Risk-Return Balances XL Group

We retain our Neutral recommendation on XL Group (XL - Analyst Report) based on its substantial exposure to catastrophe losses as well as declining trend in the net investment income.

Counting on the positives, XL Group remains focused on those lines of business within its insurance and reinsurance operations that provide the best return on capital over the pricing cycle. New business coupled with improved rates aided the uptick at Insurance.

Higher premiums at the Reinsurance segment largely came from the U.S. crop books of business fueled by increasing commodity prices. With a strong international exposure and a diversified suite of product offering, we believe the company is well positioned to write higher premiums fueling top-line growth going forward.

XL Group is also taking initiatives to expand its operations. XL Group has received prior approval to establish a Brazilian insurance operation. Once the company receives final approval, it intends to offer Casualty, Property, Professional and Specialty insurance products through XL Seguros Brasil S.A., thereby launching its insurance operations there.

With Brazil continuing to be a growth engine in the global economy, we expect XL Group to capitalize on the opportunities as and when they arise.

Xl Group scores strongly with the rating agencies. A.M. Best Co. reiterated the issuer credit rating (ICR) of “bbb” of XL Group and its wholly-owned subsidiary, XL Group Ltd. The ratings also reflect enhanced risk management programs as well as focus on underwritings.

Concurrently, the rating agency also reaffirmed the financial strength rating (FSR) of A (Excellent) and ICR of “a” of the property/casualty subsidiaries of XL Group. We believe, the company scoring strongly with the rating agencies will retain investor confidence in the company as well as help it to write more business going forward.

XL Group continues to enhance shareholders’ value through dividend payment as well as share repurchase. In the third quarter of 2011, XL Group spent $307.7 million to buy back 15.1 million shares bringing the year to date repurchases worth $566 million.

The company is left with $290.4 million under its authorization. We believe the company’s strong financial position will support it to continue to buy back shares and pay dividends regularly thereby, sharing more profits with shareholders.

On the flip side, XL has substantial exposure to losses resulting from natural and man-made disasters and other catastrophic events. The third quarter suffered hugely due to cat losses totaling $110.4 million.

The magnitude of loss widened sequentially. XL Group incurred an underwriting loss of $22.2 million in the third quarter compared to underwriting gains of $64.7 million in the year ago quarter while combined ratio deteriorated 670 basis points year over year to 101.6%.

Net investment income at XL Group has been on the decline for the past few years. The third quarter experienced lower US interest rates on the property and casualty portfolio and cash outflows from the invested portfolio effecting net investment income. With performance closely linked to credit markets, the exposure to these assets can further cause volatility in investment earnings.

The Zacks Consensus Estimate for fourth-quarter 2011 is 56 cents per share. For full years 2011 and 2012, the Zacks Consensus Estimates are, respectively, $1.12 per share and $2.22 per share.

The quantitative Zacks #3 Rank (short-term Hold rating) for the company indicates no clear directional pressure on the stock over the near term.

Based in Dublin, Ireland, XL Group is a leading global provider of insurance, reinsurance and financial risk solutions to enterprises and insurance companies. It competes with ACE Limited (ACE - Analyst Report).

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