in re: xl capital ltd. securities litigation 03-cv-02001...

UNITED STATES DISTRICT COURT

DISTRICT OF CONNECTICUT

HAROLD MALIN AND SANDRA JOAN MALIN REVOCABLE TRUST, Individually and On Behalf of All Others Similarly Situated,

Plaintiffs, vs.

XL CAPITAL LTD., BRIAN M. O’HARA, JERRY de ST. PAER, RONALD L. BORNHUETTER, NICHOLAS M. BROWN, JR. AND HENRY CHARLES V. KEELING,

Defendants.

) ) ) ) ) ) ) ) ) ) ) ) ) )

Civil Action No. 3:03-CV-2001-SRU

CLASS ACTION

CORRECTED AMENDED CLASS ACTION COMPLAINT FOR VIOLATIONS OF THE FEDERAL SECURITIES LAWS

DEMAND FOR JURY TRIAL June 21, 2004

Case 3:03-cv-02001-PCD Document 35-1 Filed 06/21/2004 of 119

TABLE OF CONTENTS

Page

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I. INTRODUCTION ...............................................................................................................1

II. SUMMARY AND OVERVIEW.........................................................................................5

III. CONFIDENTIAL SOURCES ...........................................................................................15

IV. JURISDICTION AND VENUE ........................................................................................16

V. THE PARTIES...................................................................................................................16

VI. CONTROL PERSONS ......................................................................................................18

VII. FALSE AND MISLEADING STATEMENTS.................................................................20

XL’s CARZ “Put Dates” Subject the Company to $614 Million Repurchase Liability................36

NYID Issues Scathing Report on Its Examination on XL’s United States Reinsurance Operations – NAC Re ........................................................................................................37

XL’s LYONs “Put Date” Subjected the Company to $295 Million Repurchase Liability ...........42

Credit-Strapped – XL Pays $111.9 Million for a $500 Million Put Option Agreement to Get New York State Statutory Relief in Order to Bring NAC Re Reinsurance Operations Into Statutory Compliance: .............................................................................53

XL’s LYONs “Put Date” Subjected the Company to $300 Million Repurchase Liability: ..........59

XL Shocks Investors with Another Huge Reserve Shortfall in Its NAC Re Reinsurance Operations Causing Its Stock Price to Plummet:...............................................................60

XL Formally Admits Weakness of Its Financial Reporting and Reserve Analysis for NAC Re Operations: ...................................................................................................................63

VIII. POST CLASS PERIOD EVENTS AND ADMISSIONS .................................................66

A.M. Best and Moody’s Ratings Agencies Swiftly Downgraded XL’s Financial Strength Ratings Immediately Impacting the Company’s Ability to Raise Capital and Write Policies:..............................................................................................................................67

XL Fires President of XL Re America i.e., NAC Re and Other Senior Executives Responsible for Running the NAC Reinsurance Operations:............................................70

XL Offers Noteholders of its CARZ $15 Million Not to Exercise Their Right to “Put” The Notes Back to the Company: ......................................................................................72


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XL Files its 2003 Report on Form 10-K Admitting That Ratings Downgrades Would Hurt the Company and Loss Developments Indeed Required a Change in Reserve Methodology Assumptions: ...............................................................................................73

Individual Defendants Personal Economic Motivation to Misrepresent the Company’s Financials – Year-End Bonuses and Insider Trading: .......................................................74

IX. XL’s FALSE FINANCIAL REPORTING ........................................................................77

XL’s Failure to Record Adequate Reinsurance Loss Reserves: ....................................................82

The First Warning:.........................................................................................................................82

The Second Warning: ....................................................................................................................82

The Third Warning: .......................................................................................................................82

The Fourth Warning:......................................................................................................................83

The Extremely Belated Admission: ...............................................................................................83

XL Knew That the Review It Conducted in 2003 Was Routine for Reinsurers and Should Have Been Conducted in 2001 and Ongoing Throughout the Class Period:.....................86

During The Class Period, XL Received a Scathing Reinsurance Examination Report from NAC Re’s Regulator, the NYID: ..............................................................................92

XL’s Shareholder Equity Was Overstated Throughout The Class Period:....................................95

XL’s GAAP Violations Were Material: ........................................................................................95

XL Failed to Make Required Disclosures:.....................................................................................96

XL Lacked Adequate Internal Controls:........................................................................................97

Defendants O’Hara’s and de St. Paer’s False Certifications: ......................................................101

X. APPLICABILITY OF PRESUMPTION OF RELIANCE: FRAUD-ON-THE-MARKET DOCTRINE ...................................................................................................104

XI. NO SAFE HARBOR .......................................................................................................105

XII. PLAINTIFFS’ CLASS ACTION ALLEGATIONS........................................................105

PRAYER FOR RELIEF ..............................................................................................................111

JURY TRIAL DEMANDED.......................................................................................................112


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I. INTRODUCTION

1. This is a securities class action brought on behalf of purchasers of XL Capital Ltd.

(“XL” or the “Company”) publicly traded securities from November 1, 2001 to October 16, 20031

(the “Class Period”) against XL and several of its executive officers: Brian M. O’Hara (“O’Hara”),

Jerry de St. Paer (“de St. Paer”), Ronald L. Bornhuetter (“Bornhuetter”), Nicholas M. Brown, Jr.

(“Brown”), and Henry Charles V. Keeling (“Keeling”) (collectively, the “Individual Defendants”),

for violations of §§10(b) and 20(a) of the Securities Exchange Act of 1934 (“1934 Act” or

“Exchange Act”) and Rule 10b-5 promulgated thereunder, by making false and misleading pubic

statements concerning the Company’s financial results and prospects during the Class Period.

2. Specifically, plaintiffs allege that during the Class Period, XL and the Individual

Defendants issued false and misleading statements in press releases, analyst conference calls and

quarterly and fiscal year-end reports filed with the Securities and Exchange Commission (“SEC”)

regarding the Company’s financial condition, including its earnings and shareholder equity, by

failing to adequately reserve for losses in its “NAC Re”2 reinsurance operations (see Glossary of

Terms attached hereto as Exhibit (“Ex.”) 1) acquired in the summer 1999. As a result of the

Company’s failure to record adequate loss reserves, XL materially understated its expenses and

liabilities and overstated the Company’s earnings, shareholder equity and capital surplus in

violation of Generally Accepted Accounting Principles (“GAAP”) and Statutory Accounting

Practices (“SAP”).3 The Company’s failure to record adequate loss reserves caused the Company’s

1 XL’s fiscal year is January 1 through December 31.

2 “NAC Re” means XL’s United States reinsurance operation which during the Class Period was also known as “XL Re America,” “XL Reinsurance America” and “XLRA.”

3 SAP are rules, procedures and guidelines for financial reporting to insurance regulatory bodies in the United States.


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financial statements during the Class Period to be false and misleading and the stock price of XL to

be artificially inflated.

3. XL and the Individual Defendants knew or deliberately disregarded that the NAC Re

reinsurance operations was inadequately reserved, as throughout the Class Period the Company

reported repeated loss reserve shortfalls from NAC Re reinsurance operations in the Company’s

financial statements. The reported reserve shortfalls required hundreds of millions of dollars in

quarterly and year-end charges to income in 2001, 2002 and the first nine months of 2003.

Throughout the Class Period, securities analysts and investors consistently inquired with XL and

the Individual Defendants about whether the NAC Re reserve deficiency had been corrected in light

of the hundreds of millions in reported reserve shortfalls. On each occasion, defendants falsely

assured investors that XL had reviewed the NAC Re reserves “with great scrutiny,” had taken the

necessary corrective measures to properly reserve for adverse loss developments at NAC Re, that

the Company’s actuarial reserve methodologies were “extremely conservative,” and “continued to

be appropriate” to reserve for losses going forward.

4. In truth, XL and the Individual Defendants knew or deliberately disregarded that the

Company’s reinsurance operations was experiencing a trend of extreme adverse loss development

and knew that reserve amounts the Company had taken for prior years were not adequate for

current reserve needs. For example, XL and the Individual Defendants knew that 1997-2000

“accident years” (the year in which a loss occurred) had developed so adversely that XL’s

methodologies to determine reserves in its reinsurance operations were no longer appropriate to

assess its existing losses.

5. In addition, XL and the Individual Defendants knew that the accounting and record

keeping systems for NAC Re were in disarray resulting in inaccurate and incomplete claims and

premium payment records. In many instances the Company had incomplete or no records at all


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pertaining to claims made by its policyholders and whether claims were paid. Indeed, in 2001, the

Company’s actuarial and reserve methodologies as applied to NAC Re had already resulted in

material reserve shortfalls and, by spring 2002, had resulted in severe admonishments from the

New York State Insurance Department (“NYID”) because XL and NAC Re had filed misstated

financial statements with the department which materially understated loss reserves, loss expenses

and overstated assets and shareholder surplus.

6. It was no accident that XL did not record the necessary loss reserve expenses or

correct known flaws in its internal controls to address adverse loss development trends in the NAC

Re reinsurance operations. Defendants knew that if XL properly reserved for the known adverse

loss developments at NAC Re, its reported expenses would materially increase and severely reduce

its earnings and shareholder equity and shareholder surplus, thereby causing the Company’s

financial strength and debt ratings to be downgraded by credit ratings agencies, A.M. Best,4

Moody’s, Standard & Poor’s (“S&P”)5 and Fitch Ratings. Such downgrades would have crippled

XL’s ability to secure credit, raise capital, write new business and execute its publicly stated

growth strategy.

7. Instead, defendants bragged that XL’s “strong balance sheet” and the content of its

book of business (types of policies written, underwritten and reinsured) insulated the Company

from the adverse loss development experiences being suffered by other insurers and reinsurers like

American Insurance Group (“AIG”) during the Class Period. In fact, XL leveraged its false

4 A.M. Best is the self-described largest and longest established company devoted to issuing in-depth reports and financial-strength ratings about insurance organizations and offers the largest coverage of insurers and reinsurers in the United States, Canada, the United Kingdom and worldwide of any interactive rating organization.

5 Moody’s and S&P are company-rating services that issue ratings denoting the relative investment quality of corporate and municipal debt.


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financials to rapidly grow the Company’s business, writing more policies in 2001, 2002 and 2003,

than ever before based upon the false representation that the Company had capital surplus, strong

underwriting capacity and by using the resulting favorable financial strength and debt ratings to

raise additional cash to finance its growth.

8. Indeed, the Company’s false financials and the appearance of capital and financial

strength allowed XL to increase net earned premiums from $3.5 billion in 2001 to $6.0 billion in

2002 to $7.0 billion in 2003. At the same time that defendants misrepresented the Company’s

financials, and falsely assured investors that its reinsurance operations was sufficiently reserved,

the Individual Defendants unloaded more than 400,000 shares of XL stock for illegal insider

trading proceeds of $35.6 million, and pocketed more than $8.1 million in incentive bonuses

earned as a result of the Company’s falsely reported Company earnings and stock price

performance.

9. Then, on October 17, 2003, XL announced that it had suffered yet another reserve

shortfall for the NAC Re reinsurance which would require $184 million charge to earnings in

3Q03, at least the fifth major charge since the Company acquired NAC Re. Defendants explained,

despite earlier representations that they had reviewed their reserve practices at NAC Re with “great

scrutiny,” that only now would XL undertake a “comprehensive loss reserve review” of its

underwriting policies and its reserving methodologies at NAC Re to “finally put this issue behind

[them].” This type of review, however, which XL had falsely represented, was done on an ongoing

basis, and was in fact required by GAAP, SEC rules and state regulatory reporting agencies.

10. Upon this revelation, investors immediately sold off XL stock causing the stock

price to fall from $79.40 per share to $73.37 per share on trading volume of 11.5 million shares,

nearly 20 times the average trading volume. Ultimately, the Company reported that even $184

million was not enough to cover the latest NAC Re reserve shortfall and that it needed to take


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another $663 million charge to earnings for inadequate reserves in FY03. In total, the Company

recorded $1.46 billion in charges from 1999-2003 for NAC Re losses in accident years 1997-2001.

86%, or $1.25 billion, related to accident years 1997-1999, which were 4-7 years old at the end of

2003.

II. SUMMARY AND OVERVIEW

11. Defendant XL is a Bermuda-based financial service holding company registered in

the Cayman Islands. Through its operating subsidiaries, XL provides global insurance, reinsurance,

and financial products and services.

12. The Company’s principal executive offices are located in Hamilton, Bermuda,

HM11. Its United States headquarters is located in Stamford, Connecticut. Bermuda, however,

provides XL with tax-free status and XL generates tax-free income on profit earned in Bermuda.

XL capitalizes on this tax-free status by transferring profit to Bermuda subsidiaries through capital

management, the use of reinsurance, and intercompany retrocessions. The no-tax status allows

insurance and reinsurance companies like XL to accumulate reserves and profit more quickly than

in taxed jurisdictions like the United States. In addition, Bermuda has a more permissive

regulatory environment than the United States and only one regulatory authority, making it easier

to facilitate the introduction of new product offerings and allowing the parent (XL) to avoid the

stronger regulatory over sight of state regulators in the United States.

13. In June 1999, XL, seeking to expand its reinsurance operations in the United States,

acquired NAC Re Corp., a Delaware corporation, in a $1.2 billion transaction. NAC Re Corp. was

a holding company that owned NAC Reinsurance Corporation, a reinsurance company. As a

reinsurer, NAC Re writes reinsurance contracts whereby it assumes all or some of the risk of


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insurance policies written by other insurers, or ceding6 companies (also called “direct” or “primary”

insurance writer), in exchange for a portion of the premium written. Simply, NAC Re writes

insurance policies for direct or primary insurers. These policies allow direct insurers to spread

some or all of the insurance risks under their policies.

14. At the close of the NAC Re acquisition in 1999, XL explained that the acquisition of

NAC Re would expand the Company’s reinsurance sales and give it a larger United States

presence. Specifically, defendant O’Hara praised the Company’s acquisition of NAC Re, declaring

it as “the premier broker-market reinsurer” in the United States and promised investors that NAC

Re would be a platform for XL’s United States expansion and add to the Company’s overall

profitability.

15. In connection with the 1999 merger, XL also increased loss reserves for NAC Re by

$95 million – a recognition that NAC Re was already inadequately reserved. It was not enough. In

2000, XL needed to take another charge to income of $122 million NAC Re operations. Then, XL

took additional charges of $180 million in 4Q01, $215 million in 4Q02, $184 million in 3Q03 and

$663 million in 4Q03. Despite actual knowledge that as early as 1999 that the NAC Re reinsurance

operations was severely under-reserved, XL failed to perform a “comprehensive claims audit”

(actually, a routine and required process for reinsurers) or substantially review and correct its

internal controls, its reserve methodologies or review its cedant’s underwriting policies until after

the Class Period and investors had lost hundreds of millions of dollars.

16. Moreover, on each instance that the Company took the above-referenced charges to

income for reserve shortfalls at NAC Re, investors demanded an explanation of why XL had taken

additional reserves for its NAC Re reinsurance operations, and whether this pattern would continue.

6 A “ceding” company is defined as a company that transfers all or part of an insurance risk to another company through reinsurance (hereinafter, cedants or cedents). See Ex. 1.


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In response, XL falsely assured investors that the Company had in fact “turned the corner” on

inadequate reserve issues at NAC Re, had revisited its loss reserve methodology and process “with

great scrutiny” and was “reserved at the right levels” going forward.

17. In addition, defendants repeatedly and falsely represented that their methodologies

used to determine the amount of reserves, despite knowledge of severe adverse loss developments,

“continued to be appropriate” in public filings:

Management believes that the reserves for unpaid losses and loss expenses are sufficient to pay losses that fall within coverages assumed by the Company.

The methodology of estimating loss reserves is periodically reviewed to ensure that the assumptions made continue to be appropriate and any adjustments resulting therefrom are reflected in income of the year in which the adjustments are made.

18. XL and the Individual Defendants also made the following false and misleading

statements in press releases and analyst conference calls.

We have a tremendous track-record of claim-handling, having paid out almost $2bn in losses with no litigation and our reputation holds us well.

* * *

We conduct a full actuarial review of all our business units annually....

We have [all NAC Re reserve issues] put [ ] behind us, and all the other actuarial reviews checked out positively....

* * *

[E]fficient reserves and a double a-rated balance sheet, [puts XL] in an unencumbered position to move forward.

We looked at it, [the reserves issues at NAC Re] to say the least, with great scrutiny. And we believe, given all the facts we know today, it is at the right reserve levels....

* * *

Our reserving methodology is quite conservative.

19. In fact, however, defendants knew or deliberately disregarded that the Company’s

NAC Re reinsurance operations was experiencing an increasingly negative trend of serious and


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unexpected (by investors) adverse development and knew that XL had not in fact set aside adequate

loss reserves. Indeed, defendant O’Hara admits that with regard to the various operations within

XL, and specifically NAC Re, he is “very plugged in and connected to all our units and operations.

We have a very flat organization. I get weekly reports from every unit.” See ¶175, infra. For

example, XL knew that by the end of 2001:

(a) Accident year 1997 had developed adversely for four straight years leading

the Company to add approximately $102 million to its reserves for that accident year;

(b) Accident year 1998 had developed adversely for three straight years causing

the Company to add approximately $183 million to its reserves for that year; and

(c) Accident year 1999 had developed adversely in both 2000 and 2001, causing

the Company to add approximately $113 million to its reserves for that accident year.

20. XL and the Individual Defendants also knew that the Company’s internal controls

and specifically its accounting and claims processing systems for its NAC Re reinsurance

operations was in complete disarray throughout the Class Period. The lack of sufficient accounting

procedures and record keeping practices resulted in incomplete and inaccurate records regarding

claims reported by its cedants and claim payment records which directly undermined XL’s ability

to accurately assess the Company’s loss reserves through its actuarial and/or reserving

methodologies. Indeed, actuaries project and estimate future loss reserves based on claims data. If

claims data is not accurately accounted for or tested, the actuary cannot accurately establish loss

reserves.

21. The material weaknesses in the Company’s internal controls were known to the

Individual Defendants. In fact, former employee confidential witnesses (“CWs”) in the United

States and from the Company’s Bermuda headquarters confirm that even at the time of the

acquisition, the Company did not do a detailed review of NAC Re’s claim history or review the


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claims history or underwriting policies of its cedents. In addition, CWs report that throughout the

Class Period, the accounting systems at NAC Re remained incapable of tracking claims and

payment records and in many instances told its cedents that it had paid claims when, in fact, it had

not; and also told its cedents that it didn’t owe them for submitted claims when, in fact, it did.

22. In fact, the failure to keep records tracking reported claims and claims paid resulted

in material deficiencies and inaccurate reporting of the Company’s financials to the NYID.

Specifically, in May 2002, the NYID harshly admonished the Company for its careless record

keeping and financial reporting which resulted in the understatement of liabilities and loss

expense adjustments and violated New York State Insurance Law and Regulatory requirements.

23. XL and the Individual Defendants deliberately disregarded these facts because the

Company needed to maintain the appearance of financial strength and capital surplus which was

required to write more policies and achieve positive ratings from insurance ratings agencies. In the

second half of 2001, the reinsurance industry experienced dramatic changes driven by many

reinsurers exiting property and casualty reinsurance business resulting in: (1) lower capacity (less

coverage availability for insurance and reinsurance purchasers); (2) dramatic premium rate

increases; (3) better contract terms and leverage for insurers and reinsurers; and (4) escalating flight

to quality, as insurers required reinsurers to be financially strong and able to pay future claims. The

increasingly competitive environment created substantial growth opportunities to reinsurers,

especially those with “AA” ratings and “strong balance sheets.”

24. XL, recognizing the opportunity to take advantage of high premiums and low

capacity, embarked on a strategy to grow all of its business segments. Indeed, the appearance of

XL’s balance sheet strength was crucial to its growth strategy as XL’s capital lenders and insurance

ratings agencies used the Company’s earnings, shareholder equity, capital liquidity and capital

ratios to assess the Company’s ability to pay debts and to rate its notes and bonds. Therefore, the


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Company’s ability to grow was simultaneously dependent upon its consolidated net worth and

capital surplus, and its ability to achieve and maintain an “AA” ratings or better from the major

insurance and reinsurance ratings agencies, e.g., A.M. Best, Moody’s, S&P and Fitch. An October

5, 2001 Bear, Stearns & Co., Inc. analyst report discussed the growth outlook for XL:

XL Capital’s management sees for itself a leadership role in a global insurance market in transition, with a major advantage in its strong balance sheet. The company believes that, looking beyond pricing opportunities, it will benefit from a flight to quality where ratings, capital strength and reputation will mean more to [insurance] buyers than price.

25. Indeed, as reported in the Company’s Report on Form 10-K for the year ending

December 31, 2001:

The Company’s 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 would be adversely affected in financial guaranty and long-tailed insurance and reinsurance lines of business.

26. Despite knowledge that the Company’s financial statements were materially false

and misleading, defendants bragged that XL was worthy of high ratings and that the Company’s

credit ratings and strong balance sheets allowed XL to take advantage of the “flight to quality” in

an environment of low capacity stating the following:

XL’s AA rating placed it among a small number of large companies with top tier ratings....

* * *

[W]e have gotten larger lines on a lot of renewals, both reinsurance and insurance, that we think is because of our better rating and also I think because of our reputation as well....

* * *

We’re growing, we’re committed to a double A and you’re seeing substantial top line growth. We are clearly solidly in the double A range at the moment. We intend to stay there.... [W]e will maintain our double A capital ratio.


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27. XL leveraged the false financials and the financial strength and debt ratings to

support four stock and debt securities offerings during the Class Period raising more than $1.87

billion:

Date Security Type Shares (in millions) Price Net Proceeds

(in millions)

A.M. Best

Ratings 11/01/01 Ordinary Shares (common) Equity 9.2 $89.00 $788

01/10/02 6.50% Guaranteed Senior Notes Due Debt $600 million

face amount $99.47 $589 a+

08/09/02 8% Series A Preferred Equity 9.2 $25.00 $223 a- 11/13/02 7.625% Series B Preferred Equity 11.5 $25.00 $278 a- TOTAL $1,878 (amounts in millions, except price)

28. Indeed, prior to and during the Class Period, XL substantially financed its business

through the offering of debt securities, convertible bonds and convertible notes. Much of the risk

and value of the convertible bonds and notes were dependent on the financial performance of the

Company and ratings by S&P, Moody’s, A.M. Best and Fitch. For example, in April 2001, the

Company issued $255 million of 6.58% Guaranteed Senior Notes. On May 18, 2001 and

September 4, 2001, respectively, XL issued $1.01 billion principal amount at maturity of Zero

Coupon Convertible Debentures (“CARZ”) and $509 million principal amount at maturity of

Liquid Yield Option Notes (“LYONs”).

29. Each of the CARZ and LYONs debt securities gave bondholders the right to require

the Company to repurchase the bonds on predetermined dates (“put” dates) at predetermined values

as set forth in the relevant debenture. XL’s repurchase obligations on the CARZ and LYONs were

also subject to credit ratings assigned by S&P’s bond rating agency. For example, if the

Company’s financial strength and credit ratings fell below the level of “BBB+,” that too would


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trigger bondholder’s rights to demand conversion into shares at 5.9467 shares per CARZ and 5.277

per LYONs.7

30. During the Class Period, a put date for the CARZ was scheduled to occur on May

23, 2002. If the bondholders for the CARZ “put” their bonds to the Company on that date, XL

would be obligated to repurchase the bonds at a total price of $614 million – approximately 33% of

its then outstanding debt.

31. During the Class Period, the “put” dates for the LYONs were scheduled to occur on

September 7, 2002 and September 7, 2003, respectively. If the bondholders for the LYONs put

their shares to the Company on either date, XL would be obligated to repurchase the shares at

prices of $295 million and $305 million, respectively.

32. In addition, during the Class Period, all of the Company’s bank facilities, indentures

and other documents relating to the Company’s outstanding indebtedness, including the Company’s

credit facilities, contained cross default provisions to each other and other affirmative covenants.

The covenants provided for, among other things, minimum required ratings of the Company’s

insurance and reinsurance operating subsidiaries and the level of secured indebtedness in the future.

The Company’s credit facilities and the 6.58% Guaranteed Senior Notes (“Senior Notes”) also

contained minimum consolidated net worth covenants.

33. Thus, it was imperative that XL achieve and maintain high credit and agency

ratings. However, in order to do so, the Company falsified its quarterly and year-end financials

reported to the public in press releases and documents filed with the SEC. Specifically, XL failed

to record adequate loss reserves for its reinsurance operations thereby understating expenses and

liabilities and overstating shareholder equity and capital surplus.

7 The CARZ and LYONs were rated “A+” by S&P at the date of issuance.


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34. Each of the Company’s financial reports was false and misleading as XL failed to

record adequate loss reserves for its reinsurance operations, NAC Re. Instead, XL dribbled reserve

increases in incremental amounts so as not to risk falling below statutory capital requirements,

finance agreements, loan covenants, letter of credits, and having to repurchase its convertible debt

either from put dates or ratings downgrades.

35. The false financials also caused the Company’s stock price to be artificially inflated.

The Individual Defendants took advantage of the artificial inflation and unloaded more than

400,000 shares of XL stock for illegal insider trading proceeds of $35.6 million, and pocketed more

than $8.1 million in incentive bonuses based upon falsely reported Company earnings and stock

price performance.

36. Then, on October 17, 2003, XL announced that its 3Q03 results would be reduced

by $184 million or approximately $1.16 per share due to adverse loss developments – once again,

in its NAC Re reinsurance operations and once again, for accident years 1997-2000.

37. In conjunction with the October 17, 2003 announcement of the reserve shortfalls, the

Company also announced in a press release that it would conduct an “extensive” audit review

which it had falsely told investors was part of its regular practice or reserve review. Defendant

O’Hara stated:

I am personally leading a review of this book of business, which will include an intensive claims audit and review of the ceding company claims files that will be completed by year end.... I intend to fully address our exposure to the 1997 through 2000 North American casualty reinsurance book written by the former NAC Re so that it will not adversely affect our financial results in 2004 and beyond.

38. Investors were furious and sold off XL shares causing the Company’s share price to

plunge more than $6.00 per share to $73.37 per share on October 17, 2003, on trading of 11.5

million shares. Notably, only two weeks earlier, on October 1, 2003, defendant O’Hara

suspiciously unloaded 40,000 shares of his XL stock for more than $3 million in insider trading


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proceeds. On October 14, 2003, just three days before the reserves bombshell, defendant Keeling

unloaded another 5,000 shares for $400,000.

39. On January 13, 2004, the Company announced that the “claims audit review”

uncovered an additional $663 million reserve shortfall and the Company would take a charge to

earnings to increase loss reserves for accident years 1997-2001 for NAC Re reinsurance contracts.

The Company held a conference call on January 14, 2004 admitting that what was told to investors

throughout the Class Period was not credible:

We are acutely aware that this legacy adverse development and the former NAC Re has been unacceptably recurring and costly to shareholders and has damaged our credibility.

40. The XL January 14, 2004 conference call disclosures also essentially admitted that

despite its earlier representations that the:

(a) Review of its cedents’ underwriting portfolios during the Class Period was not

sufficiently comprehensive to adequately make reserve assessments;

(b) Company’s reserve review process during the Class Period did not sufficiently

look at cedants’ own claim files to assess the adequacy of their own reserves;

(c) Company’s actuarial reviews during the Class Period did not properly focus

on known “problem areas” like the Company’s NAC Re reinsurance operations which had been

under reserved for years; and

(d) Adverse development trend for accident years 1997-2000 indeed required the

Company to change its actuarial methodologies to account for these development patterns.

41. By January 15, 2004, A.M. Best, Moody’s and S&P slashed XL’s credit ratings:

• A.M. Best Co. downgraded all debt ratings of XL affecting approximately $2.4 billion of securities issued or guaranteed by XL Capital and its affiliates.

• Moody’s Investor Services lowered the ratings of XL Capital Ltd (senior unsecured debt to A2 from A1) and debt-issuing affiliates, as well as the insurance financial


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strength ratings of members of the XL Reinsurance America Inc intercompany pool and XL Re (to Aa3 from Aa2).

• S&P lowered its credit ratings to A from A+ and cut most of the financial strength ratings on XL’s operating units to AA- from AA.

• Fitch Ratings placed XL’s long term issuer and senior debt rating of ‘A’, and preferred stock rating of ‘A-’ on Rating Watch Negative.

42. XL also announced that it had fired several of the executives at the Company’s NAC

Re operations including: C. Fred Madsen, President of the Company’s NAC Re reinsurance

operations; Martha Bannerman, the Company’s General Counsel and Chief Administrative Officer

for its NAC Re reinsurance operations; and a week later, Brown, Chief Executive Officer of the

Company’s insurance and formerly Chief of Reinsurance Operations at NAC Re abruptly left the

Company.

III. CONFIDENTIAL SOURCES

43. The allegations herein are based upon plaintiffs’ ongoing investigation, including

interviews of CWs, former XL employees who worked for the Company during the Class Period

and who are knowledgeable about the facts occurring during the Class Period. Plaintiffs also

reviewed relevant Company documents, SEC filings, press releases, analyst reports and other

reports by third parties.

44. The witnesses spoke to plaintiffs on a confidential basis and are therefore referred to

herein as “CW” as follows:

(a) CW1 is a former facultative analyst in the Company’s NAC Re reinsurance

operations between 2001 and 2004 inclusive and was supporting the Company’s Vice President of

Accounting, Claims and Underwriting all based at the Company’s Stamford, Connecticut

headquarters. CW1 was responsible for communicating with direct insurers to verify claims paid on

liability assumed by NAC Re and determining whether policies written in fact covered the losses

claimed. CW1 was also responsible for verifying that cedant companies had actually made their


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premium payments on policies ceded to NAC Re and interfacing the direct insurers and NAC Re’s

accounting department in Stamford, Connecticut, regarding claims made and claims paid.

(b) CW2 is a former Senior Vice President of XL Insurance, at the Company’s

Bermuda headquarters, responsible for managing direct insurance business for coverage of liability,

property, and professional liability.

IV. JURISDICTION AND VENUE

45. The claims asserted herein arise under §§10(b) and 20(a) of the Exchange Act and

Rule 10b-5 promulgated thereunder by the SEC [17 C.F.R. §240.10b-5]. Jurisdiction is conferred

by §27 of the Exchange Act.

46. Venue is proper in this District pursuant to §27 of the Exchange Act, 15 U.S.C.

§78aa and 28 U.S.C. §1391(b). Many of the acts and transactions alleged herein, including

preparation and dissemination of materially false and misleading information, occurred in

substantial part in this District. Additionally, the Company maintains principal executive offices in

this District.

V. THE PARTIES

47. Pursuant to Court Order dated April 16, 2004, lead plaintiff is Alaska Ironworkers

Pension Trust which purchased XL’s publicly traded securities during the Class Period and suffered

damages as a result of the wrongful acts alleged herein.

48. Plaintiffs Harold Malin and Sandra Joan Malin Revocable Trust purchased XL

securities during the Class Period, and suffered damages as a result of the wrongful acts alleged

herein.

49. Defendant XL is a corporation organized and existing under the laws of the Cayman

Islands with its principal place of business at XL House, One Bermudiana Road, Hamilton,

Bermuda HM 11. XL’s North American headquarters is located within the judicial district at

Seaview House, 70 Seaview Avenue, Stamford, Connecticut.


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50. Defendant O’Hara is, and was, at all times during the Class Period, XL’s President

and Chief Executive Officer (“CEO) and has been a director of the Company since 1986. During

the Class Period, defendant O’Hara sold 121,000 shares of XL common stock for proceeds of

$10,223,433.

51. O’Hara signed all of the Company’s public filings made with the SEC during the

Class Period, including, written certifications pursuant to §§302 and 906 of the Sarbanes-Oxley Act

of 2002 for the June 30, 2002 Report on Form 10-Q and for all subsequently filed quarterly and

annual reports. O’Hara was also the chief spokesperson for the Company as he was consistently

quoted in the Company press releases and spoke directly with investors and analysts during

investor conferences and quarterly and year-end earnings conference calls.

52. Defendant de St. Paer is and was, at all times during the Class Period raised herein,

XL’s Executive Vice President and Chief Financial Officer (“CFO”). De St. Paer signed all filings

made with the SEC including written certifications pursuant to §§302 and 906 of the Sarbanes-

Oxley Act of 2002 including all subsequently filed quarterly and annual reports. De St. Paer was

among the chief spokespersons for the Company and was present during all Company conference

calls and spoke directly to the public, including many of the false and misleading statements herein.

53. Defendant Brown was at all times relevant to the allegations raised herein XL’s

Executive Vice President of the Company and Chief Executive of Insurance Operations. Brown

served as President and CEO of NAC Re until XL’s merger in June 1999 when he was appointed

CEO of XL America, Inc. (“XL America”). In July 2000, Brown was promoted to Chief Executive

of Insurance Operations. Brown had full management and supervisory responsibility for

employees of XL America and its subsidiaries, including NAC Re. In addition, Brown also had

management, profit, and loss responsibility for all North American property and casualty insurance

and reinsurance operations and related service businesses. Brown is an actuary and has a B.A.


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degree summa cum laude in mathematics from the University of Delaware, an M.A. degree in

economics from Trinity College and is a Fellow of the Casualty Actuarial Society. During the

Class Period, defendant Brown sold 91,500 shares of XL common stock for proceeds of

$8,293,890. Brown was present and/or directly made statements to the public, including

presentations and conferences.

54. Defendant Keeling was at all times during the Class Period CEO of the Company’s

Reinsurance Operations. Keeling was present during the October 20, 2003 and January 14, 2003

Company conference calls and/or directly made statements to the public. During the Class Period,

defendant Keeling sold 127,635 shares of XL stock for proceeds of $11,791.135.

55. Defendant Bornhuetter is and was, at all relevant times during the Class Period, a

director at the Company and the former Chairman of NAC Re. Previously, Bornhuetter was an

actuary and served as Chairman of NAC Re from 1993 until 1999 and Chairman of the Board of

NAC Re reinsurance Corporation from 1990 until 1999, having served as a director of both since

August 1985. From November 1996 through December 1998, he also served as CEO of NAC Re

from August 1985 through October 1996, he also served as President of NAC Re. Bornhuetter

developed the Bornhuetter-Ferguson actuarial incurred loss method, a favored model used by

actuaries to calculate incurred losses and loss reserves. Bornhuetter signed the Registration

Statement and/or amendments pursuant to the Shelf Offering, the 2001 Report on Form 10-K and

the 2002 Report on Form 10-K. During the Class Period, defendant Bornhuetter sold 62,440 shares

of XL common stock for proceeds of $5,336,163.

VI. CONTROL PERSONS

56. During the Class Period, the Individual Defendants, as senior executive officers

and/or directors of XL, had access to the adverse undisclosed information described herein

regarding the Company’s business operations, financial condition, loss reserves, products, markets,


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customer relationships and present and future business prospects. The Individual Defendants knew

or recklessly disregarded that said adverse undisclosed information had not been disclosed to, and

was being concealed from the investing public.

57. Because they were responsible for running the Company, it is appropriate to treat the

Individual Defendants as a group for pleading purposes and to presume that the false, and

misleading and incomplete information contained in the Company’s public filings, press releases

and other publications, as alleged herein, are their collective actions. Each of the Individual

Defendants was directly involved in the day-to-day operations of the Company at the highest levels

and was privy to confidential proprietary information concerning the Company and its business,

operations, products, growth, financial statements, and financial condition, as alleged herein. Said

defendants knew of the Company’s inadequate loss reserves, were involved in the drafting,

producing, reviewing and/or disseminating the false and misleading statements and information

alleged herein, were aware of or deliberately disregarded that the false and misleading statements

were being issued regarding the Company, and approved or ratified these statements, in violation of

the federal securities laws.

58. As officers, directors and controlling persons of a publicly held company whose

securities were, and are, registered with the SEC pursuant to the 1934 Act, traded on the New York

Stock Exchange (“NYSE”), and governed by the provisions of the federal securities laws, the

Individual Defendants each had a duty to promptly disseminate accurate and truthful information

with respect to the Company’s financial condition and performance, growth, operations, financial

statements, business, products, markets, management, earnings and present and future business

prospects, and to correct any previously issued statements that had become materially misleading or

untrue, so that the market price of the Company’s securities would be based upon truthful and


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accurate information. The Individual Defendants’ misrepresentations and omissions during the

Class Period violated these specific requirements and obligations.

59. Each of the defendants is liable as a direct participant in, and co-conspirator with

respect to the wrongs complained of herein. In addition, the Individual Defendants, by reason of

their positions, are “controlling persons” within the meaning of §20 of the 1934 Act and had the

power and influence to cause the Company to engage in the unlawful conduct complained of

herein. Because of their positions of control, the Individual Defendants were able to and did,

directly or indirectly, control the conduct of the Company’s business.

60. The Individual Defendants, because of their positions with the Company, controlled

and/or possessed the authority to control the contents of the SEC filings, reports, press releases, and

presentations to securities analysts and through them, to the investing public. The Individual

Defendants were provided with copies of the Company’s reports and press releases alleged herein

to be misleading, prior to or shortly after their issuance, and had the ability and opportunity to

prevent their issuance or cause them to be corrected. Thus, each of the defendants had the

opportunity to commit the fraudulent acts alleged herein.

VII. FALSE AND MISLEADING STATEMENTS

61. False and Misleading Statements:8 On November 1, 2001, XL issued a press release

announcing that it had filed a Prospectus and Prospectus Supplement (“Prospectus”) with the SEC

dated November 1, 2001 to sell 8,000,000 ordinary shares that was pursuant to their effective Shelf

Registration Statement filed on October 22, 2001.

XL Prices Issue of Ordinary Shares

HAMILTON, Bermuda, Nov 1, 2001 /PRNewswire via COMTEX/ -- XL Capital Ltd (“XL”) (NYSE: XL) announced today that it has agreed to sell 8,000,000

8 False and misleading statements are primarily in bold type with emphasis.


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ordinary shares pursuant to XL’s currently effective shelf registration statement (plus up to an additional 1,200,000 shares issuable upon exercise of the underwriters’ over allotment option)....

As of September 30, 2001, the Company had consolidated assets of approximately 25.7 billion and shareholder equity of approximately $4.8 billion.

62. The ordinary shares were being issued at an initial price to the public of $89.00 per

share. The Prospectus, incorporated by reference into the October 22, 2001 Registration Statement,

December 31, 2000 Report on Form 10-K, and the April 6, 2001 proxy statement, among other

documents (“November 2001 Offering Documents”). The December 31, 2000 Report on Form 10-

K made the following false and misleading statements about the Company’s practice of estimating

“case reserves” and “IBNR” reserves:9

UNPAID LOSSES AND LOSS EXPENSES

Most of the Company’s incurred but not reported (“IBNR”) loss reserves are derived from casualty business.... IBNR is calculated in using several standard actuarial methodologies including paid and incurred loss development, Bornhuetter-Ferguson and frequency and severity approaches. The Company believes the methods presently adopted provide a reasonably objective result as it is based upon the Company’s loss data rather than more theoretical models often used in the low frequency high layer business the Company writes....

* * *

Additionally, claims audits are conducted for specific claims and claims procedures at the offices of selected ceding companies.

* * *

SIGNIFICANT ACCOUNTING POLICIES LOSSES AND LOSS EXPENSES

The reserve for losses incurred but not reported [IBNR] has been estimated by management in consultation with independent actuaries and is based on loss

9 In preparing periodic financial statements, a reinsurer must treat amounts of earned premiums as current income and amounts of incurred claims as offsets to current income. Loss reserves must be established for known claims (“case reserves”) as well as for incurred-but-not-reported claims (“IBNR reserves”). Reinsurers that underwrite casualty risks with long discovery or reporting delays often carry IBNR reserves much larger than their case reserves.


- 22 -

development patterns determined by reference to the Company’s underwriting practices, the policy form and the experience of the relevant industries.

* * *

Management believes that the reserves for unpaid losses and loss expenses are sufficient to pay losses that fall within coverages assumed by the Company.... The methodology of estimating loss reserves is periodically reviewed to ensure that the assumptions made continue to be appropriate and any adjustments resulting therefrom are reflected in income of the year in which the adjustments are made.

* * *

REINSURANCE OPERATIONS

Underwriting opportunities presented are evaluated based upon a number of factors including the type and layer of risk to be assumed, actuarial evaluation of premium adequacy, the cedent’s underwriting and claims experience, the cedent’s financial condition and claims paying rating, exposure and or experience with the cedent, and the line of business to be underwritten.

In addition, the Company assesses a variety of other circumstances including: the reputation of the proposed cedent and the likelihood of establishing a long-term relationship with the cedent....

On-site underwriting reviews are performed where it is deemed necessary to determine the quality of a current or prospective cedent’s underwriting operation.

63. False and Misleading Statements: The Company’s proxy statement incorporated by

reference into the Registration Statement assured investors that the Company had adequate internal

controls in place to assure its accounting and reserving methodologies were appropriate to

recommend that the financials be included in the public documents filed with SEC and regulatory

agencies:

The Audit Committee of the Board of Directors meets with the Company’s independent accountants to discuss the scope and results of their audit and to review the Company’s financial reporting, accounting and control systems. The Audit Committee reviews the Company’s reserving methodology and reserves.... The Audit Committee met six times during fiscal 2000.

* * *

The Audit Committee shall:

Review the reserving methodology and process of the Company and the Company’s reserves, together with internal or external actuarial reports or studies.


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* * *

Review and assess compliance with all applicable rules and regulations of the Securities and Exchange Commission and the New York Stock Exchange specifically applicable to the composition and responsibilities of the Audit Committee.

64. The November 1, 2001 Shelf Offering issuance of 9.2 million Class A ordinary

shares raised $788 million in proceeds.

Reasons Why Statements in ¶¶61-63 Were False and Misleading:

65. The statements in the November 2001 Offering Documents falsely assured investors

that: (a) the Company had in place adequate internal controls to ensure that its financials were

being reported accurately; (b) its reserves methods were based upon the Company’s actual loss data

rather than more theoretical models; (c) claims audits were being conducted at the ceding

companies; and finally (d) the Company’s methodology of estimating loss reserves were

periodically reviewed to ensure that assumptions made continued to be appropriate.

66. In truth, however, the Company’s reserve practices and methodologies for its NAC

Re reinsurance operations were severely flawed in November 2001 and throughout the Class

Period, and had been since the close of the NAC Re acquisition in June 1999 resulting in false

financial reports, inadequate reserves and disputes with its primary insurers.

67. According to CW1, a former facultative analyst for the Company’s reinsurance

operation, NAC Re, between 2001 and 2004, XL had “serious accounting problems” for the NAC

Re operations for the years prior to XL acquisition of the business in June 1999. CW1 reported that

the NAC Re accounting system was completely unreliable, and in fact, when CW1 began working

at NAC Re in 2001, there were thousands of claims which had been submitted to NAC Re from its

direct insurers, i.e., cedant companies, but had not yet been paid by NAC Re even though the

acquisition had closed in 1999. According to CW1, most of his/her daily responsibilities involved

reconciling or attempting to reconcile NAC Re cedant premium payments and NAC Re’s payment


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liabilities on claims for years prior to 2001 because NAC Re’s accounting department was unable

to reconcile, through its accounting system, whether claims had been paid. CW1 reported that

between 2001 and 2004 many of the unreconciled premium payments dated back as far as 1995-

1996.

68. CW1 further reported that the Company’s accounting system for NAC Re

reinsurance operations was so disorganized, that claims submitted by cedant companies were not

paid by NAC Re even though NAC Re had represented to the cedants (erroneously) that they were

indeed paid. In fact, CW1 reported that many disputes with cedant companies were caused by

NAC Re representing that it had paid claims when in fact it had not. Because the accounting

records for NAC Re were so poorly kept, the records of payments on reported claims were often

incomplete and some of its policy holders complained of claims left unpaid over periods of years.

69. CW1 stated that the same record keeping flaws in the accounting department

impacted the Company’s ability to collect premiums from its cedant companies because the

accounting department had often “no record whatsoever” or many times simply lost track of

payments. CW1 also reported that NAC Re’s accounting system did not even accurately keep track

of when its cedant companies paid their premiums and that NAC Re often refused to pay on

cedant’s reported claims stating that the cedant company had not paid its premium. CW1 reported,

however, that most times XL was proven to be wrong and in fact did owe for these disputed claims

because the cedant company would actually send XL a copy of the checks which had indeed been

cashed by NAC Re and a spreadsheet of accounts to which the premiums were applied.

70. According to CW1 the accounting problems at NAC Re were well known to XL’s

management team in Stamford, Connecticut and that information regarding claims he/she collected

and assembled from cedant companies was sent directly to XL’s Vice President of Claims for NAC

Re, David Hughes, in XL’s Stamford, Connecticut headquarters. CW1 further reported that even


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outside of the Company and conversations with co-workers, direct insurers and brokers at other

insurance companies, the NAC Re accounting department was considered a “joke and an

embarrassment.”

71. Further confirming the false and misleading nature of XL’s claim that its reserves

were based upon actual loss data and development patterns, etc., is the account of CW2, a former

senior vice president in the Company’s Bermuda headquarters during the Class Period. CW2

reported that when XL acquired NAC Re, XL “did not do the due diligence that needed to be done”

on NAC Re and that XL “did not look a heck of a lot” at NAC Re’s claims history.

72. More specifically, CW2 reported that XL’s due diligence process for the NAC Re

acquisition did not consist of a detailed review of claims within NAC Re or communications with

the direct insurers (cedents) from which NAC Re assumed liabilities. According to CW2, XL’s

actuaries used NAC Re’s loss data or “loss runs” at the time of the acquisition but that claims data

was not fully tested, i.e., reviewed at the claims level from the cedant companies. Nevertheless,

according to CW2, XL’s actuarial computations for setting reserves were based upon the data

provided by NAC Re. CW2 further described that in the reinsurance industry, especially in

acquisitions, it is known that many times loss data is incomplete resulting in a “bad base” upon

which actuarial analysis can be performed in order to set reserves for future losses.

73. XL’s failure to test NAC Re’s underlying claims data and failure to later maintain

internal controls regarding accurate record keeping or reported claims and claims payments were in

direct contradiction of the assurances given to investors and in violation of GAAP and the

American Institute of Certified Public Accountants (“AICPA”)10 rules. Moreover, in light of its

10 For the court’s convenience plaintiff has attached hereto as Exhibit 1 to the Consolidated Class Action Complaint, excerpts of the AICPA Audit and Accounting Guide: Audits of Property and Liability Insurance Companies – Glossary.


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knowledge that claims tracking and record keeping systems were unreliable, the statement that it

had reviewed its reserve methodologies to ensure that the assumptions made “continue to be

appropriate” was false and misleading.

74. The reports of both CW1 and CW2 and the impact of the Company’s lack of internal

controls are further confirmed by a Report on Examination of the NAC Reinsurance Corporation as

of December 31, 1999 (“Examination Report”) by the NYID, NAC Re’s New York State

Regulator, published in May 2002 covering the December 31, 1999 annual statement and

transactions, and submissions through 2001. As discussed in detail below at ¶¶107-113 and 233-

236, the Company’s inadequate accounting systems described by CW1 resulted in NAC Re

reporting materially inaccurate financial statements and related data with NYID including balance

sheet entries for which the Company could provide “no documentary support.” Specifically, line

items “reinsurance payable of paid losses and loss adjustment expenses.” The Report outlined the

Company’s repeated failures to keep accurate accounting records and its failure to submit accurate

financial statements, in violation of New York State Insurance Laws.

75. As evidenced by the Company’s repeated loss reserve shortfalls throughout the

Class Period for NAC Re, summarized at ¶203, XL failed to update its methodology as required

due to huge shortfalls in the loss reserves and obtain sufficient data from its cedents to record

adequate loss reserves.

76. False and Misleading Statements: On January 7, 2002, the Company announced that

it had agreed to sell $600 million of its 6.5% Senior Notes due 2012 through XL Finance (Europe)

pic, a wholly owned subsidiary of XL. The senior notes would be guaranteed by XL. The senior

notes would be sold pursuant to XL’s currently effective shelf registration statement. XL also

stated that the net proceeds from the sale of senior notes would be used to repay XL’s outstanding


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five-year revolving credit facilities and for general corporate purposes, which may include share

repurchases and acquisitions.

77. On January 9, 2002, the Company filed its Form 424b Prospectus for the issuance of

6.5% Senior Notes. The Prospectus incorporated by reference the Company’s Report on Form 10-

K for the FY00, and the Company’s Report on Form 10-Q for the period ending September 30,

2001 (“January 2002 Offering Documents”). Pursuant to the offering, the Company raised net

proceeds of $588.9 million.

78. The January 2002 Offering Documents contained the false and misleading

statements discussed above in ¶¶76, 77. Based upon the Company’s false financials, however,

A.M. Best rated the debt security at “a-.” The Company raised $589 million in the offering.

79. On January 28, 2002, the Company pre-announced that its 4Q01 earnings would be

negatively impacted by reserve shortfalls in the Company’s NAC Re operations:

XL Announces Fourth Quarter Charges

HAMILTON, Bermuda, Jan 28, 2002 PRNewswire – FirstCall via COMTEX/ --XL Capital Ltd (NYSE: XL) (“XL”) XL Capital Ltd announced today that fourth quarter results will include charges primarily for increased prior period casualty reinsurance loss reserves and several large loss events occurring in the fourth quarter of 2001.

Mr. Brian M. O’Hara, XL’s President and Chief Executive Officer, stated: “Following our regular year-end reserve review, we are increasing the reserves of our North American casualty reinsurance book due to adverse development from underwriting years predating our acquisition of NAC Re Corporation.

80. False and Misleading Statements: Between January 29, 2002 and February 13, 2002,

XL and the Individual Defendants issued a series of false and misleading statements about the

Company’s 4Q01 results and the “adverse developments” resulting in a huge $180 million charge

to earnings and what XL had done to address inadequate reserves in its NAC Re reinsurance

operations.


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81. False and Misleading Statements: On January 29, 2002, the Company and

specifically, defendant O’Hara, presented at the Salomon Smith Barney conference, with analysts,

during which the Company falsely assured investors that it had taken the necessary corrective

action to address reserve deficiencies at XL’s reinsurance operations– NAC Re: the Company also

falsely stated that its claims handling process had a tremendous track record and reported that its

reputation was supported by full actuarial reviews done on all lines of the business every year:

Our core casualty business, which has been in the doldrums for some time, is experiencing very robust growth, and that’s where my heart is. Now we can play pretty well, down to the bottom. We have a tremendous track-record of claim-handling, having paid out almost $2bn in losses with no litigation and our reputation holds us well.

We conduct a full actuarial review of all our business units annually. The actuaries only came to me 1.5 weeks ago with their concerns about developments at NAK* [sic] in 1996-1999. The first thing we did when we purchased NAK was cut out renewal business ($100m). Going forward from that, we’re in very good shape. We have taken corrective action on 2000, and our problems reflect what every re-insurer faced. We have put it behind us, and all the other actuarial reviews checked out positively.

82. By February 1, 2002, based upon the Company’s false assurances, the Company’s

stock price spiked from $86.91 per share to $88.12 per share on January 29, 2002.


83. The statement that the Company had a tremendous track record for claims handling

was false and misleading when made. In truth, as reported by CW1, the Company’s department did

not have the controls in place to ensure that its claim payment and premium records were complete

and accurate. Indeed, according to CW1, XL’s NAC Re reinsurance operations could not keep

track of when or whether it had paid claims made by direct insurers and in many instances did not

have records evidencing certain transactions. The Company’s claim handling process at its

reinsurance operations throughout the Class Period was totally unreliable, causing direct insurers to

consistently complain about the poor handling of their premium payments and XL’s failure to

reimburse for reported claims.


- 29 -

84. In addition, the statements that the Company conducts a “full actuarial review” of all

its business, that XL had “put this [NAC Re] issue behind [them],” and “all other actuarial review

checked out positively,” and that going forward the NAC Re business was in “good shape” were all

false and misleading statements when made. In truth, XL knew or deliberately disregarded that

what it called a “full actuarial review” did not include standard reviews of its cedent claims files; it

did not include a detailed review of the claim assumptions which it had previously told investors

was done on a regular basis to ensure that such assumptions continued to be appropriate. In fact,

GAAP and AICPA Audit and Accounting Guide for Audits of Property and Liability Insurance

Companies outlines the requirements of detailed reviews of cedent companies’ claims processing

and an assessment of the accuracy and reliability of data received:

Internal Control of the Assuming Company

6.47 A significant component of an assuming company’s internal control that is related to assumed reinsurance is the assessment of the accuracy and reliability of data received from the ceding companies. Principal control activities of the assuming company may include –

● Maintaining underwriting files with information relating to the business reasons for entering the reinsurance contracts and anticipated results of the contracts....

● Monitoring the actual results reported by the ceding companies and investigating the reasons for and the effects of significant deviations from anticipated results.

● Visiting the ceding companies to review and to evaluate their under-writing, claims processing, loss reserving, and loss-reserve-development-monitoring procedures.

● Obtaining the report of the ceding companies’ independent accountants on controls (relating to ceding reinsurance) placed in operation (and tests of operating effectiveness). See SAS No. 70, Service Organizations.

85. Defendants admitted in October 2003, after the Company suffered its fifth

consecutive year of significant reserve shortfalls for NAC Re business, their failure to maintain

proper internal controls as required by GAAP and set forth below. ¶¶221, 222 and 244-251.

Further, as reported by CW1, XL did not even maintain the accuracy of its own records used to

make reserve judgments, much less its cedents.


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86. False and Misleading Statements: On February 12, 2002, XL formally announced

its financial results for the 4Q01. The Company also reported that in 4Q01, it had taken a $180

million before tax charge for “adverse developments in loss reserve of United States casualty

reinsurance operations, in the former NAC Re book, representing deficiencies in underwriting years

1997-99.”

XL Capital Ltd Reports Fourth Quarter 2001 Results

HAMILTON, Bermuda, Feb 12, 2002 /PRNewsWire – FirstCall via COMTEX/-- XL Capital Ltd (‘“XL” or the “Company”‘) (NYSE: XL) today reported a net loss of $83.6 million, or a loss of $0.64 per share in the fourth quarter of 2001, compared with net income of $0.6 million, or income of $0.01 per share, in 2000’s fourth quarter. The net operating loss for the fourth quarter ended December 31, 2001 was $6.1 million, or a loss of $0.05 per share, compared to net operating income of $143.0 million, or income of $1.13 per share in the fourth quarter a year ago.

The Company’s 2001 fourth quarter results primarily reflect previously announced adverse prior period loss development on its U.S. casualty reinsurance book, [NAC Re] losses related to the bankruptcy of Enron Corp., American Airlines Flight 587 and several large European property losses.

87. On February 13, 2002, the Company held a conference call for investors and

analysts conducted by defendants O’Hara and de St. Paer. During the call, defendants discussed

the charge to income resulting from materially insufficient loss reserves in the NAC Re book of

business. In addition, the Company announced that there was a $180 million reserve shortfall for

the NAC Re business. Commenting on the Company’s 4Q01 results and $180 million reserve

shortfall in NAC Re’s casualty reinsurance operation, defendant O’Hara stated:

In Q4, incurred charge for adverse development in loss reserves of US casualty reinsurance operations, in the former NAC Re book, representing deficiencies in underwriting years 1997-99. Increase in net losses for these years pre-tax: $180m. Net impact on XL’s results in Q4 after tax: $140m.... Other large loss events, including bankruptcy of Enron and crash of American Airlines flight 587: $96m pre-tax.

88. False and Misleading Statements: During the February 13, 2002 conference call,

defendant O’Hara acknowledged that the Company knew of materially insufficient loss reserves at


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NAC Re. Securities analysts specifically probed defendants whether the Company had finally

taken the necessary steps to ensure that the NAC Re’s financial reporting and inadequate loss

reserves had been adequately addressed. Indeed, XL had taken a $95 million reserve charge at the

close of the merger in 1999 and $122 million more in 2000 and now an additional $180 million for

2001. Moreover, the Company had previously told investors that its reserves methods were based

on loss data and that the audit committee regularly reviewed the Company’s reserving

methodology, it was sound and the assumptions made to take the revenues “continued to be

appropriate.” See ¶¶61-63, supra. During the call, Charles Gates of Credit Suisse First Boston

asked O’Hara to provide more information on the $180 million reserve shortfall:

Q. Elaborate on additional reserve that used to be NAC Re?

[O’Hara:] A. That was for 1997, 1998, 1999. When we bought NAC Re we re-underwrote the book and let $100m of business go, which was a good move. We saw the market was in serious decline.

* * *

Q. On NAC Re – is this issue over?

A. We think we’ve turned a corner now.

89. False and Misleading Statements: During the same call, analysts also asked why it

was necessary to take additional reserve charges related to the NAC Re business when it took such

a big reserve increase in 2000 and whether it was because the Company had not taken enough in

2000. XL responded that:

It was development this year that we didn’t pick up until our year-end reserve review.

90. False and Misleading Statements: Finally, with regard to whether the Company had

the assets and capital to support the expansion of the business planned for 2002, O’Hara stated:

We brought extra capital on board at the end of the year and with long-term debt in order to create room for expansion of business. We have sufficient assets to support operating leverage in AA range .... If more capital is required, we can respond with non-equity, non-common stock capital.


- 32 -

91. On February 13, 2002, after defendants’ false assurance that problems with reserves

at NAC Re had been resolved, XL stock price skyrocketed by 6% from $91.25 per share to $97.11

per share.


92. The statement that the Company had “turned a corner now” with regard to

materially insufficient reserves at NAC Re was false and misleading. In fact, XL and the

Individual Defendants knew at the end of 2001 that the adverse loss developments in its

reinsurance operations described in ¶¶87-88, 94 had occurred three years in a row and were

continuing and would require additional charges going forward. Further, XL knew that it had not

adjusted its reinsurance actuarial methodologies for these current trends and other factors that

would modify past experience, such as subsequent charges for inadequate loss reserves in prior

accident years. As noted in ¶¶216-217, according to Financial Accounting Standard No. 60 (“FAS

60”) the “liability for unpaid claims shall be based on the estimated ultimate cost of settling the

claims (including the effects of inflation and other societal and economic factors), using past

experience adjusted for current trends, and any other factors that would modify past experience.”

93. XL and the Individual Defendants also knew that because its internal controls and

claims paying and reviewing process was in such disarray and that because of the disorganization it

could not accurately track premium payment claims made by its ceding companies, or track

whether NAC Re had paid such claims. Further, XL knew that it maintained wholly inaccurate or

incomplete records, rendering the Company unable to produce reliable loss reserve amounts. The

weakness of the Company’s internal controls filtered into its preparation of financial statements

filed with the SEC and with state regulators, in particular, the NYID, causing NAC Re’s GAAP and

statutory financial statements to be false and misleading and specifically understated its loss

reserves and loss expenses.


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94. The statement in ¶89 that it was a “development this year” was also false and

misleading. In fact, defendants knew that accident years 1997-1999 in the NAC Re reinsurance

operations had been developing adversely which, as of 2002, had occurred for three consecutive

years requiring XL to add to its reserve $95 million, $122 million and $180 million for 1999, 2000

and 2001, respectively. Moreover, even if the statement had been true, that the Company did not

pick it up until what it called a “year-end reserve review,” it was because its internal controls and

specifically, its accounting department systems were inadequate to provide accurate claims

reporting and payment information records to actuaries for proper reserve analyses. Finally, the

Company admits it had not done a “comprehensive review” of the cedent companies’ underwriting,

reserves processes and claims processing required by GAAP and AICPA rules described herein at

¶221.

95. With regard to O’Hara’s statement that the Company had “sufficient assets to

support operating leverage in AA range,” that too was false and misleading. Defendants knew or

deliberately disregarded that XL’s financial statements representing its reserves, shareholder equity

and expenses were false and misleading. As discussed in detail in ¶¶196-209, the Company’s

FY01 financial statements materially understated the Company’s reserves and expenses, and

overstated the Company’s earnings, shareholder equity and shareholder surplus. Defendants were

motivated, however, to understate the Company’s expenses and liability for reserves because XL’s

debt ratings, which supported its debt and securities offerings, were critically important to XL and

more importantly, its ability to write new business was dependent upon the appearance of capital

strength and surplus. See Report on Form 10-K for the FY01:

The Company’s 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 would be adversely affected in financial guaranty and long-tailed insurance and reinsurance lines of business.


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96. Had the Company taken adequate reserves in 2001 ($622 million after tax) for

accident years 1997-1999, the Company’s debt and financial strength ratings would have dropped –

as they did even upon the October 17, 2003 announcement of a $184 million shortfall and

immediately upon the announcement of a $663 million reserve shortfall in January 2004. See

¶¶167-168, 178-180. Indeed, a rating decrease or a stock drop could have force XL to immediately

pay its CARZ and LYONs bondholders approximately $909 million. See ¶¶28-31. Such an

increase in immediately payable debt would have crippled its ability to write new business and

crushed the Company’s ability to raise capital.

97. False and Misleading Statements: On March 26, 2002, XL filed its annual Report on

Form 10-K for the FY01. The Company’s Form 10-K was signed by defendants O’Hara, de St.

Paer and Bornhuetter. The Form 10-K falsely reported the Company’s net income, loss and

reserves, shareholder equity for the year ended December 31, 2001, as detailed in ¶¶196-209, infra.

With regard to the Company’s methodology for reserving for losses, the Company represented that

its methods were based upon actual loss data rather than merely theoretical models subject to

more uncertainty:

CLAIMS ADMINISTRATION

Claims management for the reinsurance operations includes the receipt of loss notifications, the establishment of loss reserves and approval of loss payments. Additionally, claims audits are conducted for specific claims and claims procedures at the offices of selected ceding companies.

* * *

Most of the Company’s incurred but not reported (“IBNR”) loss reserves are derived from casualty business. Casualty business generally has a longer tail than the Company’s other lines of business. IBNR is calculated using several standard actuarial methodologies including paid and incurred loss development, Bornhuetter-Ferguson and frequency and severity approaches. The Company believes the methods presently adopted provide a reasonably objective result as it is based upon the Company’s loss data rather than more theoretical models often used in the low frequency high layer business the Company writes.


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98. The Form 10-K for the period ending December 31, 2001 also discussed the

Company’s reserve methodologies and made the following false and misleading statement

concerning the Company’s reserve reviews:

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

Reasons Why Statements in ¶¶97, 98 are False and Misleading:

99. The statement that the Company’s reserve methods were based upon loss data rather

than more theoretical models was false and misleading. In fact, XL and the Individual Defendants

knew the “loss data” it had from its NAC Re reinsurance operations were incomplete and

inaccurate as reported by CW1 above.

100. CW1’s account is consistent with the Company’s failure to accurately assess and

record loss reserves necessary to account for known adverse loss development trends in the NAC

Re reinsurance operations throughout the Class Period.

101. XL’s failure to test NAC Re’s underlying claims data even during the due diligence

phase of the acquisition, as reported by CW2, and failure to maintain internal controls regarding

accurate record keeping or reported claims and claims payments reported by CW1 was in direct

contradiction of the assurances given to investors and in violation of GAAP and AICPA rules.

Moreover, had the Company reviewed its “loss experience regularly for loss trends” as it

represented to investors, it would have recognized that accident years 1997-2000 had experienced

three consecutive years of adverse loss development (recorded in calendar years 1999-2001) and

that for each of those years XL’s assumptions and methodologies had missed the mark by $95-$180

million. See ¶¶207-209. Instead, XL deliberately disregarded those known trends and instead

failed to record adequate reserve and thus misrepresented the Company’s financial condition in

order to maintain favorable financial strength and debt ratings to the detriment of investors.


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102. In fact, the reports of both CW1 and CW2 regarding the impact of the Company’s

lack of internal controls was confirmed by the Examination Report by the NYID, NAC Re’s New

York State Regulator, published in May 2002 and discussed in detail below.

103. False and Misleading Statements: On April 29, 2002, the Company reported its

financial results for 1Q02 in a press release:

XL Capital Ltd Reports First Quarter 2002 Results; Net Operating Income Per Share $1.53 in 2002 Compared With $1.24 in 2001

HAMILTON, Bermuda, Apr 29, 2002 /PRNewsWire – FirstCall via COMTEX/-- XL Capital Ltd (“XL” or the “Company”) (NYSE: XL) today reported that net income for the first quarter ended March 31, 2002 was $89.5 million, or $0.65 per share, compared with $218.9 million, or $1.73 per share, in the first quarter of 2001. Net operating income for the first quarter of 2002 was $210.4 million, or $1.53 per share, compared with $156.7 million, or $1.24 per share, for the quarter ended March 31, 2001.

* * *

Commenting on the first quarter results, Brian M. O’Hara, President and Chief Executive Officer of XL, stated, “Our first quarter results reflect the strong growth and improved market conditions that we continue to see in all segments of the Company. Additionally, we have benefited from a flight to quality and from new premiums from the inclusion of XL Winterthur International and Le Mans Re in the first quarter.”

104. False and Misleading Statements: On May 14, 2002, XL filed its quarterly report

with the SEC reiterating the false financials on Form 10-Q for the quarter ending March 31, 2002.

The Company’s Form 10-Q was signed by defendants O’Hara and de St. Paer.

For all or the reasons set forth in ¶¶196-254, XL’s false financial reporting was in violation of

GAAP, and defendants statements concerning the Company’s first quarter financials were false and

misleading.

XL’s CARZ “Put Dates” Subject the Company to $614 Million Repurchase Liability

105. On May 23, 2002, the Company faced the risk of having to pay $614 million to

repurchase its outstanding CARZ pursuant to “put” agreements contained in the debentures as

discussed at ¶¶28-31. Had all the bondholders chosen to exercise their put rights, the Company


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would immediately be forced to pay $614 million to repurchase the bonds using cash or shares –

approximately 33% of its outstanding debt. Because the bonds are primarily held by sophisticated

investors, repurchase of the bonds was likely if the stock price fell or XL’s balance sheet

deteriorated because it would reduce the value and attractiveness of the CARZ securities.

106. In addition, if the Company’s debt ratings from S&P at anytime fell below BBB+,

the noteholders had the right to put their notes to the Company and to demand repurchase.

However, because the Company had materially understated its liabilities and overstated its net

income and shareholder equity, XL was able to fraudulently maintain strong ratings from rating

agencies, thus staving of bondholder repurchase demands during the Class Period, which would

have crippled the Company as set forth herein.

NYID Issues Scathing Report on Its Examination on XL’s United States Reinsurance Operations – NAC Re

107. On May 31, 2002, the NYID filed its Examination Report of the NAC Re

Reinsurance Corporation, as of December 31, 1999. The Examination Report also included a

review of transactions subsequent to 1999 through at least 2001. According to the NYID, the

report was “confined to financial statements and comments on those matters that involve

departures from laws, regulations or rules, of which are deemed to require explanation or

description.” First, NYID found that the XL’s NAC Re reinsurance operations was in violation of

§310 of New York State Insurance Code requiring insurers to “facilitate such examination.”

108. The Examination Report further suggested that the Company did not comply with

Section 310, demonstrated among other things by the fact that:

• Documentation provided was often inaccurate and incomplete.

109. The Examination Report made additional factual findings directly addressing NAC

Re’s financial statements and inaccuracies in its accounts and records as follows:

i. Annual Statement Balances


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During the examination ... It was discovered that the Company did not have support for several of the annual statement balances as follows:

• Reinsurance payable of paid losses & loss adjustment expenses – In examination testing of this account, it was revealed the Company set up a payable based only on an e-mail from an affiliate. Also, the Company failed to provide information on a timely basis and when provided, it did not tie to the annual statement.

* * *

It is recommended that the Company maintain support for all annual statement balances.

110. The NYID Examination Report also outlined NAC Re violations of §1505(b) of the

New York Insurance Law, specifically, regarding the Company’s failure to accurately record

reinsurance payable on paid losses and loss adjustment expense and failure to maintain records

to support entries on its balance sheet:

ii. Reinsurance Payable on Paid Losses & Loss Adjustment Expenses

During the review of Reinsurance payable on paid losses & loss adjustment expenses, discrepancies were found in two of the four balances tested. These discrepancies resulted in a $988,000 understatement of the reinsurance payable account. Due to the immateriality of this amount, no examination change was made. However, it is recommended that the Company report accurate amounts in its filed annual statements.

111. The report also discussed “open items” on the NAC Re’s balance sheet:

The open items report balance for NAC Re International, an affiliate, was $18,786,870, however, the Company reported $26,231,000 in Schedule F, Part 1. No support could be provided for this difference.

112. Finally, the Examination Report discussed the section of the Company’s financial

statements called “other expenses” stating “the company was unable to provide support for three

of the five balances requested.”

113. The NYID Examination Report seriously criticized the Company’s financial reports

because they were inaccurate or incomplete and because the Company could not supply supporting

documents for balance sheet entries. The Examination Report corroborated facts disclosed by CW1


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as detailed above that the Company’s accounting systems were so disorganized that the Company

itself could not keep track of claims reports or claims payment transactions and in many instances

had no records of certain transactions. Nevertheless, despite actual knowledge that its internal

controls were insufficient to ensure that its financials were reported accurately with regulatory

agencies and the public, defendants failed to perform a comprehensive analysis of its internal

controls, reserving methodologies and cedents’ claims files until investors were damaged by

hundreds of millions of dollars. Instead, the Company falsely confirmed that its reserves were

“efficient” [sufficient] for the Company to move forward in an unencumbered position.

114. False and Misleading Statement: On July 30, 2002, the Company reported its


XL Capital Ltd Reports Second Quarter 2002 Results

Net Operating Income Per Share $0.18 in 2002 Compared With $1.25 in 2001

HAMILTON, Bermuda, Jul 30, 2002 /PRNewsWire – FirstCall via COMTEX/-- XL Capital Ltd (“XL” or the “Company”) (NYSE: XL) today reported a net loss for the quarter ended June 30, 2002 of $91.7 million, or a loss of $0.68 per share, compared with net income of $128.6 million, or income of $1.01 per share, in the second quarter of 2001. Net operating income for the second quarter of 2002 was $25.0 million, or $0.18 per share, compared with $160.1 million, or $1.25 per share, for the quarter ended June 30, 2001.

115. False and Misleading Statement: On July 31, 2002, the Company hosted a

conference call for analysts during which the Company assured investors of the sufficiency of the

Company reserves and that its “double a” rated balance sheet would drive revenue and earnings

growth for the remainder of 2002 and 2003:

Now to address the outlook. I would like to offer some guidance for the balance of 2002 and our initial thoughts on 2003 earnings. The adjustment for losses on WTC behind us, diminished exposure to asbestos, efficient [sufficient] reserves and a double a-rated balance sheet, I believe we are in an unencumbered position to move forward.

Looking at the second half of 2002 for XL, barring unusual events, I see nothing standing in the way of a strong performance.... [W]e currently expect growth of $8 per share, perhaps in the $8.10 to $8.20 range per share as initial guidance.


- 40 -

Reasons Why Statements in ¶¶114, 115 Were False and Misleading:

116. The July 31, 2002 statement that the Company had “efficient” reserves with a “AA”

rated balance sheet, in an unencumbered position to move forward, was false and misleading when

made. In fact, as a result of the Company’s failure to record adequate reserves for losses in its

NAC Re reinsurance operations, the Company’s balance sheet materially understated the

Company’s expenses and liabilities and overstated shareholder equity and capital surplus as

discussed in detail in ¶¶196-254. Defendants knew that material charges in its reinsurance

operations had been required for three consecutive years to account for serious loss reserve

shortfalls. Defendants also knew or deliberately disregarded that its NAC Re reinsurance

accounting systems, record keeping and financial reporting was woefully deficient as described by

NYID and CW1, and that its reserving methodologies did not include a detailed or comprehensive

review of its reinsurance ceding companies underlying policies or claims records. Defendants also

knew NAC Re’s accounting department deficiencies also resulted in false financial documents filed

with the NYID. Indeed, the Company’s so-called “AA” rating was also wholly dependent upon the

false financials and the appearance of capital surplus.

117. False and Misleading Statement: On August 6, 2002, XL filed its quarterly Report

on Form 10-Q for the period ending June 30, 2002 with the SEC, reiterating the false financials for

the quarter ending June 30, 2002. The Company’s Form 10-Q was signed by defendants O’Hara

and de St. Paer. In addition, defendants O’Hara and de St. Paer signed written certifications

pursuant to §§302 and 906 of the Sarbanes-Oxley Act of 2002. For all of the reasons set forth in

¶¶196-254, the financials reported in the Company’s Form 10-Q for the period ending June 30,

2002 were false and misleading.

118. False and Misleading Statement: On August 9, 2002, the Company announced that

it had agreed to sell 8,000,000 8% Series A preference ordinary shares pursuant to XL’s currently


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effective shelf registration statement (plus up to an additional 1,200,000 preference shares issuable

upon exercise of the underwriters’ over allotment option). The capital raised would pay for

investors who “put” their CARZ to the Company:

XL Prices Issue of Preference Ordinary Shares

HAMILTON, Bermuda, Aug. 9 /PRNewswire-FirstCall/ -- XL Capital Ltd (“XL”) (NYSE: XL) announced today that it has agreed to sell 8,000,000 Series A preference ordinary shares pursuant to XL’s currently effective shelf registration statement (plus up to an additional 1,200,000 preference shares issuable upon exercise of the underwriters’ overallotment option). The preference shares are being issued at an initial price to the public of $25.00 per share and will not be exchangeable for or convertible into ordinary shares of XL. The managing underwriters for XL’s preference share offering are Merrill Lynch, Pierce, Fenner & Smith Incorporated and Salomon Smith Barney Inc., as joint book-runners.

The net proceeds from the sale of the preference shares will be used for general corporate purposes, including, without limitation, payment for any Liquid Yield Option(TM) Notes put to XL on September 7, 2002 by the holders thereof.

* * *

As of June 30, 2002, XL Capital Ltd had consolidated assets of approximately $31.2 billion and consolidated shareholders’ equity of approximately $5.4 billion.

119. Based on the Company’s false and misleading financial statements, AM Best

assigned the debt securities rating of “a-.”

120. False and Misleading Statements: On August 9, 2002, XL filed its Report on Form

424b Prospectus with the SEC in connection of its sale of eight million series A preference ordinary

shares. The Prospectus incorporated by reference XL’s Report on Form 10-K for the year ending

December 31, 2001 and the Company’s April 5, 2002 proxy statement. The Form 10-K for the

period ending December 31, 2001 included the following false and misleading statements:

CLAIMS ADMINISTRATION

Claims management for the reinsurance operations includes the receipt of loss notifications, the establishment of loss reserves and approval of loss payments. Additionally, claims audits are conducted for specific claims and claims procedures at the offices of selected ceding companies.


- 42 -

121. The Company’s April 5, 2002 proxy statement stated:

AUDIT COMMITTEE

The Audit Committee of the Board of Directors meets with the Company’s independent auditors to discuss the scope and results of their audit and to review the Company’s financial reporting, accounting and control systems. The Audit Committee also reviews the Company’s reserving methodology and reserves.... The Audit Committee met five times during fiscal 2001.

RESPONSIBILITIES

The Audit Committee shall:

Review with Company management and the independent auditors the proposed overall plan and scope of the Company’s annual audit, the adequacy of the Company’s system of internal controls, and the Company’s audited financial statements and related disclosures.

* * *

Review the reserving methodology and process of the Company and the Company’s reserves, together with internal or external actuarial reports or studies.

* * *

Review and assess compliance with all applicable rules and regulations of the Securities and Exchange Commission and the New York Stock Exchange specifically applicable to the composition and responsibilities of the Audit Committee.

122. Pursuant to the August 9, 2002 offering, the Company, including false

representations about the Company’s financials, raised net proceeds of $222.8 million.

123. Between August 29, 2002 and September 13, 2002 defendant Bornhuetter sold

12,500 shares of his stock for proceeds of $1 million.

XL’s LYONs “Put Date” Subjected the Company to $295 Million Repurchase Liability

124. The Company faced the risk of having to pay $295 million on September 7, 2002 to

repurchase its outstanding LYONs pursuant to “put” agreements contained in the debentures. The

LYONs gave the bondholders the option to “put” their bonds back to the Company i.e., force the

Company to repurchase the bonds. Had all the bondholders chosen to exercise their puts, the

Company would immediately be forced to pay $295 million to repurchase the bonds using cash or


- 43 -

shares – approximately 16% of its outstanding debt. Because the bonds are primarily held by

sophisticated institutional investors, repurchase of the bonds was likely if the stock price fell or

XL’s balance sheet deteriorated because it would reduce the value and attractiveness of the LYONs

securities.

125. In addition, if the Company’s debt ratings from S&P at anytime fell below BBB+,

the noteholders had the right to put their notes to the Company and to demand repurchase.

However, because the Company had materially understated its liabilities and overstated its net

income and shareholder equity, XL was able to fraudulently maintain strong ratings from rating

agencies, thus staving of bondholder repurchase demands during the Class Period, which would

have crippled the Company as set forth herein.

126. False and Misleading Statement: On October 30, 2002, XL announced its financial

results for the 3Q02.

XL Reports Third Quarter 2002 Results

Net Operating Income $221.0 million, per share $1.61 Net Income $184.0 million, per share $1.34

HAMILTON, Bermuda, Oct. 30, 2002 /PRNewswire – FirstCall via COMTEX/ – XL Capital Ltd (NYSE: XL) (“XL” or the “Company”) today reported net income available to ordinary shareholders for the quarter ended September 30, 2002 of $184.0 million, or income of $1.34 per share, compared with a net loss of $840.0 million, or a loss of $6.70 per share, in the third quarter of 2001. Net operating income for the third quarter of 2002 was $221.0 million, or $1.61 per share, compared with a net operating loss of $761.8 million, or a loss of $6.07.

127. False and Misleading Statement: On the same day, the Company held a conference

call with securities analysts to discuss its 3Q02 results. During the call, the Company forecasted

earnings per share (“EPS”) of at least $8.00 for 2003 and bragged in its conference call with

analysts about its balance sheet growth, that ratings downgrades of other organizations had

narrowed “high quality” insurers and reinsurers and that XL was the leader in the industry poised

to take advantage of the hard market for the next two years.


- 44 -

Looking at our balance sheet, we have increased our shareholder’s equity from $5.4 billion at the end of June to $5.9 billion in September 30th which is attributable to this quarter’s net income, improvement is net unrealized gains on investment and the $230 million in preference (ph) shares issued in August. At (ph) book value for ordinary share has increased to $42.10 from $39.60 at June 30th.

Last but not least, the impact of rating agency downgrades on several organizations has reduced the number of high-quality insurers and reinsurers and has underscored the need to increase the rate of earnings growth and ROEs in the industry. All of this reinforces our belief that the hard market has at least two years of momentum. We are already in the strategic businesses that we want to be in the P&C area. XL is the leader in this industry with all the important ingredients in place to build on our leadership position.


128. The statement that the Company had increased its shareholder equity was false and

misleading as the Company failed to disclose that its reported shareholder equity was materially

overstated because it knowingly failed to record reserves for known shortfalls in its NAC Re

reinsurance operations as discussed below in ¶¶196-254.

129. False and Misleading Statement: On November 8, 2002, XL filed its quarterly report

with the SEC reiterating the previously released false financials in its Form 10-Q for the quarter

ending September 30, 2002. The Company’s Form 10-Q was signed by defendants O’Hara and de

St. Paer. In addition, defendants O’Hara and de St. Paer signed written certifications pursuant to

§§302 and 906 of the Sarbanes-Oxley Act of 2002 for all of the reasons stated in ¶¶196-254 below.

The financial results reported in the Company’s 3Q02 Form 10-Q were false and misleading.

130. False and Misleading Statements: On November 12, 2002, the Company announced

in a press release that it has agreed to sell 10,000,000 7-5/8% Series B preference ordinary shares

pursuant to XL’s currently effective shelf registration statement (plus up to an additional 1,500,000

preference shares issuable upon exercise of the underwriters’ over allotment option). The

preference shares were issued at an initial price to the public of $25.00 per share and would not be

exchangeable for or convertible into ordinary shares of XL. The net proceeds from the sale of the

preference shares would be used for general corporate purposes. The Company also falsely stated


- 45 -

that as of September 30, 2002, XL had consolidated shareholders equity of approximately $5.9

billion.

131. On November 15, 2002, the Company filed its Form 424B Prospectus for the

issuance of its $10 million worth of 7-5/8% series B preference ordinary shares. The Prospectus

incorporated by reference the Company’s annual Report on Form 10-K for the year ending

December 31, 2001; the Company’s proxy statement filed with the SEC on April 5, 2002; and the

Company’s most recent quarterly report for the period ending September 30, 2002 (“November

2002 Offering Documents”). Collectively, the Prospectus and the documents incorporated therein

made the same false and misleading statements regarding the audit committee and their

responsibilities as discussed in ¶¶120, 121.

132. As a result of the Company’s false and misleading financial statements, A.M. Best

assigned the debt securities a rating of “a-.”

133. Pursuant to the November 15, 2002 offering, and the false and misleading

statements within the November 2002 Offerings Documents, the Company raised net proceeds of

$278.4 million.

134. False and Misleading Statement: On January 3, 2003, Mark Lane of William, Blair

& Co., Inc. issued a report reiterating XL and the Individual Defendants’ comments in the

Company’s conference call regarding their 3Q02 revenue and earnings results and specifically

reiterating that defendants had assured investors that reserve inadequacies at NAC Re had been

addressed:

Although certain reinsurers continued to experience adverse reserve development in the casualty reinsurance business in 2002, XL’s management states that the major reserve inadequacies within its casualty reinsurance book related to the NAC Reinsurance acquisition in 1999 have been addressed.

135. False and Misleading Statement: On February 11, 2003, XL announced its financial

results for 4Q02 in a press release. The reported results beat First Call analyst EPS projections


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reporting $1.82 per share compared with analyst estimates of $1.79 per share. The Company,

however, reported that it once again had a reserve shortfall in United States casualty reinsurance,

i.e., NAC Re for accident years between 1997 and 2000 and would increase reserves by $215

million. The Company again reassured investors of its forecasted earnings for 2003 of at least

$8.00 per share despite continuing historical additional charges for reserve strengthening at NAC

Re:

XL Capital Ltd Reports Fourth Quarter and Full Year 2002 Results Announces Expensing of Stock Options Granted in 2003

HAMILTON, Bermuda, Feb 11, 2003 /PRNewswire-FirstCall via-COMTEX/--

Fourth Quarter Net Income $214.1 Million, or $1.56 Per Ordinary Share Fourth Quarter Net Operating Income $250.2 Million, or $1.82 Per Ordinary Share

XL Capital Ltd (“XL” or the “Company”) (NYSE: XL) today reported net income available to ordinary shareholders for the quarter ended December 31, 2002 of $214.1 million, or net income of $1.56 per ordinary share, compared with a net loss of $83.6 million, or a net loss of $0.64 per ordinary share, in the fourth quarter of 2001. Net operating income for the fourth quarter of 2002 was $250.2 million, or ordinary share, compared with a net operating loss of $2.6 million, or a loss of $0.02....

* * *

Commenting on the fourth quarter 2002 results, Brian M. O’Hara, President and Chief Executive Officer of XL, stated: “We had a very good quarter with strong underwriting results, delivering an operating return on common equity of 17% and increasing our book value ordinary share to $44.48. This was achieved while strengthening reserves during the quarter for prior years.”

“The reserve strengthening primarily occurred in our U.S. casualty reinsurance business, reflecting deterioration in the underwriting results for the 1997 to 2000 accident years.”

136. False and Misleading Statement: On February 12, 2003, XL hosted a conference call

with analysts during which defendants attempted to explain why, once again the Company had

another huge reserve shortfall related to the NAC Re’s business. Analysts sought answers to

whether in hindsight the Company had overpaid for NAC Re which had, based upon reserve

shortfalls to date, obviously had been under-reserved by at least $500 million and whether it was


- 47 -

finally reserved adequately. XL again falsely assured investors that it had substantively reviewed

reserves at NAC Re, indeed, had done so with “great scrutiny” and that it was now adequately

reserved.

RON FRANK: ... Couple of things if I could, Brian, on the reinsurance operations, you know, clearly with respect to Charlie’s questions those have nicked you a few times now and I was wondering if you could put your earnings guidance for 2003, if you could put that in the context of how you’ve gotten comfortable at long last with the reserves for that operation, since this is -- this has been a recurring thorn for you....

BRIAN O HARA: Okay, Ron. We looked at it, to say the least, with great scrutiny. And we believe, given all the facts we know today, it is at the right reserve levels.

Reasons Why Statements in ¶¶134-136 Are False and Misleading:

137. The statement that the Company had reviewed NAC Re reserves with "great

scrutiny" and that the reserves were at the right reserve levels were false and misleading when

made as defendant knew that the Company had not in fact done a comprehensive review of its

assumptions and reserve methodologies made to set reserves for the NAC Re operations. XL and

the Individual Defendants were in possession of “all the facts” regarding adverse loss developments

and trends in its reinsurance operations which had allegedly required hundreds of millions in

reserve charges but failed to change the assumption or methodologies used to set its reserves. In

addition, XL was also in possession of the facts reported by CW1 that during the entire Class

Period XL’s record keeping practices for claims reports and payments was in complete disarray

such that it could not accurately assess loss data to set reserves and the inaccuracy and

incompleteness of its records had already resulted in a scathing report from the NYID. These facts

are corroborated by Examination Report of the NYID. Defendants own admissions on October 17,

2003 and January 2004 confirm that the Company had not done a detailed claims audit or

substantially reviewed the underlying claims assumptions used to set reserves, had not audited its

material cedents and had not made the necessary adjustments to its assumptions and methodologies

to accurately set loss reserves. See ¶¶167-175, 177. All of these steps are required by GAAP and


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AICPA standards and the Company falsely represented that it had been done on an ongoing basis

and on February 12, 2003, done with "great scrutiny."

138. On February 12, 2003, Wachovia Securities analyst Susan P. Spivak issued a report

“XL Q4 Earnings Modestly Above But Lots Of Noise.” The report criticized XL again for taking

hundreds of million in reserves related to NAC Re only months after the Company told investors

that it had “turned the corner” on reserve issues at NAC Re:

XL: Q4 Earnings Modestly Above But Lots Of “Noise” (Part 1 of 2)

* * *

“Noise” in Q4 related to reserve strengthening in the reinsurance line (NAC Re business) and a loss from equity in insurance affiliates ....

We are disappointed with the need for the reinsurance reserve charge. Since XL purchased NAC Re in 1999, the company has continually needed to add to reserves on this business....

* * *

Financial Highlights

In Q4 2002, XL strengthened reserves by $215 million pretax, or $170 million after-tax ($1.24 per share), mainly relating to U.S. casualty reinsurance business written during the years of 1997-2000.

139. False and Misleading Statements: On March 31, 2003, XL filed its annual Report on

Form 10-K with the SEC reiterating the false financials for the FY02. The Company’s Form 10-K

was signed by defendants O’Hara, de St. Paer and Bornhuetter. In addition, defendants O’Hara and

de St. Paer signed written certifications pursuant to §§302 and 906 of the Sarbanes-Oxley Act of

2002. The Form 10-K also reported the Company’s explosive growth of the Company’s net

premiums written from $3.47 billion in 2001 to $5.97 billion in 2002. The Company’s explosive

growth in premiums written, however, was based upon artificially inflated earnings and shareholder

equity, resulting in phony financial strength and debt ratings assigned to the Company based upon

false financial statements. Specifically, XL failed to record adequate loss reserves for known


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adverse loss trends and reserve shortfalls in its reinsurance book of business. For all of the reasons

set forth below in ¶¶196-254, the financial results in its March 31, 2003 Form 10-K were false and

misleading.

140. False and Misleading Statements: The March 31, 2003 Form 10-K admitted,

however, that despite actual knowledge that its NAC Re reinsurance division had severe and

repeated loss reserve shortfalls and that its accounting department was suffering from a lack of

internal controls for which it had already been admonished by NYID, the Company had not

changed any of its reserve methodologies or the key assumptions for reserving. The Company

stated, with respect to loss reverses, the following:

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

* * *

The Company did not change its methodology or key assumptions in 2001 or 2000. This adverse development was due to an increase in the size and frequency of the reported claims for these lines that was greater than previously expected in the underlying loss reporting patterns used to estimate ultimate losses.

141. False and Misleading Statement: On April 28, 2003, the Company announced its


XL Capital Ltd Reports First Quarter 2003 Results

– Net Income $239.9 million, or $1.74 per ordinary share – Net Operating Income $250.1 million, or $1.82 per ordinary share HAMILTON, Bermuda, April 28, 2003 /PRNewswire – FirstCall via COMTEX/ – XL Capital Ltd (NYSE: XL) (“XL” or the “Company”) today reported net income available to ordinary shareholders for the quarter ended March 31, 2003 of $239.9 million, or net income of $1.74 per ordinary share, compared with net income of $89.5 million, or a net income of $0.65 per ordinary share, in the first quarter of 2002. Net operating income for the first quarter of 2003 was $250.1 million, or $1.82 per ordinary share, compared with net operating income of $207.6 million, or $1.51 per ordinary share, for the quarter ended March 31, 2002 (see below for a reconciliation to net income).


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Commenting on the first quarter 2003 results, Brian M. O’Hara, President and Chief Executive Officer of XL, stated: “We had a very strong first quarter with excellent underwriting results reflected in our combined ratio of 86.1% and net earned premium growth of 42% in our general insurance and reinsurance operations. Our net operating income return on ordinary shareholders’ equity exceeded 16% and book value per ordinary share increased to $46.09, a record level for XL.

“Our general insurance and reinsurance businesses continue to see very strong pricing, most notably in casualty, professional lines and marine worldwide,” said Mr. O’Hara.

142. False and Misleading Statements: On April 29, 2003, the Company hosted a

conference call for analysts during which defendants boasted that its double and triple “A” rating

was one of the factors differentiating XL from other insurance companies who were looking to do

business with only “higher quality organizations “of which XL was one. The Company further

bragged about the fact that its “Triple A” reinsurer was of the few remaining “Triple A rated”

reinsurers in the world:

Industry financial strength ratings continue to be under pressure from the rating agencies. The flight-to-quality has been another factor in our growth. Both the insured and the insurance companies that we reinsure are seeking to deal with higher quality organizations of which there is a smaller number. Increasingly differentiating XL. As a result, our double-A and Triple-A ratings are important factors to our ongoing success....

* * *

In our financial products and services segment, earned premiums doubled from the Q1 2002, reflecting the continued steady growth of our financial guarantee insurance and reinsurance businesses. XL financial assurance, our Triple-A reinsurer is one of the few remaining Triple-A-rated financial guarantee, reinsured in the world. We continue to focus on plain vanilla financial guarantee transactions with an emphasis on ROE....

* * *

BRIAN O’HARA: Thanks, Jerry. I would like to provide a few comments on the outlook for XL for the balance of the year. The market continues strong. I see no reason for this environment to change any time soon. And we expect the current hard market to continue throughout 2004. Turning to guidance for 2003, our underwriting results in the Q1 were excellent.... Our guidance for the fall under 2003 remains at $8.00 per share.


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143. During the same call, O’Hara also specifically discussed how XL was different than

newer reinsurers and that XL would not suffer from competition because it was in a better “reserve

position” and had financial strength ratings that could support capital raising efforts:

The investment markets are going to be a challenge for quite a while. The new players, while they don’t have the old problems, don’t have the reserves built up, they don’t have the treaty support. They don’t have the ratings. So they are limited in what impact they can have on the market. And they just aren’t in a position to take gambles.... Everybody still has to look very seriously at margin, and they too have similar constraints that the new capital have in terms of reserve positioning, the ratings, and treaty support, and the cost of reinsurance. The cost of reinsurance isn’t going down any time soon.

* * *

[W]e are very committed to maintaining capital to support our double-A insurance and reinsurance and our Triple-A financial products and services ratings. And we monitor that on a regular basis. The thing that I can tell you is that we are not contemplating any equity financing. And -- but I can also assure you we monitor carefully and will protect our credit ratings. They are strategically important to us.

Reasons Why Statements in ¶¶139-143 Are False and Misleading:

144. The statement regarding the Company’s ratings differentiating XL from other

reinsurers specifically because its competitors “don’t have the reserves built up” and “don’t have

the ratings” was false and misleading when made. Defendants knew or deliberately disregarded

that XL’s financial strength and debt ratings were only the result of the Company’s false financial

statements and its failure to record loss reserves for known loss development trends in its NAC Re

operations. Indeed, but for the Company’s failure to address known weaknesses in its internal

controls and to timely record hundreds of millions in reserves, the Company would not “have the

ratings” or reserve positioning allowing defendants to represent XL as a “higher quality

organization.”

145. False and Misleading Statement: On April 30, 2003, Deutsch Bank-North America

issued a report rating XL a strong buy repeating XL management statements in the April 28, 2003

conference call and reiterating the Company’s FY03 guidance of $8.00 per share. The report also


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noted that the Company was benefiting from flight to quality because of its “AA” and “AAA”

rating comments regarding “prior year reserve” movement strongly suggested that XL’s “balance

sheet fixing” was finally over:

HIGHLIGHTS:

Building reserve redundancies. On the first quarter earnings conference call, XL Capital’s management stated the underwriting conditions remain strong, with casualty prices rising and players focusing on margin improvement rather than market share growth. Management also stated that there was very little prior-year reserve movement, and the company is building redundancies. This suggests that the balance sheet fixing appears to be over and future earnings will be stronger....

* * *

Management reiterated its 2003 EPS guidance of $8.00 per share ....

* * *

DETAILS:

On XL Capital’s first quarter earnings conference all, management maintained their 2003 EPS guidance of $8.00. They highlighted that the underwriting environment continues to be strong, so they expect the company’s combined ratio to be below 90%....

* * *

Management stated that casualty prices continue to rise, and it expects that trend to continue through 2004. Furthermore, XL Capital is benefiting from a flight to quality given its AA and AAA ratings.

146. False and Misleading Statement: On the same day, April 30, 2003, William, Blair &

Co., Inc. issued a report based upon XL’s comments during the conference call and reiterated the

Company’s FY03 forecast of $8.00 per share and specifically committed upon the strength of the

Company’s balance sheet:

XL Capital: Impressive Underwriting Margins; Reiterate Outperform Rating

* * *

The balance sheet remains in good shape and XL does not need any equity capital to support current growth expectations, in our opinion. Total debt to total capitalization was 21.7% as of March 31, 2003, 27.6% including all preferred securities as debt. Management stated that it is experiencing no issues with


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collecting from its reinsurers and we do not have any major concerns among XL’s top reinsurance recoverable exposures - - in excess of 3% of its exposure....

Management reiterated its 2003 EPS guidance of $8.00 per share, which includes a $0.30 per share loss for Annuity and Life Re, although it continues to provide minimal guidance regarding premium growth targets.

147. False and Misleading Statement: On May 15, 2003, XL filed its quarterly report

with the SEC reiterating the false financials on Form 10-Q for the quarter ending March 31, 2003.

The Company’s Form 10-Q was signed by defendants O’Hara and de St. Paer. In addition,

defendants O’Hara and de St. Paer signed written certifications pursuant to §§302 and 906 of the

Sarbanes-Oxley Act of 2002, as discussed in ¶¶196-254, the financial results reported in the Form

10-Q were false and misleading when made.

Credit-Strapped – XL Pays $111.9 Million for a $500 Million Put Option Agreement to Get New York State Statutory Relief in Order to Bring NAC Re Reinsurance Operations Into Statutory Compliance:

148. By 2Q03, XL and the Individual Defendants knew that the Company was strapped

for credit and that it had exhausted its available letters of credit from bank lenders. In addition,

defendants knew that NYID, which had only one year earlier issued a scathing report on the

Company’s NAC Re reinsurance operation citing specifically that its reported statutory surplus (the

statutory equivalent to shareholder equity) and assets on its annual statement were materially

overstated and that its financial books and records were not kept accurately and in compliance with

New York State Law, would require additional collateral for items on NAC Re’s balance sheet

including a receivable of approximately $3 billion from XL Re Bermuda, an alien (non-admitted)

company.

149. The Company’s NAC Re reinsurance operations writes reinsurance policies and

retrocedes 75% of its reinsurance liability to another XL subsidiary, XL Re in Bermuda. To satisfy

the state’s requirements, insurers, especially those like NAC Re who cede or retrocede reinsurance


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risk to non-admitted, or “alien” reinsurance companies, must provide collateral for receivables or

write the asset down to $0, which reduces surplus by the amount of the writedown dollar for dollar.

150. In February, 2003, NAC Re reported to NYID that it had 2.3 billion in receivables

on its balance sheet from reinsurance it had retroceded to XL Re. However, unless NAC Re

provided collateral for the receivable, pursuant to SAP and New York State Law, NAC Re would

have to write off 100% of the receivables from XL Re. Put simply, NYID demanded NAC Re

provide collateral for its XL Re receivables so they could be assured that NAC Re would be able to

pay its claims if XL Re was unable to pay or elected to default on NAC Re’s receivable.

151. XL had secured $2 billion in letters of credit from its syndicated bank lenders but

needed over $500 million more to satisfy New York State regulatory requirements for its NAC Re

reinsurance division. XL knew it had exhausted its ability to obtain additional collateral using

letters of credit and was forced to set up an alternative form of collateral and provide an additional

insurance trust in order to satisfy statutory requirements.

152. Thus, in May 2003, XL began preparations to provide another $500 million in

collateral security for NAC Re by entering into a complex “put” option agreement to provide the

Company with statutory relief” through a New York State Regulation 114 Trust. Regulation 114

governs the manner in which insurers must establish trust accounts that provide ceding companies

with credit for reinsurance from non-admitted reinsurers. A Regulation 114 trust establishes a

segregated trust account into which assets are deposited, (in this case by XL) in the form of

securities or cash in which the cedent is the beneficiary (in this case NAC Re). The United States

cedent, in this case NAC Re, then includes information about the trust in its own financial reports

to state regulators in order to avoid write downs of receivables and surplus, for the amount of

uncollateralized receivables from the non-admitted, alien reinsurer.


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153. In sum, because XL was fully extended on letters of credit, XL had to spend $111.9

million to provide statutory relief to NAC Re by entering into a complex $500 million insurance

trust put transaction. Thus, in the event of default by XL Re, NAC Re could withdraw assets from

the Regulation 114 Trust fund to fulfill its United States reinsurance obligations. This complex

transaction was 6.6% of XL’s June 30, 2003 shareholder equity, and 40% of NAC Re’s June 30,

2003 shareholder surplus.

154. False and Misleading Statement: On June 18, 2003, XL filed an amended quarterly

Report on Form 10-Q with the SEC reiterating the false financials for the quarter ending March 31,

2003. See ¶¶196-254. The Company’s Form 10-Q was signed by defendants O’Hara and de St.

Paer. Defendants O’Hara and de St. Paer also signed written certifications pursuant to §§302 and

906 of the Sarbanes-Oxley Act of 2002. The amended Form 10-Q made the following false

statement regarding the Company’s ability to meet its statutory obligations using its commercial

facilities from banks:

The Company has several letter of credit facilities provided on a syndicated and bilateral basis from commercial banks.... All of the commercial facilities are scheduled for renewal during the remainder of 2003. 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 cedant. This could take the form of additional insurance trusts supported by the Company’s investment portfolio or funds withheld using the Company’s cash resources. The value of letters of credit required is driven by, among other things, loss development of existing reserves, the payment pattern of such reserves, the expansion of business written by the Company and the loss experience of such business.

Reasons Why Statements in ¶154 Were False and Misleading:

155. The statement that “in the event credit support is insufficient, the Company would

be required to provide alternative security” was false and misleading when made. In truth, on June

18, 2003 defendants already knew its credit support was in fact insufficient and their commercial


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facilities could not be relied upon, and that as early as May 22, 2003, XL had already set up a trust

with the stated purpose of affecting a $500 million put transaction agreement to provide NAC Re

with statutory relief from state regulators. See ¶¶148-153.

156. Between May 29, 2003 and July 11, 2003, defendants O’Hara, Keeling and Brown

sold a total of 52,000 shares of their XL stock for illegal insider trading proceeds of $2.5 million.

157. On July 14, 2003, XL issued a press release announcing it had entered into a Capital

Markets Transaction to increase capital resources:

XL Capital Ltd Completes $500 Million Capital Markets Transaction

HAMILTON, Bermuda, Jul 14, 2003 /PRNewswire-FirstCall via COMTEX/ -- XL Capital Ltd (NYSE: XL) (“XL”) announced today that it has entered into a capital markets transaction to increase its capital resources and capacity to provide reinsurance financial statement credit to its U.S. property and casualty insurance operations. Through the transaction, XL obtained an unconditional right to put up to $500 million of its preference ordinary shares to a high quality asset-backed trust for a period of up to 30 years. The securities issued by the trust were rated “A-” by Standard and Poor’s Ratings Group and “A3” by Moody’s Investor Services, Inc. The transaction was privately placed.

158. False and Misleading Statement: On July 31, 2003, the Company announced its


XL Reports Second Quarter 2003 Results

Record Net Income $347.7 million, or $2.51 per ordinary share

HAMILTON, Bermuda, July 31, 2003 /PRNewswire-FirstCall -- XL Capital Ltd (NYSE: XL) (“XL” or the “Company”) (NYSE: XL) today reported net income available to ordinary shareholders for the quarter ended June 30, 2003 of $347.7 million, or $2.51 per ordinary share, compared with a net loss of $91.7 million, or $0.68 per ordinary share, in the second quarter of 2002....

* * *

Total assets as of June 30, 2003 were $39.2 billion compared with $35.6 billion as of December 31, 2002. Book value per ordinary share as at June 30, 2003 increased to $51.40 compared with $44.48 as at December 31, 2002.

159. False and Misleading Statement: On August 1, 2003, XL held a conference call

during which defendants made the following false and misleading statements bragging about the


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Company’s debt to capital ratios and debt ratings. The Company also reiterated its 2003 EPS

guidance of $8.00 per share:

We continue to benefit from our AA level financial strength ratings from the major rating agencies, and we are able to better leverage terms and conditions as a result of our financial strength relative to most of our competition....

* * *

Our debt to total capital ratio is a healthy 20 percent, down from 22 present [sic] at year-end due to the increase in our total equity base....

* * *

[T]he rating agencies are still very concerned about the industry’s capital adequacy. Our strong results for the first half of 2003 have bolstered our AA capital position....

Based on recent discussions with the rating agencies, we do not anticipate having to raise common equity or common equity linked capital over the near to medium-term.... I don’t believe any change in our previous guidance for 2003 is warranted.

160. False and Misleading Statement: During the same August 1, 2003 call, analysts also

asked defendants why the amount the Company had recorded in IBNR reserves had actually gone

down considering that the Company was reporting strong growth in its casualty business.

Defendants O’Hara and de St. Paer again falsely told investors that the Company’s reserving

methodologies were extremely conservative – meaning that current reserves were more than

enough to cover potential losses.

BRIAN O’HARA: Yes, ... in terms of our overall actuarial reserve, which I think this hits directly at the point you are raising, have consistently been and continue to be a pretty conservative house in terms of the way we provide. So I think it is just a mix of those various numbers flowing through rather than any trend.

BRIAN O’HARA: ... You can see that the reserving process continues to be pretty conservative, and, of course, that supports very strong cash flow as well.

* * *

RON FRANK, ANALYST, SMITH BARNEY: A couple of things. One, I just want to clarify on the unchanged guidance, the guidance that I recall is about $8.00 this year; is that correct?


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JERRY DE ST. PAER: That is right.

161. XL was asked once again about the reserves at its reinsurance operations and once

again falsely assured investors that its reinsurance business was reserved at very conservative

levels:

BRIAN O’HARA: Good morning, Ron. You have heard Brian in the past talk about financial conservative bias in the actuarial and (inaudible) technology, and no where more does that apply than here.

* * *

RON FRANK: On that subject, can I infer from the comments you just made that you are still feeling pretty confident you are done with North American Casualties as far the prior year issues are concerned?

BRIAN O’HARA: Yes. Things look very good.

* * *

MARK LANE: In your response to Ron’s question, do you feel better about your reserve position now than just in mid-May, or are we going to have to wait until the end of the year before we have a real good sense if there is anymore reserve development that may continue to trickle in?

BRIAN O’HARA: What I recall saying was that if we had any, it would be easily absorbed in the growing profit run-rate that we have on casualty lines. But we don’t do a reserve analysis until later in the third quarter.

162. Finally, defendants again took the opportunity to boast about the Company’s

competitive advantage in the marketplace because it had better ratings and credit than the newer

entries into the marketplace commenting that it would be in the best interest of larger insurers like

AIG to do business with XL:

ADAM KLAUBER: Okay. And finally, the casualty markets are obviously very robust right now. Have you seen more competitors move into the market?

BRIAN O’HARA: I think there are a lot of people who would like to get into it. In the casualty market, credit ratings are increasingly important, particularly in the reinsurance area. Our AA has increasing competitive advantage vis-a-vis others who have ambitions, but they are only going to have limited acceptance ....

* * *


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With our AA rating, we think that we have so few competitors at that range, that it would behoove them to want to do business with us.


163. The statements that the Company’s overall actuarial reserve and reserving process

was “pretty conservative,” and its comments regarding XL’s financial strength and debt ratings

were false and misleading when made. XL and the Individual Defendants knew that the Company

had inadequate accounting controls at NAC Re, which made any estimate of loss reserves

unreliable. In fact, defendants knew that material charges in its reinsurance operations had been

required for three consecutive years to account for serious loss reserve shortfalls and that its

reserving methodologies did not include a detailed or comprehensive review of its reinsurance

ceding companies underlying policies or claims records or account for known negative trends

affecting the financial results. Moreover, as a result of the Company’s failure to record adequate

reserves for losses in its NAC Re reinsurance operations, the Company’s balance sheet materially

understated the Company’s expenses and liabilities and overstated shareholder equity and capital

surplus as discussed in detail in ¶¶196-254. Indeed, the Company’s so-called “AA” rating was

purely a result of the false financials and the appearance of capital surplus.

164. False and Misleading Statement: On August 15, 2003, XL filed its quarterly Report

on Form 10-Q with the SEC reiterating the false financials for the quarter ending June 30, 2003.

The Company’s Form 10-Q was signed by defendants O’Hara and de St. Paer. In addition,

defendants O’Hara and de St. Paer signed written certifications pursuant to §§302 and 906 of the

Sarbanes-Oxley Act of 2002.

XL’s LYONs “Put Date” Subjected the Company to $300 Million Repurchase Liability:

165. The Company faced the risk of having to pay $305 million to repurchase their

outstanding LYONs on September 7, 2003 pursuant to “put” agreements contained in the

debentures. The LYONs debentures, as described above in ¶¶28-31, 124, 125, gave the


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bondholders the option to “put” their bonds back to the Company, i.e., force the Company to

repurchase the bonds on specified dates, one being September 7, 2003 or upon the occasion of

certain events affecting the credit ratings assigned to the bonds. For example, if the Company’s

financial strength and/or debt ratings at anytime dropped below BBB+ the bondholders had the

right to put their bonds to the Company and to demand repurchase. Had all the bondholders chosen

to exercise their puts, the Company would immediately be forced to pay $305 million to repurchase

the notes using cash or shares – approximately 16% of its outstanding debt.

166. On October 1, 2003, defendant O’Hara sold a massive 40,000 shares for proceeds

of more than of $3.1 million and on October 14, 2003 defendant Keeling sold 5,000 shares for

proceeds of $398,500.

XL Shocks Investors with Another Huge Reserve Shortfall in Its NAC Re Reinsurance Operations Causing Its Stock Price to Plummet:

167. On October 17, 2003, at 5:49 a.m., XL issued a press release announcing yet another

huge loss reserve shortfall in its NAC Re Reinsurance business and a corresponding $184 million

reserve charge for its reinsurance operations:

XL Capital Ltd. Announces That Third Quarter Results Will Be Impacted by Prior Period Losses in North American Casualty Reinsurance Operations

HAMILTON, Bermuda, Oct. 17 /PRNewswire-FirstCall/ -- XL Capital Ltd (“XL” or the “Company”) (NYSE: XL) announced today that third quarter results will be lower than anticipated due to higher than expected losses in its North American reinsurance operations primarily from new casualty claims for the 1997 to 2000 underwriting years. As a result of these losses, the Company expects its third quarter 2003 net income to be reduced by approximately $184 million pre-tax or $160 million after-tax, or approximately $1.16 per ordinary share, compared to analysts’ current expectations. The Company will report third quarter results after the close of market trading on October 29, 2003.

Brian M. O’Hara, President and Chief Executive Officer of XL, stated; “As we have previously noted, the underwriting years in the late 1990’s were among the worst in the industry’s history for North American casualty business. ... The claims stem from the former NAC Re book, primarily from general liability, medical malpractice, professional lines and surety.”


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“I am personally leading a review of this book of business, which will include an intensive claims audit and review of the ceding company claims files that will be completed by year end,” Mr. O’Hara noted. “I intend to fully address our exposure to the 1997 through 2000 North American casualty reinsurance book written by the former NAC Re so that it will not adversely affect our financial results in 2004 and beyond.

168. Immediately, at 8:27 a.m., on October 17, 2003, Bloomberg reported S&P’s ratings

services placed ratings on XL and its other core holdings on CreditWatch with negative

implications.

169. On October 17, 2003 at 9:23 a.m., Wachovia Securities issued a report stating that

after XL finishes its process of reviewing its reserves at NAC Re it “could lead to additional

strengthening,” i.e. more charges.

170. On October 17, 2003, at 12:25 p.m., Wachovia Securities issued a report lowering

3Q03 earnings estimates for XL from $2.08 per share to $0.92 per share based upon the Company

revelation of yet another reserve shortfall and was in the process of a review that would likely lead

to additional reserve charges:

XL: Additional Reserve Strengthening – Lowering 2003 Estimates (Part 1 of 2)

* * *

Additional Reserve Strengthening--Lowering 2003 Estimates: Undergoing Further Reserve Review Of NAC Re Portfolio Earnings Estimate Revised Down

* * *

We are lowering our Q3 2003 EPS estimate to $0.92 per share from $2.08 to incorporate the company’s announced reserve strengthening in its North American casualty reinsurance operations (NAC Re book) of $160 million after-tax, or $1.16 per share. The increase in reserves relates to business written during 1997 through 2000 primarily in the lines of general liability, medical malpractice, professional, and surety. Our adjusted 2003 EPS estimate is $6.83 per share.

We calculated that XL has strengthened reserves for just NAC Re business by $644 million pretax since the merger was completed in June 1999 (at a price of $1.19 billion). In addition, XL is in the process of further reviewing its reserves at NAC Re, a process which should be completed by year-end 2003 and could lead to additional strengthening.


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171. The October 17, 2003 announcement caused investors to sell off shares of XL stock

and question management’s credibility concerning its prior comments that loss reserves for its

reinsurance operations were at the right levels, the processes by which the Company reviewed and

assessed its loss reserves and whether the review of cedent Company claims files meant that

another charge to income was imminent.

172. Indeed, trading volume of XL on October 16, 2003 was a mere 653,000 shares. On

October 17, 2003 after the announcement investors traded 11.5 million shares of XL stock. As a

result, XL’s share price plunged nearly 8% or $6.03 per share to close at $73.37 per share on

October 17, 2003.

173. Following news of this, securities analysts following the Company lambasted XL for

its failure to assess reserves needs at its NAC Re. For example, William Yankus of Fox-Kelton

Inc. stated the following:

BALANCE SHEET AND MANAGEMENT CREDIBILITY NOW IN QUESTION: This is the THIRD year of significant reserve charges for XL and related earnings disappointments. From 2001-2003 XL has had to address lingering balance sheet issues. As mentioned earlier, the 3Q hit of $184 million is the fourth prior year charge related to NAC Re reinsurance operation since the 1999 acquisition. This type of balance sheet weakness is surprising, given XL’s status and reputation a one of the industry’s most diligent setters of loss reserves. Clearly, XL management has failed in assessing the reserve needs of its NAC Re acquisition over a fairly extended time frame (1999-2003).

The magnitude of the NAC Re loss development also brings into question XL’s assessment of the remainder of its loss reserves for the more difficult 1997-2000 period.

174. On October 17, 2003, William, Blair & Co., Inc. also issued a report on XL’s latest

reserve shortfall for the NAC Re business, indicating that the Company’s ongoing review would

likely result in an additional reserve charge:

XL: Third-quarter Loss Reserve Charge; Issue Is Potential Fourth-quarter Charge

* * *


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XL this morning announced that it expects to take a third-quarter charge of $1.16 per share to increase loss reserves for casualty reinsurance business written by the former NAC Re between 1997 and 2000. This charge is highly disappointing and reduces management’s credibility further, in our opinion. Loss reserve adequacy within casualty reinsurance has been the key risk for XL the past few years....

* * *

Management expects to complete a comprehensive loss reserve review in the fourth quarter to address loss reserve adequacy definitively, which likely will result in another charge, in our opinion. The size of the charge this quarter should not affect XL’s capital position, but a charge in the fourth quarter would put further pressure on capital depending on the size....

We reduced our third-quarter EPS estimate to $0.92 from $2.08 and our 2003 EPS estimate to $6.84 from $8.00....

* * *

We believe the company could reasonably absorb another $200 million to $300 million pretax charge given the completion of its contingent capital transaction in July. In July, XL announced a unique capital markets transactions that effectively allows XL Re America (XL’s U.S. domiciled reinsurer) to access $500 million of capital directly through the issuance of preferred securities in the event of any capital impairment at XL Re America.... Following the announcement this morning, S&P placed XL America’s double-A financial strength rating on CreditWatch negative, along with the parent company’s debt ratings. S&P cited the $214 million of adverse reserve development in 2003--$184 million in the third quarter--along with the outstanding fourth-quarter loss reserve study as reason for the change in outlook. S&P expects XL to “replenish the reserve losses through capital markets activity following the completion of the (fourth quarter reserve) study.” We are not certain if S&P is referring to the exercising of XL’s contingent capital markets transaction or the anticipation of an additional capital markets transactions. S&P stated it is reviewing whether it believes XL America is “core” to the overall operations of XL. If S&P views the business as noncore, it does not expect a downgrade to exceed two notches.

XL Formally Admits Weakness of Its Financial Reporting and Reserve Analysis for NAC Re Operations:

175. On October 20, 2003, the Company hosted a conference call with analysts to discuss

the October 17, 2003 announcement of a huge $184 million reserve charge to income related to its

reinsurance division XL Reinsurance America, formerly NAC Re. During the call defendants

admitted that the reserve practices had been inadequate and that it was embarking upon a reserve


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review that would uncover any and all information about the underwriting years 1997-2000 of

NAC Re’s book to make sure the Company was properly reserved going forward. Indeed, such a

reserve review should have been conducted earlier as XL had represented throughout the Class

Period that, “estimating loss reserves is periodically reviewed to ensure that the assumptions

made continue to be appropriate.” Notwithstanding bold statements throughout the Class Period

that its reserve methods were conservative and problems at NAC Re were over, defendant could not

provide answers:

Now, I would like to try and address some of the questions that may already be on your minds. Firstly, you might ask, if these are unexpected claims, how come they have only just now materialized? I would answer by saying that it appears to be a combination of factors, including, most importantly, increasing loss costs. Our cedents may have reserved at historical appropriate levels, which do not hold up in the current environment. Our cedents may also have been overly optimistic. We may have attached at a level that would not historically have been breached, but in the current environment, has been so. It is also possible that some carriers may have under-reserved on a case spaces, due to fears of the discoverability of their reserve during claims litigation.

Next, you might ask whether they are new claims to the cedents. In answer, some are and some are not. If they’re not new, you might ask whether they didn’t have a duty to disclose this information to us earlier. Many treaties have a reporting trigger set at 50 percent of the retention or deductible under the treaty. If the cedents put up a normal precautionary reserve only, then under the terms of the treaty, they generally would not have to report this to us. The more detailed claims audit that we have initiated is, in part, designed to enable us to better understand this dynamic.

* * *

However, the process we’ve now initiated is very focused, particularly on the major problem areas that actually come from a relatively small number of cedents. It will be broader; it will take a much larger section of the cedent’s portfolio of claims and it will be deeper; it will look in much greater detail at the underlying claim assumptions, but also at claims that may not yet have reached our attachment point or been advised to us by the cedents.

* * *

At the risk of some duplication of Henry’s comments, our action plan has four major components. First, we are undertaking, as Henry said, a comprehensive claims audits of all material cedents, looking at their own claims files and reviewing the current status of these claims and independently estimating likely outcomes.


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* * *

The reviews pursuant to our action plan will go beyond the claims on which we’ve been noticed and will look exposures on which claims may have a possibility of reaching our layers. We will draw our own conclusions on the likelihood of penetrating our layers; we will be going further and deeper. We will establish additional case reserves wherever we feel appropriate.

Second, we intend to review all key loss picks and reserve analysis procedures, and we will make adjustments to these if necessary also before year-end.

Third, we are undertaking a thorough investigation of future loss mitigation initiatives, including commutation of policies. This will be an ongoing part of the review process to settle fully any claims we can during this process.

Fourth, we have already committed to the rating agencies and the regulators that we will replenish any capital lost to maintain our risk-based capital ratios for year-end and to demonstrate our commitment to our obligations at the highest level. We will complete this action plan before year-end. We believe this action plan will give us the granular level of information to dimension the new and unusual aspects of the development we’ve seen, and to establish the reserves and management measures to ensure this problem is not coming back. I’m adding my commitment to Brian’s to seeing this through this year.

* * *

Indeed, again in the third quarter, more than $500 million of new operating cash flow is expected. Our fundamental business model is intact and performing. As we noted at the outset, we plan to report fully our third-quarter results on October 29, and we will have another conference call to review those results on Thursday, October 30th.

* * *

RON FRANK, ANALYST, SALOMON SMITH BARNEY: [T]his operation has been your source of greatest frustration and uncertainty going back a while now, is it unfair to expect that you might have become, for lack of a better term, a bit more paranoid a bit sooner and undertaken something like what you’re about to undertake in regard to the study sooner?

Second, are you at all concerned at the management level that any part of this may relate to disconnects within the organization in terms of the quality or volume of reporting that you’ve been getting from the various levels of the organization, vis-a-vis the old NAC Re?

BRIAN O’HARA: Let me actually work from the back to the front. No, I’m very plugged-in and connected to all of our units and operations. We have a very flat organization. I get weekly reports from every unit.


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176. XL’s October 17, 2003 and October 20, 2003 promises to conduct a comprehensive

loss review was in fact a stark admission that it had failed to do what it had represented to investors

was done throughout the Class Period. It was only in February 2002 that XL told investors after

recording $180 million reserve shortfall for NAC Re that it “conducted a full actuarial review,”

and everything checked out positively. Then, on February 11, 2003 XL stated that it had reviewed

the NAC Re reserves with “great scrutiny.” The review purportedly begun in the 4Q03 was not

extraordinary at all but in fact was required on an ongoing basis by GAAP and AICPA 6.47 and

6.48 as part of maintaining the Company’s internal controls. See detailed rules at ¶221. XL and

the Individual Defendants knew and deliberately disregarded that its reserve review, record

keeping, and claim investigation process was unreliable as evidenced by three consecutive years of

hundreds of millions of dollars in reserve shortfalls in one in its NAC Re book of business resulting

as of October 17, 2003 huge damages to XL investors.

VIII. POST CLASS PERIOD EVENTS AND ADMISSIONS

177. On January 13, 2004, XL announced that as a result of its year-end audit and reserve

review described to investors on October 20, 2003 the Company would take a $663 million pre-tax

charge to income for its 4Q03 financial results, on top of the previously announced third quarter

charge of $184 million. The charge would also reduce reported fiscal 2003 earnings by $4.73 per

share and the Company would report only $2.69 per share a far cry from the $18.00 the Company

had projected during 2003. Again the $663 million charge to income was related to what the

Company called adverse developments in the North American reinsurance operations – NAC Re.

In other words, even after charges of $95 million, $122 million, $180 million, $215 million and

$184 million in 1999, 2000, 2001, 2002 and 2003, respectively, the Company had still inadequately

reserved for the division to the tune of $663 million:


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XL Capital Ltd Completes Previously Announced Claims Audit Review and Year-End Reserve Review

Announces Fourth Quarter Charge of $647 Million After Tax

Company to Raise at Least $750 Million of New Capital

HAMILTON, Bermuda, Jan 13 /PRNewswire-FirstCall -- XL Capital Ltd (NYSE: XL) (“XL” or the “Company”) announced today that it has completed its previously announced claims audit and regularly scheduled year-end reserve reviews. As a result, the Company expects that its fourth quarter 2003 results will be adversely affected by a pre-tax reserve charge of $694 million, or $647 million after tax, $4.73 per ordinary share after tax, in the fourth quarter of 2003. Fourth quarter 2003 results are expected to be announced on February 10, 2004.

The majority of the charge, $663 million pre-tax, primarily related to adverse development in the Company’s North American reinsurance operations for casualty business written during the 1997 through 2001 underwriting years.

XL’s President and Chief Executive Officer, Brian M. O’Hara stated, “The review that we have undertaken included an extraordinary claims audit review of our North American reinsurance operations going well beyond our long established processes. This was driven by an acceleration in claims in the third quarter relating to business underwritten during the 1997 to 2001 years. This trend continued in the fourth quarter, in response to which we have changed the actuarial development patterns that normally would have applied to the expected loss development of this business.”

* * *

Mr. O’Hara also noted, “In order to sustain the appropriate levels of capital for our business, we expect to raise additional capital of at least $750 million in the first half of 2004, principally in the form of mandatory convertible securities.”

A.M. Best and Moody’s Ratings Agencies Swiftly Downgraded XL’s Financial Strength Ratings Immediately Impacting the Company’s Ability to Raise Capital and Write Policies:

178. On January 14, 2004, the following news article discussed insurance ratings

agencies, including Moody’s and S&P, lowering their ratings and downgrading XL in response to

the huge increase in reserves to XL Re America’s book of business. Moody’s specifically indicated

that the reserve additions call into question whether the Company has in place adequate

underwriting and actuarial controls:

Rating Agencies Respond To XL’s Reserve Strengthening


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Rating agency S&P downgraded the financial strength ratings of XL’s core operating subsidiaries to ‘AA-’ from ‘AA’ and removed them for CreditWatch. The outlook is stable.

* * *

Rating agency A.M. Best placed XL’s ‘A+’ (Superior) financial strength rating under review with negative implications (A.M. Best downgraded the debt ratings). The magnitude of reserve charges was larger than A.M. Best expected and XL’s risk-adjusted capital has fallen below levels required for its current ‘A+’ rating.

* * *

Rating agency Moody’s downgraded XL Re’s financial strength rating to ‘Aa3’ from ‘Aa2,’ with a stable outlook.

* * *

The charges also call into question XL’s underwriting and actuarial controls, according to Moody’s.

Rating agency Fitch put XL’s ‘AA’ financial strength rating on Rating Watch Negative mainly due to uncertainty relating to capital raising.

XL’s ratings would most likely be lowered by one notch if its capital raising efforts are not executed as planned (or would be affirmed with stable outlook if successful).

In the long-run, XL will have to return to historical profit performance to maintain its current ratings (earnings have been below expectations for the last 3 years due to adverse reserve development in 2002 and 2003 and losses from the September 11 event in 2001).

179. On January 15, 2004, Dow Jones published the following news article:

XL Takes $647M Reserve Hit.

The new year is still in its infancy, but one familiar scene from previous years is already being played out in the insurance industry – a big reserve charge quickly followed by rating agency reactions.

* * *

It was larger than we had anticipated, cumulatively for the year, said Robert DeRose, analyst at the Oldwick, N.J.-based A.M. Best Company. The Agency has downgraded all debt ratings of XL Capital, and also placed its –plus financial strength ratings for XL Capital and its affiliated companies under review with negative implications.

We have taken a rating action on XL group because charges were higher than we had anticipated, added Karole Barkley, analyst at the New York-based Standard &


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Poor’s Ratings Services, which also cut its XL ratings. S&Ps ratings actions include cutting its counterparty-credit and financial-strength ratings on core operating companies to double-A-minus from double-A, as well as lowering its counterparty-credit rating on XL Capital to from-plus and removing it from the CreditWatch status.

Moody’s Investors Service in New York cut ratings of XL Capitals senior unsecured debt to 2 from 1, as well as insurance financial strength ratings for members of the XL Reinsurance Americas intercompany pool and XL Re, to a3 from a2. The outlooks for all rated members of the XL Capital group are now stable.

180. On January 16, 2004, Lloyds List Business and Insurance Journal issued an article

discussing Moody’s ratings downgrade of XL:

XL Hit by Reduced Ratings.

MOODY’s Investors Service has lowered ratings on some units of XL Capital, the Bermudian insurance group that has announced higher-than-expected reserve strengthening amounting to $694m. The insurer plans to raise $750m by issuing new securities, writes James Brewer.

* * *

Moody’s said the charges, together with others taken in 2002 and at the time of the acquisition of XL Reinsurance America in 1999, called into question the quality of underwriting and actuarial controls under the operation’s former NAC Re control.

181. On January 15, 2004, Deutsch Bank-North America issued a report discussing

managements corrective actions to assure that further revenue shortfalls would not occur:

XL: Management Upbeat on Outlook for 2004 and Beyond-Buy – Part 1/2

* * *

HIGHLIGHTS:

* * *

Reserve review appears to be comprehensive. We believe the company conducted an extremely detailed and conservative review of reserves at XL America. Approximately 64% of the 3Q and 4Q reserve charges were on an incurred but not reported (IBNR) basis. XL had non-renewed most of the NAC Rebusiness acquired in 1999, and has re-underwritten the renewed business during the past two years.

* * *

DETAILS:


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* * *

Reserve charge appears extremely conservative. The company completed a thorough review of casualty reserves at XL America, going over 85% of the total premiums in the affected lines of business. The majority of adverse reserve development was for accident years 1997-2001, and related to problem lines such as D&O, E&O, medical malpractice, general liability, and umbrella. Management stated that the spurt in reported claims in the third and fourth quarters was a result of claims filings by approximately 17 cedant insurers, whose policies XL management thoroughly reviewed as part of the reserve study....

* * *

Underwriting Year

Level of Reserve Addition ($ in mm)

Ultimate Loss Ratio

1997 $58 127% 1998 $108 162% 1999 $141 203% 2000 $163 201% 2001 $153 151%

Source: Company data

* * *

The company appears to be taking a number of steps in its reserving process to reduce the possibility of reserving errors in the future. Management stated that the company will increase communication with its cedants to avoid claims surprise filings, adhere to stricter underwriting guidelines, and proactively manage the business that it writes.

182. XL America: The company appears to have taken meaningful action to prevent

further adverse reserve development in its North American casualty business. Following the

acquisition of NAC Re in 1999, XL Capital non-renewed approximately 63% of the business it

bought.

XL Fires President of XL Re America i.e., NAC Re and Other Senior Executives Responsible for Running the NAC Reinsurance Operations:

183. On January 14, 2004, the Company also announced that it had fired several of its

senior officers at its reinsurance operations and its insurance operations. Specifically, the Company

fired (a) C. Fred Madsen, the Company’s President of its reinsurance operations, XL Re America


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(formerly NAC Re); and (b) Martha Bannerman, the Company’s General Counsel for reinsurance

operations at the former NAC Re. Both individuals had been senior executives at NAC Re prior to

its acquisition by XL in 1999.

184. During the January 14, 2004 conference call, XL defendants were specifically asked

if there was any management accountability with regard to the Company’s failure to adequately

reserve for losses within the Company’s Casualty Reinsurance division:

FELICE GELMAN, ANALYST, SUNOVA CORP.: So far there really hasn’t been any discussion of whether there is any management accountability here....

HENRY KEELING: Perhaps I can address that for you. The President and General Counsel and Chief Administrative Officer of XL Re America are no longer with the company.

185. On January 22, 2004, only one week after the Company announced that its 4Q03

charge in connection with the claims audit review would be a whopping $663 million, in addition

to the $184 million which had previously been announced for 3Q03, the Company reported that

defendant Brown, CEO of the Company’s insurance operations and Chief of XL Re America, i.e.,

NAC Re would abruptly retire. Brown was President and CEO of NAC Re prior to the acquisition

by XL in 1999. Brown is also an actuary and oversaw underwriting reviews and reserve

methodologies of the Company’s insurance division during the Class Period.

XL Capital Ltd Announces Retirement of Insurance Operations Chief Executive

HAMILTON, Bermuda, Jan 22 /PRNewswire-FirstCall/ -- XL Capital Ltd (NYSE: XL) (“XL” or the “Company”) today announced the retirement of Mr. Nicholas Brown, Chief Executive of the Company’s Insurance Operations.


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XL Offers Noteholders of its CARZ $15 Million Not to Exercise Their Right to “Put” The Notes Back to the Company:

186. On May 18, 2004 XL faced another looming CARZ put obligation on May 23,

200411 that potentially exposed them to a gigantic $649 million payment. After already

experiencing a $663 million reserve charge and having received downgrades from the major credit

agencies, XL offered noteholders of its CARZ an aggregate of $15 million not to exercise their

right to put their notes back to the Company to avoid paying $649 million dollars repurchasing their

notes:

XL Announces Its Intention to Make a One-Time Cash Payment to Holders of Its Zero-Coupon Convertible Debentures Due May 2021 for Not Exercising Put Rights

HAMILTON, Bermuda, May 18 /PRNewswire-FirstCall/ -- XL Capital Ltd (NYSE: XL) (“XL” or “the Company”) announced today that it intends to make a one-time cash payment to holders of its Zero-Coupon Convertible Debentures due 2021 (the “Debentures”) who do not exercise their rights to put the Debentures to XL.

Pursuant to the terms of the indenture governing the Debentures, XL is obligated to purchase for cash Debentures tendered and not withdrawn before the close of business on May 21, 2004, at their accreted value of $641.88 per $1,000 principal amount at maturity on May 24, 2004. XL intends to pay a one-time cash payment of $14.84 for every $1,000 aggregate principal amount at maturity of the Debentures held to each Debenture holder not exercising its put right. This payment is approximately equal to 2.31% of each Debenture’s accreted value and 1.48% of each Debenture’s principal amount at maturity. XL will make this payment to holders of record as of the close of business on May 26, 2004, as promptly as possible following that date. In the event all of the Debentures remain outstanding on that date, the aggregate payment by XL would be $15 million.

187. In sum, XL knew that as announced on January 13, 2004 the Company needed to

and would go to capital markets to raise $750 million in the form of mandatory convertible

securities. See ¶177. Thus, XL could not spend $649 million in capital or issuing shares to the

CARZ bondholders. An additional $649 million capital expenditure would severely impact the

11 See ¶105 for similar CARZ put date that occurred on May 23, 2002.


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Company’s financial strength and debt ratings, and compress the Company’s capital surplus even

further than the additional loss reserves of $663 million recorded in 4Q03.

188. Likewise, had the Company taken the necessary reserve charges for NAC Re

totaling $622 million net of tax in its 2001 financial statements, XL would have likely been “put”

and had to repurchase $614 million of the CARZ on the May 23, 2002 put date.

XL Files its 2003 Report on Form 10-K Admitting That Ratings Downgrades Would Hurt the Company and Loss Developments Indeed Required a Change in Reserve Methodology Assumptions:

189. On March 15, 2004, the Company filed its Report on Form 10-K for the period

ending December 31, 2003. The Report on Form 10-K discussed recent ratings agency downgrades

resulting from the October 2003 and January 2004 reserve shortfall announcements. The Report on

Form 10-K also made the following admissions, including, the importance of the Company to

maintain strong ratings from ratings agencies in order to write business and avoid violation of the

Company’s capital and credit facilities:

Ratings and Capital Management

Management continues to focus heavily on the Company’s financial strength and claims paying ratings because the Company’s ability to write business is dependent on the quality of these ratings ... the Company’s results were significantly impacted in the second half of 2003 by prior period adverse development mainly from its North American Casualty reinsurance business written in the 1997 through 2001 underwriting years and, accordingly, some of the Company’s ratings have been downgraded. The Company currently anticipates it will raise additional capital of approximately $750 million in the first half of 2004 in the form of mandatory convertible securities. The Company currently anticipates that it will be able to successfully raise this capital, however, if the Company does not achieve this, it is likely that the Company’s ratings could be lowered further which could trigger downgrade provisions contained in the Company’s various capital and credit facility documents as well as impact the ability of the Company to write new business.

190. The Report on Form 10-K also discussed in detail the impact of its “reserve review”

which resulted in the $663 million additional reserve shortfall and charge to income. The Company

admitted that it “changed its actuarial methodology and key assumptions” as plaintiffs allege


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could have and should have been done based upon recent loss experience and information known

and/or available to the Company as early as the end of 2001:

In the third quarter of 2003, the Company received a significant increase in reported claims that were in excess of the Company’s expected claims development. In addition, the Company completed an actuarial review for the longer tail lines of this book of business, using data evaluated at March 31, 2003. As a result, the Company recorded an increase in loss reserves of $184.0 million in the third quarter of 2003....

The claims audit review included both internal and external resources, a comprehensive claims audit of the largest and most significant ceding companies, and a review of loss ratios and reserve analysis procedures....

As a result of the new information obtained in the claims audit review, the Company changed its actuarial methodology and key assumptions for determining ultimate loss reserves. The Company separately reviewed the historical loss development of its major cedents using several actuarial methodologies; where the analysis of a cedent’s experience concluded that the experience was worse than the Company’s historical loss development experience, the Company projected that cedent’s ultimate loss based on the cedent’s own experience. In addition, the Company assumed that the more recent experience was more indicative of future loss development by selecting development patterns that were based on the most recent experience rather than on the Company’s longer term historical experience.

Individual Defendants Personal Economic Motivation to Misrepresent the Company’s Financials – Year-End Bonuses and Insider Trading:

191. In addition to maintaining financial strength and debt ratings, increase capacity to

write more premiums, and avoid paying out on repurchase demands by bondholders, XL and the

Individual Defendants were personally motivated to report false financials and earnings as a

substantial portion of their individual annual compensation and was based upon XL’s financial

performance and specifically, revenues and EPS. In fact, during the Class Period, each of the

defendants’ huge earned bonuses were based upon the achievement of growth in EPS. According

to XL’s 2001 proxy statement, XL executive officers bonuses were based 40% on growth in cash

EPS, 30% on cash return on tangible equity, 20% on total return on tangible equity, and 10% on

growth in book value, including dividends paid but excluding unrealized appreciation or

depreciation of investments.


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192. Had XL adequately reserved for the adverse development for NAC Re reinsurance

division during the Class Period, as described in ¶¶196-232, its EPS would have been severely and

negatively impacted. In addition, XL would have failed to achieve strong credit and debt rating,

which gave the Company leverage to grow by raising capital. Nevertheless, as a result of the false

financials, the Individual Defendants earned huge year end bonuses which range from 66% to

182% of their annual salaries and up to $1 million for some of the Individual Defendants.

193. During the Class Period, these defendants received the following massive bonuses:

(a) O’Hara received two bonuses of $1 million in 2001 and 2002 that equaled

approximately 250% and 175% of his annual salary, respectively;

(b) De St. Paer received bonuses of $850,000 and $700,000 in 2001 and 2002 that

equaled approximately 250% and 175% of his annual salary, respectively;

(c) Brown received bonuses of $450,000 and $3,050,000 in 2001 and 2002 that

equaled approximately 69% and 469% of his annual salary, respectively; and

(d) Keeling received bonuses of $300,000 and $500,000 in 2001 and 2002 that

equaled approximately 66% and 103% of his annual salary, respectively.

194. A breakdown of the defendants’ bonus and salary structure for years 2001-2003 is

provided below:

Annual Compensation

Name and Principal Position Year Salary Bonus

Other Annual Compensation(1)

2003 $1,000,000 $0 $134,428 2002 $1,000,000 $1,000,000 $131,525 2001 $1,000,000 $1,000,000 $140,004

Brian M. O’Hara

2003 $475,000 $300,000 $218,336 2002 $400,000 $700,000 $361,254 2001 $344,102 $850,000 $141,571

Jerry de St. Paer

Nicholas M. 2003 $650,000 $0 $88,776


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2002 $650,000 $3,050,000 $85,280 2001 $650,000 $450,000 $71,378

Brown, Jr.

2003 $430,295 $0 $51,872 2002 $482,910 $500,000 $195,045 2001 $450,000 $300,000 $204,443

Henry C. V. Keeling

195. Additionally, several of the Individual Defendants took advantage of XL’s

artificially inflated stock price and collectively unloaded 402,575 shares of their XL common stock

for illegal insider trading proceeds of $35,644,621 million:

Insider Date Shares Price Proceeds

Percent of Common Stock Holdings Sold

Ronald L. Bornhuetter 02/19/2002 6,000 $92.600 $555,600 02/20/2002 9,000 $93.120 $838,080 02/25/2002 5,000 $92.920 $464,600 02/27/2002 10,000 $95.880 $958,800 08/29/2002 7,500 $74.000 $555,000 09/13/2002 5,000 $74.040 $370,200 03/06/2003 320 $67.950 $21,744 03/06/2003 305 $67.950 $20,725 03/06/2003 170 $67.950 $11,552 03/06/2003 165 $67.950 $11,212 05/08/2003 14,680 $80.420 $1,180,566 05/09/2003 4,300 $80.950 $348,085 62,440 $5,336,163 54.9% Nicholas M. Brown, Jr. 11/02/2001 20,000 $91.250 $1,825,000 12/03/2001 20,000 $93.750 $1,875,000 03/04/2002 19,500 $96.460 $1,880,970 03/04/2002 2,000 $96.460 $192,920 06/11/2003 30,000 $84.000 $2,520,000 91,500 $8,293,890 82.7% Henry (Charles Vaughan) Keeling 03/06/2002 65,000 $96.190 $6,252,350 03/07/2002 15,000 $94.320 $1,414,800 03/08/2002 22,635 $93.470 $2,115,693 06/10/2003 4,800 $82.350 $395,280 06/10/2003 200 $82.560 $16,512 07/08/2003 5,000 $83.800 $419,000 08/12/2003 5,000 $78.990 $394,950 09/09/2003 5,000 $76.760 $383,800 10/14/2003 5,000 $79.750 $398,750 127,635 $11,791,135 56.8% Brian M. O’Hara 02/19/2002 25,000 $94.360 $2,359,000


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Insider Date Shares Price Proceeds

Percent of Common Stock Holdings Sold

02/19/2002 2,800 $93.520 $261,856 02/20/2002 17,200 $93.510 $1,608,372 01/02/2003 12,000 $77.320 $927,840 04/14/2003 7,000 $74.120 $518,840 04/14/2003 4,300 $74.140 $318,802 04/14/2003 400 $74.110 $29,644 04/14/2003 300 $74.130 $22,239 06/02/2003 6,000 $87.050 $522,300 06/02/2003 2,000 $86.910 $173,820 06/02/2003 2,000 $86.950 $173,900 06/02/2003 1,000 $86.920 $86,920 06/02/2003 1,000 $87.100 $87,100 10/01/2003 40,000 $78.320 $3,132,800 121,000 $10,223,433 26.2% Totals: 402,575 $35,644,621

XL’S FALSE FINANCIAL REPORTING

196. In order to artificially inflate XL’s stock price, avoid ratings downgrades and

artificially inflate their policy writing capacity, the Individual Defendants caused XL to issue false

financial reports that improperly understated XL’s loss expenses as well as its loss and loss expense

reserves (“loss reserves”), thereby materially overstating its net income, EPS, shareholder equity

and surplus.

197. XL’s publicly reported financial results during the Class Period included the

following (amounts in millions, except EPS):

Year end 12/31/0112

Reported shareholder net loss $576 Minimum understatement of shareholder net loss $622 Actual shareholder net loss

$1,198

12 Plaintiffs believe the 2001 misstatement amounts reflected in this table are conservative, and that XL’s actual 2001 financial statement errors are likely even greater.


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Reported loss per share $4.55

Minimum understatement of loss per share $4.91 Actual loss per share

$9.46

Reported shareholder equity $5,437

Minimum overstatement of shareholder equity $622 Actual shareholder equity $4,815

198. The Class Period reported results were included in the quarterly Reports on Form

10-Q and the annual Reports on Form 10-K filed with the SEC, as well as in Company press

releases and analyst conference calls. But, the reported results and the representations made by

defendants about the Company’s financials, were false and misleading when made because XL’s

annual and quarterly financial statements during the Class Period were not fair presentations of its

results and were presented in violation of GAAP and SEC rules.

199. GAAP are those principles recognized by the accounting profession as the

conventions, rules and guidelines that define acceptable accounting practices. SEC Regulation S-X

(17 C.F.R. §210.4-01(a)(1)) states that financial statements filed with the SEC that are not prepared

in compliance with GAAP are presumed to be misleading and inaccurate, despite footnote or other

disclosure. Regulation S-X requires that interim financial statements must also comply with

GAAP, with the exception that interim financial statements need not include disclosures that would

be duplicative of disclosures accompanying annual financial statements. 17 C.F.R. §210.10-01(a).

200. Defendants caused XL to falsify its reported financial results for 2001 through its

improper accounting for reinsurance loss reserves, which resulted in materially and artificially

inflated income, EPS, shareholder equity and subsidiaries’ statutory surplus. XL’s failure to correct

its woefully inadequate loss reserves caused its 2002 and 2003 financial statements to be similarly

misstated. Absent the Company’s improper accounting, XL would have reported materially lower

earnings, EPS and shareholder equity. XL’s improper financial reporting enabled XL and the


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Individual Defendants to conceal from investors, creditors, guarantors and regulators, the true

financial condition of the Company throughout the Class Period. As a result, XL avoided ratings

downgrades likely to have occurred, but for the false financials, and artificially inflated XL’s policy

writing capacity, which is determined based on reported surplus.13

201. On October 17, 2003, after having already surprised the investment community with

material charges for inadequate reinsurance loss reserves every year from 1999 through 2002

(which totaled $612 million), XL announced yet another loss reserve shortfall requiring a

whopping $184 million charge to income. XL also explained that it would finally conduct

necessary on-site “claims audit review” of the insurance companies that it reinsured (“cedents”)

and that these review could result in even more charges for unrecorded loss reserves. Ultimately,

XL announced that this review revealed another $663 million in charges, for a total of $1.46

billion in belated charges for inadequate loss reserves. As alleged herein, this review should have

been completed prior to March 2002 when it filed its 2001 financial statements.

202. All $1.46 billion in charges were for inadequate reinsurance loss reserves related to

reinsurance coverage assumed by the Company’s NAC Re reinsurance operations14 during 1997-

2001 (“accident years”). 86%, or $1.25 billion, of these total charges were for incurred claims

assumed by NAC Re that occurred during the earlier 1997-1999 accident years. In accounting for

insurance, “accident years” refers to the dates policyholder losses were incurred, while “calendar

years” refers to the accounting period in which the losses were recorded. Insurance companies are

13 The impact on net income from charges for inadequate reserves reduce both shareholder equity and shareholder surplus dollar for dollar.

14 NAC Re transferred (“retroceded”) 75% of its reinsurance business (premiums and loss expenses) to XL Re, which was XL’s reinsurance subsidiary in Bermuda. XL, as the parent company of both reinsurers, was responsible for reporting all reserves in the total NAC Re book of business in which either NAC Re or another XL subsidiary was responsible for paying the claims.


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responsible for setting sufficient loss reserves for each accident year, including losses for “incurred

but not reported” claims. Thus, the continual charges recorded by XL between 1999 and 2003

shows a consistent pattern of failing to record sufficient loss reserves for the same accident years

1997-2001 (overwhelmingly for 1997-1999). Recording sufficient loss reserves is required by

GAAP, the SEC and the National Association of Insurance Commissioners (“NAIC”), which

provides uniform rules and standards to state regulatory bodies in the United States.

203. While XL claims to have eventually recorded enough loss reserves, subsequently

recording belated loss reserves and loss expenses that should have been recorded years earlier does

not correct prior GAAP violations, because, for example, 1) the income from earlier calendar years

remains inflated; and 2) losses and loss ratios are understated in the periods that loss reserves were

improperly recorded. Accordingly, XL’s delinquent charges for inadequate loss reserves did not

cure the financial statement errors and did not prevent the Company’s earlier financial statements

from being materially false and misleading. Following are the amount of charges recorded by XL

for what it refers to as “adverse development”15 for calendar years 1999 through 2003:

204. In accounting for insurance, reasonable fluctuations in reserves for prior accident

years are expected. However, when actuaries use “point estimates” loss reserve methodologies,

15 Adverse development is a term used for additions to accident year losses in subsequent calendar years (reserve deficiency). Favorable development is a term used for reductions to accident year losses in subsequent calendar years (reserve redundancy). When insurance companies properly estimate reserves, adverse development and favorable development are generally expected to offset one another over a multi-year period. For the five accident years 1997-2001, NAC Re has never had any favorable development in any calendar year – 19 out of 19 recorded developments were adverse developments, totaling $1.46 billion.

1999 4Q00 4Q01 4Q02 4Q03 4Q04 TOTAL

$95 million $122 million $180 million $215 million $184 million $663 million $1.46 billion


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each estimate is supposed to have an equal chance to develop favorably or adversely. As stated by

XL in their 2003 Report on Form 10-K:

The single point reserve estimate is generally management’s best estimate which the Company considers to be one that has an equal likelihood of developing a redundancy or deficiency as the loss experience matures.

Clearly, that methodology was not followed by XL with respect to its reinsurance loss reserves

during the Class Period.

205. Defendants’ statements putting forth purported excuses for the belated charges in

3Q03 and 4Q03 relating to accident years 1997-2001 were astounding:

We are acting on new information that developed in our third quarter and especially late in the third quarter. This new information is in the form of new claims and by that, we mean new claims from older years that defy expected reporting patterns. I said earlier in the year that we expected to be able to absorb, in our current improving run-rate, any claims from this period in NAC Re book that might exceed expected levels. This was the case until this upsurge in Q3....

* * *

[T]he claims pattern was hugely skewed towards September and even through the last three weeks of September. So no, the pattern it was not smooth over the course of the quarter.

206. If defendants are to be believed, despite recording additional, extraordinary charges

in 1999, 2000, 2001 and 2002 for previously unrecorded loss reserves for accident years 1997-

2000, totaling $612 million, suddenly, the claims received for the same accident years 1997-2000

in the last three weeks of 3Q03 was a surprise and represented “new information” with respect to

the latest charges. In addition, of the total NAC Re related charges of $1.46 billion through

December 31, 2003, 86%, or $1.25 billion, were related to the 1997-1999 accident years, which

were four to seven years old by that time.


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XL’s Failure to Record Adequate Reinsurance Loss Reserves:

The First Warning:

207. Shortly after XL acquired NAC Re in June 1999, XL was forced to record a $95

million charge for previously unrecorded loss reserves, an acknowledgement that NAC Re had

failed to record sufficient loss reserves in accordance with GAAP and SAP. The additional loss

reserves were almost entirely related to claims from accident years 1997 and 1998. Although XL

later tried to excuse this $95 million charge by attributing it to a “difference in reserve

methodologies,” NAC Re and XL were both required to comply with GAAP and SAP with respect

to loss reserves (and other account balances) at all times. As such, notwithstanding the fact that

even though the $95 million charge was still not enough, the fact that XL needed to record such a

substantial increase in loss reserves outside of the initial reserve setting process was a clear red flag

and an indication that even before 1999 ended, XL was already aware of problems in accounting

for the NAC Re book of business, specifically with respect to recording sufficient reinsurance loss

reserves in the proper year.

The Second Warning:

208. At the end of 4Q00, XL reported that, in addition o the $95 million charge taken in

the summer of 1999, the Company needed to record an additional $122 million charge to make up

for the still inadequate NAC Re reinsurance loss reserves, again for accident years 1997 and 1998,

as well as 1999.

The Third Warning:

209. By no later than November 1, 2001, XL knew that for the third year in a row, it

would again need to record a significant charge in the fourth quarter to account for inadequate

reinsurance loss reserves for the 1997-1999 accident years, in connection with the NAC Re book of

business. This time, the belated charge ballooned to $180 million – demonstrating that the problem


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of unrecorded loss reserves for accident years 1997-1999 in NAC Re operations was actually

getting worse each year. Clearly by then, the “red flags” had been raised and were flapping wildly.

The Fourth Warning:

210. In the face of these red flags, XL still did not conduct a basic review of cedent

claims or take other steps to properly estimate and record required loss reserves based upon the

information known at the time. To make matters worse, XL was forced to announce yet another

year-end charge for 2002, much larger than each of the three previous charges: $215 million.

The Extremely Belated Admission:

211. Finally, following the $184 million charge in 3Q03, XL finally admitted what it

should have done in 2001. According to defendant Keeling on XL’s January 14, 2004 conference

call:

As you know, in the third quarter of 2003, XL Re America experienced exceptional adverse development. And based on that development, XL Capital decided to conduct an in-depth examination of XL Re America cedent reserve and claim reporting process, forming the Claims Audit Review task force to carry out this activity.

212. However, the “exceptional adverse development” had been a known and ongoing

occurrence since 1999, and XL had told investors on several occasions before and during the Class

Period that it had already taken steps to address the problem of not recording sufficient loss

reserves. Such steps, at a minimum, would have included an examination of the cedent claims

reporting process and cedent loss reserves. Throughout the Class Period, investors relied upon

representations that XL had already taken such steps.

213. Nevertheless, XL failed to take the necessary steps to properly record loss reserves

in accordance with GAAP and SAP – that is, the Company failed to follow its own stated internal

controls, check the cedents’ claims records and perform the necessary procedures to ensure that XL

set up sufficient loss reserves, in the correct year, as required by GAAP and SAP. XL’s attempts to

blame its failure to properly account for its loss expenses and its loss reserves on cedents’ poor


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controls or failure to properly report to XL is completely improper and not acceptable under GAAP

or SAP. Every reinsurer faces the same reporting challenges with respect to cedent data, and this in

no way absolves XL from responsibility for setting materially correct loss reserves. The FASB,

AICPA, NAIC, NYID and ratings agencies all expect and presume that reinsurance companies will

comply with the accounting and reporting requirements and set appropriate loss reserves – as is

required by the relevant accounting standards. According to GAAP, SAP and SEC Regulations,

XL, not XL’s cedents, was responsible for setting adequate loss reserves on its books.

214. According to the most basic accounting principles, companies are required to record

loss reserves on an accrual basis – meaning that expenses must be recorded in the period in which

they are incurred, rather than the period in which they are paid. Financial Accounting Standard No.

5, Accounting for Contingencies. For insurance companies, this is required in order to properly

record loss expenses that require reserves and the premium revenue related to those expenses in the

same period. FASB Statement of Concepts No. 6, ¶¶144-146. This is critical for insurance

companies, because investors, analysts, regulators and guarantors rely on the accuracy of reported

loss ratios (insurance losses and claims expenses divided by the related earned policy premiums)

and underwriting profit or loss (earned policy premiums minus losses, claims expense,

commissions and operating expenses). When companies improperly set their loss reserves too low,

their loss ratios are artificially understated and underwriting profit is artificially overstated.

215. GAAP, the SEC and insurance regulatory bodies including the NYID require that

companies set up adequate loss reserves for each accident year so that loss ratios and underwriting

profit or loss are not materially misstated or misleading. However, XL knew that its loss reserves

for reinsurance were consistently much lower than they should have been. For example, as of

December 31, 2001, XL knew that its historical pattern of setting up inadequate loss reserves for


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accident years 1997-1999 had already resulted in $397 million in delinquent charges for inadequate

loss reserves (during calendar years 1999-2001) as discussed above.

216. Statement of Financial Accounting Standards No. 60 (“FAS 60”), Accounting and

Reporting by Insurance Enterprises, states that loss reserves at the end of an accounting period must

be sufficient to account for all claims and costs of settling claims, taking into account changes in

current trends, societal and economic factors and any other factors that would modify past

experience. According to FAS 60:

Claim Cost Recognition

A liability for unpaid claim costs relating to insurance contracts other than title insurance contracts, including estimates of costs relating to incurred but not reported claims, shall be accrued when insured events occur....

The liability for unpaid claims shall be based on the estimated future cost of settling the claims (including the effects of inflation and other societal and economic factors), using past experience adjusted for current trends, and any other factors that would modify past experience....

* * *

A liability for all costs expected to be incurred in connection with the settlement of unpaid claims (claim adjustment expenses) shall be accrued when the related liability for unpaid claims is accrued. Claim adjustment expenses include costs associated directly with specific claims paid or in the process of settlement, such as legal and adjusters’ fees. Claim adjustment expenses also include other costs that cannot be associated with specific claims but are related to claims paid or in the process of settlement, such as internal costs of the claims function.

FAS 60, ¶¶17-20 (emphasis in original, footnotes omitted)

217. XL violated GAAP by failing to comply with the terms of FAS 60 because it did not

record loss reserves adequate to cover its known and estimated claims liabilities for the costs of

NAC Re reinsurance as described above. Further, XL knew this by November 2001, at the latest,

as demonstrated by its repeated failure to set up sufficient loss reserves for its reinsurance

liabilities, which by that time had already required two consecutive years of charges to income

totaling $217 million for accident years 1997-1999 as alleged herein and reflected in the table in


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¶203. Nevertheless, XL waited another two years before it took the steps necessary to determine

what the loss reserves should actually be, i.e., the “comprehensive reserve review” XL disclosed it

would undertake in its October 17, 2003 press release.

218. On October 17, 2003, XL issued a press release announcing a $184 million charge

for inadequate reinsurance loss reserves and also quoted defendant O’Hara saying:

“I am personally leading a review of this book of business [reinsurance] ... and review of the ceding company claims files that will be completed by year end,” Mr. O’Hara noted. “I intend to fully address our exposure to the 1997 through 2000 North American casualty reinsurance book written by the former NAC Re so that it will not adversely affect our financial results in 2004 and beyond.”

219. It was conspicuously apparent by the last sentence, and explicitly admitted by

defendants during XL’s October 20, 2003 conference call, that the review of cedent claims records

would likely result in additional charges in 4Q03:

Because of the unusual nature of the recent adverse development in the XL Re America book, it was not possible for us to estimate with any level of confidence the amount of reserves required, if any, beyond what we have already established.

220. Indeed, on January 14, 2004, XL announced that the 4Q03 charges resulting from

O’Hara’s review was an astounding $663 million.

XL Knew That the Review It Conducted in 2003 Was Routine for Reinsurers and Should Have Been Conducted in 2001 and Ongoing Throughout the Class Period:

221. A reinsurer assumes responsibility for certain losses under insurance policies written

by other insurance companies, called cedents, or primary or direct writers, in exchange for a portion

of the policy premium from the primary insurance contract. XL, as the reinsurer, is responsible

for properly accounting for premiums, losses and loss reserves related to its reinsurance contracts.

The AICPA Audit and Accounting Guide for Audits of Property and Liability Insurance Companies

instructs reinsurers on how to fulfill their responsibility for the accuracy, reliability and

completeness of data received from the ceding companies related to the assumed reinsurance:

Internal Control of the Assuming Company


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6.47 A significant component of an assuming company’s internal control that is related to assumed reinsurance is the assessment of the accuracy and reliability of data received from the ceding companies. Principal control activities of the assuming company may include –

● Maintaining underwriting files with information relating to the business reasons for entering the reinsurance contracts and anticipated results of the contracts. The underwriting files may include – – Historical loss ratios and combined ratios of the ceding companies. – Anticipated loss ratios under the contracts. – Indications of the frequency and content of reports for the ceding companies. – Prior business experience with the ceding companies. – The assuming company’s experience on similar risks. – Information regarding pricing and ceding commissions.

● Monitoring the actual results reported by the ceding companies and investigating the reasons for and the effects of significant deviations from anticipated results.

● Visiting the ceding companies to review and to evaluate their underwriting, claims processing, loss reserving, and loss-reserve-development-monitoring procedures

● Obtaining the report of the ceding companies’ independent accountants on controls (relating to ceding reinsurance) placed in operation (and tests of operating effectiveness). See SAS No. 70, Service Organizations.

6.48 Additional control activities of the assuming company may include – ● Obtaining and analyzing recent financial information of the ceding

companies, such as – – Financial statements and, if audited, the independent auditor’s

report. – Financial reports filed with the SEC (United States), Department of

Trade (United Kingdom), or similar authorities in other countries. – Financial statements filed with insurance regulatory authorities,

with particular attention to loss reserve development. ● Obtaining and reviewing available sources of information on the ceding

companies, such as– – Insurance industry reporting and rating services. – Insurance department examination reports. – Loss reserve certifications filed with regulatory authorities. – Letters relating to the design and operation of controls filed with

regulatory authorities. ● Inquiries about the general business reputation of the ceding companies

and the background of their owners and managements.

AICPA Audit and Accounting Guide for Audits of Property and Liability Insurance Companies,

Chapter 6, “Reinsurance,” ¶6.47-48.


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222. Because of the above requirements for adequate reinsurance controls, it is an

industry practice that almost all reinsurance contracts or treaties provide that the reinsurer may

review and audit all reinsured policy and claims-related records of the cedent at any time, with

reasonable notice. Thus, although XL admittedly waited until 4Q03 to conduct a “comprehensive”

claims audit review of its cedents, XL had the ability and should have performed such a review two

years earlier particularly given the fact that it had incurred three consecutive years of prior adverse

loss development for which the Company was required to belatedly increase its prior accident year

reserves. In fact XL falsely represented that it actually conducted a “full actuarial review ...

annually.” See ¶81.

223. Indeed, by November 1, 2001, XL already knew it would need to take a material

charge for previously unrecorded loss reserves for the NAC Re reinsurance operations for the third

year in a row. Such adverse experience was a red flag and clearly put XL on notice that the

Company was required to conduct a claims audit review of its cedents as indicated by AICPA

Audit and Accounting Guide §§6.47 and 6.48. However, they did not do this despite statements

made by defendants each time the Company announced the charges (during the Class Period), that

assured investors that XL was taking the necessary steps to properly account for reinsurance losses,

and that the problems were behind them. See ¶81. Investors relied on XL’s representations that it

had in fact, reviewed and confirmed the adequacy of its internal controls and “fixed” whatever

other circumstances had led to the delinquent charges. Unfortunately for investors, creditors,

regulators and guarantors of XL, the Company failed to implement the above basic, but required,

internal controls and failed to exercise its duty to thoroughly audit the cedents’ claims pursuant to

GAAP and SEC rules until 4Q03.

224. According to defendant Keeling, on XL’s January 14, 2004 conference call:

The treaties that were selected for review under the CAR [Claims Audit Review] process encompassed 85 percent of the total premium written for these


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problem classes during the [accident] years in question. The action plan that we announced earlier included four components. Firstly, a comprehensive claims audit of the largest and most significant cedents for the years in question. Second, we reviewed our selected loss ratio picks (ph) and our reserve analysis procedures. Third was a consideration of future loss mitigation initiatives. And lastly was maintaining appropriate risk-based capital ratios for year-end at XL Re America for rating and regulatory purposes.

225. However, these steps were neither complicated nor unusual. In fact, reinsurers are

required to perform procedures such as these on an ongoing basis in order to comply with GAAP

and SAP requirements for proper internal controls and setting appropriate loss reserves. XL was at

the very least deliberately reckless in refusing to perform these basic and required steps by the end

of FY01, because by that time, defendants knew that the Company’s internal controls and reserve

setting processes consistently (three consecutive years) failed to produce reliable estimates of loss

expenses and loss reserves by wide margins.

226. If XL had indeed conducted an appropriate claims audit review in 2001, as was

required under the circumstances, it would have obtained and/or reviewed and acknowledged all

the data required to set materially correct loss reserves for accident years 1997-1999, just as the

claims audit review that they finally performed in 4Q03 should have resulted in materially correct

loss reserves for accident years 1997-2001, as the Company claimed.

227. Further, given the changed circumstance indicated by the unprecedented levels of

ongoing material adverse loss development from 1999-2001, especially for accident years 1997-

1999, XL was required to adjust its actuarial models to account for the increasing costs of

providing insurance, and indeed, falsely told the public that it made such adjustments. See ¶¶16-

17. As set forth in FAS 60: “The liability for unpaid claims shall be based on the estimated future

cost of settling the claims (including the effects of inflation and other societal and economic

factors), using past experience adjusted for current trends, and any other factors that would

modify past experience.” Nevertheless, despite knowledge of three consecutive years of materially


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adverse loss development because XL repeatedly failed to set sufficient loss reserves for accident

years 1997-1999, the Company failed to make the necessary modifications and adjustments to their

actuarial models and reserve setting process for reinsurance until 4Q03.

228. According to AICPA Statement of Position 92-4 (“SOP 92-4”), Auditing Insurance

Entities’ Loss Reserves:

Changes in the Environment

* * *

Because many variables can affect past and future loss projections, the effect of changes in such variables on the results of loss projections should be carefully considered.

Identification of changes in variables and consideration of their effect on loss reserve projections are critical steps in the loss reserving process....

* * *

If changes in variables have occurred, mechanical application of loss projection methods may result in unreasonable estimates of ultimate claim costs.

SOP 92-4, ¶¶40-42.

Risk Factors and Developing a Range

* * *

Some risk factors existing within the company that may affect the variability of the company’s loss reserves are –

• The frequency and severity of claims associated with a line of business. Medical malpractice, directors’ and officers’ liability, and other lines of business that typically produce few claims with large settlement amounts tend to have a high degree of variability.

* * *

Some external factors that may affect the variability of loss reserves are—

• Catastrophes or major civil disorders.

• Jury awards and social inflation arising from the legal environment in principal states in which a company’s risks are underwritten.

SOP 92-4, ¶¶84-85.


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229. XL violated SOP 92-4 because it did not properly consider changes in the

environment or variability in estimating reinsurance loss reserves, as set forth herein.

230. XL also violated GAAP by failing to properly record loss expenses and loss reserves

in its interim financial statements as indicated by APB Opinion No. 28, ¶17:

Interim Financial Reporting:

* * *

The amounts of certain costs and expenses are frequently subjected to year-end adjustments even though they can be reasonably approximated at interim dates. To the extent possible such adjustments should be estimated and the estimated costs and expenses assigned to interim periods so that the interim periods bear a reasonable portion of the anticipated annual amount.

231. In a striking coincidence, XL’s quarterly loss ratios for its reinsurance segment

during 2001, 2002 and 2003 were remarkably stable, considering that the reinsurance business

cycle is notoriously volatile. Shown below are XL’s reinsurance loss and loss expense ratios on a

quarterly basis:

1Q01 2Q01 3Q01 4Q01 1Q02 2Q02 3Q02 4Q02 1Q03 2Q03 3Q03 4Q04 Loss and loss expense ratio

63.1% 62.7% 326.8% 170.4% 62.8% 86.3% 62.5% 85.2% 63.7% 62.9% 83.6% 146.4%

232. Implausibly, six of the quarters’ loss and loss expense ratios fell in a narrow range of

62.5% to 63.7%. Of the other six quarters, four of them were higher than this range because of

delinquent charges by XL for inadequate loss reserves (4Q01, 4Q02, 3Q03 and 4Q03) and the other

two quarters were higher than this range due to losses in connection with the September 11, 2001

terrorist attacks (3Q01 and 2Q02). The stability of the quarters where the loss and loss expense

ratio were between 62.5% and 63.7% is simply unbelievable for a reinsurance segment with a

substantial amount of casualty business, where loss ratios are notoriously unstable, because losses

are “low frequency, high severity,” which should cause troughs and spikes over time (from ongoing

operations, not from delinquent charges for previous accident years). In fact, the appearance of


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stability in a business segment with expected erratic results suggests that the recorded losses were

based on targets or actuarial models that were designed to reach predetermined results.

During The Class Period, XL Received a Scathing Reinsurance Examination Report from NAC Re’s Regulator, the NYID:

233. XL’s largest United States subsidiary, NAC Re, was required to file annual

statements16 with the NYID in conformity with SAP. SAP are insurance industry accounting rules

promulgated by the NAIC and various state regulatory authorities. Accounting for insurance

premiums, expenses and loss reserves is substantially similar under GAAP and SAP. NAC Re’s

most recent Examination Report by NYID was completed in May 2002 and severely criticized

NAC Re for numerous reporting deficiencies, violations of New York State Insurance Law, lack of

cooperation with the examiner and numerous other breaches.

234. The May 2002 Examination Report from NYID was as of December 31, 1999 and

included a review of certain transactions and reports in 2000 and 2001. Information in the Report

confirms that XL knew no later than May 2002 (and probably much earlier), that the NYID had

concluded that XL lacked adequate internal controls over its NAC Re reinsurance operations, and

that NYID found it necessary to make a $189 million adjustment to increase loss reserves beyond

what NAC Re reported to NYID as of December 31, 1999, based on additional loss reserves taken

by the Company in 2000 and 2001.

235. Among the NYID Examination Report findings were the following:

(a) Due to numerous adjustments by NYID to amounts NAC Re reported in its

annual statement, NAC Re’s policyholder surplus was reduced to $175,542,194 from $440,103,494,

reflecting a reported overstatement of 150%.

16 The annual statement is a set of financial statements, footnotes, and numerous supporting schedules that insurance companies are required to file with insurance regulators every year. The regulator typically conducts a formal examination of the annual statement every three to five years.


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(b) The examination calculation of liability for loss reserves, which was

conducted in accordance with generally accepted actuarial principles and practices and based on

statistical information contained in NAC Re’s internal records and filed annual statements, was

$1,175,734,849, which was $189,000,000 higher than NAC Re’s reported reserve balance of

$986,734,849, reflecting a reported understatement of 19%.

(c) The Company did not comply with provisions of New York Insurance Law

that require facilitation of the examination and aid to the examiners. As stated in the examiner’s

report:

“The designated contact person did not have the authority, knowledge and experience to effectively facilitate the examination;

“Requests for information were not responded to in a timely manner;

“Documentation provided was often inaccurate and incomplete.”

* * *

“The above significantly increased the length of the examination, increased the cost of the examination to the Company and put a strain on [NYID’s] resources.”

(d) The open items report balance for an affiliate of NAC Re was $18,786,870,

however, NAC Re reported $26,231,000, an overstatement of $7,444,130. NAC Re was unable to

provide support for the reported amounts, and the NYID found this to be a violation of New York

Insurance Law §1505(b), which states:

The books, accounts and records of each party to all such transactions shall be maintained as to clearly and accurately disclose the nature and details of the transactions including such accounting information as is necessary to support the reasonableness of the charges or fees to the respective parties.

The above finding by NYID put XL on notice that their accounting and record-keeping at NAC Re,

their largest U.S reinsurance subsidiary, was in violation of state law. This was a highly significant

finding, because the SEC has substantially similar rules for maintaining adequate books and

records.


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(e) The examination calculation of the common stock balance (an asset) was

reduced to $148,324,133 from $222,516,133, reflecting a reported overstatement of 50%. Eighty

percent of the reduction was due to understated loss reserves of NAC Re subsidiaries.

(f) The Company did not have support for several annual statement balances,

including reinsurance payable on paid losses and loss adjustment expenses. In fact, a payable was

set up based solely on an email from an affiliate, which is improper because that is not sufficient

documentation to support such a payable.

(g) For the reinsurance payable on paid losses and loss adjustment expenses,

discrepancies were found in half of the balances tested, resulting in a $988,000 understatement of the

reinsurance payable account.

(h) After adjustments recorded by NYID, NAC Re’s ratios for liabilities to liquid

assets and premiums in the course of collection to policyholders’ surplus violated benchmarks used

by the Insurance Regulatory Information System of the NAIC.

(i) Several of NAC Re’s ceded reinsurance contracts were not signed within nine

months of their effective dates, a violation of NAIC Accounting Practices and Procedures. This was

also a finding by NYID in their previous Examination Report, but NAC Re failed to correct the

problem, even though NYID told NAC Re to discontinue the practice.

(j) Some contracts did not have executed liability and interest pages, and others

were not even in writing.

(k) Several amounts NAC Re reported on Schedule F (reinsurance schedules)

could not be supported by internal records. The Company was either unable to provide

documentation or the documentation provided did not agree with the reported amounts.

(l) The Company did not comply with any of its five affiliate service agreements,

and did not properly allocate expenses to certain members of the holding company system.


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236. Because of this highly critical Examination Report from NYID in May 2002, the

Company clearly knew of the problems with accounting systems for its NAC Re reinsurance

operations, particularly with respect to setting adequate loss reserves and having appropriate

internal controls.

XL’s Shareholder Equity Was Overstated Throughout The Class Period:

237. Because of XL’s failure to record adequate loss reserves and loss expenses during

the Class Period, its shareholder equity as reported in its press releases and SEC filings was

overstated by the following amounts ($ in millions):

December 31, 2001 December 31, 2002 June 30, 2003

Reported shareholder equity

$5,437 $6,570 $7,565

Minimum overstatement of shareholder equity

$ 622 $ 557 $ 557

Actual shareholder equity $4,815 $6,013 $7,008

XL’s GAAP Violations Were Material:

238. XL’s unrecorded reinsurance loss reserves and loss expenses and resulting

overstatement of stockholder equity alleged herein were material. As an initial matter, XL’s

financial misstatements were clearly material solely from a numerical (quantitative) standpoint,

because the Company’s earnings and shareholder equity were so inflated – by hundreds of millions

of dollars – that XL averted ratings downgrades and artificially inflated XL’s policy writing

capacity.

239. However, definitions of materiality are not limited to numbers and amounts. SEC

Staff Accounting Bulletin No. 99 (“SAB 99”), Materiality, summarizes GAAP definitions of

materiality. Among other items, SAB 99 says: “A matter is ‘material’ if there is a substantial

likelihood that a reasonable person would consider it important.” It also stresses that materiality


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requires qualitative, as well as quantitative, considerations. For example, if a known misstatement

would cause a significant market reaction, that reaction should be taken into account in determining

the materiality of the misstatement. SAB 99 further states:

Among the considerations that may well render material a quantitatively small misstatement of a financial statement item are –

* * *

• whether the misstatement masks a change in earnings or other trends

• whether the misstatement hides a failure to meet analysts’ consensus expectations for the enterprise

* * *

• whether the misstatement concerns a segment or other portion of the registrant’s business that has been identified as playing a significant role in the registrant’s operations or profitability

* * *

• whether the misstatement affects the registrant’s compliance with loan covenants or other contractual requirements

SAB 99 also says that an intentional misstatement of even immaterial items may be illegal and

constitute fraudulent financial reporting.

240. XL’s misstatements satisfy each of these criteria and thus were material from both a

quantitative and qualitative perspective.

XL Failed to Make Required Disclosures:

241. The SEC requires that, as to annual and interim financial statements filed with the

SEC, registrants include a management’s discussion and analysis section which provides

information with respect to the results of operations and “also shall provide such other information

that the registrant believes to be necessary to an understanding of its financial condition, changes in

financial condition and results of operations.” See Regulation S-K, 17 C.F.R. §229.303.


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Regulation S-K states that, as to annual results, the management’s discussion and analysis section

shall:

Describe any unusual or infrequent events or transactions or any significant economic changes that materially affected the amount of reported income from continuing operations, and in each case, indicate the extent to which income was so affected. In addition, describe any other significant components of revenues or expenses that, in the registrant’s judgment, should be described in order to understand the registrant’s results of operations.

Describe any known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations. If the registrant knows of events that will cause material change in the relationship between costs and revenues (such as known future increases in costs of labor or materials or price increases or inventory adjustments), the change in the relationship shall be disclosed.

17 C.F.R. §229.303(a)(3)(i)(ii).

242. In addition, the SEC, in its May 18, 1989 Interpretive Release No. 34-26831, has

indicated that registrants should employ the following two-step analysis in determining when a

known trend or uncertainty is required to be included in the MD&A disclosure pursuant to Item 303

of Regulation S-K: “A disclosure duty exists where a trend, demand, commitment, event or

uncertainty is both presently known to management and is reasonably likely to have a material

effect on the registrant’s financial condition or results of operations.”

243. During the Class Period, XL repeatedly told the market that it had taken the

necessary steps to properly set up reserves for losses and loss expenses. In fact, XL failed to

disclose to the market that it had not performed a sufficient review of cedents and related claims

information necessary to properly set loss reserves. Thus, XL violated Regulation S-K, set forth

above.

XL Lacked Adequate Internal Controls:

244. Section 13(b)(2) of the Exchange Act states, in pertinent part, that every reporting

company must: “(A) make and keep books, records and accounts which, in reasonable detail,

accurately and fairly reflect the transactions and dispositions of the assets of the issuer;” and “(B)


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devise and maintain a system of internal accounting controls sufficient to provide reasonable

assurances that – (i) transactions are executed in accordance with management’s general and

specific authorization; (ii) transactions are recorded as necessary (I) to permit the preparation of

financial statements in conformity with generally accepted accounting princples.”

15 U.S.C. §78m(b)(2)(A)(ii)-(iii).

245. These provisions require an issuer to employ and supervise reliable personnel, to

maintain reasonable assurances that transactions are executed as authorized, to properly record

transactions on an issuer’s books and, at reasonable intervals, to compare accounting records with

physical assets. SEC v. World-Wide Coin Investments, Ltd., 567 F. Supp. 724, 746 (N.D. Ga.

1983).

246. CW1 worked in NAC Re’s reinsurance operations from before the Class Period

started until after the Class Period ended. According to CW1, NAC Re’s claims record keeping,

claims processing systems, accounting records and internal controls were in disarray and the

available data was consequently inaccurate and unreliable.

247. The extent of NAC Re’s unreliable claims data and disorganized claims processing

systems rendered the accounting system incapable of producing accurate financial statements with

respect to loss expenses, loss reserves and shareholder equity. Even worse, without reliable claims

data, XL’s actuaries would not be able to generate loss reserve projections or estimates with any

amount of confidence. The fact that the submitted claims were frequently missing or incomplete

meant that actuarial models based on the claims data would necessarily produce reserves that were

materially insufficient, and would increase as XL’s NAC Re’s reinsurance operations grew.

248. XL’s management was aware of the unreliable claims data and deliberately failed to

implement proper internal controls or take other steps that were necessary to correct and complete

NAC Re’s claims data because they knew if accurate claims data was provided to the actuaries, loss


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reserve estimates would soar and XL would consequently face ratings downgrades and premium

capacity reductions.

249. Defendants caused XL to violate §13(b)(2)(A) of the Exchange Act by failing to

maintain accurate records concerning, inter alia, its claims, premiums, reserves, equity and surplus.

Defendants knew of XL’s failure to record reinsurance loss reserves and expenses in the proper

accounting periods. XL’s inaccurate and false records were not isolated or unique instances

because they were improperly maintained for multiple reporting periods, from at least fiscal 2001

through the end of the Class Period. Accordingly, XL violated §13(b)(2)(A) of the Exchange Act.

250. In addition, defendants caused XL to violate §13(b)(2)(B) of the Exchange Act by

failing to implement procedures reasonably designed to prevent accounting irregularities. XL

failed to ensure that proper review and checks were in place to ensure that it was properly recording

and reporting reinsurance-related balances. In fact, despite knowing of the Company’s lack of

adequate controls, as confirmed by the May 2002 NYID Examination Report, defendants regularly

issued quarterly and annual financial statements throughout the Class Period without ever

disclosing the deficiencies in XL’s internal accounting controls and falsely asserted that XL’s

financial statements complied with GAAP.

251. XL’s management was responsible for preparing financial statements that

conformed with GAAP. As noted by the AICPA professional standards:

[F]inancial statements are management’s responsibility.... Management is responsible for adopting sound accounting policies and for establishing and maintaining internal control that will, among other things, record, process, summarize, and report transactions (as well as events and conditions) consistent with management’s assertions embodied in the financial statements. The entity’s transactions and the related assets, liabilities and equity are within the direct knowledge and control of management.... Thus, the fair presentation of financial statements in conformity with generally accepted accounting principles is an implicit and integral part of management’s responsibility.

Statements on Auditing Standards, AU §110.03.


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252. “Financial reporting includes not only financial statements, but also other means of

communicating information that relates directly or indirectly, to the information” in the financial

statements. See FASB Statement of Concepts (“FASCON”) No. 1, ¶7. For this reason, in addition

to XL’s failure to make the required disclosures in its financial statements and in its SEC filings,

XL also shirked its duty to make such disclosures in its conference calls, its press releases and its

annual reports.

253. Due to these accounting improprieties, the Company presented its financial results

and statements in a manner that violated GAAP, including the following fundamental accounting

principles:

(a) The principle that interim financial reporting should be based upon the same

accounting principles and practices used to prepare annual financial statements (APB No. 28, ¶10);

(b) The principle that “[f]inancial reporting should provide information that is

useful to present and potential investors and creditors and other users in making rational investment,

credit and similar decisions” (FASCON No. 1, ¶34);

(c) The principle that “[f]inancial reporting should provide information about the

economic resources of an enterprise, the claims to those resources ... and the effects of transactions,

events and circumstances that change resources and claims to those resources” (FASCON No. 1,

¶40);

(d) The principle that “[f]inancial reporting should provide information about how

management of an enterprise has discharged its stewardship responsibility to owners (stockholders)

for the use of enterprise resources entrusted to it.” And “[t]o the extent that management offers

securities of the enterprise to the public, it voluntarily accepts wider responsibilities for

accountability to prospective investors and to the public in general” (FASCON No. 1, ¶50);


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(e) The principle that “[f]inancial reporting should provide information about an

enterprise’s financial performance during a period. Investors and creditors often use information

about the past to help in assessing the prospects of an enterprise. Thus, although investment and

credit decisions reflect investors’ ... expectations about future enterprise performance, those

expectations are commonly based, at least partly, on evaluations of past enterprise performance”

(FASCON No. 1, ¶42);

(f) The principle that financial reporting should be reliable in that it represents

what it purports to represent. That information should be reliable as well as relevant is a notion that

is central to accounting (FASCON No. 2, ¶¶58-59);

(g) The principle of completeness, which means that nothing is left out of the

information that may be necessary to insure that it validly represents underlying events and

conditions (FASCON No. 2, ¶79); and

(h) The principle that conservatism be used as a prudent reaction to uncertainty to

try to ensure that uncertainties and risks inherent in business situations are adequately considered.

The best way to avoid injury to investors is to try to ensure that what is reported represents what it

purports to represent (FASCON No. 2, ¶¶95, 97).

254. Moreover, defendants’ undisclosed, adverse, material information during the Class

Period is the type of information that, because of SEC regulations, national stock-exchange

regulations, and customary business practice, investors and securities analysts expect to be

disclosed and corporate officials and their legal and financial advisors know to be the type of

information that must be disclosed.

Defendants O’Hara’s and de St. Paer’s False Certifications:

255. On August 5, 2002, defendants O’Hara and de St. Paer signed and filed with the

SEC the following Certification under §906 of the Sarbanes-Oxley Act of 2002:


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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.1350(A) AND (B))

Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Chapter 63, Title 18 U.S.C. 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, 2002 of XL Capital Ltd (“Company”) fully complies with the requirements of Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934 and that the information contained in such Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Dated: August 5, 2002 / s / Brian M. O’Hara ---------------------------------------------------- Brian M. O’Hara President and Chief Executive Officer XL Capital Ltd

Dated: August 5, 2002 / s / Jerry de St. Paer

---------------------------------------------------- Jerry de St. Paer Executive Vice President and Chief Financial Officer XL Capital Ltd

O’Hara and de St. Paer signed substantially similar Certifications on November 8, 2002, March 28,

2003, May 15, 2003, June 18, 2003, and August 14, 2003 in connection with the Company’s false

Report on Form 10-K for the year ended December 31, 2002 and false Reports on Form 10-Q for the

quarters ended September 30, 2002, March 31, 2003, and June 30, 2003. At the time O’Hara and de

St. Paer signed these Certifications, they knew they were false.

256. On November 8, 2002, O’Hara signed and filed with the SEC the following

Certification under §302 of the Sarbanes-Oxley Act of 2002:

CERTIFICATION OF CHIEF EXECUTIVE OFFICER

XL CAPITAL LTD


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Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Chapter 63, Title 18 U.S.C.SS.1350(A) and (B))

I, Brian M. O’Hara, certify that:

1. I have reviewed this quarterly report on Form 10-Q of XL Capital Ltd; 2. Based on my knowledge, this quarterly 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 quarterly report;

3. Based on my knowledge, the financial statements, and other financial

information included in this quarterly report, fairly represent 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 quarterly report;

4. The registrant’s other certifying officers and I are responsible for establishing

and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) designed such disclosure controls and procedures 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 quarterly report is being prepared;

b) evaluated the effectiveness of the registrant’s disclosure controls and

procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

c) presented in this quarterly report our conclusions about the effectiveness of

the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant’s other certifying officers and I have disclosed, based on our

most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function);

a) all significant deficiencies in the design or operation of internal control

which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other

employees who have a significant role in the registrant’s internal controls; and

6. The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors


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that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Dated: November 8, 2002

/S/ BRIAN M. O’HARA Brian M. O’Hara President and Chief Executive Officer

O’Hara signed substantially similar Certifications on March 28, 2003, May 15, 2003, June 18, 2003,

and August 14, 2003 in connection with the Company’s false Report on Form 10-K for the year

ended December 31, 2002 and false Reports on Form 10-Q for the quarters ended March 30, 2003

and June 30, 2003. CFO de St. Paer signed substantially similar certifications with the same dates in

connection with the Company’s false Report on Form 10-K and false Reports on Form 10-Q for the

same periods. At the time O’Hara and de St. Paer signed these Certifications, they knew they were

false.

IX. APPLICABILITY OF PRESUMPTION OF RELIANCE: FRAUD-ON-THE-MARKET DOCTRINE

257. At all relevant times, the market for XL’s common stock was an efficient market for

the following reasons, among others:

(a) XL’s common stock met the requirements for listing, and was listed and

actively traded on the NYSE, a highly efficient and automated market;

(b) As a regulated issuer, XL filed periodic public reports with the SEC and the

NYSE;

(c) XL regularly communicated with public investors via established market

communication mechanisms, including through regular dissemination of press releases on the

national circuits of major newswire services and through other wide-ranging public disclosures, such

as communications with the financial press and other similar reporting services; and

(d) XL was followed by several securities analysts employed by major brokerage

firms who wrote reports which were distributed to the sales force and certain customers of their


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respective brokerage firms. Each of these reports was publicly available and entered the public

marketplace.

258. As a result of the foregoing, the market for XL’s common stock promptly digested

current information regarding XL from all publicly available sources and reflected such

information in XL’s stock price. Under these circumstances, all purchasers of XL’s common stock

during the Class Period suffered similar injury through their purchase of XL’s common stock at

artificially inflated prices and a presumption of reliance applies.

X. NO SAFE HARBOR

259. The statutory safe harbor provided for forward-looking statements under certain

circumstances does not apply to any of the allegedly false statements pleaded in this Complaint.

Many of the specific statements pleaded herein were not identified as “forward-looking statements”

when made. To the extent there were any forward-looking statements, there were no meaningful

cautionary statements identifying important factors that could cause actual results to differ

materially from those in the purportedly forward-looking statements. Alternatively, to the extent

that the statutory safe harbor does apply to any forward-looking statements pleaded herein,

defendants are liable for those false forward-looking statements because at the time each of those

forward-looking statements was made, the particular speaker knew that the particular forward-

looking statement was false, and/or the forward-looking statement was authorized and/or approved

by an executive officer of XL who knew that those statements were false when made.

XI. PLAINTIFFS’ CLASS ACTION ALLEGATIONS

260. Plaintiffs bring this action as a class action pursuant to Fed. R. Civ. P. 23(a) and

(b)(3) on behalf of a class, consisting of all those who purchased or otherwise acquired the common

stock of XL between November 1, 2001 and October 16, 2003, inclusive and who were damaged

thereby. Excluded from the Class are defendants, the officers and directors of the Company, at all


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relevant times, members of their immediate families and their legal representatives, heirs,

successors or assigns and any entity in which defendants have or had a controlling interest.

261. The members of the Class are so numerous that joinder of all members is

impracticable. Throughout the Class Period, XL common shares were actively traded on the

NYSE, under the ticker symbol (“XL”). While the exact number of Class members is unknown to

plaintiffs at this time and can only be ascertained through appropriate discovery, plaintiffs believe

that there are hundreds or thousands of members in the proposed Class. Record owners and other

members of the Class may be identified from records maintained by XL or its transfer agent and

may be notified of the pendency of this action by mail, using the form of notice similar to that

customarily used in securities class actions.

262. Plaintiffs’ claims are typical of the claims of the members of the Class as all

members of the Class are similarly affected by defendants’ wrongful conduct in violation of federal

law that is complained of herein.

263. Plaintiffs will fairly and adequately protect the interests of the members of the Class

and have retained counsel competent and experienced in class and securities litigation.

264. Common questions of law and fact exist as to all members of the Class and

predominate over any questions solely affecting individual members of the Class. Among the

questions of law and fact common to the Class are:

(a) Whether the federal securities laws were violated by defendants’ acts as

alleged herein;

(b) Whether the Company’s publicly disseminated press releases and statements

during the Class Period omitted and/or misrepresented material facts;

(c) Whether defendants breached any duty to convey material facts or to correct

material acts previously disseminated;


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(d) Whether defendants participated in and pursued the fraudulent scheme to

artificially inflate stock prices;

(e) Whether the defendants acted willfully, with knowledge or recklessly, in

omitting and/or misrepresenting material facts;

(f) Whether the market prices of XL’s common stock during the Class Period

were artificially inflated due to material non-disclosures and/or misrepresentations complained of

herein; and

(g) Whether the members of the Class have sustained damages and, if so, what is

the appropriate measure of damages.

265. A class action is superior to all other available methods for the fair and efficient

adjudication of this controversy since joinder of all members is impracticable. Furthermore, as the

damages suffered by individual Class members may be relatively small, the expense and burden of

individual litigation make it impossible for members of the Class to individually redress the wrongs

done to them. There will be no difficulty in the management of this action as a class action.

COUNT I

(Violation of Section 10(b) of the Exchange Act and Rule 10b-5 Promulgated Thereunder Against All Defendants)

266. Plaintiffs repeat and reallege each and every allegation contained above as if fully

set forth herein.

267. During the Class Period, defendants carried out a plan, scheme and course of

conduct which was intended to and, throughout the Class Period, did: (1) deceive the investing

public, including plaintiffs and other Class members, as alleged herein; and (2) cause plaintiffs and

other Class members to purchase XL’s common stock at artificially inflated prices. In furtherance

of this unlawful scheme, plan and course of conduct, defendants, and each of them, took the actions

set forth herein.


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268. Defendants (a) employed devices, schemes, and artifices to defraud; (b) made untrue

statements of material fact and/or omitted to state material facts necessary to make the statements

made not misleading; and (c) engaged in acts, practices, and a course of business which operated as

a fraud and deceit upon the purchasers of the Company’s common stock in an effort to maintain

artificially high market prices for XL’s common stock in violation of §10(b) of the Exchange Act

and Rule 10b-5. All defendants are sued either as primary participants in the wrongful and illegal

conduct charged herein or as controlling persons as alleged below.

269. Defendants, individually and in concert, directly and indirectly, by the use, means or

instrumentalities of interstate commerce and/or of the mails, engaged and participated in a

continuous course of conduct to conceal adverse material information about the business,

operations and future prospects of XL as specified herein.

270. These defendants employed devices, schemes and artifices to defraud, while in

possession of material adverse non-public information and engaged in acts, practices, and the

course of conduct as alleged herein in an effort to assure investors of XL’s value and performance

and continued substantial growth, which included the making of, or the participation in the making

of, untrue statements of material fact and omitting to state material facts necessary in order to make

the statements made about XL and its business operations and future prospects in the light of the

circumstances under which they were made, not misleading, as set forth more particularly herein,

and engaged in transactions, practices and a course of business which operated as a fraud and deceit

upon the purchasers of XL common stock during the Class Period.

271. Each of the Individual Defendants’ primary liability, and controlling person liability,

arises from the following facts: (1) the Individual Defendants were high-level executives and/or

directors at the Company during the Class Period and members of the Company’s management

team or had control thereof; (2) each of these defendants, by virtue of his responsibilities and


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activities as a senior officer and/or director of the Company was privy to and participated in the

creation, development and reporting of the Company’s internal budgets, plans, projections and/or

reports; (3) each of these defendants enjoyed significant personal contact and familiarity with the

other defendants and was advised of and had access to other members of the Company’s

management team, internal reports and other data and information about the Company’s finances,

operations, and sales at all relevant times; and (4) each of these defendants was aware of the

Company’s dissemination of information to the investing public which they knew or recklessly

disregarded was materially false and misleading.

272. The defendants had actual knowledge of the misrepresentations and omissions of

material facts set forth herein, or acted with reckless disregard for the truth in that they failed to

ascertain and to disclose such facts, even though such facts were available to them. Such

defendants’ material misrepresentations and/or omissions were done knowingly or recklessly and

for the purpose and effect of concealing XL’s operating condition and future business prospects

from the investing public and supporting the artificially inflated price of its common stock. As

demonstrated by defendants’ overstatements and misstatements of the Company’s business,

operations and earnings throughout the Class Period, defendants, if they did not have actual

knowledge of the misrepresentations and omissions alleged, were reckless in failing to obtain such

knowledge by deliberately refraining from taking those steps necessary to discover whether those

statements were false or misleading.

273. As a result of the dissemination of the materially false and misleading information

and failure to disclose material facts, as set forth above, the market price of XL’s common stock

was artificially inflated during the Class Period. In ignorance of the fact that market prices of XL’s

common stock were artificially inflated, and relying directly or indirectly on the false and

misleading statements made by defendants, or upon the integrity of the market in which the


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common stock trades, and/or on the absence of material adverse information that was known to or

recklessly disregarded by defendants but not disclosed in public statements by defendants during

the Class Period, plaintiffs and the other members of the Class acquired XL common stock during

the Class Period at artificially high prices and were damaged thereby.

274. At the time of said misrepresentations and omissions, plaintiffs and other members

of the Class were ignorant of their falsity, and believed them to be true. Had plaintiffs and the

other members of the Class and the marketplace known the truth regarding XL’s financial results,

which were not disclosed by defendants, plaintiffs and other members of the Class would not have

purchased or otherwise acquired their XL common stock, or, if they had acquired such common

stock during the Class Period, they would not have done so at the artificially inflated prices which

they paid.

275. By virtue of the foregoing, defendants have violated §10(b) of the Exchange Act,

and Rule 10b-5 promulgated thereunder.

276. As a direct and proximate result of defendants’ wrongful conduct, plaintiffs and the

other members of the Class suffered damages in connection with their respective purchases and

sales of the Company’s common stock during the Class Period.

COUNT II

(Violation of Section 20(a) of the Exchange Act Against the Individual Defendants)

277. Plaintiffs repeat and reallege each and every allegation contained above as if fully

set forth herein.

278. The Individual Defendants acted as controlling persons of XL within the meaning of

§20(a) of the Exchange Act as alleged herein. By virtue of their high-level positions, and their

ownership and contractual rights, participation in and/or awareness of the Company’s operations

and/or intimate knowledge of the false financial statements filed by the Company with the SEC and


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disseminated to the investing public, the Individual Defendants had the power to influence and

control and did influence and control, directly or indirectly, the decision making of the Company,

including the content and dissemination of the various statements which plaintiffs contend are false

and misleading. The Individual Defendants were provided with or had unlimited access to copies

of the Company’s reports, press releases, public filings and other statements alleged by plaintiffs to

be misleading prior to and/or shortly after these statements were issued and had the ability to

prevent the issuance of the statements or cause the statements to be corrected.

279. In particular, each of these defendants had direct and supervisory involvement in the

day-to-day operations of the Company and, therefore, is presumed to have had the power to control

or influence the particular transactions giving rise to the securities violations as alleged herein, and

exercised the same.

280. As set forth above, the defendants each violated §10(b) and Rule 10b-5 by their acts

and omissions as alleged in this Complaint. By virtue of their positions as controlling persons, the

Individual Defendants are liable pursuant to §20(a) of the Exchange Act. As a direct and proximate

result of defendants’ wrongful conduct, plaintiffs and other members of the Class suffered damages

in connection with their purchases of the Company’s common stock during the Class Period.

PRAYER FOR RELIEF

WHEREFORE, plaintiffs pray for relief and judgment, as follows:

Determining that this action is a proper class action, designating plaintiffs as Lead Plaintiffs

and certifying plaintiffs as class representatives under Rule 23 of the Federal Rules of Civil

Procedure and plaintiffs’ counsel as Lead Counsel.

A. Awarding compensatory damages in favor of plaintiffs and the other Class

members against all defendants, jointly and severally, for all damages sustained as a result of

defendants’ wrongdoing, in an amount to be proven at trial, including interest thereon;


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B. Awarding plaintiffs and the Class their reasonable costs and expenses incurred

in this action, including attorneys’ fees and expert fees; and

C. Such other and further relief as the Court may deem just and proper.

JURY TRIAL DEMANDED

Plaintiffs hereby demand a trial by jury.

DATED: June 21, 2004 SCOTT + SCOTT, LLC DAVID R. SCOTT (Bar No. CT 16080)

DAVID R. SCOTT

108 Norwich Avenue Colchester, CT 06415 Telephone: 860/537-3818 860/537-4432 (fax)

Liaison Counsel


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LERACH COUGHLIN STOIA & ROBBINS LLP WILLIAM S. LERACH DARREN J. ROBBINS 401 B Street, Suite 1700 San Diego, CA 92101 Telephone: 619/231-1058 619/231-7423 (fax)

LERACH COUGHLIN STOIA & ROBBINS LLP SHAWN A. WILLIAMS JAMES W. OLIVER 100 Pine Street, Suite 2600 San Francisco, CA 94111 Telephone: 415/288-4545 415/288-4534 (fax)

BARRETT, JOHNSTON & PARSLEY GEORGE E. BARRETT 217 Second Avenue, North Nashville, TN 37201-1601 Telephone: 615/244-2202 615/252-3798 (fax)

Co-Lead Counsel for Plaintiffs T:\CasesSF\XL Capital\CPT Consolidated.doc


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CERTIFICATE OF SERVICE

On this 21st day of June 2004 the foregoing document was served by First Class Mail on the

counsel of record listed on the attached service list.

________________________ David R. Scott


XL CAPITALService List - 6/15/2004Page 1 of 1

(04-0030)

Counsel For Defendant(s)

Leonard A. Spivak

80 Pine StreetNew York, NY 10005-1702

212/701-3000212/269-5420(Fax)

Cahill Gordon & Reindel LLPRobert Burdette Mitchell

850 Main Street, P.O. Box 7006Bridgeport, CT 06601-7006

203/674-7915203/363-8659(Fax)

Pullman & Comley

Paul S. GiordanoGeneral Counsel

XL Reinsurance America70 Seaview AvenueStamford, CT 06902-6040

XL Capital Ltd.

Counsel For Plaintiff(s)

William S. LerachDarren J. RobbinsRamzi Abadou

401 B Street, Suite 1700San Diego, CA 92101-4297

619/231-1058619/231-7423(Fax)

Lerach Coughlin Stoia & Robbins LLP

David R. Scott

108 Norwich AvenueColchester, CT 06415

860/537-3818860/537-4432(Fax)

Scott + Scott, LLC


AICPA AUDIT AND ACCOUNTING GUID E

'CPA

AUDITS OFPROPERTY ANDLIABILITYINSURANCECOMPANIES

With Conforming Changes as ofMay 1, 2000

GLOSSARY - Excerpted from the American Institute of Certified PublicAccountants Audit and Accounting Guid e

for Audits of Property and Liability Insurance Companies

Accident year. The year in which an accident occurred.

Admitted asset . An asset recognized and accepted by state insurance regulatory authoritiesin determining the financial condition of an insurance company .

Alien company . Insurance company domiciled in a foreign country .

Annual statement (convention statement or convention form) . A statement furnishingthe complete information regarding the company's condition and affairs at December31 of each year required by insurance departments of the various states in which acompany is authorized to transact business . This annual statement must be filed onthe form prescribed by the NAIC with the various insurance departments by March 1of the following year.

Assets , nonadmitted . Assets, or portions thereof, that are not permitted to be reported asadmitted assets in the annual statement filed with various insurance departments .Nonadmitted assets are defined by the insurance laws of various states . Majornonadmitted assets include: an excess of book value over statement value, ofinvestments, agents' balances or uncollected premiums over three months due, andfurniture, fixtures, supplies, equipment, and automobiles .

Assuming company . A company that accepts all or part of an insurance risk from anothercompany through reinsurance .

Case reserve . A liability for loss estimated to be paid in the future on an outstanding claim.

Ceding company . A company that transfers all or part of an insurance risk to anothercompany through reinsurance . Also called a primary company .

Claim . A demand for payment of a policy benefit because of the occurrence of an insuredevent, such as the death or disability of the insured, the maturity of an endowment,the incurrence of hospital or medical bills, the destruction or damage of property, andrelated deaths or injuries ; defects in, liens on, or challenges to the title to real estate,or the occurrence of a surety loss.

Claim adjusting . The process of investigating, appraising, negotiating and, sometimes,settling claims .

Claim frequency . The relative incidence of claims in relation to an exposure base .

Claim severity . The relative magnitude of the dollar amount of claims .

Claim or loss files . All data relating to each loss or claim together in a folder or stapledtogether, or the like, and referred to as the loss or claim file .

Combined ratios . The sum of both the loss ratio and expense ratio used to measureunderwriting performance .

Direct writing company . An insurance company whose business is produced by companyemployees, as distinguished from an agency company whose business is produced byagents .

Earned premiums . Pro rata portions of premiums applicable to the expired period of apolicy .

Incurred -but-not-reported (IBNR) claims . Claims relating to insured events that haveoccurred but have not yet been reported to the insurer or reinsurer as of the date of thefinancial statements .

Incurred losses (claims) . Losses paid or unpaid for which the company has become liableduring a period. Incurred losses for a period are calculated by adding unpaid losses atthe end of the period to losses paid during the period and subtracting unpaid losses atthe beginning of the period .

Liability for (claim) adjustment expenses . The amount needed to provide for theestimated ultimate cost required to investigate and settle losses relating to insuredevents that have occurred on or before a particular date (ordinarily, the balance sheetdate), whether or not reported to the insurer at that date .

Liability for unpaid claims . The amount needed to provide for the estimated ultimate costof settling claims relating to insured events that have occurred on or before aparticular date (ordinarily, the balance sheet date) . The estimated liability includesthe amount of money that will be required for future payments on both (1) claims thathave been reported to the insurer and (2) claims relating to insured events that haveoccurred but have not been reported to the insurer as of the date the liability isestimated .

Loss (claim)-adjustment expenses . Expenses incurred in the course of investigating andsettling claims . Loss-adjustment expenses include any legal and adjusters' fees andthe costs of paying claims and all related expenses .

Loss ratios . Expression in terms of ratios of the relationship of losses to premiums . Tworatios in common usage are (1) paid loss ratio - paid losses divided by writtenpremiums or earned premiums, and (2) incurred loss ratio - incurred losses dividedby earned premiums .

Loss reserves . A term used in statutory accounting for the liability for unpaid losses .

Losses . Claims .

NAIC (National Association of Insurance Commissioners) . An association of theInsurance Commissioners of various states in the United States .

Premium . The consideration paid for an insurance contract .

Premiums written . The premiums on all policies a company has issued in a period of time,as opposed to Earned premiums.

Property and liability insurance enterprise . An enterprise that issues insurance contractsproviding protection against (1) damage to, or loss of, property caused by variousperils, such as fire and theft, or (2) legal liability resulting from injuries to otherpersons or damage to their property . Property and liability insurance enterprises alsocan issue accident and health insurance contracts . The term property and liabilityinsurance enterprise is the current terminology used to describe a fire and casualtyinsurance enterprise . Property and liability insurance enterprises may be either stockor mutual organizations .

Quota-share reinsurance . A form of pro rata reinsurance. A reinsurance of a certainpercentage of all the business or certain classes of or parts of the business of thereinsured. For example, a company may reinsure under a quota-share treaty 50percent of all of its business or 50 percent of its automobile business .

Reinsurance . A transaction in which a reinsurer (assuming enterprise), for a consideration(premium), assumes all or part of a risk undertaken originally by another insurer(ceding enterprise) . However, the legal rights of the insured are not affected by thereinsurance transaction, and the insurance enterprise issuing the insurance contractremains liable to the insured for payment of policy benefits .

Reinsurance ceded premiums . All premiums (less return premiums) arising from policiesor coverage purchased from another insurance company for the purpose oftransferring a liability, in whole or in part, assumed from direct or reinsuranceassumed policies .

Reported claims . Claims relating to insured events that have occurred and have beenreported to the insurer and reinsurer as of the date of the financial statements, asopposed to incurred-but-not-reported (IBNR) claims .

Retrocession . A reinsurance of reinsurance assumed . For example, B accepts reinsurancefrom A, and B in turn reinsures with C the whole or a part of the reinsurance Bassumed from A . The reinsurance ceded to C by B is called a retrocession .

Statutory accounting practices . Accounting principles required by statute, regulation, orrule, or permitted by specific approval that an insurance enterprise is required to

follow in preparing its annual statement for submission to state insurance

departments .

Treaty. A contract of reinsurance .

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