s initial investment in loans or debt securities acquired in a transfer if those differences are attributable, at least in part, to credit quality. This SOP limits the yield that may be accreted (accretable yield) to the excess of the investor’s estimate of undiscounted expected principal, interest, and other cash flows (cash flows expected at acquisition to be collected) over the investor’s initial investment in the debt security. This SOP is effective for loans acquired in fiscal years beginning after December 15, 2004. The adoption of the SOP is not expected to have a material effect on the Company’s financial condition or results of operations.

In September 2004, the EITF reached a conclusion regarding Issue No. 04-8, Accounting Issues Related to Certain Features of Contingently Convertible Debt and the Effect on Diluted Earnings per Share (“EITF 04-8”), that contingently convertible securities should be included in diluted earnings per share in all periods regardless of whether the contingency is met and regardless of whether the market price contingency is substantive. EITF 04-8 is effective for reporting periods ending after December 15, 2004. Prior period earnings per share amounts presented for comparative purposes must be restated unless (i) the securities are settled in cash before the end of the effective reporting period in which the consensus is first applied or (ii) the agreement is amended such that the entire contract must be settled in cash. In November 2004 the Zero Coupon Convertible Debentures (“CARZ”) were redeemed and, therefore, EITF 04-8 does not have any effect on the Company’s diluted earnings per share.

In December 2004, the FASB issued Statement No. 123 (Revised), Share Based Payment, which requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. This statement is effective as of the beginning of the first interim or annual reporting period that begins after June 15, 2005. The Company adopted the fair-value based method of accounting for share-based payments effective January 1, 2003 using the prospective method described in FAS 148. FAS 123 (Revised) must be applied not only to new awards but to previously granted awards that are not fully vested on the effective date. However, had we adopted FAS 123 (Revised) in prior periods, the impact of that standard would have approximated the impact of FAS 123 as described in the disclosure of pro forma net income and earnings per share in Note 2 (o) – Stock Plans to our consolidated financial statements. Statement 123 (Revised) also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption.

The Company is aware of the SEC’s recent review of the loss reserving practices of the financial guaranty industry. The Company recognizes that there is diversity in practice among financial guaranty insurers and reinsurers with respect to their accounting policies. Current accounting literature, specifically FASB Statement of Financial Accounting Standards No. 60 “Accounting and Reporting by Insurance Enterprises” (“FAS 60”) and does not specifically address the unique characteristics of financial guaranty insurance contracts. Consequently, the accounting principles applied by the industry have evolved over time and incorporate the concepts of both short-duration and long-duration contracts accounting under the provisions of FAS 60 and other accounting literature such as FAS 5 and EITF 85-20. It is the Company’s understanding that the SEC has requested that the FASB review this matter and provide guidance for the accounting of financial guaranty insurance contracts. The Company will continue its loss reserving methodology as noted in Note 2 (k) until further guidance is provided by the SEC or FASB. The Company had reserves for financial guaranty insurance contracts of $120.2 million and $62.0 million at December 31, 2004 and 2003, respectively.

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3. Segment Information

The Company is organized into three underwriting segments-insurance, reinsurance, and financial products and services-in addition to a corporate segment that includes the investment and financing operations of the Company. General, life and annuity, and financial operations are disclosed separately within each segment. General operations include property and casualty lines of business.

One way in which the Company evaluates performance of each segment is based on underwriting results (i.e., underwriting profit or loss) for general operations, net income from life and annuity operations and contribution from financial operations. Other items of revenue and expenditure of the Company are not evaluated at the segment level for general operations. In addition, the Company does not allocate assets by segment for its general operations. Investment assets related to the Company’s life and annuity, and financial operations are held in separately identified portfolios. Net investment income from these assets is included in net income from life and annuity operations and contribution from financial operations, respectively.

Certain lines of business within general operations written by the Company have loss experience generally characterized as low frequency and high severity. This may result in volatility in both the Company’s results and operational cash flows.

Insurance Operations

General insurance business written includes risk management and specialty lines. Risk management products comprise global property and casualty insurance programs for large multinational companies, including umbrella liability, products recall, integrated risk and primary property and liability coverages. Specialty lines products include the following lines of business: professional liability, environmental liability, political risk insurance, aviation and satellite, marine and offshore energy insurance, surety, specie, bloodstock and other insurance including program business.

Reinsurance Operations

Reinsurance general business written includes treaty and facultative reinsurance to primary insurers of casualty and property risks, principally: general liability; professional liability; accident and health; automobile and workers’ compensation; commercial and personal property risks; specialty risks including fidelity and surety and ocean marine; property catastrophe; property excess of loss; property pro-rata; marine and energy; aviation and satellite; and various other reinsurance to insurers on a worldwide basis. The Company’s reinsurance life business is primarily European term assurance, group life, critical illness cover, immediate annuities in payment and disability income business.

Financial Products and Services

Financial products and services businesses include insurance, reinsurance and derivative solutions for complex financial risks. These include financial guaranty insurance and reinsurance, credit enhancement swaps, other collateralized transactions, weather and energy risk management products and institutional life insurance products. While each of these is unique and is tailored for the specific needs of the insured or user, they are often multi-year contracts. Due to the nature of these types of contracts, premium volume as well as underwriting results can vary significantly from period to period. The financial products and services life business written includes funding agreements, municipal guaranteed reinvestment contracts and highly structured life co/reinsurance transactions.

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3. Segment Information (continued)

The following is an analysis of results by segment together with a reconciliation to net income or loss:

			Financial
Year Ended December 31, 2004:			Products and
(U.S. dollars in thousands, except ratios)	Insurance	Reinsurance	Services	Total
General Operations:
Net premiums earned	$4,083,153	$ 2,899,396	$ –	$ 6,982,549
Fee income and other	24,229	7,623	–	31,852
Net losses and loss expenses	2,869,114	1,921,771	–	4,790,885
Acquisition costs	542,827	639,799	–	1,182,626
Operating expenses (1)	535,443	194,995	–	730,438
Exchange gains	(9,911)	(28,945)	–	(38,856)
Underwriting profit	$ 169,909	$ 179,399	$ –	$ 349,308
Life and Annuity Operations:
Net premiums earned	$ –	$ 1,310,986	$ 94,713	$ 1,405,699
Fee income and other	–	93	585	678
Claims and policy benefits	–	1,403,710	96,418	1,500,128
Acquisition costs	–	42,587	20,981	63,568
Operating expenses (1)	–	16,697	10,376	27,073
Exchange gains	–	(1,340)	–	(1,340)
Net investment income	–	204,631	88,090	292,721
Interest (income) expense	$ –	(6)	54,454	54,448
Net income from life and annuity operations	$ –	$ 54,062	$ 1,159	$ 55,221
Financial Operations:
Net premiums earned			$ 161,285	$ 161,285
Fee income and other			2,787	2,787
Net losses and loss expenses			73,055	73,055
Acquisition costs			18,670	18,670
Operating expenses (1)			73,955	73,955
Exchange gains			(482)	(482)
Underwriting loss			$ (1,126)	$ (1,126)
Net investment income, financial guarantee			$ 40,780	$ 40,780
Net realized and unrealized gain on weather and             energy derivatives			1,997	1,997
Operating expenses, weather and energy (1)			25,020	25,020
Net income from financial affiliates			12,622	12,622
Minority interest			8,708	8,708
Net realized and unrealized gain on credit derivatives			52,897	52,897
Contribution from financial operations			$ 73,442	$ 73,442

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3. Segment Information (continued)

			Financial
Year Ended December 31, 2004:			Products and
(U.S. dollars in thousands, except ratios)	Insurance	Reinsurance	Services	Total
Corporate and other:
Investment income, general operations				$ 661,535
Net realized and unrealized gains on investments and       investment derivatives (3)				269,672
Net income from investment affiliates				124,008
Net income from operating affiliates				134,735
Interest expense (2)				204,627
Amortization of intangible assets				15,827
Corporate operating expenses				196,649
Minority interest				(321)
Income tax				84,526
Net income				$1,166,613
Ratios – General operations (4):
Loss and loss expense ratio	70.3%	66.3%		68.6%
Underwriting expense ratio	26.4%	28.8%		27.4%
Combined ratio	96.7%	95.1%		96.0%

(1)	Operating expenses exclude corporate operating expenses, shown separately.
(2)	Interest expense excludes interest expense related to life and annuity operations shown separately.
(3)	This includes net realized gains on investments of $246.5 million and net realized and unrealized gains on
	investment derivatives of $23.1 million.
(4)	Ratios are based on net premium earned from general operations excluding fee income and other. The underwriting expense ratio excludes exchange gains and losses.

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3. Segment Information (continued)

The following is an analysis of results by segment together with a reconciliation to net income or loss:

			Financial
Year Ended December 31, 2003:			Products and
(U.S. dollars in thousands, except ratios)	Insurance	Reinsurance	Services	Total
General Operations:
Net premiums earned	$3,640,330	$ 2,440,703	$ –	$ 6,081,033
Fee income and other	13,670	25,240	–	38,910
Net losses and loss expenses	2,379,499	2,197,357	–	4,576,856
Acquisition costs	542,149	555,431	–	1,097,580
Operating expenses (1)	412,540	151,332	–	563,872
Exchange gains	(7,858)	(26,390)	–	(34,248)
Underwriting profit (loss)	$ 327,670	$ (411,787)	$ –	$ (84,117)
Life and Annuity Operations:
Net premiums earned	$ –	$ 664,612	$ 83,883	$ 748,495
Fee income and other	–	599	246	845
Claims and policy benefits	–	750,663	68,231	818,894
Acquisition costs	–	33,090	17,450	50,540
Operating expenses (1)	–	9,019	7,866	16,885
Exchange gains	–	(4,371)	–	(4,371)
Net investment income	–	139,241	28,616	167,857
Interest expense	–	–	12,168	12,168
Net income from life and annuity operations	$ –	$ 16,051	$ 7,030	$ 23,081
Financial Operations:
Net premiums earned			$ 139,622	$ 139,622
Fee income and other			1,990	1,990
Net losses and loss expenses			33,750	33,750
Acquisition costs			19,066	19,066
Operating expenses (1)			50,147	50,147
Underwriting profit			$ 38,649	$ 38,649
Net investment income, financial guarantee			$ 23,273	$ 23,273
Net realized and unrealized gain on weather and             energy derivatives			1,103	1,103
Operating expenses, weather and energy (1)			21,837	21,837
Net income from financial affiliates			37,108	37,108
Minority interest			11,424	11,424
Net realized and unrealized loss on credit derivatives			(25,787)	(25,787)
Contribution from financial operations			$ 41,085	$ 41,085

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3. Segment Information (continued)

			Financial
Year Ended December 31, 2003:			Products and
(U.S. dollars in thousands, except ratios)	Insurance	Reinsurance	Services	Total
Corporate and other:
Investment income, general operations				$ 588,428
Net realized and unrealized gains on investments and       investment derivatives (3)				117,337
Net income from investment affiliates				119,200
Net loss from operating affiliates				(28,185)
Interest expense (2)				187,239
Amortization of intangible assets				4,637
Corporate operating expenses				145,085
Minority interest				(2,160)
Income tax				30,049
Net income				$ 411,979
Ratios – General operations (4):
Loss and loss expense ratio	65.4%	90.0%		75.3%
Underwriting expense ratio	26.2%	29.0%		27.3%
Combined ratio	91.6%	119.0%		102.6%

(1)	Operating expenses exclude corporate operating expenses, shown separately.
(2)	Interest expense excludes interest expense related to life and annuity operations shown separately.
(3)	This includes net realized gains on investments of $120.2 million and net realized and unrealized losses on
	investment derivatives of $2.9 million.
(4)	Ratios are based on net premium earned from general operations excluding fee income and other. The underwriting expense ratio excludes exchange gains and losses.

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3. Segment Information (continued)

			Financial
Year Ended December 31, 2002:			Products and
(U.S. dollars in thousands, except ratios)	Insurance	Reinsurance	Services	Total
General Operations:
Net premiums earned	$2,832,298	$2,066,775	$ –	$4,899,073
Fee income and other	36,717	11,201	–	47,918
Net losses and loss expenses	1,771,982	1,557,065	–	3,329,047
Acquisition costs	478,548	454,300	–	932,848
Operating expenses (1)	380,901	109,796	–	490,697
Exchange gains	(56,515)	(23,787)	–	(80,302)
Underwriting profit (loss)	$ 294,099	$ (19,398)	$ –	$ 274,701
Life and Annuity Operations:
Life premiums earned	$ –	$ 980,387	$ 42,605	$1,022,992
Fee income and other	–	2	–	2
Claims and policy benefits	–	1,027,981	41,475	1,069,456
Acquisition costs	–	12,839	–	12,839
Operating expenses (1)	–	5,844	404	6,248
Net investment income	–	91,451	–	91,451
Net income from life and annuity operations	$ –	$ 25,176	$ 726	$ 25,902
Financial Operations:
Net premiums earned			$ 67,745	$ 67,745
Fee income and other			7,043	7,043
Net losses and loss expenses			(1,732)	(1,732)
Acquisition costs			9,644	9,644
Operating expenses (1)			43,068	43,068
Exchange losses			8	8
Underwriting profit			$ 23,800	$ 23,800
Investment income, financial guarantee			$ 25,962	$ 25,962
Net realized and unrealized gain on weather and energy             derivatives			16,607	16,607
Operating expenses, weather and energy (1)			14,875	14,875
Equity in net income of financial affiliates			5,166	5,166
Minority interest			10,424	10,424
Net realized and unrealized loss on credit derivatives			(46,137)	(46,137)
Contribution from financial operations			$ 99	$ 99

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3. Segment Information (continued)

			Financial
Year Ended December 31, 2002:			Products and
(U.S. dollars in thousands, except ratios)	Insurance	Reinsurance	Services	Total
Corporate and other:
Investment income, general operations				$ 617,122
Net realized and unrealized losses on investments and       investment derivatives (2)				(236,391)
Net income from investment affiliates				64,662
Net income from operating affiliates				(21,142)
Interest expense				168,086
Amortization of intangible assets				6,187
Corporate operating expenses				119,515
Minority interest				2,947
Income tax expense				22,647
Net income				$ 405,571
Ratios – General operations (3):
Loss and loss expense ratio	62.6%	75.3%		68.0%
Underwriting expense ratio	30.3%	27.3%		29.0%
Combined ratio	92.9%	102.6%		97.0%

(1)	Operating expenses exclude corporate operating expenses, shown separately.
(2)	This includes net realized losses on investments of $214.2 million and net realized and unrealized losses on investment derivatives of $22.2 million.
(3)	Ratios are based on net premiums earned from general operations, excluding fee income and other. The underwriting expense ratio excludes exchange gains and losses.

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3. Segment Information (continued)

The following tables summarize the Company’s net premiums earned by line of business:

Insurance	For the year ended
	December 31,
(U.S. dollars in thousands)	2004	2003	2002
General Operations:
Professional liability	$1,361,013	$ 937,317	$ 531,020
Other casualty	1,001,376	1,018,471	828,141
Property catastrophe	40,713	–	–
Other property	594,867	505,154	523,404
Marine, energy, aviation and satellite	889,170	784,885	512,604
Accident and health	11,235	55,893	105,100
Other (1)	184,779	338,610	332,029
Total General Operations	$4,083,153	$3,640,330	$2,832,298
Life and Annuity Operations	–	–	–
Financial Operations	–	–	–
Total	$4,083,153	$3,640,330	$2,832,298

(1) Other, includes political risk, surety, bonding, warranty and other lines.

Reinsurance	For the year ended
	December 31,
(U.S. dollars in thousands)	2004	2003	2002
General Operations:
Professional liability	$ 375,582	$ 213,555	$ 92,590
Other casualty	871,155	757,602	700,056
Property catastrophe	304,057	245,860	248,233
Other property	783,502	761,768	609,660
Marine, energy, aviation and satellite	204,500	191,344	199,509
Accident and health	42,706	30,628	22,020
Other (1)	317,894	239,946	194,707
Total General Operations	$2,899,396	$2,440,703	$2,066,775
Life and Annuity Operations	$1,310,986	664,612	980,387
Financial Operations	–	–	–
Total	$4,210,382	$3,105,315	$3,047,162

(1) Other, includes political risk, surety, bonding, warranty and other lines.

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3. Segment Information (continued)

Financial Products and Services	For the year ended
	December 31,
(U.S. dollars in thousands)	2004	2003	2002
Life and Annuity Operations	94,713	83,883	42,605
Financial Operations	161,285	139,622	67,745
Total	$255,998	$223,505	$110,350

(1) Other, includes political risk, surety, bonding, warranty and other lines.

The following table shows an analysis of the Company’s net premiums written by geographical location of subsidiary where the premium is written for the years ended December 31:

General and financial operations:	2004	2003	2002
Bermuda	$1,125,842	$1,418,408	$1,419,841
United States	3,619,679	3,230,825	2,803,523
Europe and other	2,777,176	2,202,287	1,726,056
Total general and financial operations	$7,522,697	$6,851,520	$5,949,420
Life and annuity operations:
Bermuda	$278,448	$ 83,883	$ 43,779
Europe and other	1,124,899	655,986	979,825
Total life and annuity operations	$1,403,347	$ 739,869	$1,023,604
Total	$8,926,044	$7,591,389	$6,973,024

4. Goodwill and Intangible Assets

The following table shows an analysis of intangible assets broken down between goodwill, intangible assets with an indefinite life and intangible assets with a definite life for the years ended December 31, 2004, 2003 and 2002:

		Intangible	Intangible
		assets with an	assets with a
(U.S. dollars in thousands)	Goodwill	indefinite life	definite life	Total
Balance at December 31, 2001	$1,568,636	$27,106	$ 21,201	$1,616,943
Additions	25,649	8,671	8,624	42,944
Amortization	–	–	(6,187)	(6,187)
Balance at December 31, 2002	$1,594,285	$35,777	$ 23,638	$1,653,700
Additions	180,499	–	15,945	196,444
Amortization	–	–	(4,637)	(4,637)
Balance at December 31, 2003	$1,774,784	$35,777	$ 34,946	$1,845,507
Additions	–	–	–	–
Amortization (1)	–	–	(17,725)	(17,725)
Balance at December 31, 2004	$1,774,784	$35,777	$ 17,221	$1,827,782

(1) Amortization of intangible assets includes $1.9 million related to an acquired block of business expensed through acquisition costs

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4. Goodwill and Intangible Assets (continued)

The increase in goodwill in 2003 related primarily to the settlement of the purchase price for Winterthur International (see note 5). As at December 31, 2004 goodwill and intangible assets related to the insurance segment was $450.0 million, the reinsurance segment was $1.38 billion and the financial products and services segment was $4.6 million.

5. Business Combinations

(a) Le Mans Ré

Effective January 1, 2002, the Company consolidated its investment in Le Mans Ré after increasing its ownership from 49% to 67% in order to expand its international reinsurance operations. Le Mans Ré underwrites a worldwide portfolio comprising most classes of property and casualty reinsurance business, together with a selective portfolio of life reinsurance business. On September 3, 2003, the Company exercised its option to buy the remaining 33% ownership from Les Mutuelles du Mans Assurances Group (“MMA”) for approximately $161 million in cash and changed the name of Le Mans Ré to XL Re Europe. Due to certain contractual arrangements between the Company and MMA, MMA did not have any economic interest in the earnings of XL Re Europe with effect from January 1, 2002 and accordingly, no minority interest was recorded since that date.

The cost of the acquisition for the increase in ownership from 49% to 67% in 2002 was approximately $188.5 million. Goodwill arising from the acquisition was approximately $52.6 million. The Company recognized goodwill in excess of the fair value of XL Re Europe’s net assets to increase its European franchise for its reinsurance operations. Cash paid, net of cash acquired, was $45.5 million during the year ended December 31, 2002.

Pro forma financial information and condensed balance sheet information are not presented for the acquisition of XL Re Europe because the results of XL Re Europe’s operations are not significant to the consolidated balance sheet or consolidated results of operations of the Company.

(b) Winterthur International

On July 25, 2001, the Company completed the acquisition of certain Winterthur International insurance operations (“Winterthur International”) primarily to extend its predominantly North American based large corporate insurance business globally. The Company provisionally paid to Winterthur Swiss Insurance Company (the “Seller”) $405.6 million at closing for Winterthur International based on the audited U.S. GAAP financial statements of the acquired Winterthur International operations as at December 31, 2000 and the price was subject to final determination based on the audited U.S. GAAP financial statements of the acquired Winterthur International operations as at June 30, 2001. In December 2003, the Company reached an agreement with the Seller as to the final purchase price, which was $330.2 million. As a result, $75.4 million in cash was returned to the Company.

Included in unpaid loss and loss expenses recoverable at December 31, 2004 is an unsecured reinsurance recoverable from the seller of $1.45 billion, related to certain contractual arrangements with the sale and purchase agreement, as amended (“SPA”) relating to the Company’s acquisition of Winterthur International in July 2001. The Seller is currently rated “A-” by S&P. The Seller provides the Company with post-closing protection determined as of June 30, 2004 with respect to, among other things, adverse development of reserves and premium relating to the acquired Winterthur International business (“Winterthur Business”). This protection is based upon net loss experience and development over a three-year, post-closing seasoning period based on actual loss development experience, collectible reinsurance and certain other factors set forth in the SPA. The SPA includes a process for determining the amount due from the Seller by an independent actuary process whereby the independent actuarial develops a value of the seasoned net reserves. The actual final seasoned amount is the submission that is closest to the number developed by the independent actuary.

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5. Business Combinations (Continued)

(b) Winterthur International (continued)

As the Company and the Seller were unable to come to an agreement, the Company submitted to the Seller notice to trigger the independent actuarial process as contemplated by the SPA. On February 3, 2005, both the Company and the Seller made submissions for the independent actuarial process. The Company’s submission would result in a net payable to the Company of approximately $1.45 billion in aggregate and the Seller’s submission would result in a net payable to the Company of $541 million in aggregate. Approximately $855 million of the total $909 million dollar difference between the Seller and the Company relates to seasoned losses, the remainder relates to premium seasoning. At the completion of the independent actuarial process, the Company will be entitled to a lump sum payment.

In addition, the Seller provides protection to the Company with respect to third party reinsurance receivables and recoverables related to the Winterthur Business which are $2.0 billion in the aggregate as of December 31, 2004. There are two levels of protection from the Seller for these balances:

1.

At the time of the Winterthur International acquisition, the seller provided a liquidity facility to the Company. At the time of the payment of the net reserve seasoned amount as described above. The Company has the right to repay up to the balances outstanding on this facility by assignment to the Seller of an equal amount of receivables relating to reinsurance recoverables selected by the Company. The payable balance related to this facility is included within other liabilities on the Company’s balance sheet at December 31, 2004 and amounted to approximately $281 million at that date.

2.

Under two retrocession agreements the Company has reinsurance protection on the remaining portion of reinsurance recoverables to the extent that the Company does not receive payment of such amounts from applicable third party reinsurers.

At December 31, 2004, certain reinsurers responsible for some portions of the reinsurance of the Winterthur Business have raised issues as to whether amounts claimed are due and the resolution of those discussions is also currently ongoing.

The Company may record a loss in future periods if any or some of the following occur:

(i)	The Seller’s submission is closer to the valuation developed by the independent actuary and, as such, the Seller’s submission is the actual final seasoned amount.
(ii)	There is deterioration of the net losses from what is reported in the Company’s December 31, 2004 financial statements.
(iii)	The Company is unable to make full recovery of the reinsurance recoverables related to the Winterthur Business, either from third parties or from the Seller under the additional protections.
(iv)	Any amount due from the Seller proves to be uncollectible from the Seller for any reason.

The acquisition was accounted for under the purchase method of accounting and, therefore, the identifiable assets and liabilities of Winterthur International were recorded at their estimated fair value on June 30, 2001. The process of determining the fair value of such assets and liabilities acquired, as required under purchase accounting, included management’s estimates and independent valuations. The purchase price was preliminarily allocated to the acquired assets and liabilities based upon their estimated fair value at June 30, 2001. The excess of the purchase price over acquired tangible net assets was then applied to intangible assets with finite and indefinite lives. With the settle-

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5. Business Combinations (Continued)

(b) Winterthur International (continued)

ment of the final purchase price in December 2003, the Company has finalized its allocation of the purchase price to the fair value of the acquired tangible net assets based on additional information now available. This information primarily related to loss reserves, adjustment and reinstatement premiums, reinsurance balances payable and receivable and other assets and liabilities. Once the final excess purchase price was known, the Company amended the amount attributed to goodwill by $171.0 million. This settlement of the purchase price and related adjustments represents the completion of the Company’s allocations to the fair value of net assets. Any subsequent adjustments to the carrying value will be reflected in income in the year in which the adjustments are made.

The revised fair value of significant assets and liabilities acquired by the Company includes $89.4 million of cash, $2.2 billion of invested assets, $1.3 billion of premiums receivable, $1.5 billion of unpaid losses and loss expenses recoverable, $2.8 billion of unpaid losses and loss expenses, $885 million of unearned premiums and $506 million of reinsurance balances payable. The contractual post-closing protection was considered in these fair value estimates.

Allocation of the purchase price was as follows:

(U.S. dollars in thousands)
Fair value of assets acquired	$5,011,162
Fair value of liabilities acquired	4,873,327
Fair value of tangible net assets acquired	$ 137,835
Fair value of intangible assets acquired	29,800
Goodwill related to the acquisition	185,023
	$ 352,658
Revised purchase price	$ 330,158
Other costs of acquisition	22,500
	$ 352,658

The Company recognized goodwill in excess of the fair value of the net assets of Winterthur International operations to increase its global platform for its insurance operations.

The Company estimated the total value of intangible assets acquired at $29.8 million, including $14.7 million for insurance licenses and sales force, which have an indefinite life and are not therefore subject to amortization. The remaining $15.1 million relates to the value of business in force, which is estimated to have a finite life of up to five years and is being amortized over that period.

(c) Lyndon Life Insurance Company

In the first quarter of 2002, the Company acquired Lyndon Life Insurance Company, a shell company licensed to conduct life insurance business in forty-nine U.S. states, for the purpose of obtaining licenses for the Company’s life operations. The cost of the acquisition was $13.5 million, paid in cash in April 2002, and intangible assets arising from the acquisition were $3.5 million. No goodwill was recorded on this acquisition. Lyndon Life Insurance Company has been renamed XL Life Insurance and Annuity Company.

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6. Investments

Net investment income is derived from the following sources:

Year Ended December 31
(U.S. dollars in thousands)	2004	2003	2002
Fixed maturities, short-term investments and cash equivalents	$1,023,069	$800,996	$741,277
Equity securities and other investments	24,589	15,275	17,102
Total gross investment income	1,047,658	816,271	758,379
Investment expenses	(52,622)	(36,713)	(23,844)
Net investment income	$ 995,036	$779,558	$734,535

The following represents an analysis of net realized gains (losses) and the change in unrealized appreciation on investments:

Year Ended December 31
(U.S. dollars in thousands)	2004	2003	2002
Net realized gains (losses):
Fixed maturities, short-term investments, cash and cash equivalents:
Gross realized gains	$ 414,918	$ 451,967	$ 448,923
Gross realized losses	(265,854)	(344,831)	(526,276)
Net realized gains (losses)	149,064	107,136	(77,353)
Equity securities:
Gross realized gains	146,711	183,705	52,729
Gross realized losses	(48,793)	(162,556)	(160,126)
Net realized gains (losses)	97,918	21,149	(107,397)
Write down of other investments (see Note 8)	(435)	(8,090)	(29,413)
Net realized gain on sale of investment in affiliate	–	–	3
Net realized gains (losses) on investments	246,547	120,195	(214,160)
Net realized and unrealized gains (losses)       on investment derivative instruments	23,125	(2,858)	(22,231)
Change in unrealized appreciation (depreciation):
Fixed maturities and short-term investments	165,377	139,321	478,560
Equity securities	74,465	196,705	(59,082)
Impact of net unrealized investment gain or loss on future
policy benefit reserves	(49,250)	(10,487)	–
Affiliates and other investments	(13,021)	(3,418)	(6,623)
Change in deferred income tax liability	(27,909)	20,111	(19,074)
Net change in unrealized appreciation (depreciation)       on investments	149,662	342,232	393,781
Total net realized gains and change in       unrealized appreciation (depreciation) on investments	$ 419,334	$ 459,569	$ 157,390

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6. Investments (Continued)

Net realized gains and losses in 2004 and 2003 included a loss of $6.4 million and $130.7 million, respectively, relating to certain fixed income, equity securities and other investments where the Company determined that there was an other than temporary decline in the value of those investments.

The total amount of other than temporary declines in value in 2004 related to $4.1 million on fixed income securities, $1.9 million on equity securities and $0.4 million on other investments. Of the decline in value of fixed income and equity securities considered to be other than temporary in 2004, approximately 50% related to investments in the airlines sector.

The total amount of other than temporary declines in value in 2003 related to $68.4 million on fixed income securities, $54.2 million on equity securities and $8.1 million on other investments. Of the decline in value of fixed income and equity securities considered to be other than temporary in 2003, approximately 12% related to investments in the communications sector.

The Company experienced a larger reduction in the amount of write downs for securities with declines in value deemed to be other than temporary than the decline in general defaults. As a percentage of the total fixed income portfolio, the write down for other than temporary declines was negligible in 2004 as compared with 0.6% in 2003.

The cost (amortized cost for fixed maturities and short-term investments), market value, gross unrealized gains and gross unrealized (losses) of investments are as follows:

	Cost or	Gross	Gross
December 31, 2004	Amortized	Unrealized	Unrealized	Market
(U.S. dollars in thousands)	Cost	Gains	Losses	Value
Fixed maturities
U.S. Government and Government agency	$ 4,087,004	$ 52,104	$ (27,033)	$ 4,112,075
Corporate	10,945,675	449,437	(45,265)	11,349,847
Mortgage and asset-backed securities	6,922,506	47,228	(41,176)	6,928,558
U.S. States and political subdivisions of the States	61,987	1,380	(311)	63,056
Non-U.S. Sovereign Government	2,435,176	212,546	(1,064)	2,646,658
Total fixed maturities	$24,452,348	$762,695	$(114,849)	$25,100,194
Total short-term investments	$ 1,738,845	$ 26,686	$ (4,817)	$ 1,760,714
Total equity securities	$ 778,117	$192,019	$ (7,216)	$ 962,920

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6. Investments (Continued)

	Cost or	Gross	Gross
December 31, 2003	Amortized	Unrealized	Unrealized	Market
(U.S. dollars in thousands)	Cost	Gains	Losses	Value
Fixed maturities
U.S. Government and Government agency	$ 2,278,906	$ 15,304	$ (27,056)	$ 2,267,154
Corporate	10,020,934	377,167	(61,189)	10,336,912
Mortgage and asset-backed securities	3,674,825	54,741	(21,656)	3,707,910
U.S. States and political subdivisions of the States	37,312	1,455	(45)	38,722
Non-U.S. Sovereign Government	2,978,693	173,782	(8,817)	3,143,658
Total fixed maturities	$18,990,670	$622,449	$(118,763)	$19,494,356
Total short-term investments	$ 696,798	$ 1,945	$ (1,293)	$ 697,450
Total equity securities	$ 473,112	$116,568	$ (6,230)	$ 583,450

At December 31, 2004, there were $119.7 million of gross unrealized losses on fixed income and short-term investments, and $7.2 million of gross unrealized losses on equity securities. At December 31, 2003, there were $120.0 million of gross unrealized losses on fixed income and short-term investments, and $ 6.2 million of gross unrealized losses on equity securities. At December 31, 2004, approximately 4.6% of the Company’s fixed income investment portfolio was invested in securities which were below investment grade or not rated. At December 31, 2003, approximately 5.4% of the Company’s fixed income investment portfolio was invested in securities which were below investment grade or not rated. Approximately 5.8% of the unrealized losses in the Company’s fixed income securities portfolio at December 31, 2004 related to securities that were below investment grade or not rated. The information shown below about the unrealized losses on the Company’s investments at December 31, 2004 concerns the potential affect upon future earnings and financial position should management later conclude that some of the current declines in the fair value of these investments are other than temporary declines.

The following is an analysis of how long each of those securities at December 31, 2004 had been in a continual unrealized loss position:

			Equal to or greater
	Less than 12 months		than 12 months
		Gross		Gross
December 31, 2004		Unrealized		Unrealized
(U.S. dollars in thousands)	Market Value	Losses	Market Value	Losses
Fixed maturities (including short-term investments)
U.S. Government and Government agency	$2,633,868	$15,861	$283,225	$13,350
Corporate	2,630,379	38,463	242,146	7,753
Mortgage and asset backed securities	3,458,073	34,498	310,427	8,390
U.S. States and political subdivisions of the States	21,888	232	423	5
Non-U.S. Sovereign Government	126,846	942	12,983	172
Total fixed maturities	$8,871,054	$89,996	$849,204	$29,670
Total equity securities	$ 86,251	$ 5,354	$ 10,531	$ 1,862

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6. Investments (Continued)

The contractual maturities of fixed maturity securities are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

	December 31, 2004		December 31, 2003
	Amortized	Market	Amortized	Market
(U.S. dollars in thousands)	Cost	Value	Cost	Value
Due after 1 through 5 years	$ 6,651,255	$ 6,781,511	$ 6,310,571	$ 6,492,477
Due after 5 through 10 years	4,948,847	5,130,622	4,471,015	4,624,004
Due after 10 years	5,929,740	6,259,503	4,534,259	4,669,965
Mortgage and asset-backed securities	6,922,506	6,928,558	3,674,825	3,707,910
	$24,452,348	$25,100,194	$18,990,670	$19,494,356

At December 31, 2004 and 2003, approximately $100.0 million and $418.4 million, respectively, of securities included in investments available for sale were loaned to various counter-parties through the Company’s securities lending program. At December 31, 2004 and 2003, approximately $102.0 million and $426.5 million, respectively, of cash collateral held in connection with these loans, is included in cash and cash equivalents, with a corresponding liability reflected in net payable for investments purchased.

At December 31, 2004 and 2003, approximately $463.2 million and $322.4 million, respectively, of securities were on deposit with various U.S. state or government insurance departments in order to comply with relevant insurance regulations.

The Company has three facilities available for the issue of letters of credit collateralized against the Company’s investment portfolio with a value of $1.3 billion at December 31, 2004 and $467.0 million at December 31, 2003. At December 31, 2004 and 2003, approximately $198.5 million and $234.4 million, respectively, of letters of credit were issued and outstanding under these facilities.

The fair values of securities on loan at December 31, 2004 and 2003 are detailed below.

(U.S. dollars in thousands)	2004	2003
Fixed maturities	$100,007	$407,823
Equities	–	10,619
Total	$100,007	$418,442

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7. Investments in Affiliates

The Company’s investment in affiliates and equity in net income (loss) from such affiliates are summarized below:

	December 31, 2004		December 31, 2003		December 31, 2002
		Equity in		Equity in		Equity in
		Net Income		Net Income		Net Income
	Carrying	(Loss) for	Carrying	(Loss) for	Carrying	(Loss) for
(U.S. dollars in thousands)	Value	the Year	Value	the Year	Value	the Year
Investment affiliates	$1,671,091	$124,008	$1,590,530	$119,200	$1,410,277	$54,143
Operating affiliates:
Financial affiliates	106,055	12,622	144,652	37,108	110,835	5,165
Insurance affiliates	19,902	55,775	45,229	(42,887)	83,154	(21,141)
Investment management affiliates	139,804	78,960	122,930	14,702	145,739	10,519
Total	$1,936,852	$271,365	$1,903,341	$128,123	$1,750,005	$ 48,686

The Company has invested in certain closed end funds, certain limited partnerships and similar investment vehicles, including funds managed by certain of its investment management affiliates. At December 31, 2004, investment affiliates was $1.7 billion of which $1.5 billion was included in the alternative investment portfolio and $0.2 billion consisted of private investments. At December 31, 2003, investment affiliates was $1.6 billion of which $1.4 billion was included in the alternative investment portfolio and $0.2 billion consisted of private investments.

The Company’s significant financial affiliate investments at December 31, 2004 included Primus Guaranty, Ltd. with ownership of 33%.

The Company’s insurance affiliate investments at December 31, 2004 included Sovereign Risk Insurance, American Strategic Holdings, and Special Risks Insurance and Reinsurance with ownership in those entities at 50%, 49%, and 18%, respectively.

During 2004 the Company recorded other than temporary declines in the values of Insurance Vianet and Venturion Noodle LLC. of $19.0 million and $2.0 million, respectively. The net loss from insurance affiliates in 2003 included an other than temporary decline of $40.9 million in the first quarter of 2003 in the value of the Company’s investment in Annuity & Life Re (Holdings), Ltd. (“ANNRF”). The investment was written down to its fair market value. In the fourth quarter of 2002, the Company wrote down $13.3 million of its investment in ANNRF due to a significant decline in the book value of ANNRF.

The significant investment management affiliates include Highfields Capital Management LP, a global equity investment firm, MKP Capital Management, a fixed income investment manager, specializing in mortgage-backed securities, FrontPoint Partners LLC, an integrated alternative asset firm, Stanfield Capital Partners, a credit based asset management firm and Banquo Credit Management LLC, a European credit based asset management firm. During the year, the Company sold its interest in Pareto Partners L.P. and its affiliated entities, a currency overlay and fixed income manager, resulting in income of $35.4 million.

In certain investments, the carrying value is different from the share of the investee’s underlying net assets. The difference represents goodwill on acquisition. Adoption of FAS 142 with effect from January 1, 2002 has resulted in the Company ceasing to amortize goodwill and certain intangible assets.

See Note 18(c) for further information.

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8. Other Investments

Other investments include investments over which the Company does not have significant influence and whose fair value is generally unquoted. This includes investments in limited partnerships where the Company does not participate in the management of the partnerships, and investments in non-rated collateralized debt/equity instruments. Income from other investments was $16.2 million and $6.6 million for the years ended December 31, 2004 and 2003, respectively. Unrealized gains from other investments was $4.4 million and $2.7 million as at December 31, 2004 and 2003 respectively. Income on unrated tranches of collateral debt obligations is reflected only to the extent the Company’s principal has been fully recovered. Income on alternative investments included in other investments is realized only on ultimate sale of these investments. The Company had unrealized gains of $7.3 and nil, respectively, at December 31, 2004 and 2003, related to these alternative investments.

See Note 18(b) for further information.

The Company regularly reviews the performance of these other investments.

The Company recorded losses of $0.4 million and $8.1 million in the years ended December 31, 2004 and 2003, respectively, due to other than temporary declines in values of these investments.

9. Losses and Loss Expenses

Unpaid losses and loss expenses for the Company’s general and financial operations are comprised of:

Year Ended December 31
(U.S. dollars in thousands)	2004	2003	2002
Reserve for reported losses and loss expenses	$ 9,492,750	$ 8,394,342	$ 7,684,716
Reserve for losses incurred but not reported	10,105,781	8,164,446	5,518,020
Unpaid losses and loss expenses	$19,598,531	$16,558,788	$13,202,736

Net losses and loss expenses incurred for general and financial operations are comprised of:

Year Ended December 31
(U.S. dollars in thousands)	2004	2003	2002
Loss and loss expenses payments	$ 4,926,421	$ 3,856,634	$ 4,065,857
Change in unpaid losses and loss expenses	2,903,711	2,647,140	659,621
Change in unpaid losses and loss expenses recoverable	(1,114,261)	(853,467)	(179,138)
Paid loss recoveries	(1,851,931)	(1,039,701)	(1,219,025)
Net losses and loss expenses incurred	$ 4,863,940	$ 4,610,606	$ 3,327,315

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9. Losses and Loss Expenses (Continued)

The following table represents an analysis of paid and unpaid losses and loss expenses incurred and a reconciliation of the beginning and ending unpaid losses and loss expenses for the years indicated:

Year Ended December 31
(U.S. dollars in thousands)	2004	2003	2002
Unpaid losses and loss expenses at beginning of year	$16,558,788	$13,202,736	$ 11,806,745
Unpaid losses and loss expenses recoverable	(5,776,410)	(4,807,317)	(4,633,693)
Net unpaid losses and loss expenses at beginning of year	10,782,378	8,395,419	7,173,052
Increase (decrease) in net losses and loss expenses incurred in respect       of losses occurring in:
Current year	4,596,346	3,673,321	2,927,297
Prior years	267,594	937,285	400,018
Total net incurred losses and loss expenses	4,863,940	4,610,606	3,327,315
Exchange rate effects	309,768	394,121	552,173
Net loss reserves acquired	–	199,164	189,710
Less net losses and loss expenses paid in respect of losses occurring in:
Current year	1,170,699	291,104	836,102
Prior years	1,903,790	2,525,828	2,010,729
Total net paid losses	3,074,489	2,816,932	2,846,831
Net unpaid losses and loss expenses at end of year	12,881,597	10,782,378	8,395,419
Unpaid losses and loss expenses recoverable	6,716,934	5,776,410	4,807,317
Unpaid losses and loss expenses at end of year	$19,598,531	$16,558,788	$13,202,736

Prior year net losses incurred

The following table presents the net adverse (favorable) development of reserves analyzed by each of the Company’s operating segments:

(U.S. dollars in millions)	2004	2003	2002
Insurance Segment	$ 292	$  153	$   28
Reinsurance Segment	(24)	799	385
Financial Products and Services Segment	–	(15)	(13)
Total	$ 268	$ 937	$ 400

The significant developments in prior year loss reserve year estimates for each the years indicated within each of the Company’s operating segments are discussed below.

Insurance Segment

During 2004, the Company’s net adverse prior year development of $292 million was affected by increases in reported case reserves for excess professional liability, excess casualty liability and specialty lines. These increases in reported case reserves exceeded the Company’s expected losses based on historical patterns of loss development.

Strengthening of $144 million in Professional lines was caused by a few large directors’ and officers’ claims in pre-2002 business, while changes in errors and omissions were caused by large accounting firms and exposure to

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9. Losses and Loss Expenses (Continued)

insurance/reinsurance brokers. For specialty lines, strengthening of $135 million was caused by reported loss increased in discontinued Programs business with workers’ compensation exposure environmental related coverages, and Lloyds; as well as high severity claims on the Surety book.

During 2003, the Company’s net adverse prior year development of $153 million was due primarily to increases in previously reported case reserves for excess professional liability lines of $143 million for the underwriting years 1997 through 2001. These increases in reported case reserves exceeded the Company’s expected losses based on historical patterns of loss development. Specifically, the increase related to reported case reserves for directors and officers and errors and omissions coverages. During 2003, there was an increase in the amount of litigation related to certain losses. In addition, there was adverse development of $37 million related to environmental business primarily for professional liability coverage underwritten in 2000 and 2001 that was offset by favorable development of $27 million primarily in aviation, property, marine and energy coverages.

The Company did not change its methodology or key assumptions used in 2004, 2003 or 2002 to determine ultimate loss reserves for any line of insurance business written.

During 2002, the Company’s net adverse prior year development of $28 million was comprised of an increase in loss reserves of $73 million relating to the September 11 event that was partially offset by a net decrease in the other reserves of $45 million.

In 2002, the increase in the estimate of the ultimate losses relating to the September 11 event of $73 million related primarily to the accident and health business written in the Company’s Lloyd’s operations. The Company had originally recorded ultimate losses for the September 11 event in the insurance segment of $318 million in 2001 based on management’s best estimate at that time. This best estimate was based on an analysis which had been performed to attempt to identify all possible claims and to analyze the magnitude of the potential loss. The increase in the loss reserves occurred in the second quarter of 2002 after the Company received additional information from policyholders with regard to claims relating to their insured employee casualties, including estimates of benefits payable under U.S. workers’ compensation statutes.

During 2002, the Company decreased the estimate of other reserves at the beginning of 2002 by a net amount of $45 million, consisting of a decrease in reserves relating to the excess casualty insurance business of $114 million partially offset by increases in prior year reserves for satellite lines of $30 million and other casualty insurance lines of $39 million. Estimated ultimate loss reserves were reduced for excess casualty insurance based upon lower than expected actual reported loss experience for business written in years 1997 and prior. A lack of available industry data resulted in more actuarial judgment being involved in establishing IBNR loss reserves for this line of business in the earlier years. Estimated loss reserves are then regularly updated to take into account actual claims reported. The adverse development experienced in the satellite lines was due to several satellite malfunctions that caused an increase in actual reported loss activity that was greater than expected. The adverse development for the other casualty lines was for business written in 1999 through 2001. In these years, premium rates for casualty business had declined due to competitive market pressures and in 2002, there was an increase in the size of claims reported that was higher than expected.

There is no assurance that conditions and trends that have affected the development of liabilities in the past will continue. Accordingly, it may not be appropriate to extrapolate future redundancies or deficiencies based on the Company’s historical results.

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9. Losses and Loss Expenses (Continued)

Reinsurance Segment

During 2004, net prior year reserves across the Reinsurance Segment developed favorably by $24 million. Releases of $144 million net in the property, aviation, marine and other lines of business were partially offset by strengthening of casualty and accident and health reserves amounted to approximately $120 million. Property catastrophe and property other reserve releases totaled approximately $95 million net related primarily to the 2002 and 2003 underwriting years where loss experience has been exceptionally good for the Property line. The strengthening of casualty reserves totaled $75 million and related most significantly to professional liability reserves in the London branch which were strengthened by $32 million for Enron, Worldcom and Laddering claims. The accident & health reserve strengthening of $45M relates to a portfolio of business underwritten by certain of the Company’s Lloyds syndicates

In the fourth quarter 2003, the Company reduced aviation loss reserves related to the September 11 event by $197.0 million. This reduction was due to higher than expected levels of participation (97%) in the September 11 Victim Compensation Fund, a no-fault compensation scheme funded by the U.S. government which closed on December 22, 2003. This resulted in a reduction in the estimated ultimate losses by the Company for this event.

During 2003, the Company increased its estimated reserves related to its reinsurance segment (excluding the September 11 event) by $996 million of which approximately $877 million related primarily to the Company’s North American reinsurance operations for casualty business underwritten during the 1997 through 2001 underwriting years. Of the $877 million, $184 million was recorded in the third quarter of 2003 and $663 million in the fourth quarter of 2003 as described below.

The main lines of business affected by this adverse development included general liability, medical malpractice, professional and surety lines. As previously noted, the Company’s expected loss development is actuarially determined based on historical claims analysis and projected trends. Actual reported losses may vary from expected loss development from quarter to quarter. Generally, as an underwriting year matures, the level of newly reported claims decreases and typically, unless the Company receives additional reported claims that are significantly higher or lower than expected, estimated ultimate loss reserves are not adjusted prior to a full actuarial review. In the third quarter of 2003, the Company received a significant increase in reported claims that were in excess of the Company’s expected claims development. In addition, the Company completed an actuarial review for the longer tail lines of this book of business, using data evaluated at March 31, 2003. As a result, the Company recorded an increase in loss reserves of $184.0 million in the third quarter of 2003. This adverse development has been due to several factors - competitive market pressures on pricing during these underwriting years caused premium rates for excess casualty business to decline industry wide and there has been an increase in the number and size of claims reported in recent years as a result of increases in court filings, corporate scandals, rising tort costs and settlement awards.

As a result of this increase in prior period loss reserves in the third quarter of 2003, the Company completed an extensive claims audit review at the relevant ceding companies in order to obtain information to more accurately determine an estimate of the ultimate loss reserves for this book of business. The claims audit review included both internal and external resources, a comprehensive claims audit of the largest and most significant ceding companies, and a review of loss ratios and reserve analysis procedures. Additional case reserves and potential additional loss exposure were identified during the review and upon completion of the claims review, the Company recorded a further increase to net loss reserves of $663.0 million in the fourth quarter of 2003 primarily related to the Company’s North American casualty reinsurance business written in the 1997 through 2001 underwriting years. This comprised additional case reserves of $124.0 million and an increase in IBNR reserves of $539.0 million.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

9. Losses and Loss Expenses (Continued)

As a result of the new information obtained in the claims audit review, the Company performed a supplemental analysis of its North American casualty reinsurance lines of business specific to the nature of individual cedents’ circumstances. The Company separately reviewed the historical loss development of its major cedents using several actuarial methodologies; where the analysis of a cedent’s experience concluded that the experience was worse than the Company’s historical loss development experience, the Company projected that cedent’s ultimate loss based on the cedent’s own experience. In addition, the Company assumed that the more recent experience was more indicative of future loss development by selecting development patterns that were based on the most recent experience rather than on the Company’s or cedent’s longer term historical experience.

Prior year reserves also developed adversely on certain other casualty business written in the 1998 through 2001 underwriting years outside of North America. These exposures were affected by trends similar to those as described above for the North American casualty reinsurance operations. The casualty exposures underwritten in these entities were much less than those of the North American operations so the impact on the prior year reserves was relatively smaller.

In the second quarter 2002, the Company increased its estimated loss reserves for the September 11 event by $127 million due primarily to higher than originally estimated business interruption losses and exposure to potential claims by the Lloyd’s Central Guaranty Fund. The increase followed an analysis of additional new information received from the Company’s ceding companies with regard to their increased estimates of claims relating to their exposures to the September 11 event. During 2001, the Company had recorded incurred losses for the September 11 event for its reinsurance operations of $442 million. Due to the size and complexity of the loss and the time lag in ceding companies reporting the information to the Company, establishing reserves for this loss within a short time period was difficult.

The increase in estimate for all other reinsurance reserves in 2002 of $258 million also related principally to losses on business written in 1997 through (and including) 2000 in the Company’s U.S. casualty reinsurance business and for asbestos losses in years prior to 1985. The increase in 2002 was partially offset by decreases in estimates for losses related to business written in 1985 through 1996 in these same lines of business. The increase in 2002 was also due to increases in reported claims that were in excess of the Company’s expected loss development for this business from higher court settlement awards. The Company did not change its methodology or key assumptions for determining ultimate loss reserves in 2002.

The Company has experienced significant adverse development in the casualty reinsurance business for the last several years and there can be no assurance that conditions and trends that have affected the development of liabilities in the past will not continue.

Financial Products and Services Segment

The Company commenced writing financial guaranty business in 1998 and had relied entirely upon industry data to establish reserves until the end of 2001. The Company takes into account its actual historical loss experience and revised its estimated claim reporting pattern for the unallocated losses that the Company records during each loss year. The Company uses this expected loss reporting pattern, combined with changes in reported losses, to determine the prior year development amount. Using this new methodology actual reported loss development was less than expected in 2004 and 2003, resulting in a release of prior period reserves of $10.5 million and $15.0 million. In 2002, reported losses for this business were also less than expected and with the refinement in assumptions resulted in a decrease in the estimate of reserves for prior years of $13 million.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

9. Losses and Loss Expenses (Continued)

Other loss information

The Company’s net unpaid losses and loss expenses included estimates of actual and potential non-recoveries from reinsurers. As at December 31, 2004 and 2003, the reserve for potential non-recoveries from reinsurers was $279 million and $108 million, respectively.

Except for certain workers’ compensation and long-term disability liabilities, the Company does not discount its unpaid losses and loss expenses. The Company utilizes tabular reserving for workers’ compensation and long-term disability unpaid losses that are considered fixed and determinable, and discounts such losses using an interest rate of 5% (2003: 5%). The interest rate approximates the average yield to maturity on specific fixed income investments that support these liabilities. The Company decreased the interest rate from 7% to 5% in 2003 in line with current investment yields on this portfolio. The effect of the decrease in the interest rate resulted in an increase in loss reserves of approximately $35.0 million in 2003. The amount of the discount credit included in net losses and loss expenses incurred was $22.6 million in 2002. The tabular reserving methodology results in applying uniform and consistent criteria for establishing expected future indemnity and medical payments (including an explicit factor for inflation) and the use of mortality tables to determine expected payment periods. Tabular unpaid losses and loss expenses, net of reinsurance, at December 31, 2004 and 2003 were $578.6 million and $538.8 million, respectively. The related discounted unpaid losses and loss expenses were $290.0 million and $263.8 million as of December 31, 2004 and 2003, respectively.

The nature of the Company’s high excess of loss liability and catastrophe business can result in loss payments that are both irregular and significant. Similarly, adjustments to reserves for individual years can be irregular and significant. Such adjustments are part of the normal course of business for the Company. Conditions and trends that have affected development of liability in the past may not continue in the future. Accordingly, it is inappropriate to extrapolate future redundancies or deficiencies based upon historical experience.

Asbestos and Environmental Related Claims

The Company’s reserving process includes a continuing evaluation of the potential impact on unpaid liabilities from exposure to asbestos and environmental claims, including related loss adjustment expenses. Liabilities are established to cover both known and incurred but not reported claims.

A reconciliation of the opening and closing unpaid losses and loss expenses related to asbestos and environmental exposure claims related to business written prior to 1986 for the years indicated is as follows:

Year Ended December 31,
(U.S. dollars in thousands)	2004	2003	2002
Net unpaid losses and loss expenses at beginning of year	$ 60,525	$ 66,130	$ 33,152
Net incurred losses and loss expenses	–	(1,000)	35,870
Less net paid losses and loss expenses	3,125	4,605	2,892
Net decrease in unpaid losses and loss expenses	(3,125)	(5,605)	32,978
Net unpaid losses and loss expenses at end of year	57,400	60,525	66,130
Unpaid losses and loss expenses recoverable at end of year	82,922	86,576	92,167
Gross unpaid losses and loss expenses at end of year	$140,322	$147,101	$158,297

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9. Losses and Loss Expenses (Continued)

Incurred but not reported losses, net of reinsurance, included in the above table was $22.5 million in 2004, $27.0 million in 2003 and $33.1 million in 2002. Unpaid losses recoverable are net of potential uncollectible amounts.

The Company utilizes industry standard asbestos and environmental claims models to estimate its ultimate liability for these exposures.

As of December 31, 2004, the Company had approximately 832 open claim files for potential asbestos exposures and 446 open claim files for potential environmental exposures on business written prior to 1986. Approximately 49% of the open claim files in 2004 and 43% in 2003 are due to precautionary claim notices. Precautionary claim notices are submitted by the ceding companies in order to preserve their right to receive coverage under the reinsurance contract. Such notices do not contain an incurred loss amount to the Company. The development of the number of open claim files for potential asbestos and environmental claims is as follows:

	Asbestos	Environmental
	Claims	Claims
Total number of claims outstanding at December 31, 2001	453	543
New claims reported in 2002	117	42
Claims resolved in 2002	33	70
Total number of claims outstanding at December 31, 2002	537	515
New claims reported in 2003	205	49
Claims resolved in 2003	38	74
Total number of claims outstanding at December 31, 2003(1)	704	490
New claims reported in 2004	171	38
Claims resolved in 2004	43	82
Total number of claims outstanding at December 31, 2004	832	446

(1) Includes certain precautionary claims not considered in 2003 annual report

The Company’s exposure to asbestos and environmental claims arises from policies written, both on a proportional and excess basis, after 1972. The Company discontinued writing policies with these exposures in 1985. Business written was across many different policies, each with a relatively small contract limit. The Company’s recently reported asbestos claims related to both traditional products and premises and operations coverage.

The estimation of loss and loss expense liabilities for asbestos and environmental exposures is subject to much greater uncertainty than is normally associated with the establishment of liabilities for certain other exposures due to several factors, including: (i) uncertain legal interpretation and application of insurance and reinsurance coverage and liability; (ii) the lack of reliability of available historical claims data as an indicator of future claims development; (iii) an uncertain political climate which may impact, among other areas, the nature and amount of costs for remediating waste sites; and (iv) the potential of insurers and reinsurers to reach agreements in order to avoid further significant legal costs. Due to the potential significance of these uncertainties, the Company believes that no meaningful range of loss and loss expense liabilities beyond recorded reserves can be established. As the Company’s net unpaid loss and loss expense reserves related to asbestos and environmental exposures are less than 1% of the total net reserves at December 31, 2004, further adverse development is not expected to be material to the Company’s overall net loss reserves. The Company believes it has made reasonable provision for its asbestos and environmental exposures and is unaware of any specific issues that would significantly affect its estimate for loss and loss expenses.

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9. Losses and Loss Expenses (Continued)

The September 11 Event

Terrorist attacks at the World Trade Center in New York City, in Washington, D.C. and in Pennsylvania on September 11, 2001 (collectively, “the September 11 event”) are estimated to have caused the largest ever man-made insured losses for the property and casualty insurance industry. The Company has exposure to this event with claims arising mainly from its aviation, property, personal accident and business interruption insurance and reinsurance coverages. In 2001, the Company performed a detailed analysis of contracts it believed were exposed to this event. A net loss of $795.9 million related to the September 11 event was recorded in the year ended December 31, 2001. Included in the this net loss were net losses and loss expenses of $760 million. During 2002, the Company increased loss reserves by $200.0 million following the receipt of updated loss information. Due principally to the complexity of the claims and inherent lag in reporting from insureds and cedents, management believed it was necessary to increase the estimate for ultimate losses. During 2003, the Company reduced loss reserves by $197.2 million related to the reinsurance segment, primarily aviation lines, due to higher than expected levels of participation (97%) in the September 11 Victims Compensation Fund. During 2004, the Company increased reserves by $18.7 million primarily as a result of an increase in accident and health claims related to the September 11 event.

At December 31, 2004, net losses and loss expenses comprise gross claims of $1.9 billion with estimated reinsurance recoveries of $1.1 billion. The Company has paid approximately 67% of its estimated ultimate net losses related to the September 11 event as at December 31, 2004.

10. Reinsurance

The Company utilizes reinsurance and retrocession agreements principally to increase aggregate capacity and to reduce the risk of loss on business assumed. The Company’s reinsurance and retrocession agreements provide for recovery of a portion of losses and loss expenses from reinsurers and reinsurance recoverables are recorded as assets. The Company is liable if the reinsurers are unable to satisfy their obligations under the agreements. Under its reinsurance security policy, the Company seeks to cede business to reinsurers generally rated “A” or better by Standard & Poor’s (“S&P”) or, in the case of Lloyd’s syndicates, “B+” from Moody’s Investors Service, Inc. (“Moody’s”). The Company considers reinsurers that are not rated or do not fall within the above rating categories and may grant exceptions to the Company’s general policy on a case-by-case basis.

The effect of reinsurance and retrocessional activity on premiums written and earned from general operations is shown below:

	Premiums Written			Premiums Earned
	Year Ended December 31,			Year Ended December 31,
(U.S. dollars in thousands)	2004	2003	2002	2004	2003	2002
Direct	$5,765,274	$5,028,400	$4,366,950	$5,364,305	$4,997,970	$3,964,592
Assumed	3,612,274	3,595,680	3,347,055	3,819,399	3,225,416	2,901,516
Ceded	(2,110,374)	(2,071,800)	(1,942,379)	(2,201,155)	(2,142,353)	(1,967,035)
Net	$7,267,174	$6,552,280	$5,771,626	$ 6,982,549	$6,081,033	$4,899,073

The Company recorded reinsurance recoveries on losses and loss expenses incurred of $3.0 billion, $1.9 billion and $1.4 billion for the years ended December 31, 2004, 2003 and 2002, respectively. The Company is the beneficiary of letters of credit, trust accounts and funds withheld in the aggregate amount of $1.6 billion at December 31, 2003, collateralizing reinsurance recoverables with respect to certain reinsurers.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

10. Reinsurance (Continued)

The following table presents an analysis of total unpaid losses and loss expenses recoverable between general, life and annuity, and financial operations for the year ended December 31:

(U.S. dollars in thousands)	2004	2003
General operations	$6,713,791	$5,772,881
Life and annuity operations	23,585	3,587
Financial operations	3,143	3,529
Total unpaid losses and loss expenses recoverable	$6,740,519	$5,779,997

At December 31, 2004, the total reinsurance assets of $7.8 billion include reinsurance recoverables for paid losses and loss expenses of $1.1 billion and $6.7 billion with respect to the ceded reserve for losses and loss expenses, including ceded losses incurred but not reported. Although the contractual obligation of individual reinsurers to pay their reinsurance obligations is based on specific contract provisions, the collectibility of such amounts requires significant estimation by management. The majority of the balance we have accrued as recoverable will not be due for collection until sometime in the future. Over this period of time, economic conditions and operational performance of a particular reinsurer may impact their ability to meet these obligations and while they may continue to acknowledge their contractual obligation to do so, they may not have the financial resources or willingness to fully meet their obligation to the Company.

At December 31, 2004, the provision for uncollectible reinsurance was $279 million. To estimate this provision, the reinsurance recoverable must first be allocated to applicable reinsurers. This determination is based on a process rather than an estimate, although an element of judgment must be applied. As part of this process, ceded IBNR is allocated by reinsurer. The allocations are generally based on historical relationships between gross and ceded losses. If actual experience varies materially from historical experience, the allocation of reinsurance recoverable by reinsurer will change.

The Company uses a default analysis to estimate uncollectible reinsurance. The primary components of the default analysis are reinsurance recoverable balances by reinsurer, net of collateral, and default factors used to determine the portion of a reinsurer’s balance deemed uncollectible. The definition of collateral for this purpose requires some judgment and is generally limited to assets held in trust, letters of credit, and liabilities held by us with the same legal entity for which the Company believes there is a right of offset. Default factors require considerable judgment and are determined using the current rating, or rating equivalent, of each reinsurer as well as other key considerations and assumptions.

At December 31, 2004, the use of different assumptions within the model could have a material effect on the bad debt provision reflected in the Company’s Consolidated Financial Statements. To the extent the creditworthiness of the Company’s reinsurers was to deteriorate due to an adverse event affecting the reinsurance industry, such as a large number of major catastrophes, actual uncollectible amounts could be significantly greater than the Company’s bad debt provision. Such an event could have a material adverse effect on the Company’s financial condition, results of operations, and liquidity.

Included in unpaid loss and loss expenses recoverable at December 31, 2004 from general operations is an unsecured reinsurance recoverable from Winterthur Swiss Insurance Company (currently rated A by Standard and Poor’s) of $1.45 billion related to the acquisition of Winterthur International. Also, of the total unpaid loss and loss expense recoverable and reinsurance balances receivable at December 31, 2004 of $7.8 billion, approximately $2.0

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11. Deposit Liabilities

billion related to Winterthur International and these recoverable balances are also guaranteed by Winterthur Swiss Insurance Company. See Note 5(b).

The Company has entered into certain contracts with cedants that transfer insufficient risk to be accounted for as insurance or reinsurance transactions. These contracts have been recorded as deposit liabilities and are matched by an equivalent amount of investments. The Company has investment risk related to its ability to generate sufficient investment income to enable the total invested assets to cover the payment of the estimated ultimate liability. The Company establishes an initial accretion rate at inception of the contract, which is reviewed and adjusted periodically based on claims activity. Guaranteed investment contracts are initially recorded at an amount equal to the assets received. The Company also has investment risk related to its ability to generate sufficient investment income to enable the total invested assets to cover the payment of the estimated ultimate liability. The Company establishes an initial accretion rate at inception of the contract, which is based on the contractual payment schedule.

Total deposit liabilities are comprised of the following:

Year ended December 31,
(U.S. dollars in thousands)	2004	2003
Reinsurance and insurance deposit liabilities	$1,744,412	$1,746,619
Guaranteed investment contract deposit liabilities	3,981,178	2,303,715
Total deposit liabilities	$5,725,590	$4,050,334

Interest expense of $129.9 million, $105.1 million and $65.9 million was recorded related to the accretion of deposit liabilities for the years ended December 31, 2004, 2003 and 2002, respectively.

12. Future Policy Benefit Reserves

During 2004 and 2003, the Company entered into long duration contracts that subject the Company to mortality and morbidity risks and which were accounted for as life premiums earned. Future policy benefit reserves were established using appropriate assumptions for investment yields, mortality, and expenses, including a provision for adverse deviation. The average interest rate used for the determination of the future policy benefits for these contracts was 5.1% and 5.2% at December 31, 2004 and 2003, respectively. Total future policy benefit reserves for the year ended December 31, 2004 and 2003 were $4.5 and $3.2 billion, respectively. Substantially all of these reserves relate to closed blocks of annuities.

13. Notes Payable and Debt and Financing Arrangements

As at December 31, 2004, the Company had bank, letter of credit and loan facilities available from a variety of sources, including commercial banks, totaling $7.8 billion, (2003: $6.1 billion) of which $2.7 billion (2003: $1.9 billion) of debt was outstanding. In addition, $3.0 billion (2003: $2.7 billion) of letters of credit were outstanding as at December 31, 2004, 6.6%, (2003: 8.7%) of which were collateralized by the Company’s investment portfolio, supporting U.S. non-admitted business and the Company’s Lloyd’s Syndicates’ capital requirements.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

13. Notes Payable and Debt and Financing Arrangements (Continued)

The financing structure at December 31, 2004 was as follows:

Facility		In Use/
(U.S. dollars in thousands)	Commitment (1)	Outstanding (1)
Debt:
364-day and 3-year Revolvers	$ 660,000	$ –
7.15% Senior Notes due 2005	100,000	100,000
2.53% Senior Notes due 2009	825,000	825,000
6.58% Guaranteed Senior Notes due 2011	255,000	255,000
6.50% Guaranteed Senior Notes due 2012	597,761	597,761
5.25% Senior Notes due 2014	593,670	593,670
6.375% Senior Notes due 2024	350,000	350,000
Total debt	$ 3,381,431	$ 2,721,431
Letters of Credit:
8 Facilities-total	$ 4,371,167	$ 2,991,676

(1) “Commitment” and “In Use” data represent December 31, 2004 accreted values.

The financing structure at December 31, 2003 was as follows:

Facility		In Use/
(U.S. dollars in thousands)	Commitment (1)	Outstanding (1)
Debt:
364-day Revolver	$ 675,000	$ –
7.15% Senior Notes due 2005	99,986	99,986
6.58% Guaranteed Senior Notes due 2011	255,000	255,000
6.50% Guaranteed Senior Notes due 2012	597,441	597,441
Zero Coupon Convertible Debentures due 2021	642,340	642,340
Liquid Yield Option Notes(tm) due 2021	310,716	310,716
	$ 2,580,483	$ 1,905,483
Letters of Credit:
8 facilities-total	$ 3,528,652	$ 2,695,893

(1) “Commitment” and “In Use” data represent December 31, 2003 accreted values.

There were no borrowings or repayments under the Company’s revolving credit facilities during 2004 or 2003.

During 2004, the Company renewed a $200 million unsecured bilateral letter of credit facility that was fully utilized throughout 2004 and at December 31, 2004.

In June 2004, the Company replaced its principal revolving credit and letter of credit facility that had amounted to $2.5 billion with two facilities – one $2.0 billion facility with a tenor of 3 years and a $1.0 billion facility with a tenor of 364 days. Of the aggregate amount of $3.0 billion, $600 million is available as revolving credit and up to $3.0 billion is available in the form of letters of credit, with the combined total not to exceed $3.0 billion. As at December

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13. Notes Payable and Debt and Financing Arrangements (Continued)

31, 2004 approximately $1.9 billion of the 3-year facility was in use in the form of letters of credit while the 364-day facility was unutilized at that date.

In September 2004, the Company created a new $100 million unsecured bilateral credit facility that was unutilized during 2004 and at December 31, 2004. Of the aggregate amount of $100 million, $60 million is available as revolving credit and up to $100 million is available in the form of letters of credit, with the combined total not to exceed $100 million.

In November 2004, the Company renewed its unsecured syndicated letter of credit facility that supports its operations at Lloyd’s. The renewed facility is denominated in U.K. sterling and was £450 million (approximately $863 million) at December 31, 2004.

In November 2004, the Company issued the second tranche of $300 million aggregate principal amount of 5.25% Senior Notes due September 2014. The bonds were issued at 98.419% and gross proceeds were $298.7 million. Related expenses of the offering amounted to approximately $2.0 million. Proceeds of these notes, together with proceeds from the issuance of the 2024 senior notes described below, were used to redeen the Zero Coupon Convertible Debentures (“CARZ”) as described below.

In November 2004, the Company issued $350 million aggregate principal amount of 6.375% Senior Notes due November 2024. The bonds were issued at par and gross proceeds were $350 million. Related expenses of the offering amounted to approximately $2.0 million. Proceeds of these notes, together with proceeds form the issuance of the second tranche of 2014 senior notes described above, were used to redeem the CARZ as described below.

In August 2004, the Company issued the first tranche of $300 million aggregate principal amount of 5.25% Senior Notes due September 2014. The bonds were issued at 99.432% and gross proceeds were $298.3 million. Related expenses of the offering amounted to approximately $1.7 million. Proceeds of these notes were used to redeem the Liquid Yield Option Notes (“LYONs”), as described below.

In March 2004, the Company issued 33 million 6.5% Equity Security Units (“Units”) in a public offering. The Company received approximately $800.2 million in net proceeds from the sale of the Units after deducting underwriting discounts. Each Unit has a stated amount of $25 and consists of (a) a purchase contract pursuant to which the holder agreed to purchase, for $25, a variable number of shares of the Company’s Class A Ordinary Shares on May 15, 2007 and (b) a one-fortieth, or 2.5%, ownership interest in a senior note issued by the Company due May 15, 2009 with a principal amount of $1,000. The senior notes are pledged by the holders to secure their obligations under the purchase contract. The number of shares issued under the purchase contract is contingently adjustable based on, among other things, the share price of the Company on the stock purchase date and the dividend rate of the Company. The Company will make quarterly payments at the annual rate of 3.97% and 2.53% under the purchase contracts and senior notes, respectively. The Company may defer the contract payments on the purchase contract, but not the senior notes, until the stock purchase date. In May 2007, the senior notes will be remarketed whereby the interest rate on the senior notes will be reset in order to generate sufficient remarketing proceeds to satisfy the Unit holders’ obligations under the purchase contract. If the senior notes are not successfully remarketed, then the Company will exercise its rights as a secured party and may retain or dispose of the senior notes to satisfy, in full, the Unit holders’ obligations to purchase its ordinary shares under the purchase contracts.

In connection with this transaction, $88.6 million, which is the estimated fair value of the purchase contract, was charged to “Additional paid-in capital” and a corresponding liability was established. Of the $26.9 million total

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13. Notes Payable and Debt and Financing Arrangements (Continued)

costs associated with the issuance of the Units, $23.7 million was charged to “Additional paid in capital” with the remainder deferred and amortized over the term of the senior debt. The number of ordinary shares to be issued under each purchase contract depends on, among other things, the average market price of the ordinary shares. The maximum number of ordinary shares to be issued under the purchase contracts is approximately 11 million. The Company accounts for the effect on the number of weighted average ordinary shares, assuming dilution, using the treasury stock method. The purchase contract component of the Units will have no effect on the number of weighted average ordinary shares, assuming dilution, except when the average market price of the Company’s ordinary shares is above the threshold appreciation price of $93.99 per share. Because the average market price of the Company’s ordinary shares during the period the Units were outstanding was below this price, the shares issuable under the purchase contracts were excluded from the computation of net income per ordinary share assuming dilution for the three and twelve month periods ended December 31, 2004.

In February 2003, the Company entered into an aggregate of $300.0 million of commercial paper-based credit facilities (the “Credit Facilities”). These facilities were increased to $500.0 million in June 2003. The proceeds of advances under the Credit Facilities were used to fund a trust account to collateralize the reinsurance obligations of the Company. The Company could face additional obligations under the Credit Facilities prior to the stated maturity of February 25, 2008, if certain events were to occur, including, but not limited to the Company’s insolvency, withdrawal of assets from the Regulation 114 trust by the ceding company, the downgrade of the Company’s credit ratings below certain specified levels, or the failure of the agent to have a first priority perfected security interest in the collateral posted by the Company. At maturity, the Company will be obligated to make payments in an amount equal to the principal and accrued interest outstanding under the Credit Facilities. The issued securities and the Company’s repayment obligations are recorded as a net balance on the Company’s balance sheet.

In July 2003, the Company entered into a contingent capital transaction with an aggregate value of $500.0 million. This transaction also provides the Company with an insurance trust that provides the Company with statutory relief under state insurance regulations in the U.S. Under the terms of this facility, the Company has acquired an irrevocable put option to issue preference ordinary shares into a trust in return for proceeds raised from investors. This put option may be exercised by the Company at any time. In addition, the Company may be required to issue preference ordinary shares to the trust under certain circumstances, including, but not limited to, the non-payment of the put option premium and a ratings downgrade of the Company. In connection with this transaction, the fair value of the put premiums and other related costs, in total of $109.9 million was charged to “Additional Paid in Capital” and a deferred liability was established (included with “Other liabilities”) of $102.5 million in the Consolidated Balance Sheet at December 31, 2003. The Company began to amortize this liability that resulted in additional interest expense of approximately $3.5 million in 2004 and $2.0 million in 2003 and the liability will continue to be amortized over a ten year term.

In December 2004, XL Financial Assurance Ltd. (“XLFA”) entered into a put option agreement and an asset trust expense reimbursement agreement with Twin Reefs Asset Trust (the “Asset Trust”). The put option agreement provides XLFA with the irrevocable right to require the Asset Trust at any time and from time to time to purchase XLFA’s non-cumulative perpetual Series B Preferred Shares with an aggregate liquidation preference of up to $200 million. XLFA is obligated to reimburse the Asset Trust for certain fees and ordinary expenses. To the extent that any Series B Preferred Shares are put to the Asset Trust and remain outstanding, a corresponding portion of such fees and ordinary expenses will be payable by XLFA pursuant to the asset trust expense reimbursement agreement. The put option agreement is perpetual but would terminate on delivery of notice by XLFA on or after December 9, 2009, or under certain defined circumstances, such as the failure of XLFA to pay the put option premium when due or bankruptcy. The put option is recorded at fair value with changes in fair value recognized in earnings.

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13. Notes Payable and Debt and Financing Arrangements (Continued)

In January 2002, the Company issued $600.0 million par value 6.50% Guaranteed Senior Notes due January 2012. The notes were issued at $99.469 and gross proceeds were $596.8 million. Related expenses of the offering amounted to $7.9 million. Proceeds of the notes were used to pay down two 5-year revolvers of $350.0 million and for general corporate purposes. These credit facilities were subsequently cancelled.

In April 2001, the Company issued at par $255.0 million of 6.58% Guaranteed Senior Notes due April 2011 through a private placement to institutional investors. Proceeds of the debt were used for general corporate purposes.

In September 2001, the Company issued $508.8 million principal amount at maturity (subsequently increased to $514.6 million under the provisions of an upward interest adjustment provision) of LYONs. The accretion rate on the LYONs was originally 2.875% per annum on a semi-annual basis or 2.896% per annum on an annual basis. The accretion rate for the year to September 7, 2004, was increased by 0.645% per annum on a semi-annual basis to 3.52% on a semi-annual basis and 3.551% per annum on an annual basis as a result of the of the Company’s ordinary share price in the 30-day period leading up to the second put date in September 2003. On September 7, 2004, the Company redeemed the entire issue of LYONs at their accreted value of approximately $317 million, using proceeds from the issuance of the first tranche of Senior Notes due 2014, as described above.

In May 2001, the Company issued $1,010.8 million principal amount at maturity of CARZ. On May 26, 2004, the Company made a one-time cash payment to holders of the CARZ for not exercising their put rights. On November 8, 2004, the Company redeemed the entire issue of CARZ at a total cost of approximately $657.6 million using proceeds from the issuance of the second tranche of Senior Notes due 2104 and the Senior Notes due 2024, as described above.

During 1995, the Company issued $100.0 million of 7.15% Senior Notes due November 15, 2005 through a public offering at a price of $99.9 million.

The Company has several letter of credit facilities provided on a syndicated and bilateral basis from commercial banks. These facilities are utilized to support non-admitted insurance and reinsurance operations in the U.S. and capital requirements at Lloyd’s. The commercial facilities are scheduled for renewal during 2005 and 2007. In addition to letters of credit, the Company has established insurance trusts in the U.S. that provide cedents with statutory relief required under state insurance regulation in the U.S. It is anticipated that the commercial facilities will be renewed on expiry but such renewals are subject to the availability of credit from banks utilized by the Company. In the event that such credit support is insufficient, the Company could be required to provide alternative security to cedents. This could take the form of additional insurance trusts supported by the Company’s investment portfolio or funds withheld using the Company’s cash resources. The value of letters of credit required is driven by, among other things, loss development of existing reserves, the payment pattern of such reserves, the expansion of business written by the Company and the loss experience of such business.

In general, all of the Company’s bank facilities, indentures and other documents relating to the Company’s outstanding indebtedness (collectively, the “Company’s Debt Documents”), as described above, contain cross default provisions to each other and the Company’s Debt Documents (other than the 6.5% Guaranteed Senior Notes indentures) contain affirmative covenants. These covenants provide for, among other things, minimum required ratings of the Company’s insurance and reinsurance operating subsidiaries (other than its “AAA” financial guaranty companies) and the level of secured indebtedness in the future. In addition, generally each of the Company’s Debt Documents provide for an event of default in the event of a change of control of the Company or some events involving bankruptcy, insolvency or reorganization of the Company. The Company’s credit facilities and the 6.58% Guaranteed Senior Notes also contain minimum consolidated net worth covenants.

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13. Notes Payable and Debt and Financing Arrangements (Continued)

Under the Company’s 364-day facilities, 3-year credit facility, five-year credit facilities and ten-year private placement notes described above, in the event that the Company fails to maintain a financial strength rating of at least “A” from A.M. Best or the Company’s insurance and reinsurance rated operating subsidiaries (other than its “AAA” financial guaranty companies) fail to maintain a rating of at least “A” from S&P, an event of default would occur. The Company currently has an “A+ under review” rating from A.M. Best and “AA–” from S&P.

The 6.5% Guaranteed Senior Notes indentures contains a cross default provision. In general, in the event that the Company defaults in the payment of indebtedness in the amount of $50.0 million or more, an event of default would be triggered under both the 6.5% Guaranteed Senior Notes indentures.

Given that all of the Company’s Debt Documents contain cross default provisions, this may result in all holders declaring such debt due and payable and an acceleration of all debt due under those documents. If this were to occur, the Company may not have funds sufficient at that time to repay any or all of such indebtedness.

In addition, the Company’s unsecured Lloyd’s letter of credit facility provides that, in the event that the Company’s insurance and reinsurance rated operating subsidiaries in Bermuda fall below “A” (as measured by the financial strength rating from A.M. Best at any time), the facility would then be required to be fully secured by the Company, at which time the Company would be required to either (i) provide an amount in cash to cover an amount equal to the aggregate letters of credit outstanding at that time or (ii) deposit assets in trust securing 105% of the aggregate letters of credit outstanding at that time. If this were to occur, the Company may not be able to provide the collateral required in order to maintain this facility.

14. Derivative Instruments

The Company enters into derivative instruments for both risk management and trading purposes. The Company is exposed to potential loss from various market risks, and manages its market risks based on guidelines established by management. These derivative instruments are carried at fair value with the resulting gains and losses recognized in income in the period in which they occur.

The following table summarizes these instruments and the effect on net income in the years ended December 31, 2004, 2003 and 2002:

(U.S. dollars in thousands)	2004	2003	2002
Credit derivatives	$52,897	$(25,787)	$(46,137)
Weather and energy derivatives	1,997	1,103	16,607
Investment derivatives	23,125	(2,858)	(22,231)
Net realized and unrealized (losses) gains on derivatives	$78,019	$(27,542)	$(51,761)

(a) Credit Derivatives

Credit derivatives are recorded at fair value. In determining the fair value of credit derivatives, management differentiates between investment and non-investment grade exposures and models them separately. Management estimates fair value for investment grade exposures by monitoring changes in credit quality and selecting appropriate market indices to determine credit spread movements over the life of the contracts. The determination of the credit spread movements is the basis for calculating the fair value. For credit derivatives that are non-investment grade appropriate market indices are not readily available. Accordingly, the Company uses an alternative fair value method-

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14. Derivative Instruments (Continued)

(a) Credit Derivatives (continued)

ology. Under this methodology, the fair value is determined using a cash flow model developed by the Company which is dependent upon a number of factors, including changes in interest rates, future default rates, credit spreads, changes in credit quality, future expected recovery rates and other market factors. In general, the Company holds credit derivatives to maturity. Accordingly, changes in the fair value of such credit derivatives are unrealized. For the years ended December 31, 2004, 2003, and 2002 the change in the fair value of credit derivatives issued in connection with the Company’s financial guaranty business was a gain of $52.9 million, a loss of $25.8 million, and a loss of $46.1 million, respectively.

(b) Weather and Energy Derivatives

Weather and energy derivatives are recorded at fair value, which is determined through the use of quoted market prices where available. Where quoted market prices are unavailable, the fair values are estimated using available market data and internal pricing models based upon consistent statistical methodologies. Estimating fair value of instruments which do not have quoted market prices requires management’s judgment in determining amounts which could reasonably be expected to be received from, or paid to, a third party in settlement of the contracts. The amounts could be materially different from the amounts that might be realized in an actual sale transaction. Fair values are subject to change in the near-term and reflect management’s best estimate based on various factors including, but not limited to, actual and forecasted weather conditions, changes in commodity prices, changes in interest rates and other market factors.

The change in fair value recorded for the weather and energy derivatives was a gain of $2.0 million, $1.1 million and $16.6 million for the year ended December 31, 2004, 2003 and 2002, respectively.

(c) Investment Derivatives, Including Embedded Derivatives

The Company uses foreign exchange contracts to manage its exposure to the effects of fluctuating foreign currencies on the value of certain of its foreign currency fixed maturities and equity securities investments. These contracts are not designated as specific hedges for financial reporting purposes and therefore, realized and unrealized gains and losses on these contracts are recorded in income in the period in which they occur. These contracts generally have maturities of three months or less. In addition, certain of the Company’s investment managers may, subject to investment guidelines, enter into forward contracts where potential gains may exist. The Company has exposure to foreign currency exchange rate fluctuations through its operations and in its investment portfolio. The Company’s net foreign currency denominated payable on foreign exchange contracts as at December 31, 2004 was $3.8 million and the net foreign currency denominated receivable was $31.1 million at December 31, 2003, with a net unrealized loss of $11.8 million as at December 31, 2004 and $6.7 million as at December 31, 2003.

The Company also uses foreign exchange forward contracts, in certain cases to hedge net investments in foreign operations against adverse movements in exchange rates. The Company manages its consolidated net foreign exchange exposure and from time to time hedges specific net in foreign operations. The Company measures ineffectiveness based upon the change in forward rates. For the year ended December 31, 2004, $26.7 million of net losses related to these foreign exchange forward contracts and were included in the cumulative translation adjustment. For the same period, no net losses were recorded in earnings representing the amount of the hedges’ ineffectiveness as the change in the value of the forward contract was fully offset by a corresponding change in the underlying investment.

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14. Derivative Instruments (Continued)

(d) Interest Rate Exposure

The Company utilizes a risk management strategy that incorporates the use of derivative financial instruments, primarily to reduce its exposure to interest rate risks associated with certain of its assets and liabilities. The Company uses interest rate swaps to convert certain liabilities from a fixed rate to a variable rate of interest and to convert a variable rate of interest from one basis to another. The Company is exposed to credit risk in the event of non-performance by the other parties to the forward contracts.

The Company designates certain of its derivative instruments as fair value hedges or cash flow hedges and formally and contemporaneously documents all relationships between the hedging instruments and hedged items and links the hedge to specific assets and liabilities. The Company assesses the effectiveness of the hedge, both at inception and on an on-going basis and determines whether the hedge is highly effective in offsetting changes in fair value or cash flows of the linked hedged item.

At December 31, 2004, contracts designated as fair value and cash flow hedges were in a $13.4 million net unrealized gain position. As a result of the fair value hedges, deposit liabilities were increased by $19.9 million at December 31, 2004. The ineffective portion of the hedge amounted to $1.8 million as part of net realized losses. The interest rate swap hedges resulted in a reduction in interest expense and a reduction in net investment income of $14.8 million and $4.4 million, respectively, for the year ended December 31, 2004.

At December 31, 2003, contracts designated as fair value and cash flow hedges were in a $3.2 million net unrealized gain position. As a result of the fair value hedges, deposit liabilities were increased by $3.1 million at December 31, 2003. The ineffective portion of the hedge amounted to $0.1 million as part of net realized gains. The interest rate swap hedges resulted in a reduction in interest expense of $2.6 million for the year ended December 31, 2003.

In August 2004, the Company entered into a treasury rate guarantee agreement in anticipation of the issuance of fixed-rate debt. This transaction, which met the requirements of a cash flow hedge of a forecasted transaction under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, was entered into to mitigate the interest rate risk associated with the subsequent issuance of $300.0 million of 5.25% Senior Notes due September 15, 2014 (see Note 8 above). The loss on the settlement of the treasury rate guarantee transaction on August 18, 2004 of $6.3 million was charged to Accumulated Other Comprehensive Income and is being amortized to interest expense over the 10-year term of the related debt.

In 2002, the Company entered into a treasury rate lock agreement with the underwriters of the 6.50% Guaranteed Senior Notes due 2012 (2001: 6.58% Guaranteed Senior Notes due 2011). The Notes were priced using a margin over the yield of a U.S. Treasury note with a similar maturity. The treasury rate lock agreement was designed to eliminate underlying pricing risk of the Company’s debt that would have resulted from an increase in the yield of the comparable U.S. Treasury issue between the initiation of the transaction and the pricing of the transaction. The total cost of the hedge was $4.2 million. In 2001, a loss of $5.6 million was recorded in net realized and unrealized gains and losses related to the cancellation of the treasury lock agreement relating to the 6.58% notes due 2011 due to the September 11, 2001 event

(e) Financial Market Exposure

The Company also uses bond and stock index futures to add value to the portfolio where market inefficiencies are believed to exist, to equitize cash holdings of equity managers and to adjust the duration of a portfolio of fixed income securities to match the duration of related deposit liabilities. These instruments are marked to market on a

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14. Derivative Instruments (Continued)

(e) Financial Market Exposure (continued)

daily basis and changes in fair values are recorded through net realized and unrealized gains and losses on derivative instruments. The Company measures potential losses in fair values using various statistical techniques.

(f) Other Derivatives

The Company holds warrants in conjunction with certain of its other investments. These warrants are recorded at fair value based on quoted market prices.

The Company also has investment related derivatives embedded in certain reinsurance contracts. For a particular life reinsurance contract, the Company pays the ceding company a fixed amount equal to the estimated present value of the excess of guaranteed benefit (“GMIB”) over the account balance upon the policyholder’s election to take the income benefit. The fair value of this derivative is determined based on the present value of expected cash flows. In addition, the Company has modified coinsurance and funds withheld reinsurance agreements that provide for a return based on a portfolio of fixed income securities, as such, the agreements contain embedded derivatives. The embedded derivative is bifurcated from the funds withheld balance and recorded at fair value with changes in fair value recognized in earnings.

15. Off-Balance Sheet Arrangements

In 2003, the Company entered into an aggregate of $500.0 million of commercial paper-based credit facilities (the “Credit Facilities”). The proceeds of advances under the Credit Facilities were used to fund a trust account (“Trust”) to collateralize the reinsurance obligations of the Company under an intercompany quota share reinsurance agreement. The issued securities and the Company’s repayment obligations are recorded as a net balance on the Company’s balance sheet because the Company has a contractual legal right of offset. In the event that in the future the Company were to not have the right to offset such assets (as, for example, would be the case if the assets in the Trust were withdrawn in order to satisfy the Company’s reinsurance obligations or if lender-issued securities could not be held in the Trust because they did not qualify as permitted assets under the trust agreement), then all or a portion of the assets in the Trust and the Company’s repayment obligations under the Credit Facilities would be required to be included as assets and liabilities on a gross basis, respectively, on the Company’s balance sheet.

In December 2004, XLFA entered into a put option agreement and an asset trust expense reimbursement agreement with the Asset Trust. The put option agreement provides XLFA with the irrevocable right to require the Asset Trust at any time and from time to time to purchase XLFA’s non-cumulative perpetual Series B Preferred Shares with an aggregate liquidation preference of up to $200 million. XLFA is obligated to reimburse the Asset Trust for certain fees and ordinary expenses. To the extent that any Series B Preferred Shares are put to the Asset Trust and remain outstanding, a corresponding portion of such fees and ordinary expenses will be payable by XLFA pursuant to the asset trust expense reimbursement agreement. The put option agreement is perpetual but would terminate on delivery of notice by XLFA on or after December 9, 2009, or under certain defined circumstances, such as the failure of XLFA to pay the put option premium when due or bankruptcy. The put option is recorded at fair value with changes in fair value recognized in earnings.

In July 2003, the Company entered into a contingent capital transaction with an aggregate value of $500.0 million. This transaction also provides the Company with an insurance trust that provides the Company with statutory relief under state insurance regulations in the U.S. Under the terms of this facility, the Company has acquired an irrevocable put option to issue preference ordinary shares into a trust in return for proceeds raised from investors. This put

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15. Off-Balance Sheet Arrangements (Continued)

option may be exercised by the Company at any time. In addition, the Company may be required to issue preference ordinary shares to the trust under certain circumstances, including, but not limited to, the non-payment of the put option premium and a ratings downgrade of the Company.

16. Variable Interest Entities

The Company utilizes variable interest entities both indirectly and directly in the ordinary course of business. The Company provides various forms of credit enhancement including financial guaranty insurance and reinsurance of structured transactions backed by pools of assets of specified types, municipal obligations supported by the issuers’ ability to charge fees for specified services or projects, and structured single risk based obligations including essential infrastructure projects and obligations backed by receivables from future sales of commodities and other specified services. The obligations related to these transactions are often securitized through variable interest entities. In synthetic transactions the Company guarantees payment obligations of counterparties including special purpose vehicles under credit derivatives referencing asset portfolios. The Company invests in equity tranches (or similar instruments) of collateralized debt obligations (“CDOs”), collateralized bond obligations (“CBOs”) and other investment vehicles that are issued through variable interest entities as part of the Company’s risk asset portfolio.

The Company has an investment in the junior notes of a collateralized debt obligation (“CDO”). The Company also issued financial guaranties for the senior notes of the CDO. As of December 31, 2004, the CDO had assets of $468.2 million and liabilities of $395.6 million and the Company’s maximum exposure to loss as a result of its financial guaranties and investment in this variable interest entity was approximately $412.3 million. The Company could experience a loss in the event that the cash flows relating to the underlying assets are not collected as expected. The Company is not the primary beneficiary of this entity and therefore is not required to consolidate this entity.

17. Exposures Under Guaranties

The Company provides and reinsures financial guaranties issued to support public and private borrowing arrangements. Financial guaranties are conditional commitments that guarantee the performance of an obligor to a third party, typically the timely repayment of principal and interest. The Company’s potential liability in the event of non- payment by the issuer of the insured obligation is represented by its proportionate share of the aggregate outstanding principal and interest payable (“insurance in force”) on such insured obligation. In synthetic transactions, the Company guarantees payment obligations of counterparties under credit derivatives. The future value of installment premiums for such guarantees totaled approximately $505.8 million and $467.0 million at December 31, 2004 and 2003, respectively. The range of maturity of the insured obligations is one to thirty-five years. The Company does not record a carrying value for future installment premiums as they are recognized over the term of the contract.

The Company manages its exposures to underwriting risk on these transactions through a structured process which includes but is not limited to detailed credit analysis, review of and adherence to underwriting guidelines and the use of reinsurance. The Company has also implemented surveillance policies and procedures to monitor its exposure throughout the life of the transactions. In addition, the structures of the transactions are such that the insured obligation is backed by a stream of cash flows, pools of assets or some other form of collateral. This collateral would typically become the Company’s upon the payment of a claim by the Company.

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17. Exposures Under Guaranties (Continued)

The following table presents financial guaranty aggregate insured portfolios at December 31, 2004 where the net par outstanding was $76.0 billion, which includes credit default swap exposures of $11.3 billion. The net principal and interest insured as of December 31, 2004 and 2003 was $108.3 billion and $77.3 billion, respectively. The liability for these credit derivatives had a carrying value of $49.5 million and $131.6 million at December 31, 2004 and 2003, respectively.

	Net Par
	Outstanding	% of Total
Credit Quality:
AAA	$22,031	28.9%
AA	8,541	11.2%
A	24,517	32.1%
BBB	20,325	26.7%
BB and below	850	1.1%
Total	$76,264	100.0%
	Net Par
	Outstanding	% of Total
Geographic:
United States	$65,471	85.8%
United Kingdom	2,573	3.4%
Brazil	1,423	1.9%
Mexico	681	0.9%
Other (1)	4,684	6.1%
International (2)	1,432	1.9%
Total	$76,264	100.0%

(1)	Other includes Canada, France, Germany, Korea, Chile, Australia, Japan, Portugal, El Salvador, Jamaica, Panama, Costa Rica, Qatar, New Zealand and Spain.
(2)	International includes multi-country transactions where there is no majority exposure to any single country.

	Net Par
	Outstanding	% of Total
Sector Allocation:
Collateralized Debt Obligations	$14,017	18.4%
Consumer Assets	14,868	19.5%
Public Finance	30,764	40.3%
Other Single Risk	8,676	11.4%
Other Structured Finance	515	0.7%
Commercial Assets	7,424	9.7%
Total	$76,264	100.0%

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18. Commitments and Contingencies

(a) Concentrations of Credit Risk

The creditworthiness of a counterparty is evaluated by the Company, taking into account credit ratings assigned by rating agencies. The credit approval process involves an assessment of factors including, among others, the counterparty, country and industry credit exposure limits. Collateral may be required, at the discretion of the Company, on certain transactions based on the creditworthiness of the counterparty.

The areas where significant concentrations of credit risk may exist include unpaid losses and loss expenses recoverable and reinsurance balances receivable (collectively “reinsurance assets”), investments and cash and cash equivalent balances. The Company’s reinsurance assets at December 31, 2004 amounted to $7.8 billion and resulted from reinsurance arrangements in the course of its operations. A credit exposure exists with respect to reinsurance assets as they may be uncollectible. The Company manages its credit risk in its reinsurance relationships by transacting with reinsurers that it considers financially sound, and if necessary, the Company may hold collateral in the form of funds, trust accounts and/or irrevocable letters of credit. This collateral can be drawn on for amounts that remain unpaid beyond specified time periods on an individual reinsurer basis.

In addition, the Company underwrites a significant amount of its general insurance and reinsurance business through brokers and a credit risk exists should any of these brokers be unable to fulfill their contractual obligations with respect to the payments of insurance and reinsurance balances to the Company. During 2004, 2003 and 2002, approximately 22%, 24% and 23%, respectively, of the Company’s consolidated gross written premiums from general operations were generated from or placed by Marsh & McLennan Companies. During 2004, 2003 and 2002, approximately 17%, 17% and 17%, respectively, of the Company’s consolidated gross written premiums from general operations were generated from or placed by AON Corporation and its subsidiaries. Both of these companies are large, well established companies and there are no indications that either of them is financially troubled. No other broker and no one insured or reinsured accounted for more than 10% of gross premiums written from general operations in any of the three years ended December 31, 2004, 2003, or 2002.

The Company’s available for sale investment portfolio is managed by external managers in accordance with guidelines that have been tailored to meet specific investment strategies, including standards of diversification, which limit the allowable holdings of any single issue. The Company did not have an aggregate investment in a single entity, other than the U.S. government, in excess of 10% of the Company’s shareholders’ equity at December 31, 2004, 2003, or 2002.

On July 25, 2001, the Company completed the acquisition of certain Winterthur International insurance operations (“Winterthur International”) primarily to extend its predominantly North American based large corporate insurance business globally. The Company provisionally paid to the Seller $405.6 million at closing for Winterthur International based on the audited U.S. GAAP financial statements of the acquired Winterthur International operations as at December 31, 2000 and the price was subject to final determination based on the audited U.S. GAAP financial statements of the acquired Winterthur International operations as at June 30, 2001. In December 2003, the Company reached an agreement with the Seller as to the final purchase price, which was $330.2 million. As a result, $75.4 million in cash was returned to the Company.

Included in unpaid loss and loss expenses recoverable at December 31, 2004 is an unsecured reinsurance recoverable from Winterthur Swiss Insurance Company (the “Seller”) of $1.45 billion, related to certain contractual arrangements with the sale and purchase agreement, as amended (“SPA”) relating to the Company’s acquisition of Winterthur International in July 2001. The Seller is currently rated “A-” by S&P. The Seller provides the Company with post-closing protection determined as of June 30, 2004 with respect to, among other things, adverse development

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18. Commitments and Contingencies (Continued)

(a) Concentrations of Credit Risk (Continued)

incurred losses and premium balances relating to the acquired Winterthur International business (“Winterthur Business”). This protection is based upon net loss experience and development over a three-year, post-closing seasoning period based on actual loss development experience, collectible reinsurance and certain other factors set forth in the SPA. The SPA includes an independent actuarial process for determining the net amount due to the Company from the Seller. In this process, each of the Company and the Seller submits their respective net reserves and seasoned premium amounts. The independent actuary develops its own value of the seasoned net reserves and seasoned premium amounts and the actual final seasoned amount would be in each case, the submission that is closest to the number developed by the independent actuary.

As the Company and the Seller were unable to come to an agreement, the Company submitted to the Seller notice to trigger the independent actuarial process as contemplated by the SPA. On February 3, 2005, both the Company and the Seller have made submissions for the independent actuarial process. The Company’s submissions would result in a net payable to the Company of approximately $1.45 billion in aggregate and the Seller’s submissions would result in a net payable to the Company of $541 million in aggregate. At the completion of the independent actuarial process, the Company will be entitled to a lump sum payment.

In addition, the Seller provides protection to the Company with respect to third party reinsurance receivables and recoverables related to the Winterthur Business which are $2.0 billion in the aggregate as of December 31, 2004. There are two levels of protection from the Seller for these balances:

1.

At the time of the Winterthur International acquisition, the seller provided to the Company a liquidity facility. At the time of the payment of the net reserve seasoned amount as described above. The Company has the right to repay up to the balances outstanding on this facility by assignment to the Seller of an equal amount of receivables relating to reinsurance recoverables selected by the Company. The payable balance related to this facility is included within other liabilities on the Company’s balance sheet at December 31, 2004 and amounted to approximately $281 million at that date.

2.

Under two retrocession agreements the Company has reinsurance protection on the remaining portion of reinsurance recoverables with respect to incurred losses seasoned as of June 30, 2004 to the extent that the Company does not receive payment of such amounts from applicable reinsurers with one agreement providing a limit of $1.3 billion for the insurance written in the period to June 30, 2001 and the other agreement providing a limit of $1.3 billion for the insurance written in the period to December 31, 2000.

At December 31, 2004, certain reinsurers responsible for some portions of the reinsurance of the Winterthur business have raised issues as to whether amounts claimed are due and the resolution of those discussions is also currently ongoing.

The Company may record a loss in future periods if any or some of the following occur:

(i)	A submission of the Seller is closer to the valuation developed by the independent actuary
(ii)	There is deterioration of the net reserves and premium balances, relating to the Winterthur Business, from what is reported in the Company’s December 31, 2004 financial statements
(iii)	The Company is unable to make full recovery of the reinsurance recoverables related to the Winterthur Business, either from third parties or from the Seller under the additional protections.
(iv)	Any amount due from the Seller proves to be uncollectible from the Seller for any reason.

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18. Commitments and Contingencies (Continued)

(b) Other Investments

The Company has committed to invest in several limited partnerships as part of its overall corporate strategy. The Company has commitments which include potential additional add-on clauses, to invest a further $2.2 million over the next five years.

(c) Investments in Affiliates

The Company owns a minority interest in certain closed-end funds, certain limited partnerships and similar investment vehicles, including funds managed by those companies. The Company has commitments, which include potential additional add-on clauses, to invest a further $50.6 million over the next five years.

(d) Properties

The Company rents space for certain of its offices under leases that expire up to 2017. Total rent expense under operating leases for the years ended December 31, 2004, 2003 and 2002 was approximately $31.2 million, $42.3 million and $30.4 million, respectively. Future minimum rental commitments under existing operating leases are expected to be as follows:

Year Ended December 31,
(U.S. dollars in thousands)
2005	$33,925
2006	31,440
2007	29,174
2008	24,486
2009	22,542
2010-2023	116,650
Total minimum future rentals	$258,217

During 2003, the Company entered into a purchase, sale and leaseback transaction to acquire new office space in London. The Company has recognized a capital lease asset of $185.2 million and $150.0 million as, and deferred a gain of $54.5 million and $50.0 million related to the sale at December 31, 2003 related to this lease at December 31, 2004 and 2003, respectively. The gain is being amortized to income in line with the amortization of the asset. The future minimum lease payments in the aggregate are expected to be $369.5 million and annually for the next five years are as follows:

Year Ended December 31:
(U.S. dollars in thousands)
2005	$11,747
2006	12,040
2007	12,341
2008	12,650
2009	12,966

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18. Commitments and Contingencies (Continued)

(e) Tax Matters

The Company is a Cayman Islands corporation and, except as described below, neither it nor its non-U.S. subsidiaries have paid United States corporate income taxes (other than withholding taxes on dividend income) on the basis that they are not engaged in a trade or business or otherwise subject to taxation in the United States. However, because definitive identification of activities which constitute being engaged in a trade or business in the United States is not provided by the Internal Revenue Code of 1986, regulations or court decisions, there can be no assurance that the Internal Revenue Service will not contend that the Company or its non-U.S. subsidiaries are engaged in a trade or business or otherwise subject to taxation in the United States. If the Company or its non-U.S. subsidiaries were considered to be engaged in a trade or business in the United States (and, if the Company or such subsidiaries were to qualify for the benefits under the income tax treaty between the United States and Bermuda and other countries in which the Company operates, such businesses were attributable to a “permanent establishment” in the United States), the Company or such subsidiaries could be subject to U.S. tax at regular tax rates on its taxable income that is effectively connected with its U.S. trade or business plus an additional 30% “branch profits” tax on such income remaining after the regular tax, in which case there could be a significant adverse effect on the Company’s results of operations and financial condition.

(f) Letters of Credit

At December 31, 2004 and 2003, $3.0 billion and $2.7 billion of letters of credit were outstanding, 6.6% and 8.7% of which were collateralized by the Company’s investment portfolio, supporting U.S. non-admitted business and the Company’s Lloyd’s Syndicates’ capital requirements.

19. Share Capital

(a) Authorized and Issued

The authorized share capital is 999,990,000 ordinary shares of a par value of $0.01 each. Holders of Class A ordinary shares are entitled to one vote for each share. In June 2000, the Company’s Class B ordinary shares were converted into Class A ordinary shares on a one-for-one basis. All ordinary shares in issue at December 31, 2004 are Class A ordinary shares.

The following table is a summary of Class A ordinary shares issued and outstanding:

Year Ended December 31
(in thousands)	2004	2003	2002
Balance – beginning of year	137,343	136,063	134,734
Exercise of options	819	722	1,096
Issue of restricted shares	661	512	220
Issue of shares – Employee stock purchase plan	168	67	47
Repurchase of shares	(59)	(21)	(34)
Issue of shares	–	–	–
Balance – end of year	138,932	137,343	136,063

The Company issued 9.2 million shares during November 2001 at a price of $89.00 per share to support capital requirements subsequent to the September 11 event. Net proceeds received were $787.7 million.

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19. Share Capital (continued)

(a) Authorized and Issued (continued)

In August 2002, the Company issued 9.2 million 8.00% Series A Preference Ordinary Shares at $25 per share. Gross proceeds were $230.0 million and related expenses were $7.2 million. Upon dissolution of the Company, the holders of the Preference Shares would be entitled to receive a liquidation preference of $25 per share, plus accrued and unpaid dividends. Dividends on the Preference Shares are cumulative from the date of original issuance and are payable when declared. The Company may redeem the Preference Shares on or after August 14, 2007, at a redemption price of $25 per share. The Company may, under certain circumstances, redeem the Preference Shares before August 14, 2007 at specified redemption prices, plus accrued and unpaid dividends. These circumstances include an amalgamation, consolidation or other similar transaction involving the Company in which the Preference Shares are entitled to a class vote ($26 per share redemption price), or a change in tax laws that requires the Company to pay additional amounts with respect to the Preference Shares ($25 per share redemption price). The proceeds were used for general corporate purposes.

In November 2002, the Company issued 11.5 million 7.625% Series B Preference Ordinary Shares at $25 per share. Gross proceeds were $287.5 million and related expenses were $9.1 million. Upon dissolution of the Company, the holders of the Preference Shares would be entitled to receive a liquidation preference of $25 per share, plus accrued and unpaid dividends. Dividends on the Preference Shares are cumulative from the date of original issuance and are payable when declared. The Company may redeem the Preference Shares on or after November 18, 2007, at a redemption price of $25 per share. The Company may, under certain circumstances, redeem the Preference Shares before November, 2007 at specified redemption prices, plus accrued and unpaid dividends. These circumstances include an amalgamation, consolidation or other similar transaction involving the Company in which the Preference Shares are entitled to a class vote ($26 per share redemption price), or a change in tax laws that requires the Company to pay additional amounts with respect to the Preference Shares ($25 per share redemption price). The proceeds were used for general corporate purposes.

(b) Share Repurchases

The Company has had several stock repurchase plans as part of its capital management program. On January 9, 2000, the Board of Directors authorized the repurchase of shares up to $500.0 million. During 2001, the Company repurchased 1.5 million ordinary shares at a total cost of $116.9 million, or an average cost of $76.40 per ordinary share. During 2000, the Company repurchased 5.1 million ordinary shares at a total cost of $247.7 million, or an average cost of $48.82 per ordinary share. During 2004, 2003 and 2002 no share repurchases took place under the January 9, 2000 authorization. The Company has repurchased shares from employees and directors in relation to share swaps on option exercises and withholding tax on restricted stock.

(c) Stock Plans

The Company’s long term stock plan, the 1991 Performance Incentive Program, as amended and restated effective March 7, 2003, provides for grants of non-qualified or incentive stock options, restricted stock, restricted stock units, performance shares, performance units and stock appreciation rights (“SARs”). The plan is administered by the Board of Directors and the Compensation Committee of the Board of Directors. Stock options may be granted with or without SARs. No SARs have been granted to date. Grant prices are established at the fair market value of the Company’s common stock at the date of grant. Options and SARs have a life of not longer than ten years and vest as set forth at the time of grant. Options currently vest annually over three or four years from date of grant.

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19. Share Capital (continued)

(c) Stock Plans (continued)

Restricted stock awards issued under the 1991 Performance Incentive Program vest as set forth in the applicable award agreements. These shares contained certain restrictions, prior to vesting, relating to, among other things, forfeiture in the event of termination of employment and transferability. As the shares are issued, deferred compensation equivalent to the fair market value on the date of the grant is charged to shareholders’ equity and subsequently amortized over the vesting period. Restricted stock issued under the plan totaled 596,411 shares, 496,671 shares, and 225,960 shares in 2004, 2003, and 2002, respectively.

Prior to December 31, 2003, all options granted to non-employee directors were granted under the 1991 Performance Incentive Program. In 2004, these options were granted under the Directors Stock & Option Plan. All options vest immediately on the grant date. Directors may also make an irrevocable election preceding the beginning of each fiscal year to defer cash compensation that would otherwise be payable as his or her annual retainer in increments of 10%. The deferred payments are credited in the form of ordinary share units calculated by dividing 110% of the deferred payment by the market value of the Company’s stock on the date the compensation would otherwise have been paid. These shares are distributed under the terms of the plan. Shares issued under the plan totaled 3,819, 3,153, and 3,622 in 2004, 2003 and 2002, respectively.

A second stock plan is provided for the directors that grants share units equal to their annual retainer divided by market price of the Company’s ordinary stock on January 1 of each year. These units receive dividends in the form of additional units equal to the cash value divided by the market price on the payment date. Stock units totaling 8,351, 8,598, and 6,659 were issued in 2004, 2003 and 2002, respectively. Total units are granted as shares upon retirement from the Board.

Following the merger with NAC, new option plans were created in the Company to adopt the plans. Options generally have a five or six year vesting schedule, with the majority expiring ten years from the date of grant; the remainder having no expiration. A stock plan is also maintained for non-employee directors. Options expire ten years from the date of grant and are fully exercisable six months after their grant date.

In 1999, the Company adopted the 1999 Performance Incentive Plan under which 1,250,000 options were available for issuance to employees who were not directors or executive officers of the Company.

The Employee Share Purchase Plan (the “ESPP”) was approved by the shareholders of the Company on May 10, 2002. The ESPP is administered by a committee which consists of members of the Compensation Committee of the Company’s Board of Directors. The ESPP has two offering periods a year. The first period commenced on July 1, 2002. All employees of the Company and its designated participating subsidiaries, are eligible to participate in the ESPP provided they have been employed at least one month prior to the start of the offering period and they do not hold more than 5% of the Company’s total stock, including stock acquired in the current period. Employees can invest up to 20% of their total monthly cash compensation towards the purchase of the Company’s shares up to a total market value (measured on the first day of the offering period) of U.S. $25,000. The total number of shares purchased in any offering period cannot exceed 1,000 shares. Employees who enroll in the ESPP may purchase the Company’s shares at a 15% discount on the lesser of the market price at the beginning or at the end of the six month offering period. Once purchased, employees can sell or transfer their shares to someone else’s name only during an Open Trading Window. Participants in the ESPP are eligible to receive dividends on the Company’s shares. A total of 1,255,000 ordinary shares may be issued under the ESPP. The number of share issued during the years ended December 31, 2004 and 2003 were 167,890 and 66,848, respectively.

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19. Share Capital (Continued)

(d) FAS 123

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions:

	2004	2003	2002
Dividend yield	2.54%	2.80%	2.00%
Risk free interest rate	3.00%	2.81%	4.58%
Expected volatility	27.0%	30.0%	30.9%
Expected lives	6.0 years	5.0 years	5.0 years

Total stock based compensation expensed, which related to amortization of restricted stock, was $28.4 million, $17.9 million, and $14.3 million in 2004, 2003, and 2002, respectively.

(e) Options

Following is a summary of stock options and related activity:

	2004		2003		2002
		Weighted		Weighted		Weighted
		Average		Average		Average
	Number of	Exercise	Number of	Exercise	Number of	Exercise
	Shares	Price	Shares	Price	Shares	Price
Outstanding – beginning of year	11,781,228	$72.13	11,198,066	$71.31	9,194,132	$61.10
Granted	1,883,072	$78.81	1,805,871	$68.85	3,460,149	$92.36
Exercised	(821,624)	$49.43	(698,895)	$47.13	(1,010,849)	$51.17
Cancelled	(733,136)	$82.23	(523,814)	$75.01	(445,366)	$71.07
Outstanding – end of year	12,109,540	$74.19	11,781,228	$72.13	11,198,066	$71.31
Options exercisable	8,443,215		7,278,812		6,068,326
Options available for grant	6,866,681	*	8,707,681	*	10,451,872	*

Available for grant includes shares that may be granted as either stock options or restricted stock.

The exercise price of the Company’s options granted is the market price of the Company’s Class A ordinary shares on the grant date, except as noted below.

The following options were granted with an exercise price in excess of the market price on the grant date; 295,000 options with an exercise price of $88.00 and the market price was $77.10.

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19. Share Capital (continued)

(e) Options (continued)

The following table summarizes information about the Company’s stock options (including stock appreciation rights) for options outstanding as of December 31, 2004:

	Options Outstanding			Options Exercisable
			Average
		Weighted	Remaining		Weighted
Range of	Number of	Average	Contractual	Number of	Average
Exercise Prices	Options	Exercise Price	Life	Options	Exercise Price
$24.95 – $34.63	107,861	$31.02	0.9 years	107,861	$31.02
$37.75 – $56.63	2,098,295	$47.94	3.4 years	2,098,295	$47.94
$57.00 – $82.31	6,716,217	$74.33	6.7 years	4,206,752	$74.78
$86.64 – $96.56	3,187,167	$92.45	7.3 years	2,030,307	$92.82
$24.95 – $96.56	12,109,540	$74.11	6.3 years	8,443,215	$71.86

(1)	Includes 1,601 options outstanding and exercisable, with an average exercise price of $30.59 that have no expiration date. These options are not included in the calculation of the average remaining contractual life.
(2)	Includes 14,455 options outstanding and exercisable, with an average exercise price of $40.89 that have no expiration date. These options are not included in the calculation of the average remaining contractual life.

(f) Voting

The Company’s Articles of Association restrict the voting power of any person to less than approximately 10% of total voting power.

(g) Share Rights Plan

Rights to purchase Class A ordinary shares (“the Rights”) were distributed as a dividend at the rate of one Right for each Class A ordinary share held of record as of the close of business on October 31, 1998. Each Right entitles holders of Class A ordinary shares to buy one ordinary share at an exercise price of $350. The Rights would be exercisable, and would detach from the Class A ordinary shares, only if a person or group were to acquire 20% or more of the Company’s outstanding Class A ordinary shares, or were to announce a tender or exchange offer that, if consummated, would result in a person or group beneficially owning 20% or more of Class A ordinary shares. Upon a person or group without prior approval of the Board acquiring 20% or more of Class A ordinary shares, each Right would entitle the holder (other than such an acquiring person or group) to purchase Class A ordinary shares (or, in certain circumstances, Class A ordinary shares of the acquiring person) with a value of twice the Rights exercise price upon payment of the Rights exercise price. The Company will be entitled to redeem the Rights at $0.01 per Right at any time until the close of business on the tenth day after the Rights become exercisable. The Rights will expire at the close of business on September 30, 2008, and do not have a fair value. The Company has reserved 119,073,878 Class A ordinary shares being authorized and unissued for issue upon exercise of Rights.

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20. Retirement Plans

The Company maintains both defined contribution and defined benefit retirement plans, which vary for each subsidiary. Plan assets are invested principally in equity securities and fixed maturities.

The Company has a qualified defined contribution plan which is managed externally and whereby employees and the Company contribute a certain percentage of the employee’s gross salary into the plan each month. The Company’s contribution generally vests over 5 years. The Company’s expenses for its qualified contributory defined contribution retirement plans were $38.8 million, $27.5 million and $22.2 million in the years ended December 31, 2004, 2003 and 2002, respectively.

A qualified non-contributory defined benefit pension plan exists to cover a substantial number of its U.S. employees. This plan also includes a non-qualified supplemental defined benefit plan designed to compensate individuals to the extent their benefits under the Company’s qualified plan are curtailed due to Internal Revenue Code limitations. Benefits are based on years of service and compensation, as defined in the plan, during the highest consecutive three years of the employee’s last ten years of employment. Under these plans, the Company’s policy is to make annual contributions to the plan that are deductible for federal income tax purposes and that meet the minimum funding standards required by law. The contribution level is determined by utilizing the entry age cost method and different actuarial assumptions than those used for pension expense purposes. The projected benefit obligation, accumulated benefit obligation and fair value of the assets for this plan with accumulated benefit obligations in excess of plan assets were $27.0 million, $27.0 million and $13.8 million, respectively, as of December 31, 2004, and $23.9 million, $23.9 million and $13.1 million, respectively, as of December 31, 2003.

In the first quarter of 2002, the Company curtailed its qualified non-contributory defined benefit plan. Under the terms of the curtailment, eligible employees will not earn additional defined benefits for future services. However, future service may be counted toward vesting of benefits which accumulated based on past service. The Company recognized a benefit of $9.9 million associated with this curtailment gain.

During 2003, all pension benefits and retirement plans for Winterthur International employees were transitioned into the Company’s defined contribution plan.

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21. Accumulated Other Comprehensive Income (Loss)

The related tax effects allocated to each component of the change in accumulated other comprehensive income were as follows:

	Before Tax	Tax Expense	Net of Tax
(U.S. dollars in thousands)	Amount	(Benefit)	Amount
Year Ended December 31, 2004:
Unrealized gains (losses) on investments:
Unrealized gains arising during year	$424,118	$ 40,921	$383,197
Less reclassification for gains (losses) realized in income	246,547	13,012	233,535
Net unrealized gains on investments	177,571	27,909	149,662
Derivative loss on cash flow hedge	(6,118)	–	(6,118)
Foreign currency translation adjustments	(203,808)	(30,342)	(173,466)
Change in accumulated other comprehensive income	$ (32,355)	$ (2,433)	$ (29,922)
Year Ended December 31, 2003:
Unrealized gains on investments:
Unrealized gains (losses) arising during year	$ 442,317	$ (6,659)	$ 448,976
Less reclassification for gains realized in income	120,195	13,451	106,744
Net unrealized gains (losses) on investments	322,122	(20,110)	342,232
Foreign currency translation adjustments	(36,380)	471	(36,851)
Change in accumulated other comprehensive income	$ 285,742	$(19,639)	$ 305,381
Year Ended December 31, 2002:
Unrealized gains (losses) on investments:
Unrealized gains (losses) arising during year	$ 198,695	$ (3,261)	$ 201,956
Less reclassification for gains (losses) realized in income	(214,160)	(22,335)	(191,825)
Net unrealized losses on investments	412,855	19,074	393,781
Foreign currency translation adjustments	3,615	(431)	4,046
Change in accumulated other comprehensive income	$ 416,470	$ 18,643	$ 397,827

22. Dividends

In 2004 and 2003, the Company paid dividends of $40.3 million, respectively, to Series A and Series B preference shareholders.

In 2004, four regular quarterly dividends were paid at $0.49 per share to ordinary shareholders of record as of March 8, June 7, September 6 and December 6.

In 2003, four regular quarterly dividends were paid at $0.48 per share to ordinary shareholders of record as of March 10, June 9, September 8 and December 8.

In 2002, four regular quarterly dividends were paid at $0.47 per share to ordinary shareholders of record of February 4, May 28, August 5 and December 2.

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23. Taxation

The Company is not subject to any taxes in the Cayman Islands on either income or capital gains under current Cayman law. The Company has received an undertaking that the Company will be exempted from Cayman Islands income or capital gains taxes until June 2018 in the event of any such taxes being imposed.

The Company’s Bermuda subsidiaries are not subject to any income, withholding or capital gains taxes under current Bermuda law. In the event that there is a change such that these taxes are imposed, the Bermuda subsidiaries would be exempted from any such tax until March 2016 pursuant to the Bermuda Exempted Undertakings Tax Protection Act of 1966, and Amended Act of 1987.

The Company’s Indian subsidiary is not subject to certain income and capital gains taxes under current Indian law. This subsidiary is exempt from these taxes until March 31, 2009 pursuant to the Income Tax Act 1961.

The Company’s U.S. subsidiaries are subject to federal, state and local corporate income taxes and other taxes applicable to U.S. corporations. The provision for federal income taxes has been determined under the principles of the consolidated tax provisions of the Internal Revenue Code and Regulations there under. Should the U.S. subsidiaries pay a dividend to the Company, withholding taxes will apply.

The Company has operations in subsidiary and branch form in various other jurisdictions around the world, including but not limited to the U.K., Switzerland, Ireland, Germany, France, Luxembourg and various countries in Latin America that are subject to relevant taxes in those jurisdictions.

The income tax provisions for the years ended December 31, 2004, 2003 and 2002 are as follows:

Year Ended December 31
(U.S. dollars in thousands)	2004	2003	2002
Current Expense:
U.S.	$11,953	$ 8,268	$ 988
Non U.S.	32,513	11,355	3,521
Total current expense	$44,466	$ 19,623	$ 4,509
Deferred Expense (Benefit):
U.S.	$41,673	$(97,382)	$ (2,949)
Non U.S.	(1,613)	107,808	21,087
Total deferred expense	$40,060	$10,426	$18,138
Total Tax Expense	$84,526	$30,049	$22,647

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23. Taxation (Continued)

The weighted average expected tax provision has been calculated using the pre-tax accounting income (loss) in each jurisdiction multiplied by that jurisdiction’s applicable statutory tax rate. Reconciliation of the difference between the provision for income taxes and the expected tax provision at the weighted average tax rate for the years December 31, 2004 and 2003 is provided below:

(U.S. dollars in thousands)	2004	2003
Expected tax provision at weighted average rate	$ 99,420	$33,062
Permanent differences:
Non taxable investment income	(1,619)	(3,729)
Non taxable income	(3,260)	(4,292)
Prior year adjustments	(7,358)	(1,958)
State, local and other taxes	7,234	1,467
Valuation allowance	50,240	(9,859)
Tax attributable to other comprehensive income	50	14,159
Transfer pricing adjustments	(65,513)	(12,039)
Gain on contributed securities	–	2,968
Non deductible expenses	8,630	2,009
Contingency reserve	(2,450)	6,265
Other	(848)	1,996
Total tax expense (benefit)	$ 84,526	$30,049

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23. Taxation (Continued)

Significant components of the Company’s deferred tax assets and liabilities as of December 31, 2004 and 2003 were as follows:

(U.S. dollars in thousands)	2004	2003
Deferred Tax Asset:
Net unpaid loss reserve discount	$69,555	$ 62,220
Net unearned premiums	26,868	38,060
Compensation liabilities	2,786	1,691
Net operating losses	185,997	225,227
Alternative minimum tax credits	16,881	11,927
Investment adjustments	7,533	3,610
Deferred acquisition costs	32,528	7,645
Pension	2,558	–
Bad Debt Reserve	6,502	–
Guaranty fund recoupment	3,643	–
Currency translation adjustments	9,842	–
Other	21,704	4,354
Deferred tax asset, gross of valuation allowance	386,397	354,734
Valuation allowance	68,556	18,316
Deferred tax asset, net of valuation allowance	317,841	336,418
Deferred Tax Liability:
Net unrealized appreciation on investments	25,243	23,135
Currency translation adjustments	0	3,206
Other	3,999	–
Deferred tax liability	29,242	26, 341
Net Deferred Tax Asset	$288,599	$310,077

The valuation allowance at December 31, 2004 and December 31, 2003 of $68.5 million and $18.3 million, respectively, relates to net operating loss carryforwards in Switzerland and Australia that may not be realized within a reasonable period. The deferred tax asset for certain net operating loss carryforwards and valuation allowance at December 31, 2003, was reduced by $22.4 million for amounts attributable to the pre-acquisition period of certain affiliates. U.S. net operating loss carryforwards at December 31, 2004 were approximately $248 million and will expire in future years through 2023. As of December 31, 2004, net operating loss carryforwards in the U.K. were approximately $270 million and have no expiration. As of December 31, 2004, net operating loss carryforwards in Switzerland were approximately $311 million and will expire in future years through 2011.

Management believes it is more likely than not that the tax benefit of the remaining net deferred tax assets will be realized. Management is required to determine if there is sufficient positive evidence to conclude that it is more likely than not that the deferred tax asset attributable to its U.S. group net operating losses would be utilized within a reasonable period. Management has reviewed historical taxable income and future taxable income projections for the U.S. group and has determined that in its judgment, the net operating losses will more likely than not be realized as reductions of future taxable income within a reasonable period. Specifically with regard to the U.S. group, management has determined that the projected U.S. consolidated income will be sufficient to utilize the net operating losses of approximately $248 million within a reasonable period. Management will continue to evaluate income generated in future periods by the U.S. group in determining the reasonableness of its position. If management determines that future income generated by the U.S. group is insufficient to cause the realization of the net operating

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23. Taxation (Continued)

losses within a reasonable period, a valuation allowance would be required for the U.S. portion of the net deferred tax asset, in the amount of $240 million.

Effective as of January 1, 2004, XL Re America Inc (“XLRA”), a member of the U.S. group, entered into an adverse development reinsurance treaty with another non U.S. reinsurance subsidiary of the Company. The treaty related to the 1985 through (and including) 2000 underwriting years covering any adverse development on reserves calculated as of December 31, 2003 between January 1, 2004 and December 31, 2005. The treaty has a limit of $500 million and will limit future loss development at XLRA relating to these underwriting years. Any commutation of this treaty requires the prior approval of the New York Department of Insurance. There is no impact of this treaty on the consolidated financial statements of the Company, however as part of management’s continuing evaluation of its deferred tax asset, the treaty is critical in evaluating the future income position of the U.S. group of companies. Management believes that the treaty will protect the U.S. group from unexpected prior loss development. Absent unexpected loss development from the 2000 and prior underwriting years, management has concluded that there is sufficient positive evidence of future profitability in the U.S. and that a valuation allowance as a charge against the deferred tax asset is not required at this time.

Shareholders’ equity at December 31, 2004 and 2003 reflected tax benefits of $3.6 million and $2.9 million, respectively, related to compensation expense deductions for stock options exercised for one of the Company’s U.S. subsidiaries.

24. Statutory Financial Data

The Company’s ability to pay dividends is subject to certain regulatory restrictions on the payment of dividends by its subsidiaries. The payment of such dividends is limited by applicable laws and statutory requirements of the various countries the Company operates in, including Bermuda, the U.S. and the U.K., among others. Statutory capital and surplus as reported to relevant regulatory authorities for the principal operating subsidiaries of the Company for the years ended December 31, 2004 and 2003 was as follows:

	Bermuda		U.S.(1)		U.K., Europe and Other
(U.S. dollars in thousands)	2004	2003	2004	2003	2004	2003
Required statutory capital and surplus	$3,157,650	$2,630,982	$ 152,100	$ 130,100	$308,873	$232,615
Actual statutory capital and surplus	$9,740,332	$6,584,779	$1,861,928	$1,716,528	$919,609	$806,627

(1) Required statutory capital and surplus represents the minimum regulatory requirements for licensing without considering Risk-Based Capital (“RBC”) standards. The 100% RBC level for principle U.S. operating subsidiaries was $569 million and $546 million at December 31, 2004 and 2003 respectively.

The difference between statutory financial statements and statements prepared in accordance with GAAP vary by jurisdiction however the primary difference is that statutory financial statements do not reflect deferred policy acquisition costs, deferred income tax net assets, intangible assets, unrealized appreciation on investments and any unauthorized/authorized reinsurance charges.

Except as noted below, there are no statutory restrictions on the payment of dividends from retained earnings by any of the Company’s subsidiaries as applicable minimum levels of solvency and liquidity have been met and all regulatory requirements and licensing rules complied with. At December 31, 2004, and 2003 XL Reinsurance America (“XLRA”), the Company’s lead property and casualty subsidiary in the United States, had a statutory deficit of $84.4 million and $210.3 million, respectively. As a result, XLRA is not currently able to make a dividend distribution under New York insurance law without obtaining prior approval of the New York Insurance Department. Similarly, four of the six property and casualty subsidiaries directly or indirectly owned by XLRA also had statutory deficits ranging from $0.2 million to $57.4 million at December 31, 2004 and five of the six had statutory deficits ranging from $3.6 million to

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24. Statutory Financial Data (continued)

$77.0 million at December 31, 2003. As a result, these subsidiaries are similarly unable to currently make a dividend distribution under the insurance law of their respective states of domicile without obtaining prior approval from the domicile insurance department, which include Delaware, New York and North Dakota. At December 31, 2004 and 2003, XL Insurance Company Limited (previously known as Winterthur International Insurance Company Limited) had a statutory earned deficit and is restricted from making a dividend distribution at this time under U.K. Company law.

25. Earnings Per Share

The following table sets forth the computation of basic and diluted earnings per share:

Year Ended December 31
(U.S. dollars in thousands, except per share amounts)	2004	2003	2002
Basic Earnings Per Ordinary Share:
Net income available to ordinary shareholders	$1,126,292	$371,658	$395,951
Weighted average ordinary shares outstanding	137,903	136,906	135,636
Basic earnings per ordinary share	$ 8.17	$ 2.71	$ 2.92
Diluted Earnings Per Ordinary Share:
Net income available to ordinary shareholders	$1,126,292	$371,658	$395,951
Weighted average ordinary shares outstanding – basic	137,903	136,906	135,636
Average stock options outstanding (1)	679	1,281	1,752
Weighted average ordinary shares outstanding – diluted	138,582	138,187	137,388
Diluted earnings per ordinary share	$ 8.13	$ 2.69	$ 2.88

(1) Net of shares repurchased under the treasury stock method.

26. Related Party Transactions

At December 31, 2004, the Company owned minority stakes in eight independent investment management companies (“Investment Management Affiliates”). These ownership stakes are part of the Company’s asset management strategy, pursuant to which the Company seeks to develop relationships with specialty investment management organizations, generally acquiring an equity interest in the business. The Company also invests in certain of the funds and limited partnerships and other legal entities managed by these affiliates and through these funds and partnerships pay management and performance fees to the Company’s Investment Management Affiliates.

On December 31, 2002, the Company entered into an agreement with Annuity and Life Reinsurance, Ltd. (“ALRE”), a subsidiary of Annuity and Life Re (Holdings), Ltd. (“ANR”), pursuant to which the Company assumed certain blocks of life reinsurance business. The Company has an investment in ANR that is accounted for as an affiliate under the equity method pursuant to APB Opinion 18, but the Company does not have the ability to control ANR or direct its operating and financial policies. Under the agreement, the Company assumed five blocks of life reinsurance business from ALRE and entered into a 50% quota share reinsurance contract with ALRE with respect to four of those blocks of business. As consideration for the novation of the five blocks of business from ALRE, the Company made a payment of approximately $44.0 million. As consideration for the 50% quota share reinsurance contract, the Company received a ceding commission of approximately $26.0 million. In connection with the transferred blocks of business, ALRE also transferred to the Company approximately $66.0 million in assets and related future policy benefit reserves. The 50% quota share reinsurance contract is structured as a modified coinsurance arrangement, as such, the Company recorded a liability for the funds withheld in reinsurance balances payable on the balance sheet in the amount of $25.0 million.

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26. Related Party Transactions (continued)

On August 5, 2003, the Company, under the terms of its 50% quota share reinsurance contract (the “quota share contract”) with Annuity and Life Reinsurance, Ltd. (“ALRE”), notified ALRE of its intention to elect to automatically terminate the quota share contract and recapture the business previously ceded to ALRE. Following this notice and with effect from June 30, 2003, the Company entered into a comprehensive settlement with ALRE, which in addition to the quota share contract, commuted or otherwise terminated all reinsurance relationships that the Company had with ALRE. As settlement of the quota share contract and the other insurance and reinsurance relationships, the Company received proceeds of $6.0 million.

27. XL Capital Finance (Europe) plc

XL Capital Finance (Europe) plc (“XLFE”) is a wholly owned finance subsidiary of the Company. In January 2002, XLFE issued $600 million par value 6.5% Guaranteed Senior Notes due January 2012. These Notes are fully and unconditionally guaranteed by the Company. The Company’s ability to obtain funds from its subsidiaries to satisfy any of its obligations under this guarantee is subject to certain contractual restrictions, applicable laws and statutory requirements of the various countries in which the Company operates including Bermuda, the U.S. and the U.K., among others. Required statutory capital and surplus for the principal operating subsidiaries of the Company was $3.6 billion as of December 31, 2004.

28. Unaudited Quarterly Financial Data

The following is a summary of the unaudited quarterly financial data for 2004 and 2003:

	First	Second	Third	Fourth
(U.S. dollars in thousands, except per share amount)	Quarter	Quarter	Quarter	Quarter
2004
Net premiums earned – general operations(1)	$1,574,925	$1,830,225	$1,867,284	$1,710,115
Net premiums earned – life operations	116,932	994,048	97,378	197,341
Net premiums earned – financial operations	32,588	34,024	56,471	38,202
Underwriting profit(loss) – general operations(1)	192,606	218,630	(161,968)	100,040
Net income available to ordinary shareholders	452,169	363,604	22,471	288,048
Net income per ordinary share and             ordinary share equivalent – basic	$ 3.29	$ 2.64	$ 0.16	$ 2.08
Net income per ordinary share and             ordinary share equivalent – diluted	$ 3.25	$ 2.62	$ 0.16	$ 2.07
2003
Net premiums earned – general operations (1)	$1,431,887	$1,469,520	$1,663,713	$1,515,913
Net premiums earned – life operations	92,771	70,482	86,428	498,814
Net premiums earned – financial operations	26,973	35,807	35,307	41,535
Underwriting profit(loss) general operations (1)	214,347	141,923	45,164	(485,551)
Net income (loss) available to ordinary shareholders	239,857	347,659	98,971	(314,829)
Net income (loss) per ordinary share and             ordinary share equivalent – basic (2)	$ 1.76	$ 2.54	$ 0.72	$ (2.29)
Net income (loss) per ordinary share and             ordinary share equivalent – diluted (2)	$ 1.74	$ 2.51	$ 0.71	$ (2.29)

(1)	Certain reclassifications have been made relating to the Company’s change in presentation of financial operations. There was no effect on net income from this change in presentation.
(2)	Average stock options outstanding have been excluded where anti-dilutive to earnings per share. Consequently, where there is a net loss, basic weighted average ordinary shares outstanding are used to calculate net loss per share.

161

XL CAPITAL LTD

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

28. Unaudited Quarterly Financial Data (continued)

In the third quarter at 2004 the Company recorded net loss and loss expenses of $446.8 million in relation to the 2004 Atlantic hurricane season, which resulted in four insured hurricane aggregating to the largest seasonal loss in history. In the fourth quarter of 2004 that loss estimate was increased by $69.8 million. In addition, the Company incurred net loss and loss expenses of $74.6 million in relation to the tsunami in South Asia in December of 2004.

In the third quarter of 2003, the Company recorded net losses and loss expenses incurred of $184.0 million pre-tax (approximately $160.0 million after tax) for higher than expected reported losses in its North American casualty reinsurance operations for the 1997 to 2000 underwriting years. In conjunction with this increase, the Company announced it had begun an extensive claims audit review of the relevant cedents for this book of business to have more complete information to determine ultimate loss reserves.

In the fourth quarter of 2003, the Company completed the claims audit review and its normal year end review of all of its property and casualty reserves and reported a total pre-tax charge of $694.0 million ($647.0 million post tax) related to the following changes to loss reserves :

a) Claims audit review	$ 663.0 million
b) Year end reserve review –
Reinsurance – September 11, event	$(181.0)million
Reinsurance – excluding September 11 event	62.0 million
Insurance	150.0 million
Total pre-tax charge	$ 694.0 million

Also in the fourth quarter of 2003, the Company assumed two portfolios of long duration, closed block annuity reserves of approximately $390.0 million.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

There have been no changes in or any disagreements with accountants regarding accounting and financial disclosure within the twenty-four months ending December 31, 2004.

ITEM 9A. CONTROLS AND PROCEDURES

Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures

The Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of disclosure controls and procedures pursuant to Rules 13a-15 and 15d-15 promulgated under the Securities Exchange Act of 1934, as amended, as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures are effective to provide reasonable assurance that all material information relating to the Company required to be filed in this report has been made known to them in a timely fashion.

Management’s Report on Internal Control Over Financial Reporting

The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) of the Securities Exchange Act of 1934, as amended.

162

The Company’s internal control system was designed to provide reasonable assurance to the Company’s management and board of directors regarding the preparation and fair presentation of published financial statements.

The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework (the “Framework”). Based on its assessment management concluded that, as of December 31, 2004, the Company’s internal control over financial reporting is effective based on the Framework criteria.

PricewaterhouseCoopers LLP, the Company’s independent registered public accounting firm, have issued an audit report on the Company’s assessment of its internal control over financial reporting. This report appears on page 174. See Item 8 “Financial Statements and Supplementary Data.”

Changes in Internal Control Over Financial Reporting

There have been no changes in internal control over financial reporting identified in connection with the Company’s evaluation required pursuant to Rules 13a-15 and 15d-15 promulgated under the Securities Exchange Act of 1934, as amended, that occurred during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

ITEM 9B. OTHER INFORMATION

None.

163

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Certain of the information required by this item relating to the executive officers of the Company may be found under Item 4, “Submission of Matters to a Vote of Security Holders – Executive Officers of the Company.” The balance of the information required by this item is omitted because a definitive proxy statement that involves the election of directors will be filed with the Securities and Exchange Commission not later than 120 days after the close of the fiscal year pursuant to Regulation 14A, which proxy statement is incorporated by reference.

ITEM 11. EXECUTIVE COMPENSATION

This item is omitted because a definitive proxy statement that involves the election of directors will be filed with the Securities and Exchange Commission not later than 120 days after the close of the fiscal year pursuant to Regulation 14A, which proxy statement is incorporated by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The following table summarizes the Company’s equity compensation plan information as of
December 31, 2004

	Number of securities to be issued	Weighted-average exercise	Number of Securities
	upon exercise of outstanding	price of outstanding	remaining available
	options, warrants and rights	options, warrants and rights	for future issuance
			under equity
			compensation
			plans (excluding
			securities reflected in
			column (a))
Plan Category	(a)	(b)	(c)
Equity compensation plans	11,930,432	$74.11	5,881,583 (1)
approved by security
holders
Equity compensation plans	352,725	$50.00	125,844(3)
not approved by security
holders (2)
Total	11,577,707	$74.17	5,755,739

(1)	906,177 shares may be issued as awards of restricted stock, restricted stock units or performance shares.
(2)	The Company’s 1999 Performance Incentive Program for Employees (the “1999 Program”) provides for grants of non-statutory stock options, restricted stock, performance shares and performance units to employees of the Company and its subsidiaries who are not subject to the reporting requirements of Section 16(a) of the Securities Exchange Act of 1934. The 1999 Program is administered by the Board of Directors of the Company or the Compensation Committee, as determined from time to time by the Board of Directors.
(3)	125,844 shares may be issued as awards of restricted stock or performance shares.

The remaining information required by this Item is omitted because a definitive proxy statement that involves the election of directors will be filed with the Securities and Exchange Commission not later than 120 days after the close of the fiscal year pursuant to Regulation 14A, which information is incorporated by reference.

164

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

This item is omitted because a definitive proxy statement that involves the election of directors will be filed with the Securities and Exchange Commission not later than 120 days after the close of the fiscal year pursuant to Regulation 14A, which proxy statement is incorporated by reference.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

This item is omitted because a definitive proxy statement that involves the election of directors will be filed with the Securities and Exchange Commission not later than 120 days after the close of the fiscal year pursuant to Regulation 14A, which proxy statement is incorporated by reference.

PART IV

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

Financial Statements, Financial Statement Schedules and Exhibits.

	Page
Report of Indpendent Auditors	174

1. Financial Statements

Included in Part II – See Item 8 of this report.

2. Financial Statement Schedules

Included in Part IV of this report:

	Schedule
	Number	Page
Consolidated Summary of Investments – Other than Investments in Related Parties, as at December 31, 2004 and 2003	I	176
Condensed Financial Information of Registrant, as at December 31, 2004 and for the years ended December 31, 2004, 2003, and 2002	II	177
Reinsurance, for the years ended December 31, 2004, 2003, and 2002	IV	180
Supplementary Information Concerning Property/Casualty Insurance Operations for the years ended December 31, 2004, 2003 and 2002	VI	181
Other Schedules have been omitted as they are not applicable to the Company

165

3. Exhibits

Exhibit	Description
______	_________
3.1	Memorandum of Association of the Company, incorporated by reference to Appendix G to the Joint Proxy Statement of EXEL Limited and Mid Ocean Limited on Schedule 14A filed on July 2, 1998.
3.2	Articles of Association of the Company, incorporated by reference to Appendix G to the Joint Proxy Statement of EXEL Limited and Mid Ocean Limited on Schedule 14A filed on July 2, 1998.
4.1	Rights Agreement, dated as of September 11, 1998, between EXEL Limited and ChaseMellon Shareholder Services, L.L.C., as Rights Agent, incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on October 21, 1998.
4.2	Indenture, dated as of January 10, 2002, among XL Capital Finance (Europe) plc, XL Capital Ltd and State Street Bank and Trust Company, incorporated by reference to Exhibit 4.16(a) to the Company’s Current Report on Form 8-K filed on January 14, 2002.
4.3	Form of XL Capital Finance (Europe) plc Debt Security, incorporated by reference to Exhibit 4.14 to the Company’s Current Report on Form 8-K filed on January 14, 2002.
4.4	Excerpts from the Authorizing Resolutions of the Board of Directors of XL Capital Finance (Europe) plc, dated January 7, 2002, incorporated by reference to Exhibit 4.16(b) to the Company’s Current Report on Form 8-K filed on January 14, 2002.
4.5	Indenture, dated as of September 7, 2001, between XL Capital Ltd and State Street Bank and Trust Company, relating to the Company’s Liquid Yield Option Notes due 2021, incorporated by reference to Exhibit 4.49 to the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2001.
4.6	Form of Liquid Yield Option Note due 2021, incorporated by reference to Exhibit 4.50 to the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2001.
4.7	Indenture, dated as of May 23, 2001, between XL Capital Ltd and State Street Bank and Trust Company, relating to the Company’s Zero Coupon Convertible Debentures due 2021, incorporated by reference to Exhibit 4(a) to the Company’s Registration Statement on Form S-3 (No. 333-66976) filed on August 6, 2001.
4.8	Form of Zero Coupon Convertible Debenture due 2021 (included in Exhibit 4.7 hereto), incorporated by reference to Exhibit 4(a) to the Company’s Registration Statement on Form S-3 (No. 333-66976) filed on August 6, 2001.
4.9	Form of Note Purchase Agreement, dated as of April 12, 2001, relating to the 6.58% Guaranteed Senior Notes due April 12, 2011 of X.L. America, Inc., incorporated by reference to Exhibit 10.14.43 to the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2001.
4.10	Form of Indenture between NAC Re Corp. and Shawmut Bank Connecticut, National Association, relating to the 7.15% Notes due November 15, 2005 of NAC Re Corp., incorporated by reference to Exhibit 4.1 to Amendment No. 1 to the Registration Statement on Form S-3 of NAC Re Corp. (No. 33-97878) filed on November 3, 1995.
4.11	Excerpts from the Authorizing Resolutions of the Special Finance Committee of XL Capital Ltd, dated July 29, 2002, incorporated by reference to Exhibit 4.16(c) to the Company’s Current Report on Form 8-K filed on August 14, 2002.
4.12	Excerpts from the Authorizing Resolutions of the Special Finance Committee of XL Capital Ltd, dated November 6, 2002, incorporated by reference to Exhibit 4.18 to the Company’s Current Report on Form 8-K filed on November 14, 2002.
4.13	Indenture, dated as of January 23, 2003, between XL Capital Ltd and U.S. Bank National Association, as Trustee, incorporated by reference to Exhibit 4.1 to the Company’s Amendment No. 1 to Registration Statement on Form S-3 (No. 333-101288) filed on January 23, 2003.

166

Exhibit	Description
______	_________
4.14	First Supplemental Indenture, dated as of March 23, 2004, to the Indenture, dated as of January 23, 2003, between XL Capital Ltd and U.S. Bank National Association, as Trustee, incorporated by reference to Exhibit 4.2 to the Company’s Current Report on Form 8-K filed on March 24, 2004.
4.15	Purchase Contract Agreement, dated as of March 23, 2004, between XL Capital Ltd and U.S. Bank National Association, as Purchase Contract Agent, incorporated by reference to Exhibit 4.3 to the Company’s Current Report on Form 8-K filed on March 24, 2004.
4.16	Pledge Agreement, dated as of March 23, 2004, among XL Capital Ltd and U.S. Bank Trust National Association, as Collateral Agent, Custodial Agent and Securities Intermediary, and U.S. Bank National Association, as Purchase Contract Agent, incorporated by reference to Exhibit 4.4 to the Company’s Current Report on Form 8-K filed on March 24, 2004.
4.17	Form of Normal Units Certificate (included in Exhibit 4.15 hereto), incorporated by reference to Exhibit 4.3 to the Company’s Current Report on Form 8-K filed on March 24, 2004.
4.18	Form of Stripped Units Certificate (included in Exhibit 4.15 hereto), incorporated by reference to Exhibit 4.3 to the Company’s Current Report on Form 8-K filed on March 24, 2004.
4.19	Form of 2.53% Senior Note due 2009 (included in Exhibit 4.14 hereto), incorporated by reference to Exhibit 4.2 to the Company’s Current Report on Form 8-K filed on March 24, 2004.
4.20	Indenture, dated as of June 2, 2004, between XL Capital Ltd and The Bank of New York, as Trustee, incorporated by reference to Exhibit 4.1 to the Company’s Registration Statement on Form S-3 (No. 333-116245) filed on June 7, 2004.
4.21	First Supplemental Indenture, dated as of August 23, 2004, to the Indenture, dated as of June 2, 2004, between XL Capital Ltd and The Bank of New York, as Trustee, incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on August 23, 2004.
4.22	Form of 5.25% Senior Note due 2014 (included in Exhibit 4.21 hereto), incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on August 23, 2004.
4.23	First Supplemental Indenture, dated as of September 22, 2004, to the Indenture, dated as of May 23, 2001, between XL Capital Ltd and U.S. Bank National Association (as successor to State Street Bank and Trust Company), as Trustee, incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on September 22, 2004.
4.24	Second Supplemental Indenture, dated as of November 12, 2004, to the Indenture, dated as of June 2, 2004, between XL Capital Ltd and The Bank of New York, as Trustee, incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on November 15, 2004.
4.25	Form of 6.375% Senior Note due 2024 (included in Exhibit 4.24 hereto), incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on November 15, 2004.
10.1	Amended and Restated 1991 Performance Incentive Plan, incorporated by reference to Appendix B to the Company’s Definitive Proxy Statement on Schedule 14A filed on April 4, 2003.
10.2	Retirement Plan for Nonemployee Directors, incorporated by reference to Exhibit 10.5 to the Company’s Annual Report on Form 10-K for the year ended November 30, 1996.
10.3	Amended and Restated Directors Stock & Option Plan, incorporated by reference to Appendix C to the Company’s Definitive Proxy Statement on Schedule 14A filed on April 4, 2003.
10.4	Stock Plan for Nonemployee Directors, incorporated by reference to Exhibit 10.7 to the Company’s Annual Report on Form 10-K for the year ended November 30, 1996.

167

Exhibit	Description
______	_________
10.5	Mid Ocean Limited 1993 Long Term Incentive and Share Award Plan, incorporated by reference to Exhibit 10.9.1 to the Company’s Annual Report on form 10-K for the year ended November 30, 1998.
10.6	Amendment to Mid Ocean Limited 1993 Long Term Incentive and Share Award Plan, incorporated by reference to Exhibit 10.9.2 to the Company’s Annual Report on Form 10-K for the year ended November 30, 1998.
10.7	Mid Ocean Limited Stock & Deferred Compensation Plan for Nonemployee Directors, incorporated by reference to Exhibit 10.10 to the Company’s Annual Report on Form 10-K for the year ended November 30, 1998.
10.8	NAC Re Corp. 1993 Stock Option Plan, incorporated by reference to Exhibit 10.8 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.
10.9	First Amendment to NAC Re Corp. 1993 Stock Option Plan, incorporated by reference to Exhibit 10.9 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.
10.10	Dividend Reinvestment and Share Purchase Plan, incorporated by reference to the Company’s Registration Statement on Form S-3 (No. 333-76988) filed on January 18, 2002.
10.11	Ronald L. Bornhuetter Consulting Agreement, dated July 1, 1999, incorporated by reference to Exhibit 10.13.2 to the Company’s Annual Report on Form 10-K for the year ended December 31, 1999.
10.12	Ronald L. Bornhuetter Settlement Agreement, dated June 30, 1999, incorporated by reference to Exhibit 10.13.3 to the Company’s Annual Report on Form 10-K for the year ended December 31, 1999.
10.13	Nicholas M. Brown, Jr. Employment Agreement, dated April 1, 2002, incorporated by reference to Exhibit 10.58 to the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2002.
10.14	Nicholas M. Brown, Jr. Retirement Agreement, dated April 1, 2002, incorporated by reference to Exhibit 10.59 to the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2002.
10.15	Nicholas M. Brown, Jr. Supplemental Retirement Benefit Agreement, dated March 26, 2004, incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2004.
10.16	Jerry de St. Paer Employment Agreement, dated March 1, 2001, incorporated by reference to Exhibit 10.14.37 to the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2001.
10.17	Form of Non-Statutory Stock Option Agreement (One-Time Vesting), incorporated by reference to Exhibit 10.4 to the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2004.
10.18	Form of Non-Statutory Stock Option Agreement (Incremental Vesting), incorporated by reference to Exhibit 10.5 to the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2004.
10.19	Form of Incentive Stock Option Agreement, incorporated by reference to Exhibit 10.6 to the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2004.
10.20	Form of Restricted Stock Agreement, incorporated by reference to Exhibit 10.7 to the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2004.
10.21	Form of Non-Statutory Stock Option Agreement (Renewal Form), incorporated by reference to Exhibit 10.8 to the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2004.
10.22	Form of Non-Statutory Stock Option Agreement (Non-Employee Director Renewal Form), incorporated by reference to Exhibit 10.9 to the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2004.
10.23	Form of Directors Restricted Stock Agreement, incorporated by reference to Exhibit 10.10 to the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2004.

168

Exhibit	Description
______	_________
10.24	Form of Performance Restricted Stock Agreement, incorporated by reference to Exhibit 10.11 to the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2004.
10.25	Form of Performance Restricted Stock Unit Agreement, incorporated by reference to Exhibit 10.12 to the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2004.
10.26	Form of Restricted Stock Unit Agreement, incorporated by reference to Exhibit 10.13 to the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2004.
10.27	Form of Director Stock Option Agreement, incorporated by reference to Exhibit 10.14 to the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2004.
10.28	Letter of Credit Facility and Reimbursement Agreement, dated as of June 30, 1999, by and between XL Insurance (Bermuda) Ltd (formerly XL Insurance Ltd), XL Capital Ltd, XL Europe Ltd (formerly XL Europe), XL Re Ltd (formerly XL Mid Ocean Reinsurance Ltd) and XL London Market Group plc (formerly The Brockbank Group plc), as Account Parties, and XL Insurance (Bermuda) Ltd, XL Capital Ltd, XL Re Ltd and XL Investments Ltd, as Guarantors, the Banks parties thereto from time to time and Mellon Bank, N.A., as Issuing Bank and as Agent, incorporated by reference to Exhibit 10.14.24 to the Company’s Annual Report on Form 10-K for the year ended December 31, 1999.
10.29	First Amendment, dated as of February 25, 2000, by and among XL Insurance (Bermuda) Ltd (formerly XL Insurance Ltd), XL Capital Ltd, XL Europe Ltd (formerly XL Europe), XL Re Ltd (formerly XL Mid Ocean Reinsurance Ltd), XL London Market Group (formerly The Brockbank Group plc) and XL Investments Ltd and Mellon Bank, N.A., as Issuing Bank and as Agent, and the banks listed on the signature pages thereto, to the Letter of Credit Facility and Reimbursement Agreement, dated as of June 30, 1999, incorporated by reference to Exhibit 10.14.25 to the Company’s Annual Report on Form 10-K for the year ended December 31, 1999.
10.30	Second Amendment, dated as of November 28, 2000, by and among XL Insurance (Bermuda) Ltd (formerly XL Insurance Ltd), XL Capital Ltd, XL Europe Ltd (formerly XL Europe), XL Re Ltd (formerly XL Mid Ocean Reinsurance Ltd), XL London Market Group (formerly XL Brockbank Group plc) and XL Investments Ltd and Mellon Bank, N.A., as Issuing Bank and as Agent and as a Bank, to the Letter of Credit Facility and Reimbursement Agreement, dated as of June 30, 1999, incorporated by reference to Exhibit 10.14.34 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2000.
10.31	Third Amendment, dated as of December 23, 2003, between XL Insurance (Bermuda) Ltd, XL Capital Ltd, XL Europe Ltd, XL Re Ltd, XL London Market Group plc and XL Investments Ltd and Mellon Bank, N.A., as Issuing Bank and as Agent and as a Bank, to the Letter of Credit Facility and Reimbursement Agreement, dated as of June 30, 1999, incorporated by reference to Exhibit 10.19 to the Companies Annual Report on Form 10-K for the year ended December 31, 2003.
10.32	Insurance Letters of Credit — Master Agreement between XL Mid Ocean Reinsurance Ltd and Citibank, N.A., dated May 19, 1993, incorporated by reference to Exhibit 10.33 to Amendment No. 2 to the Registration Statement on Form S-1 of Mid Ocean Limited (No. 333-63298) filed on June 25, 1993.
10.33	Second Amended and Restated Agreement for the Sale and Purchase of Winterthur International, dated as of February 15, 2001, between Winterthur Swiss Insurance Company and XL Insurance (Bermuda) Ltd (formerly XL Insurance Ltd), incorporated by reference to Exhibit 99(a) to the Company’s Current Report on Form 8-K filed August 9, 2001.
10.34	Amendment Agreement, dated July 27, 2004, between Winterthur Swiss Insurance Company and XL Insurance (Bermuda) Ltd, relating to the Second Amended and Restated Agreement for the Sale and Purchase of Winterthur International, dated as of February 15, 2001, incorporated by reference to Exhibit 10.16 to the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2004.

169

Exhibit	Description
______	_________
10.35	Amendment Agreement, dated July 19, 2002, between Winterthur Swiss Insurance Company and XL Insurance (Bermuda) Ltd, incorporated by reference to Exhibit 10.58 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.
10.36	Agreement, dated December 24, 2003, between Winterthur Swiss Insurance Company and XL Insurance (Bermuda) Ltd (including Schedule B thereto), relating to the Second Amended and Restated Agreement for the Sale and Purchase of Winterthur International, dated as of February 15, 2001, incorporated by reference to Exhibit 10.15 to the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2004.
10.37	Letter of Credit Facility and Reimbursement Agreement, dated as of December 29, 2003, by and between XL Insurance (Bermuda) Ltd, XL Capital Ltd, XL Re Ltd, and X.L. America, Inc. and Mellon Bank, N.A., as Bank, incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2004.
10.38	Pledge Agreement, dated as of December 18, 2001, made by XL Investments Ltd, XL Re Ltd, XL Insurance (Bermuda) Ltd and XL Europe Ltd, as Grantors, in favor of Citibank, N.A., as Bank, incorporated by reference to Exhibit 10.54 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2001.
10.39	Amendment No. 1, dated as of July 1, 2003, to the Pledge Agreement, dated December 18, 2001, made by XL Investments Ltd, XL Re Ltd, XL Insurance (Bermuda) Ltd, and XL Europe Ltd, as Grantors, in favour of Citibank, N.A., as Bank, incorporated by reference to Exhibit 10.67 to the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2003.
10.40	Limited Liability Company Agreement of XL Capital Principal Partners I, L.L.C., dated June 26, 2001, incorporated by reference to Exhibit 10.55 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2001.
10.41	Amended and Restated Agreement of Limited Partnership of XL Capital Partners I, L.P., dated as of May 31, 2001, incorporated by reference to Exhibit 10.56 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2001.
10.42	First Amendment, dated as of October 30, 2002, to the Amended and Restated Agreement of Limited Partnership, dated as of May 31, 2001, of XL Capital Partners I, L.P., incorporated by reference to Exhibit 10.50 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.
10.43	Second Amendment, dated as of March 6, 2003, to the Amended and Restated Agreement of Limited Partnership, dated as of May 31, 2001 of XL Capital Partners I, L.P., incorporated by reference to Exhibit 10.51 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.
10.44	Amended and Restated Agreement of Limited Partnership of XL Principal Partners I, L.P., dated June 28, 2001, incorporated by reference to Exhibit 10.57 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2001.
10.45	First Amendment, dated as of October 30, 2002, to the Amended and Restated Agreement of Limited Partnership, dated as of June 28, 2001, of XL Principal Partners I, L.P., incorporated by reference to Exhibit 10.53 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.
10.46	Second Amendment, dated as of March 6, 2003, to the Amended and Restated Agreement of Limited Partnership, dated as of June 28, 2001, of XL Principal Partners I, L.P., incorporated by reference to Exhibit 10.54 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.
10.47	364-Day Credit Agreement, dated as of June 27, 2002, between XL Capital Ltd, X.L. America, Inc., XL Insurance (Bermuda) Ltd, XL Europe Ltd and XL Re Ltd, as Account Parties and as Guarantors, the Lenders party thereto, and JPMorgan Chase Bank, as Administrative Agent, incorporated by reference to Exhibit 10.63 to the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2002.

170

Exhibit	Description
______	_________
10.48	Amendment No. 1, dated as of July 19, 2002, to the 364-Day Credit Agreement, dated as of June 27, 2002, between XL Capital Ltd, X.L. America, Inc., XL Insurance (Bermuda) Ltd, XL Europe Ltd and XL Re Ltd, the Lenders party thereto and JPMorgan Chase Bank, as Administrative Agent, incorporated by reference to Exhibit 10.56 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.
10.49	364-Day Credit Agreement, dated as of June 25, 2003, between XL Capital Ltd, X.L. America, Inc., XL Insurance (Bermuda) Ltd, XL Europe Ltd and XL Re Ltd. as Account Parties and as Guarantors, the Lenders party thereto and JPMorgan Chase Bank, as Administrative Agent, incorporated by reference to Exhibit 10.64 to the Company’s Quarterly Report on Form 10-Q for the year ended June 30, 2003.
10.50	364-Day Credit Agreement, dated as of June 23, 2004, between XL Capital Ltd, X.L. America, Inc., XL Insurance (Bermuda) Ltd and XL Re Ltd, as Account Parties and Guarantors, the Lenders party thereto, and JPMorgan Chase Bank, as Administrative Agent, incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2004.
10.51	Letter of Credit Facility and Reimbursement Agreement, dated November 18, 2002 between XL Capital Ltd, as Account Party, XL Capital Ltd, X.L. America, Inc., XL Insurance (Bermuda) Ltd, XL Europe Ltd and XL Re Ltd, as Guarantors, the Lenders party thereto and Citibank International plc, as Agent and Security Trustee incorporated by reference to Exhibit 10.57 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.
10.52	Letter of Credit Facility and Reimbursement Agreement, dated November 18, 2002, amended and restated as of June 26, 2003, between XL Capital Ltd, as Account Party, XL Capital Ltd, X.L. America, Inc., XL Insurance (Bermuda) Ltd, XL Europe Ltd and XL Re Ltd, as Guarantors, the Lenders party thereto and Citibank International plc, as Agent and Security Trustee, incorporated by reference to Exhibit 10.65 to the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2003.
10.53	Letter of Credit Facility and Reimbursement Agreement, dated November 14, 2003, between XL Capital Ltd, as Account Party, XL Capital Ltd, X.L. America, Inc., XL Insurance (Bermuda) Ltd and XL Re Ltd, as Guarantors, the Lenders party thereto and Citibank International plc, as Agent and Security Trustee, incorporated by reference to Exhibit 10.37 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.
10.54*	Letter of Credit Facility and Reimbursement Agreement, dated November 17, 2004, between XL Capital Ltd, as Account Party, XL Capital Ltd, X.L. America, Inc., XL Insurance (Bermuda) Ltd and XL Re Ltd, as Guarantors, the Lenders party thereto and Citibank International plc, as Agent and Security Trustee.
10.55	Standby Letter of Credit Agreement, dated January 31, 2003, between XL Capital Ltd, X.L. America, Inc., XL Insurance (Bermuda) Ltd, XL Europe Ltd and XL Re Ltd, as Applicant, and National Australia Bank Limited, New York Branch, as Bank, incorporated by reference to Exhibit 10.59 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.
10.56	Standby Letter of Credit Agreement, dated July 25, 2003, between National Australia Bank Limited, New York Branch, as Bank, and XL Capital Ltd, X.L. America, Inc., XL Insurance (Bermuda) Ltd, XL Europe Ltd and XL Re Ltd as Applicants, incorporated by reference to Exhibit 10.66 to the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2003.
10.57	Standby Letter of Credit Agreement, dated February 27, 2004, by and among Keybank National Association, as Bank, and XL Capital Ltd, X.L. America, Inc., XL Insurance (Bermuda) Ltd and XL Re Ltd, as Applicants, incorporated by reference to Exhibit 10.41 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.

171

Exhibit	Description
______	_________
10.58*	Amended and Restated Standby Letter of Credit Agreement, dated June 30, 2004, between XL Capital Ltd, X.L. America, Inc., XL Insurance (Bermuda) Ltd and XL Re Ltd, as Account Parties, and National Australia Bank Limited, New York Branch, as Bank.
10.59	Revolving Credit and Security Agreement, dated as of February 25, 2003, among XL Re Ltd, as Borrower, Corporate Asset Funding Company, Inc., Corporate Receivables Corporation, Charta Corporation and Ciesco, L.P., as Lenders, and Citibank, N.A. and the other Secondary Lenders from time to time parties thereto, as Secondary Lenders, and Citicorp North America, Inc., as Agent, incorporated by reference to Exhibit 10.60 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.
10.60	Agreement of Amendment, dated as of May 10, 2004, to (i) the Revolving Credit and Security Agreement, dated as of February 25, 2003, among XL Re Ltd, as Borrower, CAFCO, LLC (formerly Corporate Asset Funding Company, Inc.), CRC Funding, LLC (formerly Corporate Receivables Corporation), CHARTA, LLC (formerly CHARTA Corporation) and CIESCO, LLC (formerly CIESCO, L.P.), as Lenders, Citibank, N.A. and the other Secondary Lenders from time to time parties thereto, as Secondary Lenders, and Citicorp North America, Inc., as Agent, and (ii) the Control Agreement, dated as of February 25, 2003, among XL Re Ltd, as Borrower, Citibank North America, Inc., as Agent, and Mellon Bank, N.A., as Securities Intermediary, incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2004.
10.61	Service Agreement Relative to Sureties, Letters of Guarantees and International Stand-By Letters of Credit, dated April 25, 2003, between Société Le Mans Re and Credit Lyonnais, incorporated by reference to Exhibit 10.62 to the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2003.
10.62	First Renewal, dated November 27, 2000, between Le Mans Re and BNP Paribas, to the Reinsurance Stand-By Letter of Credit Agreement, dated October 7, 1999, incorporated by reference to Exhibit 10.63 to the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2003.
10.63	Control Agreement, dated as of February 25, 2003, between XL Re Ltd and Citicorp North America, Inc., as Agent, and Mellon Bank, N.A., as Securities Intermediary, incorporated by reference to Exhibit 10.61 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.
10.64	Offer Letter, dated as of April 12, 2004, for a U.S.$50,000,000 Committed Line of Credit between Credit Lyonnais, New York Branch, as Lender, and XL Capital Ltd, X.L., America, Inc., XL Insurance (Bermuda) Ltd and XL Re Ltd, as Account Parties, incorporated by reference to Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2004.
10.65	Three-Year Credit Agreement, dated as of June 23, 2004, between XL Capital Ltd, X.L. America, Inc., XL Insurance (Bermuda) Ltd and XL Re Ltd, as Account Parties and Guarantors, the Lenders party thereto, and JPMorgan Chase Bank, as Administrative Agent, incorporated by reference to Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2004.
10.66	364-Day Credit Agreement, dated as of September 30, 2004, between XL Capital Ltd, X.L. America, Inc., XL Insurance (Bermuda) Ltd and XL Re Ltd, as Account Parties and Guarantors, and Deutsche Bank AG, New York Branch, as Lender, incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2004.
10.67	Put Option Agreement, dated as of December 10, 2004, between XL Financial Assurance Ltd. and Twin Reefs Asset Trust, incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on December 14, 2004.
10.68	Asset Trust Expense Reimbursement Agreement, dated as of December 10, 2004, between XL Financial Assurance Ltd. and Twin Reefs Asset Trust, incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on December 14, 2004.

172

Exhibit	Description
______	_________
12*	Statements regarding computation of ratios.
21*	List of subsidiaries of the Registrant.
23*	Consent of PricewaterhouseCoopers LLP.
31*	Rule 13a-14(a)/15d-14(a) Certifications.
32*	Section 1350 Certifications.
99.1*	XL Capital Assurance Inc. audited Consolidated financial statements as at and for the years ended December 31, 2004, 2003 and 2002.
99.2*	XL Financial Assurance Ltd. audited financial statements as at and for the years ended December 31, 2004, 2003 and 2002.

* Filed herewith

173

REPORT OF INDEPENDENT AUDITORS

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders of XL Capital Ltd:

We have completed an integrated audit of XL Capital Ltd’s 2004 consolidated financial statements and of its internal control over financial reporting as of December 31, 2004 and audits of its 2003 and 2002 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.

Consolidated financial statements and financial statement schedules

In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of XL Capital Ltd and its subsidiaries at December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

Internal control over financial reporting

Also, in our opinion, management’s assessment, included in Management’s Report on Internal Controls Over Financial Reporting apprearing under Item 9A, that the Company maintained effective internal control over financial reporting as of December 31, 2004 based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control - Integrated Framework issued by the COSO. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assur-

174

ance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

The Company adopted Statement of Financial Accounting Standard No. 123, “Accounting for Stock-Based Compensation” as amended by Financial Accounting Standard No. 148, “Accounting for Stock Based Compensation” as of the effective date January 1, 2003.

/s/ PricewaterhouseCoopers LLP

New York, New York
March 11, 2005

175

XL CAPITAL LTD

SUPPLEMENTAL SCHEDULE I
CONSOLIDATED SUMMARY OF INVESTMENTS – OTHER THAN
INVESTMENTS IN RELATED PARTIES

As at December 31, 2004

			Amount
			shown
	Cost or		in the
Type of Investment	Amortized	Market	Balance
(U.S. dollars in thousands)	Cost (1)	Value	Sheet
Fixed Maturities:
Bonds and notes:
U.S. Government and Government agency	$ 4,087,004	$ 4,112,075	$ 4,112,075
Corporate	10,945,675	11,349,847	11,349,847
Mortgage and asset-backed securities	6,922,506	6,928,558	6,928,558
U.S. States and political subdivisions of the States	61,987	63,056	63,056
Non-U.S. Sovereign Government	2,435,176	2,646,658	2,646,758
Total fixed maturities	$24,452,348	$25,100,194	$25,100,194
Equity Securities	$ 778,117	$ 962,920	$ 962,920
Short-term investments	$ 1,738,845	$ 1,760,714	$ 1,760,714
Other investments	$ 297,672	$ 305,160	$ 305,160
Total investments other than related parties	$27,266,982	$28,128,988	$28,128,988

(1) Investments in fixed maturities and short-term investments are shown at amortized cost.

176

XL CAPITAL LTD
SCHEDULE II

CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED BALANCE SHEETS – PARENT COMPANY ONLY

As at December 31, 2004 and 2003

(U.S. dollars in thousands)	2004	2003
Assets
Investments available for sale:
Fixed maturities at fair value (amortized cost: 2004, $99,781; 2003, $35,660)	$ 99,639	$ 35,692
Equity securities at fair value (cost: 2004, $237; 2003, $237)	1,073	882
Short-term investments at fair value             (amortized cost: 2004, $82,647: 2003, $138,644)	82,648	138,703
Total investments available for sale	183,360	175,277
Cash and cash equivalents	43,961	62,852
Investments in subsidiaries on an equity basis	10,340,355	8,427,716
Investment in affiliates	6,723	14,568
Investments in limited partnerships	21,782	20,677
Accrued investment income	1,988	2,043
Other assets	72,266	51,158
Total assets	$10,670,435	$8,754,291
Liabilities
Amount due to subsidiaries	$ 918,599	$ 716,679
Notes payable and debt	1,768,678	953,056
Net payable for investments purchased	325	—
Accounts payable and accrued liabilities	244,138	147,641
Total liabilities	$ 2,931,740	$1,817,376
Shareholders’ Equity
Ordinary shares	$ 1,389	$ 1,373
Preference shares	207	207
Additional paid in capital	3,950,175	3,949,421
Accumulated other comprehensive income	460,273	490,195
Deferred compensation	(69,988)	(46,124)
Retained earnings	3,396,639	2,541,843
Total shareholders’ equity	$ 7,738,695	$6,936,915
Total liabilities and shareholders’ equity	$10,670,435	$8,754,291

177

XL CAPITAL LTD
SCHEDULE II

CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
STATEMENT OF INCOME AND COMPREHENSIVE INCOME – PARENT COMPANY ONLY

For the Years Ended December 31, 2004, 2003 and 2002

(U.S. dollars in thousands)	2004	2003	2002
Net investment income	$ 3,329	$ 1,883	$ 17,621
Net realized gains (losses) on investments and derivative instruments	6,010	7,016	(21,651)
Equity in net earnings of subsidiaries       (Dividends were $217,327 in 2004, $157,837 in 2003       and $1,037,951 in 2002)	1,436,389	528,914	549,937
Equity in net earnings of affiliates	526	(13,877)	(16,654)
Income from limited partnerships	2	268	272
Total revenues	1,446,256	524,204	529,525
Operating expenses	208,974	85,182	88,743
Interest expense	70,669	27,043	35,211
Total expenses	279,643	112,225	123,954
Net income	1,166,613	411,979	405,571
Preference dividend	(40,321)	(40,321)	(9,620)
Net income available to ordinary shareholders	$1,126,292	$371,658	$395,951
Net income	$1,166,613	$411,979	$405,571
Change in net unrealized appreciation on investments	149,662	342,232	393,781
Derivative loss on cash flow hedge	(6,118)	—	—
Foreign currency translation adjustments	(173,466)	(36,851)	4,046
Comprehensive income	$1,136,691	$717,360	$803,398

178

XL CAPITAL LTD
SCHEDULE II

CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
STATEMENT OF CASH FLOWS – PARENT COMPANY ONLY

For the Years Ended December 31, 2004, 2003 and 2002

(U.S. dollars in thousands)	2004	2003	2002
Cash flows provided by (used in) operating activities:
Net income	$ 1,166,613	$ 411,979	$ 405,571
Adjustments to reconcile net income to net cash provided             by operating activities:
Net realized (gains) losses on investments and derivative instruments	(6,010)	(7,016)	21,650
Equity in net earnings of subsidiaries, net of dividends	(1,434,919)	(532,339)	(522,310)
Equity in net loss (income) of affiliates, net of dividends	(526)	13,877	16,654
Amortization of deferred compensation	28,393	17,915	14,311
Amortization of discounts on fixed maturities	(1,509)	(999)	1,074
Accretion of notes payable and debt	21,457	25,196	24,515
Accrued investment income	55	1,728	(1,441)
Accounts payable and accrued liabilities	(15,804)	(7,873)	(16,358)
Other	16,009	(15,604)	(2,314)
Total adjustments	(1,392,854)	(505,115)	(464,219)
Net cash used in operating activities	(226,241)	(93,136)	(58,648)
Cash flows provided by (used in) investing activities:
Proceeds from sale of fixed maturities and short-term investments	136,652	88,321	134,190
Proceeds from redemption of fixed maturities and             short-term investments	275,430	393,555	358,338
Proceeds from sale of equity securities	—	—	955
Purchases of fixed maturities and short term investments	(411,583)	(414,760)	(425,096)
Purchases of equity securities	—	—	(582)
Investment in subsidiaries	(718,195)	(1,153,515)	(543,830)
Investment in affiliates	8,371	(7,658)	26,876
Investment in limited partnerships	3,390	6,484	20,234
Net cash used in investing activities	(705,935)	(1,087,573)	(428,915)
Cash flows provided by financing activities:
Issue of preference shares	—	—	503,579
Proceeds from exercise of options and issuance of common shares	41,480	42,113	79,375
Dividends paid	(310,773)	(303,497)	(266,674)
Amount due to from subsidiaries	201,920	1,062,597	(881,699)
Repurchase of shares	(4,602)	(1,574)	(2,512)
Dividends received from subsidiaries	217,327	157,837	1,037,951
Proceeds from loans	1,742,317	—	—
Repayment of loans	(974,384)	—	—
Net cash provided by financing activities	913,285	957,476	470,020
Net change in cash and cash equivalents	(18,891)	(223,233)	(17,543)
Cash and cash equivalents – beginning of year	62,852	286,085	303,628
Cash and cash equivalents – end of year	$ 43,961	$ 62,852	$ 286,085

179

XL CAPITAL LTD
SCHEDULE IV – REINSURANCE

For the Years Ended December 31, 2004, 2003 and 2002

		Ceded	Assumed
	Gross	to Other	from Other	Net
(U.S. dollars in thousands)	Amount	Companies	Companies	Amount
2004
Property and casualty	$5,765,274	$2,110,374	$3,612,274	$7,267,174
Life and annuity	94,597	34,757	1,343,507	1,403,347
Financial guaranty	229,395	20,555	46,684	255,524
	$6,089,266	$2,165,686	$5,002,465	$8,926,045
2003
Property and casualty	$5,028,400	$2,071,800	$3,595,680	$6,552,280
Life and annuity	95,062	28,220	673,027	739,869
Financial guaranty	263,120	14,676	50,796	299,240
	$5,386,582	$2,114,696	$4,319,503	$7,591,389
2002
Property and casualty	$4,366,950	$1,942,379	$3,347,055	$5,771,626
Life and annuity	69,094	48,644	1,003,154	1,023,604
Financial guaranty	174,202	22,119	25,711	177,794
	$4,610,246	$2,013,142	$4,375,920	$6,973,024

180

XL CAPITAL LTD
SCHEDULE VI

SUPPLEMENTARY INFORMATION
CONCERNING PROPERTY/CASUALTY INSURANCE OPERATIONS

For the Years Ended December 31, 2004, 2003 and 2002

						Losses and Loss Expenses
(U.S		Reserves				incurred related to		Net Paid	Amortization
dollars	Deferred	For Losses	Reserves for		Net			Losses and	of Deferred	Net
in	Acquisition	and Loss	Unearned	Net Earned	Investment	Current	Prior	Loss	Acquisition	Premiums
thousands)	Costs	Expenses	Premiums	Premiums	Income	Year	Year	Expenses	Costs	Written
2004(1)	$738,927	$19,598,531	$5,178,411	$7,143,834	$702,315	$4,596,346	$267,594	$3,074,489	$1,201,296	$7,522,698
2003(1)	$705,609	$16,558,788	$4,690,321	$6,220,655	$631,701	$3,673,321	$937,285	$2,816,932	$1,116,646	$6,851,520
2002(1)	$554,498	$13,202,736	$3,848,736	$4,966,818	$643,084	$2,927,297	$400,018	$2,846,831	$ 942,492	$5,949,420

(1) The information presented above includes balances from the general and financial operations. The life and annuity operations have been excluded.

181

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Date: March 11, 2005

XL CAPITAL LTD      (Registrant)      By                             /s/ BRIAN M. O’HARA
	Name: Brian M. O’Hara Title: President and Chief Executive Officer

182

POWER OF ATTORNEY

We, the undersigned directors and executive officers of XL Capital Ltd, hereby severally constitute Michael P. Esposito, Jr., Brian M. O’Hara, Charles F. Barr and Kirstin Romann Gould, and each of them singly, our true and lawful attorneys with full power to them and each of them to sign for us, and in our names in the capacities indicated below, any and all amendments to the Annual Report on Form 10-K filed with the Securities and Exchange Commission, hereby ratifying and confirming our signatures as they may be signed by our said attorneys to any and all amendments to said Annual Report on Form 10-K.

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

Signatures	Title	Date
/s/ BRIAN O’HARA	President, Chief Executive Officer and Director	March 11, 2005
	(Principal Executive Officer)
Brian M. O’Hara
/s/ JERRY M. DE ST. PAER	Executive Vice President and Chief Financial Officer	March 11, 2005
	(Principal Financial Officer and Principal
Jerry M. de St Paer	Accounting Officer)
/s/ MICHAEL P. ESPOSITO JR.	Director and Chairman of the Board of Directors	March 11, 2005
Michael P. Esposito, Jr.
/s/ DALE COMEY	Director	March 11, 2005
Dale Comey
/s/ ROBERT R. GLAUBER	Director	March 11, 2005
Robert R. Glauber
/s/ PAUL E. JEANBART	Director	March 11, 2005
Paul E. Jeanbart
/s/ JOHN LOUDON	Director	March 11, 2005
John Loudon
/s/ EUGENE M. MCQUADE	Director	March 11, 2005
Eugene M. McQuade
/s/ ROBERT S. PARKER	Director	March 11, 2005
Robert S. Parker
/s/ CYRIL E. RANCE	Director	March 11, 2005
Cyril E. Rance
/s/ ALAN Z. SENTER	Director	March 11, 2005
Alan Z. Senter
/s/ JOHN T. THORNTON	Director	March 11, 2005
John T. Thornton
/s/ ELLEN E. THROWER	Director	March 11, 2005
Ellen E. Thrower
/s/ JOHN W. WEISER	Director	March 11, 2005
John W. Weiser

183

EX-10.54

                                                                   Exhibit 10.54

                                17 NOVEMBER 2004

                                 XL CAPITAL LTD
                                AS ACCOUNT PARTY

                                 THE GUARANTORS
                               (AS DEFINED HEREIN)

                            THE LENDERS PARTY HERETO
                               (AS DEFINED HEREIN)

                           CITIBANK INTERNATIONAL PLC
                          AS AGENT AND SECURITY TRUSTEE

              CITIGROUP GLOBAL MARKETS LIMITED AND BARCLAYS CAPITAL
                                  AS ARRANGERS

                          =============================

                          LETTER OF CREDIT FACILITY AND
                            REIMBURSEMENT AGREEMENT

                          =============================



                                    CONTENTS

CLAUSE                                                                      PAGE

1.      DEFINITIONS............................................................1

2.      THE FACILITY..........................................................14

3.      UTILISATION OF THE FACILITY...........................................16

4.      TERMINATION OF LETTERS OF CREDIT......................................17

5.      PAYMENT OF DEMANDS....................................................21

6.      THE ACCOUNT PARTY'S LIABILITIES IN RELATION TO LETTERS OF CREDIT......22

7.      DEFAULT INTEREST......................................................23

8.      TERMINATION AND REDUCTION OF THE COMMITMENTS..........................23

9.      FEES..................................................................24

10.     TAXES.................................................................26

11.     TAX RECEIPTS..........................................................27

12.     INCREASED COSTS.......................................................28

13.     ILLEGALITY............................................................29

14.     MITIGATION OBLIGATIONS; REPLACEMENT OF LENDERS........................30

15.     PAYMENTS GENERALLY; PRO RATA TREATMENT; SHARING OF SET-OFFS...........31

16.     GUARANTEE AND INDEMNITY...............................................33

17.     REPRESENTATIONS AND WARRANTIES........................................36

18.     AFFIRMATIVE COVENANTS.................................................40

19.     NEGATIVE COVENANTS....................................................45

20.     EVENTS OF DEFAULT.....................................................49

21.     THE AGENT, THE ARRANGERS AND THE LENDERS..............................52

22.     NOTICES...............................................................59

23.     WAIVERS AND AMENDMENTS................................................59

24.     COSTS AND EXPENSES....................................................60

25.     INDEMNITIES...........................................................61

26.     ALTERATION TO THE PARTIES.............................................62

27.     SET OFF...............................................................67

28.     MISCELLANEOUS PROVISIONS..............................................68

29.     GOVERNING LAW AND JURISDICTION........................................69


30.     TREATMENT OF CERTAIN INFORMATION; CONFIDENTIALITY.....................70

31.     THIRD PARTY RIGHTS....................................................71


                                                                  Conformed Copy

LETTER OF CREDIT FACILITY AND REIMBURSEMENT AGREEMENT dated 17 November 2004

BETWEEN:

(1)   XL  CAPITAL  LTD,  a company  incorporated  under  the laws of the  Cayman
      Islands (the ACCOUNT PARTY);

(2)   The GUARANTORS as defined below;

(3)   The LENDERS as defined below;

(4)   CITIBANK INTERNATIONAL PLC, as agent and trustee for the Lenders (and when
      acting in such  capacities the AGENT and SECURITY  TRUSTEE  respectively);
      and

(5)   BARCLAYS  CAPITAL and CITIGROUP  GLOBAL  MARKETS  LIMITED as mandated lead
      arrangers (the ARRANGERS).

1.    DEFINITIONS

DEFINED TERMS

1.1   As used in this Agreement, the following terms have the meanings specified
      below:

ACCELERATION  EVENT means the  provision by the Agent to the Account Party of an
Acceleration  Notice  and/or the  occurrence  of any event  with  respect to any
Obligor described in Clause 20(e) or 20(f);

ACCELERATION NOTICE has the meaning assigned to such term in Clause 20;

AFFILIATE  means,  with  respect to a  specified  Person,  another  Person  that
directly, or indirectly, Controls or is Controlled by or is under common Control
with the Person specified;

AMB CASH COLLATERAL has the meaning assigned to such term in Clause 19.8;

AMB RATING UNDERTAKING has the meaning assigned to such term in Clause 19.8;

APPLICABLE  PERCENTAGE means, with respect to any Lender,  the percentage of the
Total  Commitments  represented  by  such  Lender's  Commitment.  If  the  Total
Commitments or Commitment of a Lender have terminated or expired, the Applicable
Percentage shall be determined based upon the Total Commitments or Commitment of
such Lender (as the case may be) most  recently in effect,  giving effect to any
permitted assignments or transfers;

APPLICANT means each of Mid Ocean,  Stonebridge  Underwriting,  NAC Reinsurance,
Dornoch,  County Down, XL London Market and XL Re and any other Affiliate of the
Account  Party as may be agreed by the Agent and the Account  Party from time to
time;

APPROVED CREDIT INSTITUTION means a credit institution within the meaning of the
First  Council  Directive  on  the   co-ordination  of  laws,   regulations  and
administrative  provisions relating to the taking up and pursuit of the business
of credit  institutions  (No 77/780/EEC)  which has been approved by Lloyd's for
the purpose of providing  guarantees and issuing or confirming letters of credit
comprising a member's Funds at Lloyd's;



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AUTHORISED  SIGNATORY  means, in relation to an Obligor,  any person who is duly
authorised (in such manner as may be reasonably  acceptable to the Agent) and in
respect of whom the Agent has  received a  certificate  signed by a director  or
another Authorised  Signatory of such Obligor setting out the name and signature
of such person and confirming such person's authority to act;

AVAILABLE  COMMITMENT  means in  relation  to a  Lender  at any time and save as
otherwise provided herein its Commitment less the amount of its participation in
the LC Exposures at such time  PROVIDED  THAT such amount shall not be less than
zero;

AVAILABLE   FACILITY  means,  at  any  time,  the  aggregate  of  the  Available
Commitments  adjusted,  in the  case of a  proposed  utilisation  pursuant  to a
Utilisation Request, so as to take into account:

(a)   any reduction in the Commitment of a Lender  pursuant to the terms hereof;
      and

(b)   any Letter of Credit which pursuant to any other Utilisation Request is to
      be issued;

on or  before  the  proposed  Utilisation  Date  relating  to such  utilisation;
AVAILABILITY  PERIOD means the period from (and  including)  the Closing Date to
(and including) the Commitment Termination Date;

BILATERAL LETTER OF CREDIT has the meaning given to it in Clause 4.5(b);

BIS QUALIFYING  ASSETS means fixed income  securities issued or guaranteed by US
Government  Agencies or by the Central  Governments of any OECD country having a
financial  strength  rating  of at least  "A+"  from  Standard  & Poor's  Rating
Services (or its successor);

BOARD means the Board of Governors of the Federal  Reserve  System of the United
States of America;

BUSINESS DAY means any day that is not a Saturday,  Sunday or other day on which
commercial banks in New York City,  London or Bermuda are authorised or required
by Law to remain closed;

CAPITAL LEASE  OBLIGATIONS of any Person means the obligations of such Person to
pay rent or other amounts under any lease of (or other arrangement conveying the
right  to use)  real or  personal  property,  or a  combination  thereof,  which
obligations are required to be classified and accounted for as capital leases on
a balance  sheet of such Person under GAAP,  and the amount of such  obligations
shall be the capitalised amount thereof determined in accordance with GAAP;

CENTRAL GOVERNMENT means, without limitation, government departments, ministries
and central banks;

CHANGE  IN  CONTROL  means  the  occurrence  of any of the  following  events or
conditions:

(a)   any Person,  including  any syndicate or group deemed to be a Person under
      Section  13(d)(3)  of the  Securities  Exchange  Act of 1934,  as amended,
      acquires beneficial ownership, directly or indirectly, through a purchase,
      merger or other  acquisition  transaction  or series of  transactions,  of
      shares of capital  stock of the  Account  Party  entitling  such Person to
      exercise  40% or more of the total  voting  power of all shares of capital
      stock of the Account Party that is entitled to vote generally in elections
      of



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      directors,  other than an  acquisition  by the Account  Party,  any of its
      subsidiaries or any employee benefit plans of the Account Party; or

(b)   the Account  Party  merges or  consolidates  with or into any other Person
      (other than a Subsidiary), another person (other than a subsidiary) merges
      into the Account Party or the Account Party conveys,  sells,  transfers or
      leases all or  substantially  all of its assets to another  Person  (other
      than a Subsidiary),  other than any transaction:  (i) that does not result
      in  a  reclassification,  conversion,  exchange  or  cancellation  of  the
      outstanding  shares of capital  stock of the Account Party (other than the
      cancellation  of any  outstanding  shares of capital  stock of the Account
      Party  held by the  Person  with whom it merges or  consolidates)  or (ii)
      which is effected solely to change the  jurisdiction of  incorporation  of
      the  Account  Party  and  results  in a  reclassification,  conversion  or
      exchange  of  outstanding  shares of capital  stock of the  Account  Party
      solely into shares of capital stock of the surviving entity; or

(c)   a majority of the members of the Account  Party's  board of directors  are
      persons who are then serving on the board of directors without having been
      elected by the board of directors or having been nominated for election by
      its shareholders.

CHANGE IN LAW means (a) the adoption of any Law,  rule or  regulation  after the
date of this Agreement,  (b) any change in any Law, rule or regulation or in the
interpretation  or application  thereof by any Governmental  Authority after the
date of this  Agreement  or (c)  compliance  by any Lender (or,  for purposes of
Clause  12.1 and 13, by any lending  office of such  Lender or by such  Lender's
holding company,  if any) with any request,  guideline or directive  (whether or
not having the force of Law) of any Governmental  Authority made or issued after
the date of this Agreement;

CHARGE AGREEMENT means the charge  agreement,  in substantially the form set out
in Schedule 9 that may be required  to be entered  into by the Account  Party as
chargor  pursuant to the terms  hereof and  pursuant to which the Account  Party
will grant cash cover in favour of the Security Trustee;

CLOSING  DATE  means  the date on which the  conditions  set out in  Schedule  5
(CONDITIONS  PRECEDENT)  have,  in the  reasonable  opinion of the  Agent,  been
satisfied;

CODE means the Internal Revenue Code of 1986 of the United States of America, as
amended from time to time;

COMMENCEMENT DATE means, in respect of a Letter of Credit, the date upon which a
Letter of Credit shall become effective, being any date from (and including) the
Closing Date to (but excluding) 1 December 2005;

COMMITMENT means, with respect to each Lender,  the commitment of such Lender to
participate in the issue of Letters of Credit  hereunder.  The initial amount of
each  Lender's  Commitment  is set  forth  on  Schedule  1,  or in the  Transfer
Certificate pursuant to which such Lender shall have assumed its Commitment,  as
applicable, but in each case as such Commitment may be:

(a)   reduced from time to time pursuant to Clause 8 (TERMINATION  AND REDUCTION
      OF THE COMMITMENTS) or Clause 4.5(b) (REPLACEMENT LETTERS OF CREDIT); and

(b)   reduced or increased  from time to time pursuant to  assignments  by or to
      such Lender pursuant to Clause 26.3 (TRANSFERS BY LENDERS);



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COMMITMENT  LETTER means the letters so titled from each Arranger to the Account
Party dated 16 September 2004;

COMMITMENT TERMINATION DATE means 30 November 2005;

CONSOLIDATED NET WORTH means, at any time, the consolidated shareholders' equity
of the Account Party and its Subsidiaries;

CONTROL means the possession,  directly or indirectly, of the power to direct or
cause the direction of the management or policies of a Person,  whether  through
the ability to exercise voting power, by contract or otherwise.  CONTROLLING and
CONTROLLED have meanings correlative thereto;

COUNTY DOWN means County Down Limited, a company  incorporated under the laws of
England and Wales;

DEFAULT means any event or condition which  constitutes an Event of Default or a
Potential Event of Default;

DEFAULT  PERIOD means the period from and  including the date on which the Agent
makes  payment of a Demand Amount to but excluding the date on which the Account
Party  makes a  corresponding  reimbursement  under  Clause  6.1(a) and (b) (THE
ACCOUNT PARTY'S INDEMNITY TO LENDERS);

DEMAND AMOUNT means a principal  amount to be paid by the Account Party pursuant
to Clause 6.1(a) and (b) (THE ACCOUNT PARTY'S INDEMNITY TO LENDERS);

DOLLARS or $ refers to the lawful  money of the  United  States of America  from
time to time;

DORNOCH means Dornoch Limited, a company  incorporated under the laws of England
and Wales;

ENVIRONMENTAL  LAWS means any Law, whether now existing or subsequently  enacted
or  amended,  relating  to (a)  pollution  or  protection  of  the  environment,
including natural resources, (b) exposure of Persons,  including but not limited
to employees,  to Hazardous  Materials,  (c)  protection of the public health or
welfare from the effects of products, by-products, wastes, emissions, discharges
or releases of Hazardous Materials or (d) regulation of the manufacture,  use or
introduction into commerce of Hazardous Materials,  including their manufacture,
formulation,  packaging,  labelling,  distribution,   transportation,  handling,
storage or disposal;

ENVIRONMENTAL LIABILITY means any liability,  contingent or otherwise (including
any liability for damages, costs of environmental remediation,  fines, penalties
or  indemnities),  of an Obligor or any Subsidiary  resulting from or based upon
(a)  violation of any  Environmental  Law, (b) the  generation,  use,  handling,
transportation,  storage,  treatment or disposal of any Hazardous Materials, (c)
exposure to any Hazardous  Materials,  (d) the release or threatened  release of
any Hazardous  Materials  into the  environment or (e) any contract or agreement
pursuant to which  liability  is assumed or imposed  with  respect to any of the
foregoing;

EQUITY RIGHTS means,  with respect to any Person,  any  subscriptions,  options,
warrants,  commitments,  pre-emptive rights or agreements of any kind (including
any  shareholders'  or  voting  trust   agreements)  for  the  issuance,   sale,
registration or voting of, or securities convertible into, any additional shares
of capital stock of any class,  or partnership or other  ownership  interests of
any type in, such Person;



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ERISA means the Employee  Retirement  Income  Security Act of 1974 of the United
States of America, as amended from time to time;

ERISA AFFILIATE means any trade or business (whether or not incorporated)  that,
together with the Account  Party,  is treated as a single  employer under Clause
414(b) or (c) of the Code,  or,  solely for  purposes of Clause 302 of ERISA and
Clause 412 of the Code, is treated as a single  employer under Clause 414 of the
Code;

ERISA EVENT means (a) any REPORTABLE  EVENT,  as defined in Clause 4043 of ERISA
or the regulations issued thereunder with respect to a Plan (other than an event
for which the 30-day notice period is waived); (b) the existence with respect to
any Plan of an ACCUMULATED  FUNDING  DEFICIENCY (as defined in Clause 412 of the
Code or Clause 302 of ERISA),  whether or not waived; (c) the filing pursuant to
Clause  412(d) of the Code or Clause  303(d)  of ERISA of an  application  for a
waiver of the  minimum  funding  standard  with  respect  to any  Plan;  (d) the
incurrence  by any  Obligor or any of such  Obligor's  ERISA  Affiliates  of any
liability  under Title IV of ERISA with respect to the  termination of any Plan;
(e) the  receipt by an Obligor  or any ERISA  Affiliate  from the PBGC or a plan
administrator  of any notice  relating to an intention to terminate  any Plan or
Plans or to appoint a trustee to administer  any Plan; (f) the incurrence by any
Obligor or any of its ERISA  Affiliates  of any  liability  with  respect to the
withdrawal or partial withdrawal from any Plan or Multiemployer Plan; or (g) the
receipt by any Obligor or any ERISA  Affiliate of any notice,  or the receipt by
any  Multiemployer  Plan from any Obligor or any ERISA  Affiliate of any notice,
concerning  the  imposition of Withdrawal  Liability or a  determination  that a
Multiemployer  Plan is, or is expected to be,  insolvent  or in  reorganisation,
within the meaning of Title IV of ERISA;

EVENT OF DEFAULT has the meaning assigned to such term in Clause 20;

FACILITY  means the  letter of credit  facility  granted  to the  Account  Party
pursuant to this Agreement;

FACILITY OFFICE means the office or offices notified by a Lender to the Agent in
writing on or before the date it becomes a Lender (or,  following  that date, by
not less than five  Business  Days'  written  notice)  as the  office or offices
through which it will perform its obligations under this Agreement;

FEE LETTER  means the letter from the  Arrangers  to the Account  Party dated 16
September 2004, relating to the payment of certain fees;

FINANCE  DOCUMENTS means this Agreement,  the Charge  Agreement,  the Commitment
Letter, the Fee Letter, any Letter of Credit and any other document or documents
as may be agreed by the Agent and the Account Party;

FINAL  EXPIRATION DATE means the date on which a Letter of Credit  terminates in
accordance with its terms;

FINANCE  PARTIES  means the Lenders,  the Agent,  the Arrangers and the Security
Trustee;

FINANCIAL  OFFICER  means,  with respect to any Obligor,  a principal  financial
officer of such Obligor;

FINANCIAL STRENGTH RATING has the meaning assigned to such term in Clause 9.3.

FUNDS AT LLOYD'S has the meaning  given to it in  paragraph 4 of the  Membership
Bylaw (No. 17 of 1993);



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FUNDS AT  LLOYD'S  REQUIREMENTS  means,  in respect  of any  member,  the amount
required to be maintained by that member as Funds at Lloyd's;

FUNDS DATE means the date notified by Lloyd's each year as being the latest date
in that year by which Funds at Lloyd's  can be placed  with  Lloyd's in order to
satisfy Funds at Lloyd's  Requirements in respect of the immediately  succeeding
calendar year being,  in respect of the 2004 calendar  year, 26 November 2004 or
such other date as may be advised by Lloyd's;

GAAP means  generally  accepted  accounting  principles  in the United States of
America;

GIC means a guaranteed investment contract or funding agreement or other similar
agreement issued by an Obligor or any of its  Subsidiaries  that guarantees to a
counterparty  a rate of return  on the  invested  capital  over the life of such
contract or agreement;

GOVERNMENTAL  AUTHORITY  means the government of the United  Kingdom,  or of any
other nation, or any political subdivision thereof,  whether state or local, and
any agency, authority, instrumentality,  regulatory body, court, central bank or
other entity exercising executive, legislative,  judicial, taxing, regulatory or
administrative powers or functions of or pertaining to government;

GUARANTEE  means,  with  respect  to  any  Person,   without  duplication,   any
obligations of such Person (other than  endorsements  in the ordinary  course of
business of negotiable  instruments  for deposit or collection)  guaranteeing or
intended  to  guarantee  any  Indebtedness  of any other  Person in any  manner,
whether direct or indirect,  and including  without  limitation any  obligation,
whether or not contingent, (i) to purchase any such Indebtedness or any property
constituting  security  therefor  for the purpose of assuring the holder of such
Indebtedness,  (ii) to advance or provide funds or other support for the payment
or purchase of any such Indebtedness or to maintain working capital, solvency or
other balance sheet condition of such other Person (including without limitation
keepwell  agreements,   maintenance  agreements,   comfort  letters  or  similar
agreements or  arrangements)  for the benefit of any holder of  Indebtedness  of
such other Person,  (iii) to lease or purchase property,  securities or services
primarily for the purpose of assuring the holder of such  Indebtedness,  or (iv)
to otherwise  assure or hold  harmless the holder of such  Indebtedness  against
loss in respect thereof. The amount of any Guarantee hereunder shall (subject to
any  limitations  set forth  therein)  be  deemed  to be an amount  equal to the
outstanding  principal  amount of the  Indebtedness  in  respect  of which  such
Guarantee is made. The terms  GUARANTEE and GUARANTEED used as a verb shall have
a correlative meaning;

GUARANTORS means each of the Account Party, XL America, XL Bermuda, and XL Re;

HAZARDOUS MATERIALS means all explosive or radioactive  substances or wastes and
all  hazardous  or  toxic  substances,  wastes  or other  pollutants,  including
petroleum or petroleum  distillates,  asbestos or asbestos containing materials,
polychlorinated biphenyls, radon gas, infectious or medical wastes and all other
substances or wastes of any nature regulated pursuant to any Environmental Law;

HEDGING AGREEMENT means any interest rate protection agreement, foreign currency
exchange  agreement,  commodity price protection  agreement or other interest or
currency exchange rate or commodity price hedging arrangement;

INDEBTEDNESS  means, for any Person,  without  duplication (it being understood,
for the avoidance of doubt,  that insurance  payment  liabilities,  as such, and
liabilities  arising in the  ordinary  course of such  Person's  business  as an
insurance or reinsurance  company  (including GICs and Stable Value  Instruments
and any Specified Transaction Agreement relating



                                                                  Conformed Copy


thereto)  or  corporate  member of  Lloyd's  or as a provider  of  financial  or
investment  services or contracts  (including GICs and Stable Value  Instruments
and any Specified  Transaction  Agreement  relating thereto) (in each case other
than in connection with the provision of financing to such Person or any of such
Person's  Affiliates) shall not be deemed to constitute  Indebtedness):  (i) all
indebtedness  or liability for or on account of money  borrowed by, or for or on
account of  deposits  with or  advances to (but not  including  accrued  pension
costs,  deferred  income  taxes or accounts  payable of) such  Person;  (ii) all
obligations  (including  contingent  liabilities)  of such Person  evidenced  by
bonds, debentures, notes, banker's acceptances or similar instruments; (iii) all
indebtedness or liability for or on account of property or services purchased or
acquired by such Person;  (iv) any amount secured by a Lien on property owned by
such Person  (whether or not  assumed)  and Capital  Lease  Obligations  of such
Person  (without  regard to any  limitation  of the rights and  remedies  of the
holder of such Lien or the lessor under such capital  lease to  repossession  or
sale of such property);  (v) the maximum available amount of all standby letters
of credit issued for the account of such Person and,  without  duplication,  all
drafts drawn thereunder (to the extent unreimbursed); and (vi) all Guarantees of
such Person;

INSURANCE SUBSIDIARY means any Subsidiary which is subject to the regulation of,
and is required to file statutory  financial  statements  with, any governmental
body,  agency or official in any State or territory of the United  States or the
District of Columbia  which  regulates  insurance  companies  or the doing of an
insurance business therein.

ISDA has the meaning assigned to such term in Clause 19.3(f);

ISSUING  LENDER  means any  Lender in its  capacity  as an issuer of one or more
Letters of Credit hereunder;

LAW  means  any law  (including  common  law),  constitution,  statute,  treaty,
regulation,  rule, ordinance,  order,  injunction,  writ, decree or award of any
Governmental Authority;

LC DISBURSEMENT means a payment made by a Lender pursuant to a Letter of Credit;

LC EXPOSURE means the sum of (a) the aggregate undrawn amount of all outstanding
Letters  of  Credit at such time  plus (b) the  aggregate  amount of all  Demand
Amounts.  The LC  Exposure  of any  Lender  at any time  shall be the sum of its
participation  in the outstanding  Letters of Credit at such time and the Demand
Amounts owed to it at such time;

LC  PROPORTION  means,  in  relation  to the  Lender in respect of any Letter of
Credit and save as otherwise  provided  herein,  the proportion  (expressed as a
percentage)  of such Lender's  Available  Commitment  to the Available  Facility
immediately prior to the issue of such Letter of Credit;

LENDER  AFFILIATE  means with  respect to any Lender,  (a) an  Affiliate of such
Lender  or  (b)  any  entity  (whether  a  corporation,  partnership,  trust  or
otherwise) that is engaged in making, purchasing, holding or otherwise investing
in bank loans and similar  extensions  of credit in the  ordinary  course of its
business  and is  administered  or managed by a Lender or an  Affiliate  of such
Lender;

LENDERS means any of the Persons listed in Schedule 1 (COMMITMENTS) or any other
Person that shall have become a party hereto  pursuant to Clause 26.3 (TRANSFERS
BY Lenders),  and which has not ceased to be a party hereto in  accordance  with
the terms hereof;



LETTERS OF CREDIT means Letters of Credit  issued  pursuant to the terms of this
Agreement  (including,  for the  avoidance  of doubt,  any New Letter of Credit,
Reduced Letter of Credit or Bilateral Letter of Credit referred to in Clause 4.5
(REPLACEMENT LETTERS OF CREDIT));

LETTER OF CREDIT FEES means the fees  payable by the Account  Party  pursuant to
Clause 9.2 (LETTER OF CREDIT FEES) (as adjusted  from time to time in accordance
with the provisions of Clause 9.3) (ADJUSTMENT OF LETTER OF CREDIT FEE);

LIEN means,  with respect to any asset,  any  mortgage,  deed of trust,  pledge,
lien, security interest,  charge or other encumbrance or security arrangement of
any nature  whatsoever,  including  but not limited to any  conditional  sale or
title retention  arrangement,  and any assignment,  deposit arrangement or lease
intended as, or having the effect of, security;

LIBOR means, in relation to any unpaid sum:

(a)   the display rate per annum of the offered quotation for overnight deposits
      in the currency of the relevant  unpaid sum which appears on Telerate Page
      3750 or Telerate Page 3740 (as  appropriate) at or about 11.00 a.m. on any
      relevant day; or

(b)   if the display rate cannot be determined  under  paragraph (a) above,  the
      rate  determined  by the  Agent to be the  arithmetic  mean  (rounded,  if
      necessary,  to the nearest five decimal  places with the midpoint  rounded
      upwards) of the rates notified to the Agent by each of the Reference Banks
      quoting  (provided  that at least two Reference  Banks are quoting) as the
      rate at which such  Reference Bank is offering  overnight  deposits in the
      required currency in an amount comparable to that amount to prime banks in
      the London  Interbank  Market at or about 11.00 a.m. on any relevant  day;
      and

for the  purposes  of this  definition:  TELERATE  PAGE 3750  means the  display
designated as Page 3750, and TELERATE PAGE 3740 means the display  designated as
Page 3740,  in each case on the  Telerate  Service  (or such other  pages as may
replace Page 3750 or Page 3740 on that  service or such other  service as may be
nominated by the British Bankers' Association  (including the Reuters Screen) as
the  information   vendor  for  the  purposes  of  displaying  British  Bankers'
Association Interest Settlement Rates for deposits in the currency concerned);

LLOYD'S  means  the  society  incorporated  by  Lloyd's  Act 1871 by the name of
Lloyd's;

MAJORITY  LENDERS means, at any time,  Lenders having  Commitments  representing
more than 50% of the sum of the total  Commitments at such time;  PROVIDED THAT,
if the  Commitments  have expired or been  terminated,  MAJORITY  LENDERS  means
Lenders having more than 50% of the aggregate LC Exposure of the Lenders;

MANDATORY COSTS means, in relation to any unpaid sum for any period,  a rate per
annum calculated in accordance with Schedule 4;

MARGIN STOCK means MARGIN STOCK within the meaning of  Regulations T, U and X of
the Board;

MATERIAL  ADVERSE  EFFECT  means a material  adverse  effect on: (a) the assets,
business,  financial  condition or operations of an Obligor and its Subsidiaries
taken as a whole; or (b) the ability of an Obligor to perform any of its payment
or other material obligations under this Agreement;



                                                                  Conformed Copy


MID OCEAN means Mid Ocean Limited, a company  incorporated under the laws of the
Cayman Islands;

MULTIEMPLOYER PLAN means a multiemployer plan as defined in Clause 4001(a)(3) of
ERISA;

NAC REINSURANCE means NAC Reinsurance  International Ltd, a company incorporated
under the laws of England and Wales;

NON-U.S.  BENEFIT PLAN means any plan, fund (including any superannuation  fund)
or other similar program  established or maintained outside the United States by
any Obligor or any of its  Subsidiaries,  with  respect to which such Obligor or
the Subsidiary has an obligation to contribute,  for the benefit of employees of
such  Obligor or such  Subsidiary,  which plan,  fund or other  similar  program
provides,  or results in, the type of benefits  described in Clause 3(1) or 3(2)
of ERISA, and which plan is not subject to ERISA or the Code;

OBLIGOR  JURISDICTION  means (a)  Bermuda,  (b) the Cayman  Islands,  (c) United
States, and (d) any other country (i) where any Obligor is licensed or qualified
to do business or (ii) from or through which payments  hereunder are made by any
Obligor;

OBLIGORS means each of the Account Party and the Guarantors;

OECD COUNTRY means any member of the Organisation for Economic  Co-operation and
Development;

ORIGINAL AGREEMENT means the letter of credit and reimbursement  agreement dated
14 November  2003 between,  inter alios,  the Account  Party,  the Agent and the
lenders thereto;

ORIGINAL LETTERS OF CREDIT means the letters of credit issued under the Original
Agreement;

ORIGINAL PARTIES means the parties to the Original Agreement;

PARTICIPATING  MEMBER STATE means any member  state of the European  Communities
that adopts or has adopted the euro as its lawful  currency in  accordance  with
legislation of the European Union relating to European Monetary Union;

PARTY means any party to this Agreement;

PBGC means the Pension Benefit Guaranty  Corporation  referred to and defined in
ERISA and any successor entity performing similar functions;

PERSON means any natural person, corporation,  limited liability company, trust,
joint venture,  association,  company,  partnership,  Governmental  Authority or
other entity;

PLAN means any employee  pension benefit plan (other than a Multiemployer  Plan)
subject  to the  provisions  of Title IV of ERISA or  Clause  412 of the Code or
Clause 302 of ERISA,  and in respect of which any Obligor or any ERISA Affiliate
is (or, if such plan were terminated, would under Clause 4069 of ERISA be deemed
to be) an EMPLOYER as defined in Clause 3(5) of ERISA;

POTENTIAL EVENT OF DEFAULT means an event or condition which upon notice,  lapse
of time or both would, unless cured or waived, become an Event of Default;

PRIVATE ACT means  separate  legislation  enacted in Bermuda with the  intention
that such legislation apply specifically to an Obligor, in whole or in part;



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PROCESS AGENT has the meaning assigned to such term in Clause 29.3.

QUARTERLY  DATES  means the last  Business  Day of March,  June,  September  and
December in each year,  the first of which shall be the first such day after the
date hereof;

REFERENCE BANKS means,  subject to Clause 26.6 (REFERENCE  BANKS), the principal
London offices of Citibank, N.A., ING Bank N.V., London Branch , Lloyds TSB Bank
plc and Barclays Bank PLC;

REGISTER has the meaning given to it in Clause 26.11 (MAINTENANCE OF REGISTER BY
AGENT);

RELATED  PARTIES  means,  with respect to any  specified  Person,  such Person's
Affiliates  and  the  respective  directors,  officers,  employees,  agents  and
advisors of such Person and such Person's Affiliates;

REPRESENTATIONS  means each of the  representations  and  warranties  set out in
Clause 17 (REPRESENTATIONS AND WARRANTIES);

SAP  means,  as to each  Obligor  and  each  Subsidiary  that  offers  insurance
products,  the  statutory  accounting  practices  prescribed or permitted by the
relevant Governmental Authority for such Obligor's or such Subsidiary's domicile
for the  preparation of its financial  statements and other reports by insurance
corporations  of the same type as such Obligor or such  Subsidiary  in effect on
the date such  statements  or reports are to be  prepared,  except if  otherwise
notified by the Account Party as provided in Clause 1.3;

SEC means the Securities and Exchange Commission of the United States of America
or any successor entity;

SIGNIFICANT  SUBSIDIARY means, at any time, each Subsidiary of the Account Party
that, as of such time, meets the definition of a "significant  subsidiary" under
Regulation S-X of the SEC;

SPECIFIED TRANSACTION  AGREEMENT means any agreement,  contract or documentation
with respect to the following types of transactions: rate swap transaction, swap
option,  basis swap,  asset swap,  forward  rate  transaction,  commodity  swap,
commodity  option,  equity or equity index swap,  equity or equity index option,
bond  option,   interest  rate  option,   foreign  exchange   transaction,   cap
transaction,  floor transaction,  collar transaction,  current swap transaction,
cross-currency  rate  swap  transaction,   currency  option,  credit  protection
transaction,  credit swap,  credit default swap,  credit default  option,  total
return  swap,  credit  spread  transaction,   repurchase  transaction,   reverse
repurchase  transaction,   buy/sell-back  transaction,   securities  lending  or
borrowing transaction,  weather index transaction or forward purchase or sale of
a  security,   commodity  or  other  financial   instrument  or  interest,   and
transactions  on any  commodity  futures or other  exchanges,  markets and their
associated  clearing  houses  (including any option with respect to any of these
transactions);

STABLE VALUE  INSTRUMENT  means any insurance,  derivative or similar  financial
contract or instrument  designed to mitigate the  volatility of returns during a
given  period on a  specified  portfolio  of  securities  held by one party (the
CUSTOMER)  through  the  commitment  of the other  party (the SVI  PROVIDER)  to
provide the Customer with a credited rate of return on the portfolio,  typically
determined  through  an  interest-crediting  mechanism;  in  exchange,  the  SVI
Provider typically receives a fee;

STERLING or (POUND)  refers to the lawful  currency of the United  Kingdom  from
time to time;



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STONEBRIDGE  UNDERWRITING  means  Stonebridge  Underwriting  Limited,  a company
incorporated under the laws of England and Wales;

SUBSIDIARY  means,  with respect to any Person (the  PARENT),  at any date,  any
corporation (or similar entity) of which a majority of the shares of outstanding
capital  stock  normally   entitled  to  vote  for  the  election  of  directors
(regardless  of any  contingency  which does or may suspend or dilute the voting
rights of such capital  stock) is at such time owned  directly or  indirectly by
the  parent  or  one  or  more  subsidiaries  of the  parent.  Unless  otherwise
specified, SUBSIDIARY means a Subsidiary of an Obligor;

SUBSTITUTE LENDER has the meaning give to it in Clause 4.4(a);

TAXES  means any and all  present  or future  taxes,  levies,  imposts,  duties,
deductions,  charges  or  withholdings  imposed by any  Governmental  Authority.
TAXATION and TAX shall be construed accordingly;

TOTAL COMMITMENTS means, at any time, the aggregate of the Lenders'  Commitments
(being on the date hereof (pound)450,000,000);

TOTAL FUNDED DEBT means, at any time, all  Indebtedness of the Account Party and
its Subsidiaries which would at such time be classified in whole or in part as a
liability on the  consolidated  balance sheet of the Account Party in accordance
with GAAP;

TOTAL LC  EXPOSURES  means,  at any  time,  the  aggregate  of the  Lenders'  LC
Exposures;

TRANSACTIONS  means the execution,  delivery and  performance by the Obligors of
this Agreement and the other Finance  Documents to which any Obligor is intended
to be a party and the issuance of Letters of Credit hereunder;

TRANSFER  CERTIFICATE  means a  certificate  in the form of  Schedule 8 (FORM OF
TRANSFER CERTIFICATE) delivered pursuant to Clause 26.4 (TRANSFER PROCEDURE);

TRANSFEREE means a Person to which a Lender seeks to transfer by novation all or
part of such  Lender's  rights,  benefits  and  obligations  under  the  Finance
Documents;

US GOVERNMENT  AGENCIES means US government  agencies whose debt obligations are
fully and  explicitly  guaranteed  as to the timely  repayment of principal  and
interest by the full faith and credit of the US federal government;

UTILISATION DATE means the date on which a Letter of Credit is to be issued;

UTILISATION REQUEST means a notice substantially in the form set out in Schedule
6 (FORM OF UTILISATION REQUEST);

WITHDRAWAL  LIABILITY means  liability to a Multiemployer  Plan as a result of a
complete or partial withdrawal from such  Multiemployer  Plan, as such terms are
defined in Part I of Subtitle E of Title IV of ERISA;

XL AMERICA means X.L. America,  Inc., a company  incorporated  under the laws of
Delaware, USA;

XL BERMUDA means XL Insurance  (Bermuda) Ltd, a company organised under the laws
of Bermuda;



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XL LONDON  MARKET means XL London Market Ltd (formerly  known as  Brockbank),  a
company incorporated under the laws of England and Wales;

XL RE means XL Re Ltd, a company organised under the laws of Bermuda.

INTERPRETATION

1.2   Any reference in this Agreement to:

(a)   the AGENT, SECURITY TRUSTEE,  ARRANGERS,  LENDER or any other Person shall
      be  construed  so as to  include  its and any  subsequent  successors  and
      permitted transferees in accordance with their respective interests;

(b)   BARCLAYS  CAPITAL is a  reference  to  Barclays  Capital,  the  investment
      banking  division of Barclays Bank PLC (and any  references  shall include
      Barclays Bank PLC);

(c)   CONTINUING,  in the context of an Event of Default shall be construed as a
      reference to an Event of Default  which has not been remedied or waived in
      accordance  with the terms hereof and in relation to a POTENTIAL  EVENT OF
      DEFAULT,  one which has not been remedied within the relevant grace period
      or waived in accordance with the terms hereof;

(d)   a HOLDING  COMPANY of a company or  corporation  shall be  construed  as a
      reference  to any  company  or  corporation  of which the  first-mentioned
      company or corporation is a subsidiary;

(e)   the  EQUIVALENT  on any date in one  currency  (the FIRST  CURRENCY) of an
      amount  denominated  in  another  currency  (the  SECOND  CURRENCY)  is  a
      reference  to the amount of the first  currency  which could be  purchased
      with the  amount of the  second  currency  at the spot rate  quoted by the
      Agent at or about  11.00 a.m.  on such date for the  purchase of the first
      currency with the second currency;

(f)   a MEMBER shall be construed (as the context may require) as a reference to
      an underwriting member of Lloyd's;

(g)   a MONTH is a reference to a period starting on one day in a calendar month
      and ending on the  numerically  corresponding  day in the next  succeeding
      calendar month save that,  where any such period would  otherwise end on a
      day  which is not a  Business  Day,  it shall  end on the next  succeeding
      Business Day, unless that day falls in the calendar month  succeeding that
      in which it would  otherwise have ended, in which case it shall end on the
      immediately  preceding  Business Day, PROVIDED THAT, if a period starts on
      the last  Business Day in a calendar  month or if there is no  numerically
      corresponding  day in the month in which that  period  ends,  that  period
      shall end on the last Business Day in that later month (and  references to
      MONTHS shall be construed accordingly);

(h)   a Lender's  PARTICIPATION,  in  relation  to a Letter of Credit,  shall be
      construed as a reference to the rights and  obligations  of such Lender in
      relation  to  such  Letter  of  Credit  as are  expressly  set out in this
      Agreement;

(i)   a SUCCESSOR  shall be  construed so as to include an assignee or successor
      in  title  of  such  party  and  any  person  who  under  the  laws of its
      jurisdiction  of  incorporation  or  domicile  has  assumed the rights and
      obligations  of such party under this  Agreement  or to which,  under such
      laws, such rights and obligations have been transferred;



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(j)   an ASSET or  PROPERTY  shall be  construed  to have the same  meaning  and
      effect  and to refer to any and all  tangible  and  intangible  assets and
      properties, including cash, securities, accounts and contract rights;

(k)   TAX shall be  construed  so as to  include  any and all  present or future
      stamp or documentary taxes or any other excise or property taxes, charges,
      interest,  penalties  or similar  levies  arising  from any  payment  made
      hereunder or from the execution,  delivery or enforcement of, or otherwise
      with respect to, this Agreement;

(l)   VAT shall be  construed as a reference  to value added tax  including  any
      similar tax which may be imposed in place thereof from time to time;

(m)   the WINDING-UP,  DISSOLUTION or ADMINISTRATION of a company or corporation
      shall  be  construed  so  as  to  include  any   equivalent  or  analogous
      proceedings  under the Law of the  jurisdiction  in which such  company or
      corporation is incorporated  or any  jurisdiction in which such company or
      corporation  carries on business  including  the  seeking of  liquidation,
      winding-up,  reorganisation,   dissolution,  administration,  arrangement,
      adjustment, protection or relief of debtors; and

(n)   unless the contrary intention appears:

      (i)   a Letter of Credit is CANCELLED, REPAID or PREPAID by:

            (A)   providing  the Issuing  Lender(s)  with cash cover (as defined
                  below); or

            (B)   reducing (in  accordance  with the terms of this Agreement and
                  the Letter of Credit) the amount  that may be  demanded  under
                  the Letter of Credit (or by that amount automatically reducing
                  in accordance with the terms of the Letter of Credit); or

            (C)   cancelling  the  Letter  of Credit  by (x)  providing  written
                  confirmation (in form and substance  satisfactory to the Agent
                  or the Issuing Lender) from Lloyd's that the Issuing Lender(s)
                  has no further liability under the Letter of Credit (including
                  by way of a notice  specifying that Lloyd's does not accept or
                  unconditionally  rejects a Letter of Credit  (unless the Agent
                  or the Issuing  Lender as the case may be, acting  reasonably,
                  considers that Lloyd's remains  entitled to make a claim under
                  such  Letter  of  Credit)),  and  (y) if  Lloyd's  agrees,  by
                  procuring the return of the original to the Agent;

      (ii)  CASH  COVER  is  provided,  pursuant  to the  terms  of  the  Charge
            Agreement,  in respect of a  Lender's  participation  in a Letter of
            Credit at any time by paying  an  amount  in  Sterling  equal to the
            outstanding  amount  of  that  participation  at  that  time to such
            account or accounts as the Agent may specify and creating  effective
            security  over such  amount in favour  of the  Security  Trustee  on
            behalf of the Finance Parties in form and substance  satisfactory to
            the Security  Trustee  (together  with legal  opinions,  evidence of
            corporate   authorisation,   and  similar  documentation  reasonably
            required by the Security Trustee),  in the name of the Account Party
            from which the only  withdrawals  which may be made are  withdrawals
            made with the prior  written  consent  of the  Security  Trustee  in
            accordance with the terms of the Charge Agreement; and



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      (iii) a  reference  to  PRINCIPAL  AMOUNT in respect of a Letter of Credit
            means the maximum  amount  which is expressed to be capable of being
            demanded under a Letter of Credit  ignoring the aggregate  amount of
            any cash cover held in relation to that Letter of Credit.

ACCOUNTING TERMS; GAAP AND SAP

1.3 Except as otherwise expressly provided herein, all terms of an accounting or
financial  nature  shall be  construed  in  accordance  with GAAP or SAP, as the
context  requires,  each as in effect from time to time;  provided  that, if the
Account Party  notifies the Agent that the Obligors  request an amendment to any
provision  hereof to eliminate the effect of any change occurring after the date
hereof in GAAP or SAP, as the case may be, or in the application  thereof on the
operation of such  provision  (or if the Agent  notifies  the Obligors  that the
Majority Lenders request an amendment to any provision hereof for such purpose),
regardless  of whether any such  notice is given  before or after such change in
GAAP or SAP,  as the case  may be,  or in the  application  thereof,  then  such
provision  shall be interpreted on the basis of GAAP or SAP, as the case may be,
as in effect and  applied  immediately  before  such  change  shall have  become
effective until such notice shall have been withdrawn or such provision  amended
in accordance herewith.

AGREEMENTS AND STATUTES

1.4 Any reference in this Agreement to:

(a)   this Agreement or any other  agreement or document shall be construed as a
      reference to this  Agreement or, as the case may be, such other  agreement
      or  document  as the  same  may have  been,  or may from  time to time be,
      amended, varied, novated or supplemented;

(b)   a statute or treaty  shall be  construed as a reference to such statute or
      treaty as the same may have been, or may from time to time be, amended or,
      in the case of a statute, re-enacted; and

(c)   a bylaw shall be construed  as a reference  to a bylaw made under  Lloyd's
      Acts 1871 to 1982 as the same may have been,  or may from time to time be,
      amended or replaced.

HEADINGS

1.5 Clause and Schedule headings are for ease of reference only.

TIME

1.6 Any  reference in this  Agreement to a time of day shall,  unless a contrary
indication appears, be a reference to London time.

2.    THE FACILITY

GRANT OF THE FACILITY

2.1 The Lenders, upon the terms and subject to other conditions hereof, grant to
the  Account  Party a letter  of  credit  facility  in an  aggregate  amount  of
(pound)450,000,000.



PURPOSE AND APPLICATION

2.2 (a) The   Facility  is  intended  to  support   Funds  at  Lloyd's  for  the
        underwriting business of the Applicants,  and, accordingly,  the Account
        Party shall apply all Letters of Credit  issued  hereunder in or towards
        satisfaction of such purpose.

    (b) Without prejudice to the Account Party's obligations under Clause 2.2(a)
        and the  remaining  provisions  of this  Agreement,  none of the Finance
        Parties  shall be bound  to  enquire  as to,  nor  shall  any of them be
        responsible  for, the purpose of, or  application of the proceeds of any
        Letter of Credit issued hereunder.

CONDITIONS PRECEDENT

2.3 Save as the Lenders may otherwise  agree,  the Account Party may not deliver
any Utilisation  Request unless the Agent has confirmed to the Account Party and
the Lenders that it has waived  and/or  received all of the  documents and other
evidence  listed in Schedule 5 (CONDITIONS  PRECEDENT) and that each is, in form
and substance, reasonably satisfactory to the Agent.

SEVERAL OBLIGATIONS

2.4 The  obligations  of each  Lender are several and the failure by a Lender to
perform  its  obligations  hereunder  and/or  under any Letter of Credit  issued
hereunder  shall not affect the  obligations of either Obligor towards any other
party  hereto nor shall any other party be liable for the failure by such Lender
to perform its obligations hereunder and/or under such Letter of Credit.

SEVERAL RIGHTS

2.5 The rights of each Finance Party are several and any debt arising  hereunder
at any time  from an  Obligor  to any  Finance  Party  shall be a  separate  and
independent  debt.  Each such party shall be entitled to protect and enforce its
individual rights arising out of this Agreement independently of any other party
(so that it shall  not be  necessary  for any  party  hereto  to be joined as an
additional party in any proceedings for this purpose).

CHANGE OF CURRENCY

2.6 (a) If, after the date of this Agreement, more than one currency or currency
        unit denomination are at the same time recognised by the central bank of
        any country as the lawful currency of that country, then:

      (i)   any  reference  in the  Finance  Documents  to, and any  obligations
            arising under the Finance Documents in, the currency of that country
            shall be translated  into, or paid in, the currency or currency unit
            of that country designated by the Agent; and

      (ii)  any translation  from one currency or currency unit to another shall
            be at the official rate of exchange or conversion rate recognised by
            the central  bank for the  conversion  of that  currency or currency
            unit  into  the  other,  rounded  up or  down  by the  Agent  acting
            reasonably.

    (b) If a change in any currency of a country occurs,  this Agreement will be
        amended in the manner determined by the Agent (acting  reasonably) so as
        to reflect the change in



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      currency  and to  place  the  parties  in  the  same  position,  so far as
      possible,  that they  would  have been in if no  change  in  currency  had
      occurred.

CANCELLATION OF ORIGINAL AGREEMENT

2.7 (a) From the date of this  Agreement the Account Party shall not deliver any
        Utilisation  Request (as defined in the  Original  Agreement)  under the
        Original Agreement.

    (b) The Original  Parties hereby agree that the Original  Agreement shall be
        automatically  terminated and the Total Commitments thereunder cancelled
        upon  cancellation  of all the Original  Letters of Credit in accordance
        with the terms of the Original Agreement.

3.    UTILISATION OF THE FACILITY

UTILISATION CONDITIONS FOR THE FACILITY

3.1 Save as otherwise  provided herein, a Letter of Credit will be issued at the
request of the Account Party on behalf of an Applicant if:

(a)   no later than 10.00 a.m. two Business Days before the proposed Utilisation
      Date, the Agent has received a duly completed Utilisation Request from the
      Account Party;

(b)   the  proposed  Utilisation  Date is a  Business  Day  falling  within  the
      Availability Period;

(c)   the proposed  amount of such Letter of Credit is less than or equal to the
      Available Facility;

(d)   the Letter of Credit is  substantially  in the form set out in  Schedule 7
      (FORM OF LETTER OF CREDIT) or in such other form  requested by the Account
      Party which is approved by Lloyd's and the Lenders  (such  approval by the
      Lenders  not to be  unreasonably  withheld  or  delayed  and  shall not be
      required unless the other form requested differs  materially from the form
      set out in Schedule 7);

(e)   the beneficiary of such Letter of Credit is Lloyd's; and

(f)   on and as of the proposed Utilisation Date (a) no Default has occurred and
      is  continuing  and  (b) the  Representations  are  true  in all  material
      respects.

REQUEST FOR LETTERS OF CREDIT

3.2 The Account Party may request the issue by the Lenders  hereunder of a total
of up to thirty  Letters  of  Credit  in  respect  of the  Applicants.  A single
Utilisation Request may be issued in respect of more than one Letter of Credit.

COMPLETION OF LETTERS OF CREDIT

3.3 The Agent is  authorised  to  arrange  for the issue of any Letter of Credit
pursuant to Clause 3.1 (UTILISATION CONDITIONS FOR THE FACILITY) by:

(a)   completing the Commencement Date of such Letter of Credit;



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(b)   completing  the  schedule  to such  Letter of Credit  with the  percentage
      participation  of each Lender as allocated  pursuant to the terms  hereof;
      and

(c)   executing  such  Letter of Credit on behalf of each  Lender and  following
      such  execution  delivering  such  Letter  of  Credit  to  Lloyd's  on the
      Utilisation Date.

FINAL EXPIRATION DATE

3.4   Each Letter of Credit shall expire on its Final Expiration Date.

EACH LENDER'S PARTICIPATION IN LETTERS OF CREDIT

3.5 (a) Save as otherwise provided herein,  each Lender will participate in each
        Letter of Credit  issued  pursuant  to this  Clause 3 in the  proportion
        borne by its Available  Commitment to the Available Facility immediately
        prior to the issue of such Letter of Credit.

    (b) No Lender  shall  participate  in or issue  any  Letter of Credit to the
        extent that its LC Exposure  would exceed its  Commitment  following the
        issue of that Letter of Credit.

NOTIFICATION TO LENDERS

3.6 On or before each Utilisation Date the Agent shall notify each Lender of the
Letter of Credit that is to be issued by the Agent on behalf of the Lenders, the
name of the  Applicant  in respect of whom the Letter of Credit is being  issued
and the aggregate principal amount of the relevant Letter of Credit allocated to
such Lender pursuant to this Agreement.

CANCELLATION OF AVAILABLE COMMITMENTS

3.7 On the expiry of the Availability  Period,  the Available  Facility and each
Lender's  Available  Commitment  shall be  reduced to zero and  accordingly  the
remaining  Commitments  of each  Lender  shall be equal to their  respective  LC
Exposure under any issued Letters of Credit.

4.    TERMINATION OF LETTERS OF CREDIT

CONTINUATION UNTIL LLOYD'S TERMINATION DATE

4.1 Each Party acknowledges that, subject to the terms of this Agreement:

(a)   each  issued  Letter of Credit  shall  continue  in force  unless  Lloyd's
      receives a notice  from the Agent (or any  Finance  Party,  if pursuant to
      Clause 4.6(b)) giving Lloyd's not less than four years' notice in writing,
      terminating  such  Letter of Credit  pursuant to Clause 3 of the Letter of
      Credit (a LLOYD'S TERMINATION NOTICE):

      (i)   on the later of (x) 31 December 2009 and (y) any subsequent  date as
            specified in such notice (a LLOYD'S TERMINATION DATE); or

      (ii)  at any time after the occurrence of an Acceleration  Event or whilst
            any   Continuation  CP  Event  (as  defined  in  Clause  4.6(b))  is
            continuing;

(b)   no Party,  other  than the Agent (or any  Lender,  if  pursuant  to Clause
      4.6(b)),  may deliver a Lloyd's Termination Notice (and the Agent may only
      deliver a Lloyd's Termination Notice pursuant to Clause 3 of the Letter of
      Credit and this Clause 4);



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(c)   if the  Account  Party or any Lender (a  RELEVANT  PARTY) so  requests  (a
      TERMINATION REQUEST), the Agent shall deliver a Lloyd's Termination Notice
      as required by this Clause 4, on the later of:

      (i)   the expiration of the period ending on the day three weeks after the
            corresponding Termination Request Receipt Date, as defined in Clause
            4.2(b); and

      (ii)  the expiration of any Declining Lender Notice Period,  as defined in
            Clause 4.3(a);

(d)   the  Agent  shall,  promptly  after  delivery  by the  Agent of a  Lloyd's
      Termination  Notice,  provide a copy of such Lloyd's Termination Notice to
      each Lender (and shall inform the Account Party of the Lloyd's Termination
      Date); and

(e)   a Letter of Credit will terminate on the Lloyd's Termination Date.

DELIVERY BY A RELEVANT PARTY OF A TERMINATION REQUEST

4.2 A Termination  Request may be delivered by a Relevant  Party to the Agent in
accordance with the following:

(a)   no Termination Request may be delivered before 1 January 2005;

(b)   any  Termination  Request  delivered  on a  date  (a  TERMINATION  REQUEST
      DELIVERY  DATE) from 1 January 2005 to and including 30 November 2005 will
      be deemed to have been  received  by the Agent on (a  TERMINATION  REQUEST
      RECEIPT DATE) 30 November 2005 and the corresponding  Lloyd's  Termination
      Date shall be 31 December 2009; and

(c)   from 1 December 2005,  any  Termination  Request  Receipt Date will be the
      later of (i) 1 January 2006 and (ii) the corresponding Termination Request
      Delivery Date.

DECLINING LENDER MECHANICS (ON DELIVERY BY A LENDER OF A TERMINATION REQUEST)

4.3 (a) If a Lender (a DECLINING  LENDER) delivers a Termination  Request to the
        Agent:

      (i)   the Agent shall  notify the  Account  Party  accordingly  within two
            Business Days thereafter; and

      (ii)  during  the  period   ending  on  the  day  three  weeks  after  the
            corresponding  Termination  Request Receipt Date (a DECLINING LENDER
            NOTICE  PERIOD) the Account Party may designate a Substitute  Lender
            as contemplated in Clause 4.4.

(b)   Unless a Substitute Lender has been designated  pursuant to Clause 4.4 (in
      which case the provisions of Clause 4.5(a) shall apply) upon expiry of the
      Declining Lender Notice Period the Agent shall issue a Lloyd's Termination
      Notice (in accordance with Clause 3 of the Letter of Credit)  specifying a
      Lloyd's Termination Date of the later of (i) 31 December 2009 and (ii) the
      fourth  anniversary  of the date of that notice,  whereupon  the Letter of
      Credit will terminate on such Lloyd's Termination Date.

(c)   Unless  notice  is given to the Agent as  aforesaid  each  Lender  will be
      deemed  automatically to have agreed to continue its participation in each
      Letter of Credit.



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SUBSTITUTE LENDER

4.4 (a) If any  Declining  Lender  delivers a Termination  Request,  the Account
        Party may  designate  by the date which falls no later than two Business
        Days before the end of the corresponding  Declining Lender Notice Period
        an  Approved  Credit  Institution  (which may be an  existing  Lender or
        Lenders) (the  SUBSTITUTE  LENDER) which is willing to assume all of the
        rights  and  obligations  of the  Declining  Lender  in  respect  of its
        participation  in the  relevant  Letter  of  Credit  (the OLD  LETTER OF
        CREDIT).

    (b) If the Account  Party has found a  Substitute  Lender it shall  promptly
        notify the Agent and the Declining Lender thereof and shall use its best
        efforts  to procure  the  release by Lloyd's of the Old Letter of Credit
        (an OLD  LETTER OF CREDIT  RELEASE)  from the  Funds at  Lloyd's  of the
        relevant Applicant.

    (c) The  Declining  Lender  shall as soon as  reasonably  practicable  after
        receipt  of notice  from the  Account  Party  transfer  its  rights  and
        obligations  hereunder to the Substitute  Lender in accordance  with the
        provisions of Clause 26.3 (TRANSFERS BY LENDERS).

    (d) The Substitute Lender shall pay to the Declining Lender all amounts then
        due and owing (and all fees  accrued to but  excluding  the date of such
        transfer) to the Declining Lender in respect of its participation in the
        Old Letter of Credit.

REPLACEMENT LETTERS OF CREDIT

4.5 (a) If a Substitute  Lender has become  party hereto  pursuant to Clause 4.4
        (SUBSTITUTE  LENDER),  then  subject  to the  provisions  of Clause  4.6
        (CONTINUATION  CONDITIONS  PRECEDENT) the Lenders who are deemed to have
        agreed to the  continuation  of the Old Letter of Credit (the  EXTENDING
        LENDERS) shall, together with the Substitute Lender, participate in, and
        issue as soon as reasonably practicable (on or immediately after the Old
        Letter of Credit  Release),  a new  Letter of Credit  (the NEW LETTER OF
        CREDIT)  which shall (i) replace the Old Letter of Credit and (ii) be in
        an amount equal to the Old Letter of Credit. If the New Letter of Credit
        has not been issued by the end of the Declining  Lender  Notice  Period,
        Clause 4.5(b) shall apply (on the  assumption,  if not the case,  that a
        Substitute  Lender  has not been found by the time  specified  in Clause
        4.4(a))  and the Agent  shall  promptly  deliver  a Lloyd's  Termination
        Notice (in accordance with Clause 4.3 (DECLINING LENDER MECHANICS)).

    (b) If a  Substitute  Lender  has not been  found by the time  specified  in
        Clause  4.4(a),  then the Account  Party  shall use its best  efforts to
        procure an Old Letter of Credit  Release,  and on or  immediately  after
        such Old  Letter of Credit  Release  (i)  subject to the  provisions  of
        Clause 4.6 (CONTINUATION  CONDITIONS  PRECEDENT),  the Extending Lenders
        shall participate in, and issue as soon as reasonably practicable, a new
        Letter of Credit (the REDUCED  LETTER OF CREDIT) which shall (x) replace
        their  participation in the Old Letter of Credit and (y) be in an amount
        equal to the Old  Letter of  Credit  LESS the  amount  of the  Declining
        Lender's  participation  and (ii) the Declining Lender shall participate
        in a separate  Letter of Credit (a  BILATERAL  LETTER OF  CREDIT)  which
        shall (x) replace its participation in the Old Letter of Credit,  (y) be
        in an amount equal to the Declining  Lender's  participation  in the Old
        Letter  of  Credit  and (z) have a Final  Expiration  Date  which is the
        Lloyd's  Termination  Date designated  pursuant to Clause 4.3 (DECLINING
        LENDER MECHANICS).



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CONTINUATION CONDITIONS PRECEDENT

4.6 (a) On or prior to close of business on 1  September  of each year (each,  a
        CONTINUATION CP DATE), the Account Party shall promptly notify the Agent
        if (as of such Continuation CP Date):

      (i)   an Event of Default or  Potential  Event of Default  occurs which is
            continuing;

      (ii)  any of the  Representations  cease  to be  correct  in all  material
            respects, or become misleading in any material respect; or

      (iii) any  Letter  of  Credit  ceases  solely  to be used to  support  the
            relevant Applicant's underwriting business at Lloyd's which has been
            provided in accordance with the  requirements of Lloyd's  applicable
            to it.

    (b) If on any  Continuation  CP Date any of the events  specified  in Clause
        4.6(a) (each, a  CONTINUATION  CP EVENT) has occurred and is continuing,
        then at any time  thereafter  (so long as any  Continuation  CP Event is
        continuing):

      (i)   the Agent may,  and at the request of the  Majority  Lenders  shall,
            issue a Lloyd's Termination Notice (containing the earliest possible
            Lloyd's Termination Date); and

      (ii)  any Lender shall be entitled to issue a Lloyd's  Termination  Notice
            (containing the earliest possible Lloyd's Termination Date) and such
            Lender shall  promptly  provide a copy of such  Lloyd's  Termination
            Notice to the Agent,

        and  the  Agent  shall,  in each  case,  provide  a copy of the  Lloyd's
        Termination  Notice to the Account Party (and each other Lender)  within
        two Business Days of the Agent (x) issuing a Lloyd's  Termination Notice
        (in the  case of  paragraph  (i)  above)  or (y)  receiving  a copy of a
        Lloyd's  Termination Notice from a Lender (in the case of paragraph (ii)
        above).

CANCELLATION OF BILATERAL LETTERS OF CREDIT

4.7 At any time after the issue of a  Bilateral  Letter of Credit by a Declining
Lender the Account  Party may give the Agent and the  Declining  Lender not less
than fourteen  days' prior  written  notice of its intention to procure that the
liability of the Declining Lender under such Letter of Credit is reduced to zero
(whereupon it shall do so).

REVISED LETTERS OF CREDIT

4.8 In the event that the Funds at Lloyd's  Requirements of an Applicant changes
at or around  the time of any given  Funds  Date in terms of amount  and/or  the
identity  of the  Applicant,  subject to the  approval of Lloyd's and subject to
each  Lender's LC Exposures  under the Letters of Credit  issued  hereunder  not
being  increased,  the Lenders shall co-operate with the Account Party to ensure
to the extent  reasonably  possible  that the Letters of Credit  provide for the
revised Funds at Lloyd's Requirements of the Applicants.

INCREASE TO FACILITY

4.9 If at any time a  Bilateral  Letter of Credit is  outstanding,  the  Account
Party  shall have the right to  increase  the size of the  Facility by up to the
principal amount of the Bilateral



Letter of Credit(s)  outstanding  by  introducing  a new lender (which may be an
existing Lender) and on terms that one or more outstanding  Bilateral Letters of
Credit having an aggregate  principal  amount at least equal to the increase are
cancelled at the time the increase  takes effect.  Each Lender agrees to execute
any documentation giving effect to this increase and new lender provided that no
such documentation may increase the Commitment of any Lender without the express
consent of that Lender at the time such documentation is executed.

5.    PAYMENT OF DEMANDS

DISBURSEMENT PROCEDURES

5.1 (a) The Agent shall, within a reasonable time following its receipt thereof,
        examine all documents purporting to represent a demand for payment under
        any Letter of Credit.  The Agent shall promptly  after such  examination
        (and in any event by 12 noon on the Business Day  immediately  following
        receipt of such  demand)  (i) notify each of the Lenders and the Account
        Party by  facsimile  of such demand for payment and (ii) deliver to each
        Lender  and the  Account  Party a copy of each  document  purporting  to
        represent a demand for payment under such Letter of Credit.

    (b) With respect to any drawing properly made under a Letter of Credit, each
        Lender will make an LC  Disbursement in respect of such Letter of Credit
        in accordance  with its  liability  under such Letter of Credit and this
        Agreement,  such LC  Disbursement to be made to the account of the Agent
        most recently designated by it for such purpose by notice to the Lenders
        within two Business  Days of receipt of a demand for payment  under such
        Letter of Credit by the Agent;

    (c) The Agent will and undertakes to each Lender that it will:

      (i)   make  any  such  LC   Disbursement   available  to  Lloyd's  as  the
            beneficiary  of such  Letter  of Credit by  promptly  crediting  the
            amounts so received from the Lenders,  in like funds, to the account
            identified by Lloyd's in connection  with such demand for payment on
            the date  following two Business Days after the receipt by the Agent
            of such demand; and

      (ii)  notify  each Lender on the third  Business  Day after the receipt by
            the Agent of such  demand  for  payment  that it has  credited  such
            amounts to the account identified by Lloyd's.

    (d) Promptly  following any LC  Disbursement by any Lender in respect of any
        Letter of Credit,  the Agent will  notify the  Account  Party of such LC
        Disbursement  provided  that any failure to give or delay in giving such
        notice  shall not  relieve  the  Account  Party of their  obligation  to
        reimburse the Lenders with respect to any such LC Disbursement.

RIGHT TO MAKE PAYMENTS UNDER LETTERS OF CREDIT

5.2 Each Lender  shall be entitled  to make any payment in  accordance  with the
terms of the  relevant  Letter of Credit  without  any  reference  to or further
authority from the Account Party or any other investigation or enquiry.



                                                                  Conformed Copy


LIABILITY OF LENDERS

5.3 Neither the Agent,  nor any Lender nor any of their  Related  Parties  shall
have any  liability or  responsibility  by reason of or in  connection  with the
issuance  or  transfer of any Letter of Credit or any payment or failure to make
any payment thereunder  (irrespective of any of the circumstances referred to in
the preceding sentence), or any error, omission,  interruption, loss or delay in
transmission or delivery of any draft,  notice or other  communication  under or
relating  to any Letter of Credit  (including  any  document  required to make a
drawing  thereunder),  any error in  interpretation  of  technical  terms or any
consequence  arising  from  causes  beyond  their  control;  provided  that  the
foregoing  shall not be construed to excuse the Agent or a Lender from liability
to any Obligor to the extent of any direct damages (as opposed to  consequential
damages,  claims in respect of which are hereby  waived by the  Obligors  to the
extent  permitted by applicable  Law) suffered by any Obligor that are caused by
the gross negligence or wilful misconduct of the Agent or a Lender.  The parties
hereto expressly agree that:

(a)   the  Agent  may  accept  documents  that  appear  on  their  face to be in
      substantial  compliance  with  the  terms of a Letter  of  Credit  without
      responsibility  for  further  investigation,  regardless  of any notice or
      information  to the contrary,  and may make payment upon  presentation  of
      documents that appear on their face to be in substantial  compliance  with
      the terms of such Letter of Credit;

(b)   the Agent  shall have the  right,  in its sole  discretion,  to decline to
      accept such  documents and to make such payment if such  documents are not
      in strict compliance with the terms of such Letter of Credit; and

(c)   this Clause  shall  establish  the standard of care to be exercised by the
      Agent when determining  whether drafts and other documents presented under
      a Letter of Credit comply with the terms  thereof (and the parties  hereto
      hereby waive,  to the extent  permitted by applicable Law, any standard of
      care inconsistent with the foregoing).

6.    THE ACCOUNT PARTY'S LIABILITIES IN RELATION TO LETTERS OF CREDIT

THE ACCOUNT PARTY'S INDEMNITY TO LENDERS

6.1 The  Account  Party  shall  irrevocably  and  unconditionally  as a  primary
obligation  indemnify  (on demand by the Agent (and any Lender may  require  the
Agent to make such demand)) each Lender against:

(a)   any LC Disbursement  paid or payable by such Lender in accordance with the
      terms of any Letter of Credit requested by the Account Party; and

(b)   all liabilities,  reasonable costs  (including,  without  limitation,  any
      costs  incurred in funding any amount  which falls due from such Lender in
      connection  with such Letter of  Credit),  claims,  losses and  reasonable
      expenses  which such Lender may at any time  properly  incur or sustain in
      connection with any Letter of Credit.

PRESERVATION OF RIGHTS

6.2 Neither the  obligations  of the Account  Party set out in this Clause 6 nor
the rights,  powers and remedies conferred on any Lender by this Agreement or by
Law shall be discharged, impaired or otherwise affected by:



                                                                  Conformed Copy


(a)   the winding-up,  dissolution,  administration  or  re-organisation  of any
      Lender or any other person or any change in its status, function,  control
      or ownership;

(b)   any of the  obligations  of any Lender or any other  person  hereunder  or
      under any Letter of Credit or under any other security taken in respect of
      the Account Party's obligations  hereunder or otherwise in connection with
      any Letter of Credit being or becoming illegal, invalid,  unenforceable or
      ineffective in any respect;

(c)   time or other  indulgence  being  granted  or agreed to be  granted to any
      Lender or any other  person in respect  of its  obligations  hereunder  or
      under or in  connection  with any Letter of Credit or under any such other
      security;

(d)   any amendment to, or any  variation,  waiver or release of, any obligation
      of any  Lender or any  other  person  under  any  Letter of Credit or this
      Agreement;

(e)   any  other  act,  event or  omission  which,  but for this  Clause 6 might
      operate to discharge, impair or otherwise affect any of the obligations of
      the Account Party set out in this Clause 6 or any of the rights, powers or
      remedies conferred upon any Lender by this Agreement or by Law.

The  obligations  of the  Account  Party  set out in this  Clause  6 shall be in
addition to and  independent of every other security which any Lender may at any
time hold in respect of the Account Party's obligations hereunder.

SETTLEMENT CONDITIONAL

6.3 Any settlement or discharge  between the Account Party and a Lender shall be
conditional  upon no security or payment to such Lender by the Account  Party or
any other  person on behalf of the Account  Party,  being  avoided or reduced by
virtue of any Laws relating to  bankruptcy,  insolvency,  liquidation or similar
Laws of general  application  and, if any such security or payment is so avoided
or reduced, such Lender shall be entitled to recover the value or amount of such
security or payment from the Account Party subsequently as if such settlement or
discharge had not occurred.

7.    DEFAULT INTEREST

A Demand  Amount  shall bear  interest  during  each  Default  Period in respect
thereof,  and any other amount unpaid  hereunder shall bear interest for so long
as it remains outstanding at rate of the sum of (i) two per cent. per annum (ii)
the Mandatory Costs in respect thereof at such time, and (iii) LIBOR on each day
whilst such amount  remains  outstanding.  Such interest shall be payable by the
Account Party on the date on which it reimburses the Lenders under Clause 6.1(a)
and (b) (THE ACCOUNT PARTY'S INDEMNITY TO LENDERS).

8.    TERMINATION AND REDUCTION OF THE COMMITMENTS

SCHEDULED TERMINATION

8.1 Unless previously terminated,  the unutilised Commitments shall terminate at
the close of business on the Commitment Termination Date.

VOLUNTARY CANCELLATION OR REDUCTION

8.2 The Account Party may at any time cancel,  or from time to time reduce,  the
Total  Commitments;  provided that (a) each  reduction of the Total  Commitments
shall be in an



amount of (pound)5,000,000 or a larger multiple of (pound)1,000,000  and (b) the
Account  Party  shall  not  cancel  or reduce  the  Commitments  if the Total LC
Exposures would exceed the Total Commitments.

NOTICE OF VOLUNTARY CANCELLATION OR REDUCTION

8.3 The Account Party shall notify the Agent of any election to cancel or reduce
the Total Commitments under Clause 8.2 at least three Business Days prior to the
effective date of such  cancellation or reduction,  specifying such election and
the effective date thereof.  Promptly following receipt of any notice, the Agent
shall advise the Lenders of the contents  thereof.  Each notice delivered by the
Account  Party  pursuant to this Clause shall be  irrevocable;  provided  that a
notice of  cancellation  of the  Commitments  delivered by the Account Party may
state that such notice is  conditioned  upon the  effectiveness  of other credit
facilities,  in which case such notice may be revoked by the  Account  Party (by
notice  to the  Agent  on or  prior  to the  specified  effective  date) if such
condition is not satisfied.

NO OTHER REPAYMENTS OR CANCELLATION

8.4 The  Account  Party  shall  not  repay or  cancel  all or any part of the LC
Exposures except at the times and in the manner  expressly  provided for in this
Agreement.

EFFECT OF CANCELLATION OR REDUCTION

8.5 Any  cancellation or reduction of the Commitments  shall be permanent.  Each
reduction  of the  Commitments  shall be made  rateably  among  the  Lenders  in
accordance with their respective Commitments.

9.    FEES

PARTICIPATION FEE

9.1 The Account  Party shall pay to the Agent for the account of the Lenders the
participation fees specified in the Fee Letter.

LETTER OF CREDIT FEE

9.2 (a) The Account  Party shall pay to the Agent for account of each Lender pro
        rata  according to their  respective LC Exposures  hereunder a letter of
        credit  fee  computed  at the rate of 0.65 per cent.  per annum (as such
        rate may be adjusted from time to time in accordance with the provisions
        of Clause 9.3) on the  principal  amount of each issued Letter of Credit
        payable from the  Utilisation  Date until the Final  Expiration Date (as
        extended)  of  that  Letter  of  Credit  or  any  earlier  cancellation,
        repayment  or  prepayment  of the  Letter of Credit in  accordance  with
        Clause  8  (TERMINATION  AND  REDUCTION  OF  THE  COMMITMENTS)  of  this
        Agreement;

    (b) The Letter of Credit Fees shall be payable  quarterly in arrears on each
        Quarterly Date and on the date on which the Lenders cease to have any LC
        Exposure.  Letter of Credit  Fees  accrued  through and  including  each
        Quarterly Date shall be payable on the fifth Business Day following such
        Quarterly  Date,  commencing  on the first such date to occur  after the
        Commencement Date; and

    (c) The  Agent  shall  notify  the  Account  Party in  writing  at least ten
        Business Days prior to each  Quarterly  Date of (i) the letter of credit
        fee payable in respect of each Letter



                                                                  Conformed Copy


      of Credit  issued and (ii) the  aggregate  letter of credit fee payable in
      respect of all Letters of Credit issued.

ADJUSTMENT OF LETTER OF CREDIT FEE

9.3 (a) Notwithstanding  Clause 9.2(a) above, when the Financial Strength Rating
        (as defined below) corresponds to a rating set out in Column 1 or Column
        2 below of the fee chart  (the FEE  CHART),  the  Letter  of Credit  Fee
        payable in accordance with Clause 9.2 shall be the amount set out in the
        corresponding row in Column 3 of the Fee Chart;  provided however,  that
        whilst AMB Cash  Collateral is posted in compliance  with the provisions
        of Clause  19.8  (RATINGS  DOWNGRADE)  the Letter of Credit Fee shall be
        0.30 per cent. per annum.  Upon any AMB Cash  Collateral  which has been
        posted being fully released, in each case in compliance with Clause 19.8
        (RATINGS  DOWNGRADE),  then the Letter of Credit Fee shall once again be
        payable in accordance with the Fee Chart.

    (b) Any change to the Letter of Credit Fee described above shall take effect
        on the day on which the  Financial  Strength  Rating  change is publicly
        announced by the applicable  rating  agency;  or, in the event either of
        the conditions set forth in Clause 19.8(a) or (b) are not satisfied, the
        day on which the provisions of Clause 19.8 (RATINGS DOWNGRADE) have been
        complied with.

FEE CHART

- --------------------------------------------------------------------------------

     A.M. BEST & CO.            STANDARD & POOR'S         LETTER OF CREDIT FEE
FINANCIAL-STRENGTH RATING        RATING SERVICES                Column 3
        Column 1            FINANCIAL-STRENGTH RATING
                                    Column 2
- --------------------------------------------------------------------------------
    A++                   Greater than or equal to AA+  0.55 per cent. per annum
- --------------------------------------------------------------------------------
    A+                    AA                            0.60 per cent. per annum
- --------------------------------------------------------------------------------
    A                     AA-                           0.65 per cent. per annum
- --------------------------------------------------------------------------------
    A-                    A+                            0.725 per cent. per annu
- --------------------------------------------------------------------------------
    B++ and below         A and below                   0.80 per cent. per annum
- --------------------------------------------------------------------------------

    (c) In this Clause 9.3 and in Clause 19.8,  FINANCIAL  STRENGTH RATING means
        the lower of:

      (i)   the financial-strength  rating of the Account Party from A.M. Best &
            Co. (or its successor); and

      (ii)  the lower of the  financial-strength  rating from  Standard & Poor's
            Rating Services (or its successor) of XL Bermuda and XL Re.

        In the event that  either A.M.  Best & Co. or Standard & Poor's  Ratings
        Services  changes  the  designation  of its ratings  (including  without
        limitation  by  increasing  the number of ratings  available  or notches
        within  ratings),  then the Agent and all the Lenders shall negotiate in
        good faith such amendments to this Clause 9.3 as are necessary to ensure
        that (in the opinion of the Lenders, acting reasonably) the Letter



                                                                  Conformed Copy


        of Credit Fees payable  relative to the strength of the relevant  rating
        are the same as they are on the date hereof.

COMMITMENT FEE

9.4 (a) The Account  Party shall pay to the Agent for the account of each Lender
        a fee computed at the rate of 33 per cent.  per annum of the  applicable
        Letter  of  Credit  Fee  from  time to time on that  Lender's  Available
        Commitment for the Availability Period.

    (b) The  accrued  commitment  fee is  payable  quarterly  in arrears on each
        Quarterly Date during the  Availability  Period,  on the last day of the
        Availability  Period and, if cancelled in full, on the cancelled  amount
        of the relevant  Lender's  Commitment  at the time the  cancellation  is
        effective.

AGENT FEES

9.5 The  Account  Party  agrees to pay to the Agent,  for its own  account,  the
agency fees payable in the amounts and at the times specified in the Fee Letter.

PAYMENT OF FEES

9.6 All fees payable  hereunder  shall be paid on the dates due, in  immediately
available  funds,  to the Agent for  distribution,  in the case of the Letter of
Credit Fees referred to in Clause 9.2 and the  commitment fee referred in Clause
9.4, to the Lenders  entitled  thereto.  Fees paid shall not be refundable under
any  circumstances  absent  manifest error in the calculation or payment of fees
due and payable.

BASIS OF CALCULATION

9.7 The fees payable pursuant to Clauses 9.1, 9.2 and 9.4 shall be calculated on
the basis of actual days elapsed and a 365 day year.

10.   TAXES

TAX GROSS-UP

10.1 All  payments  to be made by an Obligor  to any  Finance  Party  hereunder,
whether in respect of principal, interest, fees or any other item, shall be made
free and clear of and  without  deduction  for or on account of tax unless  such
Obligor  is  required  to  make  such a  payment  subject  to the  deduction  or
withholding of tax, in which case the sum payable by such Obligor (in respect of
which such  deduction or  withholding is required to be made) shall be increased
to the extent  necessary to ensure that such Finance Party receives a sum net of
any deduction or  withholding  equal to the sum which it would have received had
no such deduction or withholding been made or required to be made.

TAX INDEMNITY

10.2 Without  prejudice to Clause 10.1 (TAX  GROSS-UP),  if any Finance Party is
required  to make any  payment of or on account of tax on or in  relation to any
sum received or receivable  hereunder  (including any sum deemed for purposes of
tax to be received or  receivable  by such Finance Party whether or not actually
received or  receivable)  or if any  liability in respect of any such payment is
asserted,  imposed,  levied or assessed  against any Finance Party,  the Account
Party shall,  upon demand of the Agent,  promptly  indemnify  the Finance  Party
which



                                                                  Conformed Copy


suffers a loss or  liability  as a result  against  such  payment or  liability,
together with any interest, penalties, costs and expenses payable or incurred in
connection therewith, PROVIDED THAT this Clause 10.2 shall not apply to:

(a)   any tax imposed on and calculated by reference to the net income  actually
      received or receivable by such Finance Party by the  jurisdiction in which
      such Finance Party is incorporated; or

(b)   any tax imposed on and  calculated  by  reference to the net income of the
      Facility  Office of such Finance Party actually  received or receivable by
      such Finance  Party by the  jurisdiction  in which its Facility  Office is
      located; or

(c)   the extent a loss,  liability or cost is  compensated  for by an increased
      payment under Clause 10.1 (TAX GROSS-UP).

CLAIMS BY LENDERS

10.3 A Lender  intending to make a claim pursuant to Clause 10.2 (TAX INDEMNITY)
shall promptly notify the Agent of the event giving rise to the claim, whereupon
the Agent shall promptly notify the Account Party thereof.

11.   TAX RECEIPTS

NOTIFICATION OF REQUIREMENT TO DEDUCT TAX

11.1 If, at any time,  an Obligor is  required by Law to make any  deduction  or
withholding  from any sum payable by it hereunder (or if thereafter there is any
change  in the  rates  at which  or the  manner  in  which  such  deductions  or
withholdings are calculated),  such Obligor shall promptly,  upon becoming aware
of the same, notify the Agent.

EVIDENCE OF PAYMENT OF TAX

11.2 If an  Obligor  makes  any  payment  hereunder  in  respect  of which it is
required  to make any  deduction  or  withholding,  it shall pay the full amount
required to be deducted or withheld to the relevant  taxation or other authority
within the time allowed for such payment under  applicable Law and shall deliver
to the Agent for each Lender,  within thirty days after it has made such payment
to the applicable  authority,  an original receipt (or a certified copy thereof)
issued by such authority evidencing the payment to such authority of all amounts
so required to be deducted or withheld in respect of that Lender's share of such
payment.

TAX CREDIT PAYMENT

11.3 If an additional  payment is made under Clause 10 (TAXES) by an Obligor for
the benefit of any Finance Party and such Finance Party, in its sole discretion,
determines  that it has obtained  (and has derived full use and benefit  from) a
credit  against,  a relief or remission  for, or repayment of, any tax, then, if
and to the extent that such Finance Party, in its sole opinion, determines that:

(a)   such credit, relief, remission or repayment is in respect of or calculated
      with  reference  to the  additional  payment  made  pursuant  to Clause 10
      (TAXES); and

(b)   its tax affairs for its tax year in respect of which such credit,  relief,
      remission or repayment was obtained have been finally settled,



                                                                  Conformed Copy


such Finance Party shall,  to the extent that it can do so without  prejudice to
the retention of the amount of such credit, relief,  remission or repayment, pay
to such Obligor such amount as such Finance  Party shall,  in its sole  opinion,
determine  to be the amount  which will leave such  Finance  Party  (after  such
payment)  in no worse  after-tax  position  than it would  have  been in had the
additional payment in question not been required to be made by such Obligor.

TAX CREDIT CLAWBACK

11.4 If any Finance  Party  makes any  payment to an Obligor  pursuant to Clause
11.3 (TAX CREDIT PAYMENT) and such Finance Party subsequently determines, in its
sole  opinion,  that the credit,  relief,  remission  or repayment in respect of
which such payment was made was not  available or has been  withdrawn or that it
was unable to use such credit,  relief,  remission  or  repayment  in full,  the
Obligor  shall  reimburse  such Finance  Party such amount as such Finance Party
determines,  in its sole opinion, is necessary to place it in the same after-tax
position as it would have been in if such credit, relief, remission or repayment
had been obtained and fully used and retained by such Finance Party.

TAX AND OTHER AFFAIRS

11.5 No  provision  of this  Agreement  shall  interfere  with the  right of any
Finance  Party to arrange  its tax or any other  affairs in  whatever  manner it
thinks fit, oblige any Finance Party to claim any credit,  relief,  remission or
repayment in respect of any payment under Clause 10.1 (TAX GROSS-UP) in priority
to any other credit,  relief,  remission or repayment available to it nor oblige
any  Finance  Party to  disclose  any  information  relating to its tax or other
affairs or any computations in respect thereof.

12.   INCREASED COSTS

INCREASED COSTS

12.1 Subject to Clause 12.2  (EXCEPTIONS),  if after the date of this Agreement,
the result of:

(a)   the   introduction   of  or  any  change  in  the   official  or  judicial
      interpretation  or  application  of any Law (having the force of law or if
      not  having  the  force of law,  generally  complied  with by a Lender  in
      relation to any relevant jurisdiction); and/or

(b)   compliance (without adopting materially less prudent policies or standards
      than  those  previously  adopted  by it) by any  Lender or by the  holding
      company of any Lender with any of the matters  mentioned in paragraph  (a)
      above,

including in each case, without limitation, those Laws relating to Taxation, any
change in  currency,  any reserve,  special  deposit,  cash ratio,  liquidity or
capital adequacy  requirement or any other form of banking or monetary controls,
is that:

      (i)   a Lender  or its  holding  company  incurs an  additional  cost as a
            result of that Finance Party having  entered  into,  or  performing,
            maintaining or funding its obligations under this Agreement; or

      (ii)  a Lender or its holding company incurs an additional cost in making,
            funding or  maintaining  any Letters of Credit made or to be made by
            it under this Agreement; or

      (iii) any amount  payable to a Lender or the effective  return to a Lender
            under  this  Agreement  or the  effective  return to a Lender or its
            holding  company on its



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            capital is reduced as a result of any change in the amount or nature
            of the capital  resources  required to be  allocated in respect of a
            Lender's participation under this Agreement; or

      (iv)  a Lender  makes any payment or foregoes any interest or other return
            on or calculated  by reference to any amount  received or receivable
            by it from the Account Party or the Agent under this Agreement;

            then and in each such case:

            (A)   the Lender shall notify the Account Party through the Agent of
                  the relevant  event  promptly upon becoming aware of the event
                  giving  details of any costs or amount  likely to be  demanded
                  under paragraph (B);

            (B)   promptly following any demand from time to time by that Lender
                  through the Agent,  the  Account  Party shall pay to the Agent
                  for the account of that Finance Party (or, as the case may be,
                  its  holding  company)  such amount as shall  compensate  such
                  Finance Party or its holding company for the additional  cost,
                  reduction, payment or foregone interest or other return.

EXCEPTIONS

12.2 Clause 12.1 shall not apply to or in respect of:

(a)   any circumstances referred to in Clause 10.2 (TAX INDEMNITY);

(b)   any  circumstances  for which a relevant  Lender has been  compensated for
      under Clause 11.3 (TAX CREDIT PAYMENT).

13.   ILLEGALITY

If,  after the date of this  Agreement,  any Change in Law or in the official or
judicial  interpretation  or  application  thereof  shall  make it  unlawful  or
contrary to an official  directive  in any  jurisdiction  for any Lender to make
available  or  fund  or  maintain  or to  give  effect  to  its  obligations  as
contemplated by this Agreement or the Letters of Credit (or, by reason only of a
Change of Law,  the Lender  ceases to be an Approved  Credit  Institution),  the
Lender shall  promptly on becoming  aware of the same give notice thereof to the
Account Party through the Agent, whereupon:

(a)   where such change  makes it unlawful or contrary to an official  directive
      to maintain or give effect to its obligations under this Agreement, if the
      Agent on behalf of such Lender so requires,  the Account Party shall by no
      later than the last day of any  applicable  grace period  specified by the
      applicable  Law ensure that the  liabilities  of such  Lender  under or in
      respect of each  Letter of Credit  are  cancelled  within  the  meaning of
      Clause  1.2(l)(i)(A)  (or  use  its  best  efforts  to  ensure  that  such
      liabilities are cancelled within the meaning of Clause 1.2(l)(i)(C)),  the
      Commitment  of that Lender shall  forthwith  be cancelled  and the Account
      Party shall prepay  forthwith fees,  costs and expenses due to that Lender
      hereunder;

(b)   where such  change  only makes it  unlawful  or  contrary  to an  official
      directive  to  participate  in  further   Letters  of  Credit  under  this
      Agreement,  then upon receipt by the Agent of that notice,  the  Available
      Commitment of that Lender shall be reduced to



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      zero,  and  upon  the  expiry  of each  Letter  of  Credit  in which it is
      participating at such time, its resulting Available  Commitment shall also
      be  cancelled,  provided  that if the  Lender  subsequently  transfers  or
      assigns its rights and  obligations  under this  Agreement to a new lender
      pursuant to Clause 26.5 (RIGHTS TO SUBSTITUTE A SINGLE BANK),  the Account
      Party  may by  notice to the Agent  increase  the  Commitment  of such new
      lender  by the  amount of the  Available  Commitment  that was  previously
      cancelled.

14.   MITIGATION OBLIGATIONS; REPLACEMENT OF LENDERS.

DESIGNATION OF A DIFFERENT LENDING OFFICE

14.1 If any Lender requests  compensation  under Clause 12 (INCREASED COSTS), or
if the Account Party is required to pay any  additional  amount to any Lender or
any  Governmental  Authority  for  account of any Lender  pursuant  to Clause 10
(TAXES),  then such Lender shall use reasonable efforts to designate a different
lending  office for  funding or booking its  Letters of Credit  hereunder  or to
transfer  its  rights and  obligations  hereunder  to  another  of its  offices,
branches or  Affiliates,  if, in the  reasonable  judgment of such Lender,  such
designation or assignment (a) would eliminate or reduce amounts payable pursuant
to Clause 12 (INCREASED COSTS) or 10 (TAXES),  as the case may be, in the future
and (b) would not subject  such Lender to any  unreimbursed  cost or expense and
would not otherwise be  disadvantageous to such Lender. The Account Party hereby
agrees  to pay all  reasonable  costs and  expenses  incurred  by any  Lender in
connection with any such designation or assignment.

REPLACEMENT OF LENDERS

14.2 If any Lender requests  compensation  under Clause 12 (INCREASED COSTS), or
if any Account Party is required to pay any  additional  amount to any Lender or
any  Governmental  Authority  for  account of any Lender  pursuant  to Clause 10
(TAXES),  or if any Lender  defaults in its obligation to make LC  Disbursements
hereunder,  or if any Lender ceases to be an Approved Credit  Institution,  then
the  Account  Party may, at its sole  expense  and  effort,  upon notice to such
Lender and the  Agent,  require  such  Lender to assign  and  delegate,  without
recourse (in accordance with and subject to the restrictions contained in Clause
26.5  (RIGHT TO  SUBSTITUTE  SINGLE  LENDER)),  all its  interests,  rights  and
obligations  under this Agreement to an Approved Credit  Institution  that shall
assume such  obligations  (which  assignee  may be another  Lender,  if a Lender
accepts such assignment); provided that:

(a)   the Account  Party shall have  received the prior  written  consent of the
      Agent, which consent shall not unreasonably be withheld;

(b)   such  Lender  shall  have  received  payment  of an  amount  equal  to the
      outstanding  amount of its LC  Disbursements,  accrued  interest  thereon,
      accrued  fees and all other  amounts  payable  to it  hereunder,  from the
      assignee (to the extent of such outstanding principal and accrued interest
      and  fees)  or the  relevant  Account  Party  (in the  case  of all  other
      amounts); and

(c)   in the case of any such assignment resulting from a claim for compensation
      under Clause 12 (INCREASED COSTS) or payments required to be made pursuant
      to Clause 10 (TAXES),  such  assignment will result in a reduction in such
      compensation or payments.

A Lender shall not be required to make any such  assignment  and  delegation if,
prior  thereto,  as a result  of a  waiver  by such  Lender  or  otherwise,  the
circumstances  entitling the relevant  Account Party to require such  assignment
and delegation cease to apply.



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15.   PAYMENTS GENERALLY; PRO RATA TREATMENT; SHARING OF SET-OFFS.

PAYMENTS BY THE ACCOUNT PARTY

15.1 (a) The Account  Party shall make each payment  required to be made by them
         hereunder  or under any other  Finance  Document  (except to the extent
         otherwise  provided  therein)  in  Sterling  on the date when  due,  in
         immediately  available  cleared funds,  without set-off or counterclaim
         (and in the case of  payments  required  pursuant to Clause 6, by 11.00
         a.m. on the due date). Any amounts received after such time on any date
         may, in the discretion of the Agent, be deemed to have been received on
         the  next  succeeding  Business  Day for the  purposes  of  calculating
         interest  thereon.  All such payments shall be made to the Agent at the
         account  most  recently  notified by it,  except  payments  pursuant to
         Clauses 12 (INCREASED  Costs), 10 (TAXES),  24 (COSTS AND EXPENSES) and
         25 (INDEMNITIES),  which shall be made directly to the Persons entitled
         thereto.  The Agent shall  distribute any such payments  received by it
         for account of any other Person to the appropriate  recipient  promptly
         following receipt thereof.

     (b) If any payment  hereunder  shall be due on a day that is not a Business
         Day,  the date for payment  shall be  extended  to the next  succeeding
         Business  Day  and,  in the  case  of any  payment  accruing  interest,
         interest thereon shall be payable for the period of such extension.

CURRENCY

15.2 All amounts payable under this Agreement in respect of any Letter of Credit
shall be payable in Sterling.

APPLICATION OF INSUFFICIENT PAYMENTS

15.3 If at any time  insufficient  funds are  received by and  available  to the
Agent to pay fully all Demand  Amounts,  interest,  fees and  expenses  then due
hereunder, such funds shall be applied:

(a)   FIRST, in or towards payment pro rata of any unpaid fees, costs, expenses,
      indemnity  payments  and other  amounts due to the Agent and the  Security
      Trustee under the Finance Documents;

(b)   SECONDLY,  in or towards payment pro rata of any unpaid costs and expenses
      of the Lenders under the Finance Documents;

(c)   THIRDLY,  in or towards  payment pro rata of any  outstanding  fees (other
      than  Letter of Credit  Fees)  payable to the  Lenders  under the  Finance
      Documents;

(d)   FOURTHLY,  in or towards  payment pro rata of all accrued Letter of Credit
      Fees due to Issuing Lenders but unsatisfied under this Agreement;

(e)   FIFTHLY, in or towards payment pro rata of any interest on Demand Amounts;

(f)   SIXTHLY, in or towards payment pro rata of Demand Amounts;

(g)   SEVENTHLY,  in or towards payment pro rata of any principal  (other than a
      Demand Amount) due but unsatisfied  under this Agreement  (including,  for
      the  avoidance of doubt,  any cash cover to be provided  under a Letter of
      Credit); and



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(h)   EIGHTHLY,  in or  towards  payment  pro  rata  of any  other  sum  due but
      unsatisfied under this Agreement.

PRO RATA TREATMENT

15.4 Except to the extent otherwise provided herein:

(a)   each reimbursement of LC Disbursements shall be made to the Lenders,  each
      payment of fees  under  Clause 9 (FEES)  shall be made for  account of the
      Lenders, and each termination or reduction of the Commitments under Clause
      8 (TERMINATION AND REDUCTION OF THE  COMMITMENTS)  shall be applied to the
      respective  Commitments  of the  Lenders,  pro  rata  according  to  their
      respective Commitments; and

(b)   each payment of interest shall be made for account of the Lenders pro rata
      in  accordance  with the amounts of  interest  then due and payable to the
      respective Lenders.

SHARING OF PAYMENTS BY LENDERS

15.5 If any Lender shall,  by exercising any right of set-off or counterclaim or
otherwise,  obtain  payment  in respect of any LC  Exposures  resulting  in such
Lender receiving payment of a greater  proportion of the aggregate amount of its
LC Exposures and accrued interest thereon then due than the proportion  received
by any other Lender,  then the Lender  receiving such greater  proportion  shall
purchase  (for cash at face value)  participations  in the LC Exposures of other
Lenders to the extent  necessary so that the benefit of all such payments  shall
be shared by the Lenders  rateably in accordance with the aggregate amount of LC
Exposures; provided that:

(a)   if any such  participations  are  purchased  and all or any portion of the
      payment  giving rise thereto is recovered,  such  participations  shall be
      rescinded and the purchase  price restored to the extent of such recovery,
      without interest; and

(b)   the  provisions  of this  Clause  shall not be  construed  to apply to any
      payment made by any Obligor pursuant to and in accordance with the express
      terms  of  this  Agreement  or  any  payment   obtained  by  a  Lender  as
      consideration  for the  assignment  of or sale  of a  participation  in LC
      Disbursements  to any assignee or  participant,  other than to the Account
      Party or any  Subsidiary or Affiliate  thereof (as to which the provisions
      of this paragraph shall apply).

Each  Obligor  consents  to the  foregoing  and  agrees,  to the  extent  it may
effectively  do  so  under   applicable   Law,  that  any  Lender   acquiring  a
participation  pursuant to the foregoing  arrangements  may exercise against the
Account  Party  rights  of  set-off  and  counterclaim   with  respect  to  such
participation  as fully as if such Lender were a direct  creditor of the Account
Party in the amount of such participation and the Obligors authorise the Lenders
to exchange Transfer  Certificates and any other documentation to give effect to
those purchases of participations.

PRESUMPTIONS OF PAYMENT

15.6  Unless the Agent  shall have  received  notice from any party prior to the
date on which any payment is due to the Agent  hereunder that the payor will not
make such payment,  the Agent may assume that the payor has made such payment on
such date in  accordance  herewith  and may, in reliance  upon such  assumption,
distribute to the relevant payee the amount due. In such event, if the payor has
not in fact made such payment, then each of the



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payees  severally agrees to repay to the Agent forthwith on demand the amount so
distributed to that payee with interest thereon, for each day from and including
the date such amount is  distributed  to it to but excluding the date of payment
to the Agent,  at the Agent's  cost of funds from such  sources as the Agent may
reasonably select.

CERTAIN DEDUCTIONS BY THE AGENT

15.7 If any Lender  shall  fail to make any  payment  required  to be made by it
pursuant to Clause 15.5 (SHARING OF PAYMENTS BY LENDERS), then the Agent may, in
its  discretion  (notwithstanding  any  contrary  provision  hereof),  apply any
amounts  thereafter  received by the Agent for account of such Lender to satisfy
such  Lender's  obligations  under  such  Clauses  until  all  such  unsatisfied
obligations are fully paid.

16.   GUARANTEE AND INDEMNITY

GUARANTEE AND INDEMNITY

16.1 The Guarantors, jointly and severally, irrevocably and unconditionally:

(a)   guarantee to each Finance Party the due and punctual  payment from time to
      time on demand any and every sum or sums of money which the Account  Party
      is at any time liable to pay to any Finance Party under or pursuant to the
      Finance  Documents  and which has become due and  payable but has not been
      paid at the time such demand is made (the GUARANTEED OBLIGATIONS); and

(b)   agree as a primary obligation to indemnify each Finance Party from time to
      time on demand from and against any loss  incurred by any Finance Party as
      a result of any of the  obligations of the Account Party under or pursuant
      to the Finance Documents being or becoming void,  voidable,  unenforceable
      or  ineffective  as against the Account  Party for any reason  whatsoever,
      whether or not known to any Finance Party or any other person,  the amount
      of such loss being the amount  which the  person or persons  suffering  it
      would otherwise have been entitled to recover from the Account Party.

ADDITIONAL SECURITY

16.2 The obligations of each Guarantor  herein contained shall be in addition to
and  independent of every other security which any Finance Party may at any time
hold in respect of any of the  Account  Party's  obligations  under the  Finance
Documents.

CONTINUING OBLIGATIONS

16.3 The obligations of each Guarantor  herein contained shall constitute and be
continuing obligations notwithstanding any settlement of account or other matter
or thing  whatsoever and shall not be considered  satisfied by any  intermediate
payment or  satisfaction  of all or any of the  obligations of the Account Party
under the Finance  Documents  and shall  continue in full force and effect until
final  payment in full of all  amounts  owing by the  Account  Party  under this
Agreement  and  total  satisfaction  of  all  the  Account  Party's  actual  and
contingent obligations under the Finance Documents.



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OBLIGATIONS NOT DISCHARGED

16.4 Neither the obligations of the Guarantors  herein contained nor the rights,
powers and  remedies  conferred  in respect of the  Guarantors  upon any Finance
Party by the  Finance  Documents  or by Law  shall be  discharged,  impaired  or
otherwise affected by:

(a)   the winding-up,  dissolution,  administration  or  re-organisation  of the
      Account  Party or any other person or any change in its status,  function,
      control or ownership;

(b)   any of the  obligations of the Account Party or any other person under the
      Finance  Documents or under any other  security taken in respect of any of
      its obligations  under the Finance  Documents  being or becoming  illegal,
      invalid, unenforceable or ineffective in any respect;

(c)   time or other  indulgence  being  granted  or agreed to be  granted to any
      Obligor in respect of its obligations under the Finance Documents or under
      any such other security;

(d)   any amendment to, or any  variation,  waiver or release of, any obligation
      of any  Obligor  under  the  Finance  Documents  or under  any such  other
      security;

(e)   any failure to take, or fully to take, any security contemplated hereby or
      otherwise agreed to be taken in respect of the Obligors' obligations under
      the Finance Documents;

(f)   any failure to realise or fully to realise  the value of, or any  release,
      discharge,  exchange or substitution  of, any security taken in respect of
      the Obligors' obligations under the Finance Documents; or

(g)   any other act, event or omission  which,  but for this Clause 16.4,  might
      operate to discharge, impair or otherwise affect any of the obligations of
      any Guarantor  herein  contained or any of the rights,  powers or remedies
      conferred upon any of the Finance  Parties by the Finance  Documents or by
      Law.

SETTLEMENT CONDITIONAL

16.5 Any  settlement  or  discharge  between  any Obligor and any of the Finance
Parties shall be conditional upon no security or payment to any Finance Party by
the  Account  Party or any other  person on behalf of the  Account  Party  being
avoided or reduced by virtue of any Laws  relating  to  bankruptcy,  insolvency,
liquidation or similar Laws of general  application and, if any such security or
payment is so avoided or  reduced,  each  Finance  Party  shall be  entitled  to
recover the value or amount of such  security or payment from the Account  Party
subsequently as if such settlement or discharge had not occurred.

EXERCISE OF RIGHTS

16.6 No Finance  Party  shall be obliged  before  exercising  any of the rights,
powers or  remedies  conferred  upon them in  respect  of any  Guarantor  by the
Finance Documents or by Law to:

(a)   make any demand of the Account Party or any other Obligor;

(b)   take any action or obtain  judgment in any court against the Account Party
      or any other Obligor;



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(c)   make or file any  claim or proof in a  winding-up  or  dissolution  of the
      Account Party or any other Obligor; or

(d)   enforce or seek to enforce any other  security  taken in respect of any of
      the  obligations  of the  Account  Party or any  other  Obligor  under the
      Finance Documents.

DEFERRAL OF GUARANTOR'S RIGHTS

16.7 Each  Guarantor  agrees that,  so long as any amounts are or may be owed by
the Account Party under the Finance  Documents or the Account Party is under any
actual or  contingent  obligations  under the  Finance  Documents,  it shall not
exercise any rights which it may at any time have by reason of performance by it
of its obligations under the Finance Documents:

(a)   to be indemnified by the Account Party; and/or

(b)   to claim any contribution  from any other Guarantor of the Account Party's
      obligations under the Finance Documents; and/or

(c)   to take the benefit (in whole or in part and whether by way of subrogation
      or  otherwise)  of any rights of the  Finance  Parties  under the  Finance
      Documents or of any other  security  taken  pursuant to, or in  connection
      with, this Agreement by all or any of the Finance Documents.

RIGHTS OF CONTRIBUTION

16.8 The  Guarantors  (other than the Account  Party) hereby  agree,  as between
themselves,  that if any such Guarantor shall become an Excess Funding Guarantor
(as defined  below) by reason of the payment by such Guarantor of any Guaranteed
Obligations,  each other  Guarantor  (other than the Account  Party)  shall,  on
demand of such Excess Funding Guarantor (but subject to the next sentence),  pay
to such Excess Funding  Guarantor an amount equal to such  Guarantor's  Pro Rata
Share (as defined below and determined,  for this purpose,  without reference to
the properties,  debts and liabilities of such Excess Funding  Guarantor) of the
Excess Payment (as defined below) in respect of such Guaranteed Obligations. The
payment  obligation of a Guarantor to any Excess  Funding  Guarantor  under this
Clause shall be subordinate and subject in right of payment to the prior payment
in full of the obligations of such Guarantor under the other  provisions of this
Clause 16 and such Excess  Funding  Guarantor  shall not  exercise  any right or
remedy with respect to such excess until payment and satisfaction in full of all
of such obligations.

For purposes of this Clause,  (i) EXCESS FUNDING  GUARANTOR means, in respect of
any Guaranteed Obligations, a Guarantor that has paid an amount in excess of its
Pro Rata Share of such  Guaranteed  Obligations,  (ii) EXCESS PAYMENT means,  in
respect of any  Guaranteed  Obligations,  the amount  paid by an Excess  Funding
Guarantor  in excess of its Pro Rata Share of such  Guaranteed  Obligations  and
(iii)  PRO RATA  SHARE  means,  for any  Guarantor,  the ratio  (expressed  as a
percentage) of (x) the amount by which the aggregate present fair saleable value
of all properties of such Guarantor  (excluding any shares of stock of any other
Guarantor) exceeds the amount of all the debts and liabilities of such Guarantor
(including contingent, subordinated, unmatured and unliquidated liabilities, but
excluding the obligations of such Guarantor hereunder and any obligations of any
other  Guarantor that have been  Guaranteed by such Guarantor) to (y) the amount
by which the  aggregate  fair  saleable  value of all  properties  of all of the
Guarantors  (other than the Account  Party)  exceeds the amount of all the debts
and liabilities (including contingent,  subordinated, unmatured and unliquidated
liabilities,  but excluding the obligations of the Guarantors  under this Clause
16) of all of the



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Guarantors  (other than the Account  Party),  determined (A) with respect to any
Guarantor that is a party hereto on the date hereof, as of the date hereof,  and
(B) with respect to any other Guarantor, as of the date such Guarantor becomes a
Guarantor hereunder.

GENERAL LIMITATION ON GUARANTEE OBLIGATIONS

16.9 In any action or proceeding involving any state corporate Law, or any state
or  Federal  bankruptcy,  insolvency,  reorganisation  or other Law in any other
jurisdiction affecting the rights of creditors generally,  if the obligations of
any Guarantor  under Clause 16.1  (GUARANTEE  AND  INDEMNITY)  would  otherwise,
taking into account the  provisions  of Clause 16.8, be held or determined to be
void,  invalid  or  unenforceable,  or  subordinated  to the claims of any other
creditors,  on  account  of  the  amount  of its  liability  under  Clause  16.1
(GUARANTEE AND INDEMNITY),  then,  notwithstanding any other provision hereof to
the contrary,  the amount of such liability shall, without any further action by
such  Guarantor,  any Lender,  the Agent or any other Person,  be  automatically
limited and reduced to the highest amount that is valid and  enforceable and not
subordinated  to the claims of other  creditors as  determined in such action or
proceeding.

17.   REPRESENTATIONS AND WARRANTIES

17.1 Each  Obligor  represents  and  warrants to the Lenders on the date of this
Agreement,  the Closing  Date and on 1 September  of each year unless all of the
Letters of Credit will  terminate  on or before the fourth  anniversary  of such
date (with  reference  to the facts and  circumstances  subsisting  on each such
date) as follows.

ORGANISATION; POWERS

17.2 It and each of its  Significant  Subsidiaries  is duly  organised,  validly
existing  and in  good  standing  under  the  Laws  of the  jurisdiction  of its
organisation,  has all requisite power and authority to carry on its business as
now conducted  and,  except where the failure to do so,  individually  or in the
aggregate,  could not  reasonably  be expected  to result in a Material  Adverse
Effect,  is  qualified  to do business  in, and is in good  standing  in,  every
jurisdiction where such qualification is required.

AUTHORISATION; ENFORCEABILITY

17.3 The Transactions  are within such Obligor's  corporate powers and have been
duly  authorised by all necessary  corporate and, if required,  by all necessary
shareholder  action.  Each  Finance  Document to which such Obligor is party has
been duly executed and delivered by such Obligor and constitutes a legal,  valid
and binding  obligation  of such  Obligor,  enforceable  against such Obligor in
accordance with its terms,  except as such  enforceability may be limited by (a)
bankruptcy,  insolvency,  reorganisation,  moratorium or similar Laws of general
applicability  affecting  the  enforcement  of  creditors'  rights  and  (b) the
application  of  general  principles  of  equity  (regardless  of  whether  such
enforceability is considered in a proceeding in equity or at law).

GOVERNMENTAL APPROVALS; NO CONFLICTS

17.4 The  Transactions  (a) do not require any consent or approval of (including
any exchange control approval), registration or filing with, or any other action
by, any  Governmental  Authority,  except such as have been obtained or made and
are in full  force  and  effect,  (b) will not  violate  any  applicable  Law or
regulation  or the charter,  by-laws or other  organisational  documents of such
Obligor or any of its Significant  Subsidiaries or any order of any Governmental
Authority, (c) will not violate or result in a default under any material



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indenture, agreement or other instrument binding upon such Obligor or any of its
Significant  Subsidiaries  or  assets,  or give  rise to a right  thereunder  to
require  any payment to be made by any such  Person,  and (d) will not result in
the  creation or  imposition  of any Lien on any asset of such Obligor or any of
its Significant Subsidiaries.

FINANCIAL CONDITION; NO MATERIAL ADVERSE CHANGE

17.5 (a) FINANCIAL CONDITION.  The Account Party has heretofore furnished to the
         Lenders  the  consolidated  balance  sheet and  statements  of  income,
         stockholders'  equity  and cash  flows  of the  Account  Party  and its
         consolidated  Subsidiaries  (A) as of and for  the  fiscal  year  ended
         December  31,  2003,   reported  on  by   PricewaterhouseCoopers   LLP,
         independent  public  accountants  (as  provided in the Account  Party's
         Report  on Form  10-K  filed  with the SEC for the  fiscal  year  ended
         December  31,  2003),  and (B) as of and for the fiscal  quarter  ended
         September 30, 2004, as provided in the Account  Party's  Report on Form
         10-Q filed  with the SEC for the fiscal  quarter  ended  September  30,
         2004.  Such  financial  statements  present  fairly,  in  all  material
         respects,  the financial  position and results of  operations  and cash
         flows of the Account Party and its respective consolidated Subsidiaries
         as of such dates and for such  periods in  accordance  with GAAP or (in
         the  case of XL  Bermuda  or XL Re)  SAP,  subject  to  year-end  audit
         adjustments  and the absence of footnotes in the case of the statements
         referred to in Clause (B) of the first sentence of this paragraph.

     (b) NO MATERIAL ADVERSE CHANGE.  Since December 31, 2003, there has been no
         material adverse change in the assets, business, financial condition or
         operations of such Obligor and its Subsidiaries, taken as a whole.

PROPERTIES

17.6 (a) PROPERTY   GENERALLY.   Such  Obligor  and  each  of  its   Significant
         Subsidiaries  has good title to, or valid  leasehold  interests in, all
         its real and personal property  material to its business,  subject only
         to Liens  permitted by Clause 19.3 (LIENS) and except for minor defects
         in title that do not interfere with its ability to conduct its business
         as currently conducted or to utilise such properties for their intended
         purposes.

     (b) INTELLECTUAL  PROPERTY.  Such  Obligor  and  each  of  its  Significant
         Subsidiaries  owns, or is licensed to use, all trademarks,  tradenames,
         copyrights,  patents and other  intellectual  property  material to its
         business,  and the use  thereof  by such  Obligor  and its  Significant
         Subsidiaries  does not  infringe  upon the rights of any other  Person,
         except  for  any  such  infringements  that,  individually  or  in  the
         aggregate,  could not  reasonably  be  expected to result in a Material
         Adverse Effect.

LITIGATION AND ENVIRONMENTAL MATTERS

17.7 (a) ACTIONS, SUITS AND PROCEEDINGS.  Except as disclosed in Schedule 2 Part
         C or as  disclosed in the Account  Party's  filings with the SEC, or as
         routinely encountered in claims activity,  there are no actions,  suits
         or proceedings by or before any  arbitrator or  Governmental  Authority
         now pending  against or, to the knowledge of such  Obligor,  threatened
         against or affecting such Obligor or any of its  Subsidiaries (x) as to
         which there is a reasonable possibility of an adverse determination and
         that could reasonably be expected, individually or in the aggregate, to
         result in a Material  Adverse  Effect or (y) that  involve  the Finance
         Documents or the Transactions.



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(b)   ENVIRONMENTAL MATTERS. Except as disclosed in Schedule 2 Part D and except
      with respect to any other matters that,  individually or in the aggregate,
      could not reasonably be expected to result in a Material  Adverse  Effect,
      neither such Obligor nor any of its  Subsidiaries (i) has failed to comply
      with any  Environmental  Law or to  obtain,  maintain  or comply  with any
      permit,  license or other  approval  required for its  business  under any
      Environmental  Law, (ii) has incurred any Environmental  Liability,  (iii)
      has  received  notice  of any  claim  with  respect  to any  Environmental
      Liability or (iv) knows of any basis for any Environmental Liability.

COMPLIANCE WITH LAWS AND AGREEMENTS

17.8 Such Obligor and each of its  Subsidiaries  is in compliance with all Laws,
regulations  and orders of any  Governmental  Authority  applicable to it or its
property and all indentures, agreements and other instruments binding upon it or
its  property,  except  where  the  failure  to do  so,  individually  or in the
aggregate,  could not  reasonably  be expected  to result in a Material  Adverse
Effect. No Default has occurred and is continuing.

INVESTMENT AND HOLDING COMPANY STATUS

17.9 Such Obligor is not (a) an INVESTMENT  COMPANY as defined in, or subject to
regulation under, the Investment Company Act of 1940 or (b) a HOLDING COMPANY as
defined in, or subject to regulation  under,  the Public Utility Holding Company
Act of 1935.

TAXES

17.10 Such Obligor and each of its Subsidiaries has timely filed or caused to be
filed all Tax returns  and  reports  required to have been filed and has paid or
caused to be paid all Taxes  required to have been paid by it,  except (a) Taxes
that are being contested in good faith by appropriate  proceedings and for which
such  Person has set aside on its books  adequate  reserves or (b) to the extent
that the  failure  to do so could  not  reasonably  be  expected  to result in a
Material Adverse Effect.

ERISA

17.11 No ERISA Event has occurred or is reasonably  expected to occur that, when
taken  together  with all  other  such  ERISA  Events  for  which  liability  is
reasonably  expected  to occur,  could  reasonably  be  expected  to result in a
Material  Adverse  Effect.   The  present  value  of  all  accumulated   benefit
obligations  under each Plan  (based on the  assumptions  used for  purposes  of
Statement of Financial  Accounting  Standards No. 87) did not, as of the date of
the most recent financial  statements  reflecting such amounts,  exceed the fair
market  value of the assets of such Plan by an amount that could  reasonably  be
expected to result in a Material Adverse Effect.

Except as could not  reasonably  be  expected  to result in a  Material  Adverse
Effect, (i) all contributions required to be made by any Obligor or any of their
Subsidiaries with respect to a Non-U.S. Benefit Plan have been timely made, (ii)
each Non-U.S.  Benefit Plan has been maintained in compliance with its terms and
with the  requirements of any and all applicable  Laws and has been  maintained,
where required, in good standing with the applicable  Governmental Authority and
(iii)  neither  any  Obligor  nor any of their  Subsidiaries  has  incurred  any
obligation in connection  with the  termination or withdrawal  from any Non-U.S.
Benefit Plan.



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DISCLOSURE

17.12 The  reports,  financial  statements,  certificates  or other  information
furnished by such Obligor to the Lenders in connection  with the  negotiation of
this Agreement or any other Finance Document or delivered  hereunder (taken as a
whole) do not contain  any  material  misstatement  of fact or omit to state any
material  fact  necessary to make the  statements  therein,  in the light of the
circumstances  under which they were made, not  misleading;  provided that, with
respect to projected  financial  information,  such Obligor represents only that
such information was prepared in good faith based upon  assumptions  believed to
be reasonable at the time.

USE OF CREDIT

17.13 Neither such Obligor nor any of its  Subsidiaries is engaged  principally,
or as one of its important  activities,  in the business of extending credit for
the purpose,  whether immediate,  incidental or ultimate,  of buying or carrying
Margin Stock,  and no Letter of Credit will be used in connection with buying or
carrying any Margin Stock.

SUBSIDIARIES

17.14 Set forth in  Schedule  3 is a  complete  and  correct  list of all of the
Subsidiaries  of the Account Party as of 30 September  2004,  together with, for
each such  Subsidiary,  (i) the jurisdiction of organisation of such Subsidiary,
(ii) each Person holding  ownership  interests in such  Subsidiary and (iii) the
percentage  of  ownership  of such  Subsidiary  represented  by  such  ownership
interests.  Except as disclosed in Schedule 3, (x) each of the Account Party and
its Subsidiaries  owns, free and clear of Liens, and has the unencumbered  right
to vote, all outstanding  ownership interests in each Person shown to be held by
it in Schedule 3, (y) all of the issued and  outstanding  capital  stock of each
such  Person  organised  as a  corporation  is  validly  issued,  fully paid and
nonassessable  and (z) except as disclosed in filings of the Account  Party with
the SEC prior to the date hereof,  there are no  outstanding  Equity Rights with
respect to any Obligor.

WITHHOLDING TAXES

17.15 Based upon information with respect to each Lender provided by each Lender
to the Agent,  as of the date hereof,  the payment of the LC  Disbursements  and
interest  thereon,  the fees under Clause 9 (FEES) and all other amounts payable
hereunder will not be subject, by withholding or deduction, to any Taxes imposed
by any Obligor Jurisdiction.

STAMP TAXES

17.16 To ensure the  legality,  validity,  enforceability  or  admissibility  in
evidence  of  the  Finance  Documents,  it is not  necessary  that  the  Finance
Documents  or any other  document  be filed or  recorded  with any  Governmental
Authority  or that any stamp or  similar  tax be paid on or in respect of any of
the  Finance  Documents,  or any other  document  other  than such  filings  and
recordations  that have already  been made and such stamp or similar  taxes that
have already been paid.

LEGAL FORM

17.17 The  Finance  Documents  are in proper  legal  form  under the Laws of any
Obligor Jurisdiction for the admissibility thereof in the courts of such Obligor
Jurisdiction.



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CLAIMS PARI PASSU

17.18 Under the Laws of its  jurisdiction of  incorporation in force at the date
hereof, the claims of the Finance Parties against it under this Agreement or any
other Finance  Document will rank at least pari passu with the claims of all its
other  unsecured and  unsubordinated  creditors  save (i) those whose claims are
preferred  solely by any  bankruptcy,  insolvency,  liquidation or other similar
Laws of general  application;  and (ii) with respect to XL Re only, those claims
required to be preferred by and under the Bermuda Insurance Act 1978.

18.   AFFIRMATIVE COVENANTS

Until the  Commitments  have  expired or been  terminated  and all fees  payable
hereunder  shall  have been paid in full and all  Letters  of Credit  shall have
expired or terminated and all LC Disbursements  shall have been reimbursed,  the
Obligors covenant and agree with the Lenders that:

FINANCIAL STATEMENTS AND OTHER INFORMATION

18.1 Each Obligor will furnish to the Agent and each Lender:

(a)   within 135 days after the end of each fiscal year of such  Obligor  except
      for XL  America  (but in the case of the  Account  Party,  within 100 days
      after the end of each  fiscal  year of the  Account  Party),  the  audited
      consolidated   balance  sheet  and  related   statements  of   operations,
      stockholders'  equity and cash flows of such Obligor and its  consolidated
      Subsidiaries  as of the end of and for such  year,  setting  forth in each
      case in comparative form the figures for the previous fiscal year (if such
      figures were already  produced for such  corresponding  period or periods)
      (it being  understood  that delivery to the Lenders of the Account Party's
      Report  on Form  10-K  filed  with the SEC  shall  satisfy  the  financial
      statement  delivery  requirements  of this  paragraph  (a) to deliver  the
      annual financial  statements of the Account Party so long as the financial
      information  required to be contained in such Report is substantially  the
      same as the financial  information required under this paragraph (a)), all
      reported on by  independent  public  accountants  of  recognised  national
      standing (without a "going concern" or like qualification or exception and
      without any  qualification  or exception as to the scope of such audit) to
      the effect that such consolidated  financial  statements present fairly in
      all material respects the financial condition and results of operations of
      such Obligor and its consolidated  Subsidiaries on a consolidated basis in
      accordance  with GAAP or (in the case of XL Bermuda and XL Re) SAP, as the
      case may be, consistently applied;

(b)   by June 15 of each year, (i) an unaudited  consolidated  balance sheet and
      related statements of operations,  stockholders'  equity and cash flows of
      XL America and its consolidated  Subsidiaries as of the end of and for the
      immediately   preceding  fiscal  year,  setting  forth  in  each  case  in
      comparative form the figures for the previous fiscal year (if such figures
      were already  produced  for such  corresponding  period or  periods),  all
      certified by a Financial Officer of XL America as presenting fairly in all
      material respects the financial  condition and results of operations of XL
      America  and its  consolidated  Subsidiaries  on a  consolidated  basis in
      accordance  with GAAP  consistently  applied,  subject to normal  year-end
      audit  adjustments  and the absence of  footnotes,  and audited  statutory
      financial  statements for each Insurance Subsidiary of XL America reported
      on by  independent  public  accountants  of recognized  national  standing
      (without a "going concern" or like  qualification or exception and without
      any  qualification  or  exception  as to the  scope of such  audit) to the
      effect that such audited consolidated  financial statements present fairly
      in all



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      material  respects the  financial  condition  and results of operations of
      such Insurance Subsidiaries in accordance with SAP, consistently applied;

(c)   within 60 days after the end of each of the first three fiscal quarters of
      each fiscal  year of such  Obligor,  the  consolidated  balance  sheet and
      related statements of operations,  stockholders'  equity and cash flows of
      such Obligor and its  consolidated  Subsidiaries  as of the end of and for
      such  fiscal  quarter  and the then  elapsed  portion of the fiscal  year,
      setting forth in each case in comparative form the figures for (or, in the
      case of the balance sheet, as of the end of) the  corresponding  period or
      periods of the previous fiscal year (if such figures were already produced
      for such  corresponding  period or periods),  all certified by a Financial
      Officer of such Obligor as presenting  fairly in all material respects the
      financial  condition  and results of  operations  of such  Obligor and its
      consolidated  Subsidiaries on a consolidated basis in accordance with GAAP
      or (in  the  case  of XL  Bermuda  and XL Re)  SAP,  as the  case  may be,
      consistently applied, subject to normal year-end audit adjustments and the
      absence of footnotes (it being  understood that delivery to the Lenders of
      the Account  Party's  Report on Form 10-Q filed with the SEC shall satisfy
      the financial  statement  delivery  requirements  of this paragraph (c) to
      deliver the quarterly financial statements of the Account Party so long as
      the  financial  information  required  to be  contained  in such Report is
      substantially  the same as the financial  information  required under this
      paragraph (c));

(d)   concurrently  with any  delivery  of  financial  statements  under  Clause
      18.1(a),  (b) or (c), a certificate  signed on behalf of each Obligor by a
      Financial Officer (i) certifying as to whether a Default has occurred and,
      if a Default has occurred,  specifying the details  thereof and any action
      taken or proposed to be taken with respect  thereto,  (ii)  setting  forth
      reasonably  detailed  calculations  demonstrating  compliance with Clauses
      19.3 (LIENS),  19.5 (RATIO OF TOTAL FUNDED DEBT TO TOTAL  CAPITALISATION),
      19.6  (CONSOLIDATED NET WORTH) and 19.7  (INDEBTEDNESS)  and (iii) stating
      whether  any change in GAAP or (in the case of XL  Bermuda,  XL Re and any
      Insurance  Subsidiary of XL America) SAP or in the application thereof has
      occurred since the date of the audited financial statements referred to in
      Clause  17.5(a)  and,  if any such  change has  occurred,  specifying  any
      material  effect of such change on the financial  statements  accompanying
      such certificate;

(e)   concurrently  with any  delivery  of  financial  statements  under  Clause
      18.1(a) and (b)(ii), a certificate of the accounting firm that reported on
      such financial  statements  stating whether they obtained knowledge during
      the  course  of their  examination  of such  financial  statements  of any
      Default  (which  certificate  may be  limited to the  extent  required  by
      accounting rules or guidelines);

(f)   promptly after the same become publicly available,  copies of all periodic
      and other  reports,  proxy  statements and other  materials  filed by such
      Obligor  or  any of its  respective  Subsidiaries  with  the  SEC,  or any
      Governmental  Authority  succeeding to any or all of the functions of said
      Commission,  or with any U.S. or other securities exchange, or distributed
      by such Obligor to its shareholders generally, as the case may be;

(g)   concurrently  with any  delivery  of  financial  statements  under  Clause
      18.1(a),  (b) or (c) a certificate  of a Financial  Officer of the Account
      Party, setting forth on a consolidated basis for the Account Party and its
      consolidated  Subsidiaries  as of the end of the fiscal year or quarter to
      which such  certificate  relates  (i) the  aggregate  book value of assets
      which are subject to Liens  permitted under Clause 19.3(g) (LIENS) and the
      aggregate book value of liabilities which are subject to Liens



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      permitted  under  Clause  19.3(g)  (it being  understood  that the reports
      required by  paragraphs  (a), (b) and (c) of this Clause shall satisfy the
      requirement  of this Clause (i) of this Clause 18.1(g) if such reports set
      forth  separately,  in accordance with GAAP, line items  corresponding  to
      such aggregate book values) and (ii) a calculation  showing the portion of
      each  of  such  aggregate   amounts  which  portion  is   attributable  to
      transactions among wholly-owned Subsidiaries of the Account Party;

(h)   within 90 days after the end of each of the first three fiscal quarters of
      each  fiscal year and within 135 days after the end of each fiscal year of
      the Account  Party  (commencing  with the fiscal year ending  December 31,
      2004), a statement of a Financial Officer of the Account Party listing, as
      of the end of the  immediately  preceding  fiscal  quarter of the  Account
      Party,  the amount of cash and the  securities  of the  Obligors and their
      Subsidiaries that have been posted as collateral under Clause 19.3(f); and

(i)   promptly following any request therefor,  such other information regarding
      the operations,  business  affairs and financial  condition of the Account
      Party or any of its  Subsidiaries,  or  compliance  with the terms of this
      Agreement, as the Agent or any Lender may reasonably request.

"KNOW YOUR CUSTOMER" CHECKS

18.2 (a) If:

      (i)   the  introduction  of or any  change  in (or in the  interpretation,
            administration  or application  of) any law or regulation made after
            the date of this Agreement;

      (ii)  any  change  in the  status  of an  Obligor  after  the date of this
            Agreement; or

      (iii) a proposed  assignment  or transfer by a Lender of any of its rights
            and obligations under this Agreement to a party that is not a Lender
            prior to such assignment or transfer,

      obliges the Agent or any Lender (or, in the case of paragraph (iii) above,
      any prospective new Lender) to comply with "know your customer" or similar
      identification procedures in circumstances where the necessary information
      is not already  available  to it, each  Obligor  shall  promptly  upon the
      request of the Agent or any Lender supply,  or procure the supply of, such
      documentation  and other evidence as is reasonably  requested by the Agent
      (for  itself or on behalf of any  Lender) or any Lender (for itself or, in
      the case of the event described in paragraph (iii) above, on behalf of any
      prospective  new  Lender) in order for the Agent,  such  Lender or, in the
      case of the event described in paragraph (iii) above,  any prospective new
      Lender to carry out and be satisfied it has  complied  with all  necessary
      "know your customer" or other similar checks under all applicable laws and
      regulations  pursuant  to the  transactions  contemplated  in the  Finance
      Documents.

(b)   Each  Lender  shall  promptly  upon the  request of the Agent  supply,  or
      procure  the  supply  of,  such  documentation  and other  evidence  as is
      reasonably  requested  by the Agent (for itself) in order for the Agent to
      carry out and be satisfied it has complied with all  necessary  "know your
      customer"  or  other  similar  checks  under  all   applicable   laws  and
      regulations  pursuant  to the  transactions  contemplated  in the  Finance
      Documents.



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NOTICES OF MATERIAL EVENTS

18.3 Each  Obligor  will  furnish to the Agent and each  Lender  prompt  written
notice of the following:

(a)   the occurrence of any Default; and

(b)   any event or condition constituting, or which could reasonably be expected
      to have a Material Adverse Effect.

Each notice delivered under this Clause shall be accompanied by a statement of a
Financial  Officer or other  executive  officer of the relevant  Obligor setting
forth the  details of the event or  development  requiring  such  notice and any
action taken or proposed to be taken by such Obligor with respect thereto.

PRESERVATION OF EXISTENCE AND FRANCHISES

18.4 Each Obligor will, and will cause each of its Significant  Subsidiaries to,
maintain its corporate  existence and its material rights and franchises in full
force and effect in its jurisdiction of  incorporation  except where the failure
to maintain such corporate  existence and material  rights and franchises  would
not reasonably be expected to have, either  individually or in the aggregate,  a
Material  Adverse  Effect;  provided that the  foregoing  shall not prohibit any
merger  or   consolidation   permitted  under  Clause  19.1  (MERGERS)  or  19.2
(DISPOSITIONS).  Each  Obligor  will,  and will  cause  each of its  Significant
Subsidiaries to, qualify and remain  qualified as a foreign  corporation in each
jurisdiction in which failure to receive or retain such qualification would have
a Material Adverse Effect.

INSURANCE

18.5 Each Obligor will, and will cause each of its Significant  Subsidiaries to,
maintain with financially sound and reputable  insurers,  insurance with respect
to its  properties  in such amounts as is customary in the case of  corporations
engaged in the same or similar  businesses having similar  properties  similarly
situated.

MAINTENANCE OF PROPERTIES

18.6 Each Obligor will, and will cause each of its Significant  Subsidiaries to,
maintain or cause to be maintained  in good repair,  working order and condition
the properties now or hereafter owned, leased or otherwise possessed by and used
or useful in its  business  and will  make or cause to be made all  needful  and
proper repairs,  renewals,  replacements  and  improvements  thereto so that the
business  carried on in connection  therewith  may be properly  conducted at all
times except if the failure to do so would not have a Material  Adverse  Effect,
provided,  however,  that the foregoing  shall not impose on such Obligor or any
Subsidiary of such Obligor any  obligation in respect of any property  leased by
such Obligor or such Subsidiary in addition to such Obligor's  obligations under
the applicable  document creating such Obligor's or such  Subsidiary's  lease or
tenancy.

PAYMENT OF TAXES AND OTHER  POTENTIAL  CHARGES AND  PRIORITY  CLAIMS  PAYMENT OF
OTHER CURRENT LIABILITIES

18.7 Each  Obligor  will,  and will  cause each of its  Subsidiaries  to, pay or
discharge:



(a)   on or prior to the date on which  penalties  attach  thereto,  all  taxes,
      assessments  and other  governmental  charges or levies imposed upon it or
      any of its properties or income;

(b)   on or prior to the date  when  due,  all  lawful  claims  of  materialmen,
      mechanics, carriers, warehousemen, landlords and other like Persons which,
      if unpaid,  might result in the creation of a Lien upon any such property;
      and

(c)   on or prior to the date  when due,  all  other  lawful  claims  which,  if
      unpaid,  might  result in the  creation  of a Lien upon any such  property
      (other  than Liens not  forbidden  by Clause 19.3  (LIENS))  or which,  if
      unpaid,  might give rise to a claim  entitled  to  priority  over  general
      creditors of such Obligor or such  Subsidiary in any proceeding  under the
      Bermuda  Companies  Law  or  Bermuda  Insurance  Law,  or  any  insolvency
      proceeding,  liquidation,  receivership,  rehabilitation,  dissolution  or
      winding-up involving such Obligor or such Subsidiary;

provided that, unless and until  foreclosure,  distraint,  levy, sale or similar
proceedings shall have been commenced,  such Obligor or such Subsidiary need not
pay or discharge any such tax, assessment,  charge, levy or claim so long as (i)
the validity  thereof is contested in good faith and by appropriate  proceedings
diligently  conducted or (ii) such reserves or other  appropriate  provisions as
may be  required  by GAAP or SAP,  as the  case may be,  shall  have  been  made
therefor  and so long as such  failure  to pay or  discharge  would  not  have a
Material Adverse Effect.

FINANCIAL ACCOUNTING PRACTICES

18.8 Such Obligor will, and will cause each of its consolidated Subsidiaries to,
make  and  keep  books,  records  and  accounts  which,  in  reasonable  detail,
accurately and fairly reflect its  transactions  and  dispositions of its assets
and  maintain a system of internal  accounting  controls  sufficient  to provide
reasonable  assurances  that  transactions  are  recorded as necessary to permit
preparation  of  financial  statements  required  under  Clause 18.1  (FINANCIAL
STATEMENTS  AND  OTHER   INFORMATION)  in  conformity  with  GAAP  and  SAP,  as
applicable, and to maintain accountability for assets.

COMPLIANCE WITH APPLICABLE LAWS

18.9 Each Obligor will, and will cause each of its  Subsidiaries to, comply with
all applicable Laws (including but not limited to the Bermuda  Companies Law and
Bermuda  Insurance  Laws) in all  respects;  provided  that such  Obligor or any
Subsidiary  of such Obligor will not be deemed to be in violation of this Clause
as a result  of any  failure  to comply  with any such Law  which  would not (i)
result  in  fines,  penalties,  injunctive  relief  or other  civil or  criminal
liabilities  which,  in the aggregate,  would have a Material  Adverse Effect or
(ii)  otherwise  impair the ability of such  Obligor to perform its  obligations
under this Agreement.

USE OF LETTERS OF CREDIT AND PROCEEDS

18.10 No Letter of Credit will be used, whether directly or indirectly,  for any
purpose  that  entails  a  violation  of any of the  Regulations  of the  Board,
including  Regulations  U and X. Each  Applicant  will use the Letters of Credit
issued for its  account  hereunder  in the  ordinary  course of business of such
Applicant and its Affiliates. For the avoidance of doubt, the Parties agree that
the  Account  Party may apply for a Letter of Credit  hereunder  to support  the
obligations  of any  Affiliate of an  Applicant,  it being  understood  that the
Account  Party shall  nonetheless  remain the Obligor and as such be liable with
respect to such Letter of Credit.



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CONTINUATION OF AND CHANGE IN BUSINESSES

18.11 Each Obligor and its Significant  Subsidiaries  will continue to engage in
substantially  the same  business or  businesses  it engaged in (or  proposes to
engage in) on the date of this  Agreement and  businesses  related or incidental
thereto.

VISITATION

18.12 Each  Obligor  will  permit  such  Persons  as any  Lender may  reasonably
designate to visit and inspect any of the properties of such Obligor, to discuss
its affairs with its financial  management,  and provide such other  information
relating to the business and  financial  condition of such Obligor at such times
as such Lender may  reasonably  request.  Each  Obligor  hereby  authorises  its
financial management to discuss with any Lender the affairs of such Obligor.

19. NEGATIVE COVENANTS

Until the Total  Commitments  have  expired or  terminated  and all fees payable
hereunder  have been paid in full and all  Letters  of Credit  have  expired  or
terminated and all LC Disbursements  have been reimbursed,  each of the Obligors
covenants and agrees with the Lenders that:

MERGERS

19.1 No Obligor will merge with or into or  consolidate  with any other  Person,
except that if no Default  shall occur and be  continuing  or shall exist at the
time of such merger or consolidation or immediately  thereafter and after giving
effect thereto:

(a)   any Obligor may merge or consolidate with any other corporation, including
      a Subsidiary, if such Obligor shall be the surviving corporation;

(b)   the  Account  Party may merge with or into or  consolidate  with any other
      Person  in a  transaction  that  does not  result  in a  reclassification,
      conversion,  exchange or cancellation of the outstanding shares of capital
      stock of the Account Party (other than the cancellation of any outstanding
      shares of capital  stock of the Account Party held by the Person with whom
      it merges or consolidates); and

(c)   any  Obligor  may enter into a merger or  consolidation  which is effected
      solely to change the  jurisdiction  of  incorporation  of such Obligor and
      results in a  reclassification,  conversion  or  exchange  of  outstanding
      shares of capital  stock of such  Obligor  solely  into  shares of capital
      stock of the surviving entity.

DISPOSITIONS

19.2 No Obligor will, nor will it permit any of its Significant Subsidiaries to,
sell,  convey,  assign,  lease,  abandon or  otherwise  transfer  or dispose of,
voluntarily  or  involuntarily  (any of the foregoing  being referred to in this
Clause as a DISPOSITION and any series of related Dispositions  constituting but
a single Disposition),  any of its properties or assets,  tangible or intangible
(including but not limited to sale, assignment, discount or other disposition of
accounts,  contract rights, chattel paper or general intangibles with or without
recourse), except:



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(a)   Dispositions in the ordinary course of business  involving  current assets
      or other  invested  assets  classified on such Obligor's or its respective
      Subsidiaries balance sheet as available for sale or as a trading account;

(b)   sales,  conveyances,  assignments or other  transfers or  dispositions  in
      immediate  exchange for cash or tangible  assets,  provided  that any such
      sales,  conveyances  or  transfers  shall  not  individually,  or  in  the
      aggregate  for the  Obligor  and  their  respective  Subsidiaries,  exceed
      $500,000,000 in any calendar year;

(c)   Dispositions of equipment or other property which is obsolete or no longer
      used or useful in the  conduct  of the  business  of such  Obligor  or its
      Subsidiaries;

(d)   Dispositions  between  or  among  the  Obligors  and  their  wholly  owned
      Subsidiaries; or

(e)   Dispositions   with   Affiliates   in  accordance   with  Clause   19.4(c)
      (TRANSACTIONS WITH AFFILIATES).

LIENS

19.3 No Obligor will,  nor will it permit any of its  Subsidiaries  to,  create,
incur, assume or permit to exist any Lien on any property or assets, tangible or
intangible, now owned or hereafter acquired by it, except:

(a)   Liens existing on the date hereof (and extension,  renewal and replacement
      Liens upon the same  property,  provided  that the amount  secured by each
      Lien constituting such an extension, renewal or replacement Lien shall not
      exceed the amount secured by the Lien theretofore  existing) and listed on
      Part B of Schedule 2;

(b)   Liens arising from taxes, assessments, charges, levies or claims described
      in Clause 18.7 (PAYMENT OF TAXES AND OTHER POTENTIAL  CHARGES AND PRIORITY
      CLAIMS,  PAYMENTS OF OTHER  CURRENT  LIABILITIES)  that are not yet due or
      that remain payable without  penalty or to the extent  permitted to remain
      unpaid under the provision of Clause 18.7;

(c)   Liens on property  securing all or part of the purchase  price  thereof to
      such Obligor and Liens  (whether or not  assumed)  existing on property at
      the time of purchase  thereof by such Obligor (and extension,  renewal and
      replacement Liens upon the same property);  provided (i) each such Lien is
      confined  solely to the property so  purchased,  improvements  thereto and
      proceeds thereof, and (ii) the aggregate amount of the obligations secured
      by all such Liens on any particular property at any time purchased by such
      Obligor,  as  applicable,  shall not exceed 100% of the lesser of the fair
      market value of such property at such time or the actual purchase price of
      such property;

(d)   zoning  restrictions,  easements,  minor  restrictions  on the use of real
      property, minor irregularities in title thereto and other minor Liens that
      do not in the aggregate materially detract from the value of a property or
      asset to, or materially impair its use in the business of, such Obligor or
      any such Subsidiary;

(e)   Liens securing  Indebtedness  permitted by Clause  19.7(b)  (INDEBTEDNESS)
      covering  assets  whose market  value is not  materially  greater than the
      amount of the Indebtedness secured thereby plus a commercially  reasonable
      margin;



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(f)   Liens on cash and  securities  of an  Obligor  or any of its  Subsidiaries
      incurred as part of the management of its investment  portfolio including,
      but not limited to,  pursuant to any  International  Swaps and Derivatives
      Association,  Inc.  (ISDA)  documentation  or  any  Specified  Transaction
      Agreement in accordance with the Account  Party's  Statement of Investment
      Policy  Objectives and Guidelines as in effect on the date hereof or as it
      may be changed from time to time by  resolution  duly adopted by the board
      of directors of the Account Party (or any committee thereof);

(g)   Liens on cash and securities not to exceed  $500,000,000  in the aggregate
      securing  obligations  of an  Obligor or any of its  Subsidiaries  arising
      under any ISDA documentation or any other Specified  Transaction Agreement
      (it being  understood  that in no event shall this  paragraph (g) preclude
      any Person (other than any  Subsidiary of the Account  Party) in which the
      Account Party or any of its  Subsidiaries  shall invest (each an INVESTEE)
      from granting Liens on such Person's assets to secure hedging  obligations
      of  such  Person,  so long as such  obligations  are  non-recourse  to the
      Account  Party or any of its  Subsidiaries  (other  than any  investees)),
      provided that, for purposes of  determining  the aggregate  amount of cash
      and/or  securities  subject to such Liens  under  this  paragraph  (g) the
      aggregate  amount of cash  and/or  securities  on which any Obligor or any
      Subsidiary  shall have granted a Lien in favour of a  counterparty  at any
      time  shall  be  netted  against  the  aggregate  amount  of  cash  and/or
      securities on which such counterparty  shall have granted a Lien in favour
      of such Obligor or  Subsidiary,  as the case may be, at such time, so long
      as the relevant agreement between such Obligor or such Subsidiary,  as the
      case may be,  provides  for the  netting of their  respective  obligations
      thereunder;

(h)   Liens on (i) assets received,  and on actual or imputed  investment income
      on  such  assets  received  incurred  as part  of its  business  including
      activities  utilizing  ISDA  documentation  or any  Specified  Transaction
      Agreement   relating  and   identified  to  specific   insurance   payment
      liabilities  or to  liabilities  arising  in the  ordinary  course  of any
      Obligors'  or  any of  their  Subsidiary's  business  as an  insurance  or
      reinsurance  company  (including  GICs and Stable  Value  Instruments)  or
      corporate  member of Lloyd's or as a provider of financial  or  investment
      services or contracts,  or the proceeds thereof (including GICs and Stable
      Value  Instruments),  in each case held in a  segregated  trust,  trust or
      other  account and  securing  such  liabilities,  or (ii) any other assets
      subject  to any trust or other  account  arising  out of or as a result of
      contractual,  regulatory  or any other  requirements;  provided that in no
      case shall any such Lien secure  Indebtedness  and any Lien which  secures
      Indebtedness shall not be permitted under this clause (h);

(i)   statutory  and  common  law  Liens of  materialmen,  mechanics,  carriers,
      warehousemen and landlords and other similar Liens arising in the ordinary
      course of business; and

(j)   Liens  existing  on property  of a Person  immediately  prior to its being
      consolidated with or merged into any Obligor or any of their  Subsidiaries
      or its becoming a Subsidiary,  and Liens existing on any property acquired
      by any Obligor or any of their  Subsidiaries  at the time such property is
      so acquired  (whether or not the  Indebtedness  secured thereby shall have
      been assumed) (and extension,  renewal and replacement Liens upon the same
      property,  provided that the amount secured by each Lien constituting such
      an  extension,  renewal  or  replacement  Lien shall not exceed the amount
      secured by the Lien theretofore existing),  provided that (i) no such Lien
      shall have been created or assumed in contemplation of such  consolidation
      or merger or such Person's  becoming a Subsidiary or such  acquisition  of
      property and (ii) each such Lien shall extend  solely to the item or items
      of  property so  acquired  and,  if



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      required by terms of the instrument  originally  creating such Lien, other
      property  which is an  improvement  to or is acquired  for specific use in
      connection with such acquired property.

TRANSACTIONS WITH AFFILIATES

19.4 No Obligor will, nor will it permit any of its Significant Subsidiaries to,
enter into or carry out any transaction  with  (including,  without  limitation,
purchase or lease  property  or  services  to, loan or advance to or enter into,
suffer to remain in existence or amend any  contract,  agreement or  arrangement
with) any Affiliate of such Obligor,  or directly or indirectly  agree to do any
of the foregoing, except:

(a)   transactions  involving  guarantees  or  co-obligors  with  respect to any
      Indebtedness described in Part A of Schedule 2;

(b)   transactions between any Obligor and its wholly-owned Subsidiaries; and

(c)   transactions  with Affiliates in good faith in the ordinary course of such
      Obligor's  business  consistent  with past  practice  and on terms no less
      favourable  to such Obligor or any  Subsidiary  than those that could have
      been obtained in a comparable transaction on an arm's length basis from an
      unrelated Person.

RATIO OF TOTAL FUNDED DEBT TO TOTAL CAPITALISATION

19.5 The Account Party will not permit its ratio of (a) Total Funded Debt to (b)
the sum of Total  Funded  Debt plus  Consolidated  Net Worth to be greater  than
0.35:1.00 at any time.

CONSOLIDATED NET WORTH

19.6 The  Account  Party will not permit its  Consolidated  Net Worth to be less
than the sum of (a)  $5,000,000,000  plus (b) 25% of consolidated net income (if
positive)  of the Account  Party and its  Subsidiaries  for each fiscal  quarter
ending on or after March 31, 2005.

INDEBTEDNESS

19.7 No Obligor will, nor will it permit any of its Subsidiaries to, at any time
create,  incur, assume or permit to exist any Indebtedness,  or agree, become or
remain liable (contingent or otherwise) to do any of the foregoing, except:

(a)   Indebtedness created hereunder and under any other Finance Document;

(b)   secured  Indebtedness  (including secured  reimbursement  obligations with
      respect  to letters of  credit)  of any  Obligor or any  Subsidiary  in an
      aggregate   principal  amount  (for  all  Obligors  and  their  respective
      Subsidiaries)  not exceeding at any time  outstanding  15% of Consolidated
      Net Worth;

(c)   other unsecured  Indebtedness,  so long as upon the incurrence  thereof no
      Default would occur or exist;

(d)   Indebtedness  consisting  of  accounts  or claims  payable and accrued and
      deferred compensation  (including options) incurred in the ordinary course
      of business by any Obligor or any Subsidiary;



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(e)   Indebtedness  incurred in  transactions  described in Clauses  19.3(f) and
      19.3(g); and

(f)   Indebtedness  existing  on the  date  hereof  and  described  in Part A of
      Schedule  2  and  extensions,   renewals  and  replacements  of  any  such
      Indebtedness  that  do  not  increase  the  outstanding  principal  amount
      thereof.

RATINGS DOWNGRADE

19.8 The Account Party will not permit the  financial-strength  rating from A.M.
Best & Co. or its successor (such rating,  an AMB RATING) of each of the Account
Party, XL Bermuda and XL Re to fall below "A-" (the AMB RATING UNDERTAKING). The
Agent may (and if so  instructed  by the  Majority  Lenders  shall)  require the
Account  Party within 5 Business Days of a failure to comply with the AMB Rating
Undertaking, either:

(a)   to provide cash cover in an amount equal to the aggregate LC Exposures for
      the time being; or

(b)   to deposit BIS Qualifying Assets with a custodian acceptable to the Agent,
      and enter into custodian and other relevant  documentation,  together with
      documentation  required  by the  Security  Trustee  to give  the  Security
      Trustee  (for the  benefit of itself  and the other  Finance  Parties)  an
      effective  and  perfected  security  interest  in  respect  of  those  BIS
      Qualifying  Assets,  in an aggregate amount equal to 105% of the aggregate
      LC Exposures for the time being.

      (each of (a) and (b), AMB CASH COLLATERAL)

Notwithstanding  any of the foregoing  provisions of this Clause 19.8, if at any
time  subsequent to the Account Party  posting AMB Cash  Collateral,  any of the
Account  Party,  XL Bermuda  and XL Re has an AMB  Rating of at least  "A",  the
Security  Trustee will instruct a bank holding any cash cover or otherwise  take
all  necessary  actions to release  and  return any AMB Cash  Collateral  to the
Account  Party and the Letter of Credit Fee shall be  determined by reference to
Clause 9.3.

PRIVATE ACT

19.9 No  Obligor  will  become  subject  to a Private  Act  other  than the X.L.
Insurance Company, Ltd. Act, 1989.

20.   EVENTS OF DEFAULT

If any of the following events (EVENTS OF DEFAULT) shall occur:

(a)   FAILURE TO PAY:

      (i)   any Obligor shall fail to pay any Demand Amount when and as the same
            shall become due and payable; or

      (ii)  any Obligor  shall fail to pay any interest or any fee payable under
            this  Agreement  or any other  Finance  Document or any other amount
            (other than an amount referred to in Clause 20(a)(i))  payable under
            this Agreement or any other Finance  Document,  when and as the same
            shall  become  due and  payable,  and such  failure  shall  continue
            unremedied for a period of 3 or more days;



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(b)   MISREPRESENTATION:  any  representation or warranty made or deemed made by
      any Obligor in or in connection  with this  Agreement or any other Finance
      Document or any amendment or modification hereof, or in any certificate or
      financial  statement  furnished pursuant to the provisions  hereof,  shall
      prove to have been false or misleading  in any material  respect as of the
      time made (or deemed made) or furnished;

(c)   BREACH OF OBLIGATIONS:

      (i)   any Obligor shall fail to observe or perform any covenant, condition
            or agreement  contained in Clause 19 (NEGATIVE  COVENANTS)  provided
            that any failure by the Account  Party to comply with the AMB Rating
            Undertaking  shall not  constitute  an Event of Default if, within 5
            Business   Days  of  a  failure  to  comply  with  such  AMB  Rating
            Undertaking,   the  Account  Party  posts  and  maintains  AMB  Cash
            Collateral in accordance with Clause 19.8 (RATINGS DOWNGRADE); or

      (ii)  any Obligor shall fail to observe or perform any covenant, condition
            or  agreement  contained  in this  Agreement  or any  other  Finance
            Document  (other than those specified in Clause 20(a) or (c)(i)) and
            such failure shall  continue  unremedied  for a period of 20 or more
            days after  notice  thereof  from the Agent (given at the request of
            any Lender) to such Obligor;

(d)   CROSS DEFAULT: any Obligor or any of its Subsidiaries shall default (i) in
      any  payment of  principal  of or  interest  on any other  obligation  for
      borrowed money in principal  amount of $50,000,000 or more, or any payment
      of any principal  amount of $50,000,000 or more under Hedging  Agreements,
      in each case beyond any period of grace provided with respect thereto,  or
      (ii)  in the  performance  of  any  other  agreement,  term  or  condition
      contained  in any such  agreement  (other than Hedging  Agreements)  under
      which any such  obligation in principal  amount of  $50,000,000 or more is
      created, if the effect of such default is to cause or permit the holder or
      holders  of such  obligation  (or  trustee  on  behalf  of such  holder or
      holders)  to cause  such  obligation  to become  due  prior to its  stated
      maturity or to terminate its  commitment  under such  agreement,  provided
      that  this  Clause  20(d)  shall not apply to  secured  Indebtedness  that
      becomes due as a result of the voluntary  sale or transfer of the property
      or assets securing such Indebtedness;

(e)   WINDING-UP:  a  decree  or  order by a court  having  jurisdiction  in the
      premises  shall have been  entered  adjudging  any  Obligor a bankrupt  or
      insolvent,   or   approving   as   properly   filed  a  petition   seeking
      reorganisation  of such  Obligor  under the Bermuda  Companies  Law or the
      Cayman  Islands  Companies  Law  (2002  Revision)  or  any  other  similar
      applicable Law, and such decree or order shall have continued undischarged
      or  unstayed  for a  period  of 60 days;  or a decree  or order of a court
      having  jurisdiction  in the premises for the appointment of a receiver or
      liquidator  or trustee or assignee in  bankruptcy  or  insolvency  of such
      Obligor or a substantial  part of its  property,  or for the winding up or
      liquidation  of its affairs,  shall have been entered,  and such decree or
      order shall have  continued  undischarged  and unstayed for a period of 60
      days;

(f)   INSOLVENCY AND RESCHEDULING: any Obligor shall institute proceedings to be
      adjudicated  a  voluntary  bankrupt,  or shall  consent to the filing of a
      bankruptcy  proceeding  against  it, or shall file a petition or answer or
      consent  seeking  reorganisation  under the Bermuda  Companies  Law or the
      Cayman  Islands  Companies  Law  (2002  Revision)  or  any  other  similar
      applicable  Law, or shall consent to the filing of any such  petition,  or
      shall consent to the appointment of a receiver or



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      liquidator  or trustee or assignee in  bankruptcy or insolvency of it or a
      substantial  part of its  property,  or shall make an  assignment  for the
      benefit of  creditors,  or shall admit in writing its inability to pay its
      debts  generally as they become due, or corporate or other action shall be
      taken by such Obligor in furtherance of any of the aforesaid purposes;

(g)   MATERIAL  UNSATISFIED  JUDGMENT OR ORDER:  one or more  judgments  for the
      payment of money in an aggregate amount in excess of $100,000,000 shall be
      rendered against any Obligor or any of its Subsidiaries or any combination
      thereof  and the same  shall not have  been  vacated,  discharged,  stayed
      (whether by appeal or otherwise) or bonded  pending  appeal within 45 days
      from the entry thereof;

(h)   ERISA EVENT: an ERISA Event (or similar event with respect to any Non-U.S.
      Benefit  Plan) shall have  occurred  that,  in the opinion of the Majority
      Lenders,  when taken together with all other ERISA Events and such similar
      events  that have  occurred,  could  reasonably  be  expected to result in
      liability of the Obligors and their  Subsidiaries  in an aggregate  amount
      exceeding $100,000,000;

(i)   CHANGE OF CONTROL: a Change in Control shall occur;

(j)   CHANGE IN OWNERSHIP:  the Account  Party shall cease to own,  beneficially
      and of record, directly or indirectly all of the outstanding voting shares
      of capital stock of XL Bermuda, XL Re or XL America; or

(k)   ILLEGALITY:  at any time it is or  becomes  unlawful  for any  Obligor  to
      perform  or comply  with any or all of its  obligations  hereunder  or any
      court or arbitrator or any governmental body, agency or official which has
      jurisdiction in the matter shall decide,  rule or order that any provision
      of the  Finance  Documents  is invalid or  unenforceable  in any  material
      respect, or any Obligor shall so assert in writing;

(l)   DEFAULT UNDER GUARANTEE:  the guarantee  contained in Clause 16 (GUARANTEE
      AND INDEMNITY)  shall terminate or cease, in whole or material part, to be
      a legally valid and binding  obligation of each Guarantor or any Guarantor
      or any Person acting for or on behalf of any of such parties shall contest
      such  validity  or  binding  nature  of  such  guarantee   itself  or  the
      Transactions, or any other Person shall assert any of the foregoing,

then,  and in every such event  (other than an event with respect to any Obligor
described  in Clause  20(e) or  20(f)),  and at any time  thereafter  during the
continuance  of such event,  the Agent may,  and at the request of the  Majority
Lenders shall, by notice to the Account Party (an ACCELERATION NOTICE), take any
of the following actions, at the same or different times:

      (i)   terminate the Total Commitments, and thereupon the Total Commitments
            shall terminate immediately;

      (ii)  require the Account Party forthwith to provide cash cover in respect
            of any LC Exposure pursuant to a Letter of Credit; and

      (iii) declare all fees and other  obligations of the Account Party accrued
            hereunder to be due and payable in whole (or in part,  in which case
            any fees and other obligations not so declared to be due and payable
            may thereafter be declared to be due and payable) and thereupon such
            fees  and  other   obligations,   shall   become  due  and   payable
            immediately, without presentment, demand, protest



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            or other notice of any kind,  all of which are hereby  waived by the
            Account Party,

      and in case of any event with  respect to any Obligor  described in Clause
      20(e) or 20(f):

            (A)   the Commitments shall automatically terminate; and

            (B)   the Account Party shall  automatically  be required to provide
                  cash cover in respect of any LC Exposure  pursuant to a Letter
                  of Credit; and

            (C)   all fees and other  obligations  of the Account  Party accrued
                  hereunder, shall automatically become due and payable, without
                  presentment,  demand, protest or other notice of any kind, all
                  of which are hereby waived by the Account Party.

21.   THE AGENT, THE ARRANGERS AND THE LENDERS

APPOINTMENT OF THE AGENT

21.1 The Arrangers and each of the Lenders  hereby  appoints the Agent to act as
its agent in  connection  herewith  and  authorises  the Agent to exercise  such
rights, powers, authorities and discretions as are specifically delegated to the
Agent by the terms hereof together with all such rights, powers, authorities and
discretions as are reasonably incidental thereto.

AGENT'S DISCRETIONS

21.2 The Agent may:

(a)   assume, unless it has, in its capacity as agent for the Lenders,  received
      notice  to the  contrary  from  any  other  party  hereto,  that  (a)  any
      representation  made or deemed to be made by an Obligor in connection with
      the Finance  Documents is true, (b) no Event of Default or Potential Event
      of Default has  occurred,  (c) no Obligor is in breach of or default under
      its  obligations  under the Finance  Documents  and (d) any right,  power,
      authority or  discretion  vested  therein upon the Majority  Lenders,  the
      Lenders or any other person or group of persons has not been exercised;

(b)   assume that the Facility  Office of each Lender is that  notified to it by
      such  Lender in writing  prior to the date  hereof  (or,  in the case of a
      Transferee,  at the end of the Transfer Certificate to which it is a party
      as Transferee) until it has received from such Lender a notice designating
      some other  office of such Lender to replace its  Facility  Office and act
      upon any such  notice  until  the same is  superseded  by a  further  such
      notice;

(c)   engage and pay for the advice or  services  of any  lawyers,  accountants,
      surveyors  or  other  experts  whose  advice  or  services  may to it seem
      necessary, expedient or desirable and rely upon any advice so obtained;

(d)   rely as to any  matters of fact which might  reasonably  be expected to be
      within the  knowledge  of an Obligor  upon a  certificate  signed by or on
      behalf of such Obligor;

(e)   rely upon any communication or document believed by it to be genuine;



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(f)   refrain from  exercising  any right,  power or discretion  vested in it as
      agent hereunder  unless and until instructed by the Majority Lenders as to
      whether or not such right,  power or discretion is to be exercised and, if
      it is to be exercised, as to the manner in which it should be exercised;

(g)   refrain from acting in accordance  with any  instructions  of the Majority
      Lenders  to begin any  legal  action or  proceeding  arising  out of or in
      connection  with the Finance  Documents  until it shall have received such
      security  as it may  require  (whether  by way of  payment  in  advance or
      otherwise) for all costs, claims, losses,  expenses (including legal fees)
      and liabilities  together with any VAT thereon which it will or may expend
      or incur in complying with such instructions; and

(h)   assume (unless it has specific  notice to the contrary) that any notice or
      request made by the Account Party is made on behalf of the Obligors.

AGENT'S OBLIGATIONS

21.3 The Agent shall:

(a)   promptly  inform  each  Lender of the  contents  of any notice or document
      received by it in its capacity as Agent from an Obligor  under the Finance
      Documents and shall promptly  deliver to each Lender a copy of each Letter
      of Credit  delivered  to Lloyd's  pursuant  to Clause 3.3  (COMPLETION  OF
      LETTERS OF CREDIT);

(b)   promptly  notify each Lender of the  occurrence of any Event of Default or
      any default by an Obligor in the due performance of or compliance with its
      obligations under the Finance Documents of which the Agent has notice from
      any other party hereto;

(c)   save  as  otherwise  provided  herein,  act as  agent  under  the  Finance
      Documents in accordance with any  instructions  given to it by an Majority
      Lenders,  which  instructions  shall be binding on the  Arrangers  and the
      Lenders; and

(d)   if so  instructed by the Majority  Lenders,  refrain from  exercising  any
      right,  power or  discretion  vested  in it as  agent  under  the  Finance
      Documents.

The  Agent's  duties  under the  Finance  Documents  are solely  mechanical  and
administrative in nature.

EXCLUDED OBLIGATIONS

21.4  Notwithstanding  anything to the  contrary  expressed  or implied  herein,
neither the Agent nor the Arrangers shall:

(a)   be bound to enquire as to (i)  whether or not any  representation  made or
      deemed to be made by an Obligor in connection  with the Finance  Documents
      is true,  (ii) the occurrence of any Default,  (iii) the performance by an
      Obligor of its obligations  under the Finance Documents or (iv) any breach
      of or default by an Obligor of or under its obligations  under the Finance
      Documents;

(b)   be bound to account to any Lender for any sum or the profit element of any
      sum received by it for its own account;

(c)   be bound to disclose to any other person any  information  relating to any
      Obligor  or any  Related  Party  if (i) such  person,  on  providing  such
      information, expressly stated



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      to the Agent or, as the case may be, the Arrangers,  that such information
      was  confidential  or (ii) such  disclosure  would or might in its opinion
      constitute a breach of any Law or be otherwise  actionable  at the suit of
      any person;

(d)   be under any obligations  other than those for which express  provision is
      made herein;

(e)   be or be deemed to be a fiduciary for any other party hereto; or

(f)   be  obliged  to carry  out any "know  your  customer"  or other  checks in
      relation to any person on behalf of any Lender and each Lender confirms to
      the Agent and the  Arranger  that it is  solely  responsible  for any such
      checks  it is  required  to  carry  out and  that  it may not  rely on any
      statement in relation to such checks made by the Agent or the Arranger.

INDEMNIFICATION

21.5 Each Lender shall,  pro rata according to its respective  Commitment,  from
time to time on demand by the Agent,  indemnify  the Agent  against  any and all
costs, claims, losses,  expenses (including legal fees) and liabilities together
with any value  added tax  thereon  (or  equivalent)  which the Agent may incur,
otherwise than by reason of its own gross  negligence or wilful  misconduct,  in
acting in its capacity as agent hereunder.

EXCLUSION OF LIABILITIES

21.6 Except in the case of gross negligence or wilful default, neither the Agent
nor the Arrangers accept any responsibility:

(a)   for the adequacy, accuracy and/or completeness of any information supplied
      by the Agent or the  Arrangers,  by an Obligor  or by any other  person in
      connection with the Finance Documents or any other agreement,  arrangement
      or document entered into, made or executed in anticipation of, pursuant to
      or in connection with the Finance Documents;

(b)   for the legality, validity,  effectiveness,  adequacy or enforceability of
      the Finance  Documents  or any other  agreement,  arrangement  or document
      entered  into,  made or executed  in  anticipation  of,  pursuant to or in
      connection with the Finance Documents; or

(c)   for the exercise of, or the failure to exercise, any judgement, discretion
      or  power  given  to any of  them by or in  connection  with  the  Finance
      Documents or any other  agreement,  arrangement or document  entered into,
      made or executed in anticipation of, pursuant to or in connection with the
      Finance Documents.

Accordingly,  neither the Agent nor the  Arrangers  shall be under any liability
(whether in negligence  or  otherwise)  in respect of such matters,  save in the
case of gross negligence or wilful misconduct.

NO ACTIONS

21.7 Each of the Lenders agree that it will not assert or seek to assert against
any  director,  officer or employee of the Agent or the  Arrangers  any claim it
might have  against any of them in respect of the matters  referred to in Clause
21.6 (EXCLUSION OF LIABILITIES).



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BUSINESS WITH THE GROUP

21.8 The Agent and the Arrangers  may accept  deposits  from,  lend money to and
generally  engage  in any  kind of  banking  or other  business  with any of the
Obligors or their Subsidiaries.

RESIGNATION

21.9 The  Agent  may  resign  its  appointment  hereunder  at any  time  without
assigning any reason  therefor by giving not less than thirty days' prior notice
to that  effect  to each of the  other  parties  hereto,  PROVIDED  THAT no such
resignation  shall be effective  until a successor for the Agent is appointed in
accordance with the succeeding provisions of this Clause 21.

SUCCESSOR AGENT

21.10 If the Agent  gives  notice of its  resignation  pursuant  to Clause  21.9
(RESIGNATION)  then any  reputable  and  experienced  Lender or other  financial
institution may be appointed as a successor to the Agent by the Majority Lenders
(with the  approval of the Account  Party,  not to be  unreasonably  withheld or
delayed,)  during the period of such notice (with the co-operation of the Agent)
but,  if no such  successor  is so  appointed,  the  Agent  may  appoint  such a
successor itself.

RIGHTS AND OBLIGATIONS

21.11 If a successor to the Agent is appointed  under the  provisions  of Clause
21.10  (SUCCESSOR  AGENT),  then (a) the retiring Agent shall be discharged from
any further obligation hereunder but shall remain entitled to the benefit of the
provisions of this Clause 21 and (b) its successor and each of the other parties
hereto shall have the same rights and  obligations  amongst  themselves  as they
would have had if such successor had been a party hereto.

OWN RESPONSIBILITY

21.12 It is understood and agreed by each Lender that at all times it has itself
been, and will continue to be, solely responsible for making its own independent
appraisal of and  investigation  into all risks  arising  under or in connection
with this Agreement including, but not limited to:

(a)   the financial condition, creditworthiness,  condition, affairs, status and
      nature of each member of the Group;

(b)   the legality, validity, effectiveness,  adequacy and enforceability of the
      Finance Documents and any other agreement, arrangement or document entered
      into,  made or executed in  anticipation  of, pursuant to or in connection
      with the Finance Documents;

(c)   whether  such  Lender  has  recourse,  and the  nature  and extent of that
      recourse,  against  an  Obligor  or any other  person or any of its assets
      under or in connection with the Finance Documents, the Transactions or any
      other agreement, arrangement or document entered into, made or executed in
      anticipation of, pursuant to or in connection with the Finance  Documents;
      and

(d)   the adequacy,  accuracy and/or completeness of any information provided by
      the  Agent  or the  Arrangers,  an  Obligor  or by  any  other  person  in
      connection  with the  Finance  Documents,  the  Transactions  or any other
      agreement, arrangement or



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      document entered into, made or executed in anticipation of, pursuant to or
      in connection with the Finance Documents.

Accordingly, each Lender acknowledges to the Agent and the Arrangers that it has
not relied on and will not hereafter  rely on the Agent and the Arrangers or any
of them in respect of any of these matters.

AGENCY DIVISION SEPARATE

21.13 In acting as agent hereunder for the Lenders,  the Agent shall be regarded
as acting  through  its  agency  division  which  shall be treated as a separate
entity from any other of its divisions or departments and,  notwithstanding  the
foregoing  provisions of this Clause 21, any information  received by some other
division or department of the Agent may be treated as confidential and shall not
be regarded as having been given to the Agent's agency division.

DECLARATION OF AGENT AS SECURITY TRUSTEE

21.14 The Agent hereby declares that it shall hold:

(a)   all rights, titles and interests that may hereafter be mortgaged, charged,
      assigned or otherwise secured in favour of the Agent by or pursuant to the
      Finance Documents;

(b)   the benefit of all representations, covenants, guarantees, indemnities and
      other contractual  provisions given in favour of the Agent (other than any
      such  benefits  given  to the  Agent  solely  for its own  benefit)  by or
      pursuant to the Finance Documents (other than this Agreement); and

(c)   all proceeds of the security referred to in paragraph (a) above and of the
      enforcement of the benefits referred to in paragraph (b) above,

on trust for itself and the other Finance Parties from time to time.

Such declaration  shall remain valid  notwithstanding  that the Agent may on the
date hereof or at any other time be the sole Finance Party; for the avoidance of
doubt, however, such declaration shall, in such case, be deemed repeated on each
date on which the Agent ceases to be the sole Finance Party.

Each of the parties  hereto  agrees that the  obligations,  rights and  benefits
vested or to be  vested in the Agent as  trustee  as  aforesaid  by the  Finance
Documents or any document entered into pursuant thereto shall (as well before as
after  enforcement) be performed and (as the case may be) exercised by the Agent
in accordance with the provisions of this Clause 21.

POWERS AND DISCRETIONS

21.15 The  Agent  shall  have all the  powers  and  discretions  conferred  upon
trustees by the Trustee Act 1925 (to the extent not  inconsistent  herewith) and
by way of supplement it is expressly declared as follows:

(a)   the Agent  shall be at liberty to place any of the Finance  Documents  and
      any other instruments, documents or deeds delivered to it pursuant thereto
      or in  connection  therewith  for the time being in its  possession in any
      safe deposit, safe or receptacle selected by the Agent or with any Lender,
      any  company  whose  business  includes  undertaking  the safe  custody of
      documents or any firm of lawyers of good repute;



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(b)   the Agent may,  whenever it thinks  fit,  delegate by power of attorney or
      otherwise to any person or persons or  fluctuating  body of persons all or
      any of the rights, trusts,  powers,  authorities and discretions vested in
      it by any of the Finance  Documents and such  delegation  may be made upon
      such  terms  and  subject  to such  conditions  (including  the  power  to
      sub-delegate)  and subject to such  regulations as the Agent may think fit
      and  the  Agent  shall  not  be  bound  to  supervise,  or be in  any  way
      responsible  for any loss incurred by reason of any  misconduct or default
      on the part of, any such delegate (or sub-delegate);

(c)   notwithstanding anything else herein contained, the Agent may refrain from
      doing  anything which would or might in its opinion be contrary to any Law
      of any  jurisdiction  or any  directive or regulation of any agency of any
      state or which would or might otherwise render it liable to any person and
      may do anything  which is, in its  opinion,  necessary  to comply with any
      such Law, directive or regulation;

(d)   save in the case of gross negligence or wilful  misconduct,  the Agent and
      every  attorney,  agent,  delegate,  sub-delegate  and  any  other  person
      appointed by any of them under any of the Finance  Documents may indemnify
      itself  or  himself  out of the  security  held by the Agent  against  all
      liabilities,  costs, fees, charges, losses and expenses incurred by any of
      them in  relation to or arising out of the taking or holding of any of the
      security  constituted  by, or any of the benefits  provided by, any of the
      Finance  Documents,  in the exercise or purported  exercise of the rights,
      trusts,  powers and discretions vested in any of them or in respect of any
      other  matter or thing done or omitted to be done in any way  relating  to
      any of the Finance Documents or pursuant to any Law or regulation; and

(e)   without prejudice to the provisions of any of the Finance  Documents,  the
      Agent  shall not be under any  obligation  to insure  any  property  or to
      require any other person to maintain any such  insurance  and shall not be
      responsible  for any loss which may be  suffered by any person as a result
      of the lack of or inadequacy or insufficiency of any such insurance.

LIABILITY

21.16 The Agent shall not be liable for any failure:

(a)   to  require  the  deposit  with  it of any  deed or  document  certifying,
      representing or constituting  the title of the Account Party to any of the
      property  mortgaged,  charged,  assigned  or  otherwise  encumbered  by or
      pursuant to any of the Finance Documents;

(b)   to obtain any  licence,  consent  or other  authority  for the  execution,
      delivery,  validity, legality,  adequacy,  performance,  enforceability or
      admissibility in evidence of any of the Finance Documents;

(c)   to register  or notify any deed or document  mentioned  at  paragraph  (a)
      above in accordance  with the  provisions of any of the documents of title
      of the Account Party;

(d)   to effect or  procure  registration  of or  otherwise  protect  any of the
      security  created by any of the Finance  Documents by registering the same
      under any  applicable  registration  Laws in any territory or otherwise by
      registering any notice,  caution or other entry  prescribed by or pursuant
      to the provisions of relevant Laws;



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(e)   to take or to require  the  Account  Party to take any steps to render the
      security  created or  purported to be created by or pursuant to any of the
      Finance  Documents  effective or to secure the  creation of any  ancillary
      charge under the Laws of any jurisdiction; or

(f)   to require  any  further  assurances  in  relation  to any of the  Finance
      Documents.

TITLE TO SECURITY ETC.

21.17 The Agent may accept without enquiry,  requisition or objection such right
and  title  as the  Account  Party  may  have  to  the  property  belonging  (or
purportedly  belonging) to it (or any part thereof)  which is the subject matter
of any of  the  Finance  Documents  and  shall  not be  bound  or  concerned  to
investigate  or make any enquiry into the right or title of the Account Party to
such property (or any part thereof) or, without  prejudice to the foregoing,  to
require the Account  Party to remedy any defect in the Account  Party's right or
title as aforesaid.

NEW SECURITY TRUSTEE

21.18 The Agent  may at any time  appoint  any  person  (whether  or not a trust
corporation) to act either as a separate trustee or as a co-trustee jointly with
the Agent:

(a)   if the Agent  considers  such  appointment  to be in the  interests of the
      Lenders; or

(b)   for the purposes of conforming to any legal requirements,  restrictions or
      conditions  which the Agent deems relevant for the purposes of the Finance
      Documents  and the Agent shall give prior notice to the Account  Party and
      the Lenders of any such appointment.

Any  person  so  appointed  shall  (subject  to the  provisions  of the  Finance
Documents)  have such powers,  authorities  and  discretions and such duties and
obligations as shall be conferred or imposed or such person by the instrument of
appointment and shall have the same benefits under this Clause 21 as the Agent.

The Agent shall have power in like manner to remove any person so appointed.

Such  reasonable  remuneration  as the Agent may pay to any person so appointed,
and any costs,  charges and expenses  incurred by such person in performing  its
functions pursuant to such appointment, shall for the purposes hereof be treated
as  costs,  charges  and  expenses  incurred  by the  Agent  under  the  Finance
Documents.

PERPETUITY PERIOD

21.19 The perpetuity period under the rule against perpetuities if applicable to
the trusts  constituted in this Clause 21 and the other Finance  Documents shall
be the  period of eighty  years  from the date of this  Agreement  and,  subject
thereto,  if the Agent  determines  that all of the  obligations  of the Account
Party under any of the  Finance  Documents  have been fully and  unconditionally
discharged, such trusts shall be wound up.

LENDER REPRESENTATIONS

21.20 Each Lender represents to the Agent on the date of issue of each Letter of
Credit that:

(a)   the  execution  and  delivery of each Letter of Credit by the Agent on the
      Lender's  behalf has been duly  authorised by all necessary  action on the
      part of the Lender; and



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(b)   the  obligations of the Lender under each Letter of Credit  constitute its
      legal, valid and binding obligations.

LETTERS OF CREDIT

21.21 Each Lender shall,  (a) pro rata according to its  respective  Commitment,
indemnify the Agent against any and all  liabilities,  costs and expenses  which
the Agent  may incur  otherwise  than by reason of its own gross  negligence  or
wilful  misconduct  (in its capacity as Agent) as a result of the  execution and
delivery of any Letter of Credit and any documents executed and delivered by the
Agent in connection therewith;  and (b) inform the Agent promptly if at any time
the collateral securing the repayment of any amounts payable under any Letter of
Credit  comprises  directly or  indirectly a security  interest over a principal
private residence.

22.   NOTICES

Except in the case of notices and other communications expressly permitted to be
given by  telephone,  all notices and other  communications  provided for herein
shall be in writing and shall be delivered by hand or overnight courier service,
mailed by certified or registered mail or sent by facsimile, as follows:

(a)   if to any Obligor, to:

      XL Capital Ltd
      XL House
      One Bermudiana Road
      Hamilton HM 11
      Bermuda

      Fax:       1 441 295 4867
      Attention: Kirstin Gould

(b)   if to the Agent:

      2nd Floor
      4 Harbour Exchange Square
      London E14 9GE

      Fax:       44 207 500 4482/4484
      Attention: Loans Agency

(c)   if to a  Lender,  to it at  its  address  (or  facsimile  number)  on  the
      signature  pages of this  Agreement,  or such  other  address  as it shall
      notify to the Agents and the Account Party.

Any party  hereto may change its  address or  facsimile  number for  notices and
other communications hereunder by notice to the other parties hereto (or, in the
case of any such  change by a Lender,  by  notice to the  Account  Party and the
Agent).  All  notices  and other  communications  given to any  party  hereto in
accordance  with the provisions of this  Agreement  shall be deemed to have been
given on the date of receipt.



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23.   WAIVERS AND AMENDMENTS

NO DEEMED WAIVERS

23.1 No failure or delay by any Finance Party in  exercising  any right or power
hereunder  shall  operate as a waiver  thereof,  nor shall any single or partial
exercise of any such right or power,  or any  abandonment or  discontinuance  of
steps to enforce such a right or power,  preclude any other or further  exercise
thereof or the exercise of any other right or power.  No waiver of any provision
of this Agreement or consent to any departure by an Obligor  therefrom  shall in
any event be  effective  unless  the same  shall be  permitted  by  Clause  23.3
(AMENDMENTS),  and then such waiver or consent  shall be  effective  only in the
specific  instance  and for the purpose for which  given.  Without  limiting the
generality  of the  foregoing,  the  issuance of a Letter of Credit shall not be
construed  as a waiver of any  Default,  regardless  of whether the Agent or any
Lender may have had notice or knowledge of such Default at the time.

REMEDIES CUMULATIVE

23.2 The rights and remedies of the Finance Parties hereunder are cumulative and
are not exclusive of any rights or remedies that they would otherwise have.

AMENDMENTS

23.3 Neither this Agreement nor any provision  hereof may be waived,  amended or
modified  except  pursuant to an agreement or agreements in writing entered into
by the Obligors  and the Majority  Lenders or by the Obligors and the Agent with
the consent of the Majority Lenders; PROVIDED that no such agreement shall:

(a)   increase the Commitment of any Lender without the written  consent of such
      Lender,

(b)   reduce the amount of any reimbursement  obligation of the Account Party in
      respect of any LC Disbursement or reduce the rate of interest thereon,  or
      reduce any fees  payable  hereunder,  without the written  consent of each
      Lender affected thereby,

(c)   postpone the scheduled date for  reimbursement of any LC Disbursement,  or
      any interest thereon, or any fees payable hereunder,  or reduce the amount
      of, waive or excuse any such payment,  or postpone the  scheduled  date of
      expiration  of any  Commitment  or any  Letter  of Credit  (other  than an
      extension  thereof  pursuant to Clause 4), without the written  consent of
      each Lender affected thereby,

(d)   change  Clause 15.4 (PRO RATA  TREATMENT)  or 15.5 (SHARING OF PAYMENTS BY
      LENDERS) without the consent of each Lender affected thereby,

(e)   release  any of the  Guarantors  from any of their  guarantee  obligations
      under Clause 16 (GUARANTEE AND INDEMNITY)  without the written  consent of
      each Lender,

(f)   release any security  granted by the Account Party pursuant to Clause 19.8
      (RATINGS  DOWNGRADE) or 20 (EVENTS OF DEFAULT) without the written consent
      of each Lender, and

(g)   change  any of the  provisions  of this  Clause or the  percentage  in the
      definition  of the term  MAJORITY  LENDERS or any other  provision  hereof
      specifying the number or percentage of Lenders required to waive, amend or
      modify any rights hereunder or



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      make any determination or grant any consent hereunder, without the written
      consent of each Lender;

and PROVIDED  FURTHER that no such  agreement  shall amend,  modify or otherwise
affect the rights or duties of the Agent  hereunder  without  the prior  written
consent of the Agent.

24.   COSTS AND EXPENSES

24.1 The Account Party shall pay:

(a)   all reasonable  out-of-pocket  expenses and charges  incurred by the Agent
      and/or the  Arrangers  (together  with VAT or any  similar tax thereon and
      including the reasonable  fees,  charges and  disbursements of counsel for
      the Agent) in connection  with the  syndication  of the credit  facilities
      provided  for  herein,   the  negotiation,   preparation,   execution  and
      administration  of the  Finance  Documents  (subject  to the  terms of the
      Commitment  Letter)  or any  amendments,  modifications  or waivers of the
      provisions hereof (whether or not the transactions  contemplated hereby or
      thereby shall be consummated);

(b)   all reasonable  out-of-pocket expenses incurred by the Agent, the Security
      Trustee or any Lender,  (together  with VAT or any similar tax thereon and
      including the  reasonable  fees,  charges and  disbursements  of one legal
      counsel  for the  Agent  and  one  legal  counsel  for  the  Lenders),  in
      connection with the preservation  and/or  enforcement or protection of its
      rights in  connection  with the Finance  Documents,  including  its rights
      under  this  Clause,  or in  connection  with  Letters  of  Credit  issued
      hereunder,  including in  connection  with any workout,  restructuring  or
      negotiations in respect thereof.

STAMP DUTY

24.2 The  Account  Party shall pay all  transfer,  stamp,  documentary  or other
similar  taxes,  assessments or charges  levied by any  governmental  or revenue
authority in respect of this Agreement or any other document referred to herein.

25.   INDEMNITIES

CURRENCY INDEMNITY

25.1 (a) If:

      (i)   any amount payable by the Account Party under or in connection  with
            this  Agreement is received by any Finance  Party in a currency (the
            PAYMENT  CURRENCY)  other than that  agreed in this  Agreement  (the
            AGREED  CURRENCY)  whether as a result of any  judgement or order or
            the enforcement  thereof, the liquidation of the payer or otherwise;
            and

      (ii)  the amount  produced by converting the Payment  Currency so received
            into the Agreed  Currency  is less than the  relevant  amount of the
            Agreed Currency.

      then the Account Party shall, as an independent obligation, indemnify such
      Finance Party for the deficiency and any loss sustained as a result.  Such
      conversion shall be made at such prevailing rate of exchange, on such date
      and in such market as is



                                                                  Conformed Copy


      determined  by such  Finance  Party  (acting  reasonably)  as  being  most
      appropriate  for the  conversion.  The Account Party shall in addition pay
      the costs of the conversion.

(b)   The Account Party waives any right it may have in any  jurisdiction to pay
      any amount under this  Agreement in a currency other than that in which it
      is expressed to be payable in this Agreement.

OTHER INDEMNITIES

25.2 The Obligors  shall  indemnify the Agent and each Lender,  and each Related
Party  of any of the  foregoing  Persons  (each  such  Person  being  called  an
INDEMNITEE)  against,  and to hold each  Indemnitee  harmless  from, any and all
losses, claims, damages,  liabilities and related expenses,  including the fees,
charges and  disbursements  of any counsel  for any  Indemnitee,  incurred by or
asserted  against any  Indemnitee  arising out of, in  connection  with, or as a
result of:

(a)   the execution or delivery of this Agreement or any agreement or instrument
      contemplated  hereby,  the  performance  by the  parties  hereto  of their
      respective  obligations  hereunder or the consummation of the Transactions
      or any other transactions contemplated hereby;

(b)   any Letter of Credit or the use of any thereof  (including  any refusal by
      any Lender to honour a demand for payment  under a Letter of Credit if the
      documents  presented in connection with such demand do not strictly comply
      with the terms of such Letter of Credit);

(c)   any actual or prospective claim,  litigation,  investigation or proceeding
      relating to any of the foregoing,  whether based on contract,  tort or any
      other theory and  regardless of whether any Indemnitee is a party thereto;
      provided that such indemnity shall not, as to any Indemnitee, be available
      to the extent that such losses,  claims,  damages,  liabilities or related
      expenses  result  from or arise  out of the  gross  negligence  or  wilful
      misconduct of such Indemnitee.

REIMBURSEMENT BY LENDERS

25.3 To the extent that the Obligors fail to pay any amount  required to be paid
by them to the Agent under  Clauses 25 (COSTS AND  EXPENSES)  or 25.1  (CURRENCY
INDEMNITY) and 25.2 (OTHER INDEMNITIES),  each Lender severally agrees to pay to
the Agent such Lender's  Applicable  Percentage  (determined as of the time that
the  applicable  unreimbursed  expense or  indemnity  payment is sought) of such
unpaid  amount;  PROVIDED that the  unreimbursed  expense or  indemnified  loss,
claim, damage, liability or related expense, as the case may be, was incurred by
or asserted against the Agent in its capacity as such.

26.   ALTERATION TO THE PARTIES

SUCCESSORS

26.1 The  provisions  of this  Agreement  shall be binding upon and inure to the
benefit  of the  parties  hereto and their  respective  successors  and  assigns
permitted hereby.

ASSIGNMENTS AND TRANSFERS BY THE ACCOUNT PARTY

26.2 The Account Party shall not assign or otherwise  transfer any of its rights
or obligations  hereunder  without the prior written consent of each Lender (and
any  attempted  assignment or transfer by the Account Party without such consent
shall be null and void).



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TRANSFERS BY LENDERS.

26.3 (a) Any  Lender  (the  TRANSFEROR)  may at any  time  transfer  to  another
         Approved Credit  Institution  (the  TRANSFEREE) all or a portion of its
         rights and obligations under this Agreement (including all or a portion
         of its  Commitment)  and  under  any  Letter of Credit to which it is a
         party; PROVIDED THAT:

      (i)   except in the case of an transfer to a Lender or a Lender Affiliate,
            each of the  Account  Party and the  Agent  must  give  their  prior
            written  consent  to such  assignment  (which  consent  shall not be
            unreasonably withheld or delayed);

      (ii)  except in the case of an transfer to a Lender or a Lender  Affiliate
            or a transfer  of the entire  remaining  amount of the  Transferor's
            Commitment,  the amount of the Commitment of the Transferor  subject
            to each such  transfer  (determined  as of the date of the  Transfer
            Certificate) shall not be less than (pound)3,000,000  unless each of
            the Account Party and the Agent otherwise consent;

      (iii) a transfer of obligations shall only be effective if the Transferee:

            (A)   if it shall not be a Lender,  has delivered  relevant contact,
                  notice and  account  details to the Agent  (with a copy to the
                  Account  Party)  as well as any  information  required  by the
                  Agent to perform "know your customer" or other checks relating
                  to any person  that it is required to carry out in relation to
                  the  Transferee,  the  completion  of which  the  Agent  shall
                  promptly notify to the Transferor and the Transferee; and

            (B)   has  confirmed to the Agent and the Account Party prior to the
                  transfer  taking  effect that it undertakes to be bound by the
                  terms  of this  Agreement  as  Lender  in form  and  substance
                  reasonably  satisfactory  to the Agent and the Account  Party;
                  and on any such transfer  being made the  Transferor  shall be
                  relieved of its obligations to the extent they are transferred
                  to the Transferee.

      PROVIDED FURTHER that any consent of the Account Party otherwise  required
      under this  paragraph  shall not be required if an Event of Default  under
      Clause  20(a),  (e) or (f) has occurred and is  continuing.  Upon transfer
      pursuant  to  Clause  26.4,  from and  after  the last to occur of (i) the
      effective  date  specified  in each  Transfer  Certificate;  and  (ii) the
      cancellation of a Letter of Credit and the issue of a new Letter of Credit
      with the  Transferee  identified as an Issuing  Lender (the ISSUING LENDER
      TRANSFER),  the Transferee  thereunder shall be a party hereto and, to the
      extent of the lesser of the interest assigned by such Transfer Certificate
      and the  Transferee's  participation  as an Issuing  Lender of a re-issued
      Letter  of  Credit  (the  TRANSFERRED  INTEREST),   have  the  rights  and
      obligations  of  a  Lender  under  this  Agreement,   and  the  Transferor
      thereunder shall, to the extent of the Transferred  Interest,  be released
      from its  obligations  under this Agreement  (and, in the case of Transfer
      Certificate  covering all of the Transferor's rights and obligations under
      this  Agreement,  such Lender  shall cease to be a party  hereto but shall
      continue to be entitled to the benefits of Clauses 12  (INCREASED  COSTS),
      10 (TAXES) 24 (COSTS AND EXPENSES) and 25  (INDEMNITIES)).  Any assignment
      or transfer by a Lender of rights or obligations under this Agreement that
      does not comply with this paragraph  shall be treated for purposes of this
      Agreement as a sale by such Lender of a  participation  in such rights and
      obligations in accordance with Clause 26.7 (PARTICIPATIONS).



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      Notwithstanding  anything to the contrary  contained herein, any Lender (a
      GRANTING  LENDER) may grant to a special  purpose vehicle (an SPV) of such
      Granting  Lender,  identified  as such in writing from time to time by the
      Granting Lender to the Agent and the Account Party,  the option to provide
      to the  Account  Party  all or any part of any LC  Disbursement  that such
      Granting  Lender would otherwise be obligated to make to the Account Party
      pursuant to Clause 2.1,  PROVIDED that (i) nothing herein shall constitute
      a commitment by any SPV to make any LC Disbursement, (ii) if an SPV elects
      not to exercise such option or otherwise  fails to provide all or any part
      of such LC  Disbursement,  the Granting  Lender shall be obligated to make
      such LC  Disbursement  pursuant to the terms  hereof and (iii) the Account
      Party may bring any proceeding  against either or both the Granting Lender
      or the SPV in order to enforce any rights of the Account Party  hereunder;
      and   (iv)  the  SPV   shall   agree  to  the   terms   of   Clause   30.2
      (CONFIDENTIALITY).  The making of an LC  Disbursement  by an SPV hereunder
      shall utilise the  Commitment  of the Granting  Lender to the same extent,
      and as if, such LC  Disbursement  were made by the Granting  Lender.  Each
      party  hereto  hereby  agrees  that no SPV shall be liable for any payment
      under this Agreement for which a Lender would otherwise be liable,  for so
      long as,  and to the  extent,  the  related  Granting  Lender  makes  such
      payment. In furtherance of the foregoing,  each party hereto hereby agrees
      (which  agreement shall survive the  termination of this Agreement)  that,
      prior to the date that is one year and one day after the  payment  in full
      of all outstanding  commercial  paper or other senior  indebtedness of any
      SPV,  it  will  not  institute  against,  or  join  any  other  person  in
      instituting against, such SPV any bankruptcy, reorganisation, arrangement,
      insolvency or  liquidation  proceedings or similar  proceedings  under the
      Laws of the United  States or any State  thereof  arising out of any claim
      against  such SPV  under  this  Agreement.  In  addition,  notwithstanding
      anything to the contrary contained in this Clause, any SPV may with notice
      to, but without  the prior  written  consent of, the Account  Party or the
      Agent and without  paying any  processing  fee  therefor,  assign all or a
      portion of its interests in any Letter of Credit to its Granting Lender or
      to any financial  institutions  (consented to by the Account Party and the
      Agent) providing  liquidity and/or credit support (if any) with respect to
      commercial  paper  issued by such SPV to issue such  Letters of Credit and
      such SPV may disclose, on a confidential basis,  confidential  information
      with  respect  to any  Account  Party and its  Subsidiaries  to any rating
      agency,  commercial  paper  dealer or provider of a surety,  guarantee  or
      credit  liquidity  enhancement  to such  SPV.  This  paragraph  may not be
      amended   without  the  consent  of  any  SPV  at  the  time   holding  LC
      Disbursements under this Agreement.

(b)   On each  occasion a  Transferor  assigns,  transfers or novates any of its
      rights and/or obligations under this Agreement,  the Transferee (unless it
      is  already  a  Lender  or a  Lender  Affiliate  immediately  prior to the
      transfer) shall ensure that the Agent has notice of the same and shall, on
      the date the assignment, transfer and/or novation takes effect, pay to the
      Agent for its own account a fee of (pound)1,000.

(c)   Neither a  Transferor  nor any other  Finance  Party is  responsible  to a
      Transferee for:

      (i)   the execution, genuineness,  validity, enforceability or sufficiency
            of any Finance Documents or any other document;

      (ii)  the collectability of amounts payable under any Finance Documents or
            the financial  condition of or the  performance  of its  obligations
            under the Finance Documents by any Obligor; or



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      (iii) the accuracy of any  statements or information  (whether  written or
            oral) made in or in connection  with or supplied in connection  with
            any Finance Documents.

(d)   Each  Transferee  confirms to the Transferor and the other Finance Parties
      that it:

      (i)   has made its own  independent  investigation  and  assessment of the
            financial  condition  and  affairs of each  Obligor  and its related
            entities in connection with its  participation in this Agreement and
            has not relied exclusively on any information  provided to it by the
            Transferor or any other Finance Party in connection with any Finance
            Documents; and

      (ii)  will  continue  to  make  its  own  independent   appraisal  of  the
            creditworthiness  of each  Obligor and its related  entities  for so
            long as  there  are  any  Commitments  or LC  Exposures  under  this
            Agreement.

(e)   Nothing in any Finance Document obliges a Transferor to:

      (i)   accept a re-transfer  from an Transferee of any of the rights and/or
            obligations assigned, transferred or novated under this Clause; or

      (ii)  support  any  losses  incurred  by the  Transferee  by reason of the
            non-performance  by any Obligor of its obligations under any Finance
            Document or otherwise.

26.4 TRANSFER PROCEDURE:

(a)   A novation is effected if:

      (i)   the  Transferor  and  the  Transferee  deliver  to the  Agent a duly
            completed  Transfer  Certificate  executed by the Transferor and the
            Transferee; and

      (ii)  the Agent executes it

      PROVIDED  THAT the Agent  shall  only be  obliged  to  execute a  Transfer
      Certificate  delivered to it by the Transferor and the Transferee  once it
      is satisfied it has complied  with all necessary  "know your  customer" or
      similar other checks under all applicable laws and regulations in relation
      to the transfer to such Transferee.

(b)   Each Party  (other than the  Transferor  and the  Transferee)  irrevocably
      authorises the Agent to execute any duly completed Transfer Certificate on
      its behalf.

(c)   To the extent that they are expressed to be the subject of the novation in
      the Transfer Certificate:

      (i)   the Transferor and the other Parties (the EXISTING  PARTIES) will be
            released  from their  obligations  to each other  under the  Finance
            Documents (the DISCHARGED OBLIGATIONS);

      (ii)  the  Transferee  and the existing  Parties  will assume  obligations
            towards each other under the Finance Documents which differ from the
            discharged  obligations  only insofar as they are owed to or assumed
            by the Transferee instead of the Transferor;



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      (iii) the rights of the Transferor  against the existing Parties under the
            Finance  Documents  and vice versa (the  DISCHARGED  RIGHTS) will be
            cancelled; and

      (iv)  the Transferee and the existing  Parties will acquire rights against
            each  other  under  the  Finance  Documents  which  differ  from the
            discharged rights only insofar as they are exercisable by or against
            the Transferee instead of the Transferor,

      all on the date specified in the proviso to Clause 26.3(a).

RIGHT TO SUBSTITUTE SINGLE LENDER

26.5  If:

(a)   any sum payable to any Finance  Party by the Account  Party is required to
      be increased under Clause 10 (TAXES); or

(b)   any Lender claims indemnification from the Account Party under Clause 12.1
      (INCREASED COSTS); or

(c)   a Lender's  Available  Commitment  has been  reduced to zero  pursuant  to
      Clause 13(b) (ILLEGALITY),

the  Account  Party may give the Agent  notice of its  intention  to arrange the
substitution of that Lender with a new bank or financial institution.

On receipt of a notice from the  Account  Party  referred  to above,  the Lender
shall use its best  endeavours to promptly  assign or transfer all of its rights
and obligations under this Agreement to an Approved Credit Institution nominated
by the Account Party.  Such transfer will be effected in accordance  with Clause
26.4 (TRANSFER  PROCEDURE) and the  consideration  for such transfer shall be an
amount equal to the sum of all amounts accrued and owing by the Account Party to
the transferring Lender as calculated on the date of transfer.

REFERENCE BANKS

26.6 If a Reference  Bank ceases to be one of the  Lenders,  the Agent shall (in
consultation with the Account Party) appoint another Lender or an affiliate of a
Lender to replace that Reference Bank.

PARTICIPATIONS

26.7 Any Lender may sell participations to one or more Lenders or other entities
(a  PARTICIPANT)  in all or a portion of such  Lender's  rights and  obligations
under this Agreement and the other Credit Documents  (including all or a portion
of its Commitment); PROVIDED that:

(a)   any such  participation  sold to a Participant  which is not a Lender or a
      Lender  Affiliate  shall be made only with the consent (which in each case
      shall not be  unreasonably  withheld) of the Account  Party and the Agent,
      unless an Event of Default under Clause 20(a), (e) or (f) has occurred and
      is continuing, in which case the consent of the Account Party shall not be
      required;

(b)   such  Lender's  obligations  under this  Agreement  and the other  Finance
      Documents shall remain unchanged;



                                                                  Conformed Copy


(c)   such Lender shall remain solely  responsible  to the other parties  hereto
      for the performance of such obligations;

(d)   the Account Party,  the Agent,  the Security Trustee and the other Lenders
      shall  continue to deal solely and directly with such Lender in connection
      with such Lender's  rights and  obligations  under this  Agreement and the
      other Finance Documents; and

(e)   the Participant shall agree to the terms of Clause 30.2 (CONFIDENTIALITY).

Any  agreement  or   instrument   pursuant  to  which  a  Lender  sells  such  a
participation  shall  provide  that such Lender  shall  retain the sole right to
enforce  this  Agreement  and the other  Finance  Documents  and to approve  any
amendment,  modification  or waiver of any  provision  of this  Agreement or the
other Finance Documents;  PROVIDED that such agreement or instrument may provide
that such Lender will not, without the consent of the Participant,  agree to any
amendment,  modification or waiver described in the first proviso to Clause 23.3
(Amendments) that affects such Participant. Subject to Clause 26.8 (NO INCREASED
COSTS),  the  Obligors  agree that each  Participant  shall be  entitled  to the
benefits of Clauses 12 (INCREASED COSTS) and 10 (TAXES) to the same extent as if
it were a Lender and had acquired its interest by assignment  pursuant to Clause
26.3 (TRANSFERS BY LENDERS).

NO INCREASED COSTS

26.8 No  Participant  or  Transferee  shall be  entitled  to receive any greater
payment  under Clause 12  (INCREASED  COSTS) and 10 (TAXES) than the  applicable
Lender would have been  entitled to receive  with  respect to the  participation
sold to such Participant or the Lender interest transferred.

CERTAIN PLEDGES

26.9 Any Lender may at any time  pledge or assign a security  interest in all or
any portion of its rights  under this  Agreement to secure  obligations  of such
Lender,  and this Clause shall not apply to any such pledge or  assignment  of a
security  interest;  PROVIDED  that no such pledge or  assignment  of a security
interest  shall  release  a Lender  from  any of its  obligations  hereunder  or
substitute any such assignee for such Lender as a party hereto.

NO TRANSFERS TO ANY ACCOUNT PARTY OR AFFILIATES

26.10  Anything in this Clause to the  contrary  notwithstanding,  no Lender may
assign or  participate  any interest in any LC Exposure  held by it hereunder to
any Obligor or any of its Affiliates or  Subsidiaries  without the prior consent
of each Lender.

MAINTENANCE OF REGISTER BY THE AGENT

26.11 The Agent, acting for this purpose as an agent of the Account Party, shall
maintain  at one of its  offices in London a copy of each  Transfer  Certificate
delivered to it and a register of the names and  addresses  of the Lenders,  and
the Commitment of, and principal amount of the LC  Disbursements  owing to, each
Lender  pursuant  to the terms  hereof  from time to time  (the  REGISTER).  The
entries in the Register shall be conclusive,  and the Account Party,  the Agent,
the  Security  Trustee  and the  Lenders  may treat  each  Person  whose name is
recorded in the Register  pursuant to the terms hereof as a Lender hereunder for
all purposes of this  Agreement,  notwithstanding  notice to the  contrary.  The
Register  shall be available for inspection by any Account Party and any Lender,
at any reasonable time and from time to time upon reasonable prior notice.



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27.   SET OFF

RIGHT OF SET-OFF

If an Event of Default shall have occurred and be continuing, each Finance Party
is hereby  authorised at any time and from time to time,  to the fullest  extent
permitted  by Law,  to set off and apply any and all  deposits  in any  currency
(general or special, time or demand,  provisional or final) at any time held and
other indebtedness in any currency at any time owing by such Finance Party to or
for  the  credit  or the  account  of any  Obligor  against  any of and  all the
obligations of such Obligor now or hereafter  existing under this Agreement held
by such Finance Party,  irrespective  of whether or not such Finance Party shall
have made any demand under this Agreement and although such  obligations  may be
unmatured. The rights of each Finance Party under this Clause are in addition to
other rights and remedies (including other rights of set-off) which such Finance
Party may have. The relevant  Finance Party may effect any appropriate  currency
exchanges to implement such set-off.

28.   MISCELLANEOUS PROVISIONS

CERTIFICATES

28.1 Any  determination  or notification by the Agent or any other Finance Party
concerning any rate or amount under the Finance  Documents shall, in the absence
of manifest error, be conclusive evidence as to that matter.

SURVIVAL

28.2 All  covenants,  agreements,  representations  and  warranties  made by the
Account Party herein and in the certificates or other  instruments  delivered in
connection  with or pursuant to this Agreement  shall be considered to have been
relied upon by the other  parties  hereto and shall  survive the  execution  and
delivery of this Agreement and the issuance of any Letters of Credit, regardless
of any  investigation  made  by any  such  other  party  or on  its  behalf  and
notwithstanding that the Agent or any Lender may have had notice or knowledge of
any Default or  incorrect  representation  or warranty at the time any credit is
extended  hereunder,  and shall continue in full force and effect as long as any
fee or any other amount payable under this  Agreement is outstanding  and unpaid
or any Letter of Credit is outstanding and so long as the  Commitments  have not
expired or  terminated.  The  provisions  of Clauses 12  (INCREASED  COSTS),  10
(TAXES), 24 (COSTS AND EXPENSES),  25 (INDEMNITIES) and 21 (AGENT) shall survive
and  remain in full  force and  effect  regardless  of the  consummation  of the
transactions  contemplated  hereby, the expiration or termination of the Letters
of Credit  and the  Commitments  or the  termination  of this  Agreement  or any
provision hereof.

COUNTERPARTS

28.3 This Agreement may be executed in  counterparts  (and by different  parties
hereto on separate  counterparts),  each of which shall  constitute an original,
but all of  which  when  taken  together  shall  constitute  one  and  the  same
instrument.

ENTIRE AGREEMENT

28.4 This  Agreement  and the other  Finance  Documents  constitute  the  entire
contract between the parties relating to the subject matter hereof and supersede
any and all previous agreements and understandings, oral or written, relating to
the subject matter hereof.



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SEVERABILITY

28.5 Any provision of this  Agreement or any other  Finance  Document held to be
invalid,  illegal  or  unenforceable  in  any  jurisdiction  shall,  as to  such
jurisdiction,  be  ineffective to the extent of such  invalidity,  illegality or
unenforceability without affecting the validity,  legality and enforceability of
the remaining  provisions hereof. The invalidity of a particular  provision in a
particular  jurisdiction  shall  not  invalidate  such  provision  in any  other
jurisdiction.  To the extent  permitted by applicable  Law, each Obligor  hereby
waives any provision of Law which renders any provision of the Finance Documents
prohibited or unenforceable in any respect.

29.   GOVERNING LAW AND JURISDICTION

GOVERNING LAW

29.1 This  Agreement  shall be  construed  in  accordance  with and  governed by
English law.

JURISDICTION

29.2 (a) All the parties agree that the courts of England are, subject to Clause
         29.2(b)  and (c) below,  to have  jurisdiction  to settle any  disputes
         which may arise in  connection  with the  creation,  validity,  effect,
         interpretation   or   performance   of,  or  the  legal   relationships
         established by, this Agreement (including,  without limitation,  claims
         for set-off or  counterclaim)  or otherwise  arising in connection with
         this  Agreement  and  for  such  purposes  irrevocably  submit  to  the
         jurisdiction of the English courts;

     (b) notwithstanding the agreement in (a) above, each of the Finance Parties
         shall  retain the right to bring  proceedings  in any other court which
         has  jurisdiction  whether by virtue of the Convention on  Jurisdiction
         and the  Enforcement of Judgments  signed on 27 September 1968 (as from
         time to time amended and  extended) or by virtue of the  Convention  on
         Jurisdiction  and the  Enforcement of Judgments  signed on 16 September
         1988 (from time to time amended and extended) or otherwise;

     (c) with respect to the courts agreed in paragraphs (a) and (b) above, each
         of the Parties irrevocably waives any objections on the ground of venue
         or forum non conveniens or any similar ground;

     (d) each of the Parties  irrevocably agrees that a judgment or order of any
         court  referred to in this Clause in connection  with this Agreement is
         conclusive  and  binding  on it and may be  enforced  against it in the
         courts of any other jurisdiction; and

     (e) each of the Parties irrevocably  consents to service of process by mail
         or in any other manner permitted by the relevant Law.

AGENT FOR SERVICE OF PROCESS

29.3 Each  Obligor  shall at all times  maintain an agent for service of process
and any other  documents in proceedings  in England or any other  proceedings in
connection with this Agreement (a PROCESS AGENT).  The Process Agent shall be XL
Services UK Limited,  XL House,  70 Gracechurch  Street,  London EC3V 0XL (Attn:
Company Secretary) and any writ, judgment or other notice of legal process shall
be sufficiently served on the relevant Obligor if delivered to the Process Agent
marked for the  attention  of the  Finance  Director at its address for the time
being. Each Obligor  undertakes not to revoke the authority of the Process Agent
without promptly appointing a successor and notifying the Agent thereof.



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WAIVER OF IMMUNITIES

29.4 To the extent that any Obligor has or  hereafter  may acquire any  immunity
from  jurisdiction  of any  court or from any  legal  process  (whether  through
service of notice, attachment prior to judgment,  attachment in aid of execution
or execution,  on the ground of sovereignty or otherwise) with respect to itself
or its property,  it hereby irrevocably  waives, to the fullest extent permitted
by applicable Law, such immunity in respect of its obligations under the Finance
Documents.

30.   TREATMENT OF CERTAIN INFORMATION; CONFIDENTIALITY

TREATMENT OF CERTAIN INFORMATION

30.1  Each of the  Obligors  acknowledges  that  from  time  to  time  financial
advisory,  investment  banking and other  services may be offered or provided to
any  Obligor  or one or more of their  Subsidiaries  (in  connection  with  this
Agreement  or  otherwise)  by  any  Lender  or by one or  more  subsidiaries  or
affiliates of such Lender and each of the Obligors hereby authorises each Lender
to share  any  information  delivered  to such  Lender by such  Obligor  and its
Subsidiaries  pursuant to this Agreement,  or in connection with the decision of
such Lender to enter into this  Agreement,  to any such subsidiary or affiliate,
it being  understood  that (a) any such  information  shall be used only for the
purpose of advising  the Obligor or  preparing  presentation  materials  for the
benefit of the Obligor and (b) any such  subsidiary or affiliate  receiving such
information  shall be bound by  Clause  30.2  (CONFIDENTIALITY)  as if it were a
Lender hereunder. Such authorisation shall survive the expiration or termination
of the  Letters  of  Credit  and  the  Commitments  or the  termination  of this
Agreement or any provision hereof.

CONFIDENTIALITY

30.2 Each of the Finance Parties agrees to maintain the  confidentiality  of the
Information (as defined below), except that Information may be disclosed:

(a)   to its and its  Affiliates'  directors,  officers,  employees  and agents,
      including  accountants,   legal  counsel  and  other  advisors  (it  being
      understood  that the  Persons  to whom  such  disclosure  is made  will be
      informed of the confidential  nature of such Information and instructed to
      keep such Information confidential);

(b)   to the extent requested by any regulatory  authority  having  jurisdiction
      over the Agent or any Lender;

(c)   to the  extent  required  by  applicable  Laws  or  regulations  or by any
      subpoena or similar legal process;

(d)   to any other Party;

(e)   in  connection  with the exercise of any  remedies  hereunder or any suit,
      action or  proceeding  relating to this  Agreement or the  enforcement  of
      rights hereunder;

(f)   subject to an agreement in writing containing provisions substantially the
      same as those of this paragraph and for the benefit of the Obligor, to (i)
      any  assignee  of or  Participant  in, or any  prospective  assignee of or
      Participant  in, any of its rights or obligations  under this Agreement or
      (ii) any actual or prospective  counterparty (or its advisors) to any swap
      or derivative transaction relating to any Obligor and its obligations;



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(g)   with the consent of the Obligor; or

(h)   to the extent such Information (i) becomes  publicly  available other than
      as a result of a breach of this Clause 30.2 or (ii)  becomes  available to
      the Agent or any Lender on a  non-confidential  basis from a source  other
      than an Obligor.

For the purposes of this Clause, INFORMATION means all information received from
an  Obligor  relating  to an  Obligor  or its  business,  other  than  any  such
information that is available to the Finance Parties on a non-confidential basis
prior to disclosure by such Obligor;  PROVIDED  that, in the case of information
received  from an Obligor  after the date hereof,  such  information  is clearly
identified  at the time of  delivery  as  confidential.  Any Person  required to
maintain the  confidentiality of Information as provided in this Clause shall be
considered  to have  complied  with its  obligation  to do so if such Person has
exercised  the same  degree  of care to  maintain  the  confidentiality  of such
Information  as such Person  would accord to its own  confidential  information.
Notwithstanding the foregoing,  each of the Finance Parties agree that they will
not  trade  the  securities  of  any  of  the  Obligors  based  upon  non-public
Information that is received by them.

30.3 Notwithstanding  anything in this Agreement to the contrary, the Agent, the
Lenders  and  the  Account  Party  (and  each  of  their  respective  employees,
representatives  or other  agents) may disclose to any and all persons,  without
limitation  of any kind,  the U.S. tax  treatment  and U.S. tax structure of the
transactions  contemplated  by this  Agreement  and all  materials  of any  kind
(including  opinions  or other tax  analyses)  that are  provided to such person
relating to such tax treatment or tax structure,  other than any information for
which  nondisclosure is reasonably  necessary in order to comply with applicable
securities  laws, and except that,  with respect to any document or similar item
that in either case contains  information  concerning  the U.S. tax treatment or
U.S.  tax  structure of such  transactions  as well as other  information,  this
paragraph shall only apply to such portions of the document or similar item that
relate to such tax treatment or tax structure

31.   THIRD PARTY RIGHTS

A person who is not a Party shall have no rights under the Contracts  (Rights of
Third Parties) Act 1999 to enforce any of its terms.

IN WITNESS  whereof the parties  hereto  have caused this  Agreement  to be duly
executed on the date first written above.



                                                                  Conformed Copy


IN WITNESS WHEREOF, XL CAPITAL LTD has caused this Agreement to be duly executed
as a Deed by an authorised officer on the day and year first above written.

ACCOUNT PARTY

EXECUTED as a DEED
for and on behalf of XL CAPITAL LTD

By:             /s/ JERRY M. DE ST. PAER

In the presence of: /s/ FIONA LUCK

GUARANTORS

EXECUTED as a DEED
for and on behalf of XL CAPITAL LTD

By:             /s/ JERRY M. DE ST. PAER

In the presence of: /s/ FIONA LUCK

SIGNED for and on behalf of XL AMERICA, INC.

By:             /s/ CAROL A. MCFATE

Title:              Managing Director, Treasury

SIGNED for and on behalf of XL INSURANCE (BERMUDA) LTD

By:             /s/ CHRISTOPHER A. COELHO

Title:              Senior Vice - President & Chief Financial Officer

SIGNED for and on behalf of XL RE LTD

By:             /s/ CHRISTOPHER V. GREETHAM

Title:              Executive Vice President and Chief Investment Officer



                                                                  Conformed Copy


AGENT

SIGNED for and on behalf of CITIBANK INTERNATIONAL PLC

By:         /s/ PAUL GIBBS

Address:    Citigroup Centre
            33 Canada Square
            Canary Wharf
            London E14 5LB

Fax:        +44 20 7500 4482/4484
Tel:        +44 20 7500 4712
Attention:  Loans Agency

ARRANGERS

SIGNED for and on behalf of BARCLAYS CAPITAL

By:         /s/ KEITH HATTON

Address:    5 The North Colonnade
            Canary Wharf
            London E14 4BB

Fax:        +44 20 7773 3820
Tel:        +44 20 7773 1572
Attention:  Keith Hatton

SIGNED for and on behalf of CITIGROUP GLOBAL MARKETS LIMITED

By:         /s/ PAUL GIBBS

Address:    Citigroup Centre
            33 Canada Square
            Canary Wharf
            London E14 5LB

Fax:        +44 20 7986 8275
Tel:        +44 20 7986 7569
Attention:  Pareejat Singhal



                                                                  Conformed Copy


SECURITY TRUSTEE

SIGNED for and on behalf of CITIBANK INTERNATIONAL PLC

By:         /s/ PAUL GIBBS

Address:    Citigroup Centre
            33 Canada Square
            Canary Wharf
            London E14 5LB

Fax:        +44 20 7500 4482/4484
Tel:        +44 20 7500 4712
Attention:  Loans Agency

LENDERS

SIGNED for and on behalf of BARCLAYS BANK PLC

By:         /s/ KEITH HATTON

Address:    1st Floor
            54 Lombard Street
            London EC3V 9EX

Fax:        +44 20 7699 2407
Tel:        +44 20 7699 3121
Attention:  Paul Johnson

SIGNED for and on behalf of CITIBANK, N.A.

By:         /s/ PAUL GIBBS

Address:    Citigroup Centre
            33 Canada Square
            Canary Wharf
            London E14 5LB

Fax:        +44 20 7500 5806
Tel:        +44 20 7508 1826
Attention:  Loans Processing Unit



                                                                  Conformed Copy


SIGNED for and on behalf of ING BANK N.V., LONDON BRANCH

By:         /s/ T. BATES & P. GALPIN

Address:    60 London Wall
            London
            EC2M 5TQ

Fax:        +44 20 7767 7507
Tel:        +44 20 7767 5907
Attention:  Lowell McElfresh

SIGNED for and on behalf of LLOYDS TSB BANK PLC

By:         /s/ JAMES BOULDEN

Address:    25 Gresham Street
            London
            EC2V 7HN

Fax:        +44 20 7661 4860
Tel:        +44 20 7661 4978
Attention:  James Boulden

SIGNED for and on behalf of THE ROYAL BANK OF SCOTLAND

By:         /s/ JOHN MALLETT

Address:    9th Floor, 280 Bishopsgate, London EC2M 4RB

Fax:        +44 20 7672 1073
Tel:        +44 20 7672 1057
Attention:  John Mallett



                                                                  Conformed Copy


SIGNED for and on behalf of CALYON NEW YORK BRANCH

By:         /s/ SEBASTIAN ROCCO /s/ WILLIAM DENTON

Address:    1301 Avenue of the Americas
            NY 10019
            USA

Fax:        +1 212 261 3438
Tel:        +1 212 261 7718 / 7227
Attention:  Peter Rasmussen /s/ Anjali Thadani

SIGNED for and on behalf of ABN AMRO BANK N.V.

By:         /s/ KIM SLATER /s/ MARTYN TAPLIN

Address:    250 Bishopsgate, London, EC2m 4AA

Fax:        +44 207 678 8604
Tel:        +44 207 678 5060
Attention:  Martin Byrne

SIGNED for and on behalf of THE BANK OF TOKYO-MITSUBISHI, LTD., NEW YORK BRANCH

By:         /s/ CHIMIE T. PEMBA

Address:    1251 Avenue of the Americas
            New York, NY 10020

Fax:        +1 212 782 6440
Tel:        +1 212 782 4340
Attention:  Chimie T. Pemba



                                                                  Conformed Copy


SIGNED for and on behalf of COMMERZBANK AG, NEW YORK AND GRAND CAYMAN BRANCHES

By:         /s/ ARNDT E. BRUNS /s/ MICHAEL P. MCCARTHY

Address:    2 World Financial Centre
            New York, NY 10281-1050

Fax:        +1 212 266 7629
Tel:        +1 212 266 7736
Attention:  Mr A. Bruns

SIGNED for and on behalf of NATIONAL AUSTRALIA BANK LIMITED
A.B.N. 12 004 044 937

By:         /s/ RAY CATT

Address:    88 Wood Street
            London EC2V 7QQ

Fax:        +44 20 7588 8356
Tel:        +44 20 7710 2100
Attention:  Lending Admin NHH

EX-10.58

                                                                   Exhibit 10.58

                              AMENDED AND RESTATED
                       STANDBY LETTER OF CREDIT AGREEMENT

      This AMENDED AND RESTATED STANDBY LETTER OF CREDIT AGREEMENT is dated as
of June 30, 2004 (the "Agreement") and is by and among National Australia Bank
Limited, New York Branch (the "Bank"), XL Capital Ltd, a company incorporated
under the laws of the Cayman Islands, XL America, Inc., a Delaware corporation,
XL Insurance (Bermuda) Ltd, a Bermuda limited liability company, and XL Re Ltd,
a Bermuda limited liability company (collectively, the "Account Parties" and
each an "Account Party").

      WHEREAS, the Account Parties, the Bank and XL Europe Ltd ("XL Europe")
have entered into two Standby Letter of Credit Agreements, one dated as of
January 31, 2003 and the other dated as of July 25, 2003 (the "Existing
Agreements") pursuant to which the Bank issued to the benefit of XL Capital
Assurance Inc. as Beneficiary, respectively, that certain US $100 Million
Standby Letter of Credit No. SB-0406 and that certain US $100 Million Standby
Letter of Credit No. SB-0429 (collectively, the "Credits" and each a "Credit");

      WHEREAS, the parties hereto desire to amend the Existing Agreements by
combining them into one agreement to govern the rights and obligations of the
parties with respect to the Credits and to make such other amendments as the
parties shall agree;

      WHEREAS, the parties hereto and XL Europe have agreed that XL Europe will
not be a party to this Agreement and that upon execution of this Agreement XL
Europe will not have any rights or obligations hereunder or under the Existing
Agreements;

      NOW, THEREFORE, the parties hereto agree that, as of the date hereof, the
Existing Agreements are hereby amended and restated in their entirety to
constitute this one Amended and Restated Standby Letter of Credit Agreement
which shall read as follows:

      1. The Account Parties unconditionally agree, jointly and severally and
regardless of the identity of the Account Party of the Credit, to pay to the
Bank, on demand in immediately available funds (in United States Dollars), on
each date on which a disbursement is made by the Bank pursuant to a Credit, an
amount equal to such disbursement. If payment is not made on the date of
disbursement, such amount shall bear interest (based on a 360-day year and
actual days


EXECUTION COPY


elapsed) from the date of disbursement until paid in full, but excluding the
date paid, at a rate per annum equal to the rate of interest from time to time
announced by the Bank as its prime rate plus 2%.

      2. The Account Parties agree to pay to the Bank, quarterly in arrears and
on the date on which a Credit expires, letter of credit fees (based on a 360-day
year and actual days elapsed) in an amount equal to 0.40% per annum of the
amount available to be drawn under such Credit from time to time.

      3. The Account Parties' joint and several obligations to reimburse Credit
disbursements as provided in Paragraph 1 above shall be absolute, unconditional
and irrevocable, and shall be performed strictly in accordance with terms of
this Agreement, irrespective of any of the following circumstances: (a) any lack
of validity or enforceability of a Credit or any document or instrument relating
thereto; (b) the existence of any claim, setoff, defense or other rights which
any of the Account Parties may have at any time against the Bank, the
Beneficiary or any other person or entity, whether in connection with this
Agreement or any unrelated transaction; (c) any document presented under a
Credit proving to be forged, fraudulent, invalid or insufficient in any respect
or any statement therein being untrue or inaccurate in any respect whatsoever;
(d) payment by the Bank under a Credit against presentation of a draft or
certificate which does not strictly comply with the terms of a Credit, provided
such payment shall have been made by the Bank in good faith and without gross
negligence and payment is made against presentation of a draft or other document
that at least substantially complies with the terms of the relevant Credit; (e)
any agreement by the Bank and the Beneficiary extending or shortening the Bank's
time after presentation to examine documents or to honor or give notice of
discrepancies; (f) at any time or from time to time, without notice to any
Account Party, the time for any performance of or compliance with any of such
reimbursement obligations of any other Account Party being waived, extended or
renewed; (g) any of such reimbursement obligations of any other Account Party
being amended or otherwise modified in any respect, or any guarantee of any of
such reimbursement obligations being released, substituted or exchanged in whole
or in part or otherwise dealt with; (h) the occurrence of any Event of Default;
(i) the existence of any proceedings of the type described in clause (g) or (h)
of Article VIII of that certain 364-Day Credit Agreement dated as of June 23,
2004 among the Account Parties hereunder, as account


EXECUTION COPY                        -2-


parties and guarantors thereunder, various lenders parties thereto and JPMorgan
Chase Bank, as administrative agent (the "Syndicated Credit Agreement") with
respect to any other Account Party or any guarantor of any of such reimbursement
obligations; (j) any lack of validity or enforceability of any of such
reimbursement obligations against any other Account Party or any guarantor of
any of such reimbursement obligations; or (k) any other event or circumstance
whatsoever, whether or not similar to any of the foregoing, that might, but for
the provisions of this Paragraph 3, constitute a legal or equitable discharge of
the obligations of any Account Party hereunder, other than performance by an
Account Party hereunder. Without limiting any other provision of this Agreement,
the Bank: (i) may rely upon any oral, telephonic, facsimile, electronic, written
or other communication believed by it in good faith to have been authorized by
any Account Party, the Beneficiary or anyone acting for any of them; (ii) shall
not be responsible for errors, omissions, interruptions or delays in
transmission or delivery of any message, advice or document in connection with a
Credit, whether transmitted by courier, mail, telecommunication or otherwise, or
for errors in interpretation of technical terms or in translation; (iii) shall
not be responsible for the identity or authority of any signer or the form,
accuracy, genuineness or legal effect of any draft, certificate or other
document presented under a Credit; and (iv) may accept as a draft any written or
electronic demand or other request for payment under a Credit, even if such
demand or other request is not in the form of a negotiable draft.

      4. If after the date hereof, the adoption of or any change in any law or
regulation or in the interpretation thereof by, or compliance by the Bank with
any guideline or request from any central bank or other authority charged with
the administration thereof (whether or not having the force of law) shall
impose, modify or deem applicable any (a) reserve, special deposit or similar
requirement against letters of credit issued by the Bank or (b) capital adequacy
or similar requirement (including without limitation a requirement which affects
the manner in which the Bank allocates capital to letters of credit), and the
result thereof shall be to increase the cost to the Bank of issuing or
maintaining a Credit (which increase in cost shall be calculated in accordance
with the Bank's reasonable averaging and attribution methods) or to reduce the
rate of return on the Bank's capital as a consequence of its obligations under a
Credit to a level below that which the Bank could have achieved but for such
circumstances, then the Account Parties shall pay to the Bank within 10 days of
demand such additional amount or amounts as shall compen-


EXECUTION COPY                        -3-


sate the Bank for such increase in cost or reduction in rate of return; provided
that this Paragraph 4 shall not apply to Taxes, which shall be governed
exclusively by Paragraph 5. A certificate of the Bank as to such additional
amount or amounts shall be conclusive, absent manifest error.

      5. (a) Any and all payments made to the Bank by any Account Party
hereunder shall be made free and clear of and without deduction for any Covered
Taxes unless an Account Party is required to withhold Covered Taxes. If an
Account Party shall be required by law to deduct any Covered Taxes from or in
respect of any sum payable hereunder to the Bank, (i) the sum payable shall be
increased as may be necessary so that after making all required deductions of
Covered Taxes (including deductions applicable to additional sums payable under
this Paragraph 5) the Bank receives an amount equal to the sum it would have
received had no such deductions been required and (ii) such Account Party shall
pay the full amount deducted to the relevant taxing authority in accordance with
applicable law and shall provide the Bank with the original or a certified copy
of the receipt evidencing such payment. If the Bank determines in good faith
that it has received a refund in respect of any Covered Taxes with respect to
which any Account Party has paid additional amounts pursuant to this Paragraph
5, the Bank shall promptly after the date of such receipt pay over the amount of
such refund to such Account Party (but only to the extent of additional amounts
paid by the Account Party under this Paragraph 5 with respect to the Covered
Taxes giving rise to such refund), net of all reasonable expenses of the Bank
(including additional Taxes attributable to such refund, as determined in good
faith by the Bank) and without interest (other than interest, if any, paid by
the relevant taxing authority with respect to such refund). Any Account Party
shall, upon demand, repay to the Bank any amount paid over to such Account Party
by the Bank in the event the Bank is required to repay any portion of such
refund to such taxing authority. If any Account Party reasonably believes that
any Covered Taxes were not correctly or legally asserted, the Bank will use
reasonable efforts to cooperate with such Account Party (at Account Party's
expense) to obtain a refund of such Covered Taxes, which refund shall be
returned to the Account Party to the extent provided in this Paragraph 5(a).
Nothing in this Paragraph 5 shall entitle any Account Party to have access to
the records of the Bank, including, without limitation, tax returns.

      (b) To the extent it is legally entitled to do so, the Bank shall from
time to time, at the written request of any Account Party, provide to such
Account Party such form, certification or


EXECUTION COPY                        -4-


similar documentation, if any (each duly completed, accurate and signed) as is
required by any jurisdiction, in order to obtain an exemption from, or reduced
rate of, deduction, payment or withholding of Covered Taxes to which the Bank is
entitled pursuant to an applicable tax treaty or other applicable law.

      (c) An assignee of the Bank or subsequent assignee shall not be entitled
to any greater gross-up payments under this Paragraph 5 than such assignee's
assignor was entitled to immediately prior to such assignment (determined taking
into account the provisions of this Paragraph 5) except to the extent that the
entitlement to greater payments resulted solely from a change in law formally
announced after the date on which such assignee became an assignee hereunder.

      (d) For purposes of this Agreement the following terms shall have the
following meanings, respectively:

      "Excluded Taxes" means, with respect to the Bank or any other recipient of
a payment from any Account Party hereunder, (a) any Taxes that are imposed as a
result of a connection the recipient of the payment has with the relevant
jurisdiction (other than a connection that is deemed to arise solely by reason
of both (i) the transactions contemplated by this Agreement and (ii) an Account
Party being organized or resident, maintaining an office or conducting business
in such jurisdiction), including without limitation any such Taxes imposed on
(or measured by) net income, net profits, branch profits or overall gross
receipts, (b) any Tax that is not imposed solely as a result of a change in law
formally announced after the date hereof and (c) any Tax that is attributable to
the recipient's failure to comply with Paragraph 5(b) above.

      "Covered Taxes" means all Taxes, other than Excluded Taxes, that are
imposed on the Bank with respect to any payment made by any Account Party
hereunder.

      "Tax" or "Taxes" means any present or future income, stamp or other tax,
levy, impost, duty, charge or withholding imposed, levied, collected, withheld
or assessed by any taxing authority (including any interest or penalties
attributable thereto).

      6. Should any of the following events (each an "Event of Default") occur
and be continuing: (a) the Account Parties fail to make payment when due of any
amount payable under


EXECUTION COPY                        -5-


this Agreement and such failure continues unremedied for at least 3 days; (b)
any representation made in any financial statement or in any certificate or
other writing delivered to the Bank by or on behalf of any Account Party in
connection with this Agreement or a Credit is in any material respect false or
misleading when made; (c) an Account Party shall default in the due performance
or observance by it of any term, covenant or agreement contained herein and such
default shall continue unremedied for a period of more than 20 days; or (d) an
event of default under and as defined in the Syndicated Credit Agreement; then
in each such event, the Bank may declare the obligations of the Account Parties
hereunder to be due and payable immediately and thereupon such obligations shall
become due and payable immediately, without presentment, demand, protest or
other notice of any kind, all of which are hereby waived by the Account Parties;
and in case of any event with respect to any Account Party described in clause
(g) or (h) of Article VIII of the Syndicated Credit Agreement, the obligations
of the Account Parties hereunder shall automatically become due and payable,
without presentment, demand, protest or other notice of any kind, all of which
are hereby waived by each Account Party. The Account Parties shall pay to the
Bank, on demand, for application to drawings under each Credit the entire amount
thereof which has not been drawn. Any amount so paid which has not been drawn at
the expiration of a Credit shall be repaid to the Account Parties, without
interest, upon the payment in full of all other amounts owing hereunder.

      7. Promptly after the occurrence of an Event of Default or an event which
with the giving of notice or the passage of time, or both, would constitute an
Event of Default, the Account Parties shall notify the Bank of such event,
together with a statement setting forth the actions being taken by the Account
Parties to remedy the same.

      8. Each Account Party hereby represents and warrants as to itself that (a)
it is duly organized, validly existing and in good standing under the laws of
the jurisdiction of its organization, has all requisite power and authority to
carry on its business as now conducted and, except where the failure to do so,
individually or in the aggregate, could not reasonably be expected to result in
a Material Adverse Effect (as such term is defined in the Syndicated Credit
Agreement), is qualified to do business in, and is in good standing in, every
jurisdiction where such qualification is required; (b) this Agreement has been
duly executed and delivered by such Account Party and constitutes a legal, valid
and binding obligation of such Account Party, enforceable against


EXECUTION COPY                        -6-


such Account Party in accordance with its terms, except as such enforceability
may be limited by bankruptcy, insolvency, reorganization, moratorium,
examination or similar laws of general applicability affecting the enforcement
of creditors' rights and the application of general principles of equity
(regardless of whether such enforceability is considered in a proceeding in
equity or at law); and (c) the execution, delivery, and performance of this
Agreement will not violate any provision of any existing law or regulation
binding on such Account Party, the violation of which would have a Material
Adverse Effect (as such term is defined in the Syndicated Credit Agreement) on
the business, operations, assets, or financial condition of such Account Party.

      9. The Account Parties jointly and severally agree to pay all reasonable
out-of-pocket expenses incurred by the Bank, including the fees, charges and
disbursements of legal counsel, in connection with the enforcement or protection
of its rights in connection with this Agreement, including its rights under this
Paragraph 9, or in connection with the Credits issued hereunder, including in
connection with any workout, restructuring or negotiations in respect thereof.

      10. The Account Parties jointly and severally agree to indemnify the Bank,
its affiliates and each of their respective directors, officers, employees,
agents and advisors (each an "Indemnitee") against, and to hold each Indemnitee
harmless from, any and all losses, claims, damages, liabilities and related
expenses, including the fees, charges and disbursements of any counsel for any
Indemnitee (but not including Excluded Taxes), incurred by or asserted against
any Indemnitee arising out of, in connection with, or as a result of (a) the
execution or delivery of this Agreement or any agreement or instrument
contemplated hereby, the performance by the parties hereto of their respective
obligations hereunder or the consummation of any transactions contemplated
hereby, (b) any Credit or the use thereof (including any refusal by the Bank to
honor a demand for payment under a Credit if the documents presented in
connection with such demand do not strictly comply with the terms of such
Credit), (c) any actual or alleged presence or release of Hazardous Materials
(as such term is defined in the Syndicated Credit Agreement) on or from any
property owned or operated by any Account Party or any of its Subsidiaries (as
such term is defined in the Syndicated Credit Agreement), or any Environmental
Liability (as such term is defined in the Syndicated Credit Agreement) related
in any way to any Account Party or any of its Subsidiaries (as such term is
defined in the Syndicated Credit Agreement), or


EXECUTION COPY                        -7-


(d) any actual or prospective claim, litigation, investigation or proceeding
relating to any of the foregoing, whether based on contract, tort or any other
theory and regardless of whether any Indemnitee is a party thereto; provided
that such indemnity shall not, as to any Indemnitee, be available to the extent
that such losses, claims, damages, liabilities or related expenses result from
or arise out of the gross negligence or willful misconduct of such Indemnitee.

      To the extent permitted by applicable law, no Account Party shall assert,
and each Account Party hereby waives, any claim against any Indemnitee, on any
theory of liability, for special, indirect, consequential or punitive damages
(as opposed to direct or actual damages) arising out of, in connection with, or
as a result of, this Agreement or any agreement or instrument contemplated
hereby, any transaction effected in connection herewith and any Credit or the
use of the proceeds thereof.

      11. Each Account Party hereby consents to the non-exclusive jurisdiction
of any court of record in the City of New York or of the United States District
Court for the Southern District of New York for the purpose of any suit, action,
proceeding or judgment relating to or arising out of this Agreement or a Credit,
and service of process by the Bank in any such suit, action, proceeding or
judgment may be made by mailing a copy thereof to such Account Party at its
address set forth in Paragraph 17 below. The Account Party also waives any claim
that New York County or the Southern District of New York is an inconvenient
forum.

      12. THIS AGREEMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH
NEW YORK LAW.

      13. If an Event of Default shall have occurred and be continuing, the Bank
is hereby authorized at any time and from time to time, to the fullest extent
permitted by law, to set off and apply any and all deposits (general or special,
time or demand, provisional or final) at any time held and other indebtedness at
any time owing by the Bank to or for the credit or the account of any Account
Party against any of and all the obligations of such Account Party now or
hereafter existing under this Agreement held by the Bank, irrespective of
whether or not the Bank shall have made any demand under this Agreement and
although such obligations may be unmatured. The rights of the Bank under this
Paragraph 13 are in addition to other rights and remedies (including other
rights of setoff) which the Bank may have.


EXECUTION COPY                        -8-


      14. Any articles, sections, clauses, provisions, terms and conditions of
the Syndicated Credit Agreement that are referenced herein (including any
related definitions, schedules and ancillary provisions) and any capitalized
terms used herein with reference to the Syndicated Credit Agreement (the
"Incorporated Terms"), shall be incorporated herein with the same meaning, force
and effect as if such Incorporated Terms were set forth in full as of the date
hereof without amendment (except for those changes or modifications to such
Incorporated Terms as may be necessary or appropriate in the Bank's reasonable
discretion to conform the Incorporated Terms to this Agreement). Each Account
Party agrees to notify the Bank promptly of any amendment or modification of or
change or waiver granted with respect to any Incorporated Term and, if the Bank
so requests by a written instrument, to execute and deliver an amendment to this
Agreement which incorporates such amendment, modification, change or waiver.

      15. No failure on the part of the Bank to exercise, and no delay in
exercising, any right, remedy or power hereunder shall operate as a waiver
thereof, nor shall any single or partial exercise by the Bank of any right,
remedy or power hereunder preclude any other or future exercise of any other
right, remedy or power. Each and every right, remedy and power hereby granted to
the Bank or allowed it by law or other agreement shall be cumulative and not
exclusive the one of any other and may be exercised by the Bank from time to
time.

      16. The Bank shall provide the Account Parties with not less than 60 days
prior written notice of its intent not to renew the term of a Credit.

      17. All demands for payment, notices or other communications hereunder
shall be in writing (including communications by facsimile transmission) and
shall be addressed, if to the Bank, at 245 Park Avenue, New York, New York
10167, Attention: Letter of Credit Department, Fax No. (212) 490-8087, and if to
the Account Parties, c/o XL Capital, Ltd., at XL House, One Bermudiana Road,
Hamilton, HM 11 Bermuda, Attention: Mr. Roderick Gray, Fax No. (441) 296-6399,
or to such other address as such party may designate by notice to the other
parties.

      18. This Agreement shall be binding upon the Account Parties and their
successors, assigns, and legal representatives, and shall inure to the benefit
of, and be enforceable by, the Bank, its successors and assigns. Neither the
Bank nor the Account Parties may assign any of its


EXECUTION COPY                        -9-


rights or obligations under this Agreement without the prior written consent of
the other, such consent not to be unreasonably withheld.

      19. EACH ACCOUNT PARTY AND THE BANK IRREVOCABLY WAIVES ITS RIGHT TO A JURY
TRIAL IN ANY ACTION OR PROCEEDING BASED UPON OR ARISING OUT OF THIS AGREEMENT, A
CREDIT OR ANY DEALINGS WITH ONE ANOTHER RELATING TO THE SUBJECT MATTER OF THIS
AGREEMENT.

      20. This Agreement may be executed in any number of counterparts and by
the several parties hereto on separate counterparts, each of which when so
executed shall be an original, but all such separate counterparts shall together
constitute but one and the same agreement. The parties agree that all telecopied
or telefaxed execution copies and signatures thereto shall be duplicate
originals.

      21. The Account Parties and the Bank agree that upon the execution and
delivery of this Agreement by each of the parties hereto, the terms and
conditions of the Existing Agreements shall be and hereby are amended,
superseded and restated in their entirety by the terms and provisions of this
Agreement. This Agreement is not intended to and shall not constitute a novation
of the Existing Agreements or the obligations or indebtedness created
thereunder.

      22. The Bank hereby notifies each Account Party that pursuant to the
requirements of the USA Patriot Act (Title III of Pub. L. 107-56 (signed into
law October 26, 2001)), the Bank is required to obtain, verify and record
information that identifies each Account Party, which information includes the
name and address of such Account Party and other information that will allow the
Bank to identify each Account Party in accordance with said Act.


EXECUTION COPY                        -10-


      IN WITNESS WHEREOF, the Bank and the Account Parties have entered into
this Amended and Restated Standby Letter of Credit Agreement as of the date
first written above.

NATIONAL AUSTRALIA BANK LIMITED
(ABN 12 004 044 937), New York Branch

By: /s/ Lawrence Karp
    ---------------------
    Name:  Lawrence Karp
    Title: Director & Head, Insurance Americas


XL CAPITAL LTD                                    XL INSURANCE (BERMUDA) LTD

By: /s/ Michael Siese                             By: /s/ Christopher Coelho
    ---------------------                             --------------------------
    Name:  Michael Siese                              Name:  Christopher Coelho
    Title: SVP, Controller                            Title: SVP, CFO, COO


XL AMERICA, INC.                                  XL RE LTD

By: /s/ Richard H. Miller                         By: /s/ James O'Shaughnessy
    ---------------------                             --------------------------
    Name:  Richard H. Miller                          Name:  James O'Shaughnessy
    Title: EVP & CFO & Treasurer                      Title: SVP & CFO


Acknowledged as of the date first written above:
XL EUROPE LTD

By: /s/ Michael Brady
    ---------------------
    Name:  Michael Brady
    Title: CFO


EXECUTION COPY                        -11-

EX-12.1

XL CAPITAL                                                                                                     EXHIBIT 12.1
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES AND PREFERENCE DIVIDENDS
000S OF U.S. DOLLARS

                                                        YR END      YR END      YR END     YR END        YR END     YR END
                                                        31-Dec      31-Dec      31-Dec     31-Dec        31-Dec     31-Dec
                                                         2004        2003        2002       2001          2000       1999
                                                       ---------   ---------   ---------    --------    --------   --------
                                                                                                 
EARNINGS:
        Pre-tax income from continuing operations        988,161     323,169     392,903    (833,916)    376,734    390,252
        Fixed charges and pref divs                      308,808     252,413     186,987     117,994      69,427     53,609
        Distributed income of equity investees            57,129     124,888      23,335       3,662       4,987      1,266
                                                       ---------   ---------   ---------    --------    --------   --------
        Subtotal                                       1,354,098     700,470     603,225    (712,260)    451,148    445,127
        Less: Minority interest                            8,387       9,264      13,371       2,113       1,093        220
        Preference share dividends                        40,321      40,321       9,620          --          --         --
                                                       ---------   ---------   ---------    --------    --------   --------

        TOTAL EARNINGS                                 1,305,390     650,885     580,234    (714,373)    450,055    444,907
                                                       =========   =========   =========    ========    ========   ========

FIXED CHARGES:
        Interest costs                                   129,203      94,337     102,200      65,350      32,147     37,378
        Accretion of deposit liabilities                 129,872     105,070      65,886      47,922      31,261     12,394
        Rental expense at 30% (1)                          9,412      12,685       9,281       4,722       6,019      3,837
                                                       ---------   ---------   ---------    --------    --------   --------
        TOTAL FIXED CHARGES                              268,487     212,092     177,367     117,994      69,427     53,609
                                                       ---------   ---------   ---------    --------    --------   --------
        Preference share dividends - XL Capital           40,321      40,321       9,620          --          --         --
                                                       ---------   ---------   ---------    --------    --------   --------
        TOTAL PREFERED DIVIDENDS                          40,321      40,321       9,620          --          --         --
                                                       ---------   ---------   ---------    --------    --------   --------

        TOTAL FIXED CHARGES AND PREFERENCE DIVIDENDS     308,808     252,413     186,987     117,994      69,427     53,609
                                                       =========   =========   =========    ========    ========   ========


        Ratio of Earnings to Fixed Charges                   4.9         3.1         3.3        (6.1)        6.5        8.3
                                                       ---------   ---------   ---------    --------    --------   --------

        RATIO OF EARNINGS TO COMBINED FIXED CHARGES
         AND PREFERENCE DIVIDENDS                            4.2         2.6         3.1        (6.1)        6.5        8.3
                                                       ---------   ---------   ---------    --------    --------   --------

DEFICIENCY                                                   N/A         N/A         N/A    (832,367)        N/A        N/A
                                                       ---------   ---------   ---------    --------    --------   --------

(1)  30% represents a reasonable approximation of the interest factor

(2)  For the year ended December 31, 2001, earnings were insufficient to
     cover fixed charges by $832.4 million.

EX-21

                                                                                                                     Exhibit 21

CORPORATE STRUCTURE - As of December 31, 2004

- -------------------------------------------------------------------------------------------------------------------------------
                                                                                                                   JURISDICTION
- -------------------------------------------------------------------------------------------------------------------------------
                                                                                                                
XL CAPITAL LTD                                                                                                        Cayman
- -------------------------------------------------------------------------------------------------------------------------------
      EXEL HOLDINGS LIMITED                                                                                           Cayman
      -------------------------------------------------------------------------------------------------------------------------
           EXEL Acquisition Ltd.                                                                                      Cayman
           --------------------------------------------------------------------------------------------------------------------
                GCR Holdings Limited (IN LIQUIDATION)                                                                 Cayman
           --------------------------------------------------------------------------------------------------------------------
           Reeve Court Holdings Ltd                                                                                   Bermuda
           --------------------------------------------------------------------------------------------------------------------
           X.L. Property Holdings Limited                                                                             Bermuda
           --------------------------------------------------------------------------------------------------------------------
           XL Insurance (Bermuda) Ltd                                                                                 Bermuda
           --------------------------------------------------------------------------------------------------------------------
                XL Weather & Energy Ltd (FORMERLY ELEMENT REINSURANCE LTD)                                            Bermuda
                ---------------------------------------------------------------------------------------------------------------
                InQuisCapital Holdings (Bermuda) Limited                                                              Bermuda
                ---------------------------------------------------------------------------------------------------------------
                    InQuisLogic (Bermuda) Limited                                                                     Bermuda
                    -----------------------------------------------------------------------------------------------------------
                    RiskConnect Limited                                                                               Bermuda
                ---------------------------------------------------------------------------------------------------------------
                Sovereign Risk Insurance Ltd.                                                                 50      Bermuda
                ---------------------------------------------------------------------------------------------------------------
                XL International (Bermuda) Ltd (FORMERLY XL WINTERTHUR INTERNATIONAL (BERMUDA) LTD)           91      Bermuda
                ---------------------------------------------------------------------------------------------------------------
                XL International Services Ltd (FORMERLY XL WINTERTHUR INTERNATIONAL SERVICES LTD)                     Bermuda
                ---------------------------------------------------------------------------------------------------------------
                    International Insurance Consulting Services Limited                                               Bermuda
                ---------------------------------------------------------------------------------------------------------------
                XL (Brazil) Holdings Ltda (FORMERLY WINTERTHUR ADMINISTRACAO E PARTICIPACOES LTDA)                    Brazil
                ---------------------------------------------------------------------------------------------------------------
                    XL Insurance (Brazil) Seguradora S/A (FORMERLY WINTERTHUR INTERNATIONAL BRASIL
                    SEGURADORA S/A)                                                                                   Brazil
                ---------------------------------------------------------------------------------------------------------------
                XL Capital Products Ltd                                                                               Bermuda
                ---------------------------------------------------------------------------------------------------------------
                XL Financial Assurance Ltd.                                                                   87      Bermuda
                ---------------------------------------------------------------------------------------------------------------
                XL Financial Solutions Ltd                                                                            Bermuda
                ---------------------------------------------------------------------------------------------------------------
                XL Services (Bermuda) Ltd                                                                             Bermuda
                ---------------------------------------------------------------------------------------------------------------
                XL Life Ltd                                                                                           Bermuda
                ---------------------------------------------------------------------------------------------------------------
                    Reeve Court General Partner Limited                                                               Bermuda
                    -----------------------------------------------------------------------------------------------------------
                         Reeve Court 4 Limited Partnership                                                            Bermuda
                         ------------------------------------------------------------------------------------------------------
                         Reeve Court 6 Limited Partnership                                                            Bermuda
                ---------------------------------------------------------------------------------------------------------------
                XL Gracechurch Limited                                                                                  UK
                ---------------------------------------------------------------------------------------------------------------
                    XL Insurance (UK) Holdings Limited (formerly XL Winterthur (UK) Holdings
                    Limited)                                                                                 42.33      UK
                ---------------------------------------------------------------------------------------------------------------
                X.L. Holdings Barbados Ltd.                                                                          Barbados
                ---------------------------------------------------------------------------------------------------------------
                    X.L. America, Inc. (*)                                                                           Delaware
                    -----------------------------------------------------------------------------------------------------------
                         XL Capital Investment Partners Inc.                                                         Delaware
                         ------------------------------------------------------------------------------------------------------
                         Brockbank Insurance Services, Inc.                                                         California
                         ------------------------------------------------------------------------------------------------------
                         XLCA Admin LLC                                                                              New York
                         ------------------------------------------------------------------------------------------------------
                         XLCDS LLC                                                                                   New York
                         ------------------------------------------------------------------------------------------------------
                         XL Weather & Energy Advisors Inc. (FORMERLY ELEMENT RE ADVISORS INC.)                       Delaware
                         ------------------------------------------------------------------------------------------------------
                         XL Weather & Energy Inc. (FORMERLY ELEMENT RE CAPITAL PRODUCTS INC.)                        Delaware
                         ------------------------------------------------------------------------------------------------------
                         XLA Garrison L.P.                                                                           Delaware
                         ------------------------------------------------------------------------------------------------------
                         Global Credit Analytics, Inc.                                                               Delaware
                         ------------------------------------------------------------------------------------------------------
                         NAC Re Corporation                                                                          Delaware
                         ------------------------------------------------------------------------------------------------------
                              XL Reinsurance America Inc.   *(A-65%) - NY                                            New York
                              -------------------------------------------------------------------------------------------------
                                   XL Financial Solutions, LLC                                                       Delaware
                                   --------------------------------------------------------------------------------------------
                                   Greenwich Insurance Company  *(A-12%)                                             Delaware
                                   --------------------------------------------------------------------------------------------
                                        Warranty Support Services LLC                                                Delaware
                                        ---------------------------------------------------------------------------------------
                                        XL Insurance America, Inc. *(A-10%)(FORMERLY WINTERTHUR
                                        INTERNATIONAL AMERICA INSURANCE COMPANY)                                     Delaware
                                        ---------------------------------------------------------------------------------------
                                             XL Select Insurance Company *(A-2%)(FORMERLY WINTERTHUR
                                             INTERNATIONAL AMERICA UNDERWRITERS INSURANCE CO.)                       Oklahoma
                                             ----------------------------------------------------------------------------------
                                             Winterthur International Services of America Inc.                       Wisconsin
                                             ----------------------------------------------------------------------------------
                                             XL Insurance Company of New York, Inc. (A-3%)                           New York
                                   --------------------------------------------------------------------------------------------
                                   Intercargo Corporation                                                            Delaware
                                   --------------------------------------------------------------------------------------------
                                        XL Specialty Insurance Company  *(A-6%)                                      Delaware
                                        ---------------------------------------------------------------------------------------
                                             Intercargo Insurance Company H.K. Ltd.                                  Hong Kong
                                             ----------------------------------------------------------------------------------
                                             Indian Harbor Insurance Company  *(A-2%)                              North Dakota
                                             ----------------------------------------------------------------------------------
                                             XL Management Services, LLC                                               Texas
                                             ----------------------------------------------------------------------------------
                                             XL Lloyds Insurance Company                                               Texas
                                             ----------------------------------------------------------------------------------
                                             ECS, Inc. (In Liquidation)                                            Pennsylvania
                                             ----------------------------------------------------------------------------------
                                                  ECS Child Care Center, Inc.                                      Pennsylvania
                                                  -----------------------------------------------------------------------------
                                                  ECS Risk & Insurance Services, Inc.                                Barbados
                                                  -----------------------------------------------------------------------------
                                                  XL Environmental Ltd                                                  UK
                                   --------------------------------------------------------------------------------------------
                                   NAC Re Financial Services, Inc.                                                   Delaware
                                   --------------------------------------------------------------------------------------------
                                   NAC Re Investment Holdings, Inc.                                                  Delaware
                                   --------------------------------------------------------------------------------------------
                                   XL Capital Assurance Inc.                                                         New York
                                   --------------------------------------------------------------------------------------------
                                        XL Capital Assurance (U.K.) Limited                                             UK
                         ------------------------------------------------------------------------------------------------------
                         37 Lambert Road LLC                                                                         Delaware
                         ------------------------------------------------------------------------------------------------------
                         XL Financial Administrative Services, Inc.                                                  Delaware
                         ------------------------------------------------------------------------------------------------------
                              XL Portfolio Advisors Inc.                                                             Delaware
                         ------------------------------------------------------------------------------------------------------
                         XL Global, Inc.                                                                             Delaware
                         ------------------------------------------------------------------------------------------------------
                         XL Insurance, Inc.                                                                          Delaware
                         ------------------------------------------------------------------------------------------------------
                         XL Global Services, Inc.                                                                    Delaware
                         ------------------------------------------------------------------------------------------------------
                              XL Investment Management (USA) LLC                                                     Delaware
                              -------------------------------------------------------------------------------------------------
                              Eagleview Insurance Brokerage Services, LLC                                            Delaware
                         ------------------------------------------------------------------------------------------------------
                         XL Life and Annuity Holding Company                                                         Delaware
                         ------------------------------------------------------------------------------------------------------
                              XL Life Insurance and Annuity Company (FORMERLY LYNDON LIFE
                              INSURANCE COMPANY)                                                                     Illinois
                              -------------------------------------------------------------------------------------------------
                              XL Asset Funding Company I LLC                                                         Delaware
                              -------------------------------------------------------------------------------------------------
                              XL Life and Annuity (Bermuda) Ltd                                                       Bermuda
                ---------------------------------------------------------------------------------------------------------------
                XL INVESTMENTS LTD                                                                                    Bermuda
                ---------------------------------------------------------------------------------------------------------------
                    First Cumberland Bank, Inc. (IN LIQUIDATION)                                                     Barbados
                    -----------------------------------------------------------------------------------------------------------
                    Garrison Investments Inc. (**)                                                                   Barbados
                    -----------------------------------------------------------------------------------------------------------
                    InQuisLogic Ltd.                                                                                 Barbados
                    -----------------------------------------------------------------------------------------------------------
                         InQuisLogic Inc.                                                                            Delaware
                    -----------------------------------------------------------------------------------------------------------
                    Kensington Investments Inc.                                                                      Barbados
                    -----------------------------------------------------------------------------------------------------------
                         XLB Partners Inc.                                                                           Barbados
                         ------------------------------------------------------------------------------------------------------
                         Cumberland Holdings, Inc.                                                                   Delaware
                         ------------------------------------------------------------------------------------------------------
                              Cumberland California, Inc.                                                            Delaware
                              -------------------------------------------------------------------------------------------------
                              Cumberland New York, Inc.                                                              Delaware
                              -------------------------------------------------------------------------------------------------
                                   Pareto Asset Management (Ireland) Limited                                  50      Ireland
                    -----------------------------------------------------------------------------------------------------------
                    RiskConnect Ltd                                                                                  Barbados
                    -----------------------------------------------------------------------------------------------------------
                         RiskConnect Inc.                                                                            Delaware
                    -----------------------------------------------------------------------------------------------------------
                    X.L. Investment Private Trustee Ltd.                                                              Bermuda
                    -----------------------------------------------------------------------------------------------------------
                         X.L. Investments (Barbados) Inc.                                                            Barbados
                         ------------------------------------------------------------------------------------------------------
                              Cybersettle, Inc.                                                               56     Delaware
                              -------------------------------------------------------------------------------------------------
                                   Cybersettle Insurance Brokerage Services LLC                                      Delaware
                                   --------------------------------------------------------------------------------------------
                                   Cybersettle Financial Services LLC                                                Delaware
                                   --------------------------------------------------------------------------------------------
                                   InsuranceNoodle, Inc.
                              -------------------------------------------------------------------------------------------------
                              TAM Investment Holdings Inc.                                                           Delaware
                    -----------------------------------------------------------------------------------------------------------
                    ClearWater Opportunity Fund Ltd.                                                                  Cayman
                ---------------------------------------------------------------------------------------------------------------
                XL (LUXEMBOURG) S.A.R.L.                                                                            Luxembourg
                ---------------------------------------------------------------------------------------------------------------
                    XL (FINANCE) S.a.r.l.                                                                           Luxembourg
                    -----------------------------------------------------------------------------------------------------------
                         XL (INTERNATIONAL) S.a.r.l.                                                                Luxembourg
                         ------------------------------------------------------------------------------------------------------
                              XL (SERVICES) S.a.r.l.                                                                Luxembourg
                              -------------------------------------------------------------------------------------------------
                                   XL (SPECIALTY) S.a.r.l.                                                          Luxembourg
                                   --------------------------------------------------------------------------------------------
                                        XL (WESTERN EUROPE) S.a.r.l.                                                Luxembourg
                                        ---------------------------------------------------------------------------------------
                                             XL Re Europe (FORMERLY LE MANS RE)                                       France
                                             ----------------------------------------------------------------------------------
                                                  XL Re Europe Services AG (FORMERLY LE MANS RE
                                                  DEUTSCHLAND AG)                                                     Germany
                                                  -----------------------------------------------------------------------------
                                                  XL Re Europe Management Company Ltd                                 Canada
                                             ----------------------------------------------------------------------------------
                                             XL Swiss Holdings Ltd                                                  Switzerland
                                             ----------------------------------------------------------------------------------
                                                       XL Re Latin America Ltd                                      Switzerland
                                                       ------------------------------------------------------------------------
                                                            XL Latin America Investments Ltd                          Bermuda
                                                            -------------------------------------------------------------------
                                                            XL Re Latin America (Argentina SA)                       Argentina
                                                            -------------------------------------------------------------------
                                                            XL Re Latin America Servicos Ltda                         Brazil
                                                       ------------------------------------------------------------------------
                                                       XL Insurance Switzerland (FORMERLY XL
                                                       WINTERTHUR INTERNATIONAL INSURANCE
                                                       SWITZERLAND)                                                 Switzerland
                                                       ------------------------------------------------------------------------
                                                       Vitodurum Reinsurance Company (FORMERLY XL
                                                       WINTERTHUR INTERNATIONAL RE)                                 Switzerland
                                                       ------------------------------------------------------------------------
                                                       XL Services Switzerland                                      Switzerland
                                                       ------------------------------------------------------------------------
                                                       XL India Business Services Private Limited                      India
                                                       ------------------------------------------------------------------------
                                                       XL Insurance Mexico                                            Mexico
                                             ----------------------------------------------------------------------------------
                                             XL Insurance (UK) Holdings Limited (FORMERLY XL
                                             WINTERTHUR (UK) HOLDINGS LIMITED)                               57.67      UK
                                             ----------------------------------------------------------------------------------
                                                  XL Insurance Company Limited (FORMERLY XL
                                                  WINTERTHUR INTERNATIONAL INSURANCE COMPANY
                                                  LIMITED)                                                              UK
                                                  -----------------------------------------------------------------------------
                                                       XL Magyarorszag Biztosito Reszvenytarsasag                     Hungary
                                                       ------------------------------------------------------------------------
                                                       XL Insurance Argentina S.A. Compania de
                                                       Seguros (formerly Winterthur International
                                                       Argentina SA Compania de Seguros)                             Argentina
                                                       ------------------------------------------------------------------------
                                                       XL Holdings (Proprietary) Limited (FORMERLY
                                                       XL WINTERTHUR HOLDINGS (PROPRIETARY) LIMITED)               South Africa
                                                       ------------------------------------------------------------------------
                                                            XL Winterthur Properties (Proprietary)
                                                            Limited                                                South Africa
                                                            -------------------------------------------------------------------
                                                            XL Insurance Company Limited (FORMERLY
                                                            XL WINTERTHUR INTERNATIONAL INSURANCE
                                                            COMPANY LIMITED)                                       South Africa
                                                  -----------------------------------------------------------------------------
                                                  XL Services UK Limited                                                UK
                ---------------------------------------------------------------------------------------------------------------
                XL Trading Partners Ltd                                                                       90      Bermuda
                ---------------------------------------------------------------------------------------------------------------
                XL Europe Holdings Ltd (FORMERLY X.L. TWO LTD.)                                                       Bermuda
                ---------------------------------------------------------------------------------------------------------------
                    XL Treasury Europe Limited                                                                     R of Ireland
                    -----------------------------------------------------------------------------------------------------------
                    XL Europe Ltd                                                                                  R of Ireland
                    -----------------------------------------------------------------------------------------------------------
                    XL Financial Services (Ireland) Ltd                                                            R of Ireland
                    -----------------------------------------------------------------------------------------------------------
                         XL Australia Pty Ltd (IN LIQUIDATION)                                                       Australia
      -------------------------------------------------------------------------------------------------------------------------
      MID OCEAN LIMITED                                                                                               Cayman
      -------------------------------------------------------------------------------------------------------------------------
           Mid Ocean Holdings Limited                                                                                 Bermuda
           --------------------------------------------------------------------------------------------------------------------
                Ridgewood Holdings Limited                                                                            Bermuda
                ---------------------------------------------------------------------------------------------------------------
                    XL London Market Group plc                                                                          UK
                    -----------------------------------------------------------------------------------------------------------
                         Brockbank Holdings Limited                                                                     UK
                         ------------------------------------------------------------------------------------------------------
                              Baltusrol Holdings Limited                                                              Bermuda
                         ------------------------------------------------------------------------------------------------------
                         County Down Limited                                                                            UK
                         ------------------------------------------------------------------------------------------------------
                         Dornoch Limited                                                                                UK
                         ------------------------------------------------------------------------------------------------------
                         Stonebridge Underwriting Limited                                                               UK
                         ------------------------------------------------------------------------------------------------------
                         XL London Market Services Ltd                                                                  UK
                         ------------------------------------------------------------------------------------------------------
                              Brockbank Personal Lines Limited - (DORMANT)                                              UK
                              -------------------------------------------------------------------------------------------------
                              Cassidy Brockbank Limited - (DORMANT)                                                     UK
                              -------------------------------------------------------------------------------------------------
                              Denham Syndicate Management Limited                                                       UK
                              -------------------------------------------------------------------------------------------------
                                   Denham Direct Underwriters Ltd                                                       UK
                                   --------------------------------------------------------------------------------------------
                                        Denham Legal and Professional Risks Ltd                                         UK
                                        ---------------------------------------------------------------------------------------
                                        Denham Tower Underwriting Agents (PTY) Limited                             South Africa
                              -------------------------------------------------------------------------------------------------
                              XL London Market Ltd- Syndicates 588/861/990/1209                                         UK
                              -------------------------------------------------------------------------------------------------
                                   Brockbank Syndicate Services Limited                                                 UK
                    -----------------------------------------------------------------------------------------------------------
                    XL Capital International Limited                                                                    UK
                    -----------------------------------------------------------------------------------------------------------
                         XL Capital Finance (Europe) plc                                                                UK
                    -----------------------------------------------------------------------------------------------------------
                    XL Financial Products Ltd.                                                                          UK
                ---------------------------------------------------------------------------------------------------------------
                XL Re Ltd                                                                                             Bermuda
                ---------------------------------------------------------------------------------------------------------------
                    ECS Reinsurance Company Inc.                                                                     Barbados
                    -----------------------------------------------------------------------------------------------------------
                    Global Capital Underwriting Ltd.                                                                    UK
                    -----------------------------------------------------------------------------------------------------------
                    NAC Re International Holdings Ltd                                                                   UK
                    -----------------------------------------------------------------------------------------------------------
                         NAC Reinsurance International Limited                                                          UK
                    -----------------------------------------------------------------------------------------------------------
                    XL BCM Limited                                                                                      UK
                    -----------------------------------------------------------------------------------------------------------
                    XL Mid Ocean Re Limited                                                                             UK
      -------------------------------------------------------------------------------------------------------------------------
      XL INVESTMENT MANAGEMENT LTD                                                                                    Bermuda
      -------------------------------------------------------------------------------------------------------------------------
      XL CAPITAL PARTNERS CORPORATION                                                                                 Cayman
      -------------------------------------------------------------------------------------------------------------------------
           XL Capital Partners I, L.P.                                                                                Cayman
           --------------------------------------------------------------------------------------------------------------------
                XL Capital Principal Partners I, L.L.C.                                                       50     Delaware
           --------------------------------------------------------------------------------------------------------------------
           XL Principal Partners I, L.P.                                                                              Cayman
           --------------------------------------------------------------------------------------------------------------------
                XL Capital Principal Partners I, L.L.C.                                                       50     Delaware
- -------------------------------------------------------------------------------------------------------------------------------


*A = COMPANY IS A MEMBER OF NAC REINSURANCE, INTERCARGO POOLING AGREEMENT WITH
     INDIVIDUAL COMPANY POOLING % NOTED
(*) - General Parter of XLA Garrison L.P.
(**) - Limited Partner of XLA Garrison L.P.

EX-23

                                                                    Exhibit 23.1


            CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
            --------------------------------------------------------

We  hereby  consent  to the  incorporation  by  reference  in  the  registration
statements of XL Capital Ltd on Form S-3 (File No.  333-116245),  Form S-3 (File
No. 333-101288),  Form S-3 (File No. 333-76988),  Form S-3 (File No. 333-72018),
Form S-3 (File No. 333-66976), Form S-3 (File No. 333-62257), Form S-8 (File No.
333-89568),  Form S-8 (File No. 333-81451),  Form S-8 (File No. 333-62137),  and
Form S-8 (File No. 333-46250) of our report dated March 11, 2005 relating to the
financial statements and financial statement schedules,  management's assessment
of the  effectiveness  of internal  control  over  financial  reporting  and the
effectiveness of internal control over financial reporting, which appears in the
2004 Annual  Report to  Shareholders,  which is  incorporated  by  reference  XL
Capital Ltd's Annual  Report on Form 10-K for the year ended  December 31, 2004.
We also  consent  to the  references  to us under  the  headings  "Experts"  and
"Selected Financial Data" in such Registration Statement.



/s/ PricewaterhouseCoopers LLP
New York, New York
March 11, 2005

EX-31

                                                                      Exhibit 31

                    CERTIFICATION OF CHIEF EXECUTIVE OFFICER
                                 XL CAPITAL LTD
            PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
                     (CHAPTER 98, TITLE 15 U.S.C. SS. 7241)

I, Brian M. O'Hara, certify that:

1. I have reviewed this Annual Report on Form 10-K of XL Capital Ltd;

2. Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact  necessary to make the statements
made, in light of the  circumstances  under which such statements were made, not
misleading with respect to the period covered by this report;

3.  Based  on my  knowledge,  the  financial  statements,  and  other  financial
information included in this report, fairly present in all material respects the
financial  condition,  results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;

4.  The  registrant's  other  certifying  officer  and  I  are  responsible  for
establishing and maintaining  disclosure  controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal  control over financial
reporting  (as defined in Exchange Act Rules  13a-15(f) and  15d-15(f))  for the
registrant and have:

      a)  Designed  such  disclosure  controls  and  procedures,  or caused such
      disclosure  controls and procedures to be designed under our  supervision,
      to ensure that material information relating to the registrant,  including
      its consolidated subsidiaries,  is made known to us by others within those
      entities,  particularly  during the  period in which this  report is being
      prepared;

      b) Designed such internal control over financial reporting, or caused such
      internal  control  over  financial  reporting  to be  designed  under  our
      supervision,  to provide reasonable assurance regarding the reliability of
      financial  reporting  and the  preparation  of  financial  statements  for
      external  purposes  in  accordance  with  generally  accepted   accounting
      principles;

      c) Evaluated the effectiveness of the registrant's disclosure controls and
      procedures  and  presented  in  this  report  our  conclusions  about  the
      effectiveness of the disclosure controls and procedures,  as of the end of
      the period covered by this report based on such evaluation; and

      d)  Disclosed  in this  report  any  change in the  registrant's  internal
      control over  financial  reporting that occurred  during the  registrant's
      most recent fiscal quarter (the registrant's  fourth fiscal quarter in the
      case of an annual report) that has materially  affected,  or is reasonably
      likely to  materially  affect,  the  registrant's  internal  control  over
      financial reporting; and



5. The registrant's other certifying officer and I have disclosed,  based on our
most recent  evaluation of internal  control over  financial  reporting,  to the
registrant's  auditors  and the audit  committee  of the  registrant's  board of
directors (or persons performing the equivalent functions):

      a) All significant  deficiencies and material  weaknesses in the design or
      operation  of  internal   control  over  financial   reporting  which  are
      reasonably likely to adversely affect the registrant's  ability to record,
      process, summarize and report financial information; and

      b) Any fraud,  whether or not material,  that involves management or other
      employees who have a significant role in the registrant's internal control
      over financial reporting.

      DATED: MARCH 11, 2005

                                         /s/ BRIAN M. O'HARA
                                         ---------------------------------------
                                         BRIAN M. O'HARA
                                         PRESIDENT AND CHIEF EXECUTIVE OFFICER


                    CERTIFICATION OF CHIEF FINANCIAL OFFICER
                                 XL CAPITAL LTD
            PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
                     (CHAPTER 98, TITLE 15 U.S.C. SS. 7241)

I, Jerry de St. Paer, certify that:

1. I have reviewed this Annual Report on Form 10-K of XL Capital Ltd;

2. Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact  necessary to make the statements
made, in light of the  circumstances  under which such statements were made, not
misleading with respect to the period covered by this report;

3.  Based  on my  knowledge,  the  financial  statements,  and  other  financial
information included in this report, fairly present in all material respects the
financial  condition,  results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;

4.  The  registrant's  other  certifying  officer  and  I  are  responsible  for
establishing and maintaining  disclosure  controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal  control over financial
reporting  (as defined in Exchange Act Rules  13a-15(f) and  15d-15(f))  for the
registrant and have:

      a)  Designed  such  disclosure  controls  and  procedures,  or caused such
      disclosure  controls and procedures to be designed under our  supervision,
      to ensure that material information relating to the registrant,  including
      its consolidated subsidiaries,  is made known to us by others within those
      entities,  particularly  during the  period in which this  report is being
      prepared;

      b) Designed such internal control over financial reporting, or caused such
      internal  control  over  financial  reporting  to be  designed  under  our
      supervision,  to provide reasonable assurance regarding the reliability of
      financial  reporting  and the  preparation  of  financial  statements  for
      external  purposes  in  accordance  with  generally  accepted   accounting
      principles;

      c) Evaluated the effectiveness of the registrant's disclosure controls and
      procedures  and  presented  in  this  report  our  conclusions  about  the
      effectiveness of the disclosure controls and procedures,  as of the end of
      the period covered by this report based on such evaluation; and

      d)  Disclosed  in this  report  any  change in the  registrant's  internal
      control over  financial  reporting that occurred  during the  registrant's
      most recent fiscal quarter (the registrant's  fourth fiscal quarter in the
      case of an annual report) that has materially  affected,  or is reasonably
      likely to  materially  affect,  the  registrant's  internal  control  over
      financial reporting; and



5. The registrant's other certifying officer and I have disclosed,  based on our
most recent  evaluation of internal  control over  financial  reporting,  to the
registrant's  auditors  and the audit  committee  of the  registrant's  board of
directors (or persons performing the equivalent functions):

      a) All significant  deficiencies and material  weaknesses in the design or
      operation  of  internal   control  over  financial   reporting  which  are
      reasonably likely to adversely affect the registrant's  ability to record,
      process, summarize and report financial information; and

      b) Any fraud,  whether or not material,  that involves management or other
      employees who have a significant role in the registrant's internal control
      over financial reporting.

      DATED: MARCH 11, 2005

                                         /s/ JERRY DE ST. PAER
                                         ----------------------------------
                                         JERRY DE ST. PAER
                                         EXECUTIVE VICE PRESIDENT AND
                                         CHIEF FINANCIAL OFFICER

EX-32

                                                                      Exhibit 32

                   CERTIFICATION ACCOMPANYING FORM 10-K REPORT
                                       OF
                                 XL CAPITAL LTD
            PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
              (CHAPTER 63, TITLE 18 U.S.C. SS.SS. 1350(a) AND (b))

Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Chapter 63, Title 18
U.S.C. ss.ss. 1350(a) and (b)), each of the undersigned hereby certifies that
the Annual Report on Form 10-K for the period ended December 31, 2004 of XL
Capital Ltd (the "Company") fully complies with the requirements of Section
13(a) or Section 15(d) of the Securities Exchange Act of 1934 and that the
information contained in such Report fairly presents, in all material respects,
the financial condition and results of operations of the Company.

      DATED: MARCH 11, 2005


      /s/ BRIAN M. O'HARA
      -------------------------------------
      BRIAN M. O'HARA
      PRESIDENT AND CHIEF EXECUTIVE OFFICER
      XL CAPITAL LTD

      DATED: MARCH 11, 2005


      /s/ JERRY DE ST. PAER
      -------------------------------------
      JERRY DE ST. PAER
      EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER
      XL CAPITAL LTD

A signed original of this written statement required by Section 906, or other
document authenticating, acknowledging, or otherwise adopting the signature that
appears in typed form within the electronic version of this written statement
required by Section 906, has been provided to XL Capital Ltd and will be
retained by XL Capital Ltd and furnished to the Securities and Exchange
Commission or its staff upon request.

EX-99.1

Exhibit 99.1

XL Capital Assurance Inc.
and Subsidiary

Consolidated Financial Statements

Years Ended December 31, 2004, 2003 and 2002

(Expressed in U.S. Dollars)

XL CAPITAL ASSURANCE INC. AND SUBSIDIARY

CONTENTS TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002

	Page
Report of Independent Registered Public Accounting Firm	1
Consolidated Financial Statements
Consolidated Balance Sheets at December 31, 2004 and 2003	2
Consolidated Statements of Operations and Comprehensive Income (Loss)
for the years ended December 31, 2004, 2003 and 2002	3
Consolidated Statements of Changes in Shareholder’s Equity for the years
ended December 31, 2004, 2003 and 2002	4
Consolidated Statements of Cash Flows for the years ended
December 31, 2004, 2003 and 2002	5
Notes to Consolidated Financial Statements	6–26

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To Board of Directors and Shareholder of XL Capital Assurance Inc. and Subsidiary:

     In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations and comprehensive income (loss), of changes in shareholder’s equity and of cash flows present fairly, in all material respects, the financial position of XL Capital Assurance Inc. and its subsidiary (the “Company”), at December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

PricewaterhouseCoopers LLP
New York, New York
March 11, 2005

1

XL CAPITAL ASSURANCE INC. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2004 AND 2003

(U.S. Dollars in thousands, except share amounts)	2004	2003
Assets
Investments
Fixed maturities available for sale, at fair value
(amortized cost: 2004 - $270,523; 2003 - $237,589)	$272,950	$239,629
Short-term investments, at fair value
(amortized cost: 2004 - $3,657; 2003 - $8,812)	3,657	8,814
Total investments	276,607	248,443
Cash and cash equivalents	58,038	76,854
Accrued investment income	2,564	2,324
Prepaid reinsurance premiums	362,725	291,530
Premiums receivable	6,938	2,712
Reinsurance balances recoverable on unpaid losses	82,895	22,998
Intangible assets - acquired licenses	11,529	11,529
Deferred Federal income tax asset	17,260	13,560
Other assets	9,259	12,703
Total assets	$827,815	$682,653
Liabilities and Shareholder’s Equity
Liabilities
Unpaid losses and loss adjustment expenses	$ 86,438	$ 25,009
Deferred premium revenue	406,296	318,547
Deferred ceding commissions, net	37,270	33,738
Reinsurance premiums payable	25,849	33,422
Accounts payable and accrued expenses	14,435	19,482
Current Federal income tax payable	2,917	6,754
Intercompany payable to affiliates	20,644	8,473
Total liabilities	593,849	445,425
Shareholder’s Equity
Common stock (par value $7,500 per share; 8,000 shares
authorized; 2,000 shares issued and outstanding)	15,000	15,000
Additional paid-in capital	239,173	239,173
Accumulated other comprehensive income (net of deferred Federal
income tax liability of: 2004 - $850; 2003 - $715)	1,578	1,327
Accumulated deficit	(21,785)	(18,272)
Total shareholder’s equity	233,966	237,228
Total liabilities and shareholder’s equity	$827,815	$682,653

See accompanying notes to consolidated financial statements.

2

XL CAPITAL ASSURANCE INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002

(U.S. Dollars in thousands)	2004	2003	2002
Revenues
Gross premiums written	$ 211,235	$ 243,317	$ 154,129
Ceded premiums written	(183,468)	(220,622)	(143,156)
Net premiums written	27,767	22,695	10,973
Change in net deferred premium revenue	(16,554)	(15,837)	(7,973)
Net premiums earned (net of ceded earned
premium of $112,273 in 2004, $81,042 in 2003,
and $32,933 in 2002)	11,213	6,858	3,000
Net investment income	10,880	5,869	5,799
Net realized (losses) gains on investments	(670)	71	1,975
Net realized and unrealized gains (losses) on
credit derivatives	2,454	2,273	(24)
Fee income and other	100	1,412	157
Total revenues	23,977	16,483	10,907
Expenses
Net losses and loss adjustment expenses (net of ceded
losses and loss adjustment expenses of $61,123 in 2004,
$13,484 in 2003 and $8,233 in 2002)	2,263	1,225	754
Net operating expenses	24,259	19,981	17,835
Total expenses	26,522	21,206	18,589
Loss before Federal income tax expense (benefit)	(2,545)	(4,723)	(7,682)
Current Federal income tax expense	4,802	6,754	45
Deferred Federal income tax benefit	(3,834)	(7,709)	(2,478)
Total Federal income tax expense (benefit)	968	(955)	(2,433)
Net loss	(3,513)	(3,768)	(5,249)
Comprehensive Income (Loss)
Unrealized (depreciation) appreciation of investments
arising during year (net of deferred Federal income tax
(benefit) expense of $(100), $(822) and $1,661)	(184)	(1,439)	3,042
Less: reclassification for (losses) gains realized in income
(net of deferred Federal income tax (benefit)
expense of $(234), $25 and $691)	(435)	46	1,284
Other comprehensive (loss) income	251	(1,485)	1,758
Comprehensive loss	$ (3,262)	$ (5,253)	$ (3,491)

See accompanying notes to consolidated financial statements.

3

XL CAPITAL ASSURANCE INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDER’S EQUITY
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002

(U.S. Dollars in thousands, except share amounts)	2004	2003	2002
Common Shares
Number of shares — beginning of year	2,000	2,000	2,000
Number of shares — end of year	2,000	2,000	2,000
Common Stock
Balance — beginning of year	$ 15,000	$ 15,000	$ 15,000
Balance — end of year	15,000	15,000	15,000
Additional Paid-In Capital
Balance — beginning of year	239,173	139,154	119,154
Capital contribution	—	100,019	20,000
Balance — end of year	239,173	239,173	139,154
Accumulated Other Comprehensive Income
Balance — beginning of year	1,327	2,812	1,054
Net change in unrealized appreciation of investments,
net of deferred Federal tax (benefit) expense of
$134 in 2004, $(847) in 2003 and $970 in 2002	251	(1,485)	1,758
Balance — end of year	1,578	1,327	2,812
Accumulated deficit
Balance — beginning of year	(18,272)	(14,504)	(9,255)
Net loss	(3,513)	(3,768)	(5,249)
Balance — end of year	(21,785)	(18,272)	(14,504)
Total shareholder’s equity	$233,966	$237,228	$142,462

See accompanying notes to consolidated financial statements.

4

XL CAPITAL ASSURANCE INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002

(U.S. Dollars in thousands)	2004	2003	2002
Cash flows provided by operating activities
Net loss	$(3,513)	$(3,768)	$(5,249)
Adjustments to reconcile net loss to net cash provided by
operating activities
Net realized losses (gains) on sale of investments	670	(71)	(1,975)
Net realized and unrealized (gains) losses on credit
derivatives, excluding cash received and paid	(542)	(725)	513
Amortization of premium on bonds	1,147	1,176	919
Increase in unpaid losses and loss adjustment
expenses, net	1,532	1,225	754
Increase in deferred premium revenue, net	16,554	15,838	7,973
Increase in deferred ceding commissions, net	3,532	22,084	10,536
Increase (decrease) in reinsurance premiums payable	(7,573)	13,981	1,793
(Increase) decrease in premiums receivable	(4,226)	1	(1,643)
(Increase) in accrued investment income	(240)	(949)	(478)
Increase (decrease) in current Federal
income tax payable	(3,837)	6,754	1,651
Deferred Federal income tax asset	(3,834)	(7,709)	(2,478)
Increase (decrease) in accounts payable and
accrued expenses	(4,427)	5,267	1,471
Increase (decrease) in intercompany payable
to affiliates	12,171	(1,816)	(1,020)
Other	3,366	(2,741)	121
Total adjustments	14,293	52,315	18,137
Net cash provided by operating activities	10,780	48,547	12,888
Cash flows from investing activities
Proceeds from sale of fixed maturities and
short-term investments	213,442	281,357	167,142
Proceeds from maturity of fixed maturities and
short-term investments	2,239	26,779	64,292
Purchase of fixed maturities and short-term investments	(245,277)	(424,562)	(258,812)
Net cash used in investing activities	(29,596)	(116,426)	(27,378)
Cash flows from financing activities
Capital contribution	—	100,019	20,000
Net cash provided by financing activities	—	100,019	20,000
(Decrease) increase in cash and cash equivalents	(18,816)	32,140	5,510
Cash and cash equivalents
Beginning of year	76,854	44,714	39,204
End of year	$58,038	$76,854	$44,714
Taxes paid (refund received)	$8,639	$  —	$(1,699)

See accompanying notes to consolidated financial statements.

5

XL CAPITAL ASSURANCE INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004, 2003 AND 2002

1. Organization and Ownership

     XL Capital Assurance Inc. (the “Company”) is a wholly owned subsidiary of XL Reinsurance America, Inc. (“XL RE AM”). XL RE AM and the Company are indirect wholly owned subsidiaries of XL Capital Ltd (“XL Capital”), a public company whose shares are listed on the New York Stock Exchange.

     The Company is an insurance company domiciled in the State of New York and licensed to conduct financial guaranty insurance business throughout the United States, except Wyoming, as well as in Puerto Rico, the District of Columbia, and the U.S. Virgin Islands. The Company has triple-A financial strength ratings from Standard & Poor’s, Moody’s Investors Service, and Fitch Ratings. The Company is primarily engaged in the business of providing credit enhancement on fixed and variable rate income securities through the issuance of financial guaranty insurance policies, and credit protection on specific referenced credits or on pools of specific referenced credits through the issuance of credit default swaps.

     Financial guaranty insurance provides an unconditional and irrevocable guaranty that protects the holder of a financial obligation against non-payment of principal and interest when due. Financial guaranty insurance may be issued to the holders of the insured obligations at the time of issuance of those obligations, or may be issued in the secondary market to holders of public bonds and structured securities. Credit default swaps are derivative contracts which offer credit protection relating to a particular security or issuer. Under the terms of a credit default swap, the seller of credit protection makes a specified payment to the buyer of credit protection upon the occurrence of one or more specified credit events with respect to a reference obligation or entity. Credit derivatives typically provide protection to a buyer rather than credit enhancement of an issue as in traditional financial guaranty insurance. See Notes 9 and 15 for further details.

     On April 24, 2002, the Company formed XL Capital Assurance (U.K.) Limited, (“XLCA-UK”), an insurance company organized under the laws of England. XLCA-UK is a wholly owned subsidiary of the Company.

     In addition to its New York headquarters and London subsidiary (which has a Madrid branch), the Company maintains branch offices domestically in California and abroad in Singapore.

2. Summary of Significant Accounting Policies

Basis of Presentation and Consolidation

     The accompanying consolidated financial statements include the accounts of the Company and its subsidiary and have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”), which for insurance companies differ in certain respects from the accounting practices prescribed or permitted by the New York Insurance Department (“NYID”) (See Note 14). The Company’s results from operations include the results of its subsidiary from April 24, 2002, the date it commenced operations. All significant intercompany accounts and transactions have been eliminated. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities, as well as the reported amounts of revenue and expenses. Actual results may differ from those estimates. Certain comparative figures have been reclassified to conform with the current year’s presentation.

Investments

     All of the Company’s investments in fixed-maturity securities are considered available-for-sale and accordingly are carried at fair value. The fair value of investments is based on quoted market prices received from a nationally recognized pricing service or dealer quotes. The net unrealized appreciation or depreciation on investments, net of deferred Federal income tax, is included in accumulated other comprehensive income (loss). Any

6

XL CAPITAL ASSURANCE INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 2004, 2003 AND 2002

unrealized depreciation in value considered by management to be other than temporary is charged to income in the period that such determination is made.

     At the end of each accounting period, the Company reviews unrealized losses on its investment securities to identify declines in fair value that are other than temporary. This review involves consideration of several factors including (i) the time period during which there has been a significant decline in value, (ii) an analysis of the liquidity, business prospects and overall financial condition of the issuer, (iii) the significance of the decline, (iv) an analysis of the collateral structure and other credit support, as applicable, of the securities in question and (v) the Company’s intent and ability to hold the investment for a sufficient period of time for the value to recover. Where the Company concludes that a decline in fair value is other than temporary, the cost of the security is written down to fair value and the previously recognized unrealized loss is therefore realized in the period such determination is made.

     With respect to securities where the decline in value is determined to be temporary and the security’s value is not written down, a subsequent decision may be made to sell that security and realize a loss. Subsequent decisions on security sales are made within the context of overall risk monitoring, changing information, general market conditions and assessing value relative to other comparable securities. For the years ended December 31, 2004, 2003 and 2002, there were no declines in fair value deemed to be other than temporary.

     Bond discounts and premiums are amortized on the effective yield method over the remaining terms of securities acquired. For mortgage-backed securities, and any other holdings for which prepayment risk may be significant, assumptions regarding prepayments are evaluated periodically and revised as necessary. Any adjustments required due to the resulting change in effective yields are recognized in current income.

     Short-term investments comprise securities with maturities equal to or greater than 90 days but less than one year at time of purchase. Cash equivalents include fixed-interest and money market fund deposits with a maturity of under 90 days when purchased.

     All investment transactions are recorded on a trade date basis. Realized gains and losses on sales of fixed-maturity securities are determined on the basis of specific identification. Investment income is recognized when earned.

Premium Revenue Recognition

     Up-front premiums are reported as written and earned pro-rata to the amount of risk outstanding over the expected period of coverage. The amount of risk outstanding is equal to the sum of the par amounts of debt insured. Premiums are allocated to each bond maturity and are earned on a straight-line basis over the term of each maturity. Installment premiums are reported as written when due and are earned over each installment period—typically a month or quarter.

     Deferred premium revenue and prepaid reinsurance premiums represent the portion of premiums written which is applicable to the unexpired terms of policies in force. If an insured issue is retired or defeased prior to the end of the expected period of coverage, the remaining deferred premium, less any amount credited to a refunding issue insured by the Company, will be recognized in income at that time.

Fee Income and Other

     The Company collects advisory and structuring fees in connection with certain transactions. Depending upon the type of fee received, the fee is either earned when services are rendered and the fee is due or deferred and earned over the life of the related transaction. Work, waiver and consent, and termination fees are earned when due and are included in Fee Income and Other. Structuring and commitment fees are included in premiums and earned on a straight-line basis over the life of the related transaction.

7

XL CAPITAL ASSURANCE INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 2004, 2003 AND 2002

Losses and Loss Adjustment Expenses

     Reserves for losses and loss adjustment expenses (“LAE”) in the accompanying consolidated balance sheets are reflected gross of reinsurance. Reserves for losses and loss adjustment expenses include case basis reserves and unallocated reserves. Case basis reserves are established when losses on specific insured obligations are probable and can be reasonably estimated. Case basis reserves represent the present value of expected future loss payments and loss adjustment expenses, net of estimated recoveries but before considering ceded reinsurance. Case basis reserves are discounted at appropriate rates to reflect the period over which claims are expected to be paid on the underlying insured transactions.

     In addition to case basis reserves, the Company maintains an unallocated loss reserve for expected levels of losses associated with currently insured issues, which is estimated by management based upon an actuarial reserving analysis. The actuarial methodology applied by the Company is in accordance with Actuarial Standards of Practice No. 36, Determination of Reasonable Provision. This methodology was adopted by the Company in 2002. The methodology applied is based on the selection of an initial expected loss ratio, as well as an expected loss emergence pattern. In accordance with the Company's accounting policy, the initial expected loss ratio is applied to earned premium each quarter and the expected loss emergence pattern is analyzed on an annual basis as part of the Company's review of the overall adequacy of the unallocated loss reserve recorded on the Company’s balance sheet.

     The Company’s selection of an initial expected loss ratio and loss emergence pattern considered the characteristics of the Company’s own book of business as well as its actual loss experience and that of the industry. On an annual basis, the Company compares its selected initial expected loss ratio to its actual loss experience, as well as to industry loss experience, and will adjust it as considered necessary, to ensure such initial expected loss ratio continues to be appropriate for the risks in its inforce business. In addition, the expected loss emergence pattern will be adjusted or realigned on an annual basis, as considered necessary, to better correlate with the underlying changes in the Company’s in force business. (e.g. changes in the average life of in-force business resulting from changes in the mix of business and risk expiration). The Company’s unallocated reserve is available to be applied to new case basis reserves that may be established for claims on current outstanding insured principal and interest in the future.

     The Company is aware of the Securities and Exchange Commission’s (the “SEC”) recent review of the loss reserving practices of the financial guaranty insurance industry. The Company recognizes that there is diversity in practice among financial guarantee insurers and reinsurers with respect to their accounting policies for loss reserves. Current accounting literature, specifically Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards No. 60 “Accounting and Reporting by Insurance Enterprises” (“SFAS 60”) and FASB Statement of Financial Accounting Standards No. 97 “Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments” (“SFAS 97”), does not specifically address the unique characteristics of financial guarantee insurance contracts. Consequently, the accounting principles applied by the industry, as well as the Company, have evolved over time and incorporate the concepts of both short-duration and long-duration contracts accounting under the provisions of SFAS 60 and SFAS 97, as well as other accounting literature, such as SFAS 5 “Accounting for Contingencies” and Emerging Issues Task Force (“EITF”) Issue No. 85-20 “Recognition of Fees for Guaranteeing a Loan”. It is our understanding that the SEC has requested that the FASB review this matter and provide guidance for the accounting of financial guarantee insurance contracts. The Company will continue its loss reserving methodology as noted above until further guidance is provided by the SEC or the FASB.

Deferred Acquisition Costs

     Certain costs incurred, primarily relating to and varying with the production of new business, have been deferred. These costs include direct and indirect expenses related to underwriting, marketing and policy issuance, rating agency fees and premium taxes, reduced by ceding commission income on premiums ceded to reinsurers. The Company considers the present value of future premiums under installment contracts written and the current value of deferred premium revenue when determining the recoverability of deferred acquisition costs (“DAC”). DAC and deferred ceding commissions (“DCC”) are amortized on a straight-line basis over the weighted average life of the Company’s in force business. If an insured issue is retired or defeased prior to the end of the expected period of coverage, the remaining net amount of DAC and DCC with respect to such insured issue is recognized at such time.

8

XL CAPITAL ASSURANCE INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 2004, 2003 AND 2002

Reinsurance

     In the normal course of business, the Company seeks to reduce the loss that may arise from events that could cause unfavorable underwriting results by reinsuring certain levels of risk in various areas of exposure with other insurance enterprises or reinsurers. Reinsurance premiums ceded are earned on a pro-rata basis over the period the reinsurance coverage is provided. Prepaid reinsurance premiums represent the portion of premiums ceded which is applicable to the unexpired term of policies in-force. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policy. Provision is made for any estimated uncollectible reinsurance. At December 31, 2004 and 2003, the Company had no provision recorded for uncollectible reinsurance.

Intangible Assets—Acquired Licenses

     Licenses to transact insurance business were recorded at fair value when acquired as part of the 2001 acquisition of The London Assurance of America, Inc. (“LAA”). Prior to 2002, the Company had been amortizing the acquired licenses over a 40-year period. Effective January 1, 2002 the Company adopted SFAS 142, “Goodwill and Other Intangible Assets,” (“SFAS 142”) and ceased amortizing the licenses as they have an indefinite life. Under SFAS 142, the recoverability of the carrying values of intangible assets is evaluated annually for impairment based on a review of forecasted discounted cash flows and by referencing other available information. As of December 31, 2004 and 2003, there were no adjustments to the carrying value of intangible assets resulting from these evaluations.

Income Taxes

     Deferred Federal income taxes are provided for temporary differences between the tax and financial reporting basis of assets and liabilities that will result in deductible or taxable amounts in future years when the reported amounts of the assets or liabilities are recovered or settled.

Derivative Instruments—Credit Default Swaps

     The Company recognizes all derivatives as either assets or liabilities in the consolidated balance sheet and measures those instruments at fair value with changes in fair value included in net realized and unrealized gains (losses) on credit derivatives in the Company’s consolidated statement of operations. Derivative instruments that the Company holds consist of credit default swaps issued by the Company which meet the definition of a derivative under FASB Statement of Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities, as amended” (“SFAS 133”). The Company intends to hold these derivative instruments until maturity. The Company does not hold any derivatives that are designated as hedges for financial reporting purposes.

Variable Interest Entities

     The Company participates in transactions which utilize variable interest entities (“VIE’s”) in the ordinary course of the Company’s business. The Company provides financial guaranty insurance of structured transactions backed by pools of assets of specified types, municipal obligations supported by the issuers’ ability to charge fees for specified services or projects, and corporate risk obligations including essential infrastructure projects and obligations backed by receivables from future sales of commodities and other specified services. The obligations related to these transactions are often securitized through off-balance sheet VIE’s. In synthetic transactions, the Company guarantees payment obligations of counterparties, including VIE’s, through credit default swaps referencing asset portfolios. The Company only provides financial guaranty insurance of these VIE’s for fixed premiums at market rates but does not hold any equity positions or subor-

9

XL CAPITAL ASSURANCE INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 2004, 2003 AND 2002

dinated debt in these off-balance sheet arrangements. These financial guaranty insurance contracts represent variable interests held by the Company in variable interest entities.

     In underwriting financial guaranty insurance, the Company believes the risk of any loss to be remote based upon the Company’s requirement that guaranteed obligations be investment-grade prior to the provision of credit enhancement. Typically, in the case of asset-backed securities and other structured obligations, such investment grade ratings are based upon subordination, cash reserves and other structural protections. Consequently, the Company has determined that it is not the primary beneficiary of any VIE’s in which it holds a variable interest. Accordingly, these VIE’s are not consolidated. Disclosures of the Company’s exposure to loss and nature and size of VIE’s in which the Company is involved are included in Note 9.

Segment Reporting

As a monoline financial guaranty insurer, the Company is one reportable operating segment.

3. Investments

     The Company’s primary investment objective is the preservation of capital through maintenance of high-quality investments with adequate liquidity. A secondary objective is optimizing long-term, after-tax returns. The credit quality of fixed-maturity securities at December 31, 2004 and 2003, based on fair value, is as follows:

		Percent of
		fixed-maturity securities
Rating		2004	2003
	AAA	62%	69%
	AA	12	7
	A	26	24
		100%	100%

The amortized cost and fair value of investments as of December 31, 2004 and 2003 are as follows:

	2004
	Cost or	Gross	Gross
	Amortized	Unrealized	Unrealized	Fair
(U.S. Dollars in thousands)	Cost	Gains	Losses	Value
Fixed maturities
U.S. Government and government
agencies and authorities	$58,507	$1,415	$(57)	$59,865
Special revenue and assessment
obligations of agencies and
authorities of government
and political subdivisions	53,502	576	(155)	53,923
Industrial and miscellaneous	158,514	1,606	(958)	159,162
Total fixed maturities	$270,523	$3,597	$(1,170)	$272,950
Short-term investments
Total short-term investments	$3,657	$  —	$  —	$3,657

10

XL CAPITAL ASSURANCE INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 2004, 2003 AND 2002

	2003
	Cost or	Gross	Gross
	Amortized	Unrealized	Unrealized	Fair
(U.S. Dollars in thousands)	Cost	Gains	Losses	Value
Fixed maturities
U.S. Government and government
agencies and authorities	$91,746	$1,481	$(184)	$93,043
Special revenue and assessment
obligations of agencies and
authorities of government
and political subdivisions	23,961	126	(396)	23,691
Industrial and miscellaneous	121,882	1,411	(398)	122,895
Total fixed maturities	$237,589	$3,018	$(978)	$239,629
Short-term investments
Total short-term investments	$8,812	$ 4	$ (2)	$8,814

     Fixed-maturity investments with a par value and fair value of $6,242,000 and $6,760,399 and $6,242,000 and $6,784,540 at December 31, 2004 and 2003, respectively, were on deposit with various regulatory authorities as required by insurance laws.

     The change in net unrealized gains (losses) consists of: 

(U.S. Dollars in thousands)	Years Ended December 31,
	2004	2003	2002
Fixed-maturity securities	$387	$(2,334)	$2,728
Short-term investments	(2)	2	—
Change in net unrealized gains (losses)	$385	$(2,332)	$2,728

     The amortized cost and fair value of bonds at December 31, 2004 and 2003 by contractual maturity are shown below. Actual maturity may differ from contractual maturity because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

(U.S. Dollars in thousands)	December 31, 2004		December 31, 2003
	Amortized	Fair	Amortized	Fair
	Cost	Value	Cost	Value
Due in one year or less	$ 15,042	$ 15,047	$ 12,030	$ 12,051
Due after one year through five years	43,702	43,631	80,849	81,616
Due after five years through ten years	66,823	67,376	57,270	57,256
Due after ten years	16,097	17,437	8,938	9,456
	141,664	143,491	159,087	160,379
Government agencies, authorities and
other mortgage-backed securities	128,859	129,459	78,502	79,250
Total	$ 270,523	$ 272,950	$ 237,589	$ 239,629

11

XL CAPITAL ASSURANCE INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 2004, 2003 AND 2002

     Proceeds from sales of fixed maturities for the years ended December 31, 2004, 2003 and 2002 were $213,442,000, $281,357,107, and $117,925,508, respectively.

     The gross realized gains and gross realized losses for the years ended December 31, 2004, 2003, and 2002 related to the sale of investments were as follows:

(U.S. Dollars in thousands)
	2004		2003		2002
	Gains	Losses	Gains	Losses	Gains	Losses
Fixed maturities	$797	$ (1,476)	$ 1,331	$(1,259)	$ 2,217	$(248)
Short-term investments	10	(1)	—	(1)	6	—
Total	$807	$ (1,477)	$ 1,331	$(1,260)	$ 2,223	$(248)
Net investment income is derived from the following sources:
(U.S. Dollars in thousands)				Year Ended December 31,
				2004	2003	2002
Fixed maturities				$10,594	$5,468	$5,180
Short-term investments				62	206	315
Cash and cash equivalents				471	325	557
				11,127	5,999	6,052
Less: investment expenses				247	130	253
Net investment income				$10,880	$5,869	$5,799

     The following table presents the Company’s investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2004:

(U.S. Dollars in thousands)
	Less than 12 months		12 months or more		Total
	Fair	Unrealized	Fair	Unrealized	Fair	Unrealized
Description of securities	Value	Losses	Value	Losses	Value	Losses
U.S. Government and
government agencies and
authorities	$ 9,956	$(54)	$264	$ (3)	$ 10,220	$ (57)
Special revenue and assessment
obligations of agencies and
authorities of government
and political subdivisions	18,434	(151)	2,189	(4)	20,623	(155)
Industrial and miscellaneous	68,131	(759)	19,961	(199)	88,092	(958)
Total temporarily
impaired fixed-maturity
securities	$96,521	$(964)	$22,414	$(206)	$ 118,935	$(1,170)

12

XL CAPITAL ASSURANCE INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 2004, 2003 AND 2002

     The high credit quality of the Company’s investment portfolio of fixed-maturity securities is primarily due to strict adherence to conservative investment guidelines. Unrealized gains and losses are deemed to be temporary and result from general interest rate movements.

4. Information Concerning Parent and Affiliates

Capital Transactions

     On May 15, 2002, the Company received a $20,000,000 capital contribution from XL RE AM. The funds were used by the Company to capitalize XLCA-UK.

     On December 8, 2003, the Company received a $100,019,000 capital contribution from XL RE AM. The funds were used to support the Company’s continued growth and for general corporate purposes.

General Services Agreements

     The Company entered into a General Services Agreement effective January 28, 2002 (the “XLFAS General Services Agreement”) with an affiliated company, XL Financial Administrative Services Inc. (“XLFAS”), which was approved by the NYID on July 18, 2002. XLFAS employs substantially all the personnel of the Company and provides the office space and furniture and equipment used by the Company. Under the terms of this agreement, operating expenses are allocated based on the requirements of Regulation 30 of the NYID. In 2004, 2003 and 2002, operating expenses were allocated to the Company under this agreement in the amount of $57,705,330, $47,813,662, and $34,236,629, respectively.

     The Company entered into a General Services Agreement effective October 22, 2004 (the “XLFP Service Agreement”) with an affiliated company, XL Financial Products Ltd. (“XLFP”), a company formed under the laws of England. The XLFP Service Agreement was approved by the NYID on October 22, 2004. The XLFP Service Agreement provides for XLFP to provide the following services to XLCA-UK: identification and analysis of business opportunities for XLCA-UK with respect to certain products typically insured by XLCA-UK; assistance in structuring and tailoring products for actual or potential clients and beneficiaries; marketing and promoting products and related activity; and prompt communication to XLCA-UK of any notices or other documents which XLFP receives relating to claims or other incidents under any of the policies. Amounts allocated to the Company under the XLFP Service Agreement in 2004 were immaterial.

     In addition to the XLFAS General Services Agreement and the XLFP Service Agreement, the Company has entered into two service agreements with certain of its U.S. affiliates, including its ultimate U.S. holding company, X.L. America, Inc. (“XLA”). These services agreements include the following:

• Amended and Restated General Services Agreement, dated January 1, 2003 (the “Global Services Agreement”) among X.L. Global Services, Inc.(“XLGS”), XLA on behalf of: the Company, XLFAS and various other affiliates. The Global Services Agreement provides for the following services to be provided by XLGS: IT Support; Reinsurance Services; Reinsurance and Retrocessional Consulting; Reinsurance and Retrocessional Contract Management; Actuarial Services; Finance Dept. Services; Internal Audit Services; and Human Resources Services. The NYID approved the Global Services Agreement on January 24, 2003.
  
  
• Second Amended and Restated General Services Agreement, dated January 1, 2003 (the “XL America General Services Agreement”), among XLA, XLFAS, the Company and various other affiliates. The XL America General Services Agreement provides for the following services to be rendered to the Company and its affiliates: Advertising; Boards; Bureaus and Association, i.e., the subsidiaries’ direct regulatory and association participation and their proportion of industry-related associated participation under the XL America trade name; Surveys and Underwriting Expenses; Professional Fees, Total Compensation; Travel

13

XL CAPITAL ASSURANCE INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 2004, 2003 AND 2002

and Expense; Insurance; Rent and Rent Items; Equipment; Printing and Stationery; Postage, Telephone and Telegraph Exchange and Express; Legal and Auditing; License Fees and Taxes; Actuarial and Accounting; Administrative and Managerial; Data Processing; Claims; and Regulatory Compliance. The XL America General Services Agreement was approved by the NYID on January 22, 2003.

     Expenses allocated to the Company under the Global Services Agreement and the XL America General Services Agreement for the years ended December 31, 2004 and 2003 were $11,419,739 and $3,305,010, respectively.

Employee Benefit Plans

     XLA maintains a qualified defined contribution pension plan for the benefit of all eligible employees and a non-qualified deferred compensation plan for the benefit of certain employees of XLFAS and some other subsidiaries (collectively, the “Plans”). XLFAS’s discretionary contributions to both Plans are based on a fixed percentage of employee contributions and compensation as defined by the Plans. The Company’s share of allocated pension expense was $1,829,140, $1,333,815 and $1,847,385 for 2004, 2003 and 2002, respectively.

Facultative Quota Share Reinsurance Treaties

     On October 6, 1999, the Company entered into an arm’s-length Facultative Quota Share Reinsurance Treaty (“Treaty”) with XL Financial Assurance Ltd (“XLFA”), a Bermuda financial guaranty reinsurer, which is 86.8% owned by XL Capital through its wholly owned subsidiary, XL Insurance (Bermuda) Ltd. The remaining 13.2% of XLFA is owned by Financial Security Assurance Holdings Ltd., an unrelated company. Under the terms of this agreement, XLFA agrees to reinsure up to 90% of the Company’s acceptable risks. The Company is allowed up to a 30% ceding commission (or such other percentage on an arm’s-length basis) on ceded premiums written under the terms of this agreement.

     The Company entered into a Facultative Master Certificate (the “XL Re Treaty”) with XL RE AM, effective as of December 1, 2002. Under the terms of the XL Re Treaty, XL RE AM agrees to automatically reinsure risks insured by the Company under financial guaranty insurance policies up to the amount necessary for the Company to comply with single risk limitations set forth in Section 6904(d) of the New York Insurance Laws. The reinsurance provided by XL RE AM may be on an excess of loss or quota share basis. The Company is allowed a 30% ceding commission (or such other percentage on an arm’s-length basis) on ceded premiums written under the terms of this agreement.

     Effective January 1, 2004, the Company commuted all the reinsurance ceded under the XL Re Treaty through December 31, 2003. The following sets forth the amounts recorded by the Company in 2004 as a result of this commutation.

(U.S. Dollars in thousands)
As of and for the year ended December 31, 2004

Ceded premiums written	$   (5,958)
Ceded premiums earned	(848)
Ceding commission revenue	(225)
Par exposure ceded	(442,929)

Related Party Guarantees

     In 2002, the Company began providing financial guaranty insurance policies insuring timely payment of investment agreements issued by XL Asset Funding Company I LLC, an affiliate of the Company. As of December 31, 2004 and 2003, the net aggregate amount of investment agreements insured was $255,730,165 and

14

XL CAPITAL ASSURANCE INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 2004, 2003 AND 2002

$149,407,865, respectively. These insurance policies are collateralized by investment securities, accrued interest, cash and cash equivalents, which as of December 31, 2004 and 2003 had an aggregate fair value of $262,421,920 and $152,717,561, respectively. Under these agreements, the Company recorded net premiums written and earned of $1,974,409 and $85,138 during 2004 and 2003, respectively.

Surplus Maintenance Agreement

     XL RE AM has contractually agreed to maintain the Company’s statutory capital and surplus at a minimum of $75,000,000. This agreement has been in effect during all periods presented herein.

5. Net Premiums Earned

     Net premiums earned are comprised of:

(U.S. Dollars in thousands)	Year Ended December 31,
	2004	2003	2002
Direct premiums written	$210,630	$240,565	$150,893
Assumed premiums written	605	2,752	3,236
Ceded premiums written	(183,468)	(220,622)	(143,156)
Net premiums written	27,767	22,695	10,973
Change in direct deferred premium revenue	(88,556)(1)	(155,695)	(118,055)
Change in assumed deferred premium revenue	807	278	(141)
Change in prepaid reinsurance premiums	71,195(1)	139,580	110,223
Net premiums earned	$11,213	$6,858	$3,000

(1) Includes $23.3 million of earned premium relating to the recognition of a full limit loss on an insured transaction — See Note 10.

6. Net Operating Expenses

     Net operating expenses are comprised of:

(U.S. Dollars in thousands)	Year Ended December 31,
	2004	2003	2002
Operating expenses
Gross operating expenses	$76,480	$66,444	$47,290
Less: Deferred acquisition costs (“DAC”)	24,652	20,719	16,110
Add: Amortization of DAC	7,223	7,436	3,760
Operating expenses	59,051	53,161	34,940
Ceding commission revenue
Gross ceding commission revenue	55,753	68,547	39,991
Less: Deferred ceding commissions (“DCC”)	35,132	48,292	28,093
Add: Amortization of DCC	14,171	12,925	5,207
Ceding commission revenue	34,792	33,180	17,105
Net operating expenses	$24,259	$19,981	$17,835

15

XL CAPITAL ASSURANCE INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 2004, 2003 AND 2002

7. Deferred Ceding Commissions and Deferred Acquisition Costs

     The ceding commission income and costs deferred and related amortization are as follows:

(U.S. dollars in thousands)	December 31,
	2004	2003
Deferred ceding commissions, net
Beginning of year	$(33,738)	$(11,654)
Ceding commission revenue
Ceding commission revenue deferred during the year	(35,132)	(48,292)
Ceding commissions amortized	14,171	12,925
Acquisition costs
Costs deferred during the year	24,652	20,719
Costs amortized	(7,223)	(7,436)
Deferred ceding commissions, net
End of year	$(37,270)	$(33,738)

8. Reinsurance

     The Company utilizes reinsurance principally to increase aggregate premium capacity and to reduce the risk of loss on financial guarantee business underwritten. This reinsurance includes the Facultative Quota Share Reinsurance Treaties with affiliates discussed in Note 4 as well as other facultative reinsurance with non-affiliated reinsurers. Reinsurance does not relieve the Company of its obligations under its policies of insurance and credit default swap contracts. Accordingly, the Company is still liable under such policies and contracts even if any or all of the reinsuring companies are unable to meet their obligations to the Company, or contest such obligations. The Company regularly monitors the financial condition of its reinsurers and believes there are no material uncollectible reinsurance balances at December 31, 2004 and 2003. The following tables set forth certain amounts ceded to affiliate and non-affiliate reinsurers as of and for the years ended December 31, 2004, 2003 and 2002. The affiliated amounts presented for 2004 do not include the effect of the commutation with XL RE AM discussed in Note 4.

(U.S. Dollars in thousands)	2004
	Affiliate	Non-Affiliate	Total
Year ended December 31
Ceded premiums written	$ 180,074	$ 3,394	$ 183,468
Ceded premiums earned	108,536	3,737	112,273
Ceding commission revenue	33,956	836	34,792
Ceded losses and loss adjustment expenses	60,189	934	61,123
At December 31
Par exposure ceded	$58,049,780	$1,265,521	$59,315,301
Reinsurance balances recoverable on unpaid losses	79,376	3,519	82,895

16

XL CAPITAL ASSURANCE INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 2004, 2003 AND 2002

(U.S. Dollars in thousands)	2003
	Affiliate	Non-Affiliate	Total
Year ended December 31
Ceded premiums written	$ 213,912	$ 6,710	$ 220,622
Ceded premiums earned	75,282	5,760	81,042
Ceding commission revenue	31,742	1,438	33,180
Ceded losses and loss adjustment expenses	11,990	1,494	13,484
At December 31
Par exposure ceded	$36,231,821	$ 635,060	$36,866,881
Reinsurance balances recoverable on unpaid losses	20,493	2,505	22,998
(U.S. Dollars in thousands)	2002
	Affiliate	Non-Affiliate	Total
Year ended December 31
Ceded premiums written	$ 136,478	$ 6,678	$ 143,156
Ceded premiums earned	29,271	3,662	32,933
Ceding commission revenue	14,924	2,181	17,105
Ceded losses and loss adjustment expenses	7,317	916	8,233
At December 31
Par exposure ceded	$19,789,347	$1,119,004	$20,908,351
Reinsurance balances recoverable on unpaid losses	8,024	1,570	9,594

9. Outstanding Exposure and Collateral

     The Company’s policies insure the scheduled payments of principal and interest on insured obligations. The net exposure retained on any risk is subject to the Company’s underwriting guidelines and regulatory risk limitations. The Company’s in force business is diversified both domestically and internationally, across multiple industries and by type of obligations insured. The total principal (or “par”) amount insured, before reinsurance, as of December 31, 2004 and 2003 was $66.0 billion and $41.2 billion, respectively. The total principal and interest amount insured, before reinsurance, as of December 31, 2004 and 2003 was $95.6 billion and $60.4 billion, respectively.

     The following tables present certain information with respect to the par amounts insured by the Company at December 31, 2004 and 2003, before and after reinsurance (or on a “gross” and “net” basis, respectively):

Risk Classes — Par Exposure	2004			2003
(U.S. Dollars in millions)	Gross	Net	% of Net	Gross	Net	% of Net
Public finance obligations	$ 24,659	$2,578	38.5%	$ 15,814	$1,650	38.4%
Structured single risks	12,837	1,330	19.8	8,938	947	22.1
Asset-backed obligations	18,593	1,806	26.9	8,342	889	20.7
Collateralized debt obligations .	9,934	993	14.8	8,065	806	18.8
Total	$ 66,023	$6,707	100.0%	$ 41,159	$4,292	100.0%

17

XL CAPITAL ASSURANCE INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 2004, 2003 AND 2002

The par amounts insured as of December 31, 2004 and 2003 and the terms of maturity are as follows:

	2004
Years to Maturity — Par Exposure	Public		Non-Public
(U.S. Dollars in millions)	Finance		Finance
	Gross	Net	Gross	Net
0 to 5 years	$834	$ 83	$11,644	$1,160
5 to 10 years	1,861	188	8,610	871
10 to 15 years	2,748	279	3,447	358
15 to 20 years	4,740	475	1,201	135
20 years and beyond	14,476	1,552	16,462	1,606
Total	$24,659	$2,577	$41,364	$4,130
	2003
Years to Maturity — Par Exposure	Public		Non-Public
(U.S. Dollars in millions)	Finance		Finance
	Gross	Net	Gross	Net
0 to 5 years	$988	$ 99	$8,835	$861
5 to 10 years	1,214	123	9,049	981
10 to 15 years	1,869	187	2,719	290
15 to 20 years	1,745	176	1,083	118
20 years and beyond	9,998	1,065	3,659	392
Total	$15,814	$1,650	$25,345	$2,642

     The Company limits its exposure to losses from writing financial guarantees through its credit approval process and by maintaining a surveillance function which monitors insured transactions. Additionally, the Company mitigates credit risk by underwriting investment-grade transactions, diversifying its portfolio and maintaining rigorous collateral requirements on asset-backed obligations, as well as through reinsurance.

     As of December 31, 2004 and 2003, the gross and net par amounts of insured obligations in the asset-backed insured portfolio are backed by the following types of collateral:

Asset-Backed Collateral Type —
Par Exposure	2004			2003
(U.S. Dollars in millions)	Gross	Net	% of Net	Gross	Net	% of Net
Consumer assets	$ 14,870	$1,434	79.4%	$5,264	$581	65.4%
Commercial assets	3,723	372	20.6	3,078	308	34.6
Total	$ 18,593	$1,806	100.0%	$8,342	$889	100.0%

18

XL CAPITAL ASSURANCE INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 2004, 2003 AND 2002

     As of December 31, 2004 and 2003, the insured portfolio was diversified by type of insured obligation as shown in the following table:

Type of Insured Obligation — Par Exposure	2004			2003
(U.S. Dollars in millions)	Gross	Net	% of Net	Gross	Net	% of Net
Consumer Mortgage	$10,969	$1,060	15.8%	$1,392	$200	4.7%
General Obligation &
Appropriation	9,903	991	14.8	6,451	646	15.0
CDO — Arbitrage Cash Flow	7,396	740	11.0	5,852	585	13.6
Utility — Public	5,661	644	9.6	3,692	416	9.7
Utility — Private	4,423	518	7.7	2,701	347	8.1
Transportation	4,263	410	6.1	2,714	257	6.0
Non Ad Valorem	2,719	309	4.6	787	104	2.4
Auto	2,978	282	4.2	2,499	245	5.7
GIC	2,557	256	3.8	1,492	149	3.5
Future Flow	2,435	243	3.6	2,268	228	5.3
Commercial ABS — Other	1,810	181	2.7	1,318	132	3.1
CDO — Synthetic	1,758	176	2.6	1,645	164	3.8
Higher Education — Private	1,567	153	2.3	1,267	123	2.9
Pre-Insured	1,010	101	1.5	880	88	2.1
Fleet Financing	1,000	100	1.5	1,000	100	2.3
Bank Product	1,054	90	1.3	1,296	120	2.8
Credit Card	567	57	0.8	992	98	2.3
Other	3,953	396	6.1	2,913	290	6.7
Total	$ 66,023	$6,707	100.0%	$ 41,159	$4,292	100.0%

     The Company seeks to maintain a diversified portfolio of insured obligations designed to spread its risk across a number of geographic areas. As of December 31, 2004 and 2003, the distribution of par exposure by geographic location is set forth in the following table:

Geographic Distribution —
Par Exposure	2004			2003
(U.S. Dollars in millions)	Gross	Net	% of Net	Gross	Net	% of Net
California	$7,678	$757	11.3%	$ 2,857	$286	6.7%
New York	3,882	376	5.6	2,921	286	6.7
Florida	1,269	301	4.5	1,123	241	5.6
Delaware	2,501	240	3.6	89	8	0.2
New Jersey	1,583	158	2.4	962	96	2.2
Massachusetts	1,591	155	2.3	1,561	152	3.5
Alabama	1,669	153	2.3	1,245	111	2.6
Illinois	1,510	149	2.2	1,206	119	2.8
Texas	1,488	149	2.2	571	57	1.3
Wisconsin	1,303	130	1.9	1,018	102	2.4
Colorado	1,153	115	1.7	1,019	102	2.4
Georgia	718	90	1.3	477	66	1.5
Indiana	843	84	1.3	147	15	0.3
District of Columbia	820	82	1.2	188	19	0.4
Michigan	682	68	1.0	707	70	1.6
Other U.S. Jurisdictions	6,253	627	9.4	3,439	346	8.1
International	6,300	613	9.1	5,442	529	12.3
US Diversified	24,780	2,460	36.7	16,187	1,687	39.4
Total	$ 66,023	$6,707	100.0%	$ 41,159	$4,292	100.0%

19

XL CAPITAL ASSURANCE INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 2004, 2003 AND 2002

     In its asset-backed business, the Company considers geographic concentration as a factor in its underwriting process. However, the existence of first-loss protection in a typical asset-backed securitization, in addition to other factors, makes it difficult to attribute geographic exposure to deals collateralized by diversified pools of obligations. For asset-backed transactions, the Company considers the seller/servicer, industry, and type of collateral to be more relevant measures of diversification.

     As of December 31, 2004 and 2003, the distribution of par exposure by form of credit enhancement is set forth in the following table:

Credit Enhancement —
Par Exposure	2004			2003
(U.S. Dollars in millions)	Gross	Net	% of Net	Gross	Net	% of Net
Financial guaranty insurance
policy	$ 60,061	$6,121	91.3%	$ 35,745	$3,761	87.6%
Credit default swap	5,962	586	8.7	5,414	531	12.4
Total	$ 66,023	$6,707	100.0%	$ 41,159	$4,292	100.0%

10. Liability for Losses and Loss Adjustment Expenses

     The Company’s liability for losses and loss adjustment expenses consists of case basis reserves and unallocated reserves. Activity in the liability for losses and loss adjustment expenses is summarized as follows:

	2004		2003
	Case	Unallocated	Case	Unallocated
(U.S. dollars in thousands)	Reserves	Reserves	Reserves	Reserves
Balance at January 1	$  —	$25,009	$  —	$10,380
Incurred losses and loss adjustment
expense	47,755	15,879	—	14,629
Paid loss and loss adjustment expense	(2,205)	—	—	—
Balance at December 31	45,550	40,888	—	25,009
Reinsurance recoverable	(45,124)	(37,771)	—	(22,998)
Net balance at December 31	$426	$3,117	$  —	$2,011

Case Basis Reserves for Losses and Loss Adjustment Expenses

     During the year ended December 31, 2004, the Company recorded a provision for losses of approximately $42.1 million, representing the present value of losses expected to be incurred in the future with respect to an insured project financing. Because this loss represented a full limit loss to the subordinated tranche of the insured transaction, the remaining unearned premium pertaining to such tranche, which aggregated approximately $23.3 million, was fully earned resulting in a net loss, before reinsurance, of approximately $18.8 million. The portion of the insured exposure to which this loss relates was fully reinsured on a first-loss basis by an affiliate of the Company and, accordingly, there was no net impact on the Company’s results of operations from this loss provision. The total remaining par insured by the Company in connection with this transaction aggregated approximately $250 million ($43.9 million net of reinsurance to affiliates) at December 31, 2004, and amortizes over

20

XL CAPITAL ASSURANCE INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 2004, 2003 AND 2002

many years into the future. The estimate of loss was necessarily based on assumptions and estimates extending over many years into the future. There is currently no payment default with respect to this transaction. Management continues to monitor the exposure and will revise its loss estimate as necessary, as information becomes available. Pursuant to the assumptions upon which the estimate was based, under its existing reinsurance arrangements, approximately 17.5% of any additional loss provision in excess of the amount currently provided will be retained by the Company. The financing vehicle through which the project financing was issued is considered a variable interest entity under FASB Interpretation No. 46 “Consolidation of Variable Interest Entities” (“FIN 46”), however, the Company is not the primary beneficiary. If there is ultimately an event of default, the Company has certain rights, which if exercised, will cause a reconsideration of the primary beneficiary. If such events occur, the Company will likely be required to consolidate the financing vehicle.

     The balance of case basis reserves at December 31, 2004 consisted of reserves for loss adjustment expenses which relate to remediation efforts associated with certain insured transactions, including the aforementioned project financing.

Unallocated Reserves

     Since the actual accrual to date has been in excess of the expected loss emergence pattern during 2004 and 2003, there has been a decrease in the estimate of reserves for prior years in order to bring the reserves in line with the Company’s actuarial expectations. As a result, there was a decrease in the estimate of reserves for prior years of $9,413,000 and $1,188,000 on a gross and net basis, respectively, for the year ended December 31, 2004 and of $7,358,000 and $536,000 on a gross and net basis, respectively, for the year ended December 31, 2003.

11. Income Taxes

     The Company’s Federal income tax return is consolidated with XLA and its subsidiaries (the “Consolidated Group”). XLA maintains a tax sharing agreement with its subsidiaries, whereby the consolidated tax liability is allocated among affiliates in the ratio that each affiliate’s separate return liability bears to the sum of the separate return liabilities of all affiliates that are members of the Consolidated Group. In addition, a complementary method is used which results in reimbursement by profitable affiliates to loss affiliates for tax benefits generated by loss affiliates. At December 31, 2004 and 2003, the Company had a Federal income tax payable of $2,917,000 and $6,754,000 to XLA, respectively.

     The U.S. Federal income tax rate applicable to ordinary income is 35%. The actual tax expense on income from operations differs from the “expected” amount for the following reasons:

	2004		2003		2002
		Percent		Percent		Percent
		of		of		of
		Pre-Tax		Pre-Tax		Pre-Tax
(U.S. Dollars in thousands)	Amount	Loss	Amount	Loss	Amount	Loss
“Expected” tax benefit	$(873)	(35.0)%	$(1,653)	(35.0)%	$(2,689)	(35.0)%
Adjustments
Gain on contributed security	—	—	533	11.3	—	—
Transfer pricing	1,485	59.6	495	10.5	—	—
Prior year true-up	326	13.0	(349)	(7.4)	—	—
Other	30	1.2	19	0.4	256	3.4
Actual tax (benefit) expense	$968	38.8%	$(955)	(20.2)%	$(2,433)	(31.6)%

21

XL CAPITAL ASSURANCE INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 2004, 2003 AND 2002

     The components of the net deferred Federal income tax position of the Company as of December 31, 2004 and 2003 are as follows:

(U.S. Dollars in thousands)	2004	2003
Deferred tax assets
Deferred ceding commissions, net	$14,034	$12,200
Deferred premium revenue	2,421	1,997
Foreign Losses	1,378	454
Other — net	368	—
Total deferred tax assets	18,201	14,651
Deferred tax liabilities
Unrealized appreciation of investments	(849)	(713)
Accretion of discount	(92)	(67)
Other	—	(311)
Total deferred tax liabilities	(941)	(1,091)
Net deferred Federal income tax asset	$17,260	$13,560

     Management has concluded that the deferred tax asset is more likely than not to be realized. The Company’s Federal income tax return is consolidated with the Consolidated Group. Management has determined that the projected U.S. consolidated income of the Consolidated Group will be sufficient to utilize the net operating losses of the Consolidated Group within a reasonable time. Management will continue to evaluate income generated in future periods by the Consolidated Group in determining the reasonableness of its position. If management determines that future income generated by the Consolidated Group is insufficient to cause the realization of the Consolidated Group’s net operating losses within a reasonable period, a valuation allowance would be required.

12. Commitments and Contingencies

     The Company’s lease commitments are comprised primarily of its office premise lease at 1221 Avenue of the Americas, New York, New York, and office space lease commitments it assumed from an affiliate, Global Credit Analytics, Inc. (“GCA”), with respect to office space at 250 Park Avenue, New York, New York.

     The table below presents the Company’s minimum lease payment obligations under the aforementioned leases, as well as estimated sub-lease income from the sub-lease of space at the aforementioned locations.

	Minimum
	Lease	Sub-lease
(U.S. Dollars in Thousands)	Payments	Income
2005	6,823	1,240
2006	6,823	1,265
2007	6,877	1,191
2008	7,147	778
2009	7,168	791
Later years	89,418	3,762
Total	$124,256	$ 9,027

     Rent expense was $5,117,598, $6,398,785 and $2,748,904 for the years ended December 31, 2004, 2003, and 2002, respectively.

     In the ordinary course of business, the Company may become party to certain litigation. The Company is not currently subject to any material pending litigation.

22

XL CAPITAL ASSURANCE INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 2004, 2003 AND 2002

13. Disclosures About Fair Values of Financial Instruments

     The following estimated fair values have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is necessary to interpret the data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amount the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.

     Fixed-maturity investments: The carrying amount is fair value, which is based primarily on quoted market prices received from a nationally recognized pricing service or dealer quotes.

     Short-term investments: The carrying amount is fair value, which approximates cost due to the short maturity of these instruments.

     Cash and cash equivalents: The carrying amount of these items is a reasonable estimate of their fair value due to the short maturity of these instruments.

     Deferred premium revenue, net of prepaid reinsurance premiums: The carrying amount of deferred premium revenue, net of prepaid reinsurance premiums, represents the Company’s future premium revenue, net of reinsurance, on policies where the premium was received at the inception of the insurance contract. The fair value of deferred premium revenue, net of prepaid reinsurance premiums, is an estimate of the premiums that would be paid under a reinsurance agreement with a third party to transfer the Company’s financial guaranty risk, net of that portion of the premiums retained by the Company to compensate it for originating and servicing the insurance contract.

     Losses and loss expenses, net of reinsurance balances recoverable: The carrying value is assumed to be fair value, because the provision is established for non-specific expected levels of losses resulting from credit failures.

     Installment premiums: The fair value of installment premiums is estimated based on the present value of the future contractual premium revenues, net of reinsurance, that would be paid under a reinsurance agreement with a third party to transfer the Company’s financial guaranty risk, net of that portion of the premium retained by the Company to compensate it for originating and servicing the insurance contract. The fair value is derived by calculating the present value of the estimated future cash flow stream (net premium and ceding commissions) discounted at 3.61% and 7.0% at December 31, 2004 and 2003, respectively.

	2004		2003
	Carrying	Estimated	Carrying	Estimated
(U.S. Dollars in thousands)	Amount	Fair Value	Amount	Fair Value
Assets
Fixed-maturity investments	$272,950	$272,950	$239,629	$239,629
Short-term investments	3,657	3,657	8,814	8,814
Cash and cash equivalents	58,038	58,038	76,854	76,854
Liabilities
Deferred premium revenue, net of
prepaid reinsurance premiums	43,571	33,046	27,017	19,800
Loss and loss adjustment expenses,
net of reinsurance recoverable on
unpaid losses	3,543	3,543	2,011	2,011
Off-Balance Sheet Instruments
Installment premiums	—	127,541	—	94,497

23

XL CAPITAL ASSURANCE INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 2004, 2003 AND 2002

14. Statutory Accounting Practices and Dividend Restrictions

     GAAP differs in certain significant respects from accounting (“SAP”) practices prescribed or permitted by the NYID. The following tables summarize the significant differences between statutory accounting practices and GAAP.

(U.S. Dollars in thousands)		2004	2003	2002
GAAP net loss		$(3,513)	$(3,768)	$(5,249)
Statutory adjustments:
Premium revenue recognition		(2,369)	(1,070)	(185)
Net losses and loss adjustment expenses		1,614	1,133	754
Deferred Federal income tax benefit		(3,834)	(7,709)	(2,478)
Current Federal income tax benefit		(353)	95	—
Deferred acquisition costs and ceding commissions, net	.	—	—	(1,118)
Net income (loss) of consolidated subsidiary		2,639	844	(218)
VIE’s are not consolidated under SAP		(542)	(725)	513
Other		(115)	178	162
Statutory net loss		$(6,473)	$(11,022)	$(7,819)
(U.S. Dollars in thousands)		2004	2003	2002
GAAP shareholder’s equity		$233,966	$237,228	$142,462
Statutory adjustments:
Premium revenue recognition		(3,637)	(1,268)	(198)
Deferred Federal income tax (benefit) liability		2,304	546	1,721
Current Federal income tax benefit		(258)	95	—
Net unpaid losses and loss adjustment expenses		3,582	2,011	786
Contingency reserve		(7,342)	(3,369)	(1,134)
Non-admitted assets		(16,511)	(13,731)	(6,211)
Intangible assets — acquired licenses		(11,529)	(11,529)	(11,529)
Unrealized appreciation of investments		(2,428)	(2,042)	(4,374)
VIE’s are not consolidated under SAP		(575)	(33)	692
Other		133	158	92
Statutory policyholders’ surplus		$197,705	$208,066	$122,307

     The principal differences result from the following statutory accounting practices:

• Bonds are carried at amortized cost rather than designated as available for sale and carried at market value. Unrealized gains or losses are not recognized as a separate component of shareholder’s equity net of applicable deferred Federal income taxes.
  
  
• A formula-based contingency reserve is established by an appropriation of unassigned surplus. This reserve is calculated at the greater of a prescribed percentage applied to insured outstanding principal or 50% of premiums written, net of ceded reinsurance. The prescribed percentage varies by the type of outstanding principal. The reserve is available to be applied to new case basis reserves that are established for claims on current outstanding insured principal and interest in the future. An unallocated reserve is not recorded.
  
  
• Current Federal income taxes are provided only on taxable income for which income taxes are currently payable and deferred tax assets are limited to an amount determined to be realizable within one year based on management’s estimation of the future realizability of deferred tax assets.

24

XL CAPITAL ASSURANCE INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 2004, 2003 AND 2002

• Under GAAP certain subsidiaries are required to be consolidated, whereas under SAP such subsidiaries are accounted for under statutory equity method accounting principles.
  
• Acquisition costs are charged to operations as incurred rather than as related premiums are earned.
  
  
• Up-front premiums are recognized as earned when the related risk has expired rather than over the period of risk.
  
  
• Certain assets designated as “non-admitted assets” are charged directly to statutory surplus, but are reflected as assets under GAAP.

     Under New York Insurance Law, the Company may pay dividends to XL RE AM, without the prior approval of the Superintendent of the NYID, only from earned statutory policyholders’ surplus subject to the maintenance of the minimum capital and surplus requirement. In addition, the dividend, together with all other dividends declared or distributed by the Company during the preceding twelve months, may not exceed the lesser of 10% of its policyholders’ surplus as shown in the Company’s last filed statement, or adjusted net investment income, as defined, for such twelve-month period. As of December 31, 2004, the Company had no earned surplus available for the payment of dividends during the next twelve months.

15. Credit Default Swaps

     Credit default swaps insured by the Company meet the definition of a derivative under SFAS 133. The Company has recorded these products at fair value, modeled on prevailing market conditions and certain other factors relating to the structure and credit quality of the transaction. The Company considers credit default swaps to be, in substance, financial guaranty contracts as the Company intends to hold them to maturity. The full change in fair value is included in net realized and unrealized gains (losses) on credit derivatives.

     Credit default swaps generally cover a portfolio of securities. The credit ratings of the underlying securities vary and a single rating is calculated for the Company’s exposure at the inception of the transaction by an independent credit rating agency. In order to effectively price and market the transaction, different tranches are modeled for the purpose of assigning credit ratings based upon the level of subordination. Generally, a primary layer of first loss protection is created with the Company participating in the senior or higher quality rated tranches of the transaction.

     The Company’s exposure is fair valued taking into account changes in credit spreads, current market conditions, as well as the overall credit quality of the underlying collateral.

     The Company’s credit default swap portfolio generally requires the Company to meet payment obligations for referenced credits within the portfolio in the event of specific credit events after exhaustion of various first loss protection levels. These credit events are contract-specific, but generally cover bankruptcy, failure to pay and repudiation. The credit default swap portfolio consists of structured pools of corporate obligations that were awarded investment-grade ratings at the deals’ inception. On a net par basis, approximately 86% of the portfolio is rated AAA with the remaining 14% allocated to other investment-grade ratings. The weighted average term of the contracts in force was 4.50 years. The components of the Company’s net credit default swap asset and liability classified with other assets and accounts payable and accrued expenses, respectively, at December 31, 2004 and 2003 are as follows:

(U.S. Dollars in thousands)	2004	2003
Assets
Gross credit derivative gains	$7,447	$4,945
Reinsurance	6,649	4,424
Net assets	$798	$521
Liabilities
Gross credit derivative losses	$1,873	$4,718
Reinsurance	1,650	4,230
Net liabilities	$223	$488

25

XL CAPITAL ASSURANCE INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
DECEMBER 31, 2004, 2003 AND 2002

     The components of the Company’s net realized and unrealized gains (losses) on credit derivatives for the years ended December 31, 2004, 2003 and 2002 are as follows:

(U.S. Dollars in thousands)	2004	2003	2002
Net premiums earned	$1,912	$1,438	$652
Loss reserves and other adjustments	—	110	(163)
Net fair value adjustment	542	725	(513)
Net realized and unrealized gains (losses)
on credit derivatives	$2,454	$2,273	$(24)

16. Quarterly Financial Information (Unaudited)

	2004
(U.S. Dollars in thousands)	First	Second	Third	Fourth	Full Year
Gross premiums written	$36,947	$57,221	$47,537	$69,530	$211,235
Net premiums written	9,854	5,707	4,929	7,277	27,767
Net premiums earned	3,363	2,362	2,825	2,663	11,213
Net investment income	2,495	2,554	2,879	2,952	10,880
Net losses and loss adjustment expenses	564	696	791	212	2,263
Income (loss) before income taxes	146	(1,683)	(2,005)	997	(2,545)
Net income (loss)	$96	$(1,126)	$(1,290)	$(1,193)	$(3,513)
	2003
(U.S. Dollars in thousands)	First	Second	Third	Fourth	Full Year
Gross premiums written	$33,240	$77,886	$72,755	$59,436	$243,317
Net premiums written	2,406	7,570	8,220	4,499	22,695
Net premiums earned	1,124	1,529	1,709	2,496	6,858
Net investment income	1,374	1,480	1,515	1,500	5,869
Net losses and loss adjustment expenses	359	529	140	197	1,225
Income (loss) before income taxes	(4,010)	374	346	(1,433)	(4,723)
Net income (loss)	$(2,400)	$(72)	$334	$(1,630)	$(3,768)

26

EX-99.2

Exhibit 99.2

XL Financial Assurance Ltd.
(Incorporated in Bermuda)

Financial Statements
For the years ended December 31, 2004, 2003 and 2002
(expressed in U.S. dollars)

March 11, 2005 

Report of Independent Registered Public Accounting Firm

To the Shareholders and Board of Directors of
XL Financial Assurance Ltd.

In our opinion, the accompanying balance sheets and the related statements of income and comprehensive income, changes in shareholders’ equity and of cash flows present fairly, in all material respects, the financial position of XL Financial Assurance Ltd. at December 31, 2004 and 2003, and the results of itsoperations and its cash flows for each of the years ended December 31, 2004, 2003 and 2002, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

Chartered Accountants

XL Financial Assurance Ltd.

Balance Sheets

As at December 31, 2004 and 2003

(U.S. dollars in thousands, except share amounts)

	2004			2003
Assets:
Investments:
Fixed maturities, at fair value
(amortized cost: 2004 - $794,190; 2003 - $542,600)	$	792,723		$	543,748
Short-term investments, at fair value
(amortized cost: 2004 - $88,227; 2003 - $40,286)		87,875			40,312
Total investments available for sale		880,598			584,060
Cash and cash equivalents	$	13,210			26,346
Accrued investment income		6,764			7,420
Deferred acquisition costs		83,868			51,477
Prepaid reinsurance premiums		52,486			98,048
Reinsurance balances receivable		40,859			33,446
Unpaid losses and loss expenses recoverable		55,441			7,745
Amounts due from parent and affiliates		32,708			23,638
Derivative assets		7,378			4,826
Other assets		138			52
Total assets	$	1,173,450		$	837,058
Liabilities, redeemable preferred shares and shareholders’ equity
Liabilities:
Unpaid losses and loss expenses	$	99,133		$	35,899
Deferred premium revenue		437,654			348,719
Reinsurance balances payable		4,022			6,275
Net payable for investments purchased		7			13
Accounts payable and accrued liabilities		2,738			1,249
Amounts due to parent and affiliates		11,482			5,296
Derivative liabilities		1,669			7,018
Dividend payable on preferred shares		1,950			1,950
Total liabilities	$	558,655		$	406,419
Redeemable preferred shares:
Series A Redeemable preferred shares (par value of $120 per share;
10,000 shares authorized; 363 issued and outstanding as at
December 31, 2004 and 2003, respectively)	$	44		$	44
Additional paid-in capital		38,956			38,956
Total redeemable preferred shares		39,000			39,000
Shareholders’ equity:
Common shares (par value of $120 per share;
10,000 shares authorized; 2,449 and 2,057 issued and outstanding as at
December 31, 2004 and 2003, respectively)		294			247
Additional paid-in capital		345,606			220,653
Accumulated other comprehensive income (loss)		(1,819	)		1,174
Retained earnings		231,714			169,565
Total shareholders’ equity	$	575,795		$	391,639
Total liabilities, redeemable preferred shares and shareholders’ equity	$	1,173,450		$	837,058

See accompanying Notes to Financial Statements

XL Financial Assurance Ltd.

Statements of Income and Comprehensive Income

For the years ended December 31, 2004, 2003 and 2002

(U.S. dollars in thousands)

	2004			2003			2002
Revenues:
Net premiums earned	$	83,908		$	77,582		$	40,811
Net investment income		24,866			16,885			20,163
Net realized gains on investments		474			1,246			8,569
Net realized and unrealized gains on derivative instruments		27,495			35,059			22,865
Total revenues	$	136,743		$	130,772		$	92,408
Expenses:
Losses and loss expenses	$	17,055		$	17,770		$	4,353
Acquisition costs		32,968			29,727			12,188
Operating expenses		10,468			7,114			6,375
Total expenses	$	60,491		$	54,611		$	22,916
Net income	$	76,252		$	76,161		$	69,492
Comprehensive Income:
Net income	$	76,252		$	76,161		$	69,492
Unrealized (depreciation) appreciation of investments		(2,519	)		(3,675	)		12,666
Less: reclassification for gains realized in income		474			1,246			8,569
Other comprehensive (loss) income	$	(2,993	)	$	(4,921	)	$	4,097
Comprehensive income	$	73,259		$	71,240		$	73,589

See accompanying Notes to Financial Statements

XL Financial Assurance Ltd.

Statements of Changes in Shareholders’ Equity

For the years ended December 31, 2004, 2003 and 2002

(U.S. dollars in thousands, except share amounts)

	2004			2003			2002
Common Shares – Number issued
Number of shares, beginning of year		2,057			2,057			2,057
Issuance of common shares		392			-			-
Number of shares, end of year		2,449			2,057			2,057
Common Shares – Issued at par
Balance - beginning of year	$	247		$	247		$	247
Issuance of common shares		47			-			-
Balance - end of year	$	294		$	247		$	247
Additional Paid-in Capital
Balance - beginning of year	$	220,653		$	220,653		$	220,653
Issuance of common shares		124,953			-			-
Balance - end of year	$	345,606		$	220,653		$	220,653
Accumulated Other Comprehensive Income (Loss)
Balance - beginning of year	$	1,174		$	6,095		$	1,998
Other comprehensive income (loss)		(2,993	)		(4,921	)		4,097
Balance - end of year	$	(1,819	)	$	1,174		$	6,095
Retained Earnings
Balance - beginning of year	$	169,565		$	100,046		$	37,237
Net income		76,252			76,161			69,492
Dividends on Series A preferred shares		(14,103	)		(6,642	)		(6,683	)
Balance – end of year	$	231,714		$	169,565		$	100,046
Total Shareholders’ Equity	$	575,795		$	391,639		$	327,041

See accompanying Notes to Financial Statements

XL Financial Assurance Ltd.

Statement of Cash Flows

For the years ended December 31, 2004, 2003 and 2002

(U.S. dollars in thousands)

	2004			2003			2002
Cash flows provided by operating activities:
Net income for the year	$	76,252		$	76,161		$	69,492
Adjustments to reconcile net income to net cash provided by operating
activities:
Net realized gains on investments		(474	)		(1,246	)		(960	)
Amortization of premium (discount) on fixed maturities		4,525			1,429			(1,108	)
Net realized gains on investment derivatives		(19	)		(2,304	)		(7,609	)
Net realized and unrealized gains on credit derivatives excluding
cash received and paid		(7,901	)		(14,076	)		(6,875	)
Accrued investment income		656			(5,494	)		1,162
Unpaid losses and loss expenses		63,234			21,835			7,472
Deferred premium revenue		88,935			160,255			104,708
Unpaid losses & loss expenses recoverable		(47,696	)		(4,067	)		(3,119	)
Deferred acquisition costs		(32,391	)		(32,153	)		(4,140	)
Amounts due from parent and affiliates		(9,070	)		(7,281	)		(11,768	)
Accounts payable and accrued liabilities		1,489			110			(629	)
Amount due to parent and affiliates		6,186			2,708			(478	)
Prepaid reinsurance premiums		45,562			(26,919	)		(60,163	)
Reinsurance balances receivable		(7,413	)		(12,380	)		1,105
Reinsurance balances payable		(2,253	)		(17,422	)		18,834
Other assets		(86	)		27			8
Total adjustments		103,284			63,022			36,440
Net cash provided by operating activities		179,536			139,183			105,932
Cash flows used in investing activities:
Proceeds from sale of fixed maturities and short-term investments		2,499,678			491,116			2,154,874
Proceeds from redemption of fixed maturities and short-term
investments		543,150			4,526,126			366,527
Purchase of fixed maturities and short-term investments		(3,222,273	)		(5,248,510	)		(2,545,838	)
Net cash used in investing activities		(179,445	)		(231,268	)		(24,437	)
Cash flows used in financing activities:
Issuance of common shares		876			-			-
Dividends paid on Series A preferred shares		(14,103	)		(6,642	)		(6,665	)
Net cash used in financing activities		(13,227	)		(6,642	)		(6,665	)
Increase (decrease) in Cash and Cash Equivalents		(13,136	)		(98,727	)		74,830
Cash and Cash Equivalents – Beginning of year		26,346			125,073			50,243
Cash and Cash Equivalents – End of year	$	13,210		$	26,346		$	125,073

See accompanying Notes to Financial Statements

XL Financial Assurance Ltd.

Notes to Financial Statements

For the years ended December 31, 2004, 2003 and 2002

(U.S. dollars in thousands, except per share amounts)

1. Organization and Business

XL Financial Assurance Ltd. (the “Company”) was incorporated with limited liability under the Bermuda Companies Act 1981 on October 14, 1998 and is registered as a Class 3 insurer under The Insurance Act 1978, amendments thereto and related regulations (“The Act”). At December 31, 2004, the Company was approximately 87% owned by XL Insurance (Bermuda) Ltd (a wholly-owned subsidiary of XL Capital Ltd); 5% by Financial Security Assurance Inc. (a wholly-owned subsidiary of Financial Security Assurance Holdings Ltd.) and 8% by Financial Security Assurance International Ltd. (owned 20% by XL Insurance (Bermuda) Ltd and 80% by Financial Security Assurance Inc.). At December 31, 2003, the Company was approximately 85% owned by XL Insurance (Bermuda) Ltd; 6% by Financial Security Assurance Inc. and 9% by Financial Security Assurance International Ltd. The Company is an integral part of a joint venture agreement between XL Capital Ltd and Financial Security Assurance Holdings Ltd.

The Company is primarily engaged in the business of providing reinsurance of financial guaranties on asset-backed and municipal obligations underwritten by XL Insurance (Bermuda) Ltd, Financial Security Assurance Inc. and XL Capital Assurance Inc. (a wholly-owned subsidiary of XL Capital Ltd) and other monoline and multiline insurance companies. This may be in the form of traditional financial guaranty insurance or via a credit derivatives execution. The Company’s underwriting policy is to provide reinsurance of asset-backed and municipal obligations that would be of a lower investment-grade quality without the benefit of the Company’s reinsurance. The asset-backed obligations reinsured by the Company are generally issued in structured transactions and are backed by pools of assets such as residential mortgage loans, consumer or trade receivables, securities or other assets having ascertainable cash flows or market value. The municipal obligations reinsured by the Company consist primarily of general obligation bonds that are supported by the issuers' taxing power and of special revenue bonds and other special obligations of states and local governments that are supported by the issuers’ ability to impose and collect fees and charges for public services or specific projects. The Company's reinsurance guarantees payments when due of scheduled payments on an insured obligation. In the case of a payment default on an insured obligation, the Company is generally required to pay the principal, interest or other such amounts due in accordance with the obligations’ original payment schedule or, at its option, to pay such amounts on an accelerated basis. The Company conducts surveillance on its exposures to try and ensure early identification of any loss events. In addition, in the normal course of business, the Company seeks to reduce the loss that may arise from such events by reinsuring certain levels of risks in various areas of exposure with other insurance enterprises or reinsurers.

On October 6, 1999, the Company entered into a Facultative Quota Share Reinsurance Treaty (“Treaty”) with XL Capital Assurance Inc. (“XLCA”). The Treaty was amended and restated on June 22, 2001 and May 1, 2004. Under the terms of this Treaty, the Company agrees to reinsure up to 90% of XLCA’s compliant risks. The Company is subject to ceding commissions of up to 30% on business assumed under the terms of this Treaty.

On October 3, 2001, the Company entered into an excess of loss reinsurance agreement with XL Insurance (Bermuda) Ltd, which indemnifies the Company up to an aggregate limit of liability of $500 million in excess of defined obligor losses.

2. Significant Accounting Policies

Basis of Preparation

These financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the

(2)

XL Financial Assurance Ltd.

Notes to Financial Statements

For the years ended December 31, 2004, 2003 and 2002

(U.S. dollars in thousands, except per share amounts)

reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.

Certain comparative figures have been reclassified to conform to the current year’s presentation.

Premiums and Acquisition Costs

Up-front premiums written and assumed are earned on a pro-rata basis over the period the coverage is provided. Installment premiums are recorded as written when reported and earned over the related installment period, which is generally one year or less.

Deferred premium revenue represents the portion of reinsurance premiums written which is applicable to the unexpired terms of policies in force. When a policy is retired or defeased prior to the end of the expected period of coverage, the remaining deferred premium, less any amount credited to a refunding issue reinsured by the Company, is recognized in income at that time.

Certain costs incurred, relating to and varying with the production of new business, have been deferred. These costs include ceding commissions paid to the reinsured. The Company considers the present value of future premiums under installment contracts written when determining the recoverability of deferred acquisition costs. The deferred acquisition costs are amortized over periods in which the related premiums are earned, except for acquisition costs incurred from business assumed from XL Capital Assurance Inc., which are amortized over the weighted average periods that the related premiums are earned. If an insured issue is retired or defeased prior to the end of the expected period of coverage; the remaining deferred acquisition costs with respect to such issue is recognized at such time.

Reinsurance

In the normal course of business, the Company utilizes reinsurance agreements principally to increase aggregate capacity, manage its risk guidelines and to reduce the risk of loss on business assumed. Reinsurance premiums ceded are expensed and commissions recorded thereon are earned on a pro-rata basis over the period the reinsurance coverage is provided. Prepaid reinsurance premiums represent the portion of premiums ceded that is applicable to the unexpired term of policies in force. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policy. A provision is made for any estimated unrecoverable reinsurance.

Investments

All of the Company’s investments in fixed maturity securities are considered available for sale and are carried at fair value. The fair value of the investments is based on quoted market values received from nationally recognized pricing services or dealer quotes. Any resulting unrealized gains or losses are reflected in other comprehensive income. Any unrealized depreciation in value considered by management to be other than temporary is charged to income in the period that it is determined.

The company reviews the fair value of its investment portfolio to identify declines in fair value that are other than temporary. This review involves consideration of several factors including (i) the time period during which there has been a significant decline in value, (ii) an analysis of the liquidity, business prospects and overall financial condition of the issuer, (iii) the significance of the decline, (iv) an analysis of the collateral structure and other credit support,

(3)

XL Financial Assurance Ltd.

Notes to Financial Statements

For the years ended December 31, 2004, 2003 and 2002

(U.S. dollars in thousands, except per share amounts)

as applicable, of the securities in question and (v) the Company’s intent and ability to hold the investment for a sufficient period of time for the value to recover. Where the Company’s analysis of the above factors results in the Company’s conclusion that declines in fair values are other than temporary, the cost of the security is written down to fair value and the previously unrealized loss is therefore realized in the period such determination is made. With respect to securities where the decline in value is determined to be temporary and the security’s value is not written down, a subsequent decision may be made to sell that security and realize a loss. Subsequent decisions on security sales are made within the context of overall risk monitoring, changing information, market conditions generally and assessing value relative to other comparable securities.

Bond discounts and premiums are amortized on the effective yield method over the remaining terms of securities acquired. For mortgage-backed securities, and any other holdings for which prepayment risk may be significant, assumptions regarding prepayments are evaluated periodically and revised as necessary. Any adjustments required due to the resulting change in effective yields are recognized in current income.

Short-term investments comprise securities with remaining maturities equal to or greater than ninety days but less than one year. All investment transactions are recorded on a trade date basis. Realized gains and losses on sales of investments are determined on the basis of specific identification. Investment income is recognized when earned and includes interest together with the amortization of premium and discount on fixed maturities and short-term investments.

Losses and Loss Expenses

Reserves for losses and loss adjustment expenses include case basis reserves and unallocated loss reserves. Case specific reserves for unpaid loss and loss expenses are recorded, as advised, by the primary insurers. The primary insurers establish case reserves for individual distressed credits when, in their management’s opinion, the future loss is deemed probable and estimable at the balance sheet date. There is usually a single reporting period lag between primary and reinsurer as it relates to the timing of any such case specific reserves.

In addition to case basis reserves, the Company maintains an unallocated loss reserve for expected levels of losses associated with currently insured issues, which is estimated by management based upon an actuarial reserving analysis. The actuarial methodology applied by the Company is in accordance with Actuarial Standards of Practice No. 36, Determination of Reasonable Provision. This methodology was adopted by the Company in 2002. The methodology applied is based on the selection of an initial expected loss ratio, as well as an expected loss emergence pattern. In accordance with the Company’s accounting policy, the initial expected loss ratio is applied to earned premium each quarter and the expected loss emergence pattern is analyzed on an annual basis as part of the Company’s review of the overall adequacy of the unallocated loss reserve recorded in the Company's balance sheet.

The Company’s selection of an initial expected loss ratio and loss emergence pattern considered the characteristics of the Company’s own book of business as well its actual loss experience and that of the industry. On an annual basis, the Company compares its selected initial expected loss ratio to its actual loss experience, as well as to industry loss experience, and will adjust it as considered necessary, to ensure such initial expected loss ratio continues to be appropriate for the risks in its in force business. In addition, the expected loss emergence pattern will be adjusted or realigned on an annual basis, as considered necessary, to better correlate with the underlying changes in the Company’s in force business (e.g. changes in the average life of in-force business resulting from changes in the mix of business and risk expiration). The Company’s unallocated reserve is available to be applied to new case basis reserves that may be established for claims on current outstanding insured principal and interest in the future.

The Company has become aware of the SEC's recent review of the loss reserving practices of certain financial guarantee companies. The Company recognizes that there is diversity in practice among financial guarantee insurers and reinsurers with respect to their accounting policies for loss reserves. Current accounting literature, specifically

(4)

XL Financial Assurance Ltd.

Notes to Financial Statements

For the years ended December 31, 2004, 2003 and 2002

(U.S. dollars in thousands, except per share amounts)

FASB Statement of Financial Accounting Standards No. 60 "Accounting and Reporting by Insurance Enterprises" ("FAS 60) and FASB Statement of Financial Accounting Standards No. 97 "Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments" ("FAS 97"), do not specifically address the unique characteristics of financial guarantee insurance contracts. Consequently, the accounting principles applied by the industry, as well as the Company, have evolved over time and incorporate the concepts of both short-duration and long-duration contracts accounting under the provisions of FAS 60 and FAS 97, as well as other accounting literature, such as FASB No. 5 “Accounting for Contingencies” and Emerging Issues Task Force (“EITF”) Issue No. 85-20 “Recognition of Fees for Guaranteeing a Loan”. It is our understanding that the SEC has requested that the FASB review this matter and provide guidance for the accounting of financial guarantee insurance contracts. The Company will continue its loss reserving methodology as noted above until further guidance is provided by the SEC or FASB.

Cash and Cash Equivalents

Cash equivalents include fixed interest deposits with a maturity of under 90 days when purchased.

Fair Value of Financial Instruments

Fair values of certain assets and liabilities are based on published market values, if available, or estimates of fair value of similar issues. Fair values are reported in notes 3 and 17.

Derivative Instruments

Credit derivatives are recorded at fair value which is determined using models developed by the Company and is dependent upon a number of factors including changes in interest rates, future default rates, credit spreads, changes in credit quality, future expected recovery rates and other market factors. The change resulting from movements in credit quality and spreads is unrealized as the credit derivatives are not traded to realize this value. Other elements of the change in fair value are based upon pricing established at the inception of the contract and are included in net realized and unrealized gains and losses on derivative instruments as shown in the statement of income.

Recent Accounting Pronouncements

In November, 2004, the FASB issued EITF 04-7, “Determining Whether an Interest Is a Potential Variable Interest in a Variable Interest Entity”.This issue provides guidance for determining the types of variability in a variable interest entity (VIE) that need to be considered to determine whether an interest is a variable interest for the purpose of evaluating consolidation of a VIE. The issue was discussed in September and November and further discussion is anticipated at a future EITF meeting. The Company has reviewed its investments in VIEs and the adoption of EITF 04-7 is not expected to have a material effect on the Company’s financial condition or results of operations.

3. Investments

Net investment income is derived from the following sources:

	2004			2003			2002
Fixed maturities, short-term investments and cash and cash
equivalents	$	26,056		$	17,446		$	20,546
Investment expenses		(1,190	)		(561	)		(383	)
Net investment income	$	24,866		$	16,885		$	20,163

(5)

XL Financial Assurance Ltd.

Notes to Financial Statements

For the years ended December 31, 2004, 2003 and 2002

(U.S. dollars in thousands, except per share amounts)

Investment expenses include $397 in expenses from an affiliate for investment management fees during the year ended December 31, 2004. Proceeds from sales of fixed maturity securities and short-term investments during the years ended December 31, 2004, 2003 and 2002 were $2,499,678, $491,116 and $2,154,874, respectively. Gross gains of $8,126, $39,884 and $44,088 and gross losses of $7,659, $36,334 and $35,519 were realized on these sales for the years ended December 31, 2004, 2003 and 2002, respectively. The amortized cost, market value and related unrealized gains (losses) of investments are as follows:

			Gross		Gross
	Amortized		Unrealized		Unrealized			Market
December 31, 2004	Cost		Gains		Losses			Value
Fixed maturities:
U.S. Government and Government agencies	$	270,656	$	745	$	(684	)	$	270,717
Corporate bonds		218,928		2,512		(1,659	)		219,781
Mortgage-backed securities		294,872		954		(3,393	)		292,433
Non-U.S. Sovereign Government bonds		9,734		126		(68	)		9,792
Total fixed maturities	$	794,190	$	4,337	$	(5,804	)	$	792,723
Short-term investments:
Total short-term investments	$	88,227	$	26	$	(378	)	$	87,875
			Gross		Gross
	Amortized		Unrealized		Unrealized			Market
December 31, 2003	Cost		Gains		Losses			Value
Fixed maturities:
U.S. Government and Government agencies	$	245,425	$	-	$	(111	)	$	245,314
Corporate bonds		168,142		2,575		(3,081	)		167,636
Mortgage-backed securities		96,123		1,658		(144	)		97,637
Non-U.S. Sovereign Government bonds		32,910		251		-			33,161
Total fixed maturities	$	542,600	$	4,484	$	(3,336	)	$	543,748
Short-term investments:
Total short-term investments	$	40,286	$	26	$	-		$	40,312

(6)

XL Financial Assurance Ltd.

Notes to Financial Statements

For the years ended December 31, 2004, 2003 and 2002

(U.S. dollars in thousands, except per share amounts)

The following table shows our investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in continuous unrealized loss position, at December 31, 2004:

	Less than 12 months					More than 12 months				Total
	Market		Unrealized			Market		Unrealized		Market		Unrealized
December 31, 2004	Value		Losses			Value		Losses		Value		Losses
U.S. Government and Government agencies	$	201,888	$	(684	)	$	-	$	-	$	201,888	$	(684	)
Corporate bonds		120,553		(1,659	)		-		-		120,553		(1,659	)
Mortgage-backed securities		234,868		(3,393	)		-		-		234,868		(3,393	)
Non-U.S. Sovereign Government bonds		6,747		(68	)		-		-		6,747		(68	)
Total fixed maturities	$	564,056	$	(5,804	)	$	-	$	-	$	564,056	$	(5,804	)

As of December 31, 2004, there was no continuous unrealized loss position greater than twelve months or more.

The contractual maturities of fixed maturity securities are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties:

		December 31, 2004			December 31, 2003
	Amortized		Market		Amortized		Market
	Cost		Value		Cost		Value
Due after 1 year through 5 years	$	300,039	$	299,361	$	210,157	$	211,164
Due after 5 through 10 years		185,888		186,810		102,846		101,771
Due after 10 years		13,391		14,120		133,474		133,176
Mortgage-backed investments		294,872		292,432		96,123		97,637
Total fixed maturities	$	794,190	$	792,723	$	542,600	$	543,748

The credit quality of the investments at December 31, 2004 was as follows:

	2004
AAA	78	%
AA	8	%
A	14	%

4. Deferred Acquisition Costs

Acquisition costs deferred for amortization against future income and related amortization charged to expenses are as follows:

(7)

XL Financial Assurance Ltd.

Notes to Financial Statements

For the years ended December 31, 2004, 2003 and 2002

(U.S. dollars in thousands, except per share amounts)

	2004			2003
Balance, beginning of year	$	51,477		$	19,324
Costs deferred during the year:
Assumed commission expense		46,764			54,618
Ceding commission income		(3,825	)		(9,686	)
Total	$	42,939		$	44,932
Costs amortized during the year		(10,548	)		(12,779	)
Balance end of year	$	83,868		$	51,477

5. Unpaid Losses and Loss Expenses

The Company's liability for losses and loss expenses consists primarily of an unallocated loss reserve. Activity in the liability for losses and loss expenses was as follows:

	2004			2003			2002
Unpaid losses and loss expenses at beginning of year	$	35,899		$	14,064		$	6,592
Unpaid losses and loss expenses recoverable		(7,745	)		(3,678	)		(559	)
Net unpaid losses and loss expenses at beginning of year		28,154			10,386			6,033
Losses and loss expenses in respect of losses occurring in:
Current year		27,707			23,147			7,917
Prior year		(10,652	)		(5,377	)		(3,564	)
Total net incurred losses and loss expenses		17,055			17,770			4,353
Loss and loss expenses paid during the year		(1,517	)		-			-
Net unpaid losses and loss expenses at end of year		43,692			28,154			10,386
Unpaid losses and loss expenses recoverable		55,441			7,745			3,678
Unpaid losses and loss expenses at end of year	$	99,133		$	35,899		$	14,064

During the year ended December 31, 2004, the Company recorded a provision for losses of approximately $42.1 million representing the present value of losses expected to be incurred in the future with respect to an insured project financing. As this loss represented a full limit loss to the subordinated tranche of the insured transaction, the remaining unearned premium pertaining to such tranche, which aggregated approximately $23.3 million, was fully earned resulting in an impact on the Company’s results of operations, before reinsurance, of approximately $18.8 million. The portion of the insured exposure to which this loss relates was fully reinsured on a first loss basis by an affiliate of the Company and, accordingly, there was no net impact on the Company’s results of operations from this loss provision. The total remaining par insured by the Company in connection with this transaction aggregated approximately $215 million ($137.3 million net of reinsurance to affiliates) at December 31, 2004, and amortizes over many years into the future. The estimate of loss was necessarily based on assumptions and estimates extending

(8)

XL Financial Assurance Ltd.

Notes to Financial Statements

For the years ended December 31, 2004, 2003 and 2002

(U.S. dollars in thousands, except per share amounts)

over many years into the future. There is currently no payment default with respect to this transaction. Management continues to monitor the exposure and will revise its loss estimate as necessary, as information becomes available. Pursuant to the assumptions upon which the estimate was based, under its existing reinsurance arrangements, approximately 52.8% of any additional loss provision in excess of the amount currently provided will be retained by the Company.

The Company commenced writing financial guaranty business in 1998 and had relied entirely upon industry data to establish reserves until the end of 2001. Beginning in 2002 the Company developed an initial expected loss ratio as well as an expected loss emergence pattern based on the characteristics of the Company’s own book of business as well its actual loss experience and that of the industry. On an annual basis a comparison is made with actual Company loss experience as well as with industry loss experience to ensure the initial expected loss ratio continues to be appropriate for the portfolio of risks covered. In cases where the initial expected loss ratio appears to be misaligned with the reported losses or the industry loss experience, the accretion rate is adjusted for consistency. The current year assessment has not identified that the initial expected loss ratio need be adjusted. In addition, the emergence pattern is realigned to better track with the underlying changes in the book of business on an annual basis. Since the actual accrual to date has been in excess of the expected loss emergence pattern, there has been a decrease in the estimate of reserves for prior years in order to bring the reserves in line with the actuarial expectation.

6. Premiums and Reinsurance

The Company utilizes reinsurance agreements principally to increase aggregate capacity, manage its risk guidelines and to reduce the risk of loss on business assumed. The Company’s reinsurance agreements provide for recovery of a portion of losses and loss expenses from reinsurers and reinsurance recoverables are recorded as assets. The Company is liable if the reinsurers are unable to satisfy their obligations under the agreements.

The effect of reinsurance activity on premiums written and earned is shown below:

	2004			2003			2002
Reinsurance premiums assumed	$	224,991		$	261,514		$	154,894
Direct premiums written		3,134			3,328			3,645
Reinsurance premiums ceded		(9,720	)		(53,924	)		(73,183	)
Net premiums assumed		218,405			210,918			85,356
Change in deferred premiums and prepaid reinsurance premiums		(134,497	)		(133,336	)		(44,545	)
Net reinsurance premiums earned	$	83,908		$	77,582		$	40,811

Net reinsurance premiums earned includes releases of deferred premium for policies which have been retired early. The amounts recognized in 2004, 2003 and 2002 were $1,015; $7,864 and $1,942 respectively.

The Company assumes and cedes business to and from affiliated monoline and multiline insurance companies; XL Capital Assurance Inc. (“XLCA”), XL Insurance (Bermuda) Ltd (“XLI”) and Financial Security Assurance Inc. (“FSA”). The amounts related to income, expenses, assets and liabilities with respects to this assumed and ceded business as of December 31, 2004 and 2003 are as follows:

(9)

XL Financial Assurance Ltd.

Notes to Financial Statements

For the years ended December 31, 2004, 2003 and 2002

(U.S. dollars in thousands, except per share amounts)

2004
	XLCA			XLI			FSA			TOTAL
Assumed and ceded transactions:
Assumed premiums	$	186,615		$	1,263		$	32,131		$	220,009
Reinsurance premiums ceded		-			4,130			-			4,130
Change in deferred premium		(76,654	)		1,186			(14,408	)		(89,876	)
Change in prepaid reinsurance premiums		-			(56,300	)		-			(56,300	)
Loss and loss expenses recoverable		-			48,662			-			48,662
Loss and loss expenses incurred		(55,588	)		(536	)		(5,545	)		(61,669	)
Assumed commission expenses		(34,257	)		(381	)		(4,470	)		(39,108	)
Ceding commission income		-			8,672			-			8,672
	XLCA			XLI			FSA			TOTAL
Assumed and ceded balances:
Deferred acquisition costs		89,999			797			15,482			106,278
Reinsurance balances receivable		25,579			14,266			639			40,484
Unpaid loss and loss expenses recoverable		-			56,213			-			56,213
Deferred premiums		(357,757	)		(3,848	)		(62,010	)		(423,615	)
Deferred ceding commission income		-			(17,477	)		-			(17,477	)
Unpaid loss and loss expenses		(78,831	)		(1,376	)		(21,293	)		(101,500	)
Reinsurance balances payable		-			-			-			-
2003
	XLCA			XLI			FSA			TOTAL
Assumed and ceded transactions:
Assumed premiums	$	209,435		$	1,729		$	46,615		$	257,779
Reinsurance premiums ceded		-			(48,940	)		(30	)		(48,970	)
Change in deferred premium		(136,737	)		187			(23,362	)		(159,912	)
Change in prepaid reinsurance premiums		-			23,314			-			23,314
Loss and loss expenses recoverable		-			3,772			8			3,780
Loss and loss expenses incurred		(11,341	)		(1,092	)		(9,780	)		(22,213	)
Assumed commission expenses		(31,064	)		(424	)		(5,187	)		(36,675	)
Ceding commission income		-			6,887			9			6,896
Assumed and ceded balances:
Deferred acquisition costs		67,511			1,005			12,416			80,932
Reinsurance balances receivable		31,445			970			667			33,082
Unpaid loss and loss expenses recoverable		-			7,204			-			7,204
Deferred premiums		(281,103	)		(5,034	)		(47,602	)		(333,739	)

(10)

XL Financial Assurance Ltd.

Notes to Financial Statements

For the years ended December 31, 2004, 2003 and 2002

(U.S. dollars in thousands, except per share amounts)

Deferred ceding commission income		-			(26,946	)		-			(26,946	)
Unpaid loss and loss expenses		(19,805	)		(492	)		(15,748	)		(36,045	)
Reinsurance balances payable		-			(6,244	)		-			(6,244	)
2002
	XLCA			XLI			FSA			TOTAL
Assumed transactions:
Assumed premiums	$	140,620		$	8,721		$	19,922		$	169,263
Reinsurance premiums ceded		-			(71,715	)		(58	)		(71,773	)
Change in deferred premium		(103,981	)		1,415			(3,722	)		(106,288	)
Change in prepaid reinsurance premiums		-			59,297			-			59,297
Loss and loss expenses recoverable		-			3,098			15			3,113
Loss and loss expenses incurred		(9,160	)		(2,522	)		(3,910	)		(15,592	)
Assumed commission expenses		(14,770	)		(1,382	)		(2,860	)		(19,012	)
Ceding commission income		-			3,808			18			3,826

Included in operating expenses at December 31, 2004, 2003 and 2002 was $50 for each year for consultancy services provided to the Company from Financial Security Assurance Inc. and Financial Security Assurance International Ltd.

7. Derivative Instruments

Credit derivatives issued by the Company meet the definition of a derivative under FAS 133. The Company has recorded these products at fair value, modeled on prevailing market conditions and certain other factors relating to the structure of the transaction. The Company considers credit derivatives to be financial guaranty contracts, in substance, as the Company intends to hold them to maturity. The Company determines fair value using a model which calculates the difference between the actual remaining present value of installment premiums and an estimated remaining present value of installment premiums under current market conditions. In essence, the model estimates the cost of an offsetting position to the original credit derivatives from other comparable counterparties under the current market environment. The model is dependent upon a number of factors including changes in credit spreads, changes in credit quality, foreign exchange and other market factors.

The Company’s credit derivatives portfolio generally requires the Company to meet payment obligations for referenced credits within the portfolio in the event of specific credit events after erosion or exhaustion of various first loss protection levels. These credit events are contract specific, but generally cover bankruptcy, failure to pay and repudiation. The notional exposure of the credit derivatives portfolio as of December 31, 2004 was $5.2 billion. Approximately 95% and 4% of the portfolio is rated AAA and BBB, respectively, with the remainder being split amongst AA and A. The weighted average term of the contracts in force was 5.69 years.

The net fair value adjustment for the years ended December 31, 2004, 2003 and 2002 was an unrealized gain of $7,921, $9,157 and $6,589, respectively. At December 31, 2004, 2003 and 2002, the Company had a net credit derivatives asset (liability) of $5,709, ($2,192) and ($16,268), respectively.

In December 2004, The Company entered into a put option agreement and an asset trust expense reimbursement agreement with Twin Reefs Asset Trust (the “Asset Trust”). The put option agreement provides The Company with

(11)

XL Financial Assurance Ltd.

Notes to Financial Statements

For the years ended December 31, 2004, 2003 and 2002

(U.S. dollars in thousands, except per share amounts)

the irrevocable right to require the Asset Trust at any time and from time to time to purchase the Company’s non-cumulative perpetual Series B Preferred Shares with an aggregate liquidation preference of up to $200 million. The Company is obligated to reimburse the Asset Trust for certain fees and ordinary expenses. To the extent that any Series B Preferred Shares are put to the Asset Trust and remain outstanding, a corresponding portion of such fees and ordinary expenses will be payable by the Company pursuant to the asset trust expense reimbursement agreement. The put option agreement is perpetual but would terminate on delivery of notice by the Company on or after December 10, 2009, or under certain defined circumstances, such as the failure of the Company to pay the put option premium when due or bankruptcy. The put option is recorded at fair value with changes in fair value recognized in earnings. At December 31, 2004, the fair value adjustment was a $19 charge to income. As the underlying structure is defined as a derivative, the underwriting and legal costs associated with establishing the Asset Trust have been expensed accordingly.

8. Variable Interest Entities

The Company primarily provides financial guaranty reinsurance or enters into a credit derivative on the senior interests, which would otherwise be rated investment grade. The obligations related to these transactions are often securitized through variable interest entities. The Company does not hold any equity positions or subordinated debt in these arrangements. Accordingly, the Company’s interest in these variable interest entities is not significant and therefore, not consolidated.

9. Shareholders’ Equity and Redeemable Preferred Shares

The Company was initially incorporated with an authorized share capital of $120,000 comprising 1,000 common shares of a par value $120 per share. These shares were issued to XL Insurance (Bermuda) Ltd on October 28, 1998. On November 3, 1998 the Company increased its authorized capital to $2.4 million divided into 10,000 common shares of a par value $120 per share and 10,000 Series A cumulative participating voting redeemable preferred shares (“Series A Redeemable Preferred Shares”) of par value $120 per share. Immediately thereafter, the Company issued 200 Series A Redeemable Preferred Shares to Financial Security Assurance Inc. for a consideration of $99,500 per share and issued 800 common shares to XL Insurance (Bermuda) Ltd for a consideration of $100,000 per share. Thereafter, the initial 1,000 common shares were repurchased pursuant to a share repurchase agreement at par. On February 3, 1999 the Company repurchased 50 Series A Redeemable Preferred Shares for a consideration of $98,000 per share from Financial Security Assurance Inc. Simultaneously, the Company issued an additional 50 common shares to XL Insurance (Bermuda) Ltd for a consideration of $100,000 per share, of which 98% ($4.9 million) was paid.

On December 6, 2000 the Company, pursuant to a share subscription agreement, issued an additional 213 Series A Redeemable Preferred Shares for a cash consideration of $24 million to Financial Security Assurance International Ltd. and an additional 1,207 Common Shares for a consideration of $136 million to XL Insurance (Bermuda) Ltd. The consideration in respect of the Common Shares was settled in part with fixed maturity securities with a fair market value of $132 million. The remainder was settled with cash. On December 7, 2004 the Series A preferred shareholder waived their anti-dilution rights which allowed the Company, pursuant to a share subscription agreement, to issue an additional 392 Common Shares for a consideration of $125 million to XL Insurance (Bermuda) Ltd. The consideration in respect of the Common Shares was settled in part with fixed maturity securities of $125,572 and cash of $876 and an inter-company payable was established for $1,448 and settled after year end.

(12)

XL Financial Assurance Ltd.

Notes to Financial Statements

For the years ended December 31, 2004, 2003 and 2002

(U.S. dollars in thousands, except per share amounts)

On December 7, 2004 the Company, subject to a written resolution to its Bye-Laws created a new class of preferred shares – “Series B Preferred Shares”. These shares were created in conjunction with the establishment of the Asset Trust (see note 7). The Series B Preferred Shares are non-cumulative redeemable perpetual preferred shares with a par value of $120 per share. The Series B preferred shares rank prior to the Common and Series A Redeemable Preferred Shares of the Company and have a liquidation preference of $100,000 each. In the event that the Company exercises its put option to the Asset Trust and the Series B preferred shares are issued, the holders of outstanding Series B Preferred Shares shall be entitled to receive, in preference to the holders of the Common and Redeemable Preferred Shares, cash dividends at a percentage rate per Series B Preferred Share as follows:

(i)	for any Dividend Period ending on or prior to December 10, 2009, One Month LIBOR plus 1.00 % per annum, calculated on an Actual/360 Basis; and
(ii)	for any subsequent Dividend Period, One-Month LIBOR plus 2.00% per annum, calculated on an Actual/360 Basis.

The holders of the Series B preferred shares will not be entitled to any voting rights as shareholders of the Company and their consent will not be required for taking any corporate action. The Series B Preferred Shares may be redeemed, in whole or in part, at the option of the Company at any time or from time to time for cash at a redemption price equal to the liquidation preference per share plus any accrued and unpaid dividends thereon to the date of redemption without interest on such unpaid dividends. However, the Series B Preferred Shares may not be redeemed, in whole or in part, at the option of the Company at any time prior to December 10, 2009.

The holder of the Common Shares is entitled to three votes per share and to such dividends as the Board of Directors may from time to time declare. Albeit, the Company resolved not to declare or grant dividends on its outstanding Common Shares until December 31, 2006. In the event of a winding-up or dissolution of the Company, whether voluntary or involuntary or for the purpose of a reorganization or otherwise or upon any distribution of capital, the Common Shareholder shall be entitled to the surplus assets of the Company remaining after distributions to the Series A Redeemable Preferred Shareholder.

The holders of the Series A Redeemable Preferred Shares are entitled to one vote per share and are entitled to receive a 5% Fixed Dividend on the amount initially paid for the Series A Redeemable Preferred Shares, plus, a participating dividend.

At any time, the Series A Redeemable Preferred Shares are redeemable by the Company in whole but not in part at its sole option at a redemption price equal to the sum of (i) the fair market value of such Series A Redeemable Preferred Shares, subject to the Cap (maximum calculated rate of return of 19%) and the Floor (minimum calculated rate of return of 8%), plus (ii) the excess, if any, of (A) a preferred percentage of the Company’s Earnings, if any, in the fiscal year in which the date of redemption occurs up to the date of the redemption, as calculated by the Company over (B) Total Dividends paid to the Series A Redeemable Preferred Shareholders in such fiscal year; provided that the sum of the accreted value of all distributions to Series A Redeemable Preferred Shareholders plus the redemption price shall not exceed 15% of the sum of the accreted value of all distributions plus the aggregate fair market value of the capital stock of the Company. At any time after the tenth anniversary of the date of the initial issue, the Series A Preferred Shares are redeemable in whole but not in part at the election of the Series A Preferred Shareholders at their sole option at a redemption price equal to fair market value provided that the sum of the accreted value of all distributions to Series A Redeemable Preferred Shareholders plus the redemption price shall not exceed 15% of the sum of the accreted value of all distributions plus the aggregate fair market value of the

(13)

XL Financial Assurance Ltd.

Notes to Financial Statements

For the years ended December 31, 2004, 2003 and 2002

(U.S. dollars in thousands, except per share amounts)

capital stock of the Company. The fair market value for redemption purposes shall be determined by mutual agreement of both Series A Preferred and Common Shareholders.

In the event of a winding-up or dissolution of the Company whether voluntary or involuntary or for the purposes of a reorganization or otherwise, or upon any distribution of capital, the Series A Redeemable Preferred Shareholders shall be entitled, to the extent of the availability of assets of the Company and in priority to the Common Shareholders, to receive an amount (the “Dissolution Amount”) equal to the sum of (i) the amount initially paid for the Series A Redeemable Preferred Shares, (ii) additional capital contributions paid by the Series A Redeemable Preferred Shareholders, (iii) any accrued and unpaid Fixed Dividends and (iv) the preferred percentage of residual Earnings of the Company, if any in the fiscal year in which winding-up or dissolution occurs, less the Total Dividends previously paid to the holders of the Series A Preferred Shares in respect of such fiscal year and (v) 13% of the cumulative undistributed residual earnings of the Company from inception of the Company through the end of the fiscal year preceding the year in which the winding-up or dissolution occurs provided that the Series A Redeemable Preferred Shareholders shall not be entitled to any further or other right of participation in the assets of the Company.

10. Dividends

During each of the years ended December 31, 2004, 2003 and 2002, fixed dividends of $1,950 were accrued on the Series A Redeemable Preferred Shares. In addition to the regular fixed 5% dividend, the Series A redeemable preferred shareholders are subject to receive a participating dividend calculated based on guidelines established in the Company’s bye-laws. The participating dividend calculation is performed and accrued in the first quarter of the subsequent fiscal year. In this regard, participating dividends of $10,053 and $4,692 were calculated for the fiscal years 2003 and 2002 and paid. During the fourth quarter of 2004, an estimate of the quarterly participating dividend in the amount of $2,100 was declared and paid prior to year end.

11. Letters of Credit

XL Capital Ltd has established a letter of credit facility with a syndicate of commercial banks. Letters of credit issued under this facility are unsecured. Letters of credit totaling $604,851 and $362,911 related to the Company were outstanding as of December 31, 2004 and 2003, respectively.

12. Taxation

Bermuda presently imposes no income tax, withholding tax or capital gains taxes and the Company is exempted until March 2016 from any such future taxes pursuant to the Bermuda Exempted Undertakings Tax Protection Act 1966, and Amended Act 1987.

13. Statutory Financial Data

Under The Act, the Company is required to prepare Statutory Financial Statements and to file a Statutory Financial Return. The Act also requires the company to meet certain minimum capital and surplus requirements. To satisfy these requirements, the Company was required to maintain a minimum level of statutory capital and surplus of $36.0 million, $31.9 million and $15.0 million as of December 31, 2004, 2003 and 2002, respectively. The following summarizes the significant differences between statutory accounting practices and generally accepted accounting principles (“GAAP”).

(14)

XL Financial Assurance Ltd.

Notes to Financial Statements

For the years ended December 31, 2004, 2003 and 2002

(U.S. dollars in thousands, except per share amounts)

	2004			2003			2002
GAAP net income	$	76,252		$	76,161		$	69,492
Deferred acquisition costs		(25,931	)		(40,372	)		(22,189	)
Net realized and unrealized gains on credit derivatives		(11,939	)		(9,157	)		(6,589	)
Statutory net income	$	38,382		$	26,632		$	40,714
GAAP shareholders’ equity and Series B
redeemable preferred shares	$	614,795		$	430,639		$	366,041
Non-admitted assets		(122,472	)		(78,621	)		(29,093	)
Statutory shareholders’ equity	$	492,323		$	352,018		$	336,948

The Company is also required to maintain a minimum liquidity ratio whereby the value of its relevant assets is not less than 75% of the amount of its relevant liabilities. As of December 31, 2004, 2003 and 2002, the Company was required to maintain relevant assets of at least $352.9 million, $238.2 million and $116.0 million, respectively. At those dates relevant assets were approximately $941.4 million, $651.3 million and $503.8 million, respectively, and the minimum liquidity ratio was therefore met.

14. Retirement Plans

The Company maintains a defined contribution plan. Plan assets are invested principally in equity securities and fixed maturities.

The plan is managed externally and employees and the Company contribute a certain percentage of the employee’s gross salary into the plan each month. The Company’s contribution generally vests over 5 years. The Company’s expenses for its defined contribution plan were $243, $228 and $189 for the years ended December 31, 2004, 2003 and 2002, respectively.

15. Amounts Due To/From Parent and Affiliates

Amounts due to/from XL Insurance (Bermuda) Ltd and affiliates of the Company are interest free and have no set terms of repayment. The balances arise as a result of the Company’s operating activities.

16. Outstanding Exposure and Collateral

The Company's policies reinsure the scheduled payments of principal and interest on asset-backed and municipal obligations. The following tables have been enhanced from the prior year to reflect the insured exposures in categories based on the Company’s underwriting and surveillance structure. The principal amount reinsured (in millions) as of December 31, 2004 and 2003 and the terms to maturity are as follows:

(15)

XL Financial Assurance Ltd.

Notes to Financial Statements

For the years ended December 31, 2004, 2003 and 2002

(U.S. dollars in thousands, except per share amounts)

	Asset Backed				Structured Investment				Structured Single Risk				Public Finance
	Securities				Products
2004
Terms to	Gross		Net		Gross		Net		Gross		Net		Gross		Net
Maturity	Par O/S		Par O/S		Par O/S		Par O/S		Par O/S		Par O/S		Par O/S		Par O/S
0 to 5 Years	$	4,958	$	4,775	$	2,281	$	2,281	$	4,234	$	3,507	$	801	$	777
5 to 10 Years		3,494		3,221		2,721		2,721		2,813		2,291		1,763		1,554
10 to 15 Years		32		32		2,654		2,654		838		650		2,996		2,511
15 to 20 Years		205		205		322		322		1,263		1,199		4,632		3,764
20 Years and		9,198		8,697		1,341		1,341		4,997		4,921		14,426		12,785
Above
Total	$	17,887	$	16,930	$	9,319	$	9,319	$	14,145	$	12,568	$	24,618	$	21,391
	Asset Backed				Structured Investment				Structured Single Risk				Public Finance
	Securities				Products
2003
Terms to	Gross		Net		Gross		Net		Gross		Net		Gross		Net
Maturity	Par O/S		Par O/S		Par O/S		Par O/S		Par O/S		Par O/S		Par O/S		Par O/S
0 to 5 Years	$	5,195	$	4,454	$	1,692	$	1,692	$	1,881	$	1,421	$	1,408	$	1,037
5 to 10 Years		4,062		3,445		2,265		2,265		3,170		1,944		1,426		1,190
10 to 15 Years		39		39		2,731		2,731		569		501		1,852		1,402
15 to 20 Years		251		251		293		293		532		506		2,984		2,766
20 Years and		959		577		1,054		1,054		2,520		2,252		10,540		8,764
Above
Total	$	10,506	$	8,766	$	8,035	$	8,035	$	8,672	$	6,624	$	18,210	$	15,159

The Company limits its exposure to losses from writing financial guaranties by underwriting investment-grade obligations and diversifying its portfolio and maintaining rigorous collateral requirements on asset-backed obligations. The gross principal amounts of reinsured obligations in the asset-backed reinsured portfolio are backed by the following types of collateral as of December 31, 2004 and 2003 (in millions):

	2004				2003
Types of Collateral	Gross		Net		Gross		Net
Collateralized debt	$	8,869	$	8,869	$	8,033	$	8,033
Corporate assets		4,527		4,403		3,348		3,071
Consumer assets	13,759			12,926		7,158		5,695

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XL Financial Assurance Ltd.

Notes to Financial Statements

For the years ended December 31, 2004, 2003 and 2002

(U.S. dollars in thousands, except per share amounts)

Pre-Insured		50		50		-		-
Total asset-backed obligations	$	27,205	$	26,248	$	18,539	$	16,799

Pre-Insured is a new category for 2004.

In its asset-backed business, the Company considers its overall geographic concentration as a factor in underwriting reinsurance covering securitizations of pools of such assets as residential mortgages or consumer receivables. In writing reinsurance for other types of asset-backed obligations, such as securities primarily backed by government or corporate debt, geographic concentration is not deemed by the Company to be significant, given other more relevant measures of diversification, such as issuer or industry.

The Company seeks to maintain a diversified portfolio of reinsured municipal obligations designed to spread its risk across a number of geographic areas. The following table sets forth, by state and territory of the United States, those states and territories in which municipalities located therein issued an aggregate of 2% or more of the Company's par amount outstanding of reinsured municipal securities as of December 31, 2004 and 2003 (in millions):

2004	Par Amount Outstanding
State/Territory	Gross		Net		% of Net
California	$	5,740	$	4,744	22.2	%
New York		3,413		2,540	11.9	%
Massachusetts		1,433		1,368	6.4	%
New Jersey		1,326		958	4.5	%
Alabama		1,292		962	4.5	%
Texas		1,236		1,111	5.2	%
Other U.S. states		9,728		9,258	43.3	%
International		450		450	2.0	%
Total	$	24,618	$	21,391	100.0	%
2003	Par Amount Outstanding
State/Territory	Gross		Net		% of Net
New York	$	2,854	$	2,174	14.3	%
California		2,651		1,880	12.4	%
Massachusetts		1,356		921	6.1	%
New Jersey		1,120		1,120	7.4	%
Alabama		970		446	3.0	%
Illinois		954		869	5.7	%
Other U.S. states		7,154		6,855	45.2	%
International		1,151		894	5.9	%
Total	$	18,210	$	15,159	100.0	%

(17)

XL Financial Assurance Ltd.

Notes to Financial Statements

For the years ended December 31, 2004, 2003 and 2002

(U.S. dollars in thousands, except per share amounts)

As of December 31, 2004 and 2003, the insured portfolio was diversified by type of insured obligation as shown in the following table (in millions):

	2004				2003
	Gross	Net	% of Net		Gross	Net	% of Net
Asset Backed Securities
Auto	3,592	3,420	20.2	%	3,705	3,106	35.4	%
Consumer Mortgage	9,658	8,997	53.1	%	2,169	1,518	17.3	%
Consumer Receivables					276	252	2.9	%
Corporate Receivables/Leases					1,998	1,998	22.9	%
Credit Card	510	510	3.0	%	1,008	819	9.3	%
Structured Finance - Other					1,350	1,073	12.2	%
Pre-Insured	50	50	0.3	%	-	-	-
EETC	312	312	1.8	%	-	-	-
Equipment Lease/Loans	569	569	3.4	%	-	-	-
Commercial ABS - Other	1,674	1,674	9.9	%	-	-	-
Commercial Real Estate	1	1	-		-	-	-
Trade Receivables	1	1	-		-	-	-
Consumer ABS - Other	322	298	1.8	%	-	-	-
Multi-Seller Conduit	298	298	1.8	%	-	-	-
Fleeting Financing	900	800	4.7	%	-	-	-
	17,887	16,930	100.0	%	10,506	8,766	100.0	%
Structured Investment Products
CDO – Bank Balance Sheet	-	-	-		1,915	1,915	23.9	%
CDO – Arbitrage Cash Flow	6,802	6,802	73.04	%	5,450	5,450	67.8	%
CDO – Market Value	200	200	2.1	%	218	218	2.7	%
CDO - Repackages	-	-	-		450	450	5.6	%
CDO - Synthetic	1,598	1,598	17.2	%	-	-	-
CDO – Secondary Program	270	270	2.9	%	-	-	-
CFO – Collateralized Fund Obligation	449	449	4.8	%	-	-	-
	9,319	9,319	100.0	%	8,033	8,033	100.0	%
Structured Single Risk
Bank Product	941	846	6.7	%	1,063	797	12.0	%
Financial Insurance	1,262	1,178	9.4	%	1,039	954	14.4	%
Future Flow	2,082	968	7.7	%	1,958	554	8.4	%

(18)

XL Financial Assurance Ltd.

Notes to Financial Statements

For the years ended December 31, 2004, 2003 and 2002

(U.S. dollars in thousands, except per share amounts)

Pre-Insured	328	328	2.6	%	1,035	1,036	15.7	%
Project Finance	-	-	-		1,672	1,420	21.4	%
Structured Investment Products – Other	-	-	-		198	198	3.0	%
Structured Finance – Other	369	361	2.9	%	1,707	1,665	25.1	%
Transportation	1,290	1,206	9.6	%	-	-	-
Utility - Public	125	125	1.0	%	-	-	-
Global Infrastructure - Other	226	226	1.8	%	-	-	-
Housing & Public Buildings	496	496	3.9	%	-	-	-
Utility - Private	4,293	4,140	32.9	%	-	-	-
GIC	2,241	2,241	17.8	%	-	-	-
Power & Utility - Other	357	318	2.5	%	-	-	-
Sovereign	135	135	1.1	%	-	-	-
	14,145	12,568	100.0	%	8,672	6,624	100.0	%
Public Finance
General Obligations	10,678	8,669	40.5	%	7,714	6,396	42.2	%
Higher Education – Public & Private	2,016	1,951	9.1	%	1,723	1,383	9.1	%
Housing	1	1	-		284	284	1.9	%
IOU’s	-	-	-		2,263	2,054	13.5	%
Non Ad Valorem	2,522	2,054	9.6	%	662	662	4.4	%
Special Revenue	-	-	-		324	162	1.1	%
Transportation	3,097	3,072	14.4	%	1,797	1,712	11.3	%
Utilities	5,168	4,577	21.4	%	3,443	2,506	16.5	%
Pre-Insured	806	806	3.8	%	-	-	-
Revenue Secured - Other	330	261	1.2	%	-	-	-
	24,618	21,391	100.0	%	18,210	15,159	100.0	%
Total	65,969	60,208			45,421	38,582

Gross financial guaranties in force (principle and interest), was $96,516 and $66,516 as of December 31, 2004 and 2003, respectively. Net financial guaranties in force (after giving effect to reinsurance), was $87,490 and $56,252 as of December 31, 2004 and 2003, respectively.

17. Disclosures about Fair Value of Financial Instruments

For financial instruments other than derivative instruments (see note 7), estimated fair values have been determined by the Company, using available market information and appropriate valuation methodologies. However, considerable judgment is necessary to interpret the data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amount the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the following estimated fair value amounts.

Fixed-maturity investments

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XL Financial Assurance Ltd.

Notes to Financial Statements

For the years ended December 31, 2004, 2003 and 2002

(U.S. dollars in thousands, except per share amounts)

The carrying amount represents fair value, which is based primarily on quoted market prices received from a nationally recognized pricing service or dealer quotes.

Short-term investments

The carrying amount represents fair value, which approximates cost due to the short maturity of these instruments.

Cash and cash equivalents

The carrying amount is a reasonable estimate of approximate fair value because of the short maturity term of these instruments.

Deferred premium revenue

The carrying amount of deferred premium revenue represents the Company's future premium revenue on policies where the premium was received at the inception of the reinsurance contract. The fair value of deferred premium revenue is an estimate of the premiums that would be paid under a reinsurance agreement with a third party to transfer the remaining term of the Company's financial guaranty risk, net of that portion of the premiums retained by the Company to compensate it for originating and servicing the reinsurance contract.

Installment premiums

Consistent with industry practice, there is no carrying amount for future installment premiums since the Company will receive premiums on an installment basis over the term of the reinsurance contract. Similar to deferred premium revenue, the fair value of installment premiums is the estimated present value of the future contractual premium revenues that would be paid under a reinsurance agreement with a third party to transfer the remaining term of the Company's financial guaranty risk, net of that portion of the premium retained by the Company to compensate it for originating and servicing the reinsurance contract. The fair value is derived by calculating the present value of the estimated future cash flow stream (net premium and ceding commissions) discounted at 3.61% . and 7% as of December 31, 2004 and 2003 respectively. The Company has determined that the costs for originating and servicing the contract would be immaterial and that the carrying value and the estimated fair value would be approximately the same. At December 31, 2004 and 2003, the fair value of such installment premiums was approximately $212.1 million and $211.7 million, respectively.

Unpaid losses and loss expenses

The carrying amount is fair value, which is the present value of the expected cash flows for specifically identified claims and potential losses in the Company's reinsured portfolio.

	2004				2003
	Carrying		Estimated		Carrying		Estimated
	Value		Fair Value		Value		Fair Value
Assets
Fixed maturities	$	792,723	$	792,723	$	543,748	$	543,748
Short-term investments		87,875		87,875		40,312		40,312
Cash and cash equivalents		13,210		13,210		26,346		26,346
Reinsurance balances receivable		40,859		40,859		33,446		33,446

(20)

XL Financial Assurance Ltd.

Notes to Financial Statements

For the years ended December 31, 2004, 2003 and 2002

(U.S. dollars in thousands, except per share amounts)

Liabilities
Deferred premium revenue	437,654	437,654	348,719	348,719
Unpaid losses and loss expenses	99,133	99,133	35,899	35,899
Reinsurance balances payable	4,022	4,022	6,275	6,275
Off balance sheet instruments
Installment premiums	-	212,056	-	211,661

18. Unaudited Quarterly Financial Information

The following is a summary of the unaudited quarterly financial data for 2004 and 2003.

	First		Second		Third		Fourth		Full
2004	Quarter		Quarter		Quarter		Quarter		Year
Gross premiums written	$	47,067	$	60,430	$	51,690	$	68,938	$	228,125
Net premiums written		40,069		53,377		41,925		83,035		218,406
Net premiums earned		19,680		19,978		17,790		26,460		83,908
Net investment income		5,140		5,737		6,225		7,764		24,866
Loss and loss expenses		1,291		4,910		7,013		3,841		17,055
Net income		31,067		16,183		7,911		21,091		76,252
	First		Second		Third		Fourth		Full
2003	Quarter		Quarter		Quarter		Quarter		Year
Gross premiums written	$	38,793	$	88,756	$	78,863	$	58,430	$	264,842
Net premiums written		30,495		69,676		66,421		44,326		210,918
Net premiums earned		13,188		18,924		19,964		25,506		77,582
Net investment income		4,070		3,404		3,904		5,507		16,885
Loss and loss expenses		5,861		5,015		2,031		4,863		17,770
Net income		13,802		21,518		17,253		23,588		76,161

(21)