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UNITED STATES FORM 10-Q S QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF XL CAPITAL LTD
CAYMAN ISLANDS
98-0191089 XL House, One Bermudiana Road, Hamilton, Bermuda HM 11 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 for
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 S No £ Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2
of the Exchange Act. (Check one): Large accelerated filer S Accelerated filer £ Non-accelerated filer £ Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes £ No S As of July 21, 2008, there were 179,064,757 outstanding Class A Ordinary Shares, $0.01 par value per share, of the registrant.
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2008
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
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
(Address of principal executive offices and zip code)
(441) 292-8515
(Registrants telephone number, including area code)
XL CAPITAL LTD INDEX TO FORM 10-Q Page No Item 1. Consolidated Balance Sheets as at June 30, 2008 (Unaudited) and
December 31, 2007 3 4 5 6 Consolidated Statements of Cash Flows for the Six Months Ended June
30, 2008 and 2007 (Unaudited) 7 8 Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations 40 Item 3. 80 Item 4. 85 Item 1. 86 Item 1A. 89 Item 2. 110 Item 4. 110 Item 6. 111 112 2
XL CAPITAL LTD
(Unaudited)
December 31, ASSETS Investments: Fixed maturities, at fair value (amortized cost: 2008, $31,457,613; 2007, $34,233,816)
$
29,120,688
$
33,607,790 Equity securities, at fair value (cost: 2008, $487,143; 2007, $664,213)
581,092
854,815 Short-term investments, at fair value (amortized cost: 2008, $1,364,906; 2007, $1,814,445)
1,340,940
1,803,198 Total investments available for sale
31,042,720
36,265,803 Investments in affiliates
2,401,799
2,611,149 Other investments (cost: 2008, $538,518; 2007, $614,848)
632,015
708,476 Total investments
34,076,534
39,585,428 Cash and cash equivalents
3,704,249
3,880,030 Accrued investment income
411,230
447,660 Deferred acquisition costs
861,524
756,854 Prepaid reinsurance premiums
1,126,438
972,516 Premiums receivable
4,121,620
3,637,452 Reinsurance balances receivable
717,818
817,931 Unpaid losses and loss expenses recoverable
4,129,001
4,697,471 Goodwill and other intangible assets
1,841,548
1,841,591 Deferred tax asset, net
386,797
370,419 Other assets
703,203
754,912 Total assets
$
52,079,962
$
57,762,264 LIABILITIES AND SHAREHOLDERS EQUITY Liabilities: Unpaid losses and loss expenses
$
22,955,473
$
23,207,694 Future policy benefit reserves
6,904,505
6,772,042 Deposit liabilities
2,956,423
7,920,085 Notes payable and debt
2,869,230
2,868,731 Reinsurance balances payable
821,721
843,511 Net payable for investments purchased
304,282
191,472 Unearned premiums
5,355,644
4,681,989 Other liabilities
1,141,904
1,326,179 Total liabilities
$
43,309,182
$
47,811,703 Commitments and Contingencies: Minority interest in equity of consolidated subsidiaries
$
1,587
$
2,419 Shareholders Equity: Series E preference ordinary shares, 1,000,000 authorized, par value $0.01 Issued and outstanding: (2008 and 2007, 1,000,000)
10
10 Class A ordinary shares, 999,990,000 authorized, par value $0.01 Issued and outstanding: (2008, 179,051,979; 2007, 177,910,151)
1,791
1,779 Additional paid in capital
7,391,966
7,358,801 Accumulated other comprehensive (loss) income
(1,516,825
)
9,159 Retained earnings
2,892,251
2,578,393 Total shareholders equity
$
8,769,193
$
9,948,142 Total liabilities and shareholders equity
$
52,079,962
$
57,762,264 See accompanying Notes to Unaudited Consolidated Financial Statements 3
CONSOLIDATED BALANCE SHEETS
(U.S. dollars in thousands, except share amounts)
June 30,
2008
2007
XL CAPITAL LTD
(Unaudited)
(Unaudited)
2008
2007
2008
2007 Revenues: Net premiums earned
$
1,681,722
$
1,930,305
$
3,394,084
$
3,721,349 Net investment income
440,352
567,215
939,581
1,120,307 Net realized gains (losses) on investments
2,040
18,296
(100,211
)
27,588 Net realized and unrealized gains on derivative instruments
8,124
9,188
52,806
16,929 Net (loss) income from investment fund affiliates
(20,435
)
67,043
(8,636
)
185,979 Fee income and other
12,796
4,649
21,087
7,986 Total revenues
$
2,124,599
$
2,596,696
$
4,298,711
$
5,080,138 Expenses: Net losses and loss expenses incurred
$
938,585
$
941,948
$
1,939,478
$
1,936,735 Claims and policy benefits
209,725
279,100
406,024
467,443 Acquisition costs
246,237
298,021
512,534
557,972 Operating expenses
298,298
306,552
562,122
587,055 Exchange losses
7,936
22,600
75,681
46,169 Interest expense
65,441
164,695
189,553
307,486 Amortization of intangible assets
420
420
840
840 Total expenses
$
1,766,642
$
2,013,336
$
3,686,232
$
3,903,700 Income before minority interest, income tax and net (loss) income from operating affiliates
$
357,957
$
583,360
$
612,479
$
1,176,438 Minority interest in net income of subsidiary
9,096
23,994 Income tax
51,205
61,288
81,907
134,043 Net (loss) income from operating affiliates
(68,901
)
41,639
(48,348
)
98,721 Net income
237,851
554,615
482,224
1,117,122 Preference share dividends
(10,080
)
(32,500
)
(22,869
) Net income available to ordinary shareholders
$
237,851
$
544,535
$
449,724
$
1,094,253 Weighted average ordinary shares and ordinary share equivalents outstanding basic
176,655
178,378
176,453
178,650 Weighted average ordinary shares and ordinary share equivalents outstanding diluted
176,910
181,613
176,946
180,570 Earnings per ordinary share and ordinary share equivalent basic
$
1.35
$
3.05
$
2.55
$
6.13 Earnings per ordinary share and ordinary share equivalent diluted
$
1.34
$
3.00
$
2.54
$
6.06 See accompanying Notes to Unaudited Consolidated Financial Statements 4
CONSOLIDATED STATEMENTS OF INCOME
(U.S. dollars in thousands, except per share amounts)
Three Months Ended
June 30,
Six Months Ended
June 30,
XL CAPITAL LTD
(Unaudited)
(Unaudited)
2008
2007
2008
2007 Net income
$
237,851
$
554,615
$
482,224
$
1,117,122 Change in net unrealized (losses) on investments, net of tax
(686,280
)
(620,461
)
(1,761,867
)
(725,384
) Change in value of cash flow hedge
109
(114
)
218
4,117 Foreign currency translation adjustments, net
6,946
65,455
237,418
95,284 Net unrealized gain (loss) on future policy benefit reserves
187
(1,688
)
(273
) Realization of accumulated other comprehensive loss in SCA
4,953
4,953 Additional pension liability
(21
)
(65
)
(188
) Comprehensive (loss) income
$
(441,395
)
$
4,635
$
(1,043,760
)
$
495,631 See accompanying Notes to Unaudited Consolidated Financial Statements 5
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(U.S. dollars in thousands)
Three Months Ended
June 30,
Six Months Ended
June 30,
XL CAPITAL LTD
(Unaudited)
2008
2007 Series A, B and E Preference Ordinary Shares: Balance beginning of year
$
10
$
207 Issuance of Series E preference ordinary shares
10 Balance end of period
$
10
$
217 Class A Ordinary Shares: Balance beginning of year
$
1,779
$
1,810 Issuance of Class A ordinary shares
13
112 Exercise of stock options
7 Repurchase of Class A ordinary shares
(1
)
(110
) Balance end of period
$
1,791
$
1,819 Additional Paid in Capital: Balance beginning of year
$
7,358,801
$
6,451,569 Issuance of Class A ordinary shares
49,093
871,123 Issuance of Series E preference ordinary shares
983,786 Repurchase of Class A ordinary shares
(4,246
)
(368,539
) Stock option expense
10,039
8,459 Exercise of stock options
42,740 Net change in deferred compensation
(21,721
)
(18,275
) Balance end of period
$
7,391,966
$
7,970,863 Accumulated Other Comprehensive (Loss) Income: Balance beginning of year
$
9,159
$
411,405 Net change in unrealized (losses) on investment portfolio, net of tax
(1,761,735
)
(743,094
) Net change in unrealized (losses) gains on affiliate and other investments, net of tax
(132
)
17,710 Change in value of cash flow hedge
218
4,117 Impact of net unrealized (loss) on future policy benefit reserves
(1,688
)
(273
) Foreign currency translation adjustments
237,418
95,284 Realization of accumulated other comprehensive loss in SCA
4,953 Additional pension liability
(65
)
(188
) Balance end of period
$
(1,516,825
)
$
(210,086
) Retained Earnings: Balance beginning of year
$
2,578,393
$
3,266,175 Net income
482,224
1,117,122 Dividends on Series A and B preference ordinary shares
(20,161
) Dividends on Series E preference ordinary shares
(32,500
)
(2,708
) Dividends on Class A ordinary shares
(135,866
)
(138,306
) Repurchase of Class A ordinary shares
(462,889
) Balance end of period
$
2,892,251
$
3,759,233 Total Shareholders Equity
$
8,769,193
$
11,522,046 See accompanying Notes to Unaudited Consolidated Financial Statements 6
CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY
(U.S. dollars in thousands)
Six Months Ended
June 30,
XL CAPITAL LTD
(Unaudited)
2008
2007 Cash flows provided by operating activities: Net income
$
482,224
$
1,117,122 Adjustments to reconcile net income to net cash provided by operating activities: Net realized losses (gains) on investments
100,211
(27,588
) Net realized and unrealized (gains) on derivative instruments
(52,806
)
(16,929
) Amortization of (discounts) on fixed maturities
(21,117
)
(37,443
) Net loss (income) from investment and operating affiliates
56,984
(284,700
) Amortization of deferred compensation
26,973
28,133 Accretion of convertible debt
499
722 Accretion of deposit liabilities
92,396
202,780 Unpaid losses and loss expenses
(665,502
)
(129,473
) Future policy benefit reserves
(8,470
)
68,415 Unearned premiums
588,745
815,040 Premiums receivable
(395,077
)
(622,568
) Unpaid losses and loss expenses recoverable
669,117
271,572 Prepaid reinsurance premiums
(139,148
)
(68,486
) Reinsurance balances receivable
118,674
185,373 Deferred acquisition costs
(93,215
)
(142,823
) Reinsurance balances payable
(45,114
)
23,683 Deferred tax asset
38,248
(25,973
) Other
(106,321
)
(113,094
) Total adjustments
$
165,077
$
126,641 Net cash provided by operating activities
$
647,301
$
1,243,763 Cash flows used in (provided by) investing activities: Proceeds from sale of fixed maturities and short-term investments
$
9,840,029
$
14,185,451 Proceeds from redemption of fixed maturities and short-term investments
1,333,153
862,036 Proceeds from sale of equity securities
529,130
520,415 Proceeds from sale of SCA common shares, net of cash sold
(110,843
) Purchases of fixed maturities and short-term investments
(7,470,615
)
(16,830,211
) Purchases of equity securities
(331,062
)
(421,672
) Net dispositions (acquisitions) of affiliates
201,749
111,270 Other investments
31,354
(125,395
) Net cash used in (provided by) investing activities
$
4,133,738
$
(1,808,949
) Cash flows (used in) provided by financing activities: Proceeds from exercise of stock options and issuance of Class A ordinary shares
867,748 Proceeds from issuance of Series E preference ordinary shares
983,796 Repurchase of Class A ordinary shares
(4,247
)
(831,538
) Dividends paid
(167,881
)
(161,175
) Proceeds from issuance of debt
322,836 Repayment of debt
(825,000
) Deposit liabilities
(5,056,582
)
435,284 Net cash flow on securities lending
186,700
53,409 Proceeds from issuance of SCA Series A perpetual preference shares
247,248 Dividends paid to minority shareholders of SCA
(16,130
) Net cash (used in) provided by financing activities
$
(5,042,010
)
$
1,076,478 Effects of exchange rate changes on foreign currency cash
85,190
9,312 (Decrease) increase in cash and cash equivalents
(175,781
)
520,604 Cash and cash equivalents beginning of period
3,880,030
2,223,748 Cash and cash equivalents end of period
$
3,704,249
$
2,744,352 See accompanying Notes to Unaudited Consolidated Financial Statements 7
CONSOLIDATED STATEMENTS OF CASH FLOWS
(U.S. dollars in thousands)
Six Months Ended
June 30,
XL CAPITAL LTD 1. Basis of Preparation and Consolidation These unaudited consolidated financial statements include the accounts of the Company and all of its subsidiaries and have been prepared in accordance with accounting principles generally
accepted in the United States of America (GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all
of the information and footnotes required by GAAP for complete financial statements. In addition, the year-end balance sheet data was derived from audited financial statements but does not include
all disclosures required by accounting principles generally accepted in the United States of America. In the opinion of management, these unaudited financial statements reflect all adjustments
(consisting of normal recurring accruals) considered necessary for a fair presentation of financial position and results of operations as at the end of and for the periods presented. The results of
operations for any interim period are not necessarily indicative of the results for a full year. All significant inter-company 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 at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from these estimates. To facilitate period-to-period comparisons, certain reclassifications have been made to prior period consolidated financial statement amounts to conform to current period presentation. There was
no effect on net income from this change in presentation. Unless the context otherwise indicates, references herein to the Company include XL Capital Ltd and its consolidated subsidiaries. 2. Significant Accounting Policies (a) Fair Value Measurements Financial Instruments subject to Fair Value Measurements In September 2006, the FASB issued FAS 157, Fair Value Measurements (FAS 157). FAS 157 clarifies that fair value is an exit price, representing the amount that would be received to sell
an asset or paid to transfer a liability in an orderly transaction between market participants. Under FAS 157, fair value measurements are not adjusted for transaction costs. FAS 157 nullifies the
guidance included in EITF Issue No. 02-3, Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management
Activities, that prohibited the recognition of a day one gain or loss on derivative contracts (and hybrid financial instruments measured at fair value under FAS 155) where a company was unable to
verify all of the significant model inputs to observable market data and/or verify the model to market transactions. However, FAS 157 requires that a fair value measurement reflect the assumptions
market participants would use in pricing an asset or liability based on the best information available. Assumptions include the risks inherent in a particular valuation technique (such as a pricing
model) and/or the risks inherent in the inputs to the model. In addition, FAS 157 prohibits the recognition of block discounts for large holdings of unrestricted financial instruments where quoted prices are readily and regularly available for an identical
asset or liability in an active market. The provisions of FAS 157 are to be applied prospectively, except changes in fair value measurements that result from the initial application of FAS 157 to
existing derivative financial instruments measured under EITF Issue No. 02-3, existing hybrid financial instruments measured at fair value and block discounts, all of which are to be recorded as an
adjustment to beginning retained earnings in the year of adoption. 8
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
XL CAPITAL LTD 2. Significant Accounting Policies (continued) (a) Fair Value Measurements (continued) The Company adopted FAS 157 as of January 1, 2008. There was no transition adjustment required to opening retained earnings as a result of the adoption of this standard. As noted above, the
fair value of a financial instrument is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date
(the exit price). Instruments that the Company owns (long positions) are marked to bid prices, and instruments that the Company has sold, but not yet purchased (short positions) are marked to offer
prices. Fair value measurements are not adjusted for transaction costs. In February 2008, the FASB issued FSP FAS 157-2, Effective Date of FASB Statement No. 157 (FSP FAS 157-2), which permits a one-year deferral of the application of FAS 157 for all
non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). FSP FAS 157-2 is
effective in conjunction with FAS 157 for interim and annual financial statements issued after January 1, 2008. Accordingly, the provisions of FAS 157 have not been applied to goodwill and other
intangible assets held by the Company which are measured annually for impairment testing purposes only. Basis of Fair Value Measurement FAS 157 also establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices
in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under
FAS 157 are described further below:
Level 1Quoted prices in active markets for identical assets/liabilities (unadjusted); no blockage factors. Level 2Other observable inputsinclude quoted prices for similar assets/liabilities (adjusted) and market corroborated inputs. Level 3Unobservable inputs. An asset or a liabilitys level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Details on assets and liabilities that have been included under the requirements of FAS 157 to illustrate the bases for determining the fair values of the assets and liabilities held by the Company
are detailed in the accounting policy sections that follow. (b) Cash and Cash Equivalents Cash equivalents include fixed interest deposits placed with a maturity of under 90 days when purchased. Bank deposits are not considered to be fair value measurements and as such are not
subject to FAS 157 disclosures. Money market funds are classified as Level 1 as these instruments are considered actively traded; however, certificates of deposit are classified as Level 2. 9
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
XL CAPITAL LTD 2. Significant Accounting Policies (continued) (c) Investments Investments Available For Sale Investments that are considered available for sale are carried at fair value. The fair value of fixed maturity securities is based upon quoted market values where available, or matrix or other
model-derived prices where quoted market values are not available, or through the use of unobservable inputs corroborated by reference to broker or underwriter bid indications where matrix or
other model-derived prices are not determinable for a particular security. The Companys valuation approach utilizes market approaches to valuations using primarily Level 2 inputs in the vast
majority of valuations, or some form of discounted cash flow analysis to obtain investment values for a small percentage of fixed maturity securities for which a price is determined. Standard inputs to
the valuations listed in approximate order of priority for use when available include: reported trades, benchmark yields, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities,
bids, offers, and reference data. The Companys valuation approach may prioritize inputs differently on any given day for any security, and not all inputs listed are available for use in the evaluation
process on any given day for each security evaluation; however, market indicators, industry and economic events are also monitored. Information of this nature is a trigger to acquire further
corroborating market data. When these inputs are not available, buckets of similar securities are identified (allocated by asset class types, sectors, sub-sectors, contractual cash flows/structure, and
credit rating characteristics) and a form of matrix or other modeled pricing is utilized to determine an appropriate security value which represents the best estimate as to what a buyer in the
marketplace would pay for a security in a current sale. In addition, the values determined by the Company for a security or class of similar securities, are corroborated against values produced by
others within the market. For fixed maturity securities where prices cannot be determined through either quoted market values or using a form of matrix or other modeled pricing due to factors specific to the security
such as limited liquidity, lack of current transactions, or trades only taking place in privately negotiated transactions, unobservable inputs are utilized in determining the fair value. These are
considered Level 3 valuations as significant inputs utilized may be difficult to corroborate with observable market data. The Company corroborates these values to broker or dealer values where
possible; however, sufficient information regarding the specific inputs utilized by the brokers cannot be obtained to support a Level 2 classification. The net unrealized gain or loss 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 remaining maturity of less than one year and are valued using the same external factors and in the same manner as fixed maturity securities. Equity securities include investments in open end mutual funds and shares of publicly traded alternative funds. The fair value of equity securities are based upon quoted market values (Level 1),
or monthly net asset value statements provided by the investment managers upon which subscriptions and redemptions can be executed (Level 2). 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. For mortgage-backed securities, and any other holdings for which there is a prepayment risk, prepayment assumptions are evaluated and revised as necessary. Prepayment fees
or call premiums that are only payable to the Company when a security is called prior to its maturity are earned when received and reflected in net investment income. 10
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
XL CAPITAL LTD 2. Significant Accounting Policies (continued) (c) Investments (continued) 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 Companys balance sheet 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 as well
as its portion of movements in certain of the investee shareholders equity balances. When financial statements of the affiliate are not available on a timely basis to record the Companys share of
income or loss for the same reporting periods as the Company, the most recently available financial statements are used. This lag in reporting is applied consistently until timely information becomes
available. 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, LLCs or similar investment vehicles. The Company records its alternative and private fund affiliates on a one month and three month lag, respectively, and its operating
affiliates on a three month lag. Significant influence is considered for other strategic investments on a case-by-case basis. Investments in affiliates are not subject to FAS 157 as they are not fair value
measurements. However, impairments associated with investments in affiliates that are deemed to be other-than-temporary are calculated in accordance with FAS 157 and appropriate disclosures
included within the financial statements during the period the losses are recorded. Other investments Contained within this asset class are investments including direct equity investments, investment funds, limited partnerships, equity tranches of collateralized loan participations and certain
structured project finance transactions. The Company accounts for its other investments that do not have readily determinable market values at estimated fair value as it has no significant influence
over these entities. Fair values for other investments, principally other direct equity investments, investment funds and limited partnerships, are primarily based on the net asset value provided by the investment
manager or the respective entity, recent financial information, available market data, and in certain cases management judgment may be required. These entities generally carry their trading positions
and investments, the majority of which have underlying securities valued using Level 1 or Level 2 inputs, at fair value as determined by their respective investment managers, accordingly, these
investments are generally classified as Level 2. Private equity investments are classified as Level 3. The net unrealized gain or loss on investments, net of tax, is included in accumulated other
comprehensive income (loss). Any unrealized loss in value considered by management to be other than temporary is charged to income in the period that it is determined. Income on unrated tranches of collateralized loan obligations is reflected only to the extent the Companys principal has been fully recovered. This is not considered to be a fair value
measurement under FAS 157 and accordingly these investments have been excluded from FAS 157 disclosures. The carrying value of these investments held by the Company at June 30, 2008 and
December 31, 2007 was $17.5 million and $22.7 million, respectively. In addition, the Company participates in structured transactions in project finance related areas under which the Company provides a cash loan supporting a trade finance transaction. These
transactions are accounted for in accordance with SOP 01-6, Accounting by Certain Entities (Including Entities with Trade Receivables) That Lend to or Finance the Activities of Others under
which the loans are considered held for investment as the Company has the intent and ability to hold for the foreseeable future or until maturity or payoff. Accordingly, these funded loan
participations are reported in the balance sheet at outstanding principal adjusted for any allowance for loan losses as considered necessary by management. These investments are not considered to be 11
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
XL CAPITAL LTD 2. Significant Accounting Policies (continued) (c) Investments (continued) fair value measurements under FAS 157 and accordingly they have been excluded from the FAS 157 disclosures. The carrying value of these investments held by the Company at June 30, 2008 and
December 31, 2007 was $81.4 million and $125.1 million, respectively. Securities lending The Company engages in a securities lending program whereby certain securities from the Companys 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 Companys policy is to require 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 retains all economic interest in the securities it lends and
receives a fee from the borrower for the temporary use of the securities. 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 Companys obligation to return the collateral plus interest included in net payable for
investments purchased. 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) 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, (v) expected
future interest rate movements, and (vi) the Companys 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 securitys 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. (d) Derivative Instruments The Company recognizes all derivatives as either assets or liabilities in the balance sheet and measures those instruments 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. The accounting for
derivatives which are designated as hedging instruments is discussed below. Changes in fair value of derivatives may create volatility in the Companys results of operations from period to period. The Company conducts its derivative activities in two main areas: investment related derivatives and weather and energy derivatives. In addition, following the secondary sale of Security Capital
Assurance Ltd common shares, the Company retained some credit derivative exposures written by Security Capital Assurance Ltd and certain of its subsidiaries (sometimes collectively referred to as
SCA) through reinsurance agreements that have certain of these derivatives exposures embedded within them. 12
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
XL CAPITAL LTD 2. Significant Accounting Policies (continued) (d) Derivative Instruments (continued) The Companys direct use of investment related derivatives includes futures, forwards, swaps and option contracts that derive their value from underlying assets, indices, reference rates or a
combination of these factors. The Company uses investment derivatives to manage duration, credit and foreign currency exposure for its investment portfolio as well as to add value to the investment portfolio through replicating permitted investments, provided the use of such investments is
incorporated into the overall portfolio evaluation. All derivatives are recorded at fair value. On the date the derivative contract is entered into, the Company may designate the derivative as a hedge of the fair value of a recognized asset or
liability (fair value hedge); a hedge of the variability in cash flows of a forecasted transaction or of amounts to be received or paid related to a recognized asset or liability (cash flow hedge); a
hedge of a net investment in a foreign operation; or the Company may not designate any hedging relationship for a derivative contract. Derivative contracts can be exchange-traded or over-the-counter (OTC). Exchange-traded derivatives (futures and options) typically fall within Level 1 of the fair value hierarchy depending on
whether they are deemed to be actively traded or not. OTC derivatives are valued using market transactions and other market evidence whenever possible, including market-based inputs to models, model calibration to market clearing transactions,
broker or dealer quotations as corroborative evidence or alternative pricing sources where an understanding of the inputs utilized in arriving at the valuations is obtained. Where models are used, the
selection of a particular model to value an OTC derivative depends upon the contractual terms and specific risks inherent in the instrument as well as the availability of pricing information in the
market. The Company generally uses similar models to value similar instruments. Valuation models require a variety of inputs, including contractual terms, market prices, yield curves, credit curves,
measures of volatility, prepayment rates and correlations of such inputs. For OTC derivatives that trade in liquid markets, such as generic forwards, interest rate swaps and options, model inputs can
generally be verified and model selection does not involve significant management judgment. Such instruments comprise the majority of derivatives held by the Company and are typically classified
within Level 2 of the fair value hierarchy. Certain OTC derivatives trade in less liquid markets with limited pricing information, or required model inputs which are not directly market corroborated which causes the determination of fair
value for these derivatives to be inherently more subjective. Accordingly, such derivatives are classified within Level 3 of the fair value hierarchy. The valuations of less standard or liquid OTC
derivatives are typically based on Level 1 and/or Level 2 inputs that can be observed in the market, as well as unobservable Level 3 inputs. Level 1 and Level 2 inputs are regularly updated to reflect
observable market changes, with resulting gains and losses reflected within Level 3. Level 3 inputs are only changed when corroborated by evidence such as similar market transactions and/or broker
or dealer quotations. 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 minimum income benefit (GMIB) over the account balance upon the policyholders 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. 13
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
XL CAPITAL LTD 2. Significant Accounting Policies (continued) (e) Fair Values of Other Financial Instruments The fair values of financial instruments not disclosed elsewhere in the financial statements approximate their carrying value due to their short-term nature or because they earn or attract interest
at market rates. Certain financial instruments, particularly insurance contracts, are excluded from fair value disclosure requirements of FAS 107, Disclosures about Fair Value of Financial
Instruments. The fair value of the Companys notes payable and debt outstanding as at June 30, 2008 and December 31, 2007, is estimated to be $2.1 billion and $2.6 billion, respectively, and is
based on quoted prices. (f) Recent Accounting Pronouncements During February 2007, the FASB issued FAS 159, The Fair Value Option for Financial Assets and Financial Liabilities (FAS 159), which permits entities to choose to measure many financial
instruments and certain other items at fair value. A company must report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent
reporting date. The fair value option may be applied on an instrument by instrument basis, with a few exceptions. The fair value option is irrevocable (unless a new election date occurs) and the fair
value option may be applied only to entire instruments and not to portions of instruments. FAS 159 is effective for interim and annual financial statements issued after January 1, 2008. The Company
did not elect to apply the Fair Value option to any existing assets or liabilities as of January 1, 2008. In March 2008, the FASB issued FAS 161, Disclosures about Derivative Instruments and Hedging Activitiesan amendment of FASB Statement No. 133. FAS 161 requires enhanced disclosures
about an entitys derivative and hedging activities, and is effective for financial statements issued for fiscal years beginning after November 15, 2008, with early application encouraged. The Company
will adopt the standard as of January 1, 2009. FAS 161 requires only additional disclosures concerning derivatives and hedging activities, and therefore the adoption of FAS 161 will not have an
impact on the Companys financial condition and results of operations. In April 2008, the FASB issued FASB Staff Position 142-3, Determination of the Useful Lives of Intangible Assets, which amends the factors that should be considered in developing renewal
or extension assumptions used to determine the useful life of an intangible asset. This interpretation will be effective for the Company beginning January 1, 2009 and must also be applied to interim
periods within 2009. The Company is currently evaluating the potential impact of this guidance; however, it is not expected to have a significant impact on the Companys financial condition and
results of operations. In May 2008, the FASB issued FAS 162 The Hierarchy of Generally Accepted Principles (FAS 162) which outlines the order of authority for the sources of accounting principles. FAS 162 will
be effective 60 days following the SECs approval of the Public Company Accounting Oversight Board amendments to AU Section 411, The Meaning of Present Fairly in Conformity with Generally
Accepted Accounting Principles. The Company does not expect SFAS 162 to have an impact on its financial condition and results of operations. In May 2008, the FASB issued FAS 163, Accounting for Financial Guarantee Insurance Contracts, an interpretation of FAS 60 to address current diversity in practice with respect to accounting
for financial guarantee insurance contracts by insurance enterprises under FAS 60, Accounting and Reporting by Insurance Enterprises (FAS 60). That diversity results in inconsistencies in the
recognition and measurement of claim liabilities because of differing views regarding when a loss has been incurred under FAS 5, Accounting for Contingencies. FAS 163 requires that an insurance
enterprise recognize a claim liability prior to an event of default (insured 14
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
XL CAPITAL LTD 2. Significant Accounting Policies (continued) (f) Recent Accounting Pronouncements (continued) event) when there is evidence that credit deterioration has occurred in an insured financial obligation. FAS 163 also clarifies how FAS 60 applies to financial guarantee insurance contracts, including
the recognition and measurement to be used to account for premium revenue and claim liabilities. Those clarifications will increase comparability in financial reporting of financial guarantee insurance
contracts by insurance enterprises. FAS 163 also requires expanded disclosures about financial guarantee insurance contracts. The standard is effective for the Company beginning January 1, 2009, and
must be applied to all interim periods within 2009, except for certain disclosures about the Companys risk management activities which are required to be included in the Companys quarterly report
on Form 10-Q for the period ended September 30, 2008. Except for those disclosures, earlier application is not permitted. The Company is currently evaluating the impact of this guidance. The
Company had reserves for financial guarantee insurance contracts of $427.4 million recorded within Unpaid Losses and Loss Expenses, at both June 30, 2008 and December 31, 2007. In May 2008, the FASB issued FSP APB 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement), which clarifies
that convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement) are not addressed by paragraph 12 of APB Opinion No. 14, Accounting for
Convertible Debt and Debt Issued with Stock Purchase Warrants. Additionally, this FSP specifies that issuers of such instruments should separately account for the liability and equity components in
a manner that will reflect the entitys non-convertible debt borrowing rate when interest cost is recognized in subsequent periods. This FSP will be effective for the Company as of January 1, 2009
and will have to be applied retrospectively to all periods presented. The Company will evaluate the impact of the adoption in the event any instruments that would be subject to this guidance are
being considered in the future, however, it is not expected to have any impact on the Companys financial condition and results of operations upon adoption as the Company does not have any
instruments issued and outstanding that will be subject to this guidance. In June 2008, the FASB issued FASB Staff Position EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities. This FASB
Staff Position (FSP) addresses whether instruments granted in share-based payment transactions may be participating securities prior to vesting and, therefore, need to be included in the earnings
allocation in computing basic earnings per share (EPS) pursuant to the two-class method described in paragraphs 60 and 61 of FASB Statement No. 128, Earnings per Share. A share-based
payment award that contains a non-forfeitable right to receive cash when dividends are paid to common shareholders irrespective of whether that award ultimately vests or remains unvested shall be
considered a participating security as these rights to dividends provide a non-contingent transfer of value to the holder of the share-based payment award. Accordingly, these awards should be
included in the computation of basic EPS pursuant to the two-class method. The guidance in this FSP is effective for the Company for the fiscal year beginning January 1, 2009 and all interim periods
within 2009. All prior period EPS data presented will have to be adjusted retrospectively to conform to the provisions of the FSP. Under the terms of the Companys restricted stock awards, grantees
are entitled to the right to receive dividends on the unvested portions of their awards. There is no requirement to return these dividends in the event the unvested awards are forfeited in the future.
Accordingly, this FSP will have an impact on the Companys EPS calculations. The Company is currently evaluating the impact of this guidance. 3. Fair Value Measurements Effective January 1, 2008, the Company adopted FAS 157, which requires disclosures about the Companys assets and liabilities that are carried at fair value. As required by FAS 157, financial
assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. 15
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
XL CAPITAL LTD 3. Fair Value Measurements (continued) The following tables set forth the Companys assets and liabilities that were accounted for at fair value as of June 30, 2008 by level within the fair value hierarchy (see Note 2 for further
information on the fair value hierarchy):
(U.S. dollars in thousands)
Quoted Prices in
Significant Other
Significant
Counterparty
Balance Assets Fixed maturities, at fair value
$
$
27,592,948
$
1,527,740
$
$
29,120,688 Equity securities, at fair value
445,970
135,122
581,092 Short-term investments, at fair value
1,332,497
8,443
1,340,940 Total investments available for sale
$
445,970
$
29,060,567
$
1,536,183
$
$
31,042,720 Cash equivalents (1)
1,989,275
503,286
2,492,561 Other investments (2)
471,487
61,593
533,080 Other assets (3)(5)
105,678
134,444
(65,844
)
174,278 Total assets accounted for at fair value
$
2,435,245
$
30,141,018
$
1,732,220
$
(65,844
)
$
34,242,639 Liabilities Financial instruments sold, but not yet
$
$
44,497
$
$
$
44,497 Other liabilities (4) (5)
21,039
79,093
(65,844
)
34,288 Total liabilities accounted for at fair value
$
$
65,536
$
79,093
$
(65,844
)
$
78,785
(1)
Cash equivalents balances subject to fair value measurements include certificates of deposit and money market funds. Operating cash balances are not subject to FAS 157. (2) The other investments balance excludes certain unrated tranches of collateralized loan obligations which are carried under the cost recovery method given the uncertainty of future cash flows, as well as certain investments in project finance
transactions which are carried at amortized cost. See Note 2 for further details. (3) Other assets include derivative instruments. (4) Other liabilities include derivative instruments. (5) The derivative balances included in each category above are reported on a gross basis by level with a netting adjustment presented separately in the Counterparty Netting column. The Company often enters into different types of derivative
contracts with a single counterparty and these contracts are covered under an ISDA master netting agreement. The fair value of the individual derivative contracts are reported gross in their respective levels based on the fair value hierarchy. (6) Financial instruments sold, but not purchased are included within Net payable for investments purchased on the balance sheet. Level 3 Gains and Losses The table below presents additional information about assets and liabilities measured at fair value on a recurring basis and for which significant Level 3 inputs were utilized to determine fair
value. The table reflects gains and losses for the three and six month periods ended June 30, 2008 for all financial assets and liabilities categorized as Level 3 as of June 30, 2008. The table does not
include gains or losses that were reported in Level 3 in prior periods for assets that were transferred out of Level 3 prior to June 30, 2008. Gains and losses for assets and liabilities classified within
Level 3 in the table below may include changes in fair value that are attributable to both observable 16
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Active Markets for
Identical Assets
(Level 1)
Observable
Inputs
(Level 2)
Unobservable
Inputs
(Level 3)
Netting
as of
June 30,
2008
purchased (6)
XL CAPITAL LTD 3. Fair Value Measurements (continued) inputs (Levels 1 and 2) and unobservable inputs (Level 3). Further, it should be noted that the following table does not take into consideration the effect of offsetting Level 1 and 2 financial
instruments entered into by the Company that are either economically hedged by certain exposures to the Level 3 positions or that hedge the exposures in Level 3 positions.
(U.S. dollars in thousands)
Fixed
Level 3 Assets and
Derivative
Short-term
Other Balance, beginning of period
$
1,221,766
$
9,569
$
52,338
$
52,446 Realized (losses) gains
(53,062
)
24,762 Movement in unrealized (losses) gains
(59,036
)
(94
)
(4,159
)
(28,544
) Purchases, issuances and settlements
165,601
(1,918
)
13,414
6,687 Transfers in and/or out of Level 3
252,471
886
Balance, end of period
$
1,527,740
$
8,443
$
61,593
$
55,351 Movement in total (losses) gains above relating to instruments still held at the reporting date
$
(10,726
)
$
19
$
(4,159
)
$
(28,544
)
(U.S. dollars in thousands)
Fixed
Level 3 Assets and
Derivative
Short-term
Other Balance, beginning of period
$
1,385,601
$
15,606
$
40,354
$
12,283 Realized (losses) gains
(132,363
)
13
26,843 Movement in unrealized (losses) gains
(216,020
)
(181
)
(3,494
)
6,189 Purchases, issuances and settlements
142,552
(6,105
)
24,733
10,036 Transfers in and/or out of Level 3
347,970
(890
)
Balance, end of period
$
1,527,740
$
8,443
$
61,593
$
55,351 Movement in total (losses) gains above relating to instruments still held at the reporting date
$
(226,154
)
$
$
(3,494
)
$
6,189 The vast majority of Level 3 assets are made up of securities where significant inputs, such as broker price indications, were utilized in determining the value that were difficult to sufficiently
corroborate with observable market data to support a Level 2 classification. Fixed maturities and short term investments In periods of market dislocation, the observability of prices and inputs may be reduced for many instruments as is currently the case for certain U.S. CMOs, ABSs, CMBSs, collateralized debt
obligations (CDOs), and other topical assets which include certain securities with underlying sub-prime and related residential mortgage exposures (such as sub-prime first liens and Alt-A asset backed
securities) for which sufficient information, such as cash flows or other security structure or market information, is not available to enable a model derived price to be determined. Fixed maturities
and short term investments classified within Level 3 are made up of those securities where either significant inputs that were difficult to corroborate with observable market data were utilized in
determining the value, or sufficient information regarding the specific inputs utilized in a corroborating value obtained from a broker was not obtained to support a Level 2 classification. The fair
values of the majority of the Companys holdings in securities exposed to sub-prime mortgages are generally not based on quoted prices for identical securities, however, where they are based on
model-derived valuations in which all significant inputs and significant value drivers are considered to be observable in active markets, these securities continue to be classified within Level 2. 17
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Maturities
Liabilities
Three Months Ended
June 30, 2008
ContractsNet
Investments
Investments
(Unaudited)
Maturities
Liabilities
Six Months Ended
June 30, 2008
ContractsNet
Investments
Investments
XL CAPITAL LTD 3. Fair Value Measurements (continued) Other investments Included within the Other Investments component of the Companys Level 3 valuations are private equity investments where the Company is not deemed to have significant influence over the
investee. The fair value of these investments is based upon net asset values received from the investment manager. The nature of the underlying investments held by the investee which form the basis
of the net asset value include assets such as private business ventures and are such that significant Level 3 inputs are utilized in the determination of the individual underlying holding values and
accordingly the fair value of the Companys investment in each entity is classified within Level 3. The Company also incorporates factors such as the most recent financial information received, the
values at which capital transactions with the investee take place, and managements judgment regarding whether any adjustments should be made to the net asset value in recording the fair value of
each position. Derivative instruments Derivative instruments classified within Level 3 include: (i) certain interest rate swaps where the duration of the contract the Company holds exceeds that of the longest term on a market
observable input, (ii) weather and energy derivatives, (iii) credit derivatives written by SCA and embedded in reinsurance provided by the Company, (iv) GMIB derivatives embedded within a certain
reinsurance contract and (v) put options included within contingent capital facilities. The majority of inputs utilized in the valuations of these types of derivative contracts are considered Level 1 or
Level 2; however, each valuation includes at least one Level 3 input that was significant to the valuation and accordingly the values are disclosed within Level 3. In addition, see Note 2 for a general discussion of types of assets and liabilities that are classified within Level 3 of the fair value hierarchy as well as the Companys valuation policies for such
instruments. 4. Security Capital Assurance Ltd (SCA) On August 4, 2006, the Company completed the sale of approximately 37% of its then financial guarantee reinsurance and insurance businesses through an initial public offering (IPO) of 23.4
million common shares of SCA for proceeds of approximately $446.9 million. On June 6, 2007, the Company completed the sale of a portion of SCAs common shares still owned by the Company
through a secondary offering and thereby reduced its ownership of SCAs outstanding common shares further from approximately 63% to approximately 46%. Accordingly, SCA is no longer a
consolidated subsidiary or operating segment of the Company and the Company accounts for its remaining investment in SCA using the equity method of accounting. Given managements view of the risk exposure along with the uncertainty facing the entire financial guarantee industry, the Company reduced the reported value of its investment in SCA to nil
at December 31, 2007. Market developments with respect to the monoline industry continue to be largely negative. During the three months ended June 30, 2008, SCA was further downgraded by
several rating agencies. In addition, the Companys shares in SCA are unregistered and thus illiquid. Based on the nature of the Companys investment in SCA and the resultant limitations on any
future business models, management continues to believe that the fair value of the Companys investment in SCA is less than the traded market value at June 30, 2008, of $0.29 per share.
Management believes this decline in value is other than temporary. Concurrent with the initial public offering (IPO) of SCA and subsequently, the Company entered into certain service, reinsurance and guarantee arrangements with SCA and its subsidiaries, to
govern certain aspects of the Companys relationship with SCA. Prior to the sale of SCA shares through the secondary offering on June 6, 2007, the effect of these arrangements was eliminated upon
consolidation of the Companys results. The income statement impacts of all transactions with 18
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
XL CAPITAL LTD 4. Security Capital Assurance Ltd (SCA) (continued) SCA subsequent to June 6, 2007 through June 30, 2008 have been included in Net (loss) income from operating affiliates. On July 28, 2008 the Company announced that an agreement had been executed with SCA (the Master Agreement) in connection with, among other things, the termination of reinsurance
agreements. For further details, see Note 12 to the Consolidated Financial Statements, Subsequent Events. As at March 31, 2008, SCA had total assets of $3.8 billion, total liabilities of $3.4 billion, outstanding preferred share equity of $246.6 million, and common shareholders equity of $101.8 million.
During the first quarter of 2008 SCA had net earned premiums of $58.4 million, total revenues of $(0.7) million, and a net loss to common shareholders before minority interest of $95.3 million. Service agreements The Company entered into a series of service agreements under which subsidiaries of the Company provided services to SCA and its subsidiaries or received certain services from SCA
subsidiaries for a period of time after the IPO. For the three and six months ended June 30, 2008, the Company reported net fee income under the aforementioned agreements aggregating to
approximately $0.5 million and $1.2 million, respectively. Reinsurance agreements As at June 30, 2008, the Company also provided certain reinsurance protections with respect to adverse development on certain transactions as well as indemnification under specific facultative
and excess of loss coverages for subsidiaries of SCA: XL Financial Assurance (XLFA) and XL Capital Assurance, Inc. (XLCA). The adverse development cover related to a specific project
financing transaction while the facultative covers generally reinsured certain policies up to the amount necessary for XLCA and XLFA to comply with certain regulatory and risk limits. The excess of
loss reinsurance provided indemnification for the portion of any individual paid loss covered by XLFA in excess of 10% of XLFAs surplus, up to an aggregate amount of $500 million, and excluded
coverage for liabilities arising other than pursuant to the terms of the underlying policies. There is a dispute between the Company and XLFA over the proper attachment point and the Companys
termination rights under the excess of loss reinsurance agreement with XLFA that the Company expects to resolve upon closing of the transactions contemplated by the Master Agreement. For the three and six months ended June 30, 2008, the Company recorded additional losses of $3.7 million and $7.3 million, respectively, related to the excess of loss contract which represented
an unwind of the discount on established reserves associated with this contract. In addition, during both the three and six months ended June 30, 2008, the Company recorded additional losses related
to the facultative reinsurance agreements totaling $22.7 million and $23.9 million, respectively. Losses included both the change in expected net loss payments as well as the impact of the mark-to-
market component of those contracts written in derivative form. With regards to the excess of loss cover, as at June 30, 2008 and December 31, 2007, the Company reported unpaid losses and loss
expenses of $265.0 million and $300.0 million, respectively which represented the discounted value of a $500.0 million full limit loss on this contract. With regards to the facultative reinsurance
agreements, total unpaid losses and loss expenses as at June 30, 2008 and December 31, 2007 were $160.5 million and $125.9 million, respectively, which included $65.8 million of unpaid losses and
loss expenses in each respective period related to the adverse development cover with SCA. In addition, carried related derivative liabilities as at June 30, 2008 and December 31, 2007 were nil and
$17.9 million, respectively, related to mark-to-market losses associated with those underlying contracts written in derivative form. These losses were based on SCA managements examination of
exposures under these agreements and have been recorded within Net (loss) income from operating affiliates. Case reserve amounts represent the discounted value of expected losses net of related
premiums and are 19
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
XL CAPITAL LTD 4. Security Capital Assurance Ltd (SCA) (continued) discounted at approximately 5%. During the three months ended March 31, 2008 the Company did not receive any information from SCA or otherwise that indicated that a change in the notional
value of the underlying reserves was necessary and as such the only losses recorded for both the excess of loss and facultative agreements during the first three months of 2008 represented the unwind
of the discount on the established reserves at December 31, 2007. During the three months ended June 30, 2008, however the Company received preliminary information from SCA management
indicating significant continued deterioration in the underlying credits related to the Companys reinsurance agreements with SCA following SCA managements reserve review. As at June 30, 2008 and December 31, 2007, the Companys total net exposure under its facultative agreements with SCA subsidiaries was approximately $6.4 billion and $7.7 billion, respectively,
of net par outstanding. Of the total net par outstanding at June 30, 2008, approximately $118.2 million and $766.4 million was related to residential mortgage backed securities (RMBS) and asset
backed securities (ABS) collateralized debt obligations (CDOs), with greater than 50% RMBS collateral, respectively. Of the total net par outstanding under the facultative agreements at
December 31, 2007, approximately $138.0 million and $769.0 million of net par outstanding was related to RMBS and ABS CDOs, with greater than 50% collateral, respectively. Of the RMBS
exposures at June 30, 2008, 100% were rated BBB. Of the related ABS CDO exposures at June 30, 2008, 26.4% were AAA rated, 15.3% were rated A, 57.4% were BBB and 27.3% were rated
below investment grade. At December 31, 2007, 100% of the RMBS exposures were rated BBB while all related ABS CDO exposures were rated AAA. The following tables present the net par outstanding related to the facultative reinsurance and the adverse development facultative reinsurance noted above at June 30, 2008 by credit quality and
broad sector allocation:
(U.S. dollars in millions)
As at June 30, 2008 (1)
Net Par
% of Total Credit Quality: AAA
$
333.7
5.2
% AA
278.8
4.3
% A
829.7
12.9
% BBB
4,251.1
65.9
% BB and below
752.3
11.7
% Total (3)
$
6,445.6
100.0
%
(U.S. dollars in millions)
As at June 30, 2008 (1)
Net Par
% of Total Broad Sector Allocation: International Finance
$
4,173.5
64.8
% Public Finance
370.6
5.7
% Structured Finance
1,901.5
29.5
% Total (3)
$
6,445.6
100.0
%
(1)
Subsequent to June 30, 2008, the Company executed an agreement with SCA in connection with, among other things, the termination of reinsurance agreements. For further details, see Note
12 to the Consolidated Financial Statements, Subsequent Events. (2) Based on information provided by SCA management. (3) As at June 30, 2008, $1.3 billion of the total $6.4 billion in net par outstanding was originally written by SCA in derivative form. 20
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Outstanding (2)
Outstanding (2)
XL CAPITAL LTD 4. Security Capital Assurance Ltd (SCA) (continued) Guarantee agreements The Company has also entered into certain guarantee agreements with subsidiaries of SCA. These guarantee agreements terminated with respect to any new business written by SCA through the
underlying agreements after the effective date of SCAs IPO, but the agreements remain in effect with respect to cessions or guarantees written under these agreements prior to the IPO. The
agreements unconditionally and irrevocably guarantee: (i) XLCA for the full and complete performance when due of all of XLFAs obligations under its facultative quota share reinsurance agreement
with XLCA, (ii) the full and complete payment when due of XLCAs obligations under certain financial guarantees issued by XLCA and arranged by XL Capital Assurance (U.K.) Limited for the
benefit of the European Investment Bank (EIB) and (iii) Financial Security Assurance (Financial Security) for the full and complete performance of XLFAs obligations under a Financial Security
Master Facultative Agreement. The guarantees the Company has provided contain a dual trigger, such that the guarantees respond only if two events occur. First, the underlying guaranteed obligation
must default on payments of interest and principal, and secondly, the relevant SCA subsidiary must fail to meet its obligations under the applicable reinsurance or guarantee. As at June 30, 2008 and
December 31, 2007, the Companys total net par outstanding falling under these guarantees was $59.2 billion and $75.2 billion, respectively. At June 30, 2008 and December 31, 2007, indirect
consumer mortgage exposures related to these guarantee agreements totaled approximately $2.6 billion and $2.9 billion, respectively, related to RMBS and $3.2 billion and $3.3 billion, respectively,
related to ABS CDOs with greater than 50% RMBS collateral. Of the RMBS exposures at June 30, 2008, 46.0% were rated AAA, 6.5% were rated A, 47.4% were rated BBB and 0.1% were
rated below investment grade. Of the related ABS CDO exposures at June 30, 2008, 13.4% were AAA rated, 24.0% were rated AA and 62.6% were rated BBB. Of the RMBS exposures at
December 31, 2007, 44.1% were rated AAA, 6.9% were rated A and 49.0% were rated BBB. All related ABS CDO exposures at December 31, 2007 were rated AAA. The following tables present the net par outstanding related to the guarantees provided by the Company to SCA at June 30, 2008 by credit quality and broad sector allocation:
(U.S. dollars in millions)
As at June 30, 2008 (1)
Net Par
% of Total Credit Quality: AAA
$
14,384.2
24.3
% AA
8,573.2
14.5
% A
17,897.5
30.2
% BBB
16,766.0
28.3
% BB and below
1,606.9
2.7
% Total
$
59,227.8
100.0
%
(U.S. dollars in millions)
As at June 30, 2008 (1)
Net Par
% of Total Broad Sector Allocation: International Finance
$
10,636.8
18.0
% Public Finance
27,124.3
45.8
% Structured Finance
21,466.7
36.2
% Total
$
59,227.8
100.0
%
(1)
Subsequent to June 30, 2008, the Company reached an agreement with SCA in connection with, among other things, the termination of reinsurance agreements. For further details, see Note
12 to the Consolidated Financial Statements, Subsequent Events. (2) Based on information provided by SCA management. 21
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Outstanding (2)
Outstanding (2)
XL CAPITAL LTD 4. Security Capital Assurance Ltd (SCA) (continued) Based on the estimated deterioration in the SCA
portfolio of insured credits, management expects that SCA will report estimated reserves for expected losses in excess of their currently available
resources. For further information, see Note 12, Subsequent
Events. As a result of these developments management determined that as at
June 30, 2008 it was necessary to accrue a liability of $56.0 million, recorded
within Other Liabilities, for the contingency associated with the
guarantees provided to SCA. This liability represents managements best
estimate of payments to be made by the Company to SCA under the guarantees for
defaults considered probable of existing at that date. The liability was
estimated based on the percentage of the estimated shortfall in SCA resources
which relate to policies subject to a guarantee issued by the Company. Of the
total case reserves expected to be recorded by SCA at June 30, 2008,
approximately 11% relate to policies which are subject to guarantees provided by
the Company. In addition, the increased expected losses and related reserves as
at June 30, 2008 heightens the possibility of a defined XLCA credit event under
a majority of the credit default swap (CDS) contracts, which could
allow the CDS counterparties to pursue early termination payments from XLCA
based on market valuations which would be substantially higher than the
estimated case reserves and in excess of SCAs ability to pay. While it is
not clear that the guarantees provided by the Company would respond to a claim
in respect of an early termination of the CDSs, management has preliminarily
estimated that the pre-IPO component of such payments could reach as much as
approximately $3 billion to $5 billion. As noted above, subsequent to June 30, 2008 the Company executed the Master Agreement with SCA in connection with, among other things, the termination of reinsurance agreements and as
such the contingent liability has been resolved as part of an aggregate agreement. The terms of the agreement were determined in consideration of a number of commercial and economic factors
associated with all existing relationships with SCA, including, but not limited to, a valuation of the commuted agreements and any potential future claims thereunder and the impact of outstanding
uncertainty on both the ratings and business operations of the Company. The total value of the consideration to be paid by the Company to SCA significantly exceeds the carried net liabilities of
$490.7 million related to such reinsurances and guarantees issued to subsidiaries of SCA as at June 30, 2008. Management considers the execution of the Master Agreement as the event giving rise to
the additional liability. There are numerous conditions precedent in this agreement that will be completed upon closing. As such, the Company expects to record a charge of approximately $1.4 to
$1.5 billion in respect of the Master Agreement during the three month period ending September 30, 2008. For further details, see Note 12, to the Consolidated Financial Statements, Subsequent
Events. Other agreements As at December 31, 2007, the Company had approximately $4.0 billion of deposit liabilities associated with guaranteed investment contracts (GICs) for which credit enhancement was provided
by XLCA. Based on the terms and conditions of the underlying GICs, upon the downgrade of XLCA below certain ratings levels, all or portions of the outstanding principal balances on such GICs
would come due. Throughout 2008, several rating agencies downgraded SCA and its subsidiaries and as a result, the Company settled all of the GIC liabilities in the first six months of 2008. 5. Segment Information Following the Companys revised strategy implemented in the second quarter of 2007, the Company is organized into four operating segments: Insurance, Reinsurance, Life Operations, and Other
Financial Linesin addition to a Corporate segment that includes the general investment and financing operations of the Company. 22
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
XL CAPITAL LTD 5. Segment Information (continued) The Company evaluates the performance for both the Insurance and Reinsurance segments based on underwriting profit and evaluates the contribution from each of the Life Operations and
Other Financial Lines segments. Other items of revenue and expenditure of the Company are not evaluated at the segment level for reporting purposes. In addition, the Company does not allocate
investment assets by segment for its property and casualty operations. Investment assets related to (i) the Companys Life Operations and Other Financial Lines segments and (ii) certain structured
products included in the Insurance and Reinsurance segments are held in separately identified portfolios. As such, net investment income from these assets is included in the contribution from each of
these segments. 23
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
XL CAPITAL LTD 5. Segment Information (continued) Three months ended June 30, 2008:
Insurance
Reinsurance
Total P&C
Life
Other Financial
Total Gross premiums written
$
1,388,771
$
397,460
$
1,786,231
$
161,251
$
$
1,947,482 Net premiums written
1,084,820
274,647
1,359,467
150,933
1,510,400 Net premiums earned
1,018,350
490,437
1,508,787
172,935
1,681,722 Fee income and other
12,189
471
12,660
136
12,796 Net losses and loss expenses
653,822
284,763
938,585
209,725
1,148,310 Acquisition costs
113,877
106,528
220,405
25,832
246,237 Operating expenses (1)
189,082
45,159
234,241
9,299
243,540 Underwriting profit (loss)
$
73,758
$
54,458
$
128,216
$
(71,785
)
$
$
56,431 Exchange losses (gains)
6,094
3,738
9,832
(1,896
)
7,936 Net investment income
298,128
98,058
396,186 Net results from structured products (2)
12,366
2,579
14,945
6,203
21,148 Contribution from P&C, Life Operations, Other Financial Lines
$
431,457
$
28,169
$
6,203
$
465,829 Corporate & other: Net realized & unrealized gains on investment & derivative instruments (3)
$
10,164 Net (loss) from investment fund and operating affiliates (4)
(89,336
) Corporate operating expenses
47,104 Interest expense (5)
50,077 Income taxes & other
51,625 Net Income
$
237,851 Ratios P&C operations: (6) Loss and loss expense ratio
64.2
%
58.1
%
62.2
% Underwriting expense ratio
29.8
%
30.9
%
30.1
% Combined ratio
94.0
%
89.0
%
92.3
% Notes:
(1)
Operating expenses exclude corporate operating expenses, shown separately. (2) The net results from P&C structured products includes net investment income, interest expense and operating expenses of $25.1 million, $3.7 million, and $6.5 million, respectively. (3) This includes net realized gains on investments of $2.1 million, net realized and unrealized gains on investment and other derivatives of $8.1 million, but does not include unrealized losses on investments for which the decline was considered
temporary, which are included in accumulated other comprehensive (loss) income. (4) Net loss from investment fund and operating affiliates for the three months ended June 30, 2008 includes additional losses totaling $82.4 million related to the reinsurance and guarantee agreements with SCA. (5) Interest expense excludes interest expense related to deposit liabilities recorded in the Insurance, Reinsurance, and Other Financial Lines segments. (6) Ratios are based on net premiums earned from property and casualty operations. The underwriting expense ratio excludes exchange gains and losses. (7) The net results from Other Financial Lines include net investment income, interest expense and operating expenses of $19.1 million, $11.7 million, and $1.2 million, respectively. 24
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(U.S. dollars in thousands, except ratios)
(Unaudited)
Operations
Lines (7)
XL CAPITAL LTD 5. Segment Information (continued) Three months ended June 30, 2007:
Insurance
Reinsurance
Total P&C
Life
Other Financial
SCA (7)
Total Gross premiums written
$
1,417,868
$
526,318
$
1,944,186
$
234,961
$
$
52,025
$
2,231,172 Net premiums written
1,105,242
399,291
1,504,533
224,487
45,720
1,774,740 Net premiums earned
1,052,700
598,449
1,651,149
239,853
39,303
1,930,305 Fee income and other
4,193
318
4,511
75
63
4,649 Net losses and loss expenses
659,421
280,299
939,720
279,100
2,228
1,221,048 Acquisition costs.
129,931
141,693
271,624
23,615
2,782
298,021 Operating expenses (1)
165,303
47,002
212,305
10,182
19,476
241,963 Underwriting profit (loss)
$
102,238
$
129,773
$
232,011
$
(72,969
)
$
$
14,880
$
173,922 Exchange losses (gains)
7,817
16,429
24,246
(1,685
)
39
22,600 Net investment income
322,997
95,949
22,343
441,289 Net results from structured products (8)
(735
)
5,587
4,852
6,791
(61
)
11,582 Contribution from P&C, Life Operations, Other Financial Lines
$
535,614
$
24,665
$
6,791
$
37,123
$
604,193 Corporate & other: Net realized & unrealized (losses) gains on investment & derivative instruments (2)
$
(13,665
)
$
27,484 Net income from investment fund and operating affiliates (3)
108,682 Corporate operating expenses
55,524 Interest expense (4)
59,416 Minority interest
9,096
9,096 Income taxes & other
(6
)
61,708 Net Income
$
14,368
$
554,615 Ratios P&C operations: (5) Loss and loss expense ratio
62.6
%
46.8
%
56.9
% Underwriting expense ratio
28.0
%
31.6
%
29.4
% Combined ratio
90.6
%
78.4
%
86.3
% Notes:
(1)
Operating expenses exclude corporate operating expenses, shown separately. (2) This includes net realized gains on investments of $18.3 million, net realized and unrealized gains on investment and other derivatives of $9.2 million, but does not include unrealized losses on investments for which the decline was considered
temporary, which are included in accumulated other comprehensive (loss) income. Net realized gains on investments includes an $81.3 million gain on the sale of SCA shares. (3) This includes $1.2 million in income from the Companys investment in SCA, subsequent to June 6, 2007. (4) Interest expense excludes interest expense related to deposit liabilities recorded in the Insurance, Reinsurance, and Other Financial Lines segments. (5) Ratios are based on net premiums earned from property and casualty operations. The underwriting expense ratio excludes exchange gains and losses. (6) For the three month period ended June 30, 2007, the net results from Other Financial Lines includes net investment income, interest expense and operating expenses of $94.9 million, $84.3 million, and $3.8 million, respectively. (7) Net income from SCA represents consolidated earnings for the period from April 1, 2007 through June 6, 2007, and prior to a secondary offering of SCAs common shares owned by the Company, which had the effect of reducing its ownership
of SCAs outstanding common shares from approximately 63% to approximately 46%. Subsequent to June 6, 2007, the Company accounts for its remaining investment in SCA using the equity method of accounting. (8) For the three month period ended June 30, 2007, the net results from P&C structured products includes net investment income, interest expense and operating expenses of $31.0 million, $20.9 million, and $5.2 million, respectively. 25
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(U.S. dollars in thousands, except ratios)
(Unaudited)
Operations
Lines (6)
and SCA
XL CAPITAL LTD 5. Segment Information (continued) Six months ended June 30, 2008:
Insurance
Reinsurance
Total P&C
Life
Other Financial
Total Gross premiums written
$
3,017,120
$
1,470,005
$
4,487,125
$
396,209
$
$
4,883,334 Net premiums written
2,268,672
1,227,348
3,496,020
375,146
3,871,166 Net premiums earned
2,026,752
1,034,815
3,061,567
332,517
3,394,084 Fee income and other
19,653
1,234
20,887
200
21,087 Net losses and loss expenses
1,338,634
600,844
1,939,478
406,024
2,345,502 Acquisition costs
239,713
222,872
462,585
49,949
512,534 Operating expenses (1)
353,587
90,517
444,104
17,382
461,486 Underwriting profit (loss)
$
114,471
$
121,816
$
236,287
$
(140,638
)
$
$
95,649 Exchange losses (gains)
59,202
17,481
76,683
(1,002
)
75,681 Net investment income
606,169
195,193
801,362 Net results from structured products (2)
3,173
13,403
16,576
13,926
30,502 Contribution from P&C, Life Operations, Other Financial Lines
$
782,349
$
55,557
$
13,926
$
851,832 Corporate & other: Net realized & unrealized (losses) on investment & derivative instruments (3)
$
(47,405
) Net (loss) from investment fund and operating affiliates (4)
(56,984
) Corporate operating expenses
83,030 Interest expense (5)
99,442 Income taxes & other
82,747 Net Income
$
482,224 Ratios P&C operations: (6) Loss and loss expense ratio
66.0
%
58.1
%
63.3
% Underwriting expense ratio
29.2
%
30.2
%
29.6
% Combined ratio
95.2
%
88.3
%
92.9
% Notes:
(1)
Operating expenses exclude corporate operating expenses, shown separately. (2) The net results from P&C structured products includes net investment income, interest expense and operating expenses of $59.2 million, $31.3 million, and $11.3 million, respectively. (3) This includes net realized losses on investments of $100.2 million, net realized and unrealized gains on investment and other derivatives of $52.8 million, but does not include unrealized losses on investments for which the decline was considered
temporary, which are included in accumulated other comprehensive (loss) income. (4) Net loss from investment fund and operating affiliates for the six months ended June 30, 2008 includes additional losses totaling $87.2 million related to the reinsurance and guarantee agreements with SCA. (5) Interest expense excludes interest expense related to deposit liabilities recorded in the Insurance, Reinsurance, and Other Financial Lines segments. (6) Ratios are based on net premiums earned from property and casualty operations. The underwriting expense ratio excludes exchange gains and losses. (7) The net results from Other Financial Lines includes net investment income, interest expense and operating expenses of $79.0 million, $58.8 million, and $6.3 million, respectively. While not reported within the contribution from the Other
Financial Lines segment, it should be noted that approximately $64.2 million of the reported realized losses on investments during the six months ended June 30 2008, primarily as a result of other-than-temporary impairments, related to
portfolios associated with funding agreements and previously associated with GICs. 26
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(U.S. dollars in thousands, except ratios)
(Unaudited)
Operations
Lines (7)
XL CAPITAL LTD 5. Segment Information (continued) Six months ended June 30, 2007:
Insurance
Reinsurance
Total P&C
Life
Other Financial
SCA (7)
Total Gross premiums written
$
2,997,274
$
1,901,204
$
4,898,478
$
448,236
$
$
156,983
$
5,503,697 Net premiums written
2,350,757
1,551,783
3,902,540
427,425
130,445
4,460,410 Net premiums earned
2,104,050
1,144,770
3,248,820
386,847
85,682
3,721,349 Fee income and other
7,285
489
7,774
149
63
7,986 Net losses and loss expenses
1,306,687
628,621
1,935,308
467,443
1,427
2,404,178 Acquisition costs
256,154
251,184
507,338
43,882
6,752
557,972 Operating expenses (1)
329,437
92,070
421,507
18,672
43,546
483,725 Underwriting profit (loss)
$
219,057
$
173,384
$
392,441
$
(143,001
)
$
$
34,020
$
283,460 Exchange losses (gains)
15,152
32,953
48,105
(1,975
)
39
46,169 Net investment income
637,178
188,783
48,468
874,429 Net results from structured products (8)
1,794
15,410
17,204
15,952
(61
)
33,095 Contribution from P&C, Life Operations, Other Financial Lines and SCA
$
998,718
$
47,757
$
15,952
$
82,388
$
1,144,815 Corporate & other: Net realized & unrealized (losses) gains on investment & derivative instruments (2)
$
(20,482
)
$
44,517 Net income from investment fund and operating affiliates (3)
284,700 Corporate operating expenses
88,003 Interest expense (4)
110,030 Minority interest.
23,994
23,994 Income taxes & other
73
134,883 Net Income
$
37,839
$
1,117,122 Ratios P&C operations: (5) Loss and loss expense ratio
62.1
%
54.9
%
59.6
% Underwriting expense ratio
27.9
%
29.9
%
28.6
% Combined ratio
90.0
%
84.8
%
88.2
% Notes:
(1)
Operating expenses exclude corporate operating expenses, shown separately. (2) This includes net realized gains on investments of $27.6 million, net realized and unrealized gains on investment and other derivatives of $16.9 million, but does not include unrealized losses on investments for which the decline was considered
temporary, which are included in accumulated other comprehensive (loss) income. Net realized gains on investments included an $81.3 million gain on the sale of SCA shares. (3) This includes $1.2 million in income from the Companys investment in SCA, subsequent to June 6, 2007. (4) Interest expense excludes interest expense related to deposit liabilities recorded in the Insurance, Reinsurance, and Other Financial Lines segments. (5) Ratios are based on net premiums earned from property and casualty operations. The underwriting expense ratio excludes exchange gains and losses. (6) For the six month period ended June 30, 2007, the net results from Other Financial Lines includes net investment income, interest expense and operating expenses of $182.5 million, $160.4 million, and $6.1 million, respectively. (7) Net income from SCA represents consolidated earnings for the period from January 1, 2007 through June 6, 2007, and prior to a secondary offering of SCAs common shares owned by the Company, which had the effect of reducing its
ownership of SCAs outstanding common shares from approximately 63% to approximately 46%. Subsequent to June 6, 2007, the Company accounted for its remaining investment in SCA using the equity method of accounting. (8) For the six month period ended June 30, 2007, the net results from P&C structured products includes net investment income, interest expense and operating expenses of $63.4 million, $37.0 million, and $9.2 million, respectively. 27
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(U.S. dollars in thousands, except ratios)
(Unaudited)
Operations
Lines (6)
XL CAPITAL LTD 5. Segment Information (continued) The following tables summarize the Companys net premiums earned by line of business: Three months ended June 30, 2008:
Insurance
Reinsurance
Life
Total P&C Operations: Casualty professional lines
$
342,600
$
63,815
$
$
406,415 Casualty other lines
206,102
104,756
310,858 Property catastrophe
(659
)
78,361
77,702 Other property
127,752
162,773
290,525 Marine, energy, aviation and satellite
151,531
29,152
180,683 Other specialty lines (1)
161,748
161,748 Other (2)
9,015
50,416
59,431 Structured indemnity
20,261
1,164
21,425 Total P&C Operations
$
1,018,350
$
490,437
$
$
1,508,787 Life Operations: Other Life
$
$
$
129,944
$
129,944 Annuity
42,991
42,991 Total Life Operations
$
$
$
172,935
$
172,935 Total
$
1,018,350
$
490,437
$
172,935
$
1,681,722 Three months ended June 30, 2007:
Insurance
Reinsurance
Life
SCA
Total P&C Operations: Casualty professional lines
$
363,209
$
81,222
$
$
$
444,431 Casualty other lines
213,816
148,254
362,070 Property catastrophe
12,243
61,040
73,283 Other property
118,267
205,689
323,956 Marine, energy, aviation and satellite
172,509
35,891
208,400 Other specialty lines (1)
144,104
144,104 Other (2)
17,037
64,442
81,479 Structured indemnity
11,515
1,911
13,426 Total P&C Operations
$
1,052,700
$
598,449
$
$
$
1,651,149 Life Operations: Other Life
$
$
$
101,748
$
$
101,748 Annuity
138,105
138,105 Total Life Operations
$
$
$
239,853
$
$
239,853 SCA
$
$
$
$
39,303
$
39,303 Total
$
1,052,700
$
598,449
$
239,853
$
39,303
$
1,930,305
(1)
Other specialty lines within the Insurance segment includes: environmental, programs, equine, warranty, and excess and surplus lines. (2) Other includes employers liability, surety, political risk and other lines 28
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(U.S. dollars in thousands)
(Unaudited)
Operations
(U.S. dollars in thousands)
(Unaudited)
Operations
XL CAPITAL LTD 5. Segment Information (continued) Six months ended June 30, 2008:
Insurance
Reinsurance
Life
Total P&C Operations: Casualty professional lines
$
688,167
$
130,436
$
$
818,603 Casualty other lines
425,370
222,645
648,015 Property catastrophe
107
171,510
171,617 Other property
258,766
342,374
601,140 Marine, energy, aviation and satellite
322,618
60,702
383,320 Other specialty lines (1)
324,924
324,924 Other (2)
(27,359
)
104,915
77,556 Structured indemnity
34,159
2,233
36,392 Total P&C Operations
$
2,026,752
$
1,034,815
$
$
3,061,567 Life Operations: Other Life
$
$
$
247,809
$
247,809 Annuity
84,708
84,708 Total Life Operations
$
$
$
332,517
$
332,517 Total
$
2,026,752
$
1,034,815
$
332,517
$
3,394,084 Six months ended June 30, 2007:
Insurance
Reinsurance
Life
SCA
Tota P&C Operations: Casualty professional lines
$
723,744
$
133,786
$
$
$
857,530 Casualty other lines
424,361
318,428
742,789 Property catastrophe
30,979
132,360
163,339 Other property
258,547
348,031
606,578 Marine, energy, aviation and satellite
343,579
67,125
410,704 Other specialty lines (1)
279,881
279,881 Other (2)
22,277
124,297
146,574 Structured indemnity
20,682
20,743
41,425 Total P&C Operations
$
2,104,050
$
1,144,770
$
$
$
3,248,820 Life Operations: Other Life
$
$
$
206,365
$
$
206,365 Annuity
180,482
180,482 Total Life Operations
$
$
$
386,847
$
$
386,847 SCA
$
$
$
$
85,682
$
85,682 Total
$
2,104,050
$
1,144,770
$
386,847
$
85,682
$
3,721,349
(1)
Other specialty lines within the Insurance segment includes: environmental, programs, equine, warranty, and excess and surplus lines. (2) Other includes employers liability, surety, political risk and other lines. 29
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(U.S. dollars in thousands)
(Unaudited)
Operations
(U.S. dollars in thousands)
(Unaudited)
Operations
XL CAPITAL LTD 6. Investments The cost (amortized cost for fixed maturities and short-term investments), fair value, gross unrealized gains and gross unrealized (losses) of the Companys investments at June 30, 2008 and
December 31, 2007 were as follows: June 30, 2008:
Cost or
Gross
Gross
Fair Fixed maturities U.S. Government and Government agency
$
2,221,096
$
55,055
$
(23,465
)
$
2,252,686 Corporate
12,884,545
46,053
(1,254,475
)
11,676,123 Mortgage and asset-backed securities
12,002,200
55,108
(1,167,737
)
10,889,571 U.S. States and political subdivisions of the States
471,055
2,084
(10,140
)
462,999 Non-U.S. Sovereign Government
3,878,717
57,647
(97,055
)
3,839,309 Total fixed maturities
$
31,457,613
$
215,947
$
(2,552,872
)
$
29,120,688 Total short-term investments
$
1,364,906
$
5,038
$
(29,004
)
$
1,340,940 Total equity securities
$
487,143
$
123,020
$
(29,071
)
$
581,092 December 31, 2007:
Cost or
Gross
Gross
Fair Fixed maturities U.S. Government and Government agency
$
2,585,336
$
102,135
$
(1,698
)
$
2,685,773 Corporate
13,407,142
104,967
(524,861
)
12,987,248 Mortgage and asset-backed securities
14,881,988
109,666
(497,777
)
14,493,877 U.S. States and political subdivisions of the States
252,818
2,803
(2,087
)
253,534 Non-U.S. Sovereign Government
3,106,532
100,207
(19,381
)
3,187,358 Total fixed maturities
$
34,233,816
$
419,778
$
(1,045,804
)
$
33,607,790 Total short-term investments
$
1,814,445
$
12,448
$
(23,695
)
$
1,803,198 Total equity securities
$
664,213
$
205,498
$
(14,896
)
$
854,815 Individual security positions comprising the gross unrealized loss balance have been evaluated by management, based on specified criteria, to determine if these impairments should be considered
other than temporary. These criteria include an assessment of the severity and length of time securities have been impaired, along with managements ability and intent to hold the securities to
recovery, among other factors included below. At June 30, 2008, there were $2,581.9 million of gross unrealized losses on fixed maturities and short-term investments, and $29.1 million of gross unrealized losses on equity securities. At
December 31, 2007, there were $1,069.5 million of gross unrealized losses on fixed maturities and short-term investments, and $14.9 million of gross unrealized losses on equity securities. At June 30,
2008 and December 31, 2007, approximately 3.0% and 2.3%, respectively, of the Companys fixed income investment portfolio was invested in securities which were below investment grade or not 30
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(U.S. dollars in thousands)
(Unaudited)
Amortized
Cost
Unrealized
Gains
Unrealized
Losses
Value
(U.S. dollars in thousands)
Amortized
Cost
Unrealized
Gains
Unrealized
Losses
Value
XL CAPITAL LTD 6. Investments (continued) rated. Approximately 8.1% of the unrealized losses in the Companys fixed income securities portfolio at June 30, 2008, related to securities that were below investment grade or not rated. The
information shown below about the unrealized losses on the Companys investments at June 30, 2008 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. Factors considered in determining that additional other-than-temporary impairment charges were not warranted include managements consideration of current and near term liquidity needs and
other available sources, an evaluation of the factors and time necessary for recovery, and the results of on-going retrospective reviews of security sales and the basis for such sales. Gross unrealized losses can be attributed to the following significant drivers:
(i)
Gross unrealized losses of $0.8 billion related to the Companys $6.9 billion Life Operations investment portfolio. Of this, $0.4 billion of gross unrealized losses have arisen on $2.5 billion of
exposures to corporate financials. At June 30, 2008, this portfolio had an average duration of 8.9 years, primarily denominated in U.K. Sterling and Euros. As a result of the long duration,
significant gross losses have arisen as the fair values of these securities are more sensitive to prevailing government interest rates and credit spreads. This portfolio has limited turnover as it
is matched to corresponding long duration liabilities. (ii) Gross unrealized losses of $0.4 billion related to the Companys $1.4 billion Topical Asset portfolio (which includes the Companys holdings of sub-prime non-agency securities, second liens,
ABS CDOs with sub-prime collateral as well as Alt-A mortgage exposures). The Company undertook a security level review of these securities and recognized charges to the extent it
believed the intrinsic value of the security was below the amortized cost. The Company recognized realized losses, consisting of charges for other-than-temporary impairments and realized
losses from sales of over $0.6 billion since the beginning of 2007. (iii) Gross unrealized losses of $0.3 billion arose as a result of the Companys holdings of certain U.S. Dollar assets in a Euro functional currency. As a result, gross unrealized losses arose which
were offset through the Companys cumulative translation adjustment account and accordingly had no impact on book value. (iv) The Company believes that the remaining balance of gross unrealized losses of $1.1 billion, which includes $0.4 billion on corporates of which $0.2 billion is in the financial sector, $0.3 billion
on the Companys Core CDO portfolio (primarily consisting of CLOs) and $0.1 billion on CMBS holdings, was primarily a function of broad market interest rate increases and credit spread
widening during the first six months of 2008, and not reflective of any fundamental issue in ultimate recovery on those securities. 31
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
XL CAPITAL LTD 6. Investments (continued) The following is an analysis of how long each category of those securities at June 30, 2008 had been in a continual unrealized loss position: June 30, 2008:
Less than 12 months
Equal to or greater
Fair
Gross
Fair
Gross Fixed maturities and short-term investments: U.S. Government and Government agency
$
954,517
$
20,498
$
37,075
$
3,037 Corporate
4,973,877
313,061
5,371,365
967,175 Mortgage and asset-backed securities
4,678,055
429,276
3,516,663
740,059 U.S. States and political subdivisions of the States
302,415
8,115
23,859
2,039 Non-U.S. Sovereign Government
2,253,292
58,340
475,362
40,276 Total fixed maturities and short-term investments
$
13,162,156
$
829,290
$
9,424,324
$
1,752,586 Total equity securities
$
205,785
$
29,071
$
$
The following is an analysis of how long each of those securities at December 31, 2007 had been in a continual unrealized loss position: December 31, 2007:
Less than 12 months
Equal to or greater
Fair
Gross
Fair
Gross Fixed maturities and short-term investments: U.S. Government and Government agency
$
122,199
$
552
$
31,795
$
1,166 Corporate
6,495,775
306,047
3,060,081
240,055 Mortgage and asset-backed securities
5,716,732
408,108
1,975,361
91,731 U.S. States and political subdivisions of the
68,028
1,844
4,202
253 Non-U.S. Sovereign Government
454,992
5,354
531,052
14,389 Total fixed maturities and short-term investments
$
12,857,726
$
721,905
$
5,602,491
$
347,594 Total equity securities
$
195,703
$
14,896
$
$
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. 32
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(U.S. dollars in thousands)
(Unaudited)
than 12 months
Value
Unrealized
Losses
Value
Unrealized
Losses
(U.S. dollars in thousands)
than 12 months
Value
Unrealized
Losses
Value
Unrealized
Losses
States
XL CAPITAL LTD 6. Investments (continued) (U.S. dollars in thousands)
June 30, 2008
December 31, 2007
Amortized
Fair
Amortized
Fair Due after 1 through 5 years
$
6,482,081
$
5,904,038
$
5,980,146
$
5,946,528 Due after 5 through 10 years
6,310,944
5,825,830
6,559,877
6,536,884 Due after 10 years
6,662,388
6,501,249
6,811,805
6,630,501 Mortgage and asset-backed securities
12,002,200
10,889,571
14,881,988
14,493,877
$
31,457,613
$
29,120,688
$
34,233,816
$
33,607,790 At June 30, 2008 and December 31, 2007, approximately $326.4 million and $144.3 million, respectively, of securities included in investments available for sale were loaned to various counter
parties through the Companys securities lending program. At June 30, 2008 and December 31, 2007, approximately $332.9 million and $146.2 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. 7. 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 the net realized and unrealized gains (losses) on derivative instruments included in net income for the three and six months ended June 30, 2008 and 2007: (U.S. dollars in thousands)
(Unaudited)
(Unaudited)
2008
2007
2008
2007 Credit derivatives (1)
$
94
$
(12,894
)
$
2,264
$
(23,354
) Weather and energy risk management derivatives
237
2,542
10,694
17,012 Other non-investment derivatives
9
(58
)
(941
) Investment derivatives (2)
7,793
19,531
39,906
24,212 Net realized and unrealized gains (losses) on derivatives
$
8,124
$
9,188
$
52,806
$
16,929
(1)
Excludes credit derivative swaps entered into within the investment portfolio. (2) Includes derivatives entered into by the Companys external investment portfolio managers on the Companys behalf, including certain credit derivative swaps used to hedge credit exposures. Credit derivatives have been entered into within the Companys investment portfolio and through the Companys reinsurance agreements with SCA (as described below) and have been recorded
at fair value. Following the secondary sale of SCA common shares, the Company retained some credit derivative exposures written by SCA through reinsurance agreements that have certain of these
derivatives exposures embedded within them. Valuation of investment related credit derivatives is based upon quoted market values where available, or matrix or other model-derived 33
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Cost
Value
Cost
Value
Three Months Ended
June 30,
Six Months Ended
June 30,
XL CAPITAL LTD 7. Derivative Instruments (continued) prices where significant inputs are market corroborated. Subsequent to June 6, 2007, the Company received SCA related derivative fair values from SCA management and has reviewed the
methodology applied in developing those estimates. SCA 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 when appropriate active market indices
are available. For credit derivatives where no appropriate market indices are readily available, the Company uses an alternative fair value methodology. Under this methodology, the fair value is
determined using a model 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 addition, judgment is applied to factors necessary to determine the rates of return and levels of subordination required by a market participant to assume the risks. Where
relevant, recent transactions or contract discussions related to similar risks are considered. In general, SCA holds credit derivatives to maturity. Accordingly, changes in the fair value of such credit
derivatives are unrealized. Subsequent to June 6, 2007, the change in value of the derivative portion of the financial guarantee reinsurance agreements the Company has with SCA are included in
Net (loss) income from operating affiliates. 8. 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 $600.0 million par value 6.5% Guaranteed Senior Notes due
January 2012. These Notes are fully and unconditionally guaranteed by the Company. XL Capital Ltds ability to obtain funds from its subsidiaries 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 $5.3 billion as of December 31, 2007. 9. Related Party Transactions For detailed information regarding the Companys transactions with SCA, see Notes 4 and 12 to the Consolidated Financial Statements, Security Capital Assurance Ltd and Subsequent
Events, respectively. At June 30, 2008 and December 31, 2007, the Company owned minority stakes in ten and eleven independent investment management companies (Investment Manager Affiliates), respectively.
These ownership stakes are part of the Companys 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 Companys Investment Manager Affiliates. In the normal course of business, the Company enters into certain quota share reinsurance contracts with a subsidiary of one of its other strategic affiliates, ARX Holding Corporation. During
the three and six months ended June 30, 2008, these contracts resulted in reported net premiums of $21.5 million and $43.1 million, net paid claims of $8.7 million and $14.9 million, and reported
acquisition costs of $7.8 million and $17.8 million, respectively. During the same periods in 2007, these contracts resulted in reported net premiums of $17.4 million and $57.0 million, net paid claims 34
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
XL CAPITAL LTD 9. Related Party Transactions (continued) of $11.6 million and $16.2 million, and reported acquisition costs of $0.6 million and $20.3 million, respectively. Management believes that these transactions are conducted at market rates consistent
with negotiated arms-length contracts. In the normal course of business, the Company enters into cost sharing and service level agreement transactions with certain other strategic affiliates, which management believes to be conducted
consistent with arms-length rates. Such transactions, individually and in the aggregate, are not material to the Companys financial condition, results of operations and cash flows. 10. Deposit Liabilities Deposit liabilities include GICs and funding agreements as well as reinsurance and insurance deposits. As at December 31, 2007, the Company had approximately $4.0 billion of deposit liabilities
associated with GICs for which credit enhancement was provided by XLCA. Based on the terms and conditions of the underlying GICs, upon the downgrade of XLCA below certain ratings levels, all
or portions of outstanding principal balances on such GICs would come due. Throughout 2008, several rating agencies downgraded SCA and its subsidiaries and as a result, the Company settled, in
the first six months of 2008, all of the GIC liabilities. At June 30, 2008, the balance of deposit liabilities associated with funding agreements was $1.1 billion. The Company expects the balance of deposit liabilities associated with funding agreements
to continue to decrease throughout 2008 as the contracts associated with the funding agreements mature and the associated deposit liabilities are settled. Management does not expect any significant
impact on the Companys results of operations or liquidity as a result of the maturity of these contracts. 35
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
XL CAPITAL LTD 11. Computation of Earnings per Ordinary Share and Ordinary Share Equivalent (U.S. dollars in thousands, except per share amounts)
(Unaudited)
(Unaudited)
2008
2007
2008
2007 Basic earnings per ordinary share and ordinary share equivalents: Net income
$
237,851
$
554,615
$
482,224
$
1,117,122 Less: preference share dividends
(10,080
)
(32,500
)
(22,869
) Net income available to ordinary shareholders
$
237,851
$
544,535
$
449,724
$
1,094,253 Weighted average ordinary shares outstanding
176,655
178,378
176,453
178,650 Basic earnings per ordinary share & ordinary share equivalents outstanding
$
1.35
$
3.05
$
2.55
$
6.13 Diluted earnings per ordinary share and ordinary share equivalents: Net income
$
237,851
$
554,615
$
482,224
$
1,117,122 Less: preference share dividends
(10,080
)
(32,500
)
(22,869
) Net income available to ordinary shareholders
$
237,851
$
544,535
$
449,724
$
1,094,253 Weighted average ordinary shares outstanding basic
176,655
178,378
176,453
178,650 Impact of share based compensation and certain conversion features (1) (2)
255
3,235
493
1,920 Weighted average ordinary shares outstanding diluted
176,910
181,613
176,946
180,570 Diluted earnings per ordinary share & ordinary share equivalents outstanding
$
1.34
$
3.00
$
2.54
$
6.06 Dividends per ordinary share
$
0.38
$
0.38
$
0.76
$
0.76
(1)
Net of shares repurchased under the treasury stock method. (2) Includes the application of the if converted method of accounting for the 6.5% Units for the period from the announcement of the Companys intent to participate in the remarketing of the 2009 Senior Notes until the agreement of the related
share purchase contracts. 12. Subsequent Events Agreement with SCA with Respect to Pre-IPO Guarantee and Reinsurance Agreements On July 28, 2008, the Company announced that it and certain of its subsidiaries had entered into an agreement (the Master Agreement) with SCA and certain of its subsidiaries (as previously
noted, sometimes collectively referred to herein as SCA) in connection with the termination of certain reinsurance and other agreements as described below. Certain of the counterparties (the
Counterparties) to credit default swap agreements with SCA are also parties, and others may become parties (at any time on or prior to the closing date), to the Master Agreement. Such
counterparties that are or become party to the Master Agreement are herein called the Counterparties. 36
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Three Months Ended
June 30,
Six Months Ended
June 30,
XL CAPITAL LTD 12. Subsequent Events (continued) The Master Agreement provides for the payment by the Company to SCA of $1.775 billion in cash, the issuance by the Company to SCA of eight million of its Class A Ordinary Shares to be
newly issued by the Company and the transfer by the Company of all of the shares it owns in SCA (representing approximately 46% of SCAs issued and outstanding shares) (the SCA Shares) to a
trust. This consideration will be made in exchange for, among other things, the full and unconditional:
commutation of the Third Amended and Restated Facultative Quota Share Reinsurance Treaty, effective July 1, 2006, between XLFA and XLCA and all individual risk cessions thereunder,
as a result of which the guarantee by XL Insurance (Bermuda) Ltd (XLIB) of XLFAs obligations to XLCA thereunder will no longer have any force or effect; commutation of the Excess of Loss Reinsurance Agreement, executed on October 3, 2001, pursuant to which XLIB agreed to reinsure certain liabilities of XLFA (the Excess of Loss
Agreement); commutation
of the Second Amended and Restated Facultative Master Certificate, effective
March 1, 2007, pursuant to which XL Re America, Inc. (XLRA)
agreed to reinsure certain liabilities of XLCA, and all individual risk
cessions thereunder; (the XLRA Master Facultative Agreement; commutation of the Facultative Quota Share Reinsurance Agreement, effective August 17, 2001, as amended by Amendment No. 1 to such agreement, dated as of August 4, 2006, pursuant
to which XLIB agreed to reinsure certain liabilities of XLFA, and all individual risk cessions thereunder; commutation of the Adverse Development Reinsurance Agreement, dated as of August 4, 2006, between XLCA and XLRA, and the Indemnification Agreement, dated as of August 4, 2006,
between XLFA and XLI; and termination of certain indemnification and services agreements between XL and SCA. After giving effect to the closing of the Master Agreement, $64.6 billion of the Companys total net exposure (which was $65.7 billion as at June 30, 2008) under reinsurance agreements and
guarantees with SCA subsidiaries will be eliminated. Pursuant to the terms of the Master Agreement, SCA will be required to use commercially reasonable efforts to commute the agreements that are the subject of the Companys guarantee of
XLCAs obligations under certain financial guarantees issued by XLCA to European Investment Bank (the EIB Policies), subject to certain limitations. These guarantees were provided for the
benefit of EIB and are made up of transportation and public building risk with an average rating of BBB, written between 2001 and 2006 with anticipated maturities ranging between 2027 and 2038.
In the event such commutations are not completed by the closing of the Master Agreement, the Companys exposures relating to the EIB Policies (which relate to project finance transactions) as at
June 30, 2008 would be approximately $1.1 billion. The total value of the consideration noted above of $1.775 billion as well as the value of the eight million ordinary shares of the Company to be transferred to SCA, significantly exceeds the
carried net liabilities of approximately $490.7 million related to such reinsurances and guarantees as at June 30, 2008. Management considers the execution of the Master Agreement as the event giving
rise to the additional liability. There are numerous conditions precedent to this agreement that will be completed upon closing. As such, the Company expects to record a charge of approximately 37
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
XL CAPITAL LTD 12. Subsequent Events (continued) $1.4 billion to $1.5 billion in respect of the Master Agreement during the three month period ending September 30, 2008. It is expected that the SCA Shares will be transferred at closing into a trust for the benefit of XLFA and/or XLCA until such time as an agreement between XLCA and the Counterparties is
reached, and thereafter will act for the benefit of the Counterparties. To the extent that the required regulatory approvals for the transfer are not received prior to closing, the SCA Shares will be
deposited into escrow pending the transfer. Upon any such deposit into escrow, the Company will irrevocably disclaim any and all voting, economic or other rights with respect to the SCA Shares. As part of the transaction, the Counterparties provided releases to the Company and SCA. The Company and SCA have obtained approval from the New York State Insurance Department for the Master Agreement and each of the commutations to which XLRA or XLCA is a party.
SCA has also obtained applicable approvals from the Bermuda Monetary Authority, the Deleware Insurance Department and other regulators. In addition to customary closing conditions, the Master Agreement is conditioned on the commutation by SCA of the Amended and Restated Master Facultative Reinsurance Agreement, dated
November 3, 1998, between Financial Security and XLFA, and all individual risk cessions thereunder. As a result of this commutation, the Companys guarantee of XLFAs obligations thereunder
(the Financial Security Guarantee) will no longer have any force or effect. On July 28, 2008, SCA announced that it had entered into an agreement with Financial Security to commute such
agreement simultaneously with the closing of the Master Agreement. The closing is also conditioned upon the termination of eight Merrill Lynch International (Merrill Lynch) asset backed security collateralized debt obligation credit default swaps entered into
between Merrill Lynch and SCA. SCA announced today that it has entered into an agreement with Merrill Lynch to terminate such agreements at or prior to closing. The closing of the Master Agreement is also conditioned upon the successful completion of the Companys capital raise (as described below). The closing of the transactions contemplated by the
Master Agreement is expected to take place in early August 2008 and concurrently with the closing of the capital raise discussed below. The parties may choose to terminate the Master Agreement if
the closing does not occur by August 15, 2008. On July 28, 2008, SCA announced that it has conducted a review of its June 30, 2008 loss reserves. Based on the preliminary results of this review, SCA believes that its case reserves will have
increased substantially as of June 30, 2008, primarily due to significant deterioration with respect to its exposure to collateralized debt obligations of asset backed securities and residential mortgage-
backed securities. As a result, SCAs New York-based insurance subsidiary, XLCA, will report negative statutory surplus and its Bermuda-based reinsurance subsidiary, XLFA, will report negative
total statutory capital and surplus as of June 30, 2008. Upon the successful closing of the transactions contemplated by the Master Agreement, SCAs settlement with Merrill Lynch International (the
Merrill Agreement) and related agreements, and pending the satisfaction of the conditions to closing of the Master Agreement and the Merrill Agreement, XLCA expects to have positive statutory
surplus and XLFA expects to have positive total statutory capital and surplus. In the absence of the consummation of the transactions contemplated by the Master Agreement, Merrill Agreement and
related agreements, XLCA and XLFA would likely be subject to regulatory action by their primary regulators, the New York Insurance Department and the Bermuda Monetary Authority. As a
result of these developments, there is substantial doubt about SCAs ability to 38
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
XL CAPITAL LTD 12. Subsequent Events (continued) continue as a going concern. Upon closing of the transactions contemplated by the Master Agreement and the Merrill Agreement, SCA intends to re-assess whether substantial doubt exists about
SCAs ability to continue as a going concern. For further details, see Note 4 to the Consolidated Financial Statements, Security Capital Assurance Ltd. Capital Raising In order to fund the payments described above in relation to the Master Agreement with SCA, the Company, on July 28, 2008, announced its intention to raise approximately $2.5 billion of
additional capital through an issuance of both ordinary shares and equity security units (the ESUs) pursuant to the Companys existing shelf registration statement. The ESUs consist of: (i) forward
purchase contracts to purchase, and the Company to issue, its ordinary shares and (ii) debt securities. In addition to the payments to SCA, the Company intends to use the net proceeds from the offerings for general corporate purposes, including, without limitation, the redemption of X.L.
America, Inc.s $255 million 6.58% Guaranteed Senior Notes due April 2011 and capital funding of certain of the Companys subsidiaries. Other related transactions Concurrent with the execution of the Master Agreement with SCA, the Company intends to (i) exercise the put option under its Mangrove Bay contingent capital facility entered into in July
2003 resulting in net proceeds to the Company of approximately $500 million in exchange for the issuance by the Company of 20,000,000 Series C Preference Ordinary Shares and (ii) upon the
Companys completion of its capital raise (as discussed above) and the closing of the transactions contemplated by the Master Agreement, redeem X.L. America, Inc.s $255 million 6.58% Guaranteed
Senior Notes due April 2011, as noted above. Dividend Reduction The Company also announced that the Board of Directors approved a reduction in the quarterly dividend payable on the Companys Class A Ordinary Shares to $0.19 per ordinary share
beginning with the quarterly dividend payable in September 2008. 39
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)
ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS General The following is a discussion of the Companys financial condition and liquidity and results of operations. Certain aspects of the Companys business have loss experience characterized as low
frequency and high severity. This may result in volatility in both the Companys and an individual segments results of operations and financial condition. This Managements Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that involve inherent risks and uncertainties. Statements that
are not historical facts, including statements about the Companys beliefs and expectations, are forward-looking statements. These statements are based upon current plans, estimates and projections.
Actual results may differ materially from those included in such forward-looking statements, and therefore undue reliance should not be placed on them. See Cautionary Note Regarding Forward-
Looking Statements below for a list of 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 Managements Discussion and Analysis of Financial Condition and Results of Operations, and the audited Consolidated
Financial Statements and notes thereto, presented under Item 7 and Item 8, respectively, of the Companys Form 10-K for the year ended December 31, 2007. Executive Overview See Executive Overview in Item 7 of the Companys Form 10-K for the year ended December 31, 2007. Results of Operations The following table presents an analysis of the Companys net income available to ordinary shareholders and other financial measures (described below) for the three months ended June 30, 2008
and 2007: (U.S. dollars and shares in thousands, except per share amounts)
(Unaudited)
2008
2007 Net income available to ordinary shareholders
$
237,851
$
544,535 Earnings per ordinary share and ordinary share equivalents basic
$
1.35
$
3.05 Earnings per ordinary share and ordinary share equivalents diluted
$
1.34
$
3.00 Weighted average number of ordinary shares and ordinary share equivalents basic
176,655
178,378 Weighted average number of ordinary shares and ordinary share equivalents diluted
176,910
181,613 The following table presents an analysis of the Companys net income available to ordinary shareholders and other financial measures (described below) for the six months ended June 30, 2008
and 2007: (U.S. dollars and shares in thousands, except per share amounts)
(Unaudited)
2008
2007 Net income available to ordinary shareholders
$
449,724
$
1,094,253 Earnings per ordinary share and ordinary share equivalents basic
$
2.55
$
6.13 Earnings per ordinary share and ordinary share equivalents diluted
$
2.54
$
6.06 Weighted average number of ordinary shares and ordinary share equivalents basic
176,453
178,650 Weighted average number of ordinary shares and ordinary share equivalents diluted
176,946
180,570 40
Three Months Ended
June 30,
Six Months Ended
June 30,
The Companys net income and other financial measures as shown below for the three and six months ended June 30, 2008 have been affected, among other things, by the following significant
items: 1) Impact of credit market movements on the Companys investment portfolio and investment fund affiliates In the first six months of 2008, particularly in the first quarter, financial market conditions continued to be extremely challenging as the global credit crisis that began in July 2007 continued to
adversely impact global fixed income markets. While credit spreads on both corporate and structured credit rallied modestly in the second quarter, spread levels remain wide resulting in continuing
depressed pricing on credit product. Continuing challenges included continued weakness in the U.S. housing market and increased mortgage delinquencies, investor anxiety over the U.S. economy,
rating agency downgrades of various structured products and financial issuers, unresolved issues with structured investment vehicles and monolines, deleveraging of financial institutions and hedge
funds and a significant dislocation in the inter-bank market. The lingering issues in the credit market were compounded during the second quarter as government rates in the U.S., U.K. and Eurozone all increased markedly. As such, both the widening in
credit spreads and the increase in interest rates were the primary drivers behind the increase of $1.8 billion in net unrealized losses and $100.2 million in net realized losses on investments reported
for the six months ended June 30, 2008. Realized losses and impairments as a result of securities where the Company determined its unrealized losses were other than temporary impairments totaled $74.7 million during the six months
ended June 30, 2008 in the Companys holdings of sub-prime non-agency securities, second liens, ABS CDOs with sub-prime collateral as well as Alt-A mortgage exposures (Topical Assets). In
addition, the Company realized losses of $19.5 million on lower-rated Jumbo mortgage securities. These losses and impairments continued to be principally concentrated in 2005, 2006, and 2007
vintage securities. The level of topical impairments have declined in the second quarter of 2008 relative to the first quarter of 2008 and the latter half of 2007, as a number of the lower tranched
securities were previously written off to security values ranging from five to thirty percent of par value. Liquidations necessary to fund the repayment of the guaranteed investment contract (GIC)
liabilities following the downgrade of XL Capital Assurance Inc. (XLCA) were funded through sales of assets in the Other Financial Lines segment investment portfolios as well as the general
investment portfolios. Managements approach was to avoid the sale of assets where current market prices did not reflect intrinsic values or where transaction costs for liquidation were excessive. As a
result, the Company continues to hold a number of the Topical Assets and these have been transferred to the general portfolio in exchange for those assets that were liquidated. The following table details the current exposures to Topical Assets within the Companys fixed income portfolio as well as the current net unrealized (loss) gain position as at June 30, 2008 and
December 31, 2007: (U.S. dollars in thousands)
As at
As at
Holding at
Percent
Net
Holding at
Percent
Net Topical Assets: Sub-prime first lien mortgages
$
724,368
2.1
%
$
(212,369
)
$
995,947
2.5
%
$
(145,785
) Alt-A mortgages
635,085
1.8
%
(174,505
)
924,783
2.3
%
(40,145
) Second lien mortgages (including sub-prime second lien mortgages)
66,265
0.2
%
(7,561
)
97,647
0.3
%
788 ABS CDOs with sub-prime collateral
17,856
0.1
%
(4,857
)
39,317
0.1
%
101 Total exposure to Topical Assets
$
1,443,574
4.2
%
$
(399,292
)
$
2,057,694
5.2
%
$
(185,041
) 41
June 30, 2008
December 31, 2007
Fair Value
of Fixed
Income
Portfolio
Unrealized
(Loss) Gain
Fair Value
of Fixed
Income
Portfolio
Unrealized
(Loss) Gain
The following table provides the earnings and comprehensive earnings impact related to the Topical Assets in the three and six months ended June 30, 2008:
Three Months Ended
Six Months Ended
Realized
Change
Realized
Change Topical Assets: Sub-prime first lien mortgages
$
(5,311
)
$
(8,709
)
$
(37,109
)
$
(66,584
) Alt-A mortgages
(9,344
)
(36,007
)
(23,431
)
(134,360
) Second lien mortgages (including sub-prime second lien mortgages)
(2,818
)
(9,526
)
(7,466
)
(8,349
) ABS CDOs with sub-prime collateral
(3,416
)
(7,341
)
(6,681
)
(4,958
) Total
$
(20,889
)
$
(61,583
)
$
(74,687
)
$
(214,251
) The Companys sub-prime and Alt-A exposures remain primarily highly rated, have strong underlying loan characteristics and are supported by adequate subordination levels. The Company had
approximately $208 million of topical investments downgraded during the quarter ended June 30, 2008 and approximately $353 million during the six months ended June 30, 2008. Of the total Topical Asset exposure as at June 30, 2008 and December 31, 2007 of $1.4 billion and $2.0 billion, respectively, approximately $56.9 million and $76.8 million, respectively, of the
related securities had ratings dependent on guarantees issued by third party guarantors (i.e. monoline insurers). Decreases in the ratings of such third party guarantors would typically decrease the fair
value of guaranteed securities; however, at June 30, 2008, in the event of non-performance on the part of these third party guarantors, the Company estimates that the average credit quality of this
portfolio would be A and that approximately 95.9% would remain investment grade. In addition, of the total fixed income portfolio as at June 30, 2008 and December 31, 2007, of $34.3 billion and
$39.1 billion, respectively, less than 2% were guaranteed by such third parties with no individual third party representing more than 1%. As noted above, the remaining changes in net unrealized losses during the six months ended June 30, 2008 were primarily as a result of spread widening in both corporate credit, particularly
financials, and CMBS assets, as well as increases in government interest rates. Spreads widened significantly in the first quarter, followed by modest tightening in second quarter. Government rates
declined significantly in first quarter but increased even more significantly in second quarter. The Company believes these losses are a result of either technical spread widening as a result of the
market events noted above, or changes in prevailing market rates for government securities, rather than any fundamental deterioration or other-than-temporary impairment. Net realized and unrealized gains on investment derivatives for the six months ended June 30, 2008 resulted primarily from corporate credit deterioration and the resulting appreciation of certain
credit derivative swaps held in the investment portfolio. Net income from investment fund affiliates was marginally negative in the first half of 2008 as the markets were particularly challenging for strategies employed by the Companys alternative
investment managers given the extreme volatility and overall pull back of credit availability. The Companys alternative investments are managed to maximize total-return on a risk-adjusted basis, and
the results over the first half of 2007 as compared to the first half of 2008 are reflective of different market conditions and opportunities available over these periods. As at June 30, 2008, approximately 13.2% of the asset and mortgage-backed holdings were classified as part of the Companys exposure to Topical Assets. This represented approximately 4.2%
of the total fixed income portfolio and 17.6% of the total net unrealized loss position. Of the Topical Asset securities, approximately 97.2% were rated as investment grade. All portfolio holdings,
including those with sub-prime exposure, are reviewed as part of the ongoing other-than-temporary-impairment monitoring process. The Company continues to actively monitor its exposures, and to
the extent market disruptions continue, including but not limited to disruptions in the residential mortgage market and the related impacts on the assumptions embedded in the Companys 42
June 30, 2008
June 30, 2008
(Loss) and
(Impairments)
in Net
Unrealized
(Loss)
(Loss) and
(Impairments)
in Net
Unrealized
(Loss)
impairment assessments and estimates of future cash flows, the Companys financial position could be negatively impacted. Consistent with the Companys overall focus on core property and casualty operations, management is committed to an overall strategic realignment of its property and casualty investment
portfolio over time. Such realignment will support reduced volatility through reduced credit spread exposure, reduced exposure to lower-rated and particularly BBB-rated securities, reduced CMBS
and financial sector exposure. The realignment will be achieved through bond maturity and coupon reinvestment, cash flows from business operations and certain opportunistic sales. This strategic
realignment will also include an assessment of the Companys risk asset portfolio. 2) Relationships with SCA The Company has multiple relationships with SCA as a result of SCAs initial origins as a wholly-owned subsidiary and its subsequent IPO. These relationships are detailed in Note 4 to the
Consolidated Financial Statements, Security Capital Assurance Ltd, and include, most significantly, a 46.9% investment along with certain guarantees and reinsurance arrangements. The Company is
not a primary originator or insurer of mortgages, nor does it guarantee mortgages other than indirectly through the activities of SCA, and as such the impact to the Company with respect to credit
enhancement activities is largely limited to the SCA investment and related reinsurance agreements and guarantees. At December 31, 2007, the Company wrote down its investment in SCA to zero. The write down of SCA to zero in the fourth quarter of 2007 was based, in part, on the losses SCA recorded in
the fourth quarter of 2007. No equity earnings have been recorded in the first six months of 2008 relating to the common equity interest in SCA as a result of their reported results throughout 2008. As a result of a significant increase in expected losses in the SCA portfolio of insured credits the Company has recorded additional losses related to both the reinsurance agreements as well as
pre-IPO guarantees. The following table summarizes the income statement impact of these relationships for both the three and six months ended June 30, 2008: (U.S. dollars in millions)
Income Statement Impact
Three Months Ended
Six Months Ended Excess of loss reinsurance agreement
$
3.7
$
7.3 Facultative reinsurance agreement
22.7
23.9 Guarantee agreements
56.0
56.0 Total
$
82.4
$
87.2 On July 28, 2008, the Company announced that it and certain of its subsidiaries had entered into an agreement (the Master Agreement) with SCA and certain of its subsidiaries (as previously
noted, sometimes collectively referred to herein as SCA) in connection with the termination of certain reinsurance and other agreements as described below. A group of counterparties (the
Counterparties) to credit default swap agreements with SCA are also parties to the Master Agreement. For a description of the Master Agreement, see Note 12 to the Consolidated Financial Statements, Subsequent Events. Under the Master Agreement, the total value of the consideration to be paid by the Company to SCA significantly exceeds the carried net liabilities of approximately $490.7 million related to
such reinsurances and guarantees as at June 30, 2008. Management considers the execution of the Master Agreement as the event giving rise to the additional liability. There are numerous conditions
precedent to this agreement that will be completed upon closing. As such, the Company expects to record a charge of approximately $1.4 billion to $1.5 billion in respect of the Master Agreement
during the three month period ending September 30, 2008. See Notes 4 and 12 to the Consolidated Financial Statements, Security Capital Assurance Ltd and Subsequent Events, respectively, for further information relating to SCA. For further
information relating to certain risks associated with the reinsurance and guarantee agreements, refer to Part II, Item 1A. Risk Factors, below. 43
June 30, 2008
June 30, 2008
3) Continuing competitive underwriting environment Insurance During the first six months of 2008, the Companys Insurance segment continued to experience increasing soft market conditions as premium rates across most lines of business decreased by
approximately 7% in the aggregate and competitive pressures continued to make new business more difficult to win. Overall, throughout the first six months of 2008, property renewals reflected
decreases in premium rates of approximately 5 to 20%, while certain casualty lines experienced premium rate reductions of approximately 5 to 15%. In addition, premium rates within certain specialty
lines of business decreased by up to 10%. Offsetting these premium rate decreases was strong pricing in the U.S. Professional D&O book of business, specifically with regards to financial institutions. New business is largely impacted by market conditions as incumbents continue to retain business in all lines and markets. However, through June, the Company has written approximately $400
million in new business. This is largely as a result of successes in the Companys organic growth strategies which include E&S, private D&O as well as construction and upper middle markets. Renewal
ratios for core property casualty, and professional lines range from approximately 82% to 91%. While the Companys Insurance segment has been impacted by general market conditions that prevail, described above, to a large degree the uncertainty surrounding its agreements with SCA
and the potential impact on the Companys results and/or liquidity has been contained to within the U.S. professional book of business, which is most rating sensitive. Actions taken by various rating
agencies relating to the Company throughout 2008 as a result of their concerns relating to the Companys agreement with SCA have resulted in limited lost renewals, again largely within the U.S.
professional D&O book, and has impacted the ability of the Companys Insurance segment to attract new business. It should be noted that to date, the impact of the uncertainty surrounding the
Companys reinsurance and guarantee agreements with SCA has been significantly less than the impact of the soft market conditions described above. For further information relating to the rating
agency actions, see Other Key Focuses of Management and Ratings below. The following table provides an analysis of gross premiums written, net premiums written and net premiums earned for the Insurance segment for the six month periods ended June 30, 2008 and
2007: (U.S. dollars in thousands)
(Unaudited)
(Unaudited)
Gross
Net
Net
Gross
Net
Net Casualty professional lines
$
690,471
$
624,297
$
688,167
$
763,009
$
691,516
$
723,744 Casualty other lines
831,813
555,741
425,370
824,203
558,684
424,361 Property catastrophe
(59
)
(2,162
)
107
15,044
(10,715
)
30,979 Other property
600,697
398,873
258,766
491,742
376,002
258,547 Marine, energy, aviation, and satellite
408,377
325,022
322,618
436,657
337,482
343,579 Other specialty lines (1)
430,827
355,917
324,924
419,099
352,237
279,881 Other (2)
11,529
(29,831
)
(27,359
)
20,491
20,449
22,277 Structured indemnity
43,465
40,815
34,159
27,029
25,102
20,682 Total
$
3,017,120
$
2,268,672
$
2,026,752
$
2,997,274
$
2,350,757
$
2,104,050
(1)
Other specialty lines within the Insurance segment includes: environmental, programs, equine, warranty, and excess and surplus lines. (2) Other includes employers liability, surety, political risk and other lines. Reinsurance In the Reinsurance segment, the first six months of 2008 reflected a decline in premium rates across most major lines of business, as market conditions continued to soften and the reinsurance 44
Six Months Ended
June 30, 2008
Six Months Ended
June 30, 2007
Premiums
Written
Premiums
Written
Premiums
Earned
Premiums
Written
Premiums
Written
Premiums
Earned
industry continued to experience pricing erosion, increased competitive pressures and increased retentions by cedants. Renewals and new business in 2008 continued to be assessed against internal
hurdle rates with a continued focus on underwriting discipline. U.S. catastrophe exposed property lines experienced rate declines of approximately 10% to 15%, while rates for non-U.S. catastrophe
exposed property lines of business dropped by up to 10%. Other property lines of business saw rates decrease by 10% to 15%. Ocean marine pricing rates remained flat to down 5%, while rates
within the aviation market decreased by up to 10%. Casualty pricing trends in the reinsurance market experienced deterioration in rates of up to 15%, however, rate changes on business actually
bound in this line of business decreased between 10 to 15%. Up to June 30, 2008, the negative impact on gross premiums written as a result of rating agency actions was limited. Since that date, some ceding companies have taken actions placing limitations
on the amount of new and/or renewal business that they will cede to the Company. The overall impact of these actions has, to date, been limited. The Company anticipates that many of these
companies will remove these limitations after the Master Agreement closes and the Companys financial strength ratings are clarified. The following table provides an analysis of gross premiums written, net premiums written and net premiums earned for the Reinsurance segment for the six month periods ended June 30, 2008
and 2007: (U.S. dollars in thousands)
(Unaudited)
(Unaudited)
Gross
Net
Net
Gross
Net
Net Casualty professional lines
$
138,193
$
138,090
$
130,436
$
157,875
$
161,585
$
133,786 Casualty other lines
250,444
244,610
222,645
396,130
377,917
318,428 Property catastrophe
331,278
231,106
171,510
405,776
231,794
132,360 Other property
455,300
349,595
342,374
572,739
453,749
348,031 Marine, energy, aviation, and satellite
89,321
83,266
60,702
107,037
93,403
67,125 Other (1)
204,109
179,321
104,915
243,547
215,235
124,297 Structured Indemnity
1,360
1,360
2,233
18,100
18,100
20,743 Total
$
1,470,005
$
1,227,348
$
1,034,815
$
1,901,204
$
1,551,783
$
1,144,770
(1)
Other includes employers liability, surety, political risk and other lines.
4) Favorable prior year reserve development During the first six months of 2008, the Company had net favorable prior year reserve development in property and casualty operations of $249.5 million compared to net favorable prior year
reserve development of $188.8 million for the same period in 2007. Reinsurance favorable development accounted for $132.5 million of the release in 2008, while favorable development within the
Insurance segment totaled $117.0 million for the same period. The Reinsurance segment released reserves in property and other short-tail lines of business of $71.6 million, $59.5 million in casualty
and other lines and $1.4 million in structural indemnity lines. The Insurance segment reserve releases consisted of favorable development $64.4 million in property lines of business, $62.0 million in
casualty and professional lines, and was offset by net adverse development of $9.4 million in specialty and other lines. For further details see the segment results in the Statement of Income Analysis
below. Financial Measures The following are some of the financial measures management considers important in evaluating the Companys operating performance: 45
Six Months Ended
June 30, 2008
Six Months Ended
June 30, 2007
Premiums
Written
Premiums
Written
Premiums
Earned
Premiums
Written
Premiums
Written
Premiums
Earned
(U.S. dollars and shares in thousands, except ratios and per share amounts)
(Unaudited)
2008
2007 Underwriting profit property and casualty operations
$
128,216
$
232,011 Combined ratio property and casualty operations.
92.3
%
86.3
% Net investment income property and casualty operations (1)
$
298,128
$
322,997
(U.S. dollars and shares in thousands, except ratios and per share amounts)
(Unaudited)
2008
2007 Underwriting profit property and casualty operations
$
236,287
$
392,441 Combined ratio property and casualty operations.
92.9
%
88.2
% Net investment income property and casualty operations (1)
$
606,169
$
637,178 Annualized return on average ordinary shareholders equity.
10.8
%
22.3
%
(Unaudited)
December 31, Book value per ordinary share
$
43.39
$
50.30 Fully diluted book value per ordinary share (2)
$
43.39
$
50.29
(1)
Net investment income relating to property and casualty operations does not include the net investment income related to the net results from structured products. (2) Fully diluted book value per ordinary share represents book value per ordinary share combined with the impact from dilution of share based compensation including in-the-money stock options at any period end. The Company believes that fully
diluted book value per ordinary share is a financial measure important to investors and other interested parties who benefit from having a consistent basis for comparison with other companies within the industry. However, this measure may not
be comparable to similarly titled measures used by companies either outside or inside of the insurance industry. Underwriting profit property and casualty operations One way that the Company evaluates the performance of its insurance and reinsurance 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 underwriting activities, plus
unrealized foreign exchange gains and losses on underwriting balances. Underwriting profit in the six month period ended June 30, 2008 is primarily reflective of the combined ratio discussed below. Combined ratio property and casualty operations The combined ratio for property and casualty 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 Companys insurance and reinsurance operations. A combined ratio
of less than 100% indicates an underwriting profit and greater than 100% reflects an underwriting loss. The Companys combined ratio for the six months ended June 30, 2008, is higher than the
same period in the previous year, primarily as a result of an increase in the loss and loss expense ratio as well as the underwriting expense ratio. The higher loss and loss expense ratio resulted from
unusually high current year attritional and catastrophe losses, primarily in property lines, combined with lower net premium earned in the first six months of 2008 as compared to the same period in
2007 as a result of the continuing competitive underwriting environment and softening market conditions noted above. Partially offsetting the increase in incurred losses was higher favorable prior
year reserve development in both the Insurance and Reinsurance segments. While both acquisition and operating expenses have decreased during the six months ended June 30, 2008 as compared to
the six months ended June 30, 2007, as a result of the lower level of net premiums earned during the same periods, the underwriting expense ratio has increased. 46
Three Months Ended
June 30,
Six Months Ended
June 30,
June 30,
2008
2007
Net investment income property and casualty operations Net investment income related to property and casualty operations is an important measure that affects the Companys overall profitability. The largest liability of the Company relates to its
unpaid loss reserves, and the Companys 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 influenced by a number of factors, including the average size of the investment portfolio, amounts and timing of inward and outward cash flows, the level
of interest rates and credit spreads and changes in overall asset allocation. Net investment income related to property and casualty operations, excluding structured products, decreased by $31.0 million
during the first six months of 2008 as compared to same period in the prior year. Overall, portfolio yields have decreased as yields earned on investment of cash flows and reinvestment of maturing
or sold securities are generally lower than on securities previously held, as prevailing market interest rates, particularly in the U.S., have decreased overall during the last twelve months. As well, the
portfolio mix has changed as a result of the settlement of the GIC liabilities, as the property and casualty operations assumed a number of the floating rate securities previously held in the
Companys Other Financial Lines segment. Book value per ordinary share Management also views the change in the Companys book value per ordinary share as an additional measure of the Companys 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 Companys net income (loss), by any changes
in the net unrealized gains and losses on its investment portfolio, currency translation adjustments and also the impact of any share repurchase or issuance activity. Book value per ordinary share
decreased by $6.91 in the first six months of 2008 as compared to an increase of $1.89 in the first six months of 2007. The decrease was primarily as a result of an increase in net unrealized losses on
investments of approximately $1.8 billion, net of tax, during the six months ended June 30, 2008. The increase in net unrealized losses on investments of $1.8 billion during the first six months of 2008
was as a result of widening credit spreads on corporate and structured credit assets, increasing government interest rates and the negative impact of the weakening U.S. dollar during this period.
Partially offsetting the decrease in book value per ordinary share was positive currency translation gains of $237.4 million in the first six months of 2008 which increased book value. Following the subsequent events noted above related to the Master Agreement and the Companys capital raise, book value per ordinary share will be significantly reduced in the third quarter of
2008. For further information, see Note 12 to the Consolidated Financial Statements, Subsequent Events. Annualized return on average ordinary shareholders equity Annualized return on average ordinary shareholders equity (ROE) is another financial measure that management considers important in evaluating the Companys operating performance. ROE
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 ROEs for its total
operations, segments and lines of business. If the Companys minimum ROE targets over the longer term are not met with respect to any line of business, the Company seeks to modify and/or exit
these lines. In addition, the Companys compensation of its senior officers is significantly dependent on the achievement of the Companys performance goals to enhance shareholder value as
measured by ROE (adjusted for certain items considered to be non-operating in nature). In the first six months of 2008, ROE was 10.8%, 11.5 percentage points lower than the same period in the
prior year primarily as a result of net losses from the Companys operating and investment fund affiliates, net realized losses on investments combined with the factors noted above which increased
the Companys combined ratio and decreased net investment income. Partially offsetting these factors which decreased ROE was a lower level of shareholders equity as a result of the increase in
unrealized losses on investments. In the first six months of 2007, ROE was 22.3% due to solid 47
underwriting results throughout its property and casualty operations combined with strong investment fund affiliate income. Other Key Focuses of Management See the discussion of the Other Key Focuses of Management in Item 7 of the Companys Form 10-K for the year ended December 31, 2007. That discussion is updated with the disclosures set
forth below. Ratings and Capital Management The Companys ability to underwrite business is largely dependent upon the quality of its claims paying and financial strength ratings as evaluated by independent rating agencies. As a result, in
the event that the Companys financial strength rating is downgraded, its ability to write business may be adversely affected. In June 2008, Moodys Investor Services, Inc. (Moodys) affirmed the A1 financial strength rating of the Companys principal insurance and reinsurance subsidiaries; however, Moodys
provided a Negative outlook with regards to these ratings as a result of further stress on the Companys capital and financial flexibility resulting from the downgrades at SCA in the first six months
of 2008 and uncertainty surrounding reinsurance and guarantee agreements with SCA. Consistent with the ratings actions noted above, Standard and Poors (S&P), in July 2008, placed the A+ financial strength rating of the Companys leading property and casualty operating
companies on CreditWatch with Negative Implications. As well, in July 2008, Fitch Ratings (Fitch) placed the A+ financial strength rating of the Companys leading property and casualty
operating subsidiaries On Watch for Possible Downgrade. In order to fund the SCA agreement described above, the Company, in July 2008, announced its intention to raise approximately $2.5 billion of additional capital through an issuance of both
ordinary shares and equity security units (the ESUs). The ESUs consist of: (i) forward purchase contracts to purchase, and the Company to issue, its ordinary shares and (ii) debt securities. In addition to the payments to SCA, the Company intends to use the net proceeds from the offerings for general corporate purposes, including, without limitation, the redemption of X.L.
America, Inc.s $255 million 6.58% Guaranteed Senior Notes due April 2011 and capital funding of certain of the Companys subsidiaries. Concurrent with the closing of the agreement with SCA, the Company i) announced its intention to exercise the put option under its Mangrove Bay contingent capital facility entered into in July
2003 resulting in net proceeds to the Company of approximately $500.0 million in exchange for the issuance by the Company of 20,000,000 Series C Preference Ordinary Shares. Prior to signing the SCA agreement, the Company obtained waivers under certain of its letters of credit and revolving credit facilities. The Company also announced, in July 2008, that the Board of Directors approved a reduction in the quarterly dividend payable on the Companys Class A Ordinary Shares to $0.19 per ordinary
share beginning with the quarterly dividend payable September 2008. For further details relating to the Companys announcement regarding the agreement with SCA as well as the capital raising activities noted above, see Note 12 to the Consolidated Financial
Statements, Subsequent Events, for further information. Other ratings and capital management initiatives include reinsurance treaties entered into to support catastrophe risk reduction measures. Following from the success of the Companys quota
share reinsurance treaty with Cyrus Reinsurance Ltd. (Cyrus Re) which reduced the Companys catastrophe exposures, the Company, effective January 1, 2008, entered into a quota share
reinsurance treaty with a newly-formed Bermuda reinsurance company, Cyrus Reinsurance II Limited (Cyrus Re II). Pursuant to the terms of the quota share reinsurance treaty, Cyrus Re II
assumes a 10% cession of certain lines of property catastrophe reinsurance and retrocession business 48
underwritten by certain operating subsidiaries of the Company for the 2008 underwriting year. In connection with such cessions, the Company pays Cyrus Re II reinsurance premium less a ceding
commission, which includes a reimbursement of direct acquisition expenses incurred by the Company as well as a commission to the Company for generating the business. The quota share reinsurance
treaty also provides for a profit commission payable to the Company. Further catastrophe exposure management initiatives included the purchase by the Company, in the second quarter of 2008, of $100 million of additional catastrophe loss protections including $75
million of industry loss warranty covers in three equal layers which pay out when industry losses for U.S. windstorms occurring during the remainder of 2008 reach $20.0 billion, $25.0 billion and $30.0
billion, respectively. In addition, in relation to catastrophe risk management, the Company considers the loss of capital due to a single large event and the loss of capital that would occur from multiple (but
potentially smaller) events in any given year. The Company imposes a limit to catastrophe risk from any single loss in a given region/peril at a 1% exceedance probability. Tier 1 limits, which include
natural catastrophes and other realistic disaster scenarios, are not to exceed 10% of shareholders equity, where Tier 2 limits, which include pandemic, longevity and country risk, are established at no
more than half of Tier 1 limits. Expense Reduction Initiative Given the softening market conditions, the Company implemented in the third quarter of 2008, an expense reduction initiative designed to reduce the Companys operating expenses. The goal of
this initiative is to achieve enhanced efficiency and an overall reduction in operating expenses by streamlining processes across all geographic locations, with a primary emphasis on corporate
functions. This will be achieved through job eliminations, increased outsourcing and the cessation of certain projects and activities. In relation to this initiative, the Company expects to incur
restructuring charges totaling approximately $50 to $60 million during the remainder of 2008. Restructuring charges relate mainly to employee termination benefits as well as ceasing to use certain
leased property. Operational Transformation Program The Company is committed to achieving competitive differentiation through the strategic alignment of initiatives that will deliver flexible and robust technology platforms to the Company and its
customers. The focal point of this strategy is the development and enhancement of a reliable infrastructure through initiatives that will improve operational efficiency, standardize processes and
optimize costs. As such, in 2008, the Insurance segment began a multiple year operational transformation program that when completed, will have consolidated numerous business processes and
technology systems into a unified global architecture and ultimately result in enhanced product differentiation and business process standardization aligned with the segments growth strategy. In
connection with this program the Company has entered into a services agreement with Accenture LLP, filed herewith as exhibit 10.1. Strategic Opportunities Related to the Companys Life Reinsurance Business As part of the Companys efforts to refocus on its core property and casualty roots, the Company is exploring strategic opportunities related to its Life Reinsurance business. Evaluation of the Impact of Recent Credit Market Volatility on Core Underwriting Operations In addition to the evaluation of the impact of the distressed credit and sub prime markets on the Companys investment portfolio and financial guarantee exposures, as discussed above,
management has also completed detailed assessments of the exposure to these credit related issues in the core property and casualty insurance and reinsurance business, in particular the Insurance
segment professional lines portfolio exposures through D&O and E&O policies. Actual policy notices as well as potential further notice activity that could arise from insureds that have been linked to
sub-prime related matters are monitored on a monthly basis. Such notice activity is considered in establishing loss and loss expense reserves at each quarter end. In the insurance 49
segment, the Company received 19 new claims during the three months ended June 30, 2008, 12 notices in April, 5 in May and 2 in June. For 2007, 56% of gross limits are side-A and for 2008, 60%
are side-A. During the reserve review process in the first quarter of 2008, the loss ratio for the 2008 report year designed to provide a provision for clash-type events such as sub-prime was increased by
approximately 5 points over the 2007 clash loss ratio. This increase applied to standard professional lines including D&O, E&O and Fiduciary exposures where the sub-prime related notice activity has
been concentrated. Notice activity during the second quarter of 2008 was in line with expectations and no further adjustment was made to the loss ratio established in the first quarter. Minor adjustments were made to the current year loss ratios and prior year reserves in the Reinsurance Segment professional lines portfolio during the first half of 2008 reflecting updated claim
activity. Such adjustments had less than a one point impact on the year-to-date loss ratio for the segment and the reserve strengthening in more recent underwriting years was more than offset by
favorable development on older underwriting years within professional lines. Global credit events have also had an impact on the trade credit portfolio written in the European Reinsurance operations
and this is reflected in the second quarter 2008 loss ratio. Management Changes and Performance Motivation In late October 2007, the Company announced that Mr. Brian M. OHara, President and Chief Executive Officer (CEO) of the Company, had informed the Companys Board of Directors of
his decision to retire as President and CEO in mid-2008. Accordingly, the Board of Directors implemented a CEO succession plan including the authorization of a Succession Committee to lead the
new CEO selection process. On March 17, 2008, the Company announced that Mr. Michael S. McGavick will replace Mr. OHara as the Companys CEO and effective May 1, 2008, Mr. McGavick
assumed the role of CEO. To provide continuity during the transition, Mr. OHara, who is currently serving as Acting Chairman of the Companys Board of Directors, will serve as Chairman during
the final year of his current term on the Board which expires in April 2009. On July 28, 2008 the Company announced executive management changes as detailed below. Henry C.V. Keeling, Executive Vice President and Chief Operating Officer, will retire from the Company effective August 1, 2008. As a result of Henrys decision to retire, the role of the Chief
Operating Officer will be eliminated. Michael C. Lobdell will leave his current position of Executive Vice President and Chief Executive of Global Business Services, effective August 31, 2008. The Company now intends to realign
the majority of Global Business Services within the business operations and the current executive structure will no longer be required. Fiona Luck, Executive Vice President and Chief of Staff, will become Special Advisor to the CEO, based in Bermuda and London and with a reduced time commitment. She will step down from
her current role and the senior leadership group on August 1, 2008, at which time the role of Chief of Staff will be eliminated. Susan Cross, Global Chief Actuary, will join the senior leadership group with immediate effect. In addition, consistent with the Companys commitment to enhancing enterprise risk management, efforts continue to identify and appoint a new Chief Enterprise Risk Officer. The Company is also focused on the retention and motivation of management, and as such announced a limited number of targeted option awards. Options awarded to the most senior executives
will have a performance vesting feature. On July 25, 2008, the Companys board of directors approved the issuance of grants to employees of options to purchase, in the aggregate, 2,831,000 ordinary
shares under our Amended and Restated 1991 Performance Incentive Program. The date of grant of the stock options will be the date that is ten days following the date of pricing of the offering
noted above. The exercise price per share of the options will be the closing sales price per share of our ordinary shares on the New York Stock Exchange on the date of grant. 50
Establishment of Reinsurance Operations in Brazil In response to the liberalization of the Brazilian reinsurance market in mid-April 2008, the Companys Reinsurance Segment launched a new initiative to serve Brazil through the establishment of
both a locally domiciled and admitted foreign reinsurer. Upon receipt of the required regulatory approvals, together these two platforms should provide, the Company with access to the entire
Brazilian reinsurance market. Critical Accounting Policies and Estimates See the discussion of the Companys Critical Accounting Policies and Estimates in Item 7 of the Companys Form 10-K for the year ended December 31, 2007. Variable Interest Entities and Other Off-Balance Sheet Arrangements See the discussion of the Companys variable interest entities and other off-balance sheet arrangements in Item 7 of the Companys Form 10-K for the year ended December 31, 2007. Statement of Income Analysis Segment Results for the three months ended June 30, 2008 compared to the three months ended June 30, 2007 The Company is organized into four operating segments: Insurance, Reinsurance, Life Operations and Financial Linesin addition to a corporate segment that includes the general investment and
financing operations of the Company. The Company evaluates the performance for both the Insurance and Reinsurance segments based on underwriting profit and evaluates the contribution from each of the Life Operations and
Other Financial Lines segments. Other items of revenue and expenditure of the Company are not evaluated at the segment level for reporting purposes. In addition, the Company does not allocate
investment assets by segment for its property and casualty operations. Investment assets related to (i) the Companys Life Operations and Other Financial Lines segments and (ii) certain structured
products included in the Insurance and Reinsurance segments, are held in separately identified portfolios. As such, net investment income from these assets is included in the contribution from each
of these segments. Insurance General insurance business written includes risk management and specialty lines. Risk management products are comprised of global property and casualty insurance programs for large
multinational companies, including umbrella liability, integrated risk and primary master property and liability coverages. Specialty lines products include directors and officers liability, environmental
liability, professional liability, aviation and satellite, employment practices liability, marine, equine and certain other insurance coverages including program business. In addition, certain structured
indemnity products structured by XLFS are included within the results of the Insurance segment covering a range of insurance risks including property and casualty insurance, certain types of residual
value exposures and other market risk management products. A large part of the Companys casualty insurance business written has loss experience that is low frequency and high severity. As a result, large losses, though infrequent, can have a significant
impact on the Companys results of operations, financial condition and liquidity. The Company attempts to mitigate this risk by using strict underwriting guidelines and various reinsurance
arrangements. 51
The following table summarizes the underwriting results for this segment: (U.S. dollars in thousands)
(Unaudited)
% Change
2008
2007 Gross premiums written
$
1,388,771
$
1,417,868
(2.1
)% Net premiums written
1,084,820
1,105,242
(1.8
)% Net premiums earned
1,018,350
1,052,700
(3.3
)% Fee income and other
12,189
4,193
190.7
% Net losses and loss expenses
653,822
659,421
(0.8
)% Acquisition costs
113,877
129,931
(12.4
)% Operating expenses.
189,082
165,303
14.4
% Underwriting profit
$
73,758
$
102,238
(27.9
)% Exchange losses
$
6,094
$
7,817
(22.0
)% Net results structured products
$
12,366
$
(735
)
NM*
*
NM Not meaningful
Gross and net premiums written decreased by 2.1% and 1.8%, respectively, during the three months ended June 30, 2008 compared with the three months ended June 30, 2007. Gross premiums
written decreased as a result of continued decreases in premium rates across most lines of business as market conditions continued to soften, selective non-renewals and decreases in new business
within certain specialty lines including professional, environmental, and aerospace lines of business. To date the Company has seen limited lost renewals from recent rating agency actions, largely
limited to U.S. professional lines as noted above. Partially offsetting these decreases was growth in certain lines of business where the Company has expanded its operations recently and by favorable
foreign exchange rate movements of $43.1 million. Net premiums written decreased as a result of the factors noted above affecting gross premiums written. Net premiums earned decreased by 3.3% in the three months ended June 30, 2008 compared with the three months ended June 30, 2007. The decrease resulted primarily from the earn-out of
overall lower net premiums written in the past twelve months including decreases in professional, aerospace, programs and marine lines of business and partially offset by growth in excess and surplus
lines as well as certain property lines of business. Fee income increased in the second quarter of 2008 as compared to the second quarter of 2007 mainly as a result of higher engineering fee revenue associated with XL GAPS, which formed in
late 2007 following the acquisition of GAPS, a loss prevention consulting service provider. The following table presents the ratios for this segment:
(Unaudited)
2008
2007 Loss and loss expense ratio
64.2
%
62.6
% Underwriting expense ratio
29.8
%
28.0
% Combined ratio
94.0
%
90.6
% The loss and loss expense ratio includes net losses incurred for both the current year and any favorable or adverse prior year development of loss and loss expense reserves held at the beginning 52
Three Months Ended
June 30,
Three Months Ended
June 30,
of the year. The following table summarizes the net (favorable) adverse prior year development relating to the Insurance segment for the three month periods ended June 30, 2008 and 2007: (U.S. dollars in millions)
(Unaudited)
2008
2007 Property
$
(53.3
)
$
(31.0
) Casualty and professional
(58.0
)
(5.3
) Specialty and other
11.6
(7.4
) Total
$
(99.7
)
$
(43.7
) Loss and loss expense ratio excluding prior year development
74.0
%
66.8
% In property lines, net prior year reserve releases for the quarter ended June 30, 2008 resulted from favorable loss experience on certain large loss case reserves while favorable prior year
development in casualty lines reflected releases in 2004 to 2006 years. Partially offsetting this favorable development was prior year reserve strengthening in certain specialty lines including marine and
environmental, most notably in the 2007 year. Within professional lines, gross reserve releases were offset by reductions in ceded reserves for a net strengthening of $4.8 million. For the three months
ended June 30, 2007, net prior period reserve releases in property lines resulted from favorable loss experience of the Companys actual versus expected analysis in the quarter. Net releases in
specialty and other lines in the same period represented positive development related to marine exposures, partially offset by adverse development in surety. Excluding prior year development, the loss ratio for the three months ended June 30, 2008 increased by 7.2 loss percentage points as compared to the same period in 2007 with 4.0 loss ratio
points attributed to an increase in catastrophe losses in 2008 relative to 2007 (i.e., 5.9 loss ratio points in the current quarter versus 1.9 loss ratio points in the second quarter of 2007). The remainder
of the increase in loss ratio was attributable to the softening rate environment impacting most lines of business and an increase in loss activity anticipated for professional lines related to sub-prime
and related credit events. Gross prior year favorable development for the quarter ended June 30, 2008 of $404.3 million exceeded the corresponding net favorable development of $99.7 million in the same period as the
impact of reductions in gross reported losses on older years in certain casualty lines was mostly offset by the impact of the reinsurance recoverable component on such losses. In addition, the impact
of gross reserve releases in professional and specialty lines was mostly offset by the impact of a reduction in estimated ceded IBNR following a reserve review in these lines. The increase in the underwriting expense ratio in the three months ended June 30, 2008, compared to the same period in 2007 was due to an increase in the operating expense ratio of 2.9 points
(18.6% as compared to 15.7%) and partially offset by a decrease in the acquisition expense ratio of 1.1 points (11.2% as compared to 12.3%). The increase in the operating expense ratio was mainly
as a result of a higher headcount which increased compensation costs as well an increase in professional fees, against lower net premiums earned. The increase in headcount and professional fees both
supported new segment initiatives, including an operational transformation program as well as the formation of XL GAPS in late 2007. The acquisition expense ratio decreased mainly due to changes
in the mix of business in certain property and casualty lines which carried lower commission rates, as well the impact from the runoff of the Companys property catastrophe program business which
carried higher commission rates. Foreign exchange losses in the three months ended June 30, 2008 and 2007 were due primarily to the change in the value of the U.S. dollar against certain European currencies including the
U.K. Sterling, the Euro and the Swiss Franc on certain inter-company balances. Net results from structured insurance products include certain structured indemnity contracts that are accounted for as deposit contracts. Results from these contracts for the three months ended
June 30, 2008, have increased compared to the same period in 2007 due to a negotiated cancellation 53
Three Months Ended
June 30,
of a contract in the second quarter of 2008 that resulted in a gain of $10.9 million combined with an accretion adjustment recorded in 2007 based on changes in expected cash flows. Reinsurance The Reinsurance segment is comprised of approximately 410 staff in 21 locations. Reinsurance business written includes casualty, property, marine, aviation and other specialty reinsurance on a
global basis. In addition, the results of certain transactions structured by XLFS that are generally written on an aggregate stop loss or excess of loss basis are included within the results of the
Reinsurance segment. The Companys reinsurance property business generally has loss experience characterized as low frequency and high severity, which can have a negative impact on the Companys results of
operations, financial condition and liquidity. The Company endeavors to manage its exposures to catastrophic events by limiting the amount of its exposure in each geographic or peril zone worldwide
and requiring that its property catastrophe contracts provide for aggregate limits and varying attachment points. The following table summarizes the underwriting results for this segment: (U.S. dollars in thousands)
(Unaudited)
% Change
2008
2007 Gross premiums written
$
397,460
$
526,318
(24.5
)% Net premiums written
274,647
399,291
(31.2
)% Net premiums earned
490,437
598,449
(18.0
)% Fee income and other
471
318
48.1
% Net losses and loss expenses.
284,763
280,299
1.6
% Acquisition costs
106,528
141,693
(24.8
)% Operating expenses
45,159
47,002
(3.9
)% Underwriting profit
$
54,458
$
129,773
(58.0
)% Exchange losses
$
3,738
$
16,429
(77.2
)% Net results structured products
$
2,579
$
5,587
(53.8
)% Gross and net premiums written decreased by 24.5% and 31.2%, respectively, in the second quarter of 2008 as compared to the second quarter in 2007. These decreases resulted from softening
market conditions and the Company declining business due to the continuing trend of certain market rates below the Companys acceptable underwriting return levels, together with increased client
retentions. For the three months ended June 30, 2008, premium rate decreases were most significant in non-U.S. property lines of business as well as U.S. casualty lines. Net premiums written reflect
the above changes in gross premiums written combined with a reduction in ceded premiums in the three months ended June 30, 2008 as compared to the same period in 2007. Ceded premiums
written decreased as a result of a reduction in property catastrophe cessions to Cyrus Re II of 10% in 2008 as compared to a 35% cession to Cyrus Re throughout 2007, offset by ceded premiums
totaling $23.3 million associated with the purchase of additional catastrophe loss protection including industry loss warranty covers in the second quarter of 2008. Net premiums earned in the second quarter of 2008 decreased 18.0% as compared to the second quarter of 2007. This decrease was a reflection of the overall reduction of net premiums written
over the last 24 months. 54
Three Months Ended
June 30,
The following table presents the ratios for this segment:
(Unaudited)
2008
2007 Loss and loss expense ratio
58.1
%
46.8
% Underwriting expense ratio
30.9
%
31.6
% Combined ratio
89.0
%
78.4
% The loss and loss expense ratio includes net losses incurred for both the current year and any favorable or adverse prior year development of loss reserves held at the beginning of the year. The
following table summarizes the net (favorable) adverse prior year development relating to the Reinsurance segment for the three month periods ended June 30, 2008 and 2007: (U.S. dollars in millions)
(Unaudited)
2008
2007 Property and other short-tail lines
$
(55.0
)
$
(48.5
) Casualty and other
(27.9
)
(31.9
) Total
$
(82.9
)
$
(80.4
) Loss and loss expense ratio excluding prior year development
75.0
%
60.3
% For the three months ended June 30, 2008, property and other short-tail lines reserve releases were seen largely in property catastrophe and property risk lines of business in the 2004 to 2007
years while casualty and other lines reserve releases were seen in both professional and casualty lines of business. Excluding prior year development, the loss ratio for the three months ended June 30,
2008 increased by 14.7 loss percentage points as compared to the same period in 2007 with 6.1 loss ratio points attributed to the impact of catastrophe losses occurring during 2008 (7.8 points)
compared to the second quarter of 2007 (1.7 points) In addition, the second quarter 2008 includes losses of $14.6 million (3.0 loss ratio points) related to three structured products transactions
impacted by property risk and catastrophe events. The remaining difference of 5.6 loss ratio points was due to the softening rate environment and higher anticipated loss activity in the professional
and trade credit portfolios. For the three months ended June 30, 2007, property and other short-tail lines reserve releases were seen largely in property risk portfolios due to favorable attritional loss
development while casualty releases related both to U.S. and non-U.S. source exposures. The decrease in the underwriting expense ratio in the three months ended June 30, 2008, as compared with the three months ended June 30, 2007, was due to a decrease in the acquisition
expense ratio of 2.0 points (21.7% compared to 23.7%) and partially offset by an increase in the operating expense ratio of 1.3 points (9.2% compared to 7.9%). The decrease in the acquisition
expense ratio was primarily due to a favorable variance in profit commissions in the second quarter of 2008 as compared to the same period in 2007. In addition, while operating expenses were lower
in the three months ended June 30, 2008 as compared to the three months ended June 30, 2007, the lower level of net premiums earned during the same periods has caused an increase in the
operating expense ratio. Foreign exchange losses in the three months ended June 30, 2008 and 2007 were due primarily to the change in the value of the U.S. dollar against certain European currencies including the
U.K. Sterling, the Euro and the Swiss Franc on certain inter-company balances. Net results from structured reinsurance products include certain structured indemnity contracts that are accounted for as deposit contracts. Results from these products for the three months ended
June 30, 2008, have decreased compared to the same period in 2007 mainly due to lower net investment income as a result of lower yields earned on invested assets in the second quarter of 2008 as
compared to the second quarter of 2007. 55
Three Months Ended
June 30,
Three Months Ended
June 30,
Life Operations Business written by the Life Operations segment is primarily European life reinsurance. This includes term assurances, group life, critical illness cover, immediate annuities, disability income
cover, and short-term accident and health business. Due to the nature of these contracts, premium volume may vary significantly from period to period. The following summarizes contribution from this segment: (U.S. dollars in thousands)
(Unaudited)
% Change
2008
2007 Gross premiums written
$
161,251
$
234,961
(31.4
)% Net premiums written
150,933
224,487
(32.8
)% Net premiums earned
172,935
239,853
(27.9
)% Fee income and other
136
75
81.3
% Claims and policy benefits
209,725
279,100
(24.9
)% Acquisition costs
25,832
23,615
9.4
% Operating expenses
9,299
10,182
(8.7
)% Exchange (gains)
(1,896
)
(1,685
)
12.5
% Net investment income
98,058
95,949
2.2
% Contribution from Life Operations
$
28,169
$
24,665
14.2
% The following table is an analysis of the Life Operations gross premiums written, net premiums written and net premiums earned for the three month periods ended June 30, 2008 and 2007: (U.S. dollars in millions)
(Unaudited)
(Unaudited)
Gross
Net
Net
Gross
Net
Net Other Life
$
108,743
$
107,942
$
129,944
$
87,562
$
86,382
$
101,748 Annuity
52,508
42,991
42,991
147,399
138,105
138,105 Total
$
161,251
$
150,933
$
172,935
$
234,961
$
224,487
$
239,853 Gross premiums written relating to other life business increased by $21.2 million in the three months ended June 30, 2008 as compared to the same period in 2007 mainly due to premium growth
in the core underlying book of term assurance and critical illness business of $16.2 million, favorable foreign exchange rate movements of $0.6 million and an increase in U.S. business of $7.7 million.
Partially offsetting these increases was a decrease of $3.3 million in short-term life, accident and health business primarily as a result of soft market conditions and cancellations experienced in the
second quarter of 2008 exceeding new business written during the period. Gross premiums written relating to annuity business decreased by $94.9 million in the three months ended June 30, 2008 as
compared to the same period in the prior year primarily as a result of a single Irish immediate annuity contract totaling $94.6 million written during the second quarter of 2007 combined with
unfavorable foreign exchange rate movements of $0.3 million. Ceded premiums written were roughly consistent with the prior year. Net premiums earned in the second quarter of 2008 decreased 27.9% as compared to the second quarter of 2007. This decrease was consistent with the decrease in gross and net premiums
written as described above. Changes in claims and policy benefits include the movement in policy benefit reserves related to other contracts (such as immediate annuities) where investment assets were acquired with the
assumption of the policy benefit reserves at the inception of the contract. Claims and policy benefit reserves decreased by $69.4 million or 24.9% in the three months ended June 30, 2008 as
compared to the three months ended June 30, 2007, primarily as a result of the factors noted above affecting 56
Three Months Ended
June 30,
Three Months Ended
June 30, 2008
Three Months Ended
June 30, 2007
Premiums
Written
Premiums
Written
Premiums
Earned
Premiums
Written
Premiums
Written
Premiums
Earned
gross and net premiums written, partially offset by an increase in incurred losses of $7.9 million associated with certain short-term life, accident and health business. For the three months ended June 30, 2008, acquisition costs increased by 9.4% largely as a result of costs associated with the growth in the core underlying book of term assurance and critical
illness business combined with unfavorable foreign exchange rate movements. Partially offsetting these increases was a favorable profit commission adjustment recorded in the second quarter of 2008
relating to a short-term life, accident and health treaty. Operating expenses decreased in the second quarter of 2008 compared to the same period in 2007 primarily due to a decrease in both
compensation expenses and corporate allocations, partially offset by unfavorable foreign exchange rate movements. Compensation expenses decreased as a result of severance costs recorded in the
second quarter of 2007 relating to the discontinuance of the Life Fund Integration strategy and were partially offset by increased compensation costs associated with a higher headcount in 2008,
consistent with growth in certain business lines noted above. Net investment income is included in the calculation of contribution from Life Operations, as it relates to income earned on portfolios of separately identified and managed life investment assets
and other allocated assets. Net investment income increased by $2.1 million or 2.2% in the three months ended June 30, 2008, as compared to the same period in 2007 primarily as a result of the
impact relating to favorable foreign exchange rate movements. Other Financial Lines The Other Financial Lines segment is comprised of the funding agreement business and previously, the guaranteed investment contract (GIC) business. As at December 31, 2007, the Company
had approximately $4.0 billion of deposit liabilities associated with GICs which were correspondingly matched with invested assets. Based on the terms and conditions of the underlying GICs, upon
the downgrade of XLCA below certain ratings levels, all or portions of outstanding principal balances on such GICs would come due. Throughout 2008, several rating agencies downgraded SCA and
its subsidiaries and as a result, the Company settled, in the first six months of 2008 all of the GIC liabilities. At June 30, 2008, the balance of deposit liabilities associated with funding agreements was
$1.1 billion. The Company expects the balance of deposit liabilities associated with funding agreements to continue to decrease throughout 2008 as the funding agreement contracts mature and the
associated deposit liabilities are settled. Management does not expect any significant impact on the Companys results of operations or liquidity as a result of the maturity of these contracts. At December 31, 2007, a significant component of the investments held in the Companys Other Financial Lines segment portfolios was comprised of Topical Assets. Liquidations necessary to
fund the repayment of the GIC liabilities following the downgrade of XLCA, were funded through sales of assets in these portfolios as well as the general investment portfolios. Managements
approach was to avoid the sale of assets where current market prices did not reflect intrinsic values or where transaction costs for liquidation were excessive. As a result, the Company continues to
hold a number of the Topical Assets and these were transferred to the general portfolio in exchange for those assets that were liquidated. For the three month period ended June 30, 2008, the net results from Other Financial Lines businesses were $6.2 million and included net investment income, interest expense and operating
expenses of $19.1 million, $11.7 million, and $1.2 million, respectively, while the results for the same period in 2007 were $6.8 million and included net investment income, interest expense and
operating expenses of $94.9 million, $84.3 million, and $3.8 million, respectively. For the three months ended June 30, 2008, net investment income, interest expense and operating expenses decreased
primarily as a result of a decrease in the average deposit liability balance and the associated asset portfolios as a result of the settlement of the GIC portfolio noted above. In addition, operating
expenses decreased due to a reduction in compensation expense associated with a lower headcount. 57
SCA Prior to the secondary offering of SCA common shares on June 6, 2007, net income from SCA was consolidated with the Companys results and SCA was considered an operating segment of the
Company. Subsequent to June 6, 2007, SCA was no longer a consolidated subsidiary or an operating segment of the Company and its remaining investment in SCA was accounted for using the equity
method of accounting, recorded on a one quarter lag through equity earnings (loss) from financial operating affiliates. At December 31, 2007, the Company reduced its investment in SCA to zero. No
equity earnings have been recorded in the second quarter of 2008 relating to the common equity interests in SCA as a result of losses reported by SCA in the first quarter of 2008, which maintained
SCAs negative book value. For further information on SCA, see Results of Operations and Other Revenues and Expenses within Managements Discussion and Analysis of Financial Condition
and Results of Operations. In addition, see Notes 4 and 12 to the Consolidated Financial Statements, Security Capital Assurance Ltd and Subsequent Events, respectively, for further information. Investment Activities The following table illustrates the change in net investment income from property and casualty operations, net (loss) income from investment fund affiliates, net realized gains on investments and
net realized and unrealized gains on investment and other derivative instruments the three months ended June 30, 2008 and 2007: (U.S. dollars in thousands)
(Unaudited)
% Change
2008
2007 Net investment income property and casualty operations (1)
$
298,128
$
322,997
(7.7
)% Net (loss) income from investment fund affiliates (2)
(20,435
)
67,043
NM
* Net realized gains on investments
2,040
18,296
(88.9
)% Net realized and unrealized gains on investment and other derivative instruments
8,124
9,188
(11.6
)%
(1)
Net investment income relating to property and casualty operations does not include the net investment income related to the net results from structured products. (2) The Company records the income related to alternative fund affiliates on a one month lag and the private investment fund affiliates on a three month lag in order for the Company to meet the accelerated filing deadlines. * NMNot meaningful Net investment income related to property and casualty operations decreased in the second quarter of 2008 as compared to the second quarter of 2007 due primarily to declining portfolio yields.
Portfolio yields decreased as yields earned on investment of cash flows and reinvestment of maturing or sold securities were generally lower than on securities previously held, as prevailing market
interest rates, particularly in the U.S., decreased overall during the last twelve months. As well, the portfolio mix changed as a result of the settlement of the GIC liabilities, as the property and
casualty operations assumed a number of the floating rate securities previously held in the Companys Other Financial Lines segment. In the three months ended June 30, 2008, the net loss from investment fund affiliates was due primarily to the results from the Companys alternative funds, which were negative in the three
months ended June 30, 2008 as compared to strong positive results in the same period of the prior year. These results reflect marginally negative returns in the Companys alternative portfolio as the
markets during the quarter were particularly challenging for strategies employed by the Companys alternative investment managers given the extreme volatility and overall pull back of credit
availability. Net income from investment affiliates in the second quarter of 2007 was due primarily to very strong performance in alternative fund affiliates. 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. Investment performance is not monitored for certain assets primarily consisting of 58
Three Months Ended
June 30,
operating cash and special regulatory deposits. The following is a summary of the investment portfolio returns for the asset/liability portfolios and risk asset portfolios:
(Unaudited)
2008 (1)
2007 (1) Asset/Liability portfolios USD fixed income portfolio
(0.9
)%
(0.1
)% Non USD fixed income portfolio
(1.3
)%
(1.9
)% Risk Asset portfolios Alternative portfolio (2)
(0.8
)%
4.3
% Equity portfolio
(1.0
)%
6.6
% High-Yield fixed income portfolio
2.0
%
1.2
%
(1)
Portfolio returns are calculated by dividing the sum of net investment income or net income from investment affiliates, realized gains (losses) and unrealized gains (losses) by the average market value of each portfolio. Performance is measured
in either the underlying asset currency or the functional currency. (2) Performance on the alternative portfolio reflects the three months ended May 31, 2008 and May 31, 2007, respectively. Net Realized Gains and Losses and Other than Temporary Declines in the Value of Investments Net realized gains on investments in the second quarter of 2008 included net realized losses of $47.7 million related to the write-down of certain of the Companys fixed income, equity and other
investments where the Company determined that there was an other than temporary decline in the value of those investments as well as net realized gains of $49.7 million from sales of investments.
Included in the balances noted above are realized losses and impairments in Topical Assets totaling $20.9 million. Net realized gains on investments in the second quarter of 2007 included net realized losses of $4.8 million from sales of investments, net realized gains of $81.3 million from the sale of SCA
common shares, and net realized losses of $58.2 million related to the write-down of certain of the Companys fixed income and equity investments where the Company determined that there was an
other than temporary decline in the value of those investments. The Companys process for identifying declines in the fair value of investments that are other than temporary involves consideration of several factors. These primary 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 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; (v) expected future interest rate movements; and (vi) the Companys intent and ability
to hold the investment for a sufficient period of time for the value to recover. Where the Companys analysis of the above factors results in the Companys 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. Net realized and unrealized gains on investment derivatives for the three month periods ended June 30, 2008 and 2007, resulted from the Companys investment strategy to manage interest rate
risk, foreign exchange risk, and credit risk and to replicate permitted investments. 59
Three Months Ended
June 30,
Other Revenues and Expenses The following table sets forth other revenues and expenses for the three months ended June 30, 2008 and 2007: (U.S. dollars in thousands)
(Unaudited)
% Change
2008
2007 Net (loss) income from operating affiliates (1)
$
(68,901
)
$
41,639
NM
* Amortization of intangible assets
420
420
0.0
% Corporate operating expenses
47,104
55,524
(15.2
)% Interest expense (2)
50,077
59,416
(15.7
)% Income tax expense
51,205
61,288
(16.5
)%
(1)
The Company records the income related to its operating affiliates on a three month lag in order for the Company to meet the accelerated filing deadlines. (2) Interest expense does not include interest expense related to structured products as reported within the Insurance and Reinsurance segments. * NM Not meaningful The following table sets forth the net income (loss) from operating affiliates for the three months ended June 30, 2008 and 2007: (U.S. dollars in thousands)
(Unaudited)
% Change
2008
2007 Net (loss) from financial operating affiliates
$
(81,677
)
$
(6,589
)
NM
* Net income from investment manager affiliates
1,741
43,889
(96.0
)% Net income from other strategic operating affiliates
11,035
4,339
154.3
% Total
$
(68,901
)
$
41,639
NM*
*
NM Not meaningful
In the three months ended June 30, 2008, the net loss from financial operating affiliates was primarily as a result of $82.4 million of additional losses related to the reinsurance and guarantee
agreements with SCA. These charges were partially offset by net income associated with other financial operating affiliates. At December 31, 2007, the Company wrote down its investment in both
SCA and Primus to zero. No equity earnings have been recorded in the second quarter of 2008 relating to the common equity interests in either SCA or Primus as a result of losses recorded by both
companies in the first quarter of 2008, which maintained both SCA and Primus negative book value. In the second quarter of 2007, the net loss from financial operating affiliates was mainly due to a
loss relating to Primus of $8.7 million relating to the widening of credit spreads throughout the first quarter of 2007. Further details on SCA related losses are included above in Results of
Operations. In addition, see Notes 4 and 12 to the Consolidated Financial Statements, Security Capital Assurance Ltd and Subsequent Events, respectively, for further information. Investment manager affiliate income decreased by $42.1 million or 96.0% during the second quarter of 2008 as compared to the same period in the prior year primarily as a result of recent
volatility in both the credit and equity markets, impacting most significantly, investment manager affiliates specializing in global equities as well as fixed income securities. Income from other strategic operating affiliates increased in the second quarter of 2008 as compared to the second quarter of 2007 mainly due to strong earnings reported in the second quarter of
2008 relating to an insurance affiliate which writes largely direct U.S. homeowners insurance and the Companys Brazilian joint venture ITAU XL Seguros Corporativos S.A. Corporate operating expenses in the three months ended June 30, 2008 decreased compared to the three months ended June 30, 2007 primarily as a result of lower compensation expenses as a 60
Three Months Ended
June 30,
Three Months Ended
June 30,
result of performance based accruals recorded in the second quarter of 2007, partially offset by an increase in professional fees associated with ongoing capital and restructuring activities. Interest expense for the three months ended June 30, 2008 as compared to the same period in 2007 was lower as a result of costs recorded in the second quarter of 2007 associated with the
retirement of the 2009 Senior Notes, combined with accretion charges recorded in the same period relating to the purchase contracts on the 6.5% Units. For more information on the Companys
financial structure, see Liquidity and Capital Resources. The decrease in the Companys income taxes arose principally from the decrease in the profitability of the Companys U.S. and European operations. Segment Results for the six months ended June 30, 2008 compared to the six months ended Insurance The following table summarizes the underwriting results for this segment: (U.S. dollars in thousands)
(Unaudited)
% Change
2008
2007 Gross premiums written
$
3,017,120
$
2,997,274
0.7
% Net premiums written
2,268,672
2,350,757
(3.5
)% Net premiums earned
2,026,752
2,104,050
(3.7
)% Fee income and other
19,653
7,285
169.8
% Net losses and loss expenses
1,338,634
1,306,687
2.4
% Acquisition costs
239,713
256,154
(6.4
)% Operating expenses.
353,587
329,437
7.3
% Underwriting profit.
$
114,471
$
219,057
(47.7
)% Exchange losses
$
59,202
$
15,152
NM
* Net resultsstructured products
$
3,173
$
1,794
76.9
%
*
NM not meaningful
Gross premiums written increased slightly by 0.7% during the six months ended June 30, 2008 compared with the six months ended June 30, 2007, primarily as a result of higher levels of long-
term agreements and favorable foreign exchange rate movements of $108.7 million. Partially offsetting these increases were continued decreases in premium rates as market conditions continued to
soften, selective non-renewals in certain property and marine lines of business and the impact of the runoff of certain property catastrophe program exposures. To date the Company has seen some
lost renewals from recent rating agency actions, largely limited to U.S. professional lines as noted above. Net premiums written decreased by 3.5% during the first six months of 2008 as compared to
same period in 2007 primarily as a result of an increase in ceded premiums written related to a change in the mix of business including an increase in long-term agreements with higher cession ratios
as well as the impact from the purchase of an adverse development cover associated with a Company owned Lloyds syndicate. Fee income increased in the first six months of 2008 as compared to the same period in 2007 mainly as a result of higher engineering fee revenue associated with XL GAPS, which formed in late
2007 following the acquisition of GAPS, a loss prevention consulting service provider. Net premiums earned decreased by 3.7% in the six months ended June 30, 2008 compared with the six months ended June 30, 2007. The decrease primarily resulted from the factors affecting net
premiums written noted above. 61
June 30, 2007
Six Months Ended
June 30,
The following table presents the ratios for this segment:
(Unaudited)
2008
2007 Loss and loss expense ratio.
66.0
%
62.1
% Underwriting expense ratio.
29.2
%
27.9
% Combined ratio
95.2
%
90.0
% The loss and loss expense ratio includes net losses incurred for both the current year and any favorable or adverse prior year development of loss and loss expense reserves held at the beginning
of the year. The following table summarizes the net (favorable) adverse prior year development relating to the Insurance segment for the six month periods ended June 30, 2008 and 2007:
(Unaudited)
2008
2007 Property
$
(64.4
)
$
(44.5
) Casualty and Professional
(62.0
)
(42.8
) Specialty and Other
9.4
23.4 Total
$
(117.0
)
$
(63.9
) Loss and loss expense ratio excluding prior year development.
71.8
%
65.1
% Net prior year releases in the six months ended June 30, 2008, totaled $117.0 million and were due primarily to favorable reserve development in global property lines of business as a result of
favorable claim development as well as reserve releases in certain casualty lines primarily in 2004 to 2006 years due to lower than expected reported loss activity. Offsetting this favorable development
was reserve strengthening within specialty lines of marine and environmental most notably in the 2007 year. Within professional lines, gross reserve releases were offset by reductions in ceded reserves
for a net strengthening of $2.7 million. In the same period in 2007, favorable loss development totaled $63.9 million comprised of favorable development in certain property and casualty lines of
business, partially offset by adverse prior period reserve development in certain specialty lines, particularly the run-off of the surety portfolio. Excluding prior year development, the loss ratio for the six months ended June 30, 2008 increased by 6.7 loss percentage points as compared to the same period in 2007 with 3.1 points of the loss
ratio increase attributable to a higher level of catastrophe losses in the current year. The remainder of the increase in loss ratio was attributable to the softening rate environment impacting most lines
of business and an increase in loss activity anticipated for professional lines related to sub-prime and related credit events. Gross prior year favorable development for the six months ended June 30, 2008 of $427.4 million exceeded the corresponding net favorable development during the same period of $117.0 million,
as the impact of reductions in gross reported losses on older years in certain casualty lines was mostly offset by the impact of the reinsurance recoverable component on such losses. In addition, the
impact of gross reserve releases in professional and specialty lines was mostly offset by the impact of a reduction in estimated ceded IBNR following a reserve review in these lines. The increase in the underwriting expense ratio in the six months ended June 30, 2008, compared to the same period in 2007 was due to an increase in the operating expense ratio of 1.7 points
(17.4% as compared to 15.7%) and partially offset by a decrease in the acquisition expense ratio of 0.4 points (11.8% as compared to 12.2%). The increase in the operating expense ratio was mainly
as a result of a higher headcount which increased compensation, increases in professional fees and the impact of unfavorable foreign exchange rate movements, against lower net premiums earned.
The increase in headcount and professional fees both supported new segment initiatives, including an operational transformation program as well as the formation of XL GAPS in late 2007, while 62
Six Months Ended
June 30,
Six Months Ended
June 30,
unfavorable foreign exchange rate movements resulted from the continued weakening of the U.S. dollar against certain European currencies. The acquisition expense ratio decreased mainly due to a
reduction in foreign excise taxes as a result of a decrease in the cession percentage of an internal quota share from 75% to 50%, lower guarantee fund assessments and the impact of the run-off of
certain programs, including ICAT, which carried higher acquisition costs. Foreign exchange losses in the six months ended June 30, 2008 and 2007 were due primarily to the change in the value of the U.S. dollar against certain European currencies including the Swiss
Franc and Swedish Krona on certain inter-company balances. Net results from structured insurance products include certain structured indemnity contracts that are accounted for as deposit contracts. Results from these contracts for the six months ended
June 30, 2008, have increased compared to the same period in 2007 mainly due to a negotiated cancellation of a contract in the first six months of 2008 that resulted in a gain of $10.9 million
combined with an accretion adjustment recorded in 2007 based on changes in expected cash flows of a structured insurance contract. Reinsurance The following table summarizes the underwriting results for this segment: (U.S. dollars in thousands)
(Unaudited)
% Change
2008
2007 Gross premiums written
$
1,470,005
$
1,901,204
(22.7
)% Net premiums written
1,227,348
1,551,783
(20.9
)% Net premiums earned
1,034,815
1,144,770
(9.6
)% Fee income and other
1,234
489
152.4
% Net losses and loss expenses
600,844
628,621
(4.4
)% Acquisition costs
222,872
251,184
(11.3
)% Operating expenses
90,517
92,070
(1.7
)% Underwriting profit
$
121,816
$
173,384
(29.7
)% Exchange losses
$
17,481
$
32,953
(47.0
)% Net results structured products
$
13,403
$
15,410
(13.0
)% Gross and net premiums written decreased by 22.7% and 20.9%, respectively, in the first six months of 2008 as compared to the first six months of 2007. These decreases resulted from the
Company declining business due to competitive pressures continuing to drive certain rates below the Companys acceptable underwriting return levels together with increased client retentions. For the
six months ended June 30, 2008, premium rate decreases were most significant in certain casualty and non-U.S. property lines of business. Partially offsetting these decreases in gross premiums written
were favorable foreign exchange rate movements of $56.7 million. The decrease in net premiums written reflects the above changes in gross premiums written, combined with a reduction in ceded
premiums in the first six months of 2008 as compared to the same period in 2007. Ceded premiums written decreased as a result of a reduction in property catastrophe cessions to Cyrus Re II of
10% in 2008 as compared to a 35% cession to Cyrus Re throughout 2007, partially offset by ceded premiums totaling $23.3 million associated with the purchase of additional catastrophe loss
protection including industry loss warranty covers in the first six months of 2008. Net premiums earned in the first six months of 2008 decreased 9.6% as compared to the same period in of 2007. This decrease was a reflection of the overall reduction of net premiums written
over the last 24 months. 63
Six Months Ended
June 30,
The following table presents the ratios for this segment:
(Unaudited)
2008
2007 Loss and loss expense ratio
58.1
%
54.9
% Underwriting expense ratio.
30.2
%
29.9
% Combined ratio
88.3
%
84.8
% The loss and loss expense ratio includes net losses incurred for both the current year and any favorable or adverse prior year development of loss reserves held at the beginning of the year. The
following table summarizes the net (favorable) adverse prior year development relating to the Reinsurance segment for the six month periods ended June 30, 2008 and 2007: (U.S. dollars in millions)
(Unaudited)
2008
2007 Property and other short-tail lines.
$
(71.6
)
$
(95.2
) Casualty and other
(59.5
)
(38.8
) Structured Indemnity
(1.4
)
9.1 Total
$
(132.5
)
$
(124.9
) Loss and loss expense ratio excluding prior year development
70.9
%
65.8
% For the six months ended June 30, 2008, casualty and other lines reserve releases included favorable development in both European and U.S. casualty and professional portfolios. In the same
period, property and other short-tail lines reserve releases were attributable to most business units globally, with minor adverse reserve development in Latin America operations. In the same period
in 2007, property and other short-tail lines reserve releases were seen largely in property risk and property catastrophe portfolios while casualty releases related to both U.S. and non-U.S. source
exposures. Excluding prior year development, the loss ratio for the six months ended June 30, 2008 increased by 5.1 loss percentage points as compared to the same period in 2007 with 1.1 points
attributable to an increase in catastrophe losses occurring during the first six months of 2008 (7.7 points in 2008 versus 6.6 points in 2007) inclusive of the impact on structured products transactions
during 2008. The remaining increase of 4.0 loss ratio points was attributable to the softening rate environment and higher anticipated loss activity in the professional and trade credit portfolios. Gross prior year favorable development for the six months ended June 30, 2008 of $252.5 million exceeded the corresponding net favorable development during the same period of $132.5 million
as the impact of favorable loss experience related to a large crop program was mostly offset by the impact of retrocessional protection related to this program. The increase in the underwriting expense ratio in the six months ended June 30, 2008, as compared with the six months ended June 30, 2007, was due to an increase in the operating expense
ratio of 0.7 points (8.7% compared to 8.0%), partially offset by a decrease in the acquisition expense ratio of 0.4 points (21.5% compared to 21.9%). The decrease in the acquisition expense ratio was
primarily due to an unfavorable adjustment recorded in the first six months of 2007 related to the earning of acquisition expenses within the individual risk portfolio in the U.S and partially offset by
a favorable variance in the first six months of 2008 in relation to profit commissions. Although operating expenses are lower in the first six months of 2008 as compared to the same period in 2007
mainly due to lower compensation costs and corporate allocations, the lower level of net premiums earned as noted above has caused an increase in the operating expense ratio. Foreign exchange losses in the six months ended June 30, 2008 and 2007 were due primarily to the change in the value of the U.S. dollar against certain European currencies including the U.K.
Sterling and Euro on certain inter-company balances. 64
Six Months Ended
June 30,
Six Months Ended
June 30,
Net results from structured reinsurance products include certain structured indemnity contracts that are accounted for as deposit contracts. Results from these products for the six months ended
June 30, 2008, decreased compared to the same period in 2007 mainly due to the impact on net investment income of lower yields earned on invested assets. Life Operations The following summarizes the contribution from this segment: (U.S. dollars in thousands)
(Unaudited)
% Change
2008
2007 Gross premiums written
$
396,209
$
448,236
(11.6
)% Net premiums written
375,146
427,425
(12.2
)% Net premiums earned
332,517
386,847
(14.0
)% Fee income and other
200
149
34.2
% Claims and policy benefits
406,024
467,443
(13.1
)% Acquisition costs
49,949
43,882
13.8
% Operating expenses
17,382
18,672
(6.9
)% Exchange (gains)
(1,002
)
(1,975
)
(49.3
)% Net investment income
195,193
188,783
3.4
% Contribution from Life operations
$
55,557
$
47,757
16.3
% The following table is an analysis of the Life Operations gross premiums written, net premiums written and net premiums earned for the six month periods ended June 30, 2008 and 2007: (U.S. dollars in millions)
(Unaudited)
(Unaudited)
Gross
Net Premiums
Net Premiums
Gross
Net Premiums
Net Premiums Other Life
$
292,478
$
290,438
$
247,809
$
248,970
$
246,943
$
206,365 Annuity
103,731
84,708
84,708
199,266
180,482
180,482 Total
$
396,209
$
375,146
$
332,517
$
448,236
$
427,425
$
386,847 Gross premiums written relating to other life business increased by $43.5 million in the six months ended June 30, 2008 as compared to the same period in 2007 mainly due to premium growth in
the core underlying book of term assurance and critical illness business of $30.4 million, premium growth in U.S. business of $11.6 million and favorable foreign exchange rate movements of $2.5
million. In addition, gross premiums written related to short-term life, accident and health business increased by $7.6 million primarily as a result of favorable foreign exchange rate movements and
partially offset by decreases in gross premiums written associated with soft market conditions experienced in the first six months of 2008. Partially offsetting these increases in gross premiums written
was a decrease related to European long-term life business from a single premium contract totaling $8.6 million written in the first six months of 2007. Gross premiums written relating to annuity
business decreased by $95.5 million in the six months ended June 30, 2008 as compared to the same period in 2007 mainly due to a single Irish immediate annuity contract totaling $94.6 million
written during the first six months of 2007 and unfavorable foreign exchange rate movements of $0.9 million. Ceded premiums written were roughly consistent with the prior year. Net premiums earned in the first six months of 2008 decreased 14.0% as compared to the same period in 2007. This decrease was consistent with the increase in gross and net premiums written
as described above. Changes in claims and policy benefits include the movement in policy benefit reserves related to other contracts (such as immediate annuities) where investment assets were acquired with the
assumption of the policy benefit reserves at the inception of the contract. Claims and policy benefit reserves decreased by $61.4 million or 13.1% in the six months ended June 30, 2008 as compared
to 65
Six Months Ended
June 30,
Six Months Ended
June 30, 2008
Six Months Ended
June 30, 2007
Premiums
Written
Written
Earned
Premiums
Written
Written
Earned
the six months ended June 30, 2007, primarily as a result of the factors noted above affecting gross and net premiums written, partially offset by higher incurred losses of $8.6 million associated with
certain short-term life, accident and health business. For the six months ended June 30, 2008, acquisition costs increased by 13.8% as compared to the same period in 2007, largely as a result of an increase in business written and foreign exchange
rate movements in the first six months of 2008, as noted above. Partially offsetting these increases was a favorable profit commission adjustment relating to a short-term life, accident and health treaty
recorded in the first six months of 2008. Operating expenses decreased by 6.9% in the first six months of 2008 as compared to the same period in the prior year mainly due to professional fees and
compensation expenses recorded in 2007 relating to the discontinuance of the Life Fund Integration strategy combined with lower corporate allocations in the first six months of 2008. Partially
offsetting these decreases were unfavorable foreign exchange rate movements of $0.5 million and an increase in compensation costs in the first six months of 2008 associated with a higher headcount
and consistent with growth in certain business lines noted above. Net investment income is included in the calculation of contribution from Life Operations, as it relates to income earned on portfolios of separately identified and managed life investment assets
and other allocated assets. Net investment income increased by $6.4 million or 3.4% in the six months ended June 30, 2008, as compared to the same period in 2007, primarily as a result of favorable
foreign exchange rate movements of $5.8 million. However, it should be noted that as at June 30, 2008, approximately $760 million of the gross unrealized losses on the Companys investments
related to portfolios of Life Operations investment assets primarily as a result of increases in both interest rates and credit spreads during this period, primarily in the U.K. and Euro-zone, and the
long duration of the underlying assets. However, as the duration and characteristics of these investments are structured to support the expected future cash outflows and long-term nature of the
associated policy benefit reserves, the Company expects minimal turnover in such assets, and accordingly considers these impairments temporary. Refer to Balance Sheet Analysis below for further
discussion of unrealized losses and gains on investments. Other Financial Lines For the six month period ended June 30, 2008, the net results from these structured products were $13.9 million and included net investment income, interest expense and operating expenses of
$79.0 million, $58.8 million, and $6.3 million, respectively, while the results for the same period in 2007 were $16.0 million and included net investment income, interest expense and operating
expenses of $182.5 million, $160.4 million, and $6.1 million, respectively. For the six months ended June 30, 2008, net investment income and interest expense both decreased primarily as a result of a
decrease in the average deposit liability balance and the associated asset portfolios as a result of the settlement of the GIC portfolio noted above. However, operating expenses increased by $0.2
million primarily due to the write-off in the first six months of 2008 of deferred acquisition expenses in relation to the settlement of certain GICs noted above and partially offset by a reduction in
compensation expense associated with a reduction in headcount. While not reported within the contribution from the Other Financial Lines segment, approximately $64.2 million of the reported
realized losses on investments during the first six months of 2008 related to portfolios associated with GICs and funding agreements. SCA As noted above, for further information on SCA, see Results of Operations and Other Revenues and Expenses within Managements Discussion and Analysis of Financial Condition and
Results of Operations. In addition, see Notes 4 and 12 to the Consolidated Financial Statements, Security Capital Assurance Ltd and Subsequent Events, respectively, for further information. Investment Activities The following table illustrates the change in net investment income from property and casualty operations, net income from investment affiliates, net realized gains on investments and net
realized 66
and unrealized gains on investment and other derivative instruments from property and casualty operations for the six months ended June 30, 2008 and 2007: (U.S. dollars in thousands)
(Unaudited)
% Change
2008
2007 Net investment income property and casualty operations (1)
$
606,169
$
637,178
(4.9
)% Net (loss) income from investment affiliates (2)
(8,636
)
185,979
NM
* Net realized (losses) gains on investments
(100,211
)
27,588
NM
* Net realized and unrealized gains on investment and other derivative instruments
52,806
16,929
211.9
%
(1)
Net investment income relating to property and casualty operations does not include the net investment income related to the net results from structured products. (2) The Company records the income related to alternative fund affiliates on a one month lag and the private investment affiliates on a three month lag in order for the Company to meet the accelerated filing deadlines. * NM Not meaningful Net investment income related to property and casualty operations decreased in the six months ended June 30, 2008 as compared to the same period in 2007 due primarily to declining portfolio
yields. Portfolio yields decreased as yields earned on investment of cash flows and reinvestment of maturing or sold securities were generally lower than on securities previously held, as prevailing
market interest rates, particularly in the U.S., decreased over the last year. As well, the portfolio mix changed as a result of the settlement of the GIC liabilities, as the property and casualty
operations assumed a number of the floating rate securities previously held in the Companys Other Financial Lines segment. Net income from investment fund affiliates decreased in the first six months of 2008 compared to the first six months of 2007, due primarily to the results from the Companys alternative funds,
which were marginally negative in the first six months of 2008 as compared to strong positive results in the same period of the prior year. These results reflect negative returns in the Companys
alternative portfolio as the markets during the first six months of 2008 were particularly challenging for strategies employed by the Companys alternative investment managers given the extreme
volatility and overall pull back of credit availability. Net income from investment affiliates in the first six months of 2007 was due primarily to very strong performance in alternative fund affiliates. 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. 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 the asset/liability portfolios and risk asset portfolios:
(Unaudited)
2008(1)
2007(1) Asset/Liability portfolios USD fixed income portfolio
(3.5
)%
1.2
% Non USD fixed income portfolio
(3.0
)%
(1.9
)% Risk Asset portfolios Alternative portfolio (2)
(0.1
)%
10.0
% Equity portfolio
(11.2
)%
9.7
% High-Yield fixed income portfolio
(3.6
)%
3.2
%
(1)
Portfolio returns are calculated by dividing the sum of net investment income or net income from investment affiliates, realized gains (losses) and unrealized gains (losses) by the average market value of each portfolio. Performance is measured
in either the underlying asset currency or the functional currency. (2) Performance on the alternative portfolio reflects the six months ended May 31, 2008 and May 31, 2007, respectively. 67
Six Months Ended
June 30,
Six Months Ended
June 30,
Net Realized Gains and Losses and Other than Temporary Declines in the Value of Investments Net realized losses on investments in the first six months of 2008 included net realized losses of $162.4 million related to the write-down of certain of the Companys fixed income, equity and
other investments where the Company determined that there was an other than temporary decline in the value of those investments as well as net realized gains of $62.2 million from sales of
investments. Included in the balances noted above are realized losses and impairments in Topical Assets totaling $74.7 million. Net realized gains on investments in the first six months of 2007 included net realized gains of $30.1 million from sales of investments, net realized gains of $81.3 million from the sale of SCA,
and net realized losses of $83.8 million related to the write-down of certain of the Companys fixed income and equity investments where the Company determined that there was an other than
temporary decline in the value of those investments. Net realized and unrealized gains on investment derivatives for the six months ended June 30, 2008 and 2007 resulted from the Companys investment strategy to manage interest rate risk,
foreign exchange risk, credit risk and to replicate permitted investments. Other Revenues and Expenses The following table sets forth other revenues and expenses for the six months ended June 30, 2008 and 2007: (U.S. dollars in thousands)
% Change
(Unaudited) Six Months
Ended June 30,
2008
2007 Net (loss) income from operating affiliates (1)
$
(48,348
)
$
98,721
NM
* Amortization of intangible assets
840
840
0.0
% Corporate operating expenses
83,030
88,003
(5.7
)% Interest expense (2)
99,442
110,030
(9.6
)% Income tax expense
81,907
134,043
(38.9
)%
(1)
The Company records the income related to its operating affiliates on a three month lag in order for the Company to meet the accelerated filing deadlines. (2) Interest expense does not include interest expense related structured products as reported within the Insurance and Reinsurance segments. * NM Not meaningful The following table sets forth the net (loss) income from operating affiliates for the six months ended June 30, 2008 and 2007: (U.S. dollars in thousands)
(Unaudited)
% Change
2008
2007 Net (loss) income from financial operating affiliates
$
(85,948
)
$
5,300
NM
* Net income from investment manager affiliates
14,620
81,315
(82.0
)% Net income from other strategic operating affiliates
22,980
12,106
89.8
% Total
$
(48,348
)
$
98,721
NM
*
*
NM Not meaningful
In the six months ended June 30, 2008, the net loss from financial operating affiliates was primarily as a result of $87.2 million of additional losses related to the reinsurance and guarantee
agreements with SCA. These charges were partially offset by net income associated with other financial operating affiliates. As noted above, at December 31, 2007, the Company wrote down its 68
Six Months Ended
June 30,
investment in both SCA and Primus to zero. No equity earnings have been recorded in the first six months of 2008 relating to the common equity interests in either SCA or Primus as a result of
both companies reported results throughout 2008. With regards to SCA, further details are included above in Results of Operations. In addition, see Notes 4 and 12 to the Consolidated Financial
Statements, Security Capital Assurance Ltd and Subsequent Events, respectively, for further information. Investment manager affiliate income decreased by $66.7 million or 82.0% during the first six months of 2008 as compared to the same period in the prior year primarily as a result of recent
volatility in both the credit and equity markets, impacting most significantly, investment manager affiliates specializing in global equities as well as fixed income securities. Income from other strategic operating affiliates increased in the first six months of 2008 as compared to the same period in 2007 mainly due to strong earnings reported in the first six months of
2008 relating to an insurance affiliate which writes largely direct U.S. homeowners insurance and the Companys Brazilian joint venture ITAU XL Seguros Corporativos S.A. Corporate operating expenses in the six months ended June 30, 2008 decreased compared to the six months ended June 30, 2007 primarily as a result of lower compensation expenses as a result
of performance based accruals recorded in the first six months of 2007, partially offset by higher professional fees in 2008 associated with ongoing capital and restructuring activities. Interest expense for the six months ended June 30, 2008 as compared to the same period in 2007 was lower as a result of costs recorded in the first six months of 2007 associated with the
retirement of the 2009 Senior Notes, combined with accretion charges recorded in the same period relating to the purchase contracts on the 6.5% Units. For more information on the Companys
financial structure, see Liquidity and Capital Resources. The decrease in the Companys income taxes arose principally from the decrease in the profitability of the Companys U.S. and European operations. Balance Sheet Analysis Investments 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. The Companys overall investment portfolio is structured to take
into account a number of variables including local regulatory requirements, business needs, collateral management and risk tolerance. 69
At June 30, 2008 and December 31, 2007, total investments, cash and cash equivalents, accrued investment income and net payable for investments purchased were $37.9 billion and $43.7 billion,
respectively. The following table summarizes the composition of the Companys total investments and cash and cash equivalents: (U.S. dollars in thousands)
(Unaudited)
Percent of
Fair Value
Percent of Cash and cash equivalents
$
3,704,249
9.8
%
$
3,880,030
8.9
% Net payable for investments purchased
(304,282
)
(0.8
)%
(191,472
)
(0.4
)% Accrued investment income
411,230
1.1
%
447,660
1.0
% Short-term investments
1,340,940
3.5
%
1,803,198
4.1
% Fixed maturities: U.S. Government and Government agency
$
2,252,686
6.0
%
$
2,685,773
6.1
% Corporate
11,676,123
30.8
%
12,987,248
29.7
% Mortgage and asset-backed securities
10,889,571
28.8
%
14,493,877
33.1
% U.S. States and political subdivisions of the States
462,999
1.2
%
253,534
0.6
% Non-U.S. Sovereign Government
3,839,309
10.1
%
3,187,358
7.3
% Total fixed maturities
$
29,120,688
76.9
%
$
33,607,790
76.8
% Equity securities
581,092
1.5
%
854,815
2.0
% Investments in affiliates
2,401,799
6.3
%
2,611,149
6.0
% Other investments
632,015
1.7
%
708,476
1.6
% Total investments and cash and cash equivalents
$
37,887,731
100.0
%
$
43,721,646
100.0
% The Company reviews on a regular basis its corporate debt concentration, credit quality and compliance with established guidelines. At June 30, 2008 and December 31, 2007, the average credit
quality of the Companys total fixed income portfolio was AA. As at June 30, 2008, approximately 48.5% of the fixed income portfolio was rated AAA by one or more of the principal ratings
agencies. Approximately 3.0% was below investment grade or not rated. Net Unrealized Gains and Losses on Investments At June 30, 2008, the Company had net unrealized losses on fixed maturities and short-term investments of $2,360.9 million and net unrealized gains on equities of $93.9 million. Of these
amounts, gross unrealized losses on fixed maturities and short term investments and equities were $2,581.9 million and $29.1 million, respectively. The information presented below for the gross
unrealized losses on the Companys investments at June 30, 2008, shows 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. The increase in net unrealized losses on investments during the six months ended June 30, 2008 was primarily due to a
widening of credit spreads as well as increasing government interest rates. 70
Fair Value at
June 30,
2008
Total
at December 31,
2007
Total
The following is an analysis of how long each of those securities with an unrealized loss at June 30, 2008 had been in a continual unrealized loss position:
(U.S. dollars in thousands)
Type of Securities
Length of time in a continual
(Unaudited)
(Unaudited)
Fixed Income and
Short-Term
Less than six months
$
390,200
$
9,652,697
At least 6 months but less than
12 months
439,090
3,509,459
At least 12 months but less than 2 years
1,509,602
7,754,189
2 years and over
242,984
1,670,135
Total
$
2,581,876
$
22,586,480
Equities
Less than six months
$
17,284
$
145,913
At least 6 months but less than
12 months
11,787
59,872
Total
$
29,071
$
205,785 The following is the maturity profile of the fixed income securities that were in a gross unrealized loss position at June 30, 2008: (U.S. dollars in thousands)
Maturity profile in years of fixed
(Unaudited)
(Unaudited) Less than 1 year remaining
$
29,004
$
667,910 At least 1 year but less than 5 years remaining
278,336
4,072,211 At least 5 years but less than 10 years remaining
361,077
4,349,254 At least 10 years but less than 20 years remaining
177,967
1,514,745 At least 20 years or more remaining
567,755
3,786,852 Mortgage and asset-backed securities
1,167,737
8,195,508 Total
$
2,581,876
$
22,586,480 Factors considered in determining that additional other-than-temporary impairment charges were not warranted include; managements consideration of current and near term liquidity needs and
other available sources, an evaluation of the factors and time necessary for recovery, and the results of on-going retrospective reviews of security sales and the basis for such sales.
(i)
Gross unrealized losses of $0.8 billion related to the Companys $6.9 billion Life Operations investment portfolio. Of this, $0.4 billion of gross unrealized losses have arisen on $2.5 billion of
exposures to corporate financials. At June 30, 2008, this portfolio had an average duration of 8.9 years, primarily denominated in U.K. Sterling and Euros. As a result of the long duration,
significant gross losses have arisen as the fair values of these securities are more sensitive to prevailing government interest rates and credit spreads. This portfolio has limited turnover as it is
matched to corresponding long duration liabilities. (ii) Gross unrealized losses of $0.4 billion related to the Companys $1.4 billion Topical Asset portfolio. The Company undertook a security level review of these securities and recognized charges to
the extent it believed the intrinsic value of the security was below the amortized cost. The Company recognized realized losses, consisting of charges for other-then-temporary impairments and
realized losses from sales of over $0.6 billion since the beginning of 2007. 71
unrealized loss position
Amount of
unrealized loss at
June 30, 2008
Fair Value of Securities in
an unrealized loss position
at June 30, 2008
income securities in a continual
unrealized loss position
Amount of
unrealized loss at
June 30, 2008
Fair value of securities in
an unrealized loss position
at June 30, 2008
(iii) Gross unrealized losses of $0.3 billion arose as a result of the Companys holdings of certain U.S. Dollar assets in a Euro functional currency. As a result, gross unrealized losses arose which
were offset through the Companys cumulative translation adjustment account, and accordingly had no impact on book value. (iv) The Company believes that the remaining balance of gross unrealized losses of $1.1 billion, which includes $0.4 billion on corporates of which $0.2 billion is in the financial sector, $0.3 billion on
the Companys Core CDO portfolio which primarily consist of CLOs, and $0.1 billion on CMBS holdings, was primarily a function of broad market interest rate increases and credit spread
widening during the first six months of 2008, and not reflective of any fundamental issue in ultimate recovery of these securities. Unpaid Losses and Loss Expenses The Company establishes reserves to provide for estimated claims, the general expenses of administering the claims adjustment process and for losses incurred but not reported. These reserves
are calculated using actuarial and other reserving techniques to project the estimated ultimate net liability for losses and loss expenses. The Companys reserving practices and the establishment of any
particular reserve reflects managements judgment concerning sound financial practice and do not represent any admission of liability with respect to any claims made against the Company. Unpaid losses and loss expenses totaled $23.0 billion at June 30, 2008, and $23.2 billion at December 31, 2007. The table below represents a reconciliation of the Companys unpaid losses and loss expenses for the six months ended June 30, 2008: (U.S. dollars in thousands)
(Unaudited)
(Unaudited)
(Unaudited) Balance as at December 31, 2007
$
23,207,694
$
(4,665,615
)
$
18,542,079 Losses and loss expenses incurred
2,012,522
(73,044
)
1,939,478 Losses and loss expenses paid/recovered
2,554,714
(705,095
)
1,849,619 Foreign exchange and other
290,409
(59,720
)
230,689 Incurred case losses and unwind of discount on reserves associated with reinsurance agreements with SCA
50,663
50,663 Paid losses on reserves associated with reinsurance agreements with SCA
51,101
51,101 Balance as at June 30, 2008
$
22,955,473
$
(4,093,284
)
$
18,862,189 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 Unpaid Losses and
Loss Expenses in Item 1, Critical Accounting Policies and Estimates in Item 7 and Item 8, Note 10 to the Consolidated Financial Statements, Losses and Loss Expenses, each in the Companys
Form 10-K for the year ended December 31, 2007 for further discussion. Unpaid Losses and Loss Expenses Recoverable and Reinsurance Balances Receivable As a significant portion of the Companys net premiums written incept in the first six months of the year, certain assets and liabilities have increased at June 30, 2008 compared to December 31,
2007. This includes deferred acquisition costs, unearned premiums, premiums receivable and prepaid reinsurance premiums. 72
Gross unpaid
losses and loss
expenses
Unpaid
losses and
loss expenses
recoverable
Net unpaid
losses
and loss
expenses
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 Companys 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 its insureds. Accordingly, the loss and loss expense reserves on the balance sheet represent the Companys total unpaid gross losses. Unpaid
losses and loss expenses recoverable relate to estimated reinsurance recoveries on the unpaid loss and loss expense reserves. At both June 30, 2008 and December 31, 2007, unpaid losses and loss expenses recoverables were $4.1 billion and $4.7 billion, respectively. The table below presents the Companys net paid and unpaid losses and loss expenses recoverable and reinsurance balances receivable at June 30, 2008 and December 31, 2007. (U.S. dollars in thousands)
(Unaudited)
December 31, Reinsurance balances receivable
$
785,554
$
872,465 Reinsurance recoverable on future policy benefits
35,717
31,856 Unpaid losses and loss expenses recoverable
4,177,455
4,804,209 Bad debt reserve on unpaid losses and loss expenses recoverable and reinsurance balances receivable
(151,907
)
(193,128
) Net paid and unpaid losses and loss expenses recoverable and reinsurance balances receivable
$
4,846,819
$
5,515,402 Fair Value Measurements of Assets and Liabilities As disclosed in Note 3 to the Consolidated Financial Statements, Fair Value Measurements, effective January 1, 2008, the Company adopted FAS 157 and has accordingly provided required
disclosures by level within the fair value hierarchy of the Companys assets and liabilities that are carried at fair value. As defined in the hierarchy, those assets and liabilities categorized as Level 3
have valuations determined using unobservable inputs. Unobservable inputs may include the entitys own assumptions about market participant assumptions, applied to a modeled valuation; however,
this is not the case with respect to the Companys Level 3 assets and liabilities. Fixed maturities and short term investments classified within Level 3 are made up of those securities where either
significant inputs were utilized in determining the value that were difficult to corroborate with observable market data, or sufficient information regarding the specific inputs utilized by a corroborating
value obtained from a broker was not obtained to support a Level 2 classification. At June 30, 2008, a significant component of Level 3 assets represents either Core CDOs, totaling $746.2 million, or
securities within the Companys topical portfolio, totaling $144.6 million. Certain asset classes, primarily consisting of privately placed investments, did not have sufficient market corroborated
information available to allow a price to be determined through a form of matrix or modeled pricing and accordingly the valuation was determined through the use of unobservable inputs
corroborated by reference to broker or underwriter bid indications. In periods of market dislocation, the observability of prices and inputs may be reduced for many instruments as is currently the
case for certain U.S. CMOs, ABSs, CMBSs, collateralized debt obligations (CDOs), and other Topical Assets which include certain securities with underlying sub-prime and related residential
mortgage exposures (such as sub-prime first liens and Alt-A asset backed securities) for which sufficient information, such as cash flows or other security structure or market information, was not
available to enable a price to be determined using a matrix or other model based approach and as such, a valuation was determined using either significant inputs that were difficult to corroborate
with observable market data or sufficient information regarding the specific inputs utilized in a corroborating value obtained from a broker was not obtained to support a Level 2 classification.
However, increased market illiquidity in the first six months of 2008 did not result in the reclassification of securities into Level 3 due to unavailable Level 2 pricing. While the remainder 73
June 30,
2008
2007
of the Companys holdings in securities exposed to sub-prime mortgages are generally not based on quoted prices for identical securities, they are based on model-derived valuations in which all
significant inputs and significant value drivers are considered to be observable in active markets, and these securities continue to be classified within Level 2. While a number of the Level 3 investments have been written down as a result of the Companys impairment analysis, the Company continues to report, at June 30, 2008, gross unrealized losses
at June 30, 2008 of $344.8 million related to Level 3 available-for-sale investments. Management completed a detailed review of the Companys underlying sub-prime and related residential mortgage
exposures, as well as a consideration of the broader structured credit market, and concluded that the unrealized gains and losses in these asset classes are the result of a decrease in value due to
technical spreads widening and broader market sentiment, rather than fundamental collateral deterioration and are temporary in nature. The remainder of the Level 3 assets relate to private equity investments where the nature of the underlying assets held by the investee include positions such as private business ventures and are
such that significant Level 3 inputs are utilized in the valuation, and certain derivative positions. Controls over Valuation of Financial Instruments The Company performs quarterly reviews of the prices determined through the use of matrix or other model derived prices to assess if the prices represent a reasonable estimate of the fair value.
This process is completed by investment and accounting personnel who are independent of those responsible for providing the valuations. The approaches taken to gain comfort include, but are not
limited to, valuation comparisons between external sources, and completing recurring reviews of the pricing methodologies utilized. As a result of this analysis, if the Company determines there is a
more appropriate fair value based upon available market data, the price originally determined may be substituted for another, or in limited circumstances management may determine that an
adjustment is required. Valuation Methodology of Level 3 Assets and Liabilities Refer to Notes 2 and 3 of the Consolidated Financial Statements, Significant Accounting Policies and Fair Value Measurements for a description of the valuation methodology utilized to
value Level 3 assets and liabilities, how the valuation methodology is validated as well as further details associated with various assets classified as Level 3. As at June 30, 2008, the Company did not
have any liabilities that were carried at fair value based on Level 3 inputs other than derivative instruments in a liability position at June 30, 2008. 74
Fair Value of Level 3 Assets and Liabilities At June 30, 2008, the fair value of Level 3 assets and liabilities as a percentage of the Companys total assets and liabilities that are carried at fair value was as follows:
(U.S. dollars in thousands)
Total Assets and
Fair Value of
Level 3 Assets Assets Fixed maturities, at fair value
$
29,120,688
$
1,527,740
5.2
% Equity securities, at fair value
581,092
0.0
% Short term investments, at fair value
1,340,940
8,443
0.6
% Total investments available for sale
$
31,042,720
$
1,536,183
4.9
% Cash equivalents (1)
2,492,561
0.0
% Other investments (2)
533,080
61,593
11.6
% Other assets (3) (4)
174,278
134,444
77.1
% Total assets carried at fair value
$
34,242,639
$
1,732,220
5.1
% Liabilities Financial instruments sold, but not yet purchased (5)
$
44,497
$
0.0
% Other liabilities (4) (6)
34,288
79,093
230.7
% Total liabilities carried at fair value
$
78,785
$
79,093
100.4
%
(1)
Cash equivalents balances subject to fair value measurements include certificates of deposit and money market funds. (2) The other investments balance excludes certain unrated tranches of collateralized loan obligations which are carried under the cost recovery method given the uncertainty of future cash flows, as well as certain investments in project finance
transactions which are carried at amortized cost. See Note 2 of the Consolidated Financial Statements for further details. (3) Other assets include derivative instruments. (4) The derivative balances included above are reported on a gross basis. (5) Financial instruments sold, but not yet purchased are included within Net payable for investments purchased on the balance sheet. (6) Other liabilities include derivative instruments. As at June 30, 2008, the balance of Level 3 assets as a percentage of the Companys total assets that were carried at fair value was 5.1%. The comparable percentage at December 31, 2007 was
3.7%. The increase was primarily as a result of change in the mix of assets in the first six months of 2008 due to the sale of investments associated with the settlement of the GIC portfolio in the first
six months of 2008. During the six months ended June 30, 2008, there were no material changes in Level 3 assets as a result of inputs the Company no longer considers observable or valid. The
increase in the percentage of total invested assets that is made up of assets which are experiencing increased market illiquidity does reduce the overall liquidity of the Companys capital resources;
however, management do not believe that this change is significant given the many other sources of liquid assets available. Level 3 liabilities at June 30, 2008 represent derivative instruments in a
liability position. For further discussion of the Companys liquidity and available capital resources see Liquidity and Capital Resources, below. Changes in the Fair Value of Level 3 Assets and Liabilities See Note 3 of the Consolidated Financial Statements, Fair Value Measurements, for an analysis of the change in fair value of Level 3 Assets and Liabilities. Based on the changes in the fair value of Level 3 assets and liabilities during the six months ended June 30, 2008, the Company does not expect any significant impact on the Companys results
of operations or liquidity. 75
(Unaudited)
Liabilities Carried
at Fair Value at
June 30, 2008
Level 3 Assets
and Liabilities
and Liabilities as
a Percentage of
Total Assets and
Liabilities
Carried at Fair
Value, by class
Liquidity and Capital Resources As a holding company, the Companys assets consist primarily of its investments in subsidiaries, and the Companys future cash flows depend on 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 the Company operates in including, among
others, Bermuda, the United States, Ireland, Switzerland and the United Kingdom, and those of the Society of Lloyds and certain contractual provisions. No assurance can be given that the Company
or its subsidiaries will be permitted to pay dividends in the future. The Company and its subsidiaries provide no guarantees or other commitments (express or implied) of financial support to the Companys subsidiaries or affiliates, except for where such
guarantees are in writing. Liquidity Liquidity is a measure of the Companys ability to generate sufficient cash flows to meet the short and long term cash requirements of the Companys business operations. The Companys operating subsidiaries provide liquidity in that premiums are generally received months or even years before losses are paid under the policies related to such premiums.
Historically, cash receipts from operations, consisting of premiums and investment income, have provided more than sufficient funds to pay losses, operating expenses and dividends to the Company. Cash flow from operations is generally derived from the receipt of investment income on the Companys total investment portfolio as well as the net receipt of premiums less claims and expenses
related to its underwriting activities in its property and casualty operations as well as its Life Operations segment. Net cash from operations was $647.3 million in the first six months of 2008
compared with $1.2 billion in the same period in 2007. The decrease was primarily as a result of lower net income during the first six months of 2008 as compared to the first six months of 2007. As part of the recent financial market turbulence that persisted in the latter part of 2007 and has continued throughout 2008, increasingly thin market liquidity has persisted throughout the U.S.
and other financial markets. Despite this increase in illiquidity throughout the financial markets, the Company successfully raised over $4 billion of cash from its fixed income portfolio in order to
settle the entire GIC portfolio in the first six months of 2008. The Company continues to manage its liquidity needs through changes in the mix of its investment portfolio as well as through other
available capital resources and lines of credit as noted below. As noted above, subsequent to June 30, 2008, the Company announced the Master Agreement with SCA in connection with, among other things, the termination of reinsurance agreements. The
agreement calls for the payment by the Company to SCA of $1.775 billion in cash and the transfer by the Company to SCA of eight million of the Companys Class A ordinary shares. The Company
plans to fund this payment through the offering of both ordinary shares and equity security units as further described below. In addition to the customary closing conditions, the Master Agreement is
conditioned on the completion of the Companys capital raise noted below. In addition, the Company intends to redeem X.L. America, Inc.s $255 million 6.58% Guaranteed Senior Notes due April 2011 and will fund the redemption from the net proceeds from the
offering of both ordinary shares and equity security units as further described below. Capital Resources At June 30, 2008, the Company had total shareholders equity of $8.8 billion. In addition to ordinary and preferred share capital, the Company depends on external sources of financing such as
debt, credit facilities and contingent capital to support its underwriting activities. 76
In order to fund the payments to SCA under the Master Agreement and the redemption of X.L. America, Inc.s $255 million 6.58% Guaranteed Senior Notes, described above, the Company, on
July 28, 2008, announced its plans to raise approximately $2.5 billion of additional capital through an issuance of both ordinary shares and equity security units (the "ESUs"). The ESUs consist of: (i)
forward purchase contracts to purchase, and the Company to issue, its ordinary shares and (ii) debt securities. In addition, the Company will use the proceeds from the offerings for general corporate
purposes as well as the replenishment of the capital base of certain of the Companys subsidiaries. Concurrent with the closing of the Master Agreement with SCA, the Company announced its intention to exercise the put option under its Mangrove Bay contingent capital facility entered into
in July 2003 resulting in net proceeds to the Company of approximately $500 million in exchange for the issuance by the Company of 20,000,000 Series C Preference Ordinary Shares. For further details relating to the Master Agreement as well as the capital raising activities noted above, see Note 12 to the Consolidated Financial Statements, Subsequent Events. On September 24, 2007, the Board of Directors of the Company approved a share repurchase program, authorizing the Company to repurchase up to $500.0 million of its Class A ordinary shares.
Repurchases may be made from time to time in the open market or in privately negotiated transactions, and the Company expects that those repurchases will be funded from cash on-hand. The
timing and amount of the share repurchases under the program will depend on a variety of factors, including market conditions, legal requirements and other factors. As at June 30, 2008, the
Company could repurchase $375.5 million of its equity securities under the share repurchase program. Debt The following table presents the Companys indebtedness under outstanding debt securities and lenders commitments as at June 30, 2008:
Notes Payable and Debt
Commitment
In Use
Year of
Payments Due by Period
Less than
1 to 3
3 to 5
After 5 5-year revolvers (1)
$
1,000,000
$
2010/2012
$
$
$
$
5-year revolver
100,000
2010
5.25% Senior Notes
745,000
745,000
2011
745,000
6.58% Guaranteed Senior Notes
255,000
255,000
2011
255,000
6.50% Guaranteed Senior Notes
598,872
598,872
2012
600,000
5.25% Senior Notes
595,955
595,955
2014
600,000 6.375% Senior Notes
350,000
350,000
2024
350,000 6.25% Senior Notes
324,403
324,403
2027
325,000
$
3,969,230
$
2,869,230
$
$
1,000,000
$
600,000
$
1,275,000 Commitment and In Use data represent June 30, 2008 accreted values. Payments Due by Period data represent ultimate redemption values.
(1)
The 2010 and 2012 5-year revolving credit facilities share a $1.0 billion revolving credit sublimit.
Credit facilities, contingent capital and other sources of collateral At June 30, 2008, the Company had six letter of credit facilities in place with total availability of $7.3 billion, of which $3.1 billion was utilized. 77
(U.S. dollars in thousands)
Expiry
1 Year
Years
Years
Years
Other Commercial
Commitment
In Use
Year of
Amount of Commitment
Less than
1 to 3
3 to 5
After 5 Letter of Credit Facility
$
200,000
$
153,564
Continuous
$
200,000
$
$
$
Letter of Credit Facility (1)
2,250,000
2010
2,250,000
Letter of Credit Facility (1)
4,000,000
2,352,706
2012
4,000,000
Letter of Credit Facility
317
317
2008
317
Letter of Credit Facility
133
133
2008
133
Letter of Credit Facility
896,355
625,251
2009
896,355
Six letter of credit facilities
$
7,346,805
$
3,131,971
$
200,450
$
3,146,355
$
4,000,000
$
(1)
Of the total letter of credit facilities above, $1 billion is also included in the revolvers under notes payable and debt.
The Company has several letter of credit facilities provided on a syndicated and bilateral basis from commercial banks. These facilities are principally utilized to support non-admitted insurance
and reinsurance operations in the United States and capital requirements at Lloyds. In addition to letters of credit, the Company has established insurance trusts in the U.S. that provide cedants with
statutory relief under state insurance regulations 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 cedants. This could take the form of additional
insurance trusts supported by the Companys investment portfolio or funds withheld using the Companys 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 loss experience of such business. In addition, the Company has entered into contingent capital transactions of which no up-front proceeds were received by the Company; however, in the event that the associated irrevocable put
and/or contingent put option 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 by the Company as applicable. As noted above, concurrent with the Companys announcement relating to the Master Agreement, the Company announced its intention to exercise
the put option under its Mangrove Bay contingent capital facility entered into in July 2003 resulting in net proceeds to the Company of approximately $500 million in exchange for the issuance by the
Company of 20,000,000 Series C Preference Ordinary Shares. Ratings The Companys ability to underwrite business is dependent upon the quality of its claims paying and financial strength ratings as evaluated by independent rating agencies. As a result, in the
event that the Company is downgraded, its ability to write business may be adversely affected. The Company regularly evaluates its capital needs to support the volume of business written in order to
maintain its assigned financial strength ratings. The Company regularly provides financial information to rating agencies to both maintain and enhance existing ratings. In June 2008, Moodys Investor Services, Inc. (Moodys) affirmed the A1 financial strength rating of the Companys principal insurance and reinsurance subsidiaries; however, Moodys
provided a Negative outlook with regards to these ratings as a result of further stress on the Companys capital and financial flexibility resulting from the downgrades at SCA in the first six months
of 2008 and uncertainty surrounding reinsurance and guarantee agreements with SCA. Consistent with the ratings actions noted above, Standard and Poors (S&P), in July 2008, placed the A+ financial strength rating of the Companys leading property and casualty operating
companies on CreditWatch with Negative Implications. As well, in July 2008, Fitch Ratings 78
Commitments
(U.S. dollars in thousands)
Expiry
Expiration per period
1 Year
Years
Years
Years
(Fitch) placed the A+ financial strength rating of the Companys leading property and casualty operating subsidiaries On Watch for Possible Downgrade. Additionally, as relates to the S&P and Moodys rating actions, further concerns were expressed relating to the Companys investment portfolio and the underlying exposure to structured mortgage
securities. The following are the current financial strength and claims paying ratings from internationally recognized rating agencies in relation to the Companys principal insurance and reinsurance
subsidiaries and pools:
Rating agency
Rating
Outlook S&P
A+
(CreditWatch with Negative Implications) Fitch
A+
(On Watch for Possible Downgrade) A.M. Best
A
(Stable) Moodys
A1
(Negative) In addition, XL Capital Ltd had the following long term debt ratings as at June 30, 2008: bbb (Stable) from A.M. Best, A(CreditWatch with Negative Implications) from S&P, Baa1 (Negative)
from Moodys and A (On Watch for Possible Downgrade) from Fitch. Other For information regarding cross-default and certain other provisions in the Companys debt and convertible securities documents, see Item 7 of the Companys Form 10-K for the year ended
December 31, 2007. See Part II, Item 2 Unregistered Sales of Equity Securities and Use of Proceeds, below. 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 Companys 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 Companys 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 and reinsurance 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 risk that the closing of the transactions contemplated by the Master
Agreement does not occur for any reason; (ii) changes to the size of the Companys claims relating to natural catastrophes; (iii) the timely and full recoverability of reinsurance placed by the
Company with third parties, or other amounts due to the Company; (iv) the projected amount of ceded reinsurance recoverables and the ratings and creditworthiness of reinsurers may change; (v) the
timing of claims payments being faster or the receipt of reinsurance recoverables being slower than anticipated by the Company; (vi) higher than expected defaults on relevant underlying obligations
of SCAs subsidiaries and the adequacy of the claims paying ability of those SCA subsidiaries; (vii) the potential for larger than expected mark-to-market movements on credit derivatives originally
written by SCA and reinsured by the Company; (viii) ineffectiveness or obsolescence of the Companys business strategy due to changes in current or future market conditions; (ix) increased
competition on the basis of pricing, capacity, coverage terms or other factors; (x) greater frequency or severity of 79
claims and loss activity, including as a result of natural or man-made catastrophic events, than the Companys underwriting, reserving or investment practices anticipate based on historical experience
or industry data; (xi) developments in the worlds financial and capital markets that adversely affect the performance of the Companys investments and the Companys access to such markets
including, but not limited to further market developments relating to sub-prime and residential mortgages (xii) the potential impact on the Company from government-mandated insurance coverage for
acts of terrorism; (xiii) the potential impact of variable interest entities or other off-balance sheet arrangements on the Company; (xiv) 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; (xv) availability of
borrowings and letters of credit under the Companys credit facilities; (xvi) changes in regulation or tax laws applicable to the Company or its subsidiaries, brokers or customers; (xvii) acceptance of
the Companys products and services, including new products and services; (xviii) changes in the availability, cost or quality of reinsurance; (xiv) changes in the distribution or placement of risks due
to increased consolidation of insurance and reinsurance brokers; (xx) loss of key personnel; (xxi) the effects of mergers, acquisitions and divestitures; (xxii) changes in ratings, rating agency policies or
practices; (xxiii) changes in accounting policies or practices or the application thereof; (xxiv) legislative or regulatory developments; (xxv) changes in general economic conditions, including inflation,
foreign currency exchange rates and other factors; (xxvi) the effects of business disruption or economic contraction due to war, terrorism or other hostilities; and (xxvii) the other factors set forth in
the Companys other documents on file with the United States Securities and Exchange Commission (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 obligation to update publicly or revise any forward-looking
statement, whether as a result of new information, future developments or otherwise. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Except as described below, there have been no material changes in the Companys market risk exposures or how those exposures are managed, since December 31, 2007. The following discussion
should be read in conjunction with Quantitative and Qualitative Disclosures about Market Risk, presented under Item 7A of the Companys Form 10-K for the year ended December 31, 2007. Market risk represents the potential for loss due to adverse changes in the fair value of financial instruments. The Company is principally exposed to the following market risks: interest rate risk,
foreign currency exchange rate risk; equity price risk; credit risk; weather and energy-related risk, and other related market risks. The Companys investment market risk arises from its investment portfolio which consists of fixed income securities, alternative investments, public equities, private investments, derivatives, other
investments, and cash, denominated in both U.S. and foreign currencies, which are sensitive to changes in interest rates, credit spreads, equity prices, foreign currency exchange rates and other related
market risks. The Companys fixed income and equity securities are classified as available-for-sale, and as such changes in interest rates, credit spreads on corporate and structured credit, equity
prices, foreign currency exchange rates or other related market instruments will have an immediate effect on comprehensive income and shareholders equity but will not ordinarily have an immediate
effect on net income. Nevertheless, changes in interest rates, credit spreads, equity prices and other related market instruments affect consolidated net income when, and if, a security is sold or
impaired. The Company enters into derivatives and other financial instruments primarily for risk management purposes. The Company conducts activities in two main types of derivative instruments:
weather and energy derivatives and investment-related derivative instruments. In addition, following the secondary sale of SCA common shares, the Company retained some credit derivative exposures
written by SCA through reinsurance agreements that have certain of these derivatives exposures 80
embedded within them. From time to time, the Company also uses investment derivative instruments such as futures, options, interest rate swaps, credit default swaps and foreign currency forward
contracts to manage the duration of its investment portfolio and foreign currency exposures and also to obtain exposure to a particular financial market. The Companys derivative transactions can
expose the Company to credit derivative risk, weather and energy risk, foreign currency exchange rate risk, etc. 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. This risk management discussion and the estimated amounts generated from the sensitivity and 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
and changes in the composition of the Companys investment portfolio. The results of analysis used by the Company to assess and mitigate risk should not be considered projections of future events
of losses. See generally Cautionary Note Regarding Forward-Looking Statements in Item 2. Interest Rate Risk The Companys 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 June 30, 2008, would decrease the fair
value of the Companys fixed income portfolio by approximately 4.4% or $1.5 billion. Foreign Currency Exchange Rate Risk Many of the Companys non-U.S. subsidiaries maintain both assets and liabilities in local currencies. Foreign currency exchange rate gains and losses arise for accounting purposes where net
assets or liabilities are denominated in foreign currencies that differ from the functional currency of those subsidiaries. In addition, the Companys shareholders equity is impacted by movements in
currency exchange rates through both the foreign exchange component of realized and unrealized gains and losses within the Companys investment portfolio, and the cumulative translation
adjustments resulting from the translation of foreign subsidiary results. The principal currencies creating foreign exchange risk for us are the British pound sterling, the Euro, the Swiss Franc, and the Canadian dollar. The Companys net notional foreign currency
denominated exposure on foreign exchange contracts was $336.3 million and $341.7 million as at June 30, 2008 and December 31, 2007 respectively, with a net unrealized loss of $1.2 million and net
unrealized gain of $0.9 million as at June 30, 2008 and December 31, 2007, respectively. Equity Price Risk The Companys equity portfolio as well as certain derivatives and certain affiliate investments are exposed to equity price risk. Equity price risk is the potential loss arising from changes in the
market value of equities. An immediate hypothetical 10% change in the value of each equity position in the Companys equity portfolio would affect the fair value of the portfolio by approximately
$50.8 million as at June 30, 2008. This excludes exposures to equities in the Companys affiliate investments. 81
As at June 30, 2008, the Companys equity portfolio was approximately $507 million as compared to $757 million as at December 31, 2007. This excludes fixed income fund investments and
publicly traded alternative funds that generally do not have the risk characteristics of equity investments. As at June 30, 2008, the Companys allocation to equity securities was approximately 1.3% of
the total investment portfolio (including cash and cash equivalents, accrued investment income and net payable for investments purchased) as compared to approximately 1.7% as at December 31,
2007. As at June 30, 2008, the top ten equity holdings represented approximately 10.5% of the Companys total equity portfolio as compared to approximately 11.5% as at December 31, 2007. Credit Risk The Companys exposure to market movements related to credit risk is primarily due to its investment portfolio, credit derivatives embedded in financial guarantee reinsurance exposures,
receivable and ceded reinsurance balances. Within the investment portfolio, credit risk is the exposure to adverse change in the creditworthiness of individual investment holdings, issuers, groups of
issuers, industries or countries. In addition, credit risk pertains to adverse change in the creditworthiness of the Companys reinsurers and retrocessionaires, and their ability to pay certain reinsurance
receivable and recoverable balances. The hypothetical case of an immediate 25 basis point adverse increase in all the global corporate and structured credit spreads to which the Companys fixed
income portfolio is exposed to at June 30, 2008, would decrease the fair value of the Companys fixed income portfolio by approximately $316.4 million. The table below shows the Companys fixed income portfolio by credit rating in percentage terms of the Companys total fixed income exposure (including fixed maturities, short-term
investments, cash and cash equivalents, accrued investment income and net payable for investments purchased) as at June 30, 2008:
Total AAA
48.5
% AA
20.4
% A
18.6
% BBB
9.5
% BB & below
2.7
% NR
0.3
% Total
100.0
% At June 30, 2008, the average credit quality of the Companys total fixed income portfolio was AA. As at June 30, 2008, the top 10 corporate holdings, which exclude government guaranteed and government sponsored enterprises, represented approximately 5.1% of the total fixed income
portfolio and approximately 14.0% of all corporate holdings. The top 10 corporate holdings listed below represent the direct exposure to the corporations listed below, including their subsidiaries, and
exclude any securitized, credit enhanced and collateralized asset or mortgage backed securities, cash and cash equivalents, pooled notes and any over-the-counter (OTC) derivative counterparty
exposure, if applicable. 82
Top 10 Corporate Holdings
Percentage of Total General Electric Company
0.8
% HBOS plc
0.7
% Citigroup Inc
0.6
% The Goldman Sachs Group, Inc
0.6
% Bank of America Corporation
0.5
% HSBC Holdings plc
0.5
% Lloyds TSB Group plc
0.4
% Merrill Lynch & Co., Inc.
0.4
% Banco Santander S.A..
0.3
% Barclays plc
0.3
%
(1)
Including fixed maturities, short-term investments, cash and cash equivalents, accrued investment income and net payable for investments purchased.
As at June 30, 2008, the top 5 corporate sector exposures represented 28.8% of the total fixed income portfolio and 78.4% of all corporate holdings.
Top 5 Sector Exposures
Fair Value
Percent of Financials
$
6,209.7
18.1
% Consumer, Non-Cyclical
1,023.4
3.0
% Communications
902.1
2.6
% Industrials
891.1
2.6
% Utilities
853.7
2.5
% Total
$
9,880.0
28.8
% The Company also has exposure to market movement related to credit risk associated with its mortgage-backed and asset-backed securities. The table below shows the breakdown of the $10.9
billion structured credit portfolio as at June 30, 2008, of which approximately 82% is AAA rated:
(U.S. dollars in millions)
Fair Value
Percent of Portfolio CMBS
$
3,365.9
30.8
% Agency
1,508.9
13.8
% Whole Loans
1,440.4
13.2
% Core CDO (non-ABS CDOs and CLOs)
903.4
8.3
% Other ABS: ABS Auto
857.0
7.8
% ABS Credit Cards
558.5
5.1
% ABS Other
853.2
7.8
% Topical: Sub-prime first lien
724.4
6.6
% Alt-A
635.1
5.8
% Second lien (including sub-prime second lien mortgages)
66.3
0.6
% ABS CDOs with sub-prime collateral
17.9
0.2
% Total
$
10,931.0
100.0
% For further discussion of the exposure to credit market movements in the Companys investment portfolio see the Investment Value-at-Risk section below. As at June 30, 2008, the Company had exposure to market movements as a result of credit risk exposures related to the facultative and excess of loss reinsurance agreements noted above. A
portion of the exposures resulting from this business represented risks written by SCA in credit 83
Fixed Income
Portfolio (1)
Fixed Income
Portfolio
derivative form which were reinsured by the Company and were required to be marked to fair value. The fair value of such instruments was determined using models developed by SCA management.
Although the Company reviewed the validity of the overall methodology applied, it relied on SCA managements application of the model to individual exposures. For further details surrounding this
exposure, see Item 1, Note 4 to the Consolidated Financial Statements, Security Capital Assurance Ltd. Subsequent to June 30, 2008, the Company announced that an agreement had been reached
with SCA in connection with the termination of reinsurance agreements. For further details relating to the SCA agreement, see Note 12 to the Consolidated Financial Statements, Subsequent
Events. With regards to unpaid losses and loss expenses recoverable and reinsurance balances receivable, the Company has credit risk should any of its reinsurers be unable or unwilling to settle amounts
due to the Company; however, these exposures are not marked to market. For further information relating to reinsurer credit risk, see Managements Discussion and Analysis of Financial Condition
and Results of Operations Unpaid Losses and Loss Expenses Recoverable and Reinsurance Balances Receivable. The Company is exposed to credit risk in the event of non-performance by the other parties to its derivative instruments in general; however, the Company does not anticipate non-performance.
The difference between the notional principal amounts and the associated market value is the Companys maximum credit exposure. Weather and Energy 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 Companys portfolio of speculative 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 that do not have quoted market prices requires managements judgment in determining amounts that 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
managements best estimate based on various factors including, but not limited to, realized and forecasted weather conditions, changes in interest rates and other market factors. 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 Companys senior management. As at June 30, 2008, the Companys VaR related to these risks did not exceed $20.0 million in any one
season. Other Market Risks The Companys private investment 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 June 30, 2008, the Companys exposure to private investments was $387.8 million compared to $427.5 million as at December 31, 2007. 84
At June 30, 2008, bond and stock index futures outstanding had a net short position of $46.2 million as compared to a net short position of $384.5 million at December 31, 2007. A 10%
appreciation or depreciation of the underlying exposure to these derivative instruments would have resulted in realized gains or realized losses of $4.6 million as at June 30, 2008 and $38.5 million as
at December 31, 2007, respectively. The Company may reduce its exposure to these futures through offsetting transactions, including options and forwards. Investment Value-at-Risk (VaR) The VaR of the investment portfolio at June 30, 2008, based on a 95% confidence level with a one month holding period was approximately $795 million as compared to $648 million at
December 31, 2007. The VaR of all investment related derivatives excluding investments in affiliates and other investments was approximately $22.1 million as compared to $19.1 million at December
31, 2007. The Companys investment portfolio VaR as at June 30, 2008 is not necessarily indicative of future VaR levels. To complement the VaR analysis based on normal market environments, the Company considers the impact on the investment portfolio of 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 Companys total risk tolerance. Given the investment portfolio allocations as at June 30, 2008, the Company would expect to lose approximately 6.3% of the portfolio if the most damaging event stress tested was repeated, all
other things held equal, as compared to 6.0% at December 31, 2007. Given the investment portfolio allocations as at June 30, 2008, the Company would expect to gain approximately 19.5% of the
portfolio if the most favorable event stress tested was repeated, all other things held equal, as compared to 18.1% at December 31, 2007. 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. ITEM 4. 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 Companys 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. Changes in Internal Control Over Financial Reporting There have been no changes in internal control over financial reporting identified in connection with the Companys 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 Companys internal
control over financial reporting. 85
On September 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 Companys 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 10b-5 promulgated thereunder (the Securities Laws). The Amended Complaint alleged that the defendants violated the Securities Laws by, among other things, failing to disclose in various
public statements, reports to shareholders and other communications the alleged inadequacy of the Companys loss reserves for its NAC Re subsidiary (now known as XL Reinsurance America, Inc.)
and that, as a consequence, the Companys earnings and assets were materially overstated. On August 26, 2005, the Court dismissed the Amended Complaint owing to its failure adequately to allege
that the lead plaintiffs had sustained a loss, but provided leave for the plaintiffs to file a further amended complaint. The plaintiffs thereafter filed another amended complaint (the Second Amended
Complaint), which is similar to the Amended Complaint in its substantive allegations. On December 31, 2005, the defendants filed a motion to dismiss the Second Amended Complaint. The plaintiffs
opposed the motion. In addition, the plaintiffs filed a motion to strike certain documents and exhibits that the XL defendants had proffered in support of the motion to dismiss. By Order dated
December 15, 2006, the Judge granted in part and denied in part plaintiffs motion to strike and allowed limited discovery through March 2, 2007. The Judge denied defendants motion to dismiss
without prejudice to its renewal at the conclusion of such discovery. On March 22, 2007, the defendants filed their renewed motion to dismiss the Second Amended Complaint. By order dated July
21, 2007, the Judge granted defendants renewed motion and dismissed the Second Amended Complaint. On August 30, 2007 plaintiffs filed a notice of appeal. Briefing on the Appeal is concluded
and the parties await scheduling of argument. The Company and the defendant present and former officers and directors will continue to vigorously defend the Malin Action. In November 2006, a subsidiary of the Company (DOJ) received a grand jury subpoena from the Antitrust Division of the U.S. Department of Justice and a subpoena from the SEC, both of
which seek documents in connection with an investigation into the municipal guaranteed investment contract (GIC) market and related products. In June 2008, subsidiaries of the Company also
received a subpoena from the Connecticut Attorney General and an Antitrust Civil Investigative Demand from the Office of the Florida Attorney General in connection with a coordinated multi-
state Attorneys General investigation into the matters referenced in the DOJ and SEC subpoenas. The Company is fully cooperating with these investigations. In March 2008, two subsidiaries of the Company were named, along with 20 other providers and insurers of municipal Guaranteed Investment Contracts and similar derivative products
(collectively Municipal Derivatives) as well as fourteen brokers of such products, in two purported federal antitrust class actions filed in the federal courts in the District of Columbia and the
Southern District of New York. These complaints allege that there was a conspiracy among the defendants during the period from January 1, 1992 to the present to rig bids for Municipal Derivatives.
The purported class of plaintiffs consists of purchasers of Municipal Derivatives. In April 2008, another federal antitrust class action containing similar allegations was filed in the Northern District of
California against 39 defendants, including the same two subsidiaries of the Company, as well as XL Capital, Ltd. The Judicial Panel on Multidistrict Litigation ordered that the Southern District of
New York will serve as the venue for these actions. The plaintiffs are expected to file a consolidated amended complaint, and defendants will then have 60 days to move or answer in response
thereto. In addition, in July 2008, the same two subsidiaries were named in similar actions filed by the cities of Los Angeles and Stockton in California state courts. The Company intends to
vigorously defend these actions. 86
From time to time, the Company has also received and responded to additional requests from Attorneys General, state insurance regulators and federal regulators for information relating to the
Companys contingent commission arrangements with brokers and agents and/or the Companys insurance and reinsurance practices in connection with certain finite-risk and loss mitigation products.
Similarly, the Companys affiliates outside the United States have, from time to time, received and responded to requests from regulators relating to the Companys insurance and reinsurance
practices regarding contingent commissions or finite-risk and loss mitigation products. The Company has fully cooperated with the regulators in these matters. In August 2005, plaintiffs in a proposed class action (the Class Action) that was consolidated into a multidistrict litigation in the United States District Court for the District of New Jersey,
captioned In re Insurance Brokerage Antitrust Litigation, MDL No. 1663, Civil Action No. 04-5184 (the MDL), filed a consolidated amended complaint (the Amended Complaint), which named
as new defendants approximately 30 entities, including Greenwich Insurance Company, Indian Harbor Insurance Company and XL Capital Ltd. In the MDL, the Class Action plaintiffs asserted
various claims purportedly on behalf of a class of commercial insureds against approximately 113 insurance companies and insurance brokers through which the named plaintiffs allegedly purchased
insurance. The Amended Complaint alleged that the defendant insurance companies and insurance brokers conspired to manipulate bidding practices for insurance policies in certain insurance lines
and failed to disclose certain commission arrangements. The named plaintiffs asserted statutory claims under the Sherman Act, various state antitrust laws and the Racketeer Influenced and Corrupt
Organizations Act (RICO), as well as common law claims alleging breach of fiduciary duty, aiding and abetting a breach of fiduciary duty and unjust enrichment. Discovery in the MDL
commenced in the latter part of 2005. Defendants filed motions to dismiss the Amended Complaint in late November 2005. By Opinion and Order dated October 3, 2006, the Court ruled on
defendants motions to dismiss the Amended Complaint, holding that plaintiffs RICO and antitrust claims were deficient as pled and directing plaintiffs to file a supplemental RICO case statement
and a supplemental statement of particularity as to their Sherman Act claims. Plaintiffs filed their supplemental pleadings on October 25, 2006 and on November 30, 2006, defendants filed motions to
dismiss plaintiffs supplemental pleadings. By Orders dated April 5, 2007, the Court dismissed plaintiffs Sherman Act and RICO claims without prejudice to their filing final amended pleadings. By
Order dated April 11, 2007, the Court stayed all proceedings in the MDL, including discovery, pending the disposition of defendants motions to dismiss plaintiffs Second Amended Complaint, which
was filed on May 22, 2007 and contained allegations as to XL that were materially similar to those set forth in plaintiffs October 2006 pleadings, but also purported to add as new defendants three
other XL entities. On June 2007, XL (along with other defendants) filed motions to dismiss the Sherman Act and RICO claims alleged in the Second Amended Complaint and to strike the newly-
named parties. By Opinion and Order dated August 31, 2007, the Court dismissed the Class Action plaintiffs Sherman Act claims with prejudice and, by Opinion and Order dated September 28, 2007, the
Court dismissed the Class Action plaintiffs RICO claims with prejudice. In its September 28, 2007, Opinion and Order, the Court declined to exercise supplemental jurisdiction over the Class Action
plaintiffs state law claims. On October 10, 2007, the Class Action plaintiffs filed a Notice of Appeal, stating their intention to appeal to the U.S. Court of Appeals for the Third Circuit (the Third
Circuit) from the District Courts October 3, 2006 Opinion and Order; April 5, 2007 Opinions and Order; August 31, 2007 Opinion and Order; and September 28, 2007 Opinion and Order. All
appellate briefs have now been filed. By Order dated July 2, 2008, the Third Circuit stayed the appeal pending further proceedings in the District Court in connection with the filings by defendant
Marsh and the Class Action plaintiffs announcing their agreement to settle the Class Action. By motion dated July 10, 2008, the Class Action plaintiffs filed a motion with the Third Circuit requesting
that the stay be vacated. The Third Circuit has not yet ruled on that motion. Various XL entities have been named as defendants in three of the many tag-along actions that have been consolidated into the MDL for pretrial purposes. On April 4, 2006, a tag-along
Complaint 87
was filed in the U.S. District Court for the Northern District of Georgia on behalf of New Cingular Wireless Headquarters LLC and several other corporations against approximately 100 defendants,
including Greenwich Insurance Company, XL Specialty Insurance Company, XL Insurance America, Inc., XL Insurance Company Limited, Lloyds syndicates 861, 588 and 1209 and XL Capital Ltd.
(the New Cingular Lawsuit). The New Cingular Lawsuit is a tag-along action that does not purport to be a class action. The New Cingular Complaint, which made the same basic allegations as
those alleged in the Class Action plaintiffs Second Amended Complaint, asserted statutory claims under the Sherman Act, the Racketeer Influenced and Corrupt Organizations Act, as well as
common law claims alleging breach of fiduciary duty, inducement to breach fiduciary duty, unjust enrichment and fraud. On January 5, 2007, the plaintiffs in the New Cingular Lawsuit filed an
Amended Complaint, a RICO Statement and a memorandum of law. In accordance with the Courts April 11, 2007 Order, all proceedings in the New Cingular Lawsuit, including discovery and
motions by defendants to dismiss the New Cingular Amended Complaint, were stayed pending the Courts disposition of defendants motions to dismiss the Second Amended Complaint filed in the
MDL. The parties are awaiting the District Courts decision as to whether the New Cingular Lawsuit will continued to be stayed or be permitted to proceed pending the Third Circuits disposition of
the Class Action plaintiffs pending appeal. On or about May 21, 2007 a tag-along Complaint was filed in the United States District Court for the District of New Jersey on behalf of Henley Management Company, Big Bear Properties,
Inc., Northbrook Properties, Inc., RCK Properties, Inc., Kitchens, Inc., Aberfeldy LP and Payroll and Insurance Group, Inc. against multiple defendants, including XL Winterthur International (the
Henley Lawsuit). The Complaint in the Henley Lawsuit, which contains certain of the basic allegations that are contained in the Class Action plaintiffs Second Amended Complaint, alleges
violations of Section 1 of the Sherman Act against all defendants and various other claims that are alleged against only defendant Marsh. The Henley Lawsuit is a tag-along action that does not
purport to be a class action. By Order dated July 11, 2007, the Court ordered that the Henley Lawsuit be consolidated into the MDL, making the Henley Lawsuit subject to the Courts April 11,
2007 stay Order. The parties are awaiting the District Courts decision as to whether the Henley Lawsuit will continued to be stayed or be permitted to proceed pending the Third Circuits disposition
of the Class Action plaintiffs pending appeal. On October 12, 2007, a Complaint in a third tag-along action, captioned Sears Roebuck & Co. v. Marsh & McLennan Companies, Inc., et al., No. 1:07-CV-2535 (the Sears Lawsuit), was filed in
the United States District Court for the Northern District of Georgia by Sears, Roebuck & Co., Sears Holdings Corporation, Kmart Corporation and Lands End Inc. Among the many named
defendants are X.L. America, Inc., XL Insurance America, Inc., XL Specialty Insurance Company and XL Insurance (Bermuda) Ltd. The Complaint in the Sears Lawsuit, which contains many of the
basic allegations that were contained in the Class Action plaintiffs Second Amended Complaint, alleges violations of the Sherman Act and RICO, as well as claims alleging breach of fiduciary duty
against the broker defendants; inducement to breach fiduciary duty against the insurer defendants; breach of contract against the broker defendants; tortious interference with contract against the
insurer defendants; unjust enrichment; common law fraud against the broker defendants; aiding and abetting common law fraud against the insurer defendants; violation of state consumer fraud
statutes; and violation of state antitrust statutes. The Sears Lawsuit is a tag-along action that does not purport to be a class action. The parties are awaiting the District Courts decision as to whether
the Sears Lawsuit will continued to be stayed or be permitted to proceed pending the Third Circuits disposition of the Class Action plaintiffs pending appeal. Three purported class actions were filed against XL Insurance Ltd (XLI) and others in the United States District Court, for the Southern District of New York on behalf of shareholders of
Security Capital Assurance, Inc. (SCA). The complaints, filed December 7, 2007, December 18, 2007 and January 8, 2008 named as defendants in addition to XLI, SCA, two SCA officers, (and in
two of the cases) Goldman Sachs & Co., J.P. Morgan Securities, Inc., and Merrill Lynch, Pierce Fenner & Smith, Inc. All allege violations of various U.S. Securities laws against the defendants 88
arising from purchases of SCA shares in the June 6, 2007 secondary offering and shortly before. The complaints allege, among other things, that the Registration Statement and other public
disclosures made by SCA and the individual defendants contained untrue statements of material facts and omitted other necessary facts to make the statements not misleading. The complaints allege
that the disclosures failed to disclose that SCA was materially exposed to risky securities relating to sub-prime real estate mortgages. The allegations against XLI claim it is liable as a selling
shareholder and as a party that controlled SCA during the relevant time period. In late April, the Judge issued an order consolidating the actions, appointing Employees Retirement System of the
state of Rhode Island as lead plaintiff, and approving its selection of lead counsel. The order further provides that the lead plaintiff shall file a Consolidated Amended Complaint. The matter is
designated In Re Security Capital Assurance Ltd. Securities Litigation. Plaintiffs Consolidated Amended Complaint is currently due to be filed on or before August 6, 2008. In connection with the secondary offering of SCA shares at issue, the Company and SCA agreed to indemnify the several underwriters of that offering against certain liabilities, including
liabilities under the Securities Act of 1933. The underwriters named as defendants in the litigation have communicated their request for the Company and/or SCA to indemnify the underwriters for
payment of legal fees and expenses incurred with respect to the litigation. 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 Companys
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, operating results and/or
liquidity, although an adverse resolution of one or more of these items could have a material adverse effect on the Companys results of operations in a particular fiscal quarter or year. The risk factors set forth below update and replace the risk factors previously disclosed in Item 1A of Part I of the Companys Form 10-K for the year ended December 31, 2007 under the
headings Risk Related to the Company, Risks Related to the Insurance and Reinsurance Industries, Risks Related to Regulation, Risks Related to Taxation and Risk Related to the
Companys Ordinary Shares, except that until such time as the transactions contemplated by the Master Agreement are consummated, (1) the risk factor set forth under the heading If the
Companys guarantee agreements with SCA are triggered, there may be a material adverse effect on the Companys financial condition, results of operations and/or liquidity as set forth in the
Companys Form 10-K for the year ended December 31, 2007, shall not be replaced and (2) the eleventh and twelfth sentences of the penultimate paragraph in the risk factor under the heading If
actual claims exceed the Companys loss reserves, its financial results could be adversely affected, as set forth in the Companys Form 10-K for the year ended December 31, 2007, should be
replaced with the following Under most of the credit default swap contracts insured by XLCA, and reinsured by the Company, it would be an event of default if XLCA should become insolvent. If
there were an event of default by XLCA, the holders of these swaps would have the right to terminate the swaps and to obtain a termination payment from XLCA, and possibly expose the Company
under the Companys reinsurance agreements or guarantees, based on the market value of the swaps at the time of termination. 89
Risks Related to the Company A downgrade in our credit ratings by one or more rating agencies could materially and negatively impact our business, financial condition, results of operations and/or liquidity. As our ability to underwrite business is dependent upon the quality of our claims paying and financial strength ratings as evaluated by independent rating agencies, a further downgrade by any of
these institutions could cause our competitive position in the insurance and reinsurance industry to suffer and make it more difficult for us to market our products. A downgrade could also result in a
substantial loss of business for us as ceding companies and brokers that place such business may move to other insurers and reinsurers with higher ratings. Based on the announcements relating to the SCA Agreement and these offerings, once successful, it is managements expectation that our financial strength and debt ratings ultimately will be
affirmed at their current levels, though we do expect that some of the rating agencies will assign a negative outlook to us. A downgrade of the A.M. Best financial strength rating of XL Capital Ltd, XL Insurance (Bermuda) Ltd or XL Re Ltd below A-, which is currently two notches below our current A.M. Best
rating of A, would constitute an event of default and may require the posting of cash collateral under our letter of credit and revolving credit facilities. Such downgrades by A.M. Best or similar
downgrades by S&P will trigger cancellation provisions in the majority of our assumed reinsurance contracts. See A decline in our ratings may allow many of our clients to terminate their contracts
with us, below. Either of these events would reduce our financial flexibility and materially adversely affect our business, financial condition and results of operations and could have a significant
adverse effect on the market price for our securities. A decline in our ratings may allow many of our clients to terminate their contracts with us. The majority of our assumed reinsurance contracts contain provisions that would allow our clients to cancel the contract in the event of a downgrade in our ratings below specified levels by one
or more rating agencies. Based on premium value, approximately 65% of our reinsurance contracts that incepted at January 1, 2008 contained provisions allowing clients to cancel those contracts
upon a decline in our ratings. Typically, the cancellation provisions in our assumed reinsurance contracts would be triggered if S&P or A.M. Best were to downgrade our financial strength ratings below A-, which is currently
three levels below our current S&P rating of A+ and two levels below our current A.M. Best rating of A. Whether a client would exercise its cancellation rights after such a downgrade would
likely depend, among other things, on the reasons for the downgrade, the extent of the downgrade, the prevailing market conditions, the degree of unexpired coverage, and the pricing and availability
of replacement reinsurance coverage. In the event of such a downgrade, we cannot predict whether or how many of our clients would actually exercise such cancellation rights or the extent to which
any such cancellations would have a material adverse effect on our financial condition, results of operations or future prospects and could have a significant adverse effect on the market price for our
securities. The occurrence of disasters could adversely affect our financial condition. We have substantial exposure to losses resulting from natural and man-made disasters and other catastrophic events. Catastrophes can be caused by various events, including hurricanes,
earthquakes, floods, hailstorms, explosions, severe weather, fires, war, acts of terrorism and political instability. The incidence and severity of catastrophes are inherently unpredictable, and it is
difficult to predict the timing of such events with statistical certainty or estimate the amount of loss any given occurrence will generate. 90
The occurrence of claims from catastrophic events is likely to result in substantial volatility in our financial condition and results of operations for the fiscal quarter or year in which a
catastrophic event occurs, as well as subsequent fiscal periods, and could have a material adverse effect on our financial condition and results of operations and our ability to write new business. This
risk is exacerbated due to accounting principles and rules that do not permit reinsurers to reserve for such catastrophic events until they occur. We expect that increases in the values and
concentrations of insured property, the effects of inflation and changes in cyclical weather patterns will increase the severity of catastrophic events in the future. Although we attempt to manage our
exposure to catastrophic events, a single catastrophic event could affect multiple geographic zones and lines of business and the frequency or severity of catastrophic events could exceed our estimates,
in each case potentially having a material adverse effect on our financial condition and results of operations. In addition, while we may, depending on market conditions, purchase catastrophe
reinsurance and retrocessional protection, the occurrence of one or more major catastrophes in any given period could result in losses that exceed such reinsurance and retrocessional protection or
make it more difficult or expensive for us to purchase reinsurance or retrocessional protection and have a material adverse effect on our financial condition and results of operations and result in
substantial liquidation of investments, possibly at a loss, and outflows of cash as losses are paid. The failure of any of the underwriting risk management strategies that we employ could have a material adverse effect on our financial condition, results of operations and/or liquidity. We seek to limit our loss exposure by, among other things, writing a number of our reinsurance contracts on an excess of loss basis, adhering to maximum limitations on reinsurance written in
defined geographical zones, limiting program size for each client and prudently underwriting each program written. In addition, in the case of proportional treaties, we generally seek to use per
occurrence limitations or loss ratio caps to limit the impact of losses from any one event. We cannot be sure that all of these loss limitation methods will have the precise risk management impact
intended. For instance, although we also seek to limit our loss exposure by geographic diversification, geographic zone limitations involve significant underwriting judgments, including the
determination of the area of the zones and the inclusion of a particular policy within a particular zones limits. Underwriting involves the exercise of considerable judgment and the making of
important assumptions about matters that are inherently unpredictable and beyond our control, and for which historical experience and probability analysis may not provide sufficient guidance. The
failure of any of the underwriting risk management strategies that we employ could have a material adverse effect on our financial condition and results of operations. Also, we cannot provide
assurance that various provisions of our policies, such as limitations or exclusions from coverage or choice of forum, will be enforceable in the manner that we intend and disputes relating to coverage
and choice of legal forum may arise, which could materially adversely affect our financial condition and results of operations. If actual claims exceed our loss reserves, our financial results could be adversely affected. Our results of operations and financial condition depend upon our ability to assess accurately the potential losses associated with the risks that we insure and reinsure. We establish reserves for
unpaid losses and loss adjustment expense (LAE) liabilities, which are estimates of future payments of reported and unreported claims for losses and related expenses with respect to insured events
that have occurred. The process of establishing reserves for property and casualty claims can be complex and is subject to considerable variability as it requires the use of informed estimates and
judgments. Actuarial estimates of unpaid loss and LAE liabilities are subject to potential errors of estimation, which could be significant, due to the fact that the ultimate disposition of claims
incurred prior to the date of such estimation, whether reported or not, is subject to the outcome of events that have not yet occurred. Examples of these events include the accuracy of the factual
information on which the estimates were based, especially as this develops, jury decisions, court interpretations, legislative changes, changes in the medical condition of claimants, public attitudes, and
economic conditions such as inflation. Any estimate of future costs is subject to the inherent limitation on the 91
ability to predict the aggregate course of future events. It should therefore be expected that the actual emergence of loss and LAE liabilities will vary, perhaps materially, from any estimate. Similarly, the actual emergence of claims for life business may vary from the assumptions underlying the policy benefit reserves, in particular, the future assumed mortality improvements on the
blocks of in-payment annuities. In relation to financial guarantee business and related exposures, we establish reserves for losses and loss adjustment expenses on such business based on managements best estimate of the
ultimate expected incurred losses. Our estimated ultimate expected incurred losses are comprised of: (i) case basis reserves, (ii) unallocated reserves, and (iii) cumulative paid losses to date.
Establishment of such reserves requires the use and exercise of significant judgment by management, including with respect to estimates regarding the occurrence and amount of a loss on an insured
or reinsured obligation. Estimates of losses may differ from actual results and such difference may be material, due to the fact that the ultimate dispositions of claims are subject to the outcome of
events that have not yet occurred. Examples of these events include changes in the level of interest rates, credit deterioration of insured and reinsured obligations, and changes in the value of specific
assets supporting insured and reinsured obligations. Both qualitative and quantitative factors are used in establishing such reserves. In determining the reserves, management considers all factors in the
aggregate, and does not attribute the reserve provisions or any portion thereof to any specific factor. In general, guarantees written in credit default swap form are exposed to the same risks as noted
above, except in events of default by the guarantor. Credit default swaps, however, do not qualify for the financial guarantee scope exception under FAS 133, and, therefore are reported at fair value
with changes in the fair value included in earnings. Fair value for such swaps are determined based on methodologies further described in Managements Discussion and Analysis of Financial
Condition and Results of OperationsCritical Accounting Policies and Estimates in the Companys Annual Report filed on Form 10-K for the year ended December 31, 2007. Any estimate of future
costs is subject to the inherent limitation on our ability to predict the aggregate course of future events. It should therefore be expected that the actual emergence of losses and loss adjustment
expenses will vary, perhaps materially, from any estimate. We have an actuarial staff in each of our operating segments that regularly evaluates the levels of loss reserves, taking into consideration factors that may impact the ultimate losses incurred. Any
such evaluation could result in future changes in estimates of losses or reinsurance recoverable and would be reflected in our results of operations in the period in which the estimates are changed.
Losses and loss expenses, to the extent that they exceed the applicable reserves, are charged to income as incurred. The reserve for unpaid losses and loss expenses represents the estimated ultimate
losses and loss expenses less paid losses and loss expenses, and comprises case reserves and incurred but not reported loss reserves (IBNR). During the loss settlement period, which can span many
years in duration for casualty business, additional facts regarding individual claims and trends often will become known and case reserves may be adjusted by allocation from IBNR without any
change in the overall reserve. In addition, application of statistical and actuarial methods may require the adjustment of the overall reserves upward or downward from time to time. Accordingly, the
ultimate settlement of losses may be significantly greater than or less than reported loss and loss expense reserves. There is a possibility that the SCA Agreement and the related commutations and releases could be challenged or that we could be subject to litigation as a result of the SCA Agreement. Any such
challenge could have a material adverse effect on our financial condition, results of operations, liquidity or the market price of our securities. We provided certain reinsurance protections (the Reinsurance Agreements) with respect to adverse development on certain transactions as well as indemnification under specific facultative and
excess of loss coverages for subsidiaries of SCA: XLFA and XLCA. As at June 30, 2008, our total net exposure under facultative agreements with SCA subsidiaries was approximately $6.4 billion of 92
net par value outstanding. Pursuant to the SCA Agreement, all of these Reinsurance Agreements will be commuted. In addition, through one or more of our subsidiaries, we entered into certain agreements with subsidiaries of SCA pursuant to which we guaranteed certain obligations of XLFA and XLCA
under specific agreements more fully described below under Description of the SCA Agreement (the Guarantee Agreements). See Description of the SCA Agreement below for more
information regarding the Guarantee Agreements and the Reinsurance Agreements. As at June 30, 2008, the total net par value outstanding of business written by subsidiaries of SCA which falls
under the Guarantee Agreements was approximately $60 billion. Pursuant to the terms of, and required conditions under, the SCA Agreement, XLFAs facultative quota share reinsurance agreement
with XLCA, and all individual risk cessions thereunder, and the Financial Security Master Facultative Agreement, and all individual risk cessions thereunder, will be commuted, thereby rendering the
XLFA Guarantee and Financial Security Guarantee of no further force and effect. After the closing under the SCA Agreement, SCA and its applicable subsidiaries will be required to use commercially reasonable efforts to commute the underlying financial guarantees that are
the subject of the EIB Guarantees. There can be no assurances that such commutation will ultimately occur and that our $1.1 billion exposure (as of June 30, 2008 after giving effect to the SCA
Agreement) under the EIB Guarantees will be eliminated. While the NYID and the BMA have approved the SCA Agreement and related agreements and transactions, as further described below, including the commutation of the agreements described
above and the Delaware Insurance Department (DID) has approved the SCA Agreement and the commutation of the XLFA/XLCA Quota Share, which approval will become effective upon the
redomestication of XLFA as a Delaware domiciled insurance company and although the Company believes the effect of the SCA Agreement will be to relieve us of all of our obligations under the
Reinsurance Agreements and the Guarantee Agreements (other than as noted above with respect to the EIB Guarantee, if such Guarantee remains in place post-closing), no assurance can be given
that the enforceability of the SCA Agreement, the agreements relating thereto and the transactions contemplated thereunder will not be challenged, including under applicable fraudulent transfer laws
(described in the following paragraph) and/or by asserting any number of other theories for recovery, including third-party beneficiary rights, or that other litigation will not be commenced against us
as a result of the SCA Agreement and such related agreements and transactions. We believe that we would have significant defenses to any such challenges and would vigorously defend against any
such claims. However, we cannot assure you that any such claims would not be made or, that any such claims would not ultimately be successful. Under federal bankruptcy law and comparable provisions of state fraudulent transfer laws (including those applicable in any state insurance insolvency proceeding) SCAs commutation and
release of our obligations pursuant to the SCA Agreement and related agreements would constitute a voidable fraudulent transfer if it was determined that SCA or any applicable subsidiary thereto,
at the time it entered into the SCA Agreement or such related agreement:
intended to hinder, delay or defraud its creditors; or received less than reasonably equivalent value or fair consideration for such release; and either
was insolvent or rendered insolvent by reason of such incurrence; or was engaged in a business or transaction for which its remaining assets constituted unreasonably small capital; or intended to incur, or believed that it would incur, debts beyond its ability to pay such debts as they mature. 93
Among other regulatory approvals obtained in connection with the SCA Agreement, the NYID issued an approval letter to XLCA under Section 1505 of the New York Insurance Law and the
DID issued an approval letter to XLFA under Section 5005(a) of the Delaware Insurance Code (effective upon XLFAs redomestication to Delaware) (both of which require that the terms of a
transaction between an issuer and one or more of its affilaites be fair and equitable) stating, in the case of NYID, that the terms of the SCA Agreement and each of the commutations are fair and
equitable to XLCA and do not adversely affect policyholders of XLCA and, in the case of the DID, stating that the terms of the SCA Agreement and the commutation of the XLFA/XLCA Quota
Share were fair and equitable to XLFA. The BMA (the domiciliary regulator of XLFA) also issued an approval letter approving the SCA Agreement and each commutation to which XLFA is a
party, including the XLFA/XLCA Quota Share. There can be no assurance that a court would agree with our, the NYIDs, the DIDs, the BMAs or SCAs conclusions, or as to what law or standard
a court would ultimately apply in making any such determination or as to how such court would ultimately rule. Additionally, in the event of any liquidation or rehabilitation or similar proceeding of
any insurance subsidiary of SCA, there can be no assurance that any insurance regulator or regulators responsible for such proceedings, in their capacity as liquidator or rehabilitator, would respect
the insurance regulatory approvals obtained in connection with the SCA Agreement. If any such challenge were successful, we could be required to honor our original obligations under the Reinsurance Agreements and Guarantee Agreements or be subject to other remedies. Any
challenge could have a material adverse effect on the market price for our securities and on our business and, if successful, could also have a material adverse effect on our financial condition, results
of operations and liquidity. On July 28, 2008, SCA announced that it has conducted a review of its June 30, 2008 loss reserves. Based on the preliminary results of this review, SCA believes that its case reserves will have
increased substantially as of June 30, 2008, primarily due to significant deterioration with respect to its exposure to collateralized debt obligations of asset backed securities and residential mortgage-
backed securities. As a result, SCAs New York-based insurance subsidiary, XLCA, will report negative statutory surplus and its Bermuda-based reinsurance subsidiary, XLFA, will report negative
total statutory capital and surplus as of June 30, 2008. Upon the successful closing of the transactions contemplated by the SCA Agreement, SCAs settlement with Merrill Lynch International (the
Merrill Agreement) and related agreements, and pending the satisfaction of the conditions to closing of the SCA Agreement and the Merrill Agreement, XLCA expects to have positive statutory
surplus and XLFA expects to have positive total statutory capital and surplus. In the absence of the consummation of the transactions contemplated by the SCA Agreement, Merrill Agreement and
related agreements, XLCA and XLFA would likely be subject to regulatory action by their primary regulators, the NYID and the BMA. As a result of these developments, there is substantial doubt
about SCAs ability to continue as a going concern. Upon closing of the transactions contemplated by the SCA Agreement and the Merrill Agreement, SCA intends to re-assess whether substantial
doubt exists about SCAs ability to continue as a going concern. Operational risks, including human or systems failures, are inherent in our business. Operational risk and losses can result from, among other things, fraud, errors, failure to document transactions properly or to obtain proper internal authorization, failure to comply with
regulatory requirements, information technology failures, or external events. We believe that our modeling, underwriting and information technology and application systems are critical to our business. Moreover, our information technology and application systems have
been an important part of our underwriting process and our ability to compete successfully. We have also licensed certain systems and data from third parties. We cannot be certain that we will have
access to these, or comparable, service providers, or that our information technology or application systems will continue to operate as intended. A major defect or failure in our internal controls or
information technology and application systems could result in management distraction, harm to our reputation or increased expense. 94
In particular, we have outsourced the day-to-day management, custody and record-keeping of our investment portfolio to third-party managers and custodians that we believe to be reputable. A
major defect in those investment managers investment management strategy, information and technology systems, internal controls or decision-making could result in management distraction and/or
significant financial loss. A major defect in custodian internal controls or information and technology systems could result in management distraction or significant financial loss. We believe appropriate controls and mitigation procedures are in place to prevent significant risk of defect in our internal controls, information technology, application systems, investment
management and custody and record-keeping, but internal controls provide only reasonable, not absolute, assurance as to the absence of errors or irregularities and any ineffectiveness of such controls
and procedures could have a material adverse effect on our business. The effects of emerging claim and coverage issues on our business are uncertain. As industry practices and legal, judicial, social and other environmental conditions change, unexpected issues related to claims and coverage may emerge. These issues may adversely affect our
business by either extending coverage beyond our underwriting intent or by increasing the number or size of claims, such as the effects that recent disruptions in the credit markets could have on the
number and size of reported claims under D&O and professional liability insurance lines of business. In some instances, these changes may not become apparent until some time after we have issued
the insurance or reinsurance contracts that are affected by the changes. As well, our actual losses may vary materially from our current estimate of the loss based on a number of factors, including
receipt of additional information from insureds or brokers, the attribution of losses to coverages that had not previously been considered as exposed and inflation in repair costs due to additional
demand for labor and materials. As a result, the full extent of liability under an insurance or reinsurance contract may not be known for many years after such contract is issued and a loss occurs. We may require additional capital in the future, which may not be available to us on satisfactory terms, on a timely basis or at all. Our future capital requirements depend on many factors, including our ability to write new business successfully and to establish premium rates and reserves at levels sufficient to cover our
losses. To the extent that the funds generated by our ongoing operations are insufficient to fund future operating requirements and cover claim payments, or that the Companys capital position is
adversely impacted by mark-to-market movements on the investment portfolio, we may need to raise additional funds through financings or curtail our growth and reduce our assets. Any future
financing may not be available on terms that are favorable to us, if at all. Following this offering, it may be more difficult for us to raise additional capital for some period of time. Any future equity
financings could be dilutive to our existing shareholders or could result in the issuance of securities that have rights, preferences and privileges that are senior to those of our other securities. Our
inability to obtain adequate capital could have a material adverse effect on our business, financial condition and results of operations. Under Rule 3-09 of Regulation S-X, we may be required to file separate audited financial statements of SCA (the SCA Financials) in our Annual Report on Form 10-K for the year ended
December 31, 2008. If we are required to file the SCA Financials and they are not available at the time of filing our Annual Report, we may not satisfy the registrant requirements for use of Form
S-3 and therefore may be ineligible to use such Form. Should we be unable to file our Annual Report including the SCA Financials on or before the required date, we may be ineligible to use Form
S-3 for a period of twelve months. This restriction could adversely affect our ability to raise capital. We may seek a no action letter or other relief from the SEC from the requirement to file the
SCA financials. However, we cannot assure you that we will be successful in obtaining such a letter or other relief. 95
We may be unable to purchase reinsurance and, even if we are able to successfully purchase reinsurance, we are subject to the possibility of uncollectability. We purchase reinsurance for our own account in order to mitigate the volatility that losses impose on our financial condition. Our clients purchase reinsurance from us to cover part of the risk
originally written by them. Retrocessional reinsurance involves a reinsurer ceding to another reinsurer, the retrocessionaire, all or part of the reinsurance that the first reinsurer has assumed.
Reinsurance, including retrocessional reinsurance, does not legally discharge the ceding company from its liability with respect to its obligations to its insureds or reinsureds. A reinsurers or
retrocessionaires insolvency, inability or refusal to make timely payments under the terms of its agreements with us, therefore, could have a material adverse effect on us because we remain liable to
our insureds and reinsureds. At June 30, 2008, we had approximately $4.8 billion of reinsurance recoverables and reinsurance balances receivable, net of reserves for uncollectible recoverables. For
further information regarding our reinsurance exposure, see Managements Discussion and Analysis of Financial Condition and Results of Operations in our Quarterly Report filed on Form 10-Q
for the quarter ended June 30, 2008, which is incorporated by reference in this prospectus supplement and the accompanying prospectus. From time to time, market conditions may limit or prevent us from obtaining the types and amounts of reinsurance that we consider adequate for our business needs such that we may not be
able to obtain reinsurance or retrocessional reinsurance from entities with satisfactory creditworthiness in amounts that we deem desirable or on terms that we deem appropriate or acceptable. Since we depend on a few brokers for a large portion of our revenues, loss of business provided by any one of them could adversely affect us. We market our insurance and reinsurance products worldwide primarily through insurance and reinsurance brokers. Marsh & McLennan Companies and AON Corporation and their respective
subsidiaries provided approximately 18% and 17%, respectively, of our gross written premiums for property and casualty operations for the year ended December 31, 2007. Loss of all or a substantial
portion of the business provided by one or more of these brokers could have a material adverse effect on our business. Our reliance on brokers subjects us to credit risk. In certain jurisdictions, when an insured or ceding insurer pays premiums for policies of insurance or contracts of reinsurance to brokers for further payment to us, such premiums might be
considered to have been paid and the insured or ceding insurer will no longer be liable to us for such amounts, whether or not we have actually received the premiums from the broker. In addition,
in accordance with industry practice, we generally pay amounts owed on claims under our reinsurance contracts to brokers, and these brokers, in turn, pay these amounts over to the clients that have
purchased reinsurance from us. Although the law is unsettled and depends upon the facts and circumstances of the particular case, in some jurisdictions, if a broker fails to make such a claims
payment to the insured or ceding insurer, we might remain liable to the insured or ceding insurer for that non-payment. Consequently, we assume a degree of credit risk associated with the brokers
with whom we transact business. Due to the unsettled and fact-specific nature of the law governing these types of scenarios, we are unable to quantify our exposure to this risk. To date, we have not
experienced any material losses related to such credit risks. Our investment performance may adversely affect our financial results and ability to conduct business. Our assets are invested by a number of professional investment advisory management firms under the direction of our management team in accordance, in general, with detailed investment
guidelines set by us. Although our investment policies stress diversification of risks, conservation of 96
principal and liquidity, our investments are subject to market-wide risks and fluctuations, as well as to risks inherent in particular securities. Investment losses could significantly decrease our asset
base, thereby adversely affecting our ability to conduct business and pay claims. We are exposed to significant capital markets risk related to changes in interest rates, credit spreads, equity prices and foreign exchange rates which may adversely affect our results of operations,
financial condition or cash flows. We are exposed to significant capital markets risk related to changes in interest rates, credit spreads and defaults, market liquidity, equity prices and foreign currency exchange rates. In the first
six months of 2008, particularly in the first quarter, financial market conditions continued to be extremely challenging as the global credit crisis that began in July 2007 continued to adversely impact
global fixed income markets. While credit spreads on both corporate and structured credit improved modestly in the second quarter, spread levels remained wide as at June 30, 2008 as compared to
June 30, 2007, resulting in continuing depressed pricing on credit product. Continuing challenges included continued weakness in the U.S. housing market and increased mortgage delinquencies,
investor anxiety over the U.S. economy, rating agency downgrades of various structured products and financial issuers, unresolved issues with structured investment vehicles and monolines,
deleveraging of financial institutions and hedge funds and a serious dislocation in the inter-bank market. If significant, continued volatility, changes in interest rates, changes in credit spreads and
defaults, a lack of pricing transparency, market liquidity, declines in equity prices, and the strengthening or weakening of foreign currencies against the U.S. dollar, individually or in tandem, could
have a material adverse effect on our consolidated results of operations, financial condition or cash flows through realized losses, impairments, and changes in unrealized positions. Levels of write
down or impairment are impacted by our assessment of the intent and ability to hold securities which have declined in value until recovery. We periodically review our investment portfolio. If, as a
result of such review, we determine to reposition or realign portions of the portfolio where we determine not to hold certain securities in an unrealized loss position to recovery, then we will incur an
other than temporary impairment charge. Our exposure to interest rate risk relates primarily to the market price and cash flow variability associated with changes in interest rates. Our investment portfolio contains interest rate sensitive
instruments, such as fixed income securities, which may be adversely affected by changes in interest rates from governmental monetary policies, domestic and international economic and political
conditions and other factors beyond our control. A rise in interest rates would increase the net unrealized loss position of our investment portfolio, offset by our ability to earn higher rates of return
on funds reinvested. Conversely, a decline in interest rates would decrease the net unrealized loss position of our investment portfolio, offset by lower rates of return on funds reinvested. Our
mitigation efforts with respect to interest rate risk are primarily focused towards maintaining an investment portfolio with diversified maturities that has a weighted average duration that is
approximately equal to the duration of our estimated liability cash flow profile. However, our estimate of the liability cash flow profile may be inaccurate and we may be forced to liquidate
investments prior to maturity at a loss in order to cover liabilities. Although we take measures to manage the economic risks of investing in a changing interest rate environment, we may not be able
to mitigate the interest rate risk of our assets relative to our liabilities. A portion of our risk asset portfolio consists of below investment-grade high yield fixed income securities. These securities, which pay a higher rate of interest, also have a higher degree of credit
or default risk. Certain sectors within the investment and below investment grade fixed income market, such as structured and corporate credit may be less liquid in times of economic weakness or
market disruptions. While we have put in place procedures to monitor the credit risk and liquidity of our invested assets, in general and those impacted by recent credit market issues specifically, it is
possible that, in periods of economic weakness or periods of turmoil in capital markets, we may experience default losses in our portfolio, in particular the structured credit portfolio, which
constituted 32% of our total portfolio as of June 30, 2008. This may result in a material reduction of net income, capital and cash flows. Beginning in the latter half of 2007 and continuing throughout 97
2008, increasing delinquencies in U.S. residential collateral in various securitized products has lead to increased volatility and decreased liquidity across financial markets as a whole. Decreases in
market liquidity have increased the difficulty and volatility in pricing across credit exposed markets. Such illiquidity volatility and related uncertainty may persist or even worsen in the future. We invest a portion of our portfolio in common stock or equity-related securities such as hedge funds and private investments. The value of these assets fluctuates, along with other factors, with
equity and credit markets. In times of economic weakness, the market value and liquidity of these assets may decline, and may impact net income, capital, and cash flows. In addition, certain of the
products offered by our Life Operations segment offer guaranteed benefits which increase our potential benefit exposure should equity markets decline. Our functional currencies of our principal insurance and reinsurance subsidiaries include the U.S. dollar, U.K. sterling, the Euro, the Swiss Franc, and the Canadian dollar. Exchange rate
fluctuations relative to the functional currencies may materially impact our financial position and results of operations. Many of our non-U.S. subsidiaries maintain both assets and liabilities in
currencies different than their functional currency, which exposes us to changes in currency exchange rates. In addition, locally-required capital levels are invested in local currencies in order to satisfy regulatory requirements and to support local insurance operations regardless of currency fluctuations.
Foreign exchange rate risk is reviewed as part of our risk management process. While we utilize derivative instruments such as futures, options and foreign currency forward contracts to, among other
things, manage our foreign currency exposure, it is possible that these instruments will not effectively mitigate all or a substantial portion of our foreign exchange rate risk. Current legal and regulatory activities relating to insurance brokers and agents, contingent commissions, the municipal guaranteed investment contract market and the financial guarantee market
could adversely affect our business, financial condition and results of operations. Contingent commission arrangements have been a focus of investigations by various regulatory agencies, including certain state Attorneys General and insurance departments. Due to various
governmental investigations into contingent commission practices, various market participants have modified or eliminated acquisition expenses formerly arising from Placement Service Agreements
and related arrangements. As a result, it is possible that policy commissions or brokerage that we pay may increase in the future and/or that different forms of contingent commissions will develop in
the future. Any such additional expense could have a material adverse effect on our financial conditions or results. One of our subsidiaries that had been a provider of municipal guaranteed investment contracts (GICs) received a grand jury subpoena in November 2006 from the Antitrust Division of the
U.S. Department of Justice (the DOJ) and a subpoena from the SEC seeking documents pursuant to respective investigations into municipal GICs and related products sold in connection with
municipal bond offerings. Our subsidiary is fully cooperating with these federal industry-wide investigations. In June 2008, subsidiaries of ours also received a subpoena from the Office of the
Connecticut Attorney General and an Antitrust Civil Investigative Demand from the Office of the Florida Attorney General in connection with a coordinated multi-state Attorneys General
investigation into the matters referenced in the DOJ and SEC subpoenas. We are fully cooperating with these investigations. At this time, we are unable to predict the potential effects, if any, that these investigations may have upon us, the insurance and reinsurance markets in general or industry and reinsurance
business practices or what, if any, changes may be made to laws and regulations regarding the industry. Any of the foregoing could also result in litigation or otherwise adversely affect our business,
financial condition, or results of operations. 98
Lawsuits, including putative class action lawsuits, have been filed against us by policyholders and security holders the ultimate outcome of which could have a material adverse effect on our
consolidated financial condition, future operating results and/or liquidity We are subject to lawsuits and arbitrations in the regular course of our business. In addition, lawsuits have been filed against us as detailed in Legal Proceedings in our Quarterly Report filed
on Form 10-Q for the quarter ended June 30, 2008, which is incorporated by reference in this prospectus supplement and the accompanying prospectus. We believe that we have substantial defenses
to all outstanding litigation and intend to pursue our defenses vigorously, although an adverse resolution of one or more of these items could have a material adverse effect on our results of
operations in a particular fiscal quarter or year. The loss of one or more key executives or the inability to attract and retain qualified personnel could adversely affect our ability to conduct business. Our success depends on our ability to retain the services of our existing key executives and to attract and retain additional qualified personnel in the future. The loss of the services of any of our
key executives or the inability to hire and retain other highly qualified personnel in the future could adversely affect our ability to conduct our business. In addition, we do not maintain key man life
insurance policies with respect to our employees. Many of our senior executives working in Bermuda are not Bermudian and our success may depend in part on the continued services of key employees in Bermuda. Under Bermuda law, non-
Bermudians (other than spouses of Bermudians and holders of permanent resident certificates) may not engage in any gainful occupation in Bermuda without an appropriate governmental work
permit. A work permit may be granted or renewed by the Bermuda government for a specific period of time, upon showing that, after proper public advertisement, no Bermudian (or spouse of a
Bermudian or holder of a permanent resident certificate) is available who meets the minimum standards reasonably required by an employer with respect to a certain position. The government of
Bermuda places a six-year term limit on individuals with work permits, subject to certain exemptions for key employees. No assurances can be given that any work permit will be issued or, if issued,
renewed upon the expiration of the relevant term. Because we are a holding company, if our subsidiaries do not make dividend and other payments to us, we may not be able to pay dividends or make payments on our debt securities and other
obligations. As a holding company with no direct operations or significant assets other than the capital stock of our subsidiaries, we rely on investment income, cash dividends and other permitted payments
from our subsidiaries to make principal and interest payments on our debt, to pay operating expenses and common and preferred shareholder dividends and to pay certain of our other obligations
that may arise from time to time. We expect future investment income, dividends and other permitted payments from these subsidiaries to be our principal source of funds to pay such expenses,
preferred and common stock dividends and obligations. The payment of dividends to us by our insurance and reinsurance subsidiaries is limited under the laws of Bermuda, the Cayman Islands, the
U.K., Ireland and certain insurance statutes of various states in the United States in which our insurance and reinsurance subsidiaries are licensed to transact business. Our U.S. insurance and reinsurance subsidiaries are subject to state regulatory restrictions that generally require cash dividends to be paid only out of earned statutory surplus. Further, the
amount payable without the prior approval of the applicable state insurance department is generally limited to the greater of 10% of policyholders surplus or statutory capital, or 100% of the
subsidiarys prior year statutory net income. In addition, Bermuda insurance laws and regulations (i) require our insurance and reinsurance subsidiaries to maintain certain minimum solvency margins
and minimum liquidity ratios, (ii) prohibit dividends that would result in a breach of these requirements, and (iii) limit the amount by which we can reduce surplus without prior approval from the
BMA. 99
In addition, the ability of our insurance and reinsurance subsidiaries to pay dividends could be constrained by our dependence on financial strength ratings from independent rating agencies. Our
ratings from these agencies depend to a large extent on the capitalization levels of our insurance and reinsurance subsidiaries. Any such restriction on our insurance and reinsurance subsidiaries
ability to pay dividends to us could have a material adverse effect on our financial condition and results of operations. Our insurance and reinsurance subsidiaries may not always be able to, or may
not, pay preferred and common stock dividends to us sufficient to make our debt payments and pay our operating expenses, shareholder dividends or other obligations. Risks Related to the Insurance and Reinsurance Industries The insurance and reinsurance industries are historically cyclical and we may experience periods with excess underwriting capacity and unfavorable premium rates. The insurance and reinsurance industries have historically been cyclical, characterized by periods of intense price competition due to excess underwriting capacity as well as periods when
shortages of capacity permitted favorable premium levels. An increase in premium levels is often offset by an increasing supply of insurance and reinsurance capacity, either by capital provided by
new entrants or by the commitment of additional capital by existing insurers or reinsurers, which may cause prices to decrease. Either of these factors could lead to a significant reduction in premium
rates, less favorable policy terms and conditions and fewer submissions for our underwriting services. In addition to these considerations, changes in the frequency and severity of losses suffered by
insureds and insurers may affect the cycles of the insurance and reinsurance industries significantly. Currently, both the insurance and reinsurance industries are experiencing soft market conditions,
including decreases in premium rates across most lines of business, increased competitive pressures and increased retention by insureds and/or cedants. Such soft market conditions may persist for the
foreseeable future. Gross and net premiums written during the three months ended June 30, 2008 decreased by 24.5% and 31.2%, respectively, as compared to the second quarter in 2007. These
decreases resulted from such softening market conditions and us declining certain business where market rates were below our acceptable underwriting return levels, together with increased retentions
by clients. Competition in the insurance and reinsurance industries could reduce our operating margins. The insurance and reinsurance industries are highly competitive. We compete on an international and regional basis with major U.S., Bermudian, European and other international insurers and
reinsurers and with underwriting syndicates, some of which have greater financial and management resources and higher ratings than we do. We also compete with new companies that continue to be
formed to enter the insurance and reinsurance markets. In addition, capital market participants have recently created alternative products that are intended to compete with reinsurance products.
Increased competition could result in fewer submissions, lower premium rates and less favorable policy terms and conditions, which could reduce our margins. Unanticipated losses from terrorism and uncertainty surrounding the future of the TRIPRA could have a material adverse effect on our financial condition and results of operations. In response to the tightening of supply in certain insurance and reinsurance markets resulting from, among other things, the September 11 event, the Terrorism Risk Insurance Program (TRIP)
was created upon the enactment of the U.S. Terrorism Risk Insurance Act of 2002 (TRIA) to ensure the availability of commercial insurance coverage for certain terrorist acts in the U.S. This law
established a federal assistance program through the end of 2005 to help the commercial property and casualty insurance industry cover claims related to future terrorism-related losses and required
that coverage for terrorist acts be offered by insurers. TRIA was originally scheduled to expire at the end of 2005, but was extended in December 2005 for an additional two years. On December 26,
2007, President George Bush approved the Terrorism Risk Insurance Program 100
Reauthorization Act of 2007 (TRIPRA), extending TRIP through December 31, 2014 and also eliminated the distinction between foreign and domestic acts of terrorism. TRIA voided in force terrorism exclusions as of November 26, 2002 for certified terrorism on all TRIA specified property and casualty business. TRIA required covered insurers to make
coverage available for certified acts of terrorism on all new and renewal policies issued after TRIA was enacted. TRIA along with further extensions to TRIP, as noted above, allows us 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 we have otherwise
complied with all the requirements as specified under TRIPRA, we are eligible for reimbursement by the Federal Government for up to 85% of our covered terrorism-related losses arising from a
certified terrorist attack. Such payment by the government will, in effect, provide reinsurance protection on a quota share basis. Entitlement to such reimbursement ends once the aggregated insured
losses for the entire insurance industry exceed $100 billion in a single program year. We believe that TRIP and the related legislation has been an effective mechanism to assist policyholders and industry participants with the extreme contingent losses that might be caused by acts
of terrorism. We cannot assure you that TRIPRA will be extended beyond 2014, and its expiration could have an adverse effect on us, our clients or the insurance industry. Potential government intervention in our industry as a result of recent events and instability in the marketplace for insurance products could hinder our flexibility and negatively affect the business
opportunities that may be available to us in the market. Government intervention and the possibility of future government intervention have created uncertainty in the insurance and reinsurance markets. Government regulators are generally concerned
with the protection of policyholders to the exclusion of other constituencies, including shareholders of insurers and reinsurers. While we cannot predict the exact nature, timing or scope of possible
governmental initiatives, such proposals could adversely affect our business by, among other things:
Providing insurance and reinsurance capacity in markets and to consumers that we target, e.g., the creation or expansion of a state or federal catastrophe funds such as those in Florida; Requiring our participation in industry pools and guarantee associations; Expanding the scope of coverage under existing policies; Regulating the terms of insurance and reinsurance policies; or Disproportionately benefiting the companies of one country over those of another. The insurance industry is also affected by political, judicial and legal developments that may create new and expanded theories of liability, which may result in unexpected claims frequency and
severity and delays or cancellations of products and services by insureds, insurers and reinsurers which could adversely affect our business. Consolidation in the insurance industry could adversely impact us. Insurance industry participants may seek to expand through mergers and acquisitions. Continued consolidation within the insurance industry will further enhance the already competitive
underwriting environment as we would likely experience more robust competition from larger, better capitalized competitors. These consolidated entities may use their enhanced market power and
broader capital 101
base to negotiate price reductions for our products and services, and reduce their use of reinsurance, and as such, we may experience rate declines and possibly write less business. Risks Related to Regulation The regulatory regimes under which we operate, and potential changes thereto, could have a material adverse effect on our business. Our insurance and reinsurance subsidiaries operate in 28 countries around the world as well as in all 50 U.S. states. Our operations in each of these jurisdictions are subject to varying degrees of
regulation and supervision. The laws and regulations of the jurisdictions in which our insurance and reinsurance subsidiaries are domiciled require, among other things, that these subsidiaries maintain
minimum levels of statutory capital, surplus and liquidity, meet solvency standards, submit to periodic examinations of their financial condition and restrict payments of dividends and reductions of
capital. Statutes, regulations and policies that our insurance and reinsurance subsidiaries are subject to may also restrict the ability of these subsidiaries to write insurance and reinsurance policies,
make certain investments and distribute funds. In recent years, the U.S. insurance regulatory framework has come under increased federal scrutiny. In addition, some state legislatures have considered or enacted laws that may alter or increase
state regulation of insurance and reinsurance companies and holding companies. Moreover, the National Association of Insurance Commissioners, which is the organization of insurance regulators
from the 50 U.S. states, the District of Columbia and the four U.S. territories, as well as state insurance regulators regularly reexamine existing laws and regulations. We may not be able to comply fully with, or obtain desired exemptions from, revised statutes, regulations and policies that govern the conduct of our business. Failure to comply with, or to
obtain desired authorizations and/or exemptions under, any applicable laws could result in restrictions on our ability to do business or undertake activities that are regulated in one or more of the
jurisdictions in which we operate and could subject us to fines and other sanctions. In addition, changes in the laws or regulations to which our insurance and reinsurance subsidiaries are subject, or in
the interpretations thereof by enforcement or regulatory agencies, could have a material adverse effect on our business. If our Bermuda operating subsidiaries become subject to insurance statutes and regulations in jurisdictions other than Bermuda or if there is a change in Bermuda law or regulations or the
application of Bermuda law or regulations, there could be a significant and negative impact on our business. XL Insurance (Bermuda) Ltd and XL Re Ltd, two of our wholly-owned operating subsidiaries, are registered Bermuda Class 4 insurers. As such, they are subject to regulation and supervision in
Bermuda. Bermuda insurance statutes and the regulations and policies of the BMA require XL Insurance (Bermuda) Ltd and XL Re Ltd to, among other things:
maintain a minimum level of capital and surplus; maintain solvency margins and liquidity ratios; restrict dividends and distributions; obtain prior approval regarding the ownership and transfer of shares; maintain a principal office and appoint and maintain a principal representative in Bermuda; file an annual statutory financial return; and 102
allow for the performance of certain periodic examinations of XL Insurance (Bermuda) Ltd and XL Re Ltd and their respective financial conditions. These statutes and regulations may restrict our ability to write insurance and reinsurance policies, distribute funds and pursue our investment strategy. We do not presently intend for XL Insurance (Bermuda) Ltd and XL Re Ltd to be admitted to do business in the United States, the United Kingdom or any jurisdiction other than Bermuda.
However, we cannot provide assurance that insurance regulators in the United States, the United Kingdom or elsewhere will not review the activities of XL Insurance (Bermuda) Ltd or XL Re Ltd,
their respective subsidiaries or their agents and claim that XL Insurance (Bermuda) Ltd or XL Re Ltd is subject to such jurisdictions licensing requirements. If any such claim is successful and XL
Insurance (Bermuda) Ltd or XL Re Ltd must obtain licenses in a jurisdiction other than Bermuda, we may be subject to taxation in such jurisdiction. In addition, XL Insurance (Bermuda) Ltd and XL Re Ltd are subject to indirect regulatory requirements imposed by jurisdictions that may limit their ability to provide insurance or reinsurance
to that jurisdictions domestic insurers or reinsurers. For example, the ability of XL Insurance (Bermuda) Ltd and XL Re Ltd to write insurance or reinsurance may be subject, in certain cases, to a
countrys limits on how much reinsurance can be purchased from non-domestic reinsurers or requirements that such non-domestic reinsurers collateralize their payment obligations to domestic ceding
companies. If we are unable to collateralize or provide other credit support for these reinsurance clients on commercially reasonable terms, we could be limited in our ability to write business for
some of our clients. Proposed legislation and regulations may have the effect of imposing additional requirements upon, or restricting the market for, non-domestic insurers or reinsurers with whom
domestic companies place business. Generally, Bermuda insurance statutes and regulations applicable to XL Insurance (Bermuda) Ltd and XL Re Ltd are less restrictive than those that would be applicable if they were governed
by the laws of any state in the United States. If in the future we become subject to any insurance laws of the United States or any state thereof or of any other jurisdiction, we cannot provide
assurance that we would be in compliance with such laws or that complying with such laws would not have a significant and negative effect on our business. The process of obtaining licenses is very time consuming and costly and XL Insurance (Bermuda) Ltd and XL Re Ltd may not be able to become licensed in jurisdictions other than Bermuda
should we choose to do so. The modification of the conduct of our business that would result if we were required or chose to become licensed in certain jurisdictions could significantly and negatively
affect our financial condition and results of operations. In addition, our inability to comply with insurance statutes and regulations could significantly and adversely affect our financial condition and
results of operations by limiting our ability to conduct business as well as subjecting us to penalties and fines. Because XL Insurance (Bermuda) Ltd and XL Re Ltd are Bermuda companies, they are subject to changes in Bermuda law and regulation that may have an adverse impact on our operations,
including through the imposition of tax liability or increased regulatory supervision. In addition, XL Insurance (Bermuda) Ltd and XL Re Ltd will be exposed to any changes in the political
environment in Bermuda, including, without limitation, changes as a result of the independence issues currently being discussed in Bermuda. The Bermuda insurance and reinsurance regulatory
framework recently has become subject to increased scrutiny in many jurisdictions, including the United Kingdom. While we cannot predict the future impact on our operations of changes in the laws
and regulation to which we are or may become subject, any such changes could have a material adverse effect on our business, financial condition and results of operations. 103
Changes in current accounting practices and future pronouncements may materially impact our reported financial results. Unanticipated developments in accounting practices may require us to incur considerable additional expenses to comply with such developments, particularly if we are required to prepare
information relating to prior periods for comparative purposes or to apply the new requirements retroactively. The impact of changes in current accounting practices and future pronouncements
cannot be predicted but may affect the calculation of net income, net equity, and other relevant financial statement line items. In particular, recent guidance and ongoing projects put in place by
standard setters globally have indicated a possible move away from the current insurance accounting models toward more fair value based models which could introduce significant volatility in the
earnings of insurance industry participants. Risks Related to Taxation We and our Bermuda insurance subsidiaries may become subject to taxes in Bermuda after March 28, 2016, which may have a material adverse effect on our financial condition, results of
operations and your investment. We and our Bermuda insurance subsidiaries have received from the Ministry of Finance in Bermuda exemptions from any Bermuda taxes that might be imposed on profits, income or any capital
asset, gain or appreciation until March 28, 2016. The exemptions are subject to the proviso that they are not construed so as to prevent the application of any tax or duty to such persons as are
ordinarily resident in Bermuda (we and our Bermuda insurance subsidiaries are not so currently designated) and to prevent the application of any tax payable in accordance with the provisions of
The Land Tax Act 1967 or otherwise payable in relation to the land leased to us and our Bermuda insurance subsidiaries. We, as a permit company under The Companies Act 1981 of Bermuda, have
received similar exemptions, which are effective until March 28, 2016. We and our Bermuda insurance subsidiaries are required to pay certain annual Bermuda government fees and certain business
fees as an insurer under The Insurance Act 1978 of Bermuda. Currently there is no Bermuda withholding tax on dividends paid by our Bermuda insurance subsidiaries to us. Given the limited
duration of the Ministry of Finances assurance, we cannot be certain that we or our Bermuda insurance subsidiaries will not be subject to any Bermuda tax after March 28, 2016. Such taxation could
have a material adverse effect on our financial condition, results of operations and the price of our ordinary shares. We may become subject to taxes in the Cayman Islands after June 2, 2018, which may have a material adverse effect on our results of operations and your investment. Under current Cayman Islands law, we are not obligated to pay any taxes in the Cayman Islands on our income or gains. We have received an undertaking from the Governor-in-Council of the
Cayman Islands pursuant to the provisions of the Tax Concessions Law, as amended, that until June 2, 2018, (i) no subsequently enacted law imposing any tax on profits, income, gains or
appreciation shall apply to us and (ii) no such tax and no tax in the nature of an estate duty or an inheritance tax shall be payable on any of our ordinary shares, debentures or other obligations.
Under current law, no tax will be payable on the transfer or other disposition of our ordinary shares. The Cayman Islands currently impose stamp duties on certain categories of documents; however,
our current operations do not involve the payment of stamp duties in any material amount. The Cayman Islands also currently impose an annual corporate fee upon all exempted companies
incorporated in the Cayman Islands. Given the limited duration of the undertaking from the Governor-in-Council of the Cayman Islands, we cannot be certain that we will not be subject to any
Cayman Islands tax after June 2, 2018. Such taxation could have a material adverse effect on our financial condition, results of operations and your investment. 104
We and our Bermuda insurance subsidiaries may become subject to U.S. tax, which may have a material adverse effect on our results of operations and your investment. We take the position that neither we nor any of our Bermuda insurance subsidiaries are engaged in a U.S. trade or business through a U.S. permanent establishment. Accordingly, we take the
position that none of our Bermuda insurance subsidiaries should be subject to U.S. tax (other than U.S. excise tax on insurance and reinsurance premium income attributable to insuring or reinsuring
U.S. risks and U.S. withholding tax on some types of U.S. source investment income). However, because there is considerable uncertainty as to the activities that constitute being engaged in a trade
or business within the United States, we cannot be certain that the U.S. Internal Revenue Service (the IRS) will not contend successfully that we or any of our Bermuda insurance subsidiaries are
engaged in a trade or business in the United States. If we or any of our Bermuda insurance subsidiaries were considered to be engaged in a trade or business in the United States, any such entity
could be subject to U.S. corporate income and additional branch profits taxes on the portion of its earnings effectively connected to such U.S. business, in which case our financial condition and
results of operations could be materially adversely affected. See Certain Tax ConsiderationsTaxation of XL Capital and XLUnited States. The Organisation for Economic Co-operation and Development is considering measures that might change the manner in which we are taxed. On July 17, 2008, the Organisation for Economic Co-operation and Development (the OECD) issued the final version of its Report on the Attribution of Profits to Permanent Establishments
(the Report). The Report is the final report on the OECDs project to establish a broad consensus regarding the interpretation and practical application of Article 7 of the OECD Model Tax
Convention on Income and on Capital (Article 7). Article 7 sets forth international tax principles for attributing profits to a permanent establishment and forms the basis of an extensive network of
bilateral income tax treaties between OECD member countries and between many OECD member and non-member countries. Part IV of the Report addresses the attribution of profits to a
permanent establishment of an enterprise that conducts insurance activities. The OECD has undertaken to implement the conclusions of the Report in two phases. First, to provide improved certainty for the interpretation of existing treaties based on the current text of
Article 7, the OECD has revised the commentary to the current version of Article 7 to take into account the conclusions of the Report that do not conflict with the existing interpretation of Article 7
reflected in the previous commentary. Second, to reflect the full conclusions of the Report, the OECD intends to issue a new version of Article 7 and related commentary to be used in the
negotiation of new treaties and amendments to existing treaties. A discussion draft of the new Article 7 and related commentary was released on July 7, 2008, and the final version of this new Article
7 is expected to be released in 2010. The final version of new Article 7 might include provisions that could change the manner in which we are taxed. If an investor acquires 10% or more of our ordinary shares, it may be subject to taxation under the controlled foreign corporation (the CFC) rules. Under certain circumstances, a U.S. person who owns 10% or more of the voting power of a foreign corporation that is a CFC (a foreign corporation in which 10% U.S. shareholders own more
than 50% of the voting power of the foreign corporation or more than 25% of a foreign insurance company) for an uninterrupted period of 30 days or more during a taxable year must include in
gross income for U.S. federal income tax purposes such 10% U.S. Shareholders pro rata share of the CFCs subpart F income, even if the subpart F income is not distributed to such 10% U.S.
Shareholder, if such 10% U.S. Shareholder owns (directly or indirectly through foreign entities) any shares of the foreign corporation on the last day of the corporations taxable year. Subpart F
income of a foreign insurance corporation typically includes foreign personal holding company income (such as interest, dividends and other types of passive income), as well as insurance and
reinsurance income (including underwriting and investment income) attributable to the insurance of 105
risks situated outside the CFCs country of incorporation. Ownership of the units being issued in these offerings (or ownership of the 7.00% Equity Security Units we issued in 2005) by a U.S. person
may cause such person to be treated for U.S. federal income tax purposes as the owner of our ordinary shares prior to the purchase contract settlement date. For purposes of interpreting the voting
restrictions in our Articles of Association, we intend to treat the ordinary shares issuable upon settlement of a purchase contract underlying a unit as currently owned by the holder of that unit. See
Certain Tax ConsiderationsTaxation of ShareholdersOwnership and Disposition of Ordinary SharesClassification as a Controlled Foreign Corporation. We believe that because of the dispersion of our share ownership, provisions in our organizational documents that limit voting power and other factors, no U.S. person or U.S. partnership that
acquires our shares directly or indirectly through one or more foreign entities should be required to include its subpart F income in income under the CFC rules of the Code. See Description of
XL Capital Ordinary Shares in the accompanying prospectus for a description of these provisions. It is possible, however, that the IRS could challenge the effectiveness of these provisions and that a
court could sustain such a challenge, in which case an investors investment could be materially adversely affected, if the investor is considered to own 10% or more of our shares. U.S. Persons who hold shares will be subject to adverse tax consequences if we are considered to be a Passive Foreign Investment Company (a PFIC) for U.S. federal income tax purposes. If we are considered a PFIC for U.S. federal income tax purposes, a U.S. person who owns any of our shares will be subject to adverse tax consequences, including a greater tax liability than
might otherwise apply and tax on amounts in advance of when tax would otherwise be imposed, in which case an investors investment could be materially adversely affected. In addition, if we were
considered a PFIC, upon the death of any U.S. individual owning shares, such individuals heirs or estate would not be entitled to a step-up in the basis of the shares which might otherwise be
available under U.S. federal income tax laws. We believe that we are not, have not been, and currently do not expect to become, a PFIC for U.S. federal income tax purposes. We cannot provide
absolute assurance, however, that we will not be deemed a PFIC by the IRS. If we were considered a PFIC, it could have material adverse tax consequences for an investor that is subject to U.S.
federal income taxation. There are currently no regulations regarding the application of the PFIC provisions to an insurance company. New regulations or pronouncements interpreting or clarifying
these rules may be forthcoming. We cannot predict what impact, if any, such guidance would have on an investor that is subject to U.S. federal income taxation. See Certain Tax
ConsiderationsTaxation of ShareholdersUnited StatesTaxation of U.S. Holders of Ordinary SharesOwnership and Dispositions of Ordinary SharesPassive Foreign Investment Companies. There is U.S income tax risk associated with reinsurance between U.S. insurance companies and their Bermuda affiliates. Congress has periodically considered legislation intended to eliminate certain perceived tax advantages of Bermuda insurance companies and U.S. insurance companies with Bermuda affiliates,
including perceived tax benefits resulting principally from reinsurance between or among U.S. insurance companies and their Bermuda affiliates. In this regard, section 845 of the Code was amended
in 2004 to permit the IRS to reallocate, recharacterize or adjust items of income, deduction or certain other items related to a reinsurance agreement between related parties to reflect the proper
amount, source or character for each item (in contrast to prior law, which only covered source and character). If the IRS were to successfully challenge our reinsurance arrangements under
section 845, our financial condition and results of operations could be materially adversely affected and the price of our ordinary shares could be adversely affected. 106
There are U.S. income tax risks associated with the related person insurance income of our non-U.S. insurance subsidiaries. If (i) the related person insurance income, which we refer to as RPII, of any one of our non-U.S. insurance subsidiaries were to equal or exceed 20% of that subsidiarys gross insurance
income in any taxable year and (ii) U.S. persons were treated as owning 25% or more of the subsidiarys stock (by vote or value), a U.S. person who owns any ordinary shares, directly or indirectly,
on the last day of such taxable year on which the 25% threshold is met would be required to include in its income for U.S. federal income tax purposes that persons ratable share of that subsidiarys
RPII for the taxable year, determined as if that RPII were distributed proportionately only to U.S. holders at that date, regardless of whether that income is distributed. The amount of RPII earned
by a subsidiary (generally premium and related investment income from the direct or indirect insurance or reinsurance of any direct or indirect U.S. holder of shares of that subsidiary or any person
related to that holder) would depend on a number of factors, including the identity of persons directly or indirectly insured or reinsured by that subsidiary. Although we do not believe that the 20%
threshold will be met in respect of any of our non-U.S. insurance subsidiaries, some of the factors that may affect the result in any period may be beyond our control. Consequently, we cannot
provide absolute assurance that we will not exceed the RPII threshold in any taxable year. The RPII rules provide that if a holder who is a U.S. person disposes of shares in a non-U.S. insurance corporation that had RPII (even if the 20% gross income threshold was not met) and met
the 25% ownership threshold at any time during the five-year period ending on the date of disposition, and the holder owned any stock at such time, any gain from the disposition will generally be
treated as a dividend to the extent of the holders share (taking into account certain rules for determining a U.S. holders share of RPII) of the corporations undistributed earnings and profits that
were accumulated during the period that the holder owned the shares (possibly whether or not those earnings and profits are attributable to RPII). In addition, such a shareholder will be required to
comply with specified reporting requirements, regardless of the amount of shares owned. We believe that these rules should not apply to dispositions of our ordinary shares because XL Capital is not
itself directly engaged in the insurance business. We cannot provide absolute assurance, however, that the IRS will not successfully assert that these rules apply to dispositions of our ordinary shares.
See Certain Tax ConsiderationsTaxation of ShareholdersUnited StatesTaxation of U.S. Holders of Ordinary SharesOwnership and Dispositions of Ordinary SharesRelated Person Insurance Income. Changes in U.S. tax law might adversely affect an investment in our shares. The tax treatment of non-U.S. companies and their U.S. and non-U.S. insurance subsidiaries has been the subject of Congressional discussion and legislative proposals. For example, one
legislative proposal would impose additional limits on the deductibility of interest by foreign-owned U.S. corporations. Another legislative proposal would treat a non-U.S. corporation as a U.S.
corporation for U.S. federal income tax purposes if it were considered to be primarily managed and controlled in the U.S. We cannot assure you that future legislative action will not increase the
amount of U.S. tax payable by us. If this happens, our financial condition and results of operations could be materially adversely affected. Additionally, the U.S. federal income tax laws and interpretations, including those regarding whether a company is engaged in a trade or business (or has a permanent establishment) within the
United States or is a PFIC, or whether U.S. holders would be required to include in their gross income subpart F income or the RPII of a CFC, are subject to change, possibly on a retroactive
basis. There are currently no regulations regarding the application of the PFIC rules to insurance companies and the regulations regarding RPII are still in proposed form. New regulations or
pronouncements interpreting or clarifying such rules may be forthcoming. We cannot be certain if, when or in what form such regulations or pronouncements may be provided and whether such
guidance will have a retroactive effect. 107
Risks Related to our Ordinary Shares Provisions in our Articles of Association may reduce the voting rights of our ordinary shares. Our Articles of Association generally provide that shareholders have one vote for each ordinary share held by them and are entitled to vote, on a non-cumulative basis, at all meetings of
shareholders. However, the voting rights exercisable by a shareholder may be limited so that certain persons or groups are not deemed to hold 10% or more of the voting power conferred by our
ordinary shares. Under these limitations, some shareholders may have less than one vote for each ordinary share held by them. Moreover, these limitations could have the effect of reducing the
voting power of some shareholders who would not otherwise be subject to such limitations by virtue of their direct share ownership. See Description of XL Capital Ordinary Shares in the
accompanying prospectus. Provisions in our Articles of Association may restrict the ownership and transfer of our ordinary shares. Our Articles of Association provide that our Board of Directors shall decline to register a transfer of shares if it appears to our Board of Directors, whether before or after such transfer, that the
effect of such transfer would be to increase the number of shares owned or controlled by any person to 10% or more of any class of voting shares, the total issued shares of XL Capital Ltd or the
voting power of XL Capital Ltd. In addition, our Articles of Association also provide that if, and for so long as, the votes conferred on any person by the ownership or control of our shares
(including any preference ordinary shares) constitute 10% or more of the votes conferred by our issued shares, each such share held by such person shall confer only a fraction of the vote that would
otherwise be conferred, as determined by the formula described in our Articles of Association, and such voting rights will continue to be readjusted until no shareholders voting rights exceed this
limitation as a result of such reduction. Notwithstanding the foregoing, our Board of Directors may make such final adjustments to the aggregate number of votes conferred on any person by the
ownership or control of shares that they consider fair and reasonable, in the light of all applicable circumstances, to ensure that such votes represent less than 10% of the aggregate voting power of
the votes conferred by all our issued shares. See Description of XL Capital Ordinary Shares in the accompanying prospectus. For these purposes, references to ownership or control of our shares
mean ownership within the meaning of Section 958 of the Code and Section 13(d)(3) of the Securities Exchange Act of 1934, as amended. Certain provisions in our charter documents and Rights Agreement could, among other things, impede an attempt to replace our directors or to effect a change of control, which could diminish the
value of our ordinary shares. Our articles of association contain provisions that may make it more difficult for shareholders to replace directors and could delay or prevent a change of control that a shareholder might
consider favorable. These provisions include a staggered board of directors, limitations on the ability of shareholders to remove directors, limitations on voting rights and certain transfer restrictions on
our ordinary shares. In addition, certain provisions in our Rights Agreement could delay or prevent a change of control that a shareholder might consider favorable. These provisions may prevent a
shareholder from receiving the benefit of any premium over the market price of our ordinary shares offered by a bidder in connection with a potential takeover. Even in the absence of a takeover
attempt or an attempt to effect a change in management, these provisions may adversely affect the prevailing market price of our ordinary shares if they are viewed as discouraging takeover attempts
in the future. See Description of XL Capital Ordinary Shares in the accompanying prospectus and Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of
Equity Securities in our Annual Report filed on Form 10-K for the year ended December 31, 2007, which is incorporated by reference in this prospectus supplement and the accompanying
prospectus. In addition, insurance regulations in certain jurisdictions may also delay or prevent a change of 108
control or limit the ability of a shareholder to acquire in excess of specified amounts of our ordinary shares. It may be difficult to enforce judgments against XL Capital Ltd or its directors and executive officers. XL Capital Ltd is incorporated pursuant to the laws of the Cayman Islands and our principal executive offices are in Bermuda. In addition, certain of our directors and officers reside outside the
United States and a substantial portion of our assets and the assets of such directors and officers are located outside the United States. As such, it may be difficult or impossible to effect service of
process within the United States upon those persons or to recover on judgments of U.S. courts against us or our directors and officers, including judgments predicated upon civil liability provisions of
U.S. federal securities laws. We have been advised by our Cayman counsel that there is doubt as to whether the courts of the Cayman Islands would enforce:
judgments of U.S. courts based upon the civil liability provisions of U.S. federal securities laws obtained in actions against XL Capital Ltd or its directors and officers who reside outside the
United States; or original actions brought in the Cayman Islands against these persons or XL Capital Ltd predicated solely upon U.S. federal securities laws. We have also been advised that there is no treaty in effect between the United States and the Cayman Islands providing for such enforcement and there are grounds upon which Cayman Islands
courts may not enforce judgments of United States courts. Some remedies available under the laws of U.S. jurisdictions, including some remedies available under U.S. federal securities laws, may not
be allowed in Cayman Islands courts as contrary to public policy. U.S. persons who own our ordinary shares may have more difficulty protecting their interests than U.S. persons who are shareholders of a U.S. corporation. The law applicable to companies established in the Cayman Islands, under which we are governed, differs in certain material respects from laws generally applicable to U.S. corporations and their
shareholders. These differences include the manner in which directors must disclose transactions in which they have an interest and their ability to vote notwithstanding a conflict of interest, the rights
of shareholders to bring class action and derivative lawsuits and the scope of indemnification available to directors and officers. Future sales of shares of our ordinary shares, including ordinary shares held by our insiders or shares issued to SCA in connection with the SCA Agreement, may depress the price of our ordinary
shares. Any sales of a substantial number of ordinary shares, or the perception that those sales might occur, may cause the market price of our ordinary shares to decline. Although SCA has agreed not to sell the 8,000,000 newly issued ordinary shares it will receive as part of the SCA Agreement prior to the expiration of the 180-day lock up period, the lock-up
agreement is only a contractual agreement, which could be waived by us and Goldman, Sachs & Co. and UBS Securities LLC at an earlier time without prior public notice or announcement and allow
SCA to sell ordinary shares prior to the expiration of such period. In addition, certain of our executive officers and directors have entered into a lock-up agreement with the underwriters not to sell
ordinary shares for a period of 90 days, but those lock-up agreements are subject to certain exceptions and could be waived by the underwriters at an earlier time, allowing our executive officers or
directors to sell ordinary shares prior to the expiration of the 90-day lock up period. Any such sales prior to or following the expiration of the applicable lock-up periods, if significant, could reduce
the market price for our ordinary shares. For a more detailed description of the lock-up agreements, see Underwriting. 109
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS (c) Purchases of Equity Securities by the Issuer and Affiliate Purchasers The following table provides information about purchases by the Company during the three months ended June 30, 2008 of equity securities that are registered by the Company pursuant to
Section 12 of the Exchange Act:
Period
Total Number
Average Price
Total Number
Approximate Dollar April 1-30, 2008
6,930
32.62
$
375.5 million May 1-31, 2008
$
375.5 million June 1-30, 2008
4,023
34.91
$
375.5 million Total
10,953
33.46
$
375.5 million
(1)
All shares were purchased in connection with the vesting of restricted shares granted under the Companys 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 Companys share repurchase program noted below. (2) On September 24, 2007, the Board of Directors of the Company approved a share repurchase program, authorizing the Company to repurchase up to $500.0 million of its Class A ordinary shares. As at June 30, 2008, the Company could
repurchase $375.5 million of its equity securities under the share repurchase program. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS At the Annual General Meeting of holders of Class A Ordinary Shares (the Shareholders) held on April 25, 2008 at the Executive Offices of the Company, XL House, One Bermudiana Road,
Hamilton HM 11, Bermuda, the Shareholders approved the following: 1. The election of three Class I Directors to hold office until 2011:
Votes in Favor
Votes Withheld Herbert N. Haag
151,932,704
6,207,076 Ellen E. Thrower
146,000,424
12,139,356 John M. Vereker
155,318,665
2,821,115 In addition, the terms of the following Directors continued after the Annual General Meeting: D.R. Comey, R. Glauber, B.M. OHara, J.T. Thornton, J. Mauriello, E.M. McQuade, R.S. Parker,
and A.Z. Senter. 2. The appointment of PricewaterhouseCoopers LLP, New York, New York, to act as the registered independent public accounting firm for the Company for the year ending December 31, 2008:
Votes In Favor
Votes Against
Abstentions
155,710,947
1,375,040
1,053,793 3. Approval of the amendment of the Companys Directors Stock and Option Plan
Votes In Favor
Votes Against
Abstentions
137,319,080
11,581,544
1,283,754 110
of Shares
Purchased (1)
Paid
per Share
of Shares
Purchased as
Part of
Publicly
Announced Plans
or Programs
Value of Shares
that May Yet Be
Purchased Under
the Plans
or Programs (2)
10.1**
Operational Transformation Services Agreement between Accenture LLP and XL Global
Services, Inc.
31**
Rule 13a-14(a)/15d-14(a) Certifications
32**
Section 1350 Certification
** 111
Filed herewith
Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
XL CAPITAL LTD
Date: July 28, 2008
/s/ MICHAEL S. MCGAVICK
Michael S. McGavick
Date: July 28, 2008
/s/ BRIAN W. NOCCO
Brian W. Nocco 112
(Registrant)
Chief Executive Officer
Executive Vice President and
Chief Financial Officer
XL OT Programme |
Accenture |
Exhibit 10.1
OPERATIONAL TRANSFORMATION SERVICES AGREEMENT
Between
ACCENTURE LLP
and
XL GLOBAL SERVICES, INC
Commercial-in-Confidence | 1 |
|
OPERATIONAL TRANSFORMATION | ||
SERVICES AGREEMENT |
XL OT Programme | Accenture |
CONTENTS |
|||||
PART A INTERPRETATION | |||||
1 | . | Definitions | |||
2 | . | Interpretation | |||
PART B - SERVICES | |||||
3 | . | Transformation Services | |||
4 | . | Statements of Work | |||
5 | . | Support Services | |||
6 | . | XL Affiliates | |||
7 | . | Additional Terms | |||
8 | . | Accenture Alliances | |||
9 | . | Outsourcing | |||
PART C - OPERATIONAL | |||||
10 | . | Joint Responsibility | |||
11 | . | Dependencies and XL Responsibilities | |||
12 | . | Relief Events | |||
13 | . | Subcontractors | |||
14 | . | Timetable | |||
15 | . | Acceptance | |||
16 | . | Governance | |||
17 | . | Change Control Procedure | |||
18 | . | Electronic Communication | |||
19 | . | Regulatory Compliance | |||
20 | . | Regulatory Change | |||
21 | . | Policies | |||
PART D - FINANCIAL | |||||
22 | . | Charges and Audit | |||
23 | . | Payment | |||
24 | . | Taxes | |||
PART E INTELLECTUAL PROPERTY | |||||
25 | . | Intellectual Property Rights | |||
26 | . | Licensed Proprietary Assets | |||
PART F CONFIDENTIALITY AND DATA PROTECTION | |||||
27 | . | Confidentiality | |||
28 | . | Data Protection | |||
PART G - LIABILITY |
Commercial-in-Confidence | 2 |
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SERVICES AGREEMENT |
XL OT Programme | Accenture |
29. | Warranties and Covenants | ||
30. | Indemnities | ||
31. | Liability | ||
32. | Force Majeure | ||
33. | Insurance | ||
PART H TERM AND TERMINATION | |||
34. | Term and Termination | ||
35. | Effect of Termination | ||
PART I MISCELLANEOUS | |||
36. | Employees and Employment Claims | ||
37. | Publicity | ||
38. | Notices | ||
39. | Waiver | ||
40. | Entire Agreement | ||
41. | Conflict | ||
42. | Amendment | ||
43. | Relationship | ||
44. | Third Party Rights | ||
45. | Assignment | ||
46. | Dispute Resolution | ||
47. | Governing Law | ||
48. | Execution | ||
49. | Schedules | ||
SCHEDULES | |||
1 | Transformation Services | ||
2 | Statement of Work Template | ||
3 | Charges | ||
4 | Capacity Services | ||
5 | Acceptance and Warranty | ||
6 | Governance | ||
7 | Change Control Procedure | ||
8 | XL Affiliates | ||
9 | XL Compliance Guidelines | ||
10 | WPDR Process | ||
11 | Key Personnel | ||
12 | Data Transfer Agreement | ||
13 | XL Policies | ||
Appendices | |||
1 | Executed WPDRs |
Commercial-in-Confidence | 3 |
|
OPERATIONAL TRANSFORMATION | ||
SERVICES AGREEMENT |
XL OT Programme | Accenture |
OPERATIONAL TRANSFORMATION SERVICES AGREEMENT DATED |
2008 |
|
PARTIES |
1 | Accenture LLP, having its registered office at 161 North Clark, Chicago, Illinois 60601 ("Accenture"); and |
2 | XL Global Services, Inc, a Delaware Corporation, with offices located at 70 Seaview Avenue, Stamford, CT 06902 ("XL). |
WHEREAS
(A) | XL is a leading global provider of commercial property and casualty insurance; |
(B) | Accenture is a leading provider of consulting and technology services, including business consulting, system consulting, information technology consulting, training, computer programming and other consulting services; |
(C) | XL is carrying out the OT Programme (as defined below); and |
(D) | Accenture has agreed to assist XL with the OT Programme, in accordance with the terms and conditions of this Agreement. |
IT IS AGREED AS FOLLOWS:
PART A INTERPRETATION
1 | Definitions |
1.1 | In this Agreement and the following definitions will apply unless inconsistent with the context or otherwise specified. |
Accenture Affiliate means any other person that, directly or indirectly, through one or more intermediaries, is controlled by or under common control with Accenture. For the purposes of this definition, control (including, with correlative meanings, the terms controlled by and under common control with), as used with respect to any person, means the possession, directly or indirectly, of the power to direct or cause the direction of the management or policies of such person, whether through the ownership of voting securities, by contract or otherwise; | |
Accenture Group means Accenture and the Accenture Affiliates; | |
Accenture Knowledge Capital means any reports, documents, templates, studies, software programs in both source code and object code, specifications, business methods, tools, methodologies, processes, techniques, analytical frameworks, algorithms, know-how, processes, products documentation, abstracts and summaries thereof, and other work product and materials (i) existing prior to commencement of the Services, (ii) developed outside the scope of the Services, or (iii) arising from the performance of the Services that are not part of the Deliverables (whether conceived or developed or lawfully acquired by Accenture Group individually or jointly with the XL | |
Commercial-in-Confidence | 4 |
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Group and others), that are proprietary to the Accenture Group or to third parties, including all Intellectual Property Rights therein and together with any derivatives, enhancements and/or modifications thereto whether or not developed as part of the Services. Accenture QA means Accentures internal quality assurance processes and measures referred to in clause 27.4 which are confidential to Accenture; Acceptance Criteria means material conformity with the specifications of the applicable WPDR or SOW and any specific acceptance criteria documented and agreed in the relevant WPDR or SOW (as updated by mutual agreement between the Parties); Acceptance Test means the relevant acceptance tests referred to in Schedule 5; ADM means the various and applicable Accenture Delivery Methodologies followed by Accenture in the performance of the Services. ADM is part of Accenture Knowledge Capital; Agreement means this document and any schedules, appendices and attachments hereto as amended and supplemented from time to time (including any WPDRs, Statements of Work and Change Control Notices executed by the Parties); Arrangement Letters means the arrangement letters relating to certain services provided by members of the Accenture Group to members of the XL Group prior to the date of this Agreement and including the arrangement letter between (1) Accenture AG and (2) XL Services Switzerland in relation to the Operational Transformation Program Phase 2 stages 1 and 2 (countersigned by XL Services Switzerland on 22 September 2007), Operational Transformation Program Phase 3 (Initial Mobilisation) dated 21 January 2008. Assumptions means the assumptions relating to the Project and the Services stipulated or referred to in this Agreement including its Schedules, any WPDRs and Statements of Work upon which the agreed terms pertaining to the Services or Project are based; Business Day means a day when clearing banks are ordinarily open for business in the City of New York, NY (other than a Saturday or Sunday); Capacity Services means the capacity services to be provided by Accenture to XL described in Clause 5.2 and Schedule 4; Change Control Procedure means the procedure detailed in Schedule 7 pertaining to the variation of this Agreement or any WPDR or Statement of Work; Change Notice means the notice given in accordance with Schedule 7 which specifies the change(s) agreed between the Parties; "Charges" means the fees and expenses payable to Accenture under this Agreement;
|
|
Commercial-in-Confidence | 5 |
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OPERATIONAL TRANSFORMATION | ||
SERVICES AGREEMENT |
XL OT Programme | Accenture |
"Confidential Information" means (a) any and all information (whether commercial, financial, technical or otherwise) relating to the disclosing party and XL Affiliates and Accenture Affiliates as the case may be, their respective employees, sub-contractors, customers and suppliers, including as to their respective products, services, methods, plans or business affairs, disclosed to or otherwise obtained by the recipient party under or in connection with any Services, Project and/or this Agreement and which is designated as being confidential or which is by its nature clearly confidential and (b) any and all information which has been derived or obtained from information described in (a) above. Confidential Information also includes Accenture Knowledge Capital and Custom Components; Custom Components means reports, documents, templates, studies, software programs in both source code and object code, specifications, business methods, tools, methodologies, processes, techniques, analytical frameworks, algorithms, knowhow, processes, products, documentation, abstracts and summaries thereof, and other work product and materials which are developed by Accenture or the Parties jointly during the course of the Services and supplied as, or as part of, a Deliverable which are business specific to the XL Group, but excluding, any Accenture Knowledge Capital; Data Privacy Laws has the meaning given to it in Clause 28.1; Defect means a defect (i) of Severity Level 1-3, as described in Annex 1 of Schedule 5, in a Warranty Item (ii) that materialises after a Warranty Item is put into live operation (iii) which prevents that Warranty Item from functioning in conformity with the test model based on the functional specifications stated in the applicable WPDR or SOW and (iv) which was tested for during the UAT for the relevant Warranty Item; "Deliverables" means reports, documents, templates, studies, software programs in both source code and object code, specifications, business methods, tools, processes, analytical frameworks, algorithms, products, and other work product and materials which are originated and prepared for XL by Accenture (either independently or in concert with XL or third parties), specified as Deliverables in Schedule 1, a WPDR or a Statement of work and delivered to XL during the course of the Services. Deliverables may comprise Custom Components and/or Accenture Knowledge Capital; Dependencies means the dependencies on and responsibilities of XL, XL Affiliates and XL Personnel specified in this Agreement, including any particular tasks and responsibilities specified in Schedule 1, a WPDR or Statement of Work as Dependencies; "Effective Date" means the date of this Agreement; "Equipment" means any computers, software, computing facilities, communications links and other equipment and items which XL is responsible for providing in connection with the Services; Force Majeure Event means acts, events, omissions, happenings or non-happenings beyond the reasonable control of a party including acts of God, severe weather, fire, explosion, flood, drought, earthquake, disease, epidemic, quarantine, |
|
Commercial-in-Confidence | 6 |
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strikes, labour shortages, work stoppages, slow downs or other industrial disputes, riots or civil disturbances, war, acts of terrorism, sabotage, acts of government, local government or regulatory bodies or any accident causing damage to or destruction, in whole or in part, of the equipment or property necessary to perform the Services; Initial Term has the meaning given to it in Clause 34.1; Intellectual Property Rights means all copyright, trade marks, patents, design rights, database rights, business or domain names, inventions and all other intellectual property rights of a similar nature recognised in any jurisdiction whether registered or not and any applications or rights for registration associated therewith; Key Personnel means the individuals named in Schedule 11 (or their agreed replacements or substitutes from time to time); License Agreement means the agreement between the Parties in relation to Licensed Proprietary Asset described in the Schedule thereto executed on or around the Effective Date; Licensed Proprietary Assets means Accenture Claim Components Solution V. 7.1 as described in the Schedule to the License Agreement, and any other assets which are owned or licensed by Accenture or Accenture Affiliates which Accenture may license to XL pursuant to the terms of mutually acceptable license agreements; Losses means losses, liabilities, damages, actions, claims, costs and expenses (including reasonable legal fees and disbursements); Mandatory Change means a proposed or actual change to this Agreement which either Party reasonably maintains, after thorough evaluation, is required in order to comply with applicable law or regulation; Minimum Effort Level means the minimum number of man-days for Accentures performance of Transformation Services upon which the discount on Accentures fees are conditional, as specified in Clause 15 of Schedule 3 (Charges); New Services means services which are not part of the Transformation Services and which XL may wish to procure and Accenture may wish to provide pursuant to an agreed SOW as referred to in clause 4; OT Programme means the operational transformation program XL is carrying out in its insurance business which comprises organisational restructuring, process re-engineering and the modification and installation of XLs applications suite in respect of which Accenture Affiliates have provided certain services to XL Affiliates pursuant to separate contractual arrangements detailed in the Arrangement Letters; Parties means the parties to this Agreement; Accenture LLP and XL Global Services, Inc. (each a Party) and any permitted successor or assignee of such Parties; |
|
Commercial-in-Confidence | 7 |
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OPERATIONAL TRANSFORMATION | ||
SERVICES AGREEMENT |
XL OT Programme | Accenture |
Programme Plan means the plan annexed to Schedule 1 depicting the timeline for the Transformation Services; "Project" means the project described in the relevant WPDR or SOW; Project Plan means any project plan or timetable specified in Schedule 1 or the relevant WPDR or SOW; Relief Event has the meaning ascribed to it in Clause 12.4 and any other event expressly specified to be a Relief Event including in Clause 25.3, Schedule 5 and Schedule 10; Service Location means the location(s) from which the Services will be delivered specified in Schedule 1 or the applicable WPDR or SOW; "Services" means all work and services to be provided to XL by Accenture pursuant to this Agreement and any WPDR or Statements of Work; Services QA means the periodic quality assurance reviews the Parties agree to perform in respect of the Services as specified in Clause 22.12; "Statement of Work" means a document substantially similar in form to that set forth at Schedule 2 which is completed and signed by XL and Accenture in relation to a Project which sets out the details of the Project, including the services, timescales, fees and the charging basis and other matters specific to that Project (and SOW shall be construed accordingly); Software means source code and object code, operating system software or other computer programs, in whatever form or media; Software Deliverables means Deliverables solely consisting of Software; System Release means a release of major Software to deliver all or a substantial part of a Capability Release as specified in Schedule 1 or the relevant WPDR; Taxes has the meaning ascribed to it in Clause 24; Term means the term of this Agreement, including the Initial Term and any agreed extension thereto; Termination Compensation means the charges payable by XL to Accenture upon termination of this Agreement specified in Schedule 3 or any specified in an SOW; Transformation Services means the transformation services to be provided by Accenture to XL as specified in Schedule 1 and the WPDRs; UAT means the user acceptance test that XL shall perform in accordance with Schedule 5; |
Commercial-in-Confidence | 8 |
|
OPERATIONAL TRANSFORMATION | ||
SERVICES AGREEMENT |
XL OT Programme | Accenture |
Virus means any software virus, spyware, trojan horse, logic bomb, malware or other analogous code whose purpose is to prevent all or part of an IT system or any Software from being used in the manner in which it was intended; Warranty means the warranty provided by Accenture in respect of Warranty Items specified in Schedule 5; Warranty Item means a Software Deliverable that is a System Release developed by Accenture or jointly by Accenture and XL Personnel in circumstances where Accenture provides at least 50% of the man-day effort and management control of the work set out in the relevant WPDR; Warranty Period means the period of 30 days from the date on which a Warranty Item is put into a live production environment provided this is within three weeks (or such other reasonable period specified in the applicable WPDR as amended by the Change Control Procedure as necessary) of UAT completion of such Warranty Item; Working Day means a day (other than a Saturday or Sunday or public holiday) in any jurisdiction in which the Services (or any part of them) or any activities under or in connection with this Agreement are to be performed or are being performed; WPDR means the Work Packet Definition Report agreed between the Parties in accordance with Clause 3.3; WPDR Process means the process for the Parties to agree WPDRs set out in Schedule 10; XL Affiliate means any other person that, directly or indirectly, through one or more intermediaries, is controlled by or under common control with XL that is listed in Schedule 8 (as amended by mutual agreement of the Parties from time to time). For the purposes of this definition, control (including, with correlative meanings, the terms controlled by and under common control with), as used with respect to any person, means the possession, directly or indirectly, of the power to direct or cause the direction of the management or policies of such person, whether through the ownership of voting securities, by contract or otherwise; XL Group means XL and the XL Affiliates; XL Information means all information, documentation and participation, including decisions and approvals, provided by XL, XL Affiliates, or parties acting on their behalf, to Accenture or Accenture Affiliates in connection with the Services; XL Insurance or XLI means the global insurance business segment of the XL Group; XL Personnel means the directors, employees, agents, contractors, sub-contractors or suppliers of the members of the XL Group and any other parties acting on behalf of any other member of the XL Group; |
Commercial-in-Confidence | 9 |
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SERVICES AGREEMENT |
XL OT Programme | Accenture |
XL Pre-Existing Rights means the ownership rights, including Intellectual Property Rights of the XL Group, in any proprietary data, information, tools, templates, intellectual capital, know-how, methodologies, or other materials or items developed or acquired by the XL Group prior to the execution of this Agreement or developed outside the scope of this Agreement, and any enhancements, modifications and/or improvements thereto; XL Supplied Materials means any and all materials which are proprietary to the XL Group or any third party supplier (other than Accenture) together with any enhancements or modifications thereto, the use of which is required by Accenture in connection with the Services; and Year means the period of 12 months immediately following the Effective Date, and each subsequent period of 12 months thereafter during the Term (and references to numbered Years shall be construed accordingly). |
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2 | Interpretation | |
2.1 | In this Agreement: | |
The headings and contents page of this Agreement are included for convenience only and are not to be used in construing any provision of the Agreement; Words importing a gender include every gender, references to the singular include the plural and vice versa and words denoting persons include individuals and bodies corporate, partnerships, unincorporated associations and other bodies (in each case, wherever resident and for whatever purpose) and vice versa; References to this Agreement or any other document are to this Agreement or that document as in force for the time being and as amended from time to time in accordance with this Agreement or that document (as the case may be); References to recitals, clauses, schedules and appendices are to recitals and clauses of, schedules to and appendices to schedules of this Agreement and references in a schedule or an appendix to a part or paragraph are to parts or paragraphs of that schedule or appendix; Unless the context requires otherwise, a reference to a statute, statutory provision or subordinate legislation (as so defined) shall be construed as including a reference to that statute, provision or subordinate legislation as in force at the date of this Agreement and as from time to time modified or consolidated, superseded, re-enacted or replaced after the date of this Agreement; and The words "other", "includes", "including" and "in particular" do not limit the generality of any preceding words and any words which follow them shall not be construed as being limited in scope to the same class as the preceding words where a wider construction is possible. |
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PART B - SERVICES | |
3 | Transformation Services |
3.1 | XL is responsible for and shall control the OT Programme. |
3.2 | Accenture will provide and XL will procure the Transformation Services during the Term in accordance with this Agreement in order to support XL in the delivery of the OT Programme. |
3.3 | The Parties acknowledge that the OT Programme is an iterative process the requirements of which will be more fully understood during the course of the Term. The Transformation Services described in Schedule 1 reflect the intentions of the Parties at the Effective Date. The Parties acknowledge that the Transformation Services require further definition and development in the form of drawing up WPDRs in accordance with the WPDR Process which will include relevant details as to scope, deliverables and respective responsibilities. |
3.4 | Throughout the Term, the Parties will co-operate in good faith and use all commercially reasonable efforts to ensure that the WPDR Process is complete in respect of each work packet at least one (1) month prior to the scheduled commencement of that work packet save in relation to those work packets in respect of which WPDRs are appended to this Agreement at Appendix 3. The parties shall ensure that any dispute between them is escalated promptly through the governance and dispute resolution procedures to achieve rapid resolution. |
3.5 | In the event, that Accenture provides any services to, or on behalf of XL, without executing a WPDR in accordance with this Agreement, such services shall be subject to the terms and conditions of this Agreement. |
3.6 | Accenture shall be a preferred supplier across XLI and GBS and business partner of the XL Group for the OT Programme. Prior to procuring any services from third parties for the benefit of XLI which Accenture or Accenture Affiliates may be able to provide, including application maintenance services, members of the XL Group shall keep members of the Accenture Group informed about major opportunities / projects and provide Accenture with the opportunity to bid on such opportunities and projects. |
3.7 | Accenture shall be the exclusive provider of the Transformation Services. XL shall not engage (and shall procure that XL Affiliates shall not engage) other services provider(s) to perform all or any part of the Transformation Services without the prior written agreement of Accenture, which shall not be unreasonably withheld. |
3.8 | XL (and/or XL Affiliates), may perform itself or acting reasonably, and in consultation with Accenture, contract with a third party to perform any service for the OT Programme that is outside the scope of the Transformation Services, including systems development, operations and related services to augment or supplement the Transformation Services. In the event XL (and/or XL Affiliates) performs itself or contracts with a third party to perform any such service, Accenture shall cooperate in good faith with XL (and/or XL Affiliates) and any such agreed third party providers to the extent reasonably required. |
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3.9 | For the avoidance of doubt, nothing in this Agreement shall prevent any member of the Accenture Group from providing services the same or similar to the Services to any other party at any time, provided that Accenture, Accenture does not breach its obligations under this Agreement in respect of any XL Confidential Information or XL owned Intellectual Property Rights. |
3.10 | The Parties may jointly designate from time to time certain key personnel, as set out in Schedule 11 (Key Personnel). Accenture and XL will cause each of the Key Personnel to devote sufficient time necessary to perform their responsibilities specified in this Agreement. With respect to the appointment of the initial and any replacement Key Personnel, the Parties will cooperate with each other to fill the Key Personnel positions with individuals who are reasonably acceptable to the other Party. Before assigning an individual to a Key Personnel position, whether as an initial assignment or a replacement, the employing Party will (i) notify the other Party of the proposed assignment; (ii) introduce the individual to appropriate representatives of the other Party; and (iii) subject to applicable law, obligations of confidentiality and the employing Partys standard personnel practices, provide the other Party with a curriculum vitae, and any other information about the individual reasonably requested by the other Party. If the other Party has a good faith objection to any such assignment within 5 Business Days, the employing Party will not assign the proposed individual, and will propose to the other Party the assignment of another individual of suitable ability and qualifications, within a mutually agreed upon timeframe. |
3.11 | Except in the event of cessation of employment, death, illness, injury, or disability, either Party will notify the other Party in writing at least 30 days prior to replacing any personnel serving in a Key Personnel position. In the event of any replacement of personnel serving in a Key Personnel position, the employing Party will provide for an appropriate transition (overlap) period for the new individual and use reasonable efforts to minimise any disruption such replacement may cause in the performance of that Partys obligations under this Agreement. |
4 | Statements of Work for New Services |
4.1 | From time to time the Parties may execute SOWs under this Agreement in respect of New Services. Notwithstanding the foregoing, nothing in this Agreement shall obligate XL to procure or Accenture to provide any New Services unless the Parties execute a SOW. Each SOW shall be executed by an authorized representative of XL and Accenture. Each properly executed SOW shall be deemed, upon its full execution, to be incorporated into this Agreement and the terms and conditions set forth in this Agreement shall govern the New Services, except for provisions in this Agreement which are specifically excluded or modified in such SOW. |
4.2 | Each SOW shall, to the extent applicable, generally conform to the format as set forth in Schedule 2 to this Agreement. |
4.3 | Each such SOW shall constitute a separate agreement between XL and Accenture for the Project described therein. |
4.4 | No member of the Accenture Group is obliged to provide any services not expressly specified in Schedule 1 unless and until the Parties execute a SOW or WPDR and the terms and conditions of this Agreement shall apply to all such Services unless modified by that SOW or WPDR. |
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4.5 | XL shall not be obligated to pay for any services not expressly specified in Schedule 1 unless and until the Parties execute a WPDR or any SOW and the terms and conditions of this Agreement shall apply to all such Services. |
5 | Support Services |
5.1 | Any application maintenance or support services which may be required by XL from Accenture from time to time in connection with the Transformation Services shall be the subject of a separate agreement which will specify applicable terms pertaining to such services. |
5.2 | Accenture will provide Capacity Services during the Term in accordance with and subject to the terms of this Agreement. Capacity Services means the provision of non- consulting technical resources to work on a full-time basis for a minimum period of 3 months, or as otherwise agreed between the parties, per resource, within the XL Global Business Services under the direction and supervision of XL and/or XL Affiliates and/or XL Personnel. XL shall be responsible for its operation and use of the Capacity Services. XL hereby commits to a minimum volume of use and duration of Capacity Services of 15 Accenture resources per year with an average of 25 Accenture full-time resources per year over the period of three years commencing a maximum of three months following the Effective Date. The Charges in respect of Capacity Services shall be determined in accordance with Schedule 4. Such Charges shall be excluded from the calculation of Eligible Fees for the purposes of the Risk/Reward Mechanism. The Parties acknowledge that XLs specific Capacity Services requirements (in relation to skills, timing and location) will be further defined as set out in Schedule 4. |
6 | XL Affiliates |
6.1 | XL may extend the benefit of the Services to other XL Affiliates subject to Clause 31.5. |
7 | Additional Terms |
7.1 | If the Services include the provision of Software and/or other proprietary materials (including Licensed Proprietary Assets), XL (and/or XL Affiliates and/or contractors or sub-contractors of the XL Group) may from time to time be required to agree to additional appropriate terms pertaining to the license and use of such Software and/or other proprietary materials which may be included as Special Conditions in a SOW or WPDR or may be in the form of a separate agreement with Accenture or a third party. |
8 | Accenture Alliances |
8.1 | Accenture agrees to extend its network of technology provider relationships on behalf of XL. For agreed upon technologies, where Proquire LLC (a wholly owned subsidiary of Accenture) (Proquire) can offer equal to, or more favourable, pricing and/or terms than XL can obtain from other sources, XL, at its sole option, may acquire such hardware and software technologies directly from Proquire. |
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8.2 | Accenture has alliance relationships with third party product and services vendors. As part of many such relationships, Accenture is able to resell certain products and services and/or may receive compensation from vendors in the form of fees or other benefits in connection with the marketing, technical and other assistance provided by Accenture. XL acknowledges that such relationships may be beneficial to Accenture and assist in its performance of the Services. In the event Accenture recommends a vendor to XL that is an Alliance partner of Accenture, Accenture agrees to so advise XL in writing of the existence of such an alliance relationship. |
9 | Outsourcing |
9.1 | Any business process outsourcing services provided by any member of the Accenture Group are excluded from the scope of this Agreement and shall be the subject of a separate written agreement. |
PART C - OPERATIONAL
10 | Joint Responsibility | |
10.1 | The Parties acknowledge that the Transformation Services is a joint effort of activity in delivering the OT Programme which is intended to be achieved using a contribution of the knowledge, resources and skills of both Parties, and third party support contracted by each Party. | |
10.2 | XL and Accenture acknowledge that the nature of the Services requires timely, active and positive good faith co-operation between the Parties to resolve any issues not foreseen at the time of commencement of the Services and each party will co-operate in good faith with the other to resolve such issues in a timely and reasonable manner. | |
11 | Dependencies and Responsibilities | |
11.1 | XL acknowledges and agrees that in order to perform the Services in accordance with the terms and conditions of this Agreement Accenture is dependent upon XLs and XL Affiliates compliance with its (and their) obligations and dependencies under this Agreement. | |
11.2 | XL shall: | |
11.2.1 | Pay all Charges which are not in good faith dispute that are due in respect of the Services pursuant to this Agreement; | |
11.2.2 | Be solely responsible for its use and operation of the Services and any Deliverables, including the implementation of any recommendations and advice, and any consequences therefrom; | |
11.2.3 | Be solely responsible for determining whether the Services and Deliverables meet the XL Groups requirements, including business, compliance and policy requirements; | |
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11.2.4 | Be solely responsible for its compliance with all applicable laws and regulations; |
11.2.5 | Perform (and procure performance by XL Affiliates and XL Personnel where applicable) responsibilities and Dependencies set out in this Agreement or otherwise reasonably required in connection with the Services; |
11.2.6 | Obtain, in advance of Accentures use, any consent necessary for Accenture (and any Accenture Affiliate) to use each item of XL Supplied Materials; |
11.2.7 | Ensure XL and XL Affiliates have adequate XL Personnel to fulfil their obligations in respect of the Services; and |
11.2.8 | Procure that XL Personnel cooperate with Accenture in connection with Services and are bound by appropriate confidentiality undertakings in respect of Deliverables and other Accenture Group Confidential Information. |
11.3 | Accenture shall be responsible for: | |
11.3.1 | Compliance with all laws and regulations applicable to its business; | |
11.3.2 | Performing (and procuring performance by Accenture Affiliates and Accenture Personnel where applicable) its obligations set out in this Agreement; | |
11.3.3 | Providing adequate numbers of personnel in accordance with Clause 29.4; and | |
11.3.4 | Procuring that its personnel and subcontractors cooperate with XL during the performance of the Services and are bound by appropriate confidentiality undertakings in respect of XL Group Confidential Information. | |
11.4 | XL will provide (or will procure), free of charge, to Accenture (or Accenture Affiliates if requested) the following throughout the continuance of the Services: | |
11.4.1 | Reasonable and sufficient access to XL Personnel and XL Affiliates (consistent with the OT Programme requirements) who are involved with or whose involvement is required in connection with the Services; | |
11.4.2 | To the extent Accenture's (or Accenture Affiliates) personnel need to work at the premises of XL and/or XL Affiliates a suitable and safe working environment and normal office services as XL generally makes available to its employees located at the premises in which Accenture or Accenture Affiliates will be rendering services , including desks, storage, furniture and other normal office equipment support, adequate computer resources, photocopying facilities, telephone and facsimile equipment and services (including voice mail services), stationery (excluding Accenture specific items), postal and courier services, archiving facilities, general office supplies, security and janitorial support, parking) and such other items, services and resources as the Parties may agree are reasonably necessary for Accenture to perform its obligations under this Agreement. By mutual agreement the Parties may determine alternative office locations which may not necessarily be collocated at an XL office location | |
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depending on space availability, provided that such separate office location (1) generally conforms to the requirements set forth in this Clause, (2) enables the relevant Accenture and XL teams to be co-located, (3) is within a reasonably convenient distance to XL offices to which such teams require access; | ||
11.4.3 | Any Equipment. XL will ensure that any Equipment it is responsible for providing to enable Accenture to provide the Services is properly installed and is reasonably sufficient and suitable (consistent with the OT Programme requirements) for its purpose and that any adjustments which may be required are carried out expeditiously. XL is responsible, at its own expense, for the reasonably prompt and continuing availability to Accenture (or Accenture Affiliates) of the Equipment in good working order throughout the duration of the Services consistent with such standards as XL generally makes available to its own employees; and | |
11.4.4 | Prompt access to XL Information reasonably required by Accenture to perform the Services. XL will ensure that all XL Information is complete, accurate, and reliable in all material respects and is provided on a timely basis. Accenture shall be entitled to rely on XL Information and will not be responsible for the verification, correction or amendment of the same. | |
12 | Relief Events | |
12.1 | Upon the occurrence of a Relief Event, the Party who first becomes aware of the Relief Event shall notify the other Party as soon as reasonably practicable. The Parties shall then co-operate in good faith and use commercially reasonable efforts to propose and agree workarounds to address and minimise the impact to the Services resulting from a Relief Event. Any changes to the scope of the Services as a result of a Relief Event shall be agreed through the Change Control Procedure. | |
12.2 | If and to the extent that any delay or failure by Accenture to perform its obligations under this Agreement is directly caused by a Relief Event, Accentures liability for such delay or failure will be excused and/or there will be an equitable adjustment of the Charges and in any time permitted for performance of the Services. For the avoidance of doubt, the foregoing shall not apply if and to the extent that a Relief Event is solely and directly caused by Accentures breach of its obligations under this Agreement. | |
12.3 | Relief Event means any of the following: | |
12.3.1 | Breach by XL (or XL Affiliates) of its (or their) obligations under this Agreement or a SOW, including non-performance of any Dependencies, or any act or omission by XL, XL Affiliates or XL Personnel which has a detrimental effect on the Services; | |
12.3.2 | Act or omission of or by Accenture resulting from Accenture's reasonable reliance on an act, instruction or direction of XL, XL Affiliates or any XL Personnel, in relation to the performance of all or any part of the Services or any other obligations; | |
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12.3.3 | Material error or omission in XL Information or other data, information or materials provided to the Accenture Group by or on behalf of XL which contributes to Accentures failure to perform its obligations; | |
12.3.4 | Infringements of third party Intellectual Property Rights by XL, XL Affiliates or XL Personnel; | |
12.3.5 | Violations of law or regulation by XL, XL Affiliates or XL Personnel; | |
12.3.6 | Service or resource reductions or specific tasks, testing procedures or other services which are given priority as requested or approved by XL; | |
12.3.7 | Significant change in the manner in which XL conducts its business; | |
12.3.8 | Force Majeure Event; | |
12.3.9 | Material act or omission of a third party (excluding Accenture's subcontractors); | |
12.3.10 | Consequence of acting in accordance with a change to the Services made through the Change Control Procedure which was required by XL but reasonably advised against by Accenture in writing to XL; or | |
12.3.11 | Assumption(s) proving to be incorrect which have a material, individual or cumulative, impact on all or any part of the Services to which the relevant Assumption relates. | |
12.4 | If Accenture incurs additional direct costs in performing the Services as a direct result of any Relief Event, then (without prejudice to its other rights and remedies) it shall be entitled to recover such reasonable additional direct costs from XL provided that it has agreed such additional direct costs with XL prior to incurring them. | |
13 | Subcontractors | |
13.1 | Accenture shall not employ or engage sub-contractors for carrying out all or any part of the Services without XLs prior written consent save that Accenture may employ as subcontractor or otherwise draw on the resources of (i) Accenture Affiliates, (ii) individual contractors (whether acting as individuals or via service companies) and (iii) third party subcontractors provided that the actual or reasonably anticipated value of the subcontractor fees does not exceed the greater of $100,000 in total in any Year or 4% of the fees due to Accenture for the applicable WPDR or SOW. Any such sub- contracting will not relieve Accenture from its obligations under this Agreement. | |
13.2 | Except as provided in Clause 13.1, prior to subcontracting any of the Services to a third party, Accenture shall notify XL of the proposed subcontractor, provide XL with any information XL may request with respect to such subcontractor, and obtain XLs written approval of such subcontractor. No subcontracting shall release Accenture from its responsibility for its obligations under this Agreement or the SOWs. Accenture shall be responsible for the work and activities of any subcontractors, including compliance with the terms and conditions of this Agreement and the SOWs. | |
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Accenture shall be responsible for all payments to any subcontractors. Accenture shall promptly pay for all services, materials, equipment and labour used by subcontractor in providing the Services and keep XLs premises and equipment free of all liens. In the event that Accenture has not paid any amount owed to a subcontractor in connection with Services provided by such subcontractor pursuant to this Agreement, XL may, in its sole discretion, withhold an amount from the Charges that is equal to such unpaid amount until it is paid by Accenture to the subcontractor. XL shall have the right to revoke its approval of any subcontractor and to direct Accenture to remove or replace such subcontractor if, in XLs reasonable opinion, (i) the subcontractors performance is deficient, (ii) XL has concerns as to subcontractors ability to perform the applicable Services or (iii) the subcontractor has made a misrepresentation in connection with any information provided to XL or Accenture pursuant to this Clause. In such circumstances, Accenture shall be provided with a reasonable period of time to replace the sub-contractor and the parties shall agree any necessary alteration to the Services in accordance with the Change Control Procedure. | |
14 | Timetable |
14.2 | Any timetable or Project Plan will be an estimate only unless such timetable or Project Plan is expressly agreed to be a binding commitment as part of a fixed price WPDR or SOW. |
14.2 | The Parties shall work together in good faith to manage the Project Plan. Accenture shall use reasonable endeavors to perform the Services in accordance with any timetable or Project Plan. |
15 | Acceptance and Warranty |
15.2 | The provisions relating to acceptance and Warranty are specified in Schedule 5. |
16 | Governance |
16.2 | The governance arrangements and procedures relating to this Agreement are detailed in Schedule 6. |
16.2 | Schedule 6 also documents the arrangements agreed between the Parties relating to the Governance of the OT Programme. Accentures role in relation to such Governance Procedures is part of the Programme Management Workstream described in Schedule 1. |
17 | Change Control Procedure |
17.2 | The Parties will agree changes to this Agreement as required in accordance with the Change Control Procedure detailed in Schedule 7. |
17.2 | A Change Notice will not be valid unless and until executed by the Parties in accordance with Schedule 7. |
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18 | Electronic Communication |
18.2 | Subject to Clause 38, the Parties may correspond, communicate and convey information to each other by email or other electronic means for normal operational communications. Each party is responsible for its own security measures in relation to such communications and neither party shall be liable to the other for any loss, damage, expense or inconvenience caused by the loss, delay, interception or corruption of any electronic communication due to any reason beyond a partys reasonable control. |
19 | Regulatory compliance |
19.1 | Notwithstanding anything in this Agreement, XL agrees and acknowledges that nothing in this Agreement is intended to constitute an offer to provide services or will result in services and/or activities which will or may require Accenture and/or any Accenture Affiliates and/or their personnel to be otherwise regulated, licensed or registered with or by an insurance and/or other authority or regulator, including without limitation, licensure and registration as an insurance producer, insurance agent, insurance intermediary, insurance adjuster, third party administrator, registered representative and/or broker dealer. Accenture and Accenture Affiliates and their personnel do not intend and will not be required to provide professional advice with respect to accounting, legal and regulatory compliance or similar areas. Any activities in these areas which are included within the Services are limited to clerical tasks and do not include any activities which may be subject to licensure, certification and/or registration in any jurisdiction. XL acknowledges that it will be ultimately responsible for determining whether any of XLs and/or XL Affiliates business practices or processes in connection with the Services comply with applicable insurance, financial services, accounting and/or tax laws and regulations (and any changes thereto). XLs current guidelines with respect to compliance with such laws and regulations are set forth in Schedule 9. Any changes to the scope of the Services due to changes in such laws and regulations or Schedule 9 shall be handled through the Change Control Procedure and at XLs cost and expense. |
19.2 | Each Party is responsible for compliance with all law and regulation applicable to its business and operations and for monitoring changes to the same. |
19.3 | XL shall be responsible for directing Accentures performance of the Services in accordance and compliance with law and regulation applicable to XL Groups business. XL and Accenture understand that there are numerous statutes, regulations and other provisions applicable to the XL Groups business. If and to the extent that XL becomes aware, at any time, of existing or new law or regulation applicable to the XL Groups business which affects the Services or Accentures performance of the Services, XL shall notify Accenture immediately and Clause 20 shall apply. |
19.4 | Without prejudice to Clause 19.2, each party will retain responsibility for its compliance with all applicable export control laws and economic sanctions programs relating to its respective business, facilities, and the provision of services or products to third parties. Accenture will not be required by the terms of this Agreement to be directly or indirectly involved in the provision of goods, software, services and/or technical data that may be |
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prohibited by applicable export control or economic sanctions programs if performed by Accenture. | ||
19.5 | Applicable export control or economic sanctions programs may include U.S. export control laws such as the Export Administration Regulations and the International Traffic in Arms Regulations, and U.S. economic sanctions programs that are or may be maintained by the U.S. Government, including sanctions currently imposed by the US Department of Treasury Office of Foreign Asset Control against designated sanctioned countries , as well as Specially Designated Nationals and Blocked Persons programs. The Parties will comply with U.S. export control and U.S. economic sanctions laws with respect to the export or re-export of U.S. origin goods, software, services and/or technical data, or the direct product thereof. | |
19.6 | Prior to providing a party any goods, software, services and/or technical data subject to export controls controlled at a level other than EAR 99/AT the providing party will provide written notice to the receiving party specifying the nature of the controls and any relevant export control classification numbers. | |
19.7 | Prior to XL contracting with any entity with respect to which Accenture will provide any goods, software, services and/or technical data under this Agreement, XL will take reasonable steps to ensure that any such provision of goods, software, services and/or technical data to such entity is not subject to restrictions or prohibitions under applicable export control or economic sanctions programs. | |
19.8 | XL is responsible for complying with any applicable import compliance requirements which may apply to the XL Groups receipt of Services or Deliverables. | |
20 | Regulatory Change | |
20.1 | In the event that a Party considers a Mandatory Change is required, it shall notify the other Party as soon as reasonably practicable. The Parties shall then co-operate in good faith and use commercially reasonable efforts to discuss and agree whether a Mandatory Change is required, the nature and extent of the Mandatory Change and shall seek to minimise the impact to the Services resulting from a Mandatory Change. | |
20.2 | If the Parties fail to agree a Change Notice in respect of a Mandatory Change either party may terminate upon 90 days notice, having first consulted with the other Party in accordance with Clause 20.1 above: | |
20.2.1 | This Agreement if the Mandatory Change affects the Services as a whole; or | |
20.2.2 | Any affected WPDR or SOW if the Mandatory Change affects only part of the Services. | |
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21 | Policies | |
21.1 | Accenture shall use reasonable endeavors to procure that its personnel working on XLs premises comply with the reasonable requirements of XLs workplace security, administrative, safety and the spirit of other reasonable corporate policies and procedures, as set out at the Effective Date and listed in Schedule 13 to the extent such requirements are compatible and consistent with Accentures own policies and procedures and practices. | |
21.2 | At XLs request, Accentures personnel shall attend one or more orientation meetings (at such sites where such personnel are engaged or via tele-conference) regarding XL's corporate compliance policies and procedures including, but not limited to, on-site rules of behavior and workplace security. Accenture shall also ensure that, while at any of XL's premises, its personnel obey all reasonable instructions and directions issued by authorized XL personnel. | |
PART D - FINANCIAL | ||
22 | Charges and Audit | |
22.1 | In consideration of the performance of the Services, XL will pay to Accenture the Charges: | |
22.1.1 | In accordance with Schedule 3; and | |
22.1.2 | In respect of Services performed under a SOW, in accordance with the charges mechanism stated in the relevant SOW. | |
22.2 | If XL requests that the completion of any part of the Transformation Services be delayed beyond the scheduled completion date in the WPDR for any reason whatsoever, other than a default on the part of Accenture, such delay and consequent adjustment to Charges shall be subject to mutual agreement through the Change Control Procedure. | |
22.3 | Accenture is not obliged to provide any services other than the Services. If, with XLs agreement, Accenture provides ancillary or additional services relating to the Services, such services shall be deemed as Services provided pursuant to this Agreement for which XL will compensate Accenture on a time and materials basis in accordance with the rates at Schedule 3 or the applicable SOW as applicable, or where agreed, at a fixed price. Such agreement shall be documented in accordance with the Change Control Procedure. | |
22.4 | If the cost to Accenture of the performance of the Services is increased by reason of the making or notification by XL of any law or of any order, or regulation, or other provision having the force of law that is applicable to the Services or any part thereof the Parties will co-operate in good faith to assess and manage the impact of any such events and the Charges and timetables will be adjusted accordingly, and documented pursuant to Change Control Procedure. | |
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22.5 | The Parties acknowledge and agree that certain elements of the Services are being provided offshore (i.e., outside the United States) to leverage the use of lower cost offshore resources and the Charges are based, in part, on the use of such lower cost resources. In the event any laws, regulations or policies are promulgated, changed, amended or otherwise come into effect at any time during the Term that were not reasonably foreseeable by either Party at the Effective Date of this Agreement that impose taxes, tariffs, restrictions or limitations on, or prohibit, the offshore portion of the Services, in whole or in part, which result in a material increase in Charges incurred by Accenture, Accenture will provide reasonable documentation to XL in support of such increased costs. The Parties will then negotiate in good faith to address the apportionment of such cost and/or alternative locations or adjustments to Services. | |
22.6 | Subject to Clause 22.9, each Party shall, upon prior notice from the other (of not less than 30 days), provide the other Party or its duly authorized representatives with reasonable access to such financial records and supporting documentation as may reasonably be requested by the other: | |
22.6.1 | In the case of XL, to audit the Charges charged to XL (and any costs or expenses to be paid or reimbursed by XL) to determine if such amounts are accurate and in accordance with this Agreement and/or the applicable WPDR or SOW. Information provided by Accenture shall include Accentures time sheets (in summary printed format only). | |
22.6.2 | In the case of Accenture, to audit results for the purpose of determining the accuracy of the Risk Reward Fee. | |
22.7 | Each party shall bear its own costs and expenses incurred in carrying out such audits, performed pursuant to this Clause 22. | |
22.8 | XL shall notify Accenture of the results of any audit as soon as reasonably practicable. If, as a result of any audit carried out pursuant to Clause 22.6, XL determines (acting reasonably) that Accenture has overcharged XL, it shall notify Accenture of the amount of such overcharge. If there is any disagreement as to the fact or extent of any overcharge, the matter shall be dealt with in accordance with Clause 45. If Accenture agrees that there has been an overcharge (or an arbitration finds that there has been an overcharge), it shall promptly pay to XL the amount of the overcharge plus interest accrued from the date such amount was paid to Accenture by XL. For purpose of this Clause 22.8, interest shall be calculated at a rate of one percent (1%) per month. | |
If the audit reveals an undercharge, XL will pay Accenture, upon receipt of an invoice, the amount of the undercharge in accordance with Clause 23.1. | ||
22.9 | The Party conducting the audit and its authorized representatives will conduct such audits in a manner that will result in a minimum of inconvenience and disruption to the business operations of the Party being audited, and a minimum of interference with the performance of the Services. Audits may be conducted only during normal business hours on Working Days and no more frequently than once in any Year. XL and its authorized representatives will not be entitled to audit or access: (i) data or information of other customers or clients of Accenture; (ii) any information relating to the costs (other than expenses incurred by Accenture personnel), profit margins or overheads of | |
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the Accenture Group under this Agreement or any other agreement or otherwise; (iii) any other Confidential Information of the Accenture Group that is not strictly relevant for the purposes of the audit. Accenture and its authorized representatives will not be entitled to audit or access any Confidential Information of the XL Group that is not strictly relevant for the purpose of the audit. All information learned or exchanged in connection with the conduct of an audit, as well as the results of any audit, constitutes Confidential Information. XL will not use any competitors of Accenture (or any Accenture subcontractor) to conduct such audits. Upon the request of XL, Accenture will promptly identify any such competitors. The authorized representatives of the Party conducting the audit will execute and deliver such confidentiality and non-disclosure agreements and comply with such security and confidentiality requirements as Accenture may reasonably require in connection with such audits. | |
22.10 | The Party being audited shall, at no extra cost, provide to the Party conducting the audit reasonable and limited assistance in connection with such audits provided that the demands on the time required from the audited Party do not exceed 1.5 man-days per quarter. |
22.11 | Accenture shall retain records and supporting documentation sufficient to document the fees paid or payable by XL under this Agreement, in accordance with Accentures standard record retention procedures, as in effect from time to time (but at a minimum not less than three years from expiration or termination of the applicable SOW or WPDR). |
22.12 | The Parties may agree to perform Services QA which shall be conducted in a manner that will result in a minimum of inconvenience and disruption to XLs business operations, and a minimum of interference with the performance of the Services. Such Services QA may be conducted only during normal business hours on Working Days at a frequency and in accordance with a process to be agreed between the Parties. |
23 | Payment |
23.1 | XL will pay any amounts not subject to a bona fide dispute payable to Accenture within forty five (45) days of the invoice date. XL will pay Accenture via electronic funds transfer using ACH CCD + or CTX format to the following account: |
Bank = Chase Bank Routing # = 071000013 Account # = 5311314 Account Type = Checking (not Savings) Invoice Qualifier = IV (plus ten digit invoice #) |
|
23.2 | Any invoice not in dispute remaining unpaid for more than forty five (45) days from the invoice date, will (i) accrue interest at a rate of one percent (1%) per month (ii) entitle Accenture to suspend performance of the Services after providing ten (10) days written notice to XL of its intention to so suspend If there is a good faith dispute with regard to a portion of an invoice, XL will provide notice and detail of the dispute prior to the invoice due date, and will pay the undisputed portion as provided in this Agreement. Upon resolution of the dispute, any disputed amounts owed Accenture will be promptly |
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paid with interest at the rate above, calculated from the date the amounts were originally due to Accenture. | |
24 | Taxes |
24.1 | Taxes shall mean, collectively taxes, duties, levies, tariffs and other similar charges (and any related interest and penalties), however designated and in all jurisdictions, imposed as a result of the existence or operation of this Agreement, all transactions contemplated herein and the delivery and use of the Services attributable to periods on or after the Effective Date. |
24.2 | Subject to Clause 24.6 Accenture shall solely be responsible for, and in no event shall XL pay or be responsible for, any Taxes: (i) imposed on or with respect to Accentures net or gross income, capital or franchise; (ii) in the nature of any Accenture employee or contractor withholding taxes, FICA, Medicare taxes, or other social security taxes, , unemployment insurance or other Taxes relating to Accenture or contractor personnel performing Services hereunder; (iii) imposed on, with respect to, or in connection with Accentures purchase of any supplies, materials, equipment, software or services for use in providing the Services; (iv) in the nature of Permits required to provide the Services; (v) imposed by any federal, state, provincial or local taxing authority as withholding taxes, or taxes in the nature of withholding taxes, on or with respect to any amounts paid or accrued with respect to the Services to the extent that tax is recoverable or creditable to Accenture; in such instances XL shall be liable to pay Accenture only for that portion of such withholding tax which is non-recoverable or non- creditable; or (vi) Taxes collected by Accenture from XL which Accenture fails to remit to the applicable tax authority. If any Taxes are assessed against XL which the Accenture had a responsibility to collect or withhold and remit to the applicable tax authority, but failed to do so, Accenture shall be responsible for any interest or penalty related thereto. |
24.3 | If any taxing jurisdiction imposes after the Effective Date a new sales, use, excise, value-added, services, consumption, or other tax (New Tax) on the provision of the Services or any component thereof, the parties shall cooperate in attempting to reduce the amount of such Tax to the maximum extent feasible; provided, however, the foregoing shall not apply to changes in tax rates . If any Taxes applicable to the Services are imposed on XL as a result of Accentures transition of Services to a location other than the initial location of XLs facility, Accenture shall have full responsibility for payment of all such Taxes; provided, however, Accenture will not be responsible for new transaction taxes which may occur subsequent to the transition. |
24.4 | The parties shall cooperate with each other to enable the parties to determine accurately their respective Tax liabilities and to reduce such liabilities to the extent permitted by law and to appropriately allocate the Taxes on the Services provided to the applicable taxing jurisdiction. Accentures invoices to XL shall separately state the amount of any Taxes Accenture is collecting from XL. Accenture shall provide to the other any resale certificates, exemption certificates, treaty certifications, information regarding out-of-state or out-of-country sales or use of equipment and services and such other similar information as XL may reasonably request. Where applicable, Accenture shall segregate all Charges, with sufficient specificity as XL may reasonably request, into the following payment streams: (a) those for taxable services; and (b) those for non-taxable services. In those instances where the payment stream is for |
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taxable services, Accenture shall also segregate the services which are subject to different tax rates. Accenture shall be responsible for registering with any applicable jurisdiction to which such Taxes are required to be remitted and for remitting all Taxes it collects or withholds from XL to the applicable taxing authority. To the extent that any sales, use, value-added, consumption or goods and services tax is required by Law or is requested by XL to be separately identified in Accentures billings to XL, Accenture shall separately identify the tax on its invoices. | |
24.5 | XL shall pay any sales, use, value-added, consumption, and other similar taxes applicable to Accentures performance of services under this Agreement on or after the Effective Date. |
24.6 | If Accenture personnel provide the Services in a country or state other than the Source Location then XL shall be responsible for reimbursing Accenture for an amount equal to the amount which represents the difference between what the non resident Accenture personnel would have incurred in tax in their Source Location had they not been assigned overseas or to a different state and the additional tax they have incurred in their Source Location and the overseas country or different state as a result of being assigned to the Services ("Tax Equalisation Amount"). Accenture shall provide to XL documentary evidence from the relevant tax authorities to support the Tax Equalisation Amount. |
PART E INTELLECTUAL PROPERTY | |
25 | Intellectual Property Rights |
25.1 | All Intellectual Property Rights belonging to a party prior to the date of this Agreement, subject to the remainder of this Clause, any derivatives of such rights shall remain vested in that party. Except as expressly provided herein, neither party shall gain by virtue of this Agreement any rights of ownership in any Intellectual Property owned by the other Party or any third party. |
25.2 | Accenture shall not obtain any rights in any XL Pre-Existing Rights or XL Supplied Materials, save that XL grants to Accenture a global, royalty-free, non-exclusive license, (with a right to sub-license to sub-contractors and Accenture Affiliates) to use, modify and enhance the content of any relevant XL Pre-Existing Rights and XL Supplied Materials to the extent and for the duration required to meet its obligations under this Agreement and in connection with the Services. |
25.3 | Any material delays in XL obtaining any required consent for Accenture to use XL Supplied Materials shall constitute a Relief Event. Any costs to XL that are associated with its carrying out these responsibilities are not included in the Charges and will be expenses payable by XL. Accenture will comply with restrictions on its use of XL Supplied Materials that are identified to, and acknowledged by, Accenture. XL retains responsibility for its contractual or other obligations to any third parties with respect to all XL Supplied Materials. Under no circumstances shall Accenture be obligated to use any XL Supplied Materials unless consents have been obtained in accordance with |
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Clause 11.2.6, but Accenture shall use its reasonable endeavors to procure an appropriate work-around if necessary consents are not obtained or are refused. | |
25.4 | Unless otherwise specified in a WPDR or SOW, upon final payment of all Charges due and payable in respect of the relevant Deliverable under or in connection with this Agreement, Accenture shall, subject to Clause 25.7 and to any restrictions applicable to any third-party materials embodied in the Deliverables, assign the newly created copyright in the final version of the Custom Components to XL. XL grants to Accenture and Accenture Affiliates a non-exclusive, perpetual, paid up, worldwide license and right to use, modify and reproduce the Custom Components for its internal business purposes (including sharing it internally within the Accenture Group) and for the purposes of providing the Services. Accenture acknowledges that, for the purposes of the foregoing, the Custom Components shall be considered "works made for hire" under applicable copyright law. After acceptance of a Deliverable by the XL, and pending final payment for that Deliverable, Accenture hereby grants to XL a revocable, non-transferable, non-exclusive unpaid right and license to use, copy, modify and prepare derivative works of the Custom Components for purposes of XLs internal business only. |
25.5 | All other Intellectual Property Rights in the Deliverables remain in and/or are assigned to Accenture. With respect to any Intellectual Property Rights embedded in the Custom Components which are not assigned or conveyed to XL, upon final payment Accenture shall grant to XL a perpetual, non-exclusive, non-transferable, paid-up, worldwide right and license to use, copy, modify, and prepare derivative works of such Custom Components and any and all components thereof, for its internal business only. |
25.6 | To the extent any Deliverable contains Confidential Information of the Accenture Group, including any Accenture Knowledge Capital, or Confidential Information of the XL Group it shall be subject to Clause 27. |
25.7 | XL and the XL Group shall have or obtain no rights in any Accenture Knowledge Capital other than (i) to use the same as authorized by Accenture in writing from time to time solely for purposes of performing XLs responsibilities under this Agreement, (ii) to the extent the Accenture Knowledge Capital is incorporated into a Deliverable, to use it only as part of the Deliverable for purposes of XLs internal business only, or (iii) pursuant to Accenture's standard license for such Accenture Knowledge Capital or, in the case of Accenture Knowledge Capital owned by third parties, pursuant to terms acceptable to the applicable third party. If any Accenture Knowledge Capital is made available to XL under (i) or (ii) above, it will be made available in an AS IS condition and without express or implied warranties of any kind; and any Accenture Knowledge Capital made available under (iii) above shall be subject only to applicable terms of the applicable license. As between XL and Accenture, Accenture Knowledge Capital will be deemed Confidential Information of Accenture for the purposes of Clause 27. |
25.8 | The Parties shall cooperate with each other and execute such other documents as may be necessary or appropriate to achieve the objectives of this Clause. |
25.9 | In no event shall Accenture or any other member of the Accenture Group be precluded from independently developing for itself, or for others, anything, whether in tangible or non-tangible form, which is competitive with, identical or similar to, the Deliverables. |
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25.10 | Accenture shall be free to use its general knowledge, skills and experience, and any ideas, concepts, know-how, and techniques that are acquired or used in the course of providing the Services. | ||
26 | Licensed Proprietary Assets | ||
26.1 | Without prejudice to Clause 7 and notwithstanding Clause 25, Licensed Proprietary Assets supplied by Accenture to XL or XL Group are subject to the terms of the License Agreement and any other license agreement agreed between the Parties. Notwithstanding anything to the contrary in the terms and conditions of this Agreement to the extent that any Deliverables (or any developments or modifications to Deliverables) contain or are derived from Licensed Proprietary Assets, the warranties, terms and conditions of the License Agreement shall apply to such Deliverables (or any developments or modifications to Deliverables) and prevail over any conflicting provision in this Agreement. | ||
26.2 | XL shall be responsible for maintenance and support of Licensed Proprietary Assets unless otherwise agreed. Accenture is not obliged to provide bug fixes, enhancements, later releases, additional methods, or updated versions of Licensed Proprietary Assets. In the event that Accenture elects, in its sole discretion, to provide bug fixes, enhancements, later releases or updated versions of Licensed Proprietary Products, XL acknowledges and agrees that such later versions of the Licensed Proprietary Products are subject to the license terms agreed between the parties or the terms and restrictions of a new license agreement if provided by Accenture. In addition, Accenture shall have no obligation to provide user support. Any assistance regarding the Licensed Proprietary Assets that is requested by XL may be made available, at Accentures option, pursuant to separate written agreement and at Accentures then current billing rates plus out-of-pocket expenses, and as agreed to by XL. | ||
PART F CONFIDENTIALITY AND DATA PROTECTION | |||
27 | Confidentiality | ||
27.1 | Each Party undertakes in respect of Confidential Information for which it is the recipient: | ||
27.1.1 | To treat such Confidential Information disclosed by the disclosing party as confidential; | ||
27.1.2 | Not without the disclosing party's prior written consent in each case to communicate or disclose all or any part of such Confidential Information to any person except: | ||
(a) | To the directors and employees of the recipient (or, the directors and employees of the member(s) of the Accenture Group or the XL Group, as the case may be) who, in each case, have a reasonable need to receive the same for or in connection with the Services; |
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(b) | To the recipient's auditors and external professional advisers who need to know the Confidential Information; | ||
(c) | To any other persons or bodies having a legal right or duty to have access to or knowledge of the Confidential Information in connection with the business of the recipient, including without limitation, any stock exchange on which shares in Accenture, XL or their respective Affiliates are traded; | ||
(d) | Where the recipient is ordered by a court of competent jurisdiction to do so or there is a statutory or regulatory obligation to do so except that the recipient shall use all reasonable endeavors to first inform the disclosing party in writing before any disclosure under such order or obligation is made; and | ||
(e) | To third parties engaged by the recipient in connection with the Services and who have been expressly authorised in writing by the disclosing party to receive the Confidential Information prior to disclosure. | ||
27.1.3 | To ensure that all persons and bodies mentioned in Clause 27.1.2 are made aware, prior to the disclosure of such Confidential Information, of the confidential nature of such information, and that they owe a duty of confidence to the disclosing party and agree to hold such Confidential Information in confidence in accordance with the terms of this Agreement; and to use its reasonable endeavors to ensure that such persons and bodies comply with such obligations; | ||
27.1.4 | Not to use Confidential Information, or subject to Clauses 27.1.2(a) to circulate Confidential Information within its own organisation and/or as expressly permitted herein, except solely to the extent necessary for the Services or any other purpose the disclosing party may hereafter expressly authorise in writing; | ||
27.1.5 | To use its reasonable endeavors to effect and maintain adequate security measures to safeguard such Confidential Information from unauthorised access, use and misappropriation, and to protect the Confidential Information in the same manner that it protects the confidentiality of its own similar information; | ||
27.1.6 | To procure at the request of the disclosing party for any of those persons and bodies referred to in Clause 27.1.2(b) and Clause 27.1.2(e) to sign a separate confidentiality undertaking with the recipient in such form as the disclosing party may reasonably require prior to giving access to such Confidential Information; and | ||
27.1.7 | To use reasonable endeavors to procure at the request of the disclosing party for any of those persons and bodies referred to in Clause 27.1.2(c) to sign a separate confidentiality undertaking with the recipient in such form as the disclosing party may reasonably require prior to giving access to such Confidential Information. | ||
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27.2 | The obligations of confidentiality in this Clause 27 shall not apply: | ||
27.2.1 | To any portion of Confidential Information where the recipient can demonstrate that the Confidential Information concerned: | ||
(a) | Is or has become publicly known through no fault of the recipient, its employees, agents and sub-contractors; or | ||
(b) | Is lawfully received from an independent third party without any restriction and without any obligation of confidentiality; or | ||
(c) | Is already known to the recipient with no obligation of confidentiality at the date it was disclosed by or obtained from the disclosing party; or | ||
(d) | Is disclosed without restriction by the disclosing party to any third party. | ||
27.2.2 | To any development made by the recipient which is independently developed by the recipient without access to or use of the disclosing party's Confidential Information. | ||
27.3 | If the receiver receives a subpoena or other validly issued administrative or judicial process requesting Confidential Information of the other party, it will promptly notify the other party of such receipt and tender to the other party the defense of such subpoena or process. If requested by the other party, the receiver will cooperate (at the expense of the other party) in opposing such subpoena or process. Unless the subpoena or process is timely limited, quashed or extended, the receiver will then be entitled to comply with such request to the extent permitted by law. Accenture will not act as an expert witness or otherwise provide litigation support services as a part of the Services. | ||
27.4 | In connection with the Services, Accenture may from time to time undertake one or more internal quality assessment reviews (which shall be undertaken at Accentures own cost and expense and for the purposes of its internal governance requirements) (Accenture QA). The parties agree that any documentation created in connection with such Accenture QA (or which are created for contract management purposes) will be Confidential Information of Accenture. Such documentation or the results of such reviews will not be discoverable or admissible (or used for any purpose) in any proceedings related to this Agreement or the Services. | ||
27.5 | Each party will return or destroy the other partys Confidential Information in its possession upon request by the other party, unless otherwise allowed to retain such Confidential Information. Each party may retain copies of the other partys Confidential Information required for compliance with its recordkeeping or quality assurance requirements or (that each party may be obligated by applicable law and/or industry and/or governmental regulations to retain. (subject to the terms of this Agreement). | ||
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28 | Data Protection | |
28.1 | The Parties shall comply with their respective obligations as data controller and data processor under any applicable data protection laws and regulations (together the Data Privacy Laws) in connection with the Services. | |
28.2 | The Parties acknowledge that, in respect of all personal data controlled by XL and processed by Accenture for the purpose of the provision the Services: | |
28.2.1 | XL alone shall determine the purposes for which and the manner in which such personal data will be processed (as defined in the Data Privacy Laws) by Accenture; | |
28.2.2 | XL shall be the data controller (as defined in the Data Privacy Laws); and | |
28.2.3 | Accenture shall be the data processor (as defined in the Data Privacy Laws). | |
28.3 | Where, in connection with this Agreement, Accenture, as a data processor, processes personal data on behalf of XL, Accenture shall: | |
28.3.1 | Process those personal data only on written instructions of XL and to the extent reasonably necessary for the performance of this Agreement; | |
28.3.2 | Not disclose those personal data to any person except as required or permitted by this Agreement, or with XLs written consent; | |
28.3.3 | Implement appropriate technical and organisational measures, as specified by XL in advance, to protect those personal data against accidental or unlawful destruction or accidental loss, alteration, unauthorised disclosure or access, and against all other unlawful forms of processing; to the extent such technical and organisational measures have not been established by XL, Accenture will maintain safeguards no less rigorous then those maintained by Accenture for its own similar personal data. XL will be responsible for the sufficiency of such policies and safeguards. | |
28.4 | Any change in the Services required by law or regulation that increases Accentures costs and expenses with respect to compliance with this Clause 28 will be subject to the operation of Clause 22.4 and the Change Control Procedure. | |
28.5 | Accenture may retain archival copies of XLs data as reasonably necessary to verify Accentures compliance with this Agreement. Accenture will identify such data to XL at the time such archival copies are withheld | |
28.6 | The Parties acknowledge that personal data collected under this Agreement may be transferred from a country within the European Union to a country outside the European Union and the Parties shall ensure that the personal data are adequately protected in accordance with Article 25 of the EU Directive 95/46/EC. In order to achieve this, the parties will, unless agreed otherwise, rely on an agreement based on the Standard Contractual Clauses for the Transfer of Personal Data to Processors established in Third Countries, dated 27 December 2001 (2002/16/EC) as amended | |
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from time to time (the EU Model Clauses) for the transfer of XL Data from a data controller to a data processor, and XL will execute or will ensure that the relevant XL Affiliate execute a data transfer agreement in the form attached as Schedule 12, in its capacity as data exporter, with Accenture or Accenture Affiliates, the data importer. | ||
PART G - LIABILITY | ||
29 | Warranties and Covenants | |
29.1 | Accenture hereby warrants to XL as follows: | |
29.1.1 | Organisation; Power. Accenture is a limited liability partnership, duly registered and validly existing under the laws of Illinois. Accenture has all requisite power and authority to execute and deliver this Agreement and to perform its obligations hereunder; | |
29.1.2 | Authority; Enforceability. The execution and delivery of this Agreement and the consummation of the transactions contemplated hereby have been duly authorised by all requisite action on the part of Accenture. This Agreement constitutes the legal, valid and binding agreement of Accenture, enforceable against Accenture in accordance with its terms (except insofar as such enforceability may be limited by applicable bankruptcy, insolvency, reorganisation, moratorium or similar laws affecting creditors rights generally, or by principles governing the availability of equitable remedies); | |
29.1.3 | Non-contravention. The execution and delivery of this Agreement and the consummation of the transactions contemplated hereby will not conflict with, or result in any violation or breach of, any contract to which Accenture is a party; | |
29.1.4 | Performance. Accenture will perform the Services using reasonable skill and care. Unless otherwise agreed in a SOW, Accenture will reperform any Services not in compliance with this warranty brought to its attention in writing within thirty (30) days after those Services are performed. This warranty does not apply to Warranty Items which are covered by the Warranty referred to in Clause 29.1.5. ; | |
29.1.5 | Warranty Items. Accenture provides the Warranty in respect of Warranty Items specified for the duration of the Warranty Period as specified in Schedule 5; | |
29.1.6 | There is no outstanding litigation, arbitrated matter or other dispute to which Accenture is a party which, if decided unfavorably to Accenture, would reasonably be expected to have a material adverse effect on XLs or Accenture's ability to fulfill their respective obligations under this Agreement; and29.1.7 Accenture shall not permit any member of its staff to work on-site at any of XL premises unless and until Accenture has obtained all required employment eligibility forms and applicable work permits and certified to XL that such forms and permits have been obtained. | |
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29.1 | XL hereby warrants to Accenture as follows: | |
29.2.1 | Organisation; Power. XL is a corporation duly registered and validly existing under the laws of the State of Delaware XL has all requisite power and authority to execute and deliver this Agreement and to perform its obligations hereunder; | |
29.2.2 | Authority; Enforceability. The execution and delivery of this Agreement and the consummation of the transactions contemplated hereby, have been duly authorised by all requisite corporate action on the part of XL. This Agreement constitutes the legal, valid and binding agreement of XL, enforceable against XL in accordance with its terms (except insofar as such enforceability may be limited by applicable bankruptcy, insolvency, reorganisation, moratorium or similar laws affecting creditors rights generally, or by principles governing the availability of equitable remedies); and | |
29.2.3 | Non-contravention. The execution and delivery of this Agreement and the consummation of the transactions contemplated hereby will not conflict with, or result in any violation or breach of, any contract to which XL is a party. | |
29.3 | EXCEPT AS OTHERWISE EXPRESSLY PROVIDED IN THIS CLAUSE 29, THE PARTIES MAKE NO REPRESENTATIONS OR WARRANTIES, AND HEREBY EXCLUDE ALL CONDITIONS, TERMS, REPRESENTATIONS AND WARRANTIES, EXPRESS OR IMPLIED, REGARDING ANY MATTER, INCLUDING FITNESS FOR A PARTICULAR PURPOSE, SATISFACTORY QUALITY, INFORMATIONAL CONTENT, SYSTEMS INTEGRATION, NON-INFRINGEMENT, INTERFERENCE WITH ENJOYMENT, OR RESULTS TO BE DERIVED FROM THE USE OF ANY SERVICES, SOFTWARE, HARDWARE, DELIVERABLES, WORK PRODUCT OR OTHER MATERIALS PROVIDED UNDER THIS AGREEMENT. ACCENTURE EXPRESSLY DISCLAIMS ANY WARRANTY, REPRESENTATION, TERM OR CONDITION AS TO THE ACCURACY OR COMPLETENESS OF DATA, OPERATIONAL CRITERIA OR PARAMETERS PROVIDED BY XL. ACCENTURE DOES NOT REPRESENT OR WARRANT, NOR IS IT A TERM OR CONDITION OF THIS AGREEMENT, THAT THE OPERATION OF ANY SOFTWARE WILL BE UNINTERRUPTED OR ERROR FREE. | |
29.4 | Accenture hereby covenants to XL as follows: | |
29.4.1 | Adequacy of Employees. Accenture will use adequate numbers of personnel to perform the Services (where the pricing for such Services is not measured by a number of people, full-time equivalents, a time-based billing mechanism or similar metric). Accenture undertakes that the Accenture employees utilised in the provision of the Services to XL will possess suitable training, education, experience and skill to perform the Services; | |
29.4.2 | Viruses. Accenture will use reasonable efforts through the use of industry standard virus protection software and other customary procedures to screen any software provided or made available by it to XL hereunder to avoid introducing any Virus that materially disrupts the proper operation of or provides improper access to XLs systems. For the avoidance of doubt, | |
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Accenture will not knowingly insert into the Software Deliverables and any software used to provide the Services any malicious code, programs or other internal components (e.g., computer "virus", computer "worm", computer time bomb, "Trojan horse", "back door", or similar component, referred to collectively as "Malicious Code") which restricts or may restrict use or access to, and/or does or may damage, destroy or alter, any system, program, data or other information; and | ||
29.4.3 | Disabling Codes. Unless otherwise agreed by the Parties, Accenture shall not, insert into a Software Deliverable or any software used to provide Services any code, device, criteria, mechanism or function designed to have the effect of damaging, destroying, disabling, or otherwise shutting down, or altering the functionality of, or specifications for, or restricting the use of or access to, all or any portion of any Software Deliverable or any other system, program, data or other information. | |
29.5 | XL hereby covenants to Accenture as follows: | |
29.5.1 | Viruses. XL will use reasonable efforts through the use of industry standard virus protection software and other customary procedures to screen any software provided or made available by it to Accenture hereunder to avoid introducing any Virus that materially disrupts the proper operation of or provides improper access to Accentures systems. For the avoidance of doubt, XL will not knowingly insert into any software used in connection with the Services any Malicious Code which restricts or may restrict use or access to, and/or does or may damage, destroy or alter, any system, program, data or other information; and | |
29.5.2 | Disabling Codes. Unless otherwise agreed by the Parties XL shall not insert into a Deliverable or any software used to provide Services any code, device, criteria, mechanism or function which would have the effect of damaging, destroying, disabling, or otherwise shutting down, or altering the functionality of, or specifications for, or restricting the use of or access to, all or any portion of any Deliverable or any other system, program, data or other information. | |
30 | Indemnities | |
30.1 | Each Party will indemnify, defend and hold harmless the other Party, its Affiliates, and their respective employees, directors, officers, principals (partners, shareholders or holders of an ownership interest, as the case may be), from and against any third party claims, demands, loss, damage or expenses (including reasonable attorneys fees and court costs) relating to: | |
30.1.1 | bodily injury or death of any person or damage to real and/or tangible personal property directly caused by the negligence or willful misconduct of the indemnifying party, its personnel or agents in connection with this Agreement; | |
30.1.2 | federal, state, and local employment taxes, workers compensation, disability, or unemployment compensation insurance premiums, or claims levied upon | |
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or attributable to the Services rendered by Accenture and its personnel, including but not limited to, all state and federal FICA, Medicare, workers compensation premiums and claims, disability, and unemployment; and, | ||
30.1.3 | Arising out of the other Partys failure to perform any obligations owed to its personnel (including, but not limited to, any claims for privilege, compensation, or benefits under any XL employee benefit plan) and/or arising out of or connected with the employment of that Partys employees or that Partys engagement of workers, including in each case their health and safety at work and any claims for discrimination, harassment or victimisation under applicable law. | |
30.2 | XL shall indemnify, defend, and hold Accenture and Accenture Affiliates (and each of its and their respective officers, directors, agents, employees, successors and assigns) harmless from any and all claims, suits, losses, judgments, damages, costs, administrative fines, penalties, or expenses, including reasonable attorneys fees, incurred by Accenture resulting from a claim that XL Materials delivered to Accenture by XL for inclusion in the materials produced or delivered by Accenture at XL's direction infringe the intellectual property rights or rights of any third party. | |
30.3 | XL will indemnify and hold Accenture and the Accenture Group harmless from third party claims arising out of XLs (or XL Affiliates) use of the Services or Deliverables and reimburse Accenture and the Accenture Group for all expenses (including counsel fees and court costs) incurred by Accenture or the Accenture Group in connection with such claim. | |
30.4 | If XL promptly notifies Accenture in writing of a third party claim against any member of the XL Group that any Deliverable infringes a copyright or trade secret of any third party, Accenture will defend such claim at its expense and will pay any costs or damages that may be finally awarded against the XL Group. Accenture will not indemnify the XL Group, however, if the claim of infringement is caused by: (a)XL or XL Affiliates modification of the Deliverable or use of the Deliverable other than as contemplated by this Agreement; (b)XL or XL Affiliates failure to use corrections or enhancements made available and communicated to XL in writing by Accenture; (c) XL or XL Affiliates use of the Deliverable in combination with any product or information not owned or developed by Accenture; (d)XL or XL Affiliates distribution, marketing or use for the benefit of third parties of the Deliverable; or (e)information, direction, specification or materials provided by XL or any XL Affiliate or any third party. If any Deliverable is, or in Accentures opinion is likely to be, held to be infringing, Accenture will at its expense and option either: (i) procure the right for XL or XL Affiliate to continue using it, (ii) replace it with a non-infringing equivalent, (iii)modify it to make it non-infringing, or (iv) direct the return of the Deliverable and refund to XL the fees paid for such Deliverable less a reasonable amount as agreed to by XL and Accenture for XL or XL Affiliates use of the Deliverable up to the time of return. The foregoing remedies constitute the XL Groups sole and exclusive remedies and Accentures entire liability with respect to infringement. | |
30.5 | To receive the indemnities contained in this Agreement, the party seeking indemnification must promptly notify the other party in writing of a claim or suit and provide reasonable cooperation (at the indemnifying partys expense) and full authority to defend or settle the claim or suit. The indemnifying party will have no obligation to | |
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indemnify the indemnified party under any settlement made without the indemnifying partys written consent. | |
30.6 | Each Party has a duty to mitigate the damages and Losses that would otherwise be recoverable from the other Party pursuant to this Agreement (including under any indemnity) by taking appropriate and commercially reasonable actions to reduce or limit the amount of such damages or amounts. |
31 | Liability |
31.1 | The sole liability of Accenture and any of its Affiliates (whether in contract, tort, negligence, strict liability in tort, by statute or otherwise) to XL, XL Affiliates or XL Personnel (if any) for any and all claims in any manner related to this Agreement, including the Deliverables or Services, will be the payment of direct damages, not to exceed (in the aggregate) (i) in respect of liability arising in connection with a Project the fees received by Accenture under this Agreement with respect to the Services or Deliverables provided in connection with that Project or (ii) in respect of any other liability the fees received by Accenture under this Agreement during the twelve (12) months preceding the events which gave rise to the liability or (in the first Year) the fees which would have been received by Accenture had the Agreement been properly and fully performed by both Parties as at the date of the event (or first event if a series of events) giving rise to the relevant liability . Except for the specific remedies expressly identified as such in this Agreement, XLs exclusive remedy for any claim arising out of this Agreement or any applicable SOW will be for Accenture, upon receipt of written notice, to use commercially reasonable efforts to cure the breach at its expense, or failing that, to return the fees paid to Accenture for the Services or Deliverables related to the breach. |
31.2 | The limitations of liability in Clause 31.1 shall not apply with respect to (i) damages occasioned by the fraud, of a Party; (ii) damages occasioned by the breach of a Partys confidentiality obligations (excluding any obligations with respect to personal data or data privacy) under the Agreement. |
31.3 | In no event will either party be liable for any consequential, incidental, indirect, special or punitive damage, loss or expenses or for business interruption, lost business, lost profits or lost savings whether direct or indirect even if it has been advised of their possible existence. |
31.4 | The allocations of liability in this Clause 31 are the agreed and bargained for understanding of the parties, and Accentures compensation for the Services reflects these allocations. |
31.5 | Accenture will provide the Services to XL and may extend the benefit of Services to XL Affiliates. In the event Accenture provides the Services to an XL Affiliate(s) or any XL |
Affiliate derives benefit from Services provided by Accenture under this Agreement, such Services to such XL Affiliate(s) will be deemed to be have been provided to XL pursuant to this Agreement. With respect to any XL Affiliates that receive Services from Accenture, XL will (i) retain responsibility for payment for such Services, and (ii) remain responsible and liable for the acts and omissions of all such XL Affiliates as if such acts and omissions were those of XL, including but not limited to breach of this | |
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Agreement by an XL Affiliate. Furthermore, notwithstanding anything in this Agreement to the contrary, the parties acknowledge and agree that no XL Affiliate shall have any rights against Accenture under this Agreement and any claims against Accenture shall be brought by XL only. For such purpose, each XL Affiliates loss in relation to such claim shall be deemed to be the actual loss of XL and shall be subject to the limitations and exclusions of liability set out in Clause 31. XL shall ensure that XL Affiliates agree that the limits and exclusions on the liability of Accenture and Accenture Affiliates shall apply to XL and XL Affiliates as set out in this Agreement. | ||
31.6 | XL shall bring any and all claims, howsoever arising, relating to the Services against Accenture only, and shall not bring any claims against any other member of the Accenture Group. | |
31.7 | Any action by either party must be brought within four (4) years after the cause of action arose unless earlier time barred by law. | |
32 | Force Majeure | |
32.1 | Without prejudice to Clause 12, neither Party shall be liable for any failure or delay in the performance (other than payment obligations under this Agreement) of its obligations arising out of a Force Majeure Event. | |
32.2 | The Party claiming the Force Majeure Event will promptly notify the other in writing of the reasons for the delay or stoppage (and the likely duration) and will take all reasonable steps to overcome the delay or stoppage. | |
32.3 | If that Party has complied with Clause 32.2, its performance under this Agreement will be suspended for the period that the Force Majeure Event continues, and the Party will have an extension of time for performance which is reasonable and in any event not less than the period of delay or stoppage. As regards such delay or stoppage: | |
32.3.1 | Any costs arising from the delay or stoppage will be borne by the Party incurring those costs; and | |
32.3.2 | The Party claiming the Force Majeure Event will take all necessary steps to bring the Force Majeure Event to a close or to find a solution including the use of alternative sources, workarounds ands similar measures whereby the obligations of the Parties may be performed despite that Force Majeure Event. | |
32.4 | Notwithstanding the foregoing, if the period of non-performance exceeds sixty (60) days from the receipt of notice of the Force Majeure Event, the party whose ability to perform was not so affected may terminate this Agreement by giving written notice to the other. | |
33 | Insurance | |
33.1 | Accenture shall, during its performance of any work required or contemplated under this Agreement, maintain in force the following insurance coverage: | |
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33.1.1 | Workers Compensation and Employers Liability in statutory amounts required by each state in the United States of America, and each jurisdiction outside of the United States of America, in which any work is performed, in whole or in part; | |
33.1.2 | Commercial Automobile Liability Insurance, covering all Accentures owned, non-owned and hired automobiles, trucks and trailers, with policy limits not less than $1,000,000; and | |
33.1.3 | Commercial General Liability Insurance (including contractual liability) covering independent contractors liability and blanket contractual liability with limits of $1,000,000 per occurrence and $5,000,000 in the aggregate through a combination of primary and excess limits, as primary coverage for losses as a result of Accentures negligence. | |
33.2 | Prior to commencement of any work under this Agreement, Accenture shall provide XL with Certificates of Insurance with respect to the above coverages. | |
33.3 | All insurance policies required to be carried by Accenture shall be written on an occurrence, not a claims-made basis, wherever possible, by companies duly licensed to transact the prescribed coverages in each jurisdiction in which the Services or any portion thereof is to be performed and having an A. M. Best rating of A- or better. | |
PART H TERM AND TERMINATION | ||
34 | Term and Termination | |
34.1 | The Term of this Agreement commences on the Effective Date and will continue unless and until terminated by either party in accordance with the provisions of this Agreement for a period of five (5) years in accordance with the Programme Plan annexed to Schedule 1 (the Initial Term). | |
34.2 | No later than 6 months prior to the expiry of the Initial Term, either Party may notify the other that it wishes to extend the Initial Term, and the Parties authorised representatives shall (not later than 1 month prior to the expiry of the Initial Term) meet to discuss the terms of any extension to the Initial Term, including revised fee rates and the length of subsequent terms. | |
34.3 | In the event that a Party intends to exercise a termination right pursuant to this Agreement, it shall consult the other party and the Parties shall then co-operate in good faith and use commercially reasonable efforts to resolve the circumstances which have given rise to the intention to exercise a termination right. In the event that a Partys intention to exercise a termination right is unchanged, the Parties shall discuss whether XL wishes to procure from Accenture termination assistance service and the terms applicable to such services. | |
34.4 | XL may terminate this Agreement in whole, but not in part, for convenience by giving not less than ninety (90) days written notice of termination to Accenture (which such notice may be served at any time), provided always that XL shall not be entitled to terminate this Agreement in the first Year. | |
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34.5 | Either Party may terminate this Agreement in whole, but not in part, for material breach of this Agreement by giving thirty (30) days written notice specifically identifying the breach as a material breach and requiring it to be remedied, unless the breach is cured within the thirty (30) day period. | |
34.6 | Either Party may terminate a WPDR or SOW (but not any other WPDR or SOW) for material breach of the relevant WPDR or SOW by giving thirty (30) days written notice thereof specifically identifying the breach as a material breach and requiring it to be remedied, unless the breach is cured within the thirty (30) day period. Where XL terminates a WPDR or SOW under this Clause 34.6, the exclusivity provisions of Clause 3.7 shall cease to apply in respect of that WPDR or SOW. | |
34.7 | In addition to all other rights or remedies provided for in this Agreement or by law, either Party hereto may terminate this Agreement in whole, but not in part with immediate effect on written notice if (a) the other Party makes a general assignment for the benefit of creditors; (b) the other Party becomes or is unable to pay debts as they fall due; (c) a trustee, custodian or receiver is appointed by any court with respect to the other Party or any substantial part of such Partys assets; (d) an action is taken by or against the other Party under any bankruptcy or insolvency laws or laws relating to the relief of debtors, including the United States Bankruptcy Code and such action is not dismissed within sixty (60) days of commencement of the action; or (e) the other Party is the subject of a winding-up petition which is not dismissed within five Business Days, or a resolution is passed for its winding-up. | |
34.8 | Accenture may upon thirty (30) days notice terminate this Agreement and any and all WPDRs and SOWs then in force if the License Agreement is terminated for any reason. | |
34.9 | This Agreement and any WPDRs or SOWs, as applicable, may also be terminated in accordance with Clauses 20.2 and 32.4. | |
35 | Effect of Termination | |
35.1 | Upon termination of this Agreement for any reason, XL will pay Accenture upon receipt of invoice in accordance with the terms set out in Clause 23 all outstanding fees and expenses due up to and including the date of termination for all Services rendered. XL shall also pay, upon receipt of invoice and appropriate supporting documentation, the following amounts upon termination of this Agreement for any reason other than termination by XL in accordance with Clause 34.5 or 34.6: | |
35.1.1 | Accentures un-recovered investment costs (e.g. accommodation leases, car leases and equipment but not including business development costs) and any demobilisation and other direct costs resulting from early termination, including cancellation charges payable to Accentures sub-contractors, rental costs, and other costs which Accenture has incurred or is obliged to pay; and | |
35.1.2 | An amount equivalent to any discount provided by Accenture in accordance with Schedule 3 if the Minimum Effort Level specified in Clause 3.6 has not been achieved. | |
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35.2 | Upon termination of this Agreement by XL pursuant to Clause 34.4 XL shall also pay to Accenture the Termination Compensation. |
35.3 | Termination of this Agreement or any WPDR or SOW, for whatever reason, will not affect any accrued rights, liabilities or payments due. |
35.4 | Termination of this Agreement for any reason will also terminate all WPDRs and Statements of Work (if any) current at the time this Agreement is terminated. |
35.5 | Termination of any WPDR or SOW will not of itself terminate this Agreement or any other WPDRs or Statements of Works in force at the time of termination. |
35.6 | The terms and conditions of this Agreement will continue to apply to any WPDR or SOW which is current at expiry of the Term until completion of the relevant Project(s). |
35.7 | All provisions of this Agreement which are by their nature intended to survive the expiration or termination of this Agreement will survive such expiration or termination. |
35.8 | Except as otherwise provided in this Agreement, upon the expiration or termination of a WPDR, an SOW or this Agreement, as the case may be, each Party shall at the request of the other Party return to the other Party or destroy all materials and properties, including all Confidential Information, of the other Party save that each Party shall be permitted to retain copies for the sole purpose of maintaining proper records and subject to the confidentiality obligations of Clause 27. Accenture shall return any advance payments which it has received from XL for Services or Deliverables which as a result of the termination shall not be delivered. XLs rights hereunder are in addition to, and not in substitution of, any other rights or remedies granted to XL hereunder or existing under any applicable Law. |
PART I - MISCELLANEOUS | |
36 | Employees and Employment Claims |
36.1 | All personnel involved in the Services shall at all relevant times remain employees or contractors of the relevant Party. Each Party shall be responsible for the payment of all salary and benefits. |
36.2 | Neither Party will, without the prior written consent of the other Party, solicit, offer work to, employ, or contract with, directly or indirectly, on its own behalf, any of the other partys Personnel or the Personnel of its Affiliates during the Personnels participation in the Services or during the twelve (12) months after the conclusion of such Services. For purposes of this Clause, Personnel includes any individual or company a party employs or has employed as a partner, employee or independent contractor and with which a party comes into direct contact in the course of the Services. However, this Clause will not apply to Personnel who independently respond to indirect solicitations (such as general newspaper advertisements, employment agency referrals and internet postings) not targeting such Personnel. |
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36.3 | If either Party reasonably determines, in good faith and consistent with applicable law, that the continued assignment of any personnel of the other Party is not in the best interests of the OT Programme, such Party will notify the other Party requesting the replacement of the individual and providing a confidential summary of the reasons why the replacement is needed. Promptly after receiving such request, the Parties will consult the matters stated in the request and either institute mutually agreeable corrective action or replace the individual within a mutually agreed upon timeframe. The replacement individual will have suitable ability and qualifications. This Clause 36.3 will not be construed to give either Party the ability to terminate the employment of any personnel of the other Party (or subcontractor personnel). |
37 | Publicity |
37.1 | Without prejudice to the generality of Clause 27, all advertising, press releases, public announcements and public disclosures by either party relating to this Agreement or the Services which includes the other partys name, trade names, trade marks, logos, service marks or trade dress (collectively, Name) or language from which the connection of such Name may be inferred or implied, will be coordinated with and subject to written approval by both Parties prior to release. Such approval may be withheld by the named party in its sole discretion. Without such approval, neither party will use the other partys name outside of its organization, except that either party may indicate to third parties that Accenture is providing services to XL Group and Accenture may use XLs name in client lists, may generally describe that the Parties are implementing a Claims system for purposes of describing Accentures capabilities in proposals to third parties, and marketing products, on its website and for information and marketing purposes. Accenture may also use XL for the purpose of client references and XL will provide reasonable co-operation to Accenture in responding to requests for reference site visits, round table discussions and other marketing activities for prospective clients of Accenture. Without prejudice to the foregoing, Accenture and XL shall as soon as reasonably practicable after the Effective Date jointly agree a formal press release to announce this Agreement. |
38 | Notices |
38.1 | All notices required to be given under this Agreement will be in writing and will be sent to the recipients and addresses shown below or any other address the recipient may designate by notice given in accordance with this Clause 38: |
Accenture: | |
Mark Robertson | |
1 Plantation Place | |
30 Fenchurch Street | |
London EC3M 3BD | |
Legal Group | |
161 North Clark | |
Chicago | |
Illinois 60601 |
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XL: | ||
Malcolm Beane | ||
70 Gracechurch St | ||
London EC3V 0XL | ||
Kenneth P Meagher | ||
70 Seaview Avenue | ||
Stamford Connecticut 06902 | ||
38.2 | SOWs may stipulate relevant recipient addresses if different from those above. | |
38.3 | Notices may be delivered personally or by letter sent as specified below. Notices will be deemed to have been received: | |
38.3.1 | By hand delivery - at the time of delivery; | |
38.3.2 | By mail deposited into the United States mail (certified mail, return receipt requested) 5 days after the date of mailing; and | |
38.3.3 | By international courier deposited to the courier- at time of receipt; | |
38.4 | Email and facsimile notices are not valid for the purposes of this Clause 38. | |
38.5 | Each party may designate a different address by giving notice to the other party in accordance with this Agreement. | |
39 | Waiver | |
39.1 | No waiver of any provision of this Agreement shall be effective unless it is in writing and signed by the party against which it is sought to be enforced. The delay or failure by either Party to exercise or enforce any of its rights under this shall not constitute or be deemed a waiver of that partys right to thereafter enforce those rights, nor shall any single or partial exercise of any such right preclude any other or further exercise of these rights or any other right. | |
40 | Entire Agreement | |
40.1 | This Agreement constitutes the entire agreement between the Parties as to its subject matter and each SOW constitutes the entire agreement between the Parties in respect of the Project which is the subject matter thereof and in each case supersedes all previous communications, conditions, warranties representations and arrangements, written or oral and whether with or by Accenture, any of its Affiliates, or any of their employees, officers, directors, agents or shareholders. Without prejudice to the foregoing, the Parties acknowledge and agree that all of the Parties obligations under | |
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the Arrangement Letters have been fulfilled as at the Effective Date. The printed terms of any purchase order or other correspondence and documents issued by XL in connection with this Agreement will not apply unless expressly accepted in writing by Accenture. | |
40.2 | Each party acknowledges that it is entering into this Agreement solely on the basis of the agreements and representations contained in this Agreement, and that it has not relied upon any representations, warranties, promises, or inducements of any kind, whether oral or written, and from any source, other than those that are expressly contained within this Agreement. Each party acknowledges that it is a sophisticated business entity and that in entering into this Agreement it has had the opportunity to consult with counsel of its choosing. |
40.3 | Notwithstanding Clause 38.4, this Agreement may be executed by facsimile and in any number of counterparts, each of which will be considered an original for all purposes, and all of which when taken together will constitute one agreement binding on the parties, notwithstanding that both parties are not signatories to the original or the same counterpart. |
40.4 | Except as a SOW may otherwise expressly provide, each SOW will be a complete statement of its subject matter and will supplement and modify the terms and conditions of this Agreement for purposes of that SOW only. |
40.5 | Each Party waives all rights and remedies which, but for this Clause 40, might otherwise be available to it in respect of any such representation, warranty, collateral contract or other assurance. The only remedy available to any Party in respect of any representation, warranty, collateral contract or other assurance that is set out in this Agreement or the relevant SOW is for breach of contract under the terms thereof. |
41 | Conflict |
41.1 | In the event of any conflict or inconsistency between the terms of this Agreement on the one hand and the terms of any WPDR or SOW on the other hand, this Agreement shall prevail to the extent of such conflict or inconsistency unless the WPDR or SOW expressly states that a specific term is modified. |
41.2 | If there is any conflict or inconsistency between a term or condition in the main part of this agreement and a term in any of the Schedules or appendices or other documents referred to or otherwise incorporated into this agreement, the term in the main part of this agreement shall take precedence unless the Schedule, the Appendix or other document which is incorporated into this agreement is stated to take precedence over the main part of this agreement. Notwithstanding the foregoing, in the event of any conflict or inconsistency between the terms of this Agreement on the one hand and the terms of the License Agreement on the other hand, the terms of the License Agreement shall prevail to the extent of such conflict or inconsistency. |
42 | Amendment |
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42.1 | Any amendment of this Agreement shall not be binding on the Parties unless set out in writing, expressed to amend this agreement and signed by authorised representatives of each of the Parties in accordance with the Change Control Procedure. |
43 | Relationship of the Parties |
43.1 | Neither party will be deemed a joint employer of the other partys employees. Subject to Clause 30.1, each party will be responsible for any and all claims by its employees. Neither partys employees will be deemed leased employees of the other for any purpose. In connection with this Agreement, each party is an independent contractor and does not have any authority to bind or commit the other. Nothing in this Agreement will be deemed or construed to create a joint venture, partnership, fiduciary, or agency relationship between the parties for any purpose. Nothing in this Agreement is intended or will be construed to confer on any party (other than XL, Accenture, and the parties entitled to indemnification under Clause 30 to the extent of such indemnification) any rights, benefits or remedies of any kind, and no other party will be deemed to be a third party beneficiary. |
44 | Assignment |
44.1 | Either Party may assign the benefit of this Agreement upon notice to the other Party, to in the case of Accenture an Accenture Affiliate and in the case of XL an XL Affiliate provided in each case that: (i) the assignee is an entity of equivalent financial standing as the relevant Party; (ii) the assignee operates in the same general area of business as the assignor or in the case of XL, the relevant XL Affiliate that is the Services recipient in accordance with Clause 31.5 and in the case of Accenture is not (in the reasonable opinion of Accenture) a competitor of the Accenture Group; and (iii) is incorporated in the United States and (iv) the assigning Party provides reasonable advance notice of the proposed assignment to the other Party. Any such assignment pursuant to this Clause 44.1 shall not be absolute, but shall have effect only for so long as the assignee remains a member of the assigning Partys Group. The assignor shall procure that the assignee assigns such benefits back to the assignor immediately prior to the assignee ceasing to be a member of the assignors Group. |
44.2 | Save as set out in Clause 44.1, this Agreement may not be assigned by either Party without the prior consent of the other Party, which consent shall be granted in that Partys sole discretion. Any assignment in contravention of this Clause 44.2 shall be void and of no effect. |
45 | Dispute Resolution |
45.1 | The parties will make good faith efforts to first resolve internally any dispute subject to Clause 45.2 by escalating it to higher levels of management. Neither party may file for arbitration under Clause 45.2 until thirty (30) days have elapsed from the initiation of such good faith efforts. |
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45.2 | Any dispute, controversy, or claim arising out of, relating to, or having any connection with this Agreement or otherwise related to the Services, including any question regarding the validity, interpretation, scope, performance, or enforceability of this dispute resolution provision, will be exclusively and finally settled by arbitration in accordance with the Commercial Arbitration Rules of the American Arbitration Association (AAA) and the AAA Optional Procedures for Large, Complex Commercial Disputes. Any arbitration will be conducted on an individual, rather than a class-wide, basis. |
45.3 | The arbitration will be conducted in New York City, New York, unless the Parties agree on another location. |
45.4 | The arbitration will be conducted by three arbitrators. Each Party will appoint an arbitrator, obtain its appointees acceptance of such appointment, and deliver written notification of such appointment and acceptance to the other Party by thirty (30) days after the due date of the respondents answering statement. The two party-appointed arbitrators will jointly agree upon and appoint a third arbitrator who will serve as the chairperson of the arbitral panel. The party arbitrators will obtain the chairpersons acceptance of such appointment and notify the parties in writing of the appointment and acceptance within thirty (30) days after their acceptance as party arbitrators. If the two party-appointed arbitrators are unable to agree upon the selection and appointment of the chairperson within that time frame, they will notify the parties in writing. Upon such notice, one or both of the parties may request in writing that the chairperson be appointed by the AAA in accordance with the AAA Rules. The AAA will notify the parties in writing of the appointment and acceptance of the chairperson within twenty-one (21) days of receiving such request. |
45.5 | The parties will be entitled to engage in reasonable discovery, including requests for production of relevant non-privileged documents. The arbitral panel may order depositions and interrogatories upon a showing of need. It is the parties intent that the discovery proceedings be conducted in a cost-effective manner. |
45.6 | All decisions, rulings, and awards of the arbitral panel will be made pursuant to majority vote of the three arbitrators. The award will be in accordance with the applicable law, will be in writing, and will state the reasons upon which it is based. The arbitrators will have no power to modify or abridge the terms of this Agreement, including, but not limited to, Clause 31. The arbitrators may award compensatory money damages and interest thereupon but may not award punitive, exemplary, extra-contractual, consequential or similar damages arising out of or in connection with a breach of this Agreement. The award of the arbitrators will be final, and judgment on the award may be entered by any court having jurisdiction to do so. |
45.7 | Costs incurred in the arbitration proceeding, including attorneys fees and expenses, will be borne in the manner determined by the arbitral panel. |
45.8 | Nothing in this Agreement will prevent the parties, prior to the formation of the arbitral panel, from applying to a court of competent jurisdiction for provisional or interim measures or injunctive relief as may be necessary to safeguard the property or rights that are the subject matter of the arbitration. Once the arbitral panel is in place, it will have exclusive jurisdiction to hear applications for such relief, except that any interim |
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measures or injunctive relief ordered by the arbitral panel may be immediately and specifically enforced by a court of competent jurisdiction. | |
45.9 | This Clause 45 will not apply to any claim arising from any patent or registered trademark. Such claims will not be subject to arbitration. They will be subject to judicial resolution. In addition, any issue regarding the enforceability of the prohibition against class-wide arbitration will be decided by a court of competent jurisdiction and not by an arbitrator. |
45.10 | Unless otherwise agreed by the parties or required by law, the parties, the arbitrators, and the AAA will maintain the confidentiality of all documents, communications, proceedings, and awards provided, produced or exchanged pursuant to an arbitration conducted under this Clause 45. |
46 | Judicial Modification |
46.1 | If a court of competent jurisdiction or arbitral panel finds any term or provision of this Agreement to be invalid, illegal or otherwise unenforceable, such term or provision will not affect the other terms or provisions of this Agreement or this Agreement as a whole. Such term or provision will be deemed modified to the extent necessary, in the courts opinion, to render such term or provision enforceable while preserving to the fullest extent permissible, the intent and agreements of the parties set forth in this Agreement. Upon such modification, the rights and obligations of the parties will be construed and enforced in accordance with such modification. |
47 | Governing Law |
47.1 | This Agreement shall be governed by and interpreted in accordance with the laws of the State of New York without giving effect to conflict of law rules. To the extent it may be applicable, the Parties expressly agree to exclude the application of the U.N. Convention on Contracts for the International Sale of Goods (1980) to this Agreement. |
47.2 | Nothing contained in this Agreement shall restrict either Parties' freedom to commence legal proceedings to preserve any legal right or remedy or protect any proprietary or trade secret right (including by way of an application for injunctive relief or equivalent remedy in any jurisdiction). |
48 | Execution |
48.1 | The Parties agree that this Agreement and each SOW may be executed in two counterparts (whether original or facsimile counterparts), each of which executed counterparts taken together shall constitute a single agreement. |
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49 | Schedules and Appendices |
49.1 | The schedules, appendices and attachments hereto are herby incorporated into and form part of this Agreement. |
This Agreement has been executed by duly authorised representatives on behalf of the Parties on the day and year first stated on page one above.
On behalf of XL Global Services, Inc. | On behalf of Accenture LLP | |||
Signed: | Signed: | |||
Print name: | Print name: | |||
Title: | Title: |
Commercial-in-Confidence | 46 |
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OPERATIONAL TRANSFORMATION | ||
SERVICES AGREEMENT |
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, Michael S. McGavick, certify that:
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1. |
I have reviewed this Quarterly Report on Form 10-Q of XL Capital Ltd; |
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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; |
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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; |
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4. |
The registrants 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: |
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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; |
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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; |
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c) |
Evaluated the effectiveness of the registrants 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 |
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d) |
Disclosed in this report any change in the registrants internal control over financial reporting that occurred during the registrants most recent fiscal quarter (the registrants fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrants internal control over financial reporting; and |
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5. |
The registrants other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrants auditors and the audit committee of the registrants board of directors (or persons performing the equivalent functions): |
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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 registrants ability to record, process, summarize and report financial information; and |
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b) |
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants internal control over financial reporting. |
Dated: July 28, 2008
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/S/ Michael S. McGavick |
Certification of Chief Financial Officer I, Brian W. Nocco, certify that:
1.
I have reviewed this Quarterly Report on Form 10-Q 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 registrants 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 registrants 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 registrants internal control over financial reporting that occurred during the registrants most recent fiscal quarter (the registrants fourth fiscal
quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrants internal control over financial reporting; and
5.
The registrants other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrants auditors and the audit committee
of the registrants 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 registrants
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 registrants internal control over financial reporting. Dated: July 28, 2008
/S/ Brian W. Nocco
XL Capital Ltd
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
(Chapter 98, Title 15 U.S.C. SS. 7241)
BRIAN W. NOCCO
Executive Vice President,
Chief Financial Officer
Exhibit 32
Certification Accompanying Form 10-Q 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 Quarterly Report on Form 10-Q for the period ended June 30, 2008 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.
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Dated: July 28, 2008 |
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/s/ Michael S. McGavick |
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Dated: July 28, 2008 |
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/s/ Brian W. Nocco |
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.