XL Capital Ltd. Q2 2008 Earnings Call Transcript

| About: XL Group (XL)

XL Capital Ltd. (NYSE:XL)

Q2 FY08 Earnings Call

July 28, 2007, 5:30 PM ET

Executives

David Radulski - IR

Michael S. McGavick - CEO

David Duclos - EVP and Chief Executive of Insurance Operations

James H. Veghte - EVP & Chief Executive of Reinsurance Operations and CEO of XL Reinsurance America Inc.

Sarah E. Street - EVP and Chief Investment Officer for XL Capital Ltd and CEO of XL Capital Investment Partners Inc.

Brian Nocco - EVP & CFO

Analysts

Jay Gelb - Lehman Brothers

Alain Karaoglan - Banc of America

Jay Cohen - Merrill Lynch

Dan Johnson - Citadel Investment

Matthew Heimermann - JPMorgan

Vinay Misquith - Credit Suisse

Ian Gutterman - Adage Capital Management

Susan Spivak - Wachovia

Josh Shanker - Citigroup

William Wilt - Morgan Stanley

Bob Glasspiegel - Langen McAlenney

Paul Newsome - Sandler O'Neill & Partners

Operator

Good afternoon. My name is Abigail and I will be your conference operator today. At this time, I would like to welcome everyone to the XL Capital Ltd. second quarter conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question and answer session, at which time instructions will be given. And now, David Radulski, XL Capital's, Director of Investor Relations.

David Radulski - Investor Relations

Thank you, Abigail. Good evening and welcome to XL Capital's second quarter 2008 conference call. This call is being simultaneously webcast on XL's web site at www.xlcapital.com. We've posted to our website several documents, including press releases, our Q2 10-Q, our financial supplement and our structured credit data supplement.

On our call today, Mike McGavick, XL Capital's CEO, will discuss priorities for XL Capital, including the SCA agreement and associated capital raise. Dave Duclos, our Chief Executive of Insurance Operations, and Jamie Veghte, our Chief Executive of Reinsurance Operations, will review current market conditions and second-quarter results. Sarah Street, XL's Chief Investment Officer, will discuss our investment portfolio, followed by Brian Nocco, our CFO, who will review the financial impacts of the SCA agreement and capital raised and our second quarter financial results. We will open it up for your questions before returning to Mike for closing remarks.

Please note that since we are currently in the process of offering securities, we must limit our discussion today, including our responses in Q&A, to information filed in our public documents. And since it is not our practice to update guidance, nothing today should be construed as either updating or affirming previously provided guidance.

Certain of the matters we'll discuss today are forward-looking statements. These statements are based on current plans, estimates and expectations. Forward-looking statements involve inherent risks and uncertainties, and a number of factors could cause actual results to differ materially from those contained in the forward-looking statements. Forward-looking statements are sensitive to many factors, including those identified in our most recent annual report on Form 10-K, our quarterly reports on Form 10-Q and other documents on file with the SEC that could cause actual results to differ materially from those contained in the forward-looking statements. Forward-looking statements speak only as of the date of which they are made and we undertake no obligation publicly to revise any forward-looking statement in response to new information, future developments or otherwise.

And with that, I turn it over to XL's Chief Executive Officer, Mike McGavick.

Michael S. McGavick - Chief Executive Officer

Good evening, everyone, and thanks for joining us. As I've told people, I came to XL because I admire its operations. I've been a competitor to its insurance operations and a client of its Reinsurance Operations. It is simply one of the great collection of underwriting talent in the world.

But it has had its history of its great earnings being wiped out by big mistakes, especially over these past eight years, and this is a pattern that can and must end. To achieve this outcome, in my only brief comments to analysts on the Q1 call before I took the job… before I started, I should say, I described three priorities at the heart of delivering on this promise of less risk and stronger earnings.

First, to work to solve the SCA matter; and of course, we have done it. Second, working to make the business less prone to large one-off events, and fulfilling that is going to require a number of actions. You can see them listed on slide four, and I'll come back to it in a moment. And third, I said I would do what it takes to… to take the action to strengthen over time our ratings, protect our ratings in the near-term and of course, that relates to the capital raise that we are engaged in at this time.

If you turn to slide five, we can dip into the details on SCA. In recent weeks, the right parties were drawn into complex negotiations facilitated by the New York Insurance Department. I want to pause and thank Eric Dinallo and his staff for their hard work in these past weeks, as well as Matthew Elderfield and the staff down at the BMA who have worked very hard. At the present, in addition to SCA and XL, we're the CDS counterparties, mainly the large banks who represent some of the largest potential claimants to SCA.

In the end we agreed to extinguish the vast majority of our exposures. In other words, almost $66 billion in notional exposure was relieved at closing of this deal, $3 billion to $5 billion of what could have been potentially immediate claims from the Pre-IPO, CDS counterparties are avoided, and our other various meaningful contracts are extinguished.

Note that there are some contracts, in total, referenced as the European Investment Bank, or EIB contracts, that are still being worked on and to which we may remain attached. The notional value of these contracts is about $1.1 billion or less than 2% of the total exposure. These contracts relate to project-financed risks and are performing well. The costs for extinguishing these risks are detailed on the slide and are clear. We will pay to SCA $1.775 billion.

We will transfer to them 8 million shares of XL stock with a six-month lockup, and we will transfer back to SCA our 46% ownership in that company. This will lead to a charge in Q3 of $1.4 billion to $1.5 billion for XL. In the end, this was a business judgment that was influenced by a number of inputs, and our view is that this is a solid outcome for us. It is final and behind us. The XL and SCA boards have approved this deal, as have the New York State Insurance Department, the Bermuda Monetary Authority and the Delaware Insurance Department, as well as other regulators.

Though they will speak for themselves, we expect upon the completion of the current capital raise that the rating agencies will take us off of negative watch. While several agencies are likely to maintain negative outlooks, we believe that all of the rating agencies will ultimately affirm our financial strength and debt ratings as they are. To pay for the cost of this agreement, we are currently raising capital. Brian Nocco will discuss the details of that shortly. But, I firmly believe that we have structured it in a way that enables our investors to participate in XL's return to strength.

Turning to slide six, even if our headline tonight is SCA is resolved and capital being raised, that is hardly the only thing we have been working on. Leading up to June and before the final negotiations on SCA became all-consuming, I had the chance to visit 12 of our offices in seven countries around the world. I did town hall Q&A sessions with more than 75% of our workforce and had extensive meetings with our local leadership, often in one-on-one settings.

The result of this education was a series of recommendations for change at XL which were reviewed and approved at our June strategic board meetings and which are now being announced and in many cases already underway. The goal is simple… to reduce the risk of the large losses that have dogged our franchise and return the core earnings power of the franchise to prominence. We will focus on our core P&C businesses' proven winners as the second quarter results show yet again despite the downward pressure of dealing with the market with SCA out there. One major related decision is that we will begin to explore strategic opportunities for our Life Reinsurance business.

We will also flatten our leadership structure to increase accountability. With the decision of Henry Keeling, our Chief Operating Officer, to retire, and I want to emphasize emphatically, Henry chose to retire, I wish he would stay. I understand, however, and respect his choice, and I wish him absolutely the best in any future endeavor. It has been a pleasure working with Henry. But, with his decision and with the willingness of others to be reassigned, we are able to eliminate a layer of management.

The business leaders, our chief actuary and the heads of our functionaries to support the move to report directly to me in the future, more of a traditional operating company model rather than the complex holding company model that was being worked toward in the past. To that group, we will expect to soon add a chief enterprise risk officer to help maintain complete focus on our risks, especially those that go beyond that which we underwrite.

With this simplified mission, also comes the chance to make the business more efficient by removing the vestiges of the holding company model and eliminating nice-to-have activities that are simply not either in keeping with the new business model nor this time in the cycle. We will move towards savings of approximately $110 million to $120 million over our 2008 run rate's expenses, resulting in a charge of $50 million to $60 million in the third quarter, at least the majority of which we expect to take in the third quarter; net-net year on… net year-on-year savings of $70 million in expenses.

But, we're investing at the same time. We have kicked off a multiyear program called Operational Transformation, in development for more than a year to rebuild the underlying global technology platform from which we work. This will lead to significant savings and further extend our global platform advantages.

Now also on the topic of investing in the business. Know that we plan a highly targeted options grant program for key employees for retention purposes. To the extent that we include senior management, senior leaders will have performance-based thresholds for vesting.

While we are investing in the underlying technology platform, it should be noted that the global network itself in both insurance and reinsurance is largely built. We have 77 offices in 27 countries that can provide global platform business in 100 countries. That this is already built means that we can eliminate a major historical source of risk. Two of the sources of major losses over the past decade were unexpected loss development after large acquisitions. Today, we have no need for such major and risky acquisitions either to compete or to grow. This alone eliminates a major source of risk to our owners.

Finally, as to our investment portfolio, today it has more sources of volatility than we would like because it has more elements than were accumulated for the support of the financial lines businesses, which we have exited. Over time, we will work to make it a more traditional P&C investment portfolio. Taken together, these actions meaningfully reduce the risks of this firm, position it to compete well in tough market conditions and will allow our underlying underwriting excellence to shine through.

You can see some evidence of that excellence in slide seven, our second-quarter highlights. Our second quarter financial results illustrate why I'm so confident in these core businesses. In a quarter that had exceptional industry-wide losses, our core P&C combined ratio was outstanding and underpinned our 13.3% operating ROE.

With that, I would like to turn it over to Dave Duclos, our Head of Insurance, to discuss his operations results. Dave?

David Duclos - Executive Vice President and Chief Executive of Insurance Operations

I'll speak to slide eight in the presentation that captures insurance financials. We feel good about the results produced in the second quarter, in light of the market conditions that exist. With strong earnings, evidenced by our 94% combined ratio, and revenues coming in slightly below prior year period, we continue to execute our strategy which focuses on retention of existing business and selectively writing new business while carefully extending our reach via product segment and geographic expansion.

I think it's important, given where we are in the cycle, to provide a bit more color around our premium results for Q2, since we're only seeing a slight reduction compared to prior year on a quarter basis, down 2.1%, and a slight increase on a year-to-date basis, up 0.7% year over year. Similar to the results achieved in the first quarter, our overall retention ratio is coming in as expected for this market and just slightly lower than prior year. While new business flow was down and our writings compared to prior-year quarter are off, as you'd expect in this pricing environment, we have offset some of the market impact as a result of new product capabilities.

Most noteworthy is the new business impact from our US E&S, US private D&O and global construction units. These initiatives along with others are generating new profitable business, offsetting much of the impact felt in the existing book, where we have also been aided by favorable foreign exchange movements on a quarter and year-to-date basis of $43 million and $109 million, respectively.

The message here is that our customers and brokers value our franchise, and to a large degree we've managed through both the current market cycle realities and SCA-related noise effectively. The competitive environment remains largely unchanged from what we described last quarter. Depending upon what line and in which part of the world you are, we're seeing decreases in price that range from single digits to high teens.

We're seeing some exceptions to this where specific classes of business are seeing stronger pricing due to actual results for loss concerns which exist. The best example would be the US financial institution sector.

On the loss side in the second quarter we saw much of the same as what we reported in our Q1 call. Industry property losses were approximately 50% greater than average for US cats at $6.8 million, and there also were a number of a non-cat loss events.

We estimate XL Insurance's share of these global Q2 market losses to be approximately 1.3%, a result similar to what was reported in Q1 of this year. This speaks to the disciplined and selective underwriting of our product lines. The insurance segment loss ratio for the second quarter was 7.2 points higher than the previous year quarter after adjusting for prior year development in both quarters. Approximately four points of this difference relates to an increase in property cat losses with the balance attributable to the softening rate environment, where our pricing is down on average 7%, impacting most lines of business, and the increase in our anticipated loss activity in professional lines, which was five points or approximately $14 million for the quarter, which translates into a 1.3 point impact on the segment loss ratio.

I can also report that the rate of D&O claims related to subprime currently appears to be tailing off with 12 notices in April, five in May and only two in June. It is still early days, but it's a good trend.

Before turning this over to Jamie, I feel a quick comment regarding the support we've continued to receive from our brokers and customers is warranted. In two words, thank you. We understand the past quarters have been challenging, but your ongoing support of this great franchise and what we bring to the market won't be lost on me or any of my associates. With the SCA closure that Mike spoke of secured, we look forward to continuing to work with our clients and brokers by delivering high-quality risk solutions.

And now, over to Jamie to comment on Reinsurance Operations.

James H. Veghte - Executive Vice President & Chief Executive of Reinsurance Operations and Chief Executive Officer of XL Reinsurance America Inc.

Thanks, Dave. I'm turning to Slide nine. Our results this quarter demonstrate how well our reinsurance platform can perform, even in challenging market conditions. We achieved a solid combined ratio of 89% despite the fact the industry has endured significantly above-average catastrophe losses in the first six months of the year. One industry source estimated the insured loss level from global catastrophe losses at 45% above the 10 year average.

From a top-line perspective, gross written premiums were $397 million for the quarter, which represents a decline of 24% compared to the prior-year quarter. This decline comes from a combination of the following factors. We have seen rate deterioration across the market, which I'll discuss in a moment. In addition, we have previously commented on the tendency of our clients to increase their net retentions, and this practice continued in the second quarter. Third, we have selectively canceled business that does not meet our hurdle rates. We have said repeatedly that our underwriting will not be market share driven, and we adhere to strict underwriting standards across XL Re.

Finally, we referenced a timing difference of $50 million during our first quarter call which we expected to renew in the second quarter. This renewal did not take place. Trading conditions remain competitive. The second quarter renewal is largely focused on US, though there is also business emanating from Latin America and Asia-Pacific. Renewals and new business opportunities continue to be assessed against well established hurdle rates.

In the quarter US cat exposed property lines experienced risk-adjusted rate reductions of 10% to 15%, while non-US cat-exposed property lines dropped 10%. Non-catastrophe-exposed property business saw rates decrease 15%. Ocean marine and aviation were off between 5% and 10%.

Casualty price trends in the US market experienced deterioration of up to 15%. However, the business actually bound by XL Re saw reductions of 10% due to the selective cancellations in this portfolio.

Finally, I would also like to comment on the effect the SCA situation has had on our business. Our signings on July 1 renewal business were satisfactory. We've had a small number of clients restrict our new and/or renewal activity since then when rating agency actions were taken. Given the time of year we are in, this principally affected the facultative account, and the overall impact has been limited to date. While some competitors have taken this opportunity to attack our franchise, I am personally gratified by the support demonstrated by our clients and brokers. The relationships and technical reputation we've developed over the years has been very beneficial in this period of uncertainty.

Now that we've put the SCA situation behind us, we would expect our trading relationships to stabilize across the market.

On the operational side, I would highlight continued progress in our plans for the newly opened Brazilian market. We recently received approval for our admitted license application and work continues to build out our infrastructure in that market.

With that, I'll turn it over to Sarah Street.

Sarah E. Street - Executive Vice President and Chief Investment Officer for XL Capital Ltd and Chief Executive Officer of XL Capital Investment Partners Inc.

Thank you, Jamie, and Good evening, everyone. Today, I'm going to briefly run through this quarter's financial results, which I'll follow with an overview of our plans to realign the portfolio over time to support our focused P&C operations.

Touching on our results on slide 10, net investment income from P&C operations was $298 million, which declined 8% relative to second quarter of 2007, primarily due to lower investment yields. Following our liquidations associated with our financial lines business, we now hold a higher proportion of floating-rate assets, and our investment income is more sensitive to rate changes at the short end of the US yield curve.

Our realized gains for the quarter were $2 million including charges of $48 million for other-than-temporary impairments. We continue to diligently scrutinize our topical assets on a security-by-security basis to identify those where we believe we have principal impairment and will not fully recover. Since March 2007, we have taken over to $600 million of OTTI and realized losses on approximately $3 billion of topical assets affected by the mortgage crisis. These OTTI charges have been primarily concentrated in our asset-backed CDO portfolio as well as lower-rated tranches of subprime, Alt-A's and jumbo mortgage-backed securities. Many of these lower-rated securities are now valued on our books at prices ranging between $0.05 and $0.30 on the dollar.

Our net unrealized losses increased by $707 million during the quarter, which was primarily the result of dramatic rises in both US and UK interest rates partially offset by modest credit spread tightening in both corporate and structured credit.

We incurred a loss in our investment fund affiliates of $20 million, driven primarily by an 80 basis point negative return for the quarter in our alternative portfolio. These results include March returns, as we record this portfolio on a one month lag. We have demonstrated our ability to generate attractive returns from this portfolio, with an 11% compounded return over the past three years.

But, as we have noted regularly, it is not always going to be earned evenly between quarters or even across years. We are satisfied with the results, given the turmoil in the markets. We have again posted data on our structured credit portfolio on the web site and have added detail regarding our exposures to agencies.

The supplemental presentation covers the highlights of our $34.3 billion fixed income portfolio, including its average credit quality, allocations to cash and government securities and provides granular detail on our $10.9 billion structured credit portfolio, which is in aggregate is AA-plus rated and holds 82% AAA bonds. Our exposure to Fannie and Freddie common and preferred stock is de minimis at $18 million.

Turning to slide 11, I would like to highlight our plans to simplify the investment strategy going forward. A number of the assets that we hold in our fixed income portfolio relate to the legacy financial lines businesses. We will be realigning our portfolio at a time to one that supports our focused P&C operations, with the goal of reducing book value volatility by being less sensitive to credit spread movements. We will continue to hold credit assets, although they will focus on higher credit quality.

Through a combination of maturities, coupon reinvestment, cash flow from operations and opportunistic sales, we will reduce our allocations in four key asset classes; firstly, those historically held for the financial lines segment, lower-rated corporates, particularly BBB's, financials and CMBS. We have $6 billion of natural cash flow from the portfolio over the next two years, so we can make meaningful progress towards these goals in that time frame.

I will now hand over to Brian Nocco, our CFO.

Brian Nocco - Executive Vice President & Chief Financial Officer

Thank you, Sarah. As Mike mentioned, we will be significantly enhancing our capital position. We intend to issue $2.5 billion of dual-tranched securities consisting of approximately $2 billion of common stock and $500 million of mandatory convertible securities. We will be exercising our option to convert our $500 million contingent capital facility into preferred stock. Additionally, we announced a 50% reduction in our per-share common dividend. We intend to maintain a strong capital position supportive of our aspirational credit ratings, which are a level higher than our current ratings.

You can see our actual June 30 capitalization and pro forma for the SCA agreement and planned capital actions. As you can see, our total capitalization is projected to increase by $1.4 billion. Additionally, our debt to capital ratio is projected to decrease from 18% to 14%. Based on discussions with the rating agencies, as Mike mentioned, we expect our ratings to been affirmed at current levels, although some of our outlooks are likely to be negative.

There's some noise in our earnings in the second quarter and there will be more in the third. The second quarter reflects $82 million in charges related to SCA exposures. The third quarter will reflect a charge of $1.4 billion to $1.5 billion related to the SCA agreement. We also expect to record charges of $50 million to $60 million in the second half of the year related to our expense reduction initiative.

As you heard from Dave and Jamie, we achieved solid underwriting results in the second quarter. On an aggregate basis, premiums were down, reflecting where we are in the cycle, more in reinsurance than insurance. We had positive prior-year development of $183 million in the quarter, partially offset by property catastrophe losses of $98 million. Our combined ratio was 92.3%.

As Sarah mentioned, income from investment affiliates was down in the quarter due to the turbulent investment markets. Our total operating expenses of $298 million for the quarter were lower than last year's $307 million, when SCA's expenses were included. Excluding SCA, they would have been $287 million.

And our Life Operations, which Mike referred to as the subject of a strategic review, contributed earnings of $28 million in the second quarter compared to $25 million in the previous-year quarter.

And now we can open it up to Q&A.

David Radulski - Investor Relations

Abigail, before you open it up for Q&A, this is David Radulski again, I will remind you that since we are currently in the process of offering securities we must limit our discussion today, including the responses that we give to your questions, to information filed in our public documents. Now, Abigail, can you give instructions for the dial-in?

Question and Answer

Operator

(Operator Instructions) Your first question comes from Jay Gelb with Lehman Brothers. Your line is open.

Jay Gelb - Lehman Brothers

Mike, can you talk about on a strategic level what you would view the target business mix being between commercial insurance and reinsurance for XL?

Michael S. McGavick - Chief Executive Officer

The exact mix between the two is something we're still reviewing. Clearly, those are the two core operations and one that deliver the lion's share of what goes on around here, especially under this simplified model.

But we haven't set a precise ratio between the business, and they will vary over time. As you may have noticed before, in the way we think of them strategically, the different businesses have different advantages. In Dave's operations, we have this global platform advantage that limits the number of competitors that can do the kind of business we do, but in Jamie's operation we have this real ability to grow and shrink according to market conditions and that alone disrupts any predictive relationship you would have between the writings across the two enterprises. And we'll be judged by market conditions, Jay. But there's no formulaic thing in place.

Jay Gelb - Lehman Brothers

Okay and the separately on the capital raise with the charge anticipated being up to $1.5 billion and then you're raising more capital than that. So does that imply that there is a deficient capital position? Or, maybe you could explain that.

Michael S. McGavick - Chief Executive Officer

Not deficient, but we did want to come out of this and in our constant consultations with the rating agencies, they wanted us to come out of this in a strongly capitalized position relative even to our aspirational ratings. It was important to us to do so. And you'll notice in the quarter, as was described by Sarah, we did have $707 million in negative marks in the quarter. In our investment portfolio, obviously, we still have those as money good and expect them to come back. But at the same time, the rating agencies do take those kinds of movements into account. So, when you take all of that together, this drove us to this size of capital raise.

Additionally, I would add, look, we have been getting noise from the investment portfolio. We are entering a volatile time, entering hurricane season. And, it was wise to us, if we were going to be in the markets raising capital, that we would raise it sufficient to be comfortable even going into those times before we can -- so that we would not be back to you. And that was the idea behind this size of raise.

Jay Gelb - Lehman Brothers

Okay thanks very much and best of luck.

Michael S. McGavick - Chief Executive Officer

Thank you.

Operator

Your next question comes from Alain Karaoglan of Banc of America. Your line is open.

Alain Karaoglan - Banc of America

Good afternoon, two questions. In terms of the $1.8 billion in cash to be paid to SCA, could you tell us what the rationale was and your thought process into coming up with that number? And in terms of the loss of $1.5 billion, what are the components of that? Is it just the 1.8 tax affected, or what happens to the reinsurance reserve that you had put up, if you could describe that a little bit more?

And the second question relates to people. Mike, do you have any concern about keeping people within the XL franchise in order to be able to continue to write the business that you want to write, both on insurance and reinsurance?

Michael S. McGavick - Chief Executive Officer

Sure. So, I have that as -- Alain, by the way, it's nice to talk to you again. I have that in two pieces. One, how do we come up with the number, how do we justify this number, and what's the difference between the 1.8 in cash and the 1.4 to 1.5 that we are talking about for a charge into Q3? And then, second about people, any concerns about retaining them and what efforts will we make?

First, as to the amount of payment, we looked at this across three economic points of view and then a business point of view. Informing our judgment on the three economic points of view were, number one, the amount of a notional exposure. When you are kind of $65 billion, $66 billion in notional exposure, there is obviously a value to no longer have that theoretical exposure to you. And that has a value, so that's the first prism.

The second prism is our own ground-up analysis of the exposures. And, those of you have been studying our website in prior quarters would have known… and I've heard it done by many analysts… amounts of our view at that time of $900 million to $1.1 billion of ground-up exposures to SCA.

I would add very quickly, though, that I would have argued that those numbers were right until very late in June, when we were informed by SCA and it was expressed as being to their surprise and to ours. But you'll get a chance to ask them themselves in their calls. But we were informed that they had had very substantial deterioration during the quarter, that there were some differences in how things were playing out that many of you shared with us before, and that would have influenced our view of that number somewhat higher. So that's the second fact you need to know is, that number was accurate until we got that information. And you'll be able to see their own release for a description of what was going on there.

And then a third economic point of view is, of course, as you see in their release, and particularly the release from the New York Insurance Department this evening, there was the specter of a potential seizure by that department. And you all know that with a seizure, those CDS contracts, the swap contracts, would have acceleration triggers, bringing those negative marks immediately full and payable due as claims that clearly would have arrived at us, because that would have been tens of billions of dollars of claim to SCA, and even in the pre-IPO section of that book of business would have represented somewhere between $3 billion and $5 billion of claims to XL.

So, when we looked across those three economic data points, it was our judgment that this particular settlement, we talk about it as about $1.9 billion when you add in the 8 million… value of the 8 million shares, plus the cash, plus the stock returned to them of their own. That's why we judged that this size of solution was, in fact, in the interest of our shareholders, and we do think it represents, as indicated by the various regulators, a full and fair consideration for the extinguishment of our exposures.

Now, your… as to your…sorry. And then, when you add that economic backdrop, you would add a business judgment. I mean it's simply true that, as the rating agencies were raising the pressure in recent weeks, the noise around SCA was getting to levels that we thought it was best to dispose of as quickly and rationally as possible. That had always been our theme, but clearly, our urgency was increased by the sense that the clock was ticking and that there could be, in the future, damage to the franchise if we didn't get this behind us. We were starting to see the signs that gave us pause.

Now, as Dave and Jamie have both spoken to, we think we have avoided that risk. We saw very little actual damage and now, with this solution, can go back and think, re-establish our place in the market in a fine way. So those were the four points of view, three economic and one of business judgment that led to our belief that this was an appropriate consideration.

Then about people, well, you've got it right, Alain. People are our core asset. That's true of all businesses, I suppose, but it is particularly true here, when you're writing some of the world's most complex risks. We are known for the quality of our underwriting prowess, and we intend to keep it. I can report to you a few things.

Number one, I'll ask Brian… excuse me… I will ask Dave Duclos and Jamie Veghte to quickly talk about the retention of their people in their operations. But to add weight to that, we will be, as I described earlier, doing a highly targeted, and I emphasize highly targeted, set of options grants to key customer-facing people particularly in order to give them a real incentive for this next phase and to energize and retain those people.

As I've already described, to the extent those are used for the senior team that reports to me, first of all, I will not participate. But to the extent they are used for senior people who report to me, there will be a significant performance feature. In fact, I can share with you the total amount of shares involved is 2.8 million or thereabouts. This will be in our 8-K.

And I can share with you that for those that are done for the senior team, there will be a 130% performance rate hurdle. And moreover, this won't even be priced until 10 days after the capital raise is done, to give the market time to calm down and not take advantage of the particular effects of the market raise. We were very thoughtful, I think, in designing this in an investor-friendly way.

I think that will go long ways as well. And then, finally, we'll get out there and communicate again. It's been frustrating for our investors, it's been frustrating for us in management, and it's been frustrating for our colleagues, clients and brokers that, during this period, we were engaged in confidential, highly sensitive and intense negotiations and could not communicate fully, as we would have wished. We are happy to be… finally be able to talk again.

And I'm reminded, by the way, that's with respect to people. I'll ask Jamie and Dave to follow up in a second. But I'm reminded, there was a second part of your ask on the SCA settlement. Yes, in total, it's about $1.9 billion when you add in the stock transfer, and that will be netted down to get to the charge for the third quarter by reversing out that which we had reserved around the FAC and the excessive loss and even a small amount that it was now reserved at the end of the third quarter of $58 million around the guarantee itself. So that's how you get to that gross number.

Jamie and Dave?

James H. Veghte - Executive Vice President & Chief Executive of Reinsurance Operations and Chief Executive Officer of XL Reinsurance America Inc.

We haven't loss any personnel over this issue. Our attrition rates are at historic levels, and no loss of key underwriters, whatsoever. Mike, Dave and I are hitting the road tomorrow to go visit many of them around the world. We're looking forward to getting them back, energized and excited about going forward.

David Duclos - Executive Vice President and Chief Executive of Insurance Operations

Yes. From an insurance perspective, Alain, I would have the same comment as Jamie. We have had some blip up, if you will, in our retention of staff post comp distribution in mid-March, but actually May and June retention levels have come back to historical numbers. And when we have lost people, and this speaks to the value, I think, of the franchise, even within the last 10 days we have been able to attract new talent into the organization from some reputable firms. And we are very proud of that.

Alain Karaoglan - Banc of America

In terms of the commutation, are you comfortable that it's done, once you do it, it's done, and it cannot come back to XL?

Michael S. McGavick - Chief Executive Officer

Yes, we're highly confident that this will stand any test. First of all, there's no provision, once closed, for it to come back from any particular source. Second, let me clarify, since it's a moment to do it, let me clarify that there is one small set of contracts that is outside of this agreement. It's referenced in the press release and elsewhere. But that is the European investment bank risks.

Now, that is $1.1 billion in notional value. It relates to public infrastructure projects in the EU. Its seven contracts, five projects, for example, include toll roads, a couple of toll roads, a hospital, this kind of thing. It is performing well, according to surveillance. It's BBB rated, on average, according to S&P. And, you have to understand that our guarantee of SCA's wrap only applies to the principal and interest payments. So it's a diminishing risk. And it can only be triggered if those projects fail, first.

And second, if then claims were presented to SCA, due to the project's failures that they could not pay, only then would we be involved. And so you know, the contract actually specifies that SCA will continue to use commercially best efforts to extinguish those contracts as well. They were just too complicated and viewed as too benign to worry about, and so we chose not to hold up the deal over those contracts.

And in fact, in the contract, it requires further that if those contracts do stay in place, that they are attached to the largest capital pool remaining at SCA. So we feel very comfortable with that. I wanted to make you clear. I knew that was going to come up at some point. I thought I'd address it now.

And then your… the larger question is, what's the way this could somehow come undone. And the most discussed risk… and by the way, I refer you all to the public documents, the prospectus on the public offering. That's where you are going to get all of the lawyer representations and all that, and that is the governing risk profile. But I will say to you this.

We had to make this decision as a Board and as businesspeople and judge the effectiveness of this solution. Our driving force throughout was that it be economically rational, which I answered in part one of your question; and then, second, that it be durable, that it stand the test of time and that it be behind us.

The most discussed risk is the risk of fraudulent conveyance. In other words, that some policyholder could later sue that somehow this risk was wrongly transferred. Our greatest protection to that, and we think it is extraordinarily strong, is the fact that the Department of Delaware, the Superintendent of New York and that department in New York, and the BMA have approved this deal today and declared it to be fair and full consideration for the extinguishment of these risks. And you can judge for yourself, well, that the regulator whose legal concern is the policyholder would not do that without it in fact reaching to that level.

And I will give you another point that is important in respect to this. The fact is that because the specter of insolvency was in play toward the end of these negotiations, the facilitated negotiations with the department included the CDS counterparties or at least a significant number of them represented in coalition by a law firm.

This, to us, was in a sense bad news because you knew with them involved, it brought in the $3 billion to $5 billion theoretical claims and was going to raise the cost. And we knew, with the department governing it, they would be governing it for all time, and as a department they sure weren't going to do anything on the cheap.

But at the same time, we viewed it as substantially strengthening our agreement because it would be clear that the counterparties of the greatest size of the claim would be involved in establishing the right level. And we knew that that would give even greater confidence to the departments to put their blessing on the deal.

As a result, our lawyers have described the risks of this transaction as losing in any subsequent lawsuit, should there be one, as remote. We're highly confident that we will prevail and that SCA is behind us.

And one last point with respect to those CDS counterparties; we were waiting for news on this throughout the day because many of them offered to sign the agreement itself, and in fact that has been happening throughout the day. They have until the deal closes to keep signing up, so there could be more, later. But as of the signing of the master agreement today, thirteen counterparties, representing a substantial majority of SCA's total and notional amount of ABS, CDO counter… CDO exposures and this would be exclusive of SCA's Merrill Lynch ABS CDO exposures, which were separately negotiated and are, by their own announcement, separately extinguishes.

Now, when I say those thirteen that will represent 97% of the total notional amount of the ABS CDOs written by SCA prior to the IPO. So we see this as behind us.

Alain Karaoglan - Banc of America

Thank you very much.

Michael S. McGavick - Chief Executive Officer

Of course, we get the releases at the closing.

Operator

Your next question comes from Jay Cohen with Merrill Lynch. Your line is open.

Jay Cohen - Merrill Lynch

Yeah, thank you, two questions. First is, Mike, as you looked at the Company, obviously, the one business that sort of jumped out is a potential change to the Life Reinsurance business. What about the investments you have and the investment managers? That's clearly not a core business and probably carried less than those investments are worth. Is that something that you have considered or will consider?

Michael S. McGavick - Chief Executive Officer

I'm well aware of these affiliates. They are an example of some of the smaller activities that I'm continuing to review. We have no announcement to make at this time, but you can bet that I'm continuing to review all of our activities. And, bluntly, we're down to smaller activities that I'm examining into the future. Obviously, kind of the headline announcement is the strategic expiration on the Life Re business.

Jay Cohen - Merrill Lynch

That's fair, thanks Mike.

Michael S. McGavick - Chief Executive Officer

Good luck, Jay.

Operator

Your next question comes from Dan Johnson with Citadel Investment. Your line is open.

Dan Johnson - Citadel Investment

All right, thank you very much. All right, can we go into the segment line by line premium disclosures; the other property line, if you would, in contrast, obviously, to the casualty lines, which were down an expected fair amount, the other property line was up quite a bit. Can you just remind me what's in there, and is that well, let's just do that.

David Duclos - Executive Vice President and Chief Executive of Insurance Operations

What's in the other property line that represents the growth is actually our construction business. We've expanded our global construction capabilities, both product and resources, and that represents the majority of the growth you're seeing in that line.

Dan Johnson - Citadel Investment

Would you mind talking a little bit more about that business in terms of risks that are going in?

David Duclos - Executive Vice President and Chief Executive of Insurance Operations

It would be a combination of infrastructure, energy, high valued properties. It's a product and service capability that we've developed over the years, and it's a global product offering. In fact, we are seeing a good share of our growth in emerging markets, in particular the Middle East, Asia so it's a global product. It combines the product capacity and technical engineering capabilities, which has just been supplemented with the recent acquisition of GAPS.

Dan Johnson - Citadel Investment

Great, thanks, that's all I have.

Operator

Your next question comes from Matthew Heimermann with JPMorgan. Your line is open.

Matthew Heimermann - JPMorgan

Good morning or good afternoon, sorry for one day. A question on the amount of capital raise. Is another way to think about this that if you look at the shareholders' equity of the Company, there's obviously quite a bit of minority interest associated with some of the affiliates? And as a consequence, you need to raise excess because, effectively, some of that holding company capital in the form of those investments just isn't liquid, to make good on the cash obligation, etcetera?

Michael S. McGavick - Chief Executive Officer

No, that would not be correct. The reasons are for those specified. We wanted to have space to our aspirational ratings. We knew that there was noise coming up both out of the kind of marks we've seen in the investment portfolio, hurricane season. We have the need for the cash to cover the payment, so that will go out in the third quarter with the charge of the $1.4 billion to $1.5 billion. Then, we have the marks in this second quarter of the $707 million.

Those were the driving forces, and ultimate driving force in this is our ratings. That is the game changing event here, and that is what we're pursuing, is getting those ratings stabilized and then, over time, hopefully improving them.

Matthew Heimermann - JPMorgan

Can you just remind me, then, how much of the… what the stat capital looks like or surplus looks like in the insurance entities, and then just where the losses are going to be incurred, from a legal perspective?

Brian Nocco - Executive Vice President & Chief Financial Officer

I don't have to stat capital of each of the insurance entities in front of me. We'll be happy to follow up with you later on that. The lion's share of the liability to SCA will be paid out of XLI Bermuda, which is the entity that issued the guarantee.

Matthew Heimermann - JPMorgan

Got you and then, on the Life Reinsurance side, can you talk about what percentage of your invested assets and what percentage of the topical assets you break out are actually on that balance sheet?

Sarah E. Street - Executive Vice President and Chief Investment Officer for XL Capital Ltd and Chief Executive Officer of XL Capital Investment Partners Inc.

Yes, the assets in that portfolio at this point are $7 billion, as there is minimal negligible topical assets.

Matthew Heimermann - JPMorgan

Okay and then, the last question, Michael was just; you made this comment in the press release about keeping some of the expenses save available for reinvestment. I know its early days on this, but from your experience in the past, what would you consider a normal reinvestment?

Michael S. McGavick - Chief Executive Officer

That savings on a year-over-year basis winds up being about $70 million and I would expect to see some of that reinvested. You've heard projects already discussed in the press release like operational transformation and such. But all of that said, I do expect to drop a substantial portion of that $70 million to the bottom line.

Matthew Heimermann - JPMorgan

Okay and then…

Michael S. McGavick - Chief Executive Officer

But we haven't given color around the exact amount.

Matthew Heimermann - JPMorgan

No, that's fair. And is it fair to say that that doesn't contemplate any changes from where you sit today? In other words, if you decided, your review with life decided it was to be sold or some other disposition, that doesn't… whatever expense ramifications that has would be incremental, not inclusive?

Michael S. McGavick - Chief Executive Officer

That would have no relationship to that $70 million…

Matthew Heimermann - JPMorgan

Okay

Michael S. McGavick - Chief Executive Officer

We still capture the $70 million.

Matthew Heimermann - JPMorgan

Just wanted to make sure, thank you.

Michael S. McGavick - Chief Executive Officer

No; I totally understand. And by the way, on this topic of savings, I want to be clear. Because we're streamlining the Company, this is an opportunity. And it's one that we should take. It's painful that there will be people impacts, obviously. But we thought this was the time to do it and to get sailing set for better days, and that's the work ahead.

But no one should be confused. This remains a world-class employer of world-class talent. We are not thinking or confused about who we are. And this isn't going to turn into some cheap commodity play. That's not the thinking that. The thinking was, we've changed the way we are approaching governing our business; we should change the way in which we, therefore, our cost structures. But this is done, and then we will manage our business with a traditional eye, keeping expenses under control into the future.

Matthew Heimermann - JPMorgan

Okay, fair enough, appreciate that.

Michael S. McGavick - Chief Executive Officer

Thank you

Operator

Your next question comes from Vinay Misquith with Credit Suisse. Your line is open.

Vinay Misquith - Credit Suisse

Hi, good evening. I believe you mentioned that you made a few hires. Could you just add some more color on that? And, Mike, if you could share with us your plans, if you plan to make some more higher-profile hires for the Company?

David Duclos - Executive Vice President and Chief Executive of Insurance Operations

Yes, I'll comment on the hires comment. Actually, from an insurance perspective, it comes in two general categories. Part of it is related to our organic growth strategy, and we've continued to hire new underwriters into the organization that complement or add to our current capabilities. We've also made hires in our risk engineering area. And the last area where we've had a focus most recently and it relates to what Mike just mentioned about operational transformation, we are starting to hire people into the organization with strong operational orientation.

Michael S. McGavick - Chief Executive Officer

Good this is Mike. In terms of the senior management team, it is substantially present. The people who will be in this direct reporting relationship to me, starting with Dave and Jamie, whom you are listening to, they are here and ready to go. I have mentioned already that Susan Cross, our -- it's in the release, I believe -- our Chief Actuary, will be stepping onto that senior team as well, to give it the right kind of balance and weight.

I am very pleased with all of that. There's one place for certain that I'll make an add, and that is, as has been advertised, we are down to what I think are going to be the finalists for the chief enterprise risk officer position. That continues to work toward a close. And we are very pleased with the quality of candidates that we have in that effort.

And then finally, with the change with Spike [ph] Lavelle, who was running our global business services and with that being broken into the businesses, it remains an open question whether I will choose to have someone on the senior team as a direct report who is focused on what you might call a simplified OT at the corporate strategic level. But that's a decision I'll make in time and not ready to make today.

Vinay Misquith - Credit Suisse

So, I think it was mentioned that on the primary insurance side you lost a few people after March. Have you managed to replace those people?

James H. Veghte - Executive Vice President & Chief Executive of Reinsurance Operations and Chief Executive Officer of XL Reinsurance America Inc.

Yes, we have.

Vinay Misquith - Credit Suisse

Okay fair enough

James H. Veghte - Executive Vice President & Chief Executive of Reinsurance Operations and Chief Executive Officer of XL Reinsurance America Inc.

Actually, as I mentioned before, in addition to replacing existing positions, we've hired new underwriters to complement existing capabilities. But I would make a comment that, as we've gone through this process of transitioning staff, we've actually upgraded in some areas.

Vinay Misquith - Credit Suisse

The second question was on the investment portfolio. Obviously, you're restructuring it. Should we expect to see a lower yield on your total portfolio because of that and, of course, lower risk?

Sarah E. Street - Executive Vice President and Chief Investment Officer for XL Capital Ltd and Chief Executive Officer of XL Capital Investment Partners Inc.

It very much will depend upon what interest rates are at the time that we restructure it in terms of when we reinvest any of the proceeds. So I think it really very much comes down to what you think will happen in interest rates going forward.

Vinay Misquith - Credit Suisse

Do you expect to sell off some of your topical assets?

Sarah E. Street - Executive Vice President and Chief Investment Officer for XL Capital Ltd and Chief Executive Officer of XL Capital Investment Partners Inc.

We are certainly going to work very diligently to reposition the portfolio. We did spend a lot of time in the quarter considering whether we should accelerate the realignment of the portfolio by taking an OTTI charge associated with the change to intent to hold. We made a conclusion that, given the fact that we have such strong cash flow coming out of the portfolio, including, actually, out of the topical, we get quite a lot of cash flow out of the topical on a quarterly basis, that actually we could achieve a lot of the repositioning over time.

But that's something that we will consider, we'll continue to consider over time and we may make that change.

Vinay Misquith - Credit Suisse

So would it be fair to assume that it's more of a longer term goal and not some short-term change in your investment portfolio?

Sarah E. Street - Executive Vice President and Chief Investment Officer for XL Capital Ltd and Chief Executive Officer of XL Capital Investment Partners Inc.

That is certainly the current plan is that we work ourselves out some of these assets over time, yes.

Vinay Misquith - Credit Suisse

Okay thank you.

Operator

Your next question comes from Ian Gutterman with Adage Capital Management. Your line is open.

Ian Gutterman - Adage Capital Management

Hi Mike, few questions I guess first the ESU that comes due in February, the $750 million, can you talk about your plans? Will that just convert or do you have plans to buy back the dilution depending on what happens between now and then?

Brian Nocco - Executive Vice President & Chief Financial Officer

You're correct. We have got roughly $750 million of ESUs which convert to equity in February of next year. We do not plan to repurchase shares to offset that. That's capital that we generally do get credit from our rating agencies for and was considered in conjunction with the capital raise to support the business.

With respect to the debt that would be associated with those ESUs and the remarketing of that debt, it actually is our intention to retire that debt.

Ian Gutterman - Adage Capital Management

Okay so I guess -- I know this has been asked, Mike, but if I can try it one more time. I guess I am a little confused, still, and maybe this is just the rating agencies are playing hardball these days. But a $1.5 billion charge, you are raising $3 billion in capital, essentially. That's 2X the charge. I understand there's the investment losses and there's cat season. But, given the price of the stock that seems to be either incredibly conservative or you really had a big gun to your head. Why couldn't you do some other shareholder-friendly things, like have sold the Life Reinsurance quicker, sold off the hedge funds, things like that, to try to reduce the pain and not issue so many shares?

Michael S. McGavick - Chief Executive Officer

First of all, I want to be clear that you may be assured that the punitive nature of such a capital raise weighed very much on our thinking. And we explored everything we could think of that would have made it less painful.

The fact is that, as we got into the last and frenzied parts of these negotiations, alternatives that I had seen widely reported in the analyst community particularly simply became unrealistic given the demands for cash and the requirement that to make the this deal that it be immediately funded, or shortly thereafter.

And that really left us subject to a public raise. There would not have been the opportunity to raise money through any of the other mechanisms you have described in an orderly way in the time frame that was required to satisfy the extinguishment of the SCA exposure.

We made the judgment that for this franchise's long-term health and the ability to earn back over time for our shareholders what they have lost, that we have made our judgment that the most important thing was to get SCA behind us and that that would require a capital raise as a method of funding.

Now, we also thought long and hard about the size of the raise and it pained us to need to take it to this level. But I have already described the reasons. They are what they are and I would never comment negatively on the rating agencies, given the way they hold our lives in their hands. But the reality is that you are well aware of their situation and the pressures that come from their situation and they were very aggressive with us. And we have been responsive.

Ian Gutterman - Adage Capital Management

Fair enough, and I wouldn't expect to do the same thing in negatives [ph]. I'll take the hit on that one. Just a follow-up. When you mentioned, again, part of this is having --

Michael S. McGavick - Chief Executive Officer

They've been thoughtful with us. Look they've been in constant contact with us, absolutely.

Ian Gutterman - Adage Capital Management

When you said part of this is to make sure you don't have to come back for the investment portfolio or hurricanes and so forth, can you give us a sense of how big a hurricane you think you can handle without the agencies asking you to raise more capital?

Michael S. McGavick - Chief Executive Officer

Yes. Look, we have talked publicly about how significantly we have reduced our hurricane season exposure. When you get into events like Katrina, for example, when we model it today as opposed to what we took then, you get a 40% reduction in the losses.

We talked about that publicly. I, by the way, have spent a lot of time being educated by Susan and others about how we have done our risk management around class risk in major events and I am satisfied that, since the days of KRW, this firm has come a great ways.

So we are in a situation now where, for our Tier 1 events, we have a maximum possible loss limit that we have that we are -- that is in these public filings of 10% of our shareholders equity. We are managing below that level today. That includes the shareholders equity. That's at a 1% likelihood event that was one in a 100. And with that in place, we are below it. Will be below it after this capital is raised. And with that kind of event, we do not expect to be back at the window, which is why we've raised it this way.

Now, look, we can all sit around and we're in the business of doing so, I suppose, and I imagine some way, way out on the tail event that might cause the whole marketplace to be back at the window. But is there anything we see coming at us in this hurricane season or the noise in our investment portfolio? We always expect to be raising capital again. We think that's critical.

Ian Gutterman - Adage Capital Management

That's great. I was just going to make sure we were at a sufficient number. So that's very helpful.

And then just a couple little small ones, the European exposure. That remains; you said SCA is trying to commute that. If they do commute that, could you have a small charge for that in the future or would they bear that? I wasn't clear on that.

Michael S. McGavick - Chief Executive Officer

It is expected to be borne by them. But look, the bottom line is its minor and they are supposed to use commercially best efforts and we expect them to do so.

Ian Gutterman - Adage Capital Management

Okay and the very last one he senior debt you're retiring, can you just explain why you are retiring debt at the same time you're issuing capital?

Brian Nocco - Executive Vice President & Chief Financial Officer

Yes. This is a private placement that had provisions in it similar to our bank agreements that we didn't violate any financial covenants, but it had restrictions in relative to transactions with affiliates. And, while we requested and achieved waivers from all of our banks, that in the case of the private placement, it was deemed more prudent to simply retire it or redeem it early.

Ian Gutterman - Adage Capital Management

Okay, that makes sense. Thank you for all the time and good luck.

Michael S. McGavick - Chief Executive Officer

Before we get to our next question, I want to add something, since it's likely to come up later if it doesn't now. You've opened the question, sort of the size of the raise, and you could step back and say, boy, you are de-risking the franchise if you are successful with that. You've talked about how well you are managing your hurricane exposure. This is a very, very large capital raise, even relative to the SCA payment.

A logical question then comes, when you are exploring the Life Re operations and what you can do there, and the logical question comes, I suppose, why so much, and where does that lead us? Could that lead us to an excess capital position over time and I just want to make it very clear that the size of the raise is heavily influenced by our need to have ourselves at the right level, day one, after funding SCA. So that is why you get to the size.

Now, if you go out into the future, you should observe, if you've followed my work before, that I'm not a believer in insurance firms keeping money beyond that which is comfortable to their ratings away from their investors unless they're putting it to work. So you may recall, when I was at Safeco, those of you who don't know, we had a significant moment after we got that franchise turned around where we sold some businesses that were no longer core to us, and in selling those businesses wound up having a lot of capital. And, since we couldn't find a way to put that to work at the profit levels we were enjoying, we chose the method of a special dividend to get that capital back to our shareholders.

Later with that same franchise we began again, through our strong earnings, to deliver more capital than we could put to work. And in that case, we used the method of significant buybacks in order to, again, get our capital back out in a way that we thought was shareholder-friendly. So I don't believe in holding onto a bunch of your shareholders money unless you can put it to work very usefully. I do believe in being comparable relative to aspirational ratings, and that's it. And we won't wait until we have those ratings. We will evaluate capital and its uses right along, and we will view that in the shareholder friendly way.

Operator

Your next question comes from Susan Spivak with Wachovia. Your line is open.

Susan Spivak - Wachovia

Good morning, just a couple of questions, quick numbers question. On page 13, where you do the pro forma cap, how many shares are you assuming for that $29 '09 book value number? That's number one. And then I was just wondering, Mike, if you could give us some kind of projection of what you expect when you do sell the life health reinsurance company. In what range should we expect proceeds from that to be, if you'll answer that?

And then, finally, Jamie, could you talk about… we know that the ratings issue has some impact on the FAC business on the reinsurance side. That happened now in July, but the real renewal season for that business is coming up in December and January and how do you feel as if you'll be positioned for that important renewal season in that line?

Michael S. McGavick - Chief Executive Officer

Well, why don't you let me start, because I want to make sure it's very clear to everyone on this call. When we talk about life, we are exploring strategic alternatives. We have not decided what we will do, Susan, so I just want to make that point of emphasis crystal clear. For what it's worth, you would observe for yourself in our numbers that the capital behind the business is about $420 million right now. But again, we're just exploring what we'll do in the future.

I'll turn it over, for the question on the pro forma, to Brian and then to Jamie.

Brian Nocco - Executive Vice President & Chief Financial Officer

On the book value per share, it, of course, reflects the payment on the SCA transaction as well as all of the capital actions we've announced. Because we had to pick a number relative to the issue price, we used, for purpose of this chart last Tuesday's close of $19.68 per-share. And that's what's reflected in the numbers.

Susan Spivak - Wachovia

How many shares are there?

Brian Nocco - Executive Vice President & Chief Financial Officer

The total number of shares after the capital raise is 289 million shares. I also will mention that in February of next year is when the current ESUs, the $745 million of ESUs that are currently on the books, convert into common stock. It's approximately 11 million shares converting at $65 a share. So actually, it will be $0.59 per-share accretive to book value when that occurs. So that $29.09 would adjust upwards.

James H. Veghte - Executive Vice President & Chief Executive of Reinsurance Operations and Chief Executive Officer of XL Reinsurance America Inc.

Hi Susan, we have been given assurances by many of the companies that have chosen to take some action that, once we get the SCA situation behind us and our ratings situations clarified, then we'll go back to normal commercial relationships. I'm very optimistic that we have kept the damage to a limited level.

Susan Spivak - Wachovia

Well, when they say get their relationship with the rating agencies back to normal, does that mean off of negative credit watch? And have they given you any indication of when that would happen?

James H. Veghte - Executive Vice President & Chief Executive of Reinsurance Operations and Chief Executive Officer of XL Reinsurance America Inc.

I can't speculate on what each company will do. They've said the ratings situation clarified.

Brian Nocco - Executive Vice President & Chief Financial Officer

This is Brian and let me address, as best I can, the rating agency. We expect all of the negative watches to come off in a relatively moderate period of time. Now, some of the agencies may continue to have negative outlooks, which is partly related to cycle and partly waiting for the dust to settle around all these transactions. But we expect negative watches to be resolved.

Michael S. McGavick - Chief Executive Officer

And we believe, with our ratings affirmed, that that will give us the ammunition to go back to those who were giving us noise. And I should tell you, that process isn't going to wait for future days. We've already started. We've already been reaching out to our broker partners and walking them through this and getting ready to go to work.

Susan Spivak - Wachovia

And the capital raise, what's the date that that needs to be completed? Is that August 15th? Am I reading that right?

Michael S. McGavick - Chief Executive Officer

August 15th is the last date by which we can finance. But obviously, we expect it to… we expect a successful capital raise much sooner than that. But that is the end of our opportunity to fund.

Susan Spivak - Wachovia

Okay, great, thank you very much for your answer.

Michael S. McGavick - Chief Executive Officer

Okay

Operator

Your next question comes from Josh Shanker with Citi. Your line is open.

Josh Shanker - Citigroup

Thank you, a few quickies; I just want to follow up on Alain's question about the charge. The $1.775 billion that comes to $1.4 billion, $1.5 billion… that's pretax and post-tax are the same?

James H. Veghte - Executive Vice President & Chief Executive of Reinsurance Operations and Chief Executive Officer of XL Reinsurance America Inc.

Most of this is out of Bermuda, so the tax benefit is quite small.

Josh Shanker - Citigroup

Okay.

James H. Veghte - Executive Vice President & Chief Executive of Reinsurance Operations and Chief Executive Officer of XL Reinsurance America Inc.

And the charge in total is $1.9 billion. It includes the value of the 8 million shares of stock.

Josh Shanker - Citigroup

Okay, thank you very much. Second question, of the $1.6 billion in AOCI, how much of that currently relates to interest rate movements, do you think?

Sarah E. Street - Executive Vice President and Chief Investment Officer for XL Capital Ltd and Chief Executive Officer of XL Capital Investment Partners Inc.

Not to differentiate, but I would say most of the ACOI at this point has really been driven by credit over the last 12 months.

Josh Shanker - Citigroup

And so the interest rate hit that for this quarter gave back gains that you had previously on the books?

Sarah E. Street - Executive Vice President and Chief Investment Officer for XL Capital Ltd and Chief Executive Officer of XL Capital Investment Partners Inc.

Correct, yes.

Josh Shanker - Citigroup

Third, when you talk about having aspirational capital, do the rating agencies share your view just on pure capital that, after this deal gets done, that the capital at XL will be far and away higher than what it would need if that were the only issue at the Company?

Michael S. McGavick - Chief Executive Officer

We've been in constant contact. That is for them to say, not for us. But I can assure you that that was what we were driving toward, and that is where we believe we will be.

Josh Shanker - Citigroup

Okay and finally, let's just say SCA can turn things around. What would be the status of those shares put into the trust?

Michael S. McGavick - Chief Executive Officer

That is really for the Department of New York, SCA and the others to work through. I think you can take it, given that the counterparties, the CDS counterparties, were significant participants in the design of the solution. I think you can take it that they will have a real interest in where those shares go, particularly in terms of establishing governance over the… especially in establishing governance over where SCA goes from here. But it's really not our issue. Our issue is that we need to give them those shares, and they will go from there.

Josh Shanker - Citigroup

Okay, thank you for your quick answers and having all my questions answered.

Michael S. McGavick - Chief Executive Officer

And remember that, at the point that we're transferring them, we hold those at zero on our balance sheet. We'd already written them down.

Operator

Your next question comes from William Wilt with Morgan Stanley. Your line is open.

William Wilt - Morgan Stanley

Thanks for that, two quick numbers questions, the first for Jamie on Slide nine, the reinsurance results, but its… I guess it's shown as a 14.7-point deterioration in the accident year loss ratio, including cats, in the reinsurance segment, looked like maybe four or five points of CAT was the difference last year to this year, which would… if that is right, then that would leave about a 10-point deterioration. I just wondered if, A, if that's right; B, if you could add some color as to the reasons for that level of deterioration.

James H. Veghte - Executive Vice President & Chief Executive of Reinsurance Operations and Chief Executive Officer of XL Reinsurance America Inc.

The difference was 6.1 points from increased cat activity, 3 points from some losses from our XL financial solutions structured indemnity portfolio and 5.6 points from a variety of other issues, including a small adjustment in our sub-prime exposure in London and some reserve strengthening in our European trade credit portfolio.

William Wilt - Morgan Stanley

Okay, thanks for that. So those sum up to the… those are the sources of the 14.7?

James H. Veghte - Executive Vice President & Chief Executive of Reinsurance Operations and Chief Executive Officer of XL Reinsurance America Inc.

Correct.

William Wilt - Morgan Stanley

Perfect, thanks, the second numbers question, I'm sorry if I'm being a bit slow on this, in the share count, the $2.1 billion of capital raise at whatever price, at least a certain number of shares plus, then, in addition to that 8 million shares, newly issued shares related to going to SCA? Is that the math, $2.1 billion…

Brian Nocco - Executive Vice President & Chief Financial Officer

Sorry if it wasn't clear. It's $2 billion that we've assumed in the capital raise. And of course, as we have firmed this up on pricing, we might tilt a little bit more one way or the other on the mix between common and mandatory converts. The total we'll raise will be $2.5 billion. This assumes $2 billion in the capital raise. The 0.1 actually relates to the 8 million shares that we're giving to SCA.

William Wilt - Morgan Stanley

All right, I see, okay, perfect, thank you very much. Good luck.

Operator

Your next question comes from Steven Labbe with Langen McAlenney. Your line is open.

Bob Glasspiegel - Langen McAlenney

It's actually Bob Glasspiegel, how're you doing, Mike? Can I guess, we say good evening, not Good morning or Good afternoon, although it feels like all three. Investments, I think you said, from your perspective; that was a minor issue relative to, certainly, SCA. You haven't gone through it fully. I was wondering, to what extent, given that we're talking about four times your capital, there's a lot of leverage if any of those numbers or valuations are wrong. But can you say we've got your seal of approval, subject to market swings, from here? Or, does that still need some time for you to go through and get comfortable?

Sarah E. Street - Executive Vice President and Chief Investment Officer for XL Capital Ltd and Chief Executive Officer of XL Capital Investment Partners Inc.

I think, as Mike and Brian have talked about, we've done a lot of work on modeling in terms of what we think could happen in the investment portfolio in relation to our capital. And that was factored in, in terms of the analysis of how much capital we wanted to raise.

Bob Glasspiegel - Langen McAlenney

So, Mike, you feel comfortable with the investment portfolio to date? The reason I ask the question is, I see in the S&P commentary, clearly, the charges that have been going on, nags at them and sort of relative to the enterprise risk management, and you've announced some changes with your enterprise risk management.

So I guess it just leaves the question whether this is still a work in process or something that has been given your stamp of approval.

Michael S. McGavick - Chief Executive Officer

Bob, I appreciate the question. Look, we are certainly comfortable with our investment portfolio. There are clearly classes of investments we are in today that are not traditional for a pure P&C play. We got into them as a result of getting into these financial lines businesses, which we are now exited. And we would like, therefore, to rework or reposition the portfolio away from those classes of instruments.

So we really have the opportunity to do that because we generate so much cash and because the portfolio itself generates sufficient capital to be able to rework it. But it takes a fair amount of time, given conditions in the marketplace, of course, a lot of these instruments are not that easy to trade. And of course, there are limitations because of a fair amount of this we view as money good, and therefore, it's held to maturity.

So there are boundaries around how much we can do over a period of time. To your point, though, would we continue to look at it hard and keep being thoughtful about how we could reduce the sources of risk? Yes, you bet we will. We have examined carefully alternatives to it. We have thought them through.

We have noticed other players in the market that are using some of those opportunities. And I will keep thinking about it. So I wouldn't say to you that there could be no more change announced in that area, but I can say, as we come to the end of this period, I am comfortable with where we are and the plan going forward.

Bob Glasspiegel - Langen McAlenney

Thanks for that thoughtful answer Mike and best of luck.

Michael S. McGavick - Chief Executive Officer

Bob I appreciate nice talking to you.

Operator

Your next question comes from Paul Newsome with Sandler O'Neill & Partners. Your line is open.

Paul Newsome - Sandler O'Neill & Partners

Good evening, thanks for the call. Just one big picture question, could you talk a little bit more, perhaps, about maybe the possibility of plan B? Your stock is down 10% in after-hours, as we speak. I know you mentioned that you might think about rejiggering the structure of the capital raise. There's always the spectrum in this crazy market that you just can't raise $2.5 billion [ph]. Is there a plan B? And how …?

Michael S. McGavick - Chief Executive Officer

As we have said at the beginning, we are in the middle of a capital raise and I can't comment on it, except for to say that, as I have said all along, we're very confident in our plans.

Paul Newsome - Sandler O'Neill & Partners

Fair enough, good luck.

Michael S. McGavick - Chief Executive Officer

Thanks, Paul, appreciate it.

David Radulski - Investor Relations

This David Radulski is I am afraid that ends our time for Q&A today. Mike McGavick offers some questions and I ask for those of you who did not get a chance to ask your questions, please contact us and we will be happy to do what we can to help.

Michael S. McGavick - Chief Executive Officer

I have just a couple of closing thoughts. First, I want to thank you for your time. I appreciate that, for a surprising number of you have been much better at keeping a job than I have been. So it was nice to be back on the line with many of you from my past.

I also want to note something. I believe in owning up to mistakes immediately; it's just a rule of thumb. And earlier, I renamed the name of the head of the Bermuda Monetary Authority, which is somewhat shocking to me, given that I worked with him quite regularly during this process. But Matthew Elderfield, if you are listening to this call, I apologize. And now I won't have to do an 8-K saying I renamed you, which would be good.

A couple of things, last thoughts. Look, this is a tough time in the cycle, no question about it. And it's been made tougher still by the fact that we have had all this noise around our franchise. And we are extremely excited, Jamie, Dave and I, to hit the road and go out to our colleagues and share with them that this burden is lifted, that SCA is behind us and that we can go forward and compete again.

So let's be realistic. We see significant deterioration results across the industry. The soft cycle has not hit bottom. We sure don't see it hitting it in '09 and it might even go into '010, for all we know. But our job then is for focus on outperforming our sector in these tougher times. That's what great underwriters do. That's what we've done in the past. That's what we're going to do into the future. That is our goal, and we think we can deliver it. We have superior underwriting talent.

We will maintain our underwriting discipline. It's demonstrated most visibly by the decline in reinsurance premium. It's appropriate to where we are in the cycle in that business, and I admire the way the operation has been diligent to do so. Will pay close attention to expenses. We demonstrated this in this quarter with this reduction we've described. And we'll streamline all that we do around these core P&C businesses.

We set our sights high. While we don't give guidance, I will share with you that our plans and capital allocation models are set at an expectation that we will produce a greater than 15% ROE as averaged over the pricing cycle from these core P&C operations.

To that end, I would tell you, we expect to deliver double-digit ROEs, even through the low end of the cycle, at least as we forecast and model today. We're doing it right now with the 13.3 that we delivered in this quarter in ROE.

So what are the big takeaways from the way we see it? We've successfully -- when we have successfully closed this capital raise, as we expect to do, SCA will be behind us. We will reduce the risk in our franchise by focusing solely on our core and well positioned P&C insurance and reinsurance businesses and through these comprehensive actions we will have strengthened our balance sheet relative to our needed ratings.

In the end, I would say it this way. We have a strong management team. It has been realigned in a more focused way and we expect to come roaring back. Thank you very much for your time.

Operator

This concludes your conference call for today. You may now disconnect.

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