Chubb strikes XL Re off facultative list

HAMILTON, Bermuda—An insurer's move to take XL Capital Corp. off its security list for facultative placements is unlikely to have a major direct financial impact on the Bermuda giant, though a larger concern is the potential damage to XL's reputation, say observers.

Warren, N.J.-based Chubb Corp. recently asked some reinsurance intermediaries to remove XL from Chubb's facultative security list--the list of reinsurers automatically eligible for a cedent's business--according to a market source familiar with the situation, who said at least one other insurer is considering such a move. Chubb declined to comment.

Reinsurance market observers say any loss of business from Chubb is unlikely to have a major impact on XL, which reported $9.14 billion in revenues and nearly $58 billion in assets for 2007. But the perception in the market of such moves could cause problems for the Bermuda-based insurer and reinsurer, they say.

The source of concern, observers say, is XL's ties to Security Capital Assurance Ltd., the holding company for financial guarantee units that XL spun off in 2006. Hamilton-based XL's 2007 results reflect $1.5 billion in charges that are primarily related to its SCA investment. It reported $430 million in net income in 2007 vs. $1.76 billion in 2006.

XL retains high financial strength ratings. Standard & Poor's Corp., Moody's Investors Service and Fitch Ratings, all based in New York, all have given XL a negative outlook, however, citing its SCA exposure. Oldwick, N.J.-based A.M. Best Co. Inc. downgraded XL in January to A, with a stable outlook.

S&P said in its outlook announcement that without a replenishment of capital, a charge exceeding $500 million would likely result in a downgrade.

According to Securities and Exchange Commission filings, as of March 31, XL's total net exposure under its facultative agreements with SCA subsidiaries was about $6.9 billion.

In addition, XL issued a guarantee covering SCA's pre-IPO business ensuring that XL Financial Assurance will pay losses when due. The guarantee is triggered if underlying debt securities default on principal and interest payments and if XLFA fails to pay claims. According to XL's annual report, as of March 31, the company's total net par outstanding falling under these guarantees was $69.57 billion, though only 2.3% of that total, or $1.58 billion, represents investments with a credit quality of BB or below.

XL's ultimate exposure has been estimated to be between $1 billion and $1.5 billion (BI, July 7).

A spokesman for New York-based American International Group Inc., the world's largest ceding insurer, said, "We have not taken XL off our approved list, but we are monitoring the situation closely." Other ceding insurers could not be reached late last week.

Responding to an earlier report on Chubb's action, XL issued a statement saying in part that XL "does not publicly...comment on any internal business agreements with our customers or partners."

The statement continued, "despite the challenges of the marketplace in general, and our own situation in particular, XL remains encouraged by the support of customers and brokers. We are grateful for the support as we work to resolve our relationship with SCA."

Concerns remain over XL's exposure to SCA.

"There is concern about (XL's) exposure to the subprime situation," said a market source who confirmed Chubb's move. Cedents are worried "there will be further developments down the road which will reduce their capital base, and they are making a pre-emptive move by taking them off the approved lists," said the source. Insurers would "rather act--and put them back on the list--than not act and have a serious problem develop."

"I would consider them essentially somewhat of a second-tier facultative player" in terms of the amount of business written, the source said, noting that XL usually works in the direct market rather than through intermediaries for its facultative placements. Several reinsurance brokers contacted declined to comment.

XL reported $2.3 billion in net premiums earned in reinsurance in 2007. A breakdown of XL's treaty vs. facultative business was not available. Observers note that facultative business is a fraction of the global reinsurance market, which is dominated by treaty business.

Chubb's action is not related to XL's treaty business.

One source noted that reinsurance recoverables are a bigger concern on facultative business, as treaty business often involves letters of credit and financial collateral.

"I think it's an issue of uncertainty and perception," said John Wicher of John Wicher & Associates Inc. in San Francisco. "The hardest thing to build in a business, I think, is patronage, and it's the easiest thing to lose."

Regardless of XL's actual financial circumstances, "the worst possible thing which can happen is the loss of confidence" in a marketplace where "there's so much uncertainty and, I think, real fear of the unknown," and where the insurance buyer has alternatives, said Mr. Wicher.

One analyst who asked not to be identified said, "XL is a huge company, with lots of lines of business," so "the financial impact is not going to be that significant. But "the perception is not too good," he said.

But John L. Ward, CEO of Cincinnati-based Cincinnatus Partners L.L.C., said that Chubb could continue to place facultative business with XL "on a one-off basis," even though the company would not do it on an automatic placement basis.

"I don't see a knee-jerk reaction in the market, but I do see growing pressure on XL to deal with the inevitable and to go public with their plan to stabilize their financial condition and give comfort to the marketplace and the rating agencies that they have adequately evaluated their problem and taken actions to assess it," he said.

XL's stock closed at $18.77 Friday, down from a 52-week high of $82.10.

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