XL CAPITAL ASSURANCE INC.AND SUBSIDIARY
INTERIM CONSOLIDATED FINANCIAL STATEMENTS 
(UNAUDITED) 
AS OF SEPTEMBER 30, 2006 AND FOR THE THREE AND NINE MONTH 
PERIODS ENDED SEPTEMBER 30, 2006 AND 2005

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|                                                                               
|-------------------------------------------------------------------------------
|XL Capital Assurance Inc. and Subsidiary 
  Interim Consolidated Balance Sheets
|(U.S. dollars in thousands, except share and per share amounts)                
|                                                                               

|                                                                                                                  |  |                 |           |                |   |         |  
|----------------------------------------------------------------------------------------------------------------- |  | --------------- | --------- | -------------- | - | ------- | -
|                                                                                                                  |  | (unaudited)     |           |                |   |        
|                                                                                                                  |  | As of           |           | As of          |  
|                                                                                                                  |  | September
  30, |           | December
  31, |  
|                                                                                                                  |  | 2006            |           | 2005           |  
|                                                                                                                  |  |                 |           |                |  
|                                                                                                                  |  |                 |           |                |  
|Assets                                                                                                            |  |                 |           |                |   |         |  
|Investments                                                                                                       |  |                 |           |                |   |         |  
|Debt securities available for sale, at fair value
(amortized cost:
  2006 - $327,779; 2005 - $281,719)            |  | $               | 324,739   |                | $ | 279,423 |  
|Short-term investments, at fair value (amortized
cost: 2006 - $3,417;
  2005 - $7,244)                            |  |                 | 3,417     |                |   | 7,242   |  
|Other invested assets                                                                                             |  |                 |          |                |   | 17,621  |  
|                                                                                                                  |  |                 |           |                |   |         |  
|Total investments                                                                                                 |  |                 | 328,156   |                |   | 304,286 |  
|                                                                                                                 
|Cash and cash equivalents                                                                                         |  |                 | 73,140    |                |   | 32,337  |  
|Accrued investment income                                                                                         |  |                 | 2,241     |                |   | 2,650   |  
|Prepaid reinsurance
  premiums                                                                                    |  |                 | 527,117   |                |   | 440,241 |  
|Premiums receivable                                                                                               |  |                 | 7,226     |                |   | 5,034   |  
|Reinsurance balances
  recoverable on unpaid losses                                                               |  |                 | 133,723   |                |   | 122,073 |  
|Intangible assets -
  acquired licenses                                                                           |  |                 | 11,529    |                |   | 11,529  |  
|Deferred federal income
  tax asset                                                                               |  |                 | 15,894    |                |   | 18,845  |  
|Other assets                                                                                                      |  |                 | 13,185    |                |   | 16,711  |  
|                                                                                                                  |  |                 |           |                |   |         |  
|Total assets                                                                                                      |  | $               | 1,112,211 |                | $ | 953,706 |  
|                                                                                                                  |  |                 |           |                |   |         |  
|Liabilities
  and Shareholders Equity                                                                            |  |                 |           |                |   |         |  
|Liabilities                                                                                                       |  |                 |           |                |   |         |  
|Unpaid losses and loss adjustment
expenses                                                                        |  | $               | 142,853   |                | $ | 131,602 |  
|Deferred premium revenue                                                                                          |  |                 | 588,285   |                |   | 492,406 |  
|Deferred ceding commissions, net                                                                                  |  |                 | 43,928    |                |   | 41,191  |  
|Reinsurance premiums payable                                                                                      |  |                 | 25,011    |                |   | 1,080   |  
|Funds held - affiliate                                                                                            |  |                 |          |                |   | 15,859  |  
|Payable for investments purchased                                                                                 |  |                 | 13,929    |                |   |        |  
|Accounts payable, accrued expenses and other
liabilities                                                          |  |                 | 29,556    |                |   | 32,719  |  
|Current federal income tax payable                                                                                |  |                 | 2,285     |                |   | 1,023   |  
|Intercompany payable to affiliates                                                                                |  |                 | 15,190    |                |   | 10,878  |  
|                                                                                                                  |  |                 |           |                |   |         |  
|Total liabilities                                                                                                 |  |                 | 861,037   |                |   | 726,758 |  
|                                                                                                                  |  |                 |           |                |   |         |  
|Shareholders Equity                                                                                              |  |                 |           |                |   |         |  
|Common stock (par value $7,500 per share; 8,000
shares authorized;
  2,000 shares issued and outstanding)         |  |                 | 15,000    |                |   | 15,000  |  
|Additional paid-in capital                                                                                        |  |                 | 264,173   |                |   | 239,173 |  
|Accumulated other comprehensive (loss) (net of
deferred federal
  income tax liability of: 2006 - $0; 2005 - $57) |  |                 | (3,040    | )              |   | (2,355  | )
|Accumulated deficit                                                                                               |  |                 | (24,959   | )              |   | (24,870 | )
|                                                                                                                  |  |                 |           |                |   |         |  
|Total shareholders equity                                                                                        |  |                 | 251,174   |                |   | 226,948 |  
|                                                                                                                  |  |                 |           |                |   |         |  
|Total liabilities and shareholders
equity                                                                        |  | $               | 1,112,211 |                | $ | 953,706 |  
|                                                                                                                  |  |                 |           |                |   |         |  

See notes to interim consolidated financial statements.
1

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|                                                                        
|------------------------------------------------------------------------
|XL Capital Assurance Inc. and Subsidiary                                
|Interim Consolidated Statements of Operations and
  Comprehensive Income
|(U.S. dollars in thousands)                                             
|                                                                        

|                                                           |  |                      |         |                     |   |         |   |      |          |   |   |          |  
|---------------------------------------------------------- |  | -------------------- | ------- | ------------------- | - | ------- | - | ---- | -------- | - | - | -------- | -
|                                                           |  | (unaudited)          |         | (unaudited)         |  
|                                                           |  | Three
  Months Ended |         | Nine
  months ended |  
|                                                           |  | September
  30,      |         | September
  30,     |  
|                                                           |  |                      |         |                     |   |         |   |      |          |   |   |          |  
|                                                           |  | 2006                 |         | 2005                |   | 2006    |   | 2005 |         
|                                                           |  |                      |         |                     |   |         |   |      |         
|                                                           |  |                      |         |                     |   |         |   |      |          |   |   |          |  
|Revenues                                                   |  |                      |         |                     |   |         |   |      |          |   |   |          |  
|Gross premiums written                                     |  | $                    | 65,080  |                     | $ | 59,269  |   | $    | 235,211  |   | $ | 174,647  |  
|Ceded premiums written                                     |  |                      | (60,030 | )                   |   | (54,270 | ) |      | (212,589 | ) |   | (157,773 | )
|                                                           |  |                      |         |                     |   |         |   |      |          |   |   |          |  
|Net premiums written                                       |  |                      | 5,050   |                     |   | 4,999   |   |      | 22,622   |   |   | 16,874   |  
|                                                           |  |                      |         |                     |   |         |   |      |          |   |   |          |  
|Change in net deferred
  premium revenue                   |  |                      | (1,130  | )                   |   | (1,322  | ) |      | (8,928   | ) |   | (6,617   | )
|                                                           |  |                      |         |                     |   |         |   |      |          |   |   |          |  
|Net premiums earned                                        |  |                      | 3,920   |                     |   | 3,677   |   |      | 13,694   |   |   | 10,257   |  
|                                                           |  |                      |         |                     |   |         |   |      |          |   |   |          |  
|Net investment income                                      |  |                      | 4,228   |                     |   | 3,399   |   |      | 11,646   |   |   | 9,600    |  
|Net realized (losses) gains
  on investments               |  |                      | (23     | )                   |   | 5       |   |      | (1,407   | ) |   | 14       |  
|Net realized and unrealized
  losses on credit derivatives |  |                      | (379    | )                   |   | (125    | ) |      | (499     | ) |   | (253     | )
|Fee income and other                                       |  |                      |        |                     |   |        |   |      | 1,000    |   |   | 76       |  
|                                                           |  |                      |         |                     |   |         |   |      |          |   |   |          |  
|Total revenues                                             |  |                      | 7,746   |                     |   | 6,956   |   |      | 24,434   |   |   | 19,694   |  
|                                                           |  |                      |         |                     |   |         |   |      |          |   |   |          |  
|Expenses                                                   |  |                      |         |                     |   |         |   |      |          |   |   |          |  
|Net losses and loss
  adjustment expenses                  |  |                      | 496     |                     |   | 292     |   |      | 1,410    |   |   | 4,774    |  
|Net operating expenses                                     |  |                      | 8,128   |                     |   | 7,474   |   |      | 20,878   |   |   | 19,383   |  
|                                                           |  |                      |         |                     |   |         |   |      |          |   |   |          |  
|Total expenses                                             |  |                      | 8,624   |                     |   | 7,766   |   |      | 22,288   |   |   | 24,157   |  
|                                                           |  |                      |         |                     |   |         |   |      |          |   |   |          |  
|Income (loss) before federal income taxes                  |  |                      | (878    | )                   |   | (810    | ) |      | 2,146    |   |   | (4,463   | )
|                                                           |  |                      |         |                     |   |         |   |      |          |   |   |          |  
|Total federal income tax
  expense (benefit)               |  |                      | 2,423   |                     |   | (194    | ) |      | 2,235    |   |   | (1,062   | )
|                                                           |  |                      |         |                     |   |         |   |      |          |   |   |          |  
|Net loss                                                   |  | $                    | (3,301  | )                   | $ | (616    | ) | $    | (89      | ) | $ | (3,401   | )
|                                                           |  |                      |         |                     |   |         |   |      |          |   |   |          |  
|Comprehensive income (loss)                                |  |                      |         |                     |   |         |   |      |          |   |   |          |  
|Net loss                                                   |  | $                    | (3,301  | )                   | $ | (616    | ) | $    | (89      | ) | $ | (3,401   | )
|Other comprehensive income
  (loss)                        |  |                      | 7,265   |                     |   | (3,268  | ) |      | (685     | ) |   | (2,303   | )
|                                                           |  |                      |         |                     |   |         |   |      |          |   |   |          |  
|Comprehensive income (loss)                                |  | $                    | 3,964   |                     | $ | (3,884  | ) | $    | (774     | ) | $ | (5,704   | )
|                                                           |  |                      |         |                     |   |         |   |      |          |   |   |          |  

See notes to interim consolidated financial statements.
2

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|                                                                    
|--------------------------------------------------------------------
|XL Capital Assurance Inc. and Subsidiary                            
|Interim Consolidated Statements of Changes in Shareholders
  Equity
|(U.S. dollars in thousands, except share amounts)                   
|                                                                    

|                                                                                                                         |  |                      |         |                |   |         |  
|------------------------------------------------------------------------------------------------------------------------ |  | -------------------- | ------- | -------------- | - | ------- | -
|                                                                                                                         |  | (unaudited)          |         |                |   |        
|                                                                                                                         |  | Nine
  Months        |         | Year Ended     |  
|                                                                                                                         |  | Ended                |         | December
  31, |  
|                                                                                                                         |  | September
  30, 2006 |         | 2005           |  
|                                                                                                                         |  |                      |         |                |  
|                                                                                                                         |  |                      |         |                |   |         |  
|Common
  Shares                                                                                                          |  |                      |         |                |   |         |  
|Number of shares -
  beginning of year                                                                                   |  |                      | 2,000   |                |   | 2,000   |  
|                                                                                                                         |  |                      |         |                |   |         |  
|Number of shares - end of period                                                                                         |  |                      | 2,000   |                |   | 2,000   |  
|                                                                                                                         |  |                      |         |                |   |         |  
|Common
  Stock                                                                                                           |  |                      |         |                |   |         |  
|Balance - beginning of
  year                                                                                            |  | $                    | 15,000  |                | $ | 15,000  |  
|                                                                                                                         |  |                      |         |                |   |         |  
|Balance - end of period                                                                                                  |  |                      | 15,000  |                |   | 15,000  |  
|                                                                                                                         |  |                      |         |                |   |         |  
|Additional
  Paid-In Capital                                                                                             |  |                      |         |                |   |         |  
|Balance - beginning of
  year                                                                                            |  |                      | 239,173 |                |   | 239,173 |  
|Capital contribution                                                                                                     |  |                      | 25,000  |                |   |        |  
|                                                                                                                         |  |                      |         |                |   |         |  
|Balance - end of period                                                                                                  |  |                      | 264,173 |                |   | 239,173 |  
|                                                                                                                         |  |                      |         |                |   |         |  
|Accumulated
  Other Comprehensive Income (Loss)                                                                          |  |                      |         |                |   |         |  
|Balance - beginning of
  year                                                                                            |  |                      | (2,355  | )              |   | 1,578   |  
|Net change in unrealized appreciation of investments, net of deferred
  federal tax benefit of $57 in 2006, $793 in 2005 |  |                      | (685    | )              |   | (3,933  | )
|                                                                                                                         |  |                      |         |                |   |         |  
|Balance - end of period                                                                                                  |  |                      | (3,040  | )              |   | (2,355  | )
|                                                                                                                         |  |                      |         |                |   |         |  
|Accumulated
  Deficit                                                                                                    |  |                      |         |                |   |         |  
|Balance - beginning of
  year                                                                                            |  |                      | (24,870 | )              |   | (21,785 | )
|Net loss                                                                                                                 |  |                      | (89     | )              |   | (3,085  | )
|                                                                                                                         |  |                      |         |                |   |         |  
|Balance - end of period                                                                                                  |  |                      | (24,959 | )              |   | (24,870 | )
|                                                                                                                         |  |                      |         |                |   |         |  
|Total shareholders equity                                                                                               |  | $                    | 251,174 |                | $ | 226,948 |  
|                                                                                                                         |  |                      |         |                |   |         |  

See notes to interim consolidated financial statements.
3

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|                                             
|---------------------------------------------
|XL Capital Assurance Inc. and Subsidiary     
|Interim Consolidated Statements of Cash Flows
|(U.S. dollars in thousands)                  
|                                             

|                                                                                             |  |                     |          |      |   |          |  
|-------------------------------------------------------------------------------------------- |  | ------------------- | -------- | ---- | - | -------- | -
|                                                                                             |  | (unaudited)         |         
|                                                                                             |  | Nine
  Months Ended |         
|                                                                                             |  | September
  30,     |         
|                                                                                             |  |                     |         
|                                                                                             |  | 2006                |          | 2005 |  
|                                                                                             |  |                     |          |      |  
|                                                                                             |  |                     |          |      |  
|Cash flows provided by (used in) operating
  activities                                      |  |                     |          |      |   |          |  
|Net loss                                                                                     |  | $                   | (89      | )    | $ | (3,401   | )
|Adjustments to reconcile
  net loss to net cash provided by (used in) operating activities   |  |                     |          |      |   |          |  
|Net realized losses (gains) on sale of
investments                                           |  |                     | 1,407    |      |   | (14      | )
|Net realized and unrealized losses on credit
derivatives, excluding
  cash received and paid |  |                     | 499      |      |   | 253      |  
|Amortization of premium on bonds                                                             |  |                     | 471      |      |   | 661      |  
|(Decrease) increase in unpaid losses and loss
adjustment expenses,
  net                     |  |                     | (399     | )    |   | 4,274    |  
|Increase in deferred premium revenue, net                                                    |  |                     | 9,003    |      |   | 6,617    |  
|Increase in deferred ceding commissions,
net                                                 |  |                     | 2,737    |      |   | 3,949    |  
|Increase (decrease) in reinsurance premiums
payable                                          |  |                     | 23,931   |      |   | (19,912  | )
|(Increase) decrease in premiums
receivable                                                   |  |                     | (2,192   | )    |   | 1,907    |  
|Decrease in accrued investment income                                                        |  |                     | 409      |      |   | 924      |  
|Increase in current federal income tax
payable                                               |  |                     | 1,262    |      |   |         |  
|Provision for deferred federal income tax
asset                                              |  |                     | 2,951    |      |   | (1,062   | )
|(Decrease) Increase in accounts payable and accrued
expenses                                 |  |                     | (1,430   | )    |   | 10,181   |  
|Increase (decrease) in intercompany payable to
affiliates                                    |  |                     | 4,312    |      |   | (10,109  | )
|Other                                                                                        |  |                     | 1,453    |      |   | (529     | )
|                                                                                             |  |                     |          |      |   |          |  
|Total adjustments                                                                            |  |                     | 44,414   |      |   | (2,860   | )
|                                                                                             |  |                     |          |      |   |          |  
|Net cash provided by (used in) operating
activities                                          |  |                     | 44,325   |      |   | (6,261   | )
|                                                                                             |  |                     |          |      |   |          |  
|Cash
  flows used in investing activities                                                    |  |                     |          |      |   |          |  
|Proceeds from sale of debt
  securities and short-term investments                           |  |                     | 80,856   |      |   | 78,103   |  
|Proceeds from maturity of
  debt securities and short-term investments                       |  |                     | 11,575   |      |   | 9,982    |  
|Purchase of debt
  securities and short-term investments                                     |  |                     | (120,953 | )    |   | (101,285 | )
|                                                                                             |  |                     |          |      |   |          |  
|Net cash used in investing activities                                                        |  |                     | (28,522  | )    |   | (13,200  | )
|                                                                                             |  |                     |          |      |   |          |  
|                                                                                             |  |                     |          |      |   |          |  
|Cash
  flows provided by financing activities                                                |  |                     |          |      |   |          |  
|Capital contribution                                                                         |  |                     | 25,000   |      |   |         |  
|                                                                                             |  |                     |          |      |   |          |  
|Net cash provided by financing activities                                                    |  |                     | 25,000   |      |   |         |  
|                                                                                             |  |                     |          |      |   |          |  
|                                                                                             |  |                     |          |      |   |          |  
|Increase (decrease) in cash and cash
equivalents                                             |  |                     | 40,803   |      |   | (19,461  | )
|Cash and
  cash equivalents                                                                  |  |                     |          |      |   |          |  
|Beginning of year                                                                            |  |                     | 32,337   |      |   | 58,038   |  
|                                                                                             |  |                     |          |      |   |          |  
|End of period                                                                                |  | $                   | 73,140   |      | $ | 38,577   |  
|                                                                                             |  |                     |          |      |   |          |  
|Supplemental
  cash flow disclosure                                                          |  |                     |          |      |   |          |  
|Tax refund received under
  tax sharing agreement                                            |  | $                   | 759      |      | $ |         |  

See notes to interim consolidated financial statements.
4

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|                                                  
|--------------------------------------------------
|XL Capital Assurance Inc. and Subsidiary          
|Notes to Interim Consolidated Financial Statements
|(UNAUDITED)                                       
|                                                  

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|-- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|1. | Organization and Ownership                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|   | Through June 30, 2006, XL
  Capital Assurance Inc. (XLCA) was a wholly owned subsidiary of XL
  Reinsurance America, Inc. (XL RE AM), which in turn is an indirect wholly
  owned subsidiary of XL Capital Ltd (XL Capital), a public company whose
  shares are listed on the New York Stock Exchange. On March 17, 2006, XL
  Capital formed Security Capital Assurance Ltd (SCA), a Bermuda based
  holding company, in anticipation of contributing its ownership interests in
  its financial guaranty insurance and financial guaranty reinsurance operating
  businesses to SCA and selling an interest therein to the public through an
  initial public offering of SCA common shares (the IPO). The contribution of
  such businesses to SCA occurred on July 1, 2006 and the IPO was consummated
  on August 4, 2006. The aforementioned operating businesses contributed to SCA
  by XL Capital consisted of: (i) XLCA and its wholly-owned subsidiary, XL
  Capital Assurance (U.K.) Limited (XLCA-UK) and (ii) XL Financial Assurance
  Ltd. (XLFA). After the IPO, a secondary offering by XL Capital, the
  exercise of the underwriters over-allotment option and restricted share
  awards to management of SCA, XL Capitals ownership of SCAs outstanding
  common shares represents approximately a 63 percent economic interest. As a
  result of limitations on XL Capitals voting power contained in SCAs
  bye-laws, the votes conferred by the common shares owned by XL Capital will
  not exceed, with respect to elections of directors, 50.1% of the aggregate
  voting power of all common shares entitled to vote generally at any election
  of directors or, with respect to any other matter presented to SCAs
  shareholders for their action or consideration, 47.5% of the aggregate voting
  power of all common shares entitled to vote on such matter.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|   | XLCA is an insurance
  company domiciled in the State of New York and is licensed to conduct
  financial guaranty insurance business throughout all 50 of the United States,
  as well as in the Commonwealth of Puerto Rico, the District of Columbia, and
  the U.S. Virgin Islands. In addition, XLCA through XLCA-UK, which is an
  insurance company organized under the laws of England, is permitted to
  conduct financial guaranty business in England, Ireland, Spain, France,
  Portugal, Italy, Norway, The Netherlands, Greece, and Germany. XLCA and
  XLCA-UK are hereafter collectively referred to as the (Company). Also, to
  facilitate distribution of its products XLCA maintains a branch office in
  Singapore and XLCA-UK maintains a branch office in Madrid. In addition XLCA
  has an office in California. XLCA and XLCA-UK have triple-A financial
  strength ratings from Standard & Poors Ratings Services, Moodys
  Investors Service, Inc., and Fitch Inc. The Company is primarily engaged in
  the business of providing credit enhancement on fixed and variable rate
  income securities through the issuance of financial guaranty insurance
  policies, and credit protection on specific referenced credits or on pools of
  specific referenced credits through guarantees of credit default swaps issued
  by trusts (the
  Trusts) established to comply with New York State Insurance Law.                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|   | Financial guaranty
  insurance provides an unconditional and irrevocable guaranty to the holder of
  a debt obligation of full and timely payment of principal and interest. In
  the event of a default under the obligation, the insurer has recourse against
  the issuer and/or any related collateral (which is more common in the case of
  insured asset-backed obligations or other non-municipal debt) for amounts
  paid under the terms of the policy. Credit default swaps are derivative
  contracts which offer credit protection relating to a particular security or
  pools of specified securities. Under the terms of a credit default swap, the
  seller of credit protection makes a specified payment to the buyer of credit
  protection upon the occurrence of one or more specified credit events with
  respect to a referenced security. Credit derivatives typically provide
  protection to a buyer rather than credit enhancement of an issue as in
  traditional financial guaranty insurance. The Companys underwriting policies
  limit the Company to providing credit protection on obligations or referenced
  securities that it determines would be of investment-grade quality without
  the benefit of credit enhancement provided by the Company through the
  issuance of insurance policies and credit default swaps. See Note 3 for
  further details.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               

5

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|                                                  
|--------------------------------------------------
|XL Capital Assurance Inc. and Subsidiary          
|Notes to Interim Consolidated Financial Statements
|(UNAUDITED)                                       
|                                                  

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|2. | Basis of Presentation and Consolidation                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   | These unaudited interim
  consolidated financial statements include the accounts of the
  Company, its subsidiary and the Trusts and have been prepared in accordance
  with U.S. generally accepted accounting principles (GAAP) for interim
  financial information and with the instructions to Form 10-Q and Article 10
  of Regulation S-X. Accordingly, they do not include all of the information
  and footnotes required by GAAP for complete financial statements. In the
  opinion of management, these unaudited financial statements reflect all
  adjustments (consisting of normal recurring accruals) considered necessary
  for a fair presentation of financial position, results of operations and cash
  flows as at the end of and for the periods presented. The results of
  operations for any interim period are not necessarily indicative of the
  results for a full year. All significant inter-company accounts and
  transactions have been eliminated. These statements should be read in
  conjunction with the Companys December 31, 2005 consolidated financial
  statements and notes thereto filed with the Securities and Exchange
  Commission as an Exhibit to the XL Capitals Form 10-K for the year ended
  December 31, 2005. The preparation of financial statements in conformity with
  GAAP requires management to make estimates and assumptions that affect the
  reported amounts of assets and liabilities and disclosure of contingent
  assets and liabilities at the date of the financial statements and the
  reported amounts of revenues and expenses during the reporting period. Actual
  results could differ materially from these estimates.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|3. | Credit Default Swaps                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   | Credit default swaps
  entered into by the Company meet the definition of a derivative instrument
  under FASB Statement of Accounting Standards No. 133, Accounting for
  Derivative Instruments and Hedging Activities (SFAS 133), as amended by
  SFAS No. 149. Credit default swaps are recognized at fair value and recorded
  as either assets or liabilities in the accompanying consolidated balance
  sheets. The Company intends to hold these derivative instruments until
  maturity.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   | The fair value of credit
  default swaps is determined using a model developed by the Company and is
  dependent upon a number of market factors including changes in interest
  rates, credit spreads, changes in credit quality, and expected recovery
  rates. The change resulting from movements in these factors is unrealized as
  the credit default swaps are not traded to realize this value. Other elements
  of the change in fair value are based upon pricing established at the
  inception of the contract, as well as events triggering loss payments under
  the contracts by the Company.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   | Changes in the fair value
  of credit default swaps attributable to earnings from premiums received by
  the Company from the issuance of such contracts are recorded in the line item
  caption entitled net premiums earned in the accompanying consolidated
  statements of operations. In addition, changes in the fair value of credit
  default swaps attributable to losses from actual and expected payments to
  counterparties under such contracts are recorded in the line item caption
  entitled net losses and loss adjustment expenses in the accompanying
  consolidated statements of operations, and the remaining components of the
  change in fair value of credit default swaps, which are attributable to the
  market and other factors discussed above, are recorded in the line item
  caption entitled net realized and unrealized gains (losses) on credit
  derivatives in the accompanying consolidated statements of operations. This
  presentation is applicable only to credit default swaps issued by the Company
  that it has the intent and ability to hold to maturity and is consistent with
  practices in the financial guaranty insurance industry for reporting the
  results of such instruments.                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   | The Companys credit
  default swap portfolio generally requires the Company to meet payment
  obligations for referenced credits within the portfolio in the event of
  specific credit events after exhaustion of various first-loss protection
  levels. These credit events are contract-specific, but generally cover
  bankruptcy, failure to pay and repudiation. The credit default swap portfolio
  consists                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          

6

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|                                                  
|--------------------------------------------------
|XL Capital Assurance Inc. and Subsidiary          
|Notes to Interim Consolidated Financial Statements
|(UNAUDITED)                                       
|                                                  

| |                                                                                                                                                                                                                                                                                                                                                           
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | of structured pools of
  corporate obligations that were awarded investment-grade ratings at the
  deals inception. At September 30, 2006, on a net par basis, approximately
  97.8% of the portfolio was rated AAA with the remaining 2.2% rated at or above
  investment-grade. The weighted average term of the contracts in-force was
  12.8 years.
| |                                                                                                                                                                                                                                                                                                                                                           
| | The following tables
  present the amounts related to credit default swaps reflected in our
  financial statements as at and for the periods indicated:                                                                                                                                                                                                   

|                                                           |  |                                                  |        |                             |   |        |  
|---------------------------------------------------------- |  | ------------------------------------------------ | ------ | --------------------------- | - | ------ | -
|                                                           |  | (unaudited)
  Three Months Ended
  September 30, |       
|                                                           |  |                                                  |       
|(U.S. dollars in thousands)                                |  | 2006                                             |        | 2005                        |  
|                                                           |  |                                                  |        |                             |  
|Statements
  of Operations                                 |  |                                                  |        |                             |   |        |  
|Net premiums earned                                        |  | $                                                | 627    |                             | $ | 507    |  
|Net realized and
  unrealized losses on credit derivatives |  |                                                  | (379   | )                           |   | (125   | )
|Net losses and loss
  adjustment expenses                  |  |                                                  | 81     |                             |   | 60     |  
|                                                           |  |                                                  |        |                             |   |        |  
|                                                           |  | (unaudited)
  Nine Months Ended
  September 30,  |       
|                                                           |  |                                                  |        |                             |  
|                                                           |  | 2006                                             |        | 2005                        |  
|                                                           |  |                                                  |        |                             |  
|Statements
  of Operations                                 |  |                                                  |        |                             |   |        |  
|Net premiums earned                                        |  | $                                                | 1,653  |                             | $ | 1,268  |  
|Net realized and
  unrealized losses on credit derivatives |  |                                                  | (499   | )                           |   | (253   | )
|Net losses and loss
  adjustment expenses                  |  |                                                  | 230    |                             |   | 141    |  
|                                                           |  |                                                  |        |                             |   |        |  
|(U.S. dollars in thousands)Balance Sheets                  |  | (Unaudited)
  As at
  September 30,
  2006       |        | As at
  December 31,
  2005 |  
|                                                           |  |                                                  |        |                             |  
|Assets                                                     |  |                                                  |        |                             |   |        |  
|Reinsurance balances
  recoverable on unpaid losses        |  | $                                                | 11,010 |                             | $ | 9,334  |  
|Other assets                                               |  |                                                  | 12,795 |                             |   | 16,378 |  
|                                                           |  |                                                  |        |                             |   |        |  
|Total assets                                               |  | $                                                | 23,805 |                             | $ | 25,712 |  
|                                                           |  |                                                  |        |                             |   |        |  
|                                                           |  |                                                  |        |                             |   |        |  
|Liabilities                                                |  |                                                  |        |                             |   |        |  
|Unpaid losses and loss
  adjustment expenses               |  | $                                                | 12,061 |                             | $ | 10,155 |  
|Other liabilities                                          |  |                                                  | 12,340 |                             |   | 15,423 |  
|                                                           |  |                                                  |        |                             |   |        |  
|Total liabilities                                          |  | $                                                | 24,401 |                             | $ | 25,578 |  
|                                                           |  |                                                  |        |                             |   |        |  

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|4. | New Accounting Pronouncements and Developments                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   | In June 2005, at the
  request of the Securities and Exchange Commission, the Financial Accounting
  Standards Board (FASB) added a project to their agenda to review and
  provide guidance for the accounting for financial guaranty insurance
  contracts under which it will consider claims liability recognition, premium
  recognition, and the related amortization of deferred policy acquisition
  costs. Current accounting literature, specifically FASB Statement of
  Financial Accounting Standards No. 60, Accounting and Reporting by Insurance
  Enterprises (SFAS 60), and FASB Statement of Financial Accounting
  Standards No. 97, Accounting and Reporting by Insurance Enterprises for

7

---



|                                                  
|--------------------------------------------------
|XL Capital Assurance Inc. and Subsidiary          
|Notes to Interim Consolidated Financial Statements
|(UNAUDITED)                                       
|                                                  

| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Certain Long-Duration
  Contracts and for Realized Gains and Losses from the Sale of Investments
  (SFAS 97), does not specifically address the unique characteristics of
  accounting for financial guaranty insurance contracts. Consequently, the
  accounting principles applied by the industry, as well as the Company, have
  evolved over time and incorporate the concepts of both short-duration and
  long-duration contract accounting under the provisions of SFAS 60 and SFAS
  97, as well as other accounting literature, such as FASB No. 5, Accounting
  for Contingencies, and Emerging Issues Task Force (EITF) Issue No. 85-20,
  Recognition of Fees for Guaranteeing a Loan. The FASB arrived at tentative
  decision during the third quarter of 2006 which will form the basis of the
  forthcoming Exposure Draft. The Company will continue to apply the accounting
  policies as disclosed in its audited historical consolidated financial
  statements as of December 31, 2005 and 2004 and the years ended December 31,
  2005, 2004, and 2003 until further guidance is provided by the FASB.                                          
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | In February 2006, the FASB
  issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments
  (SFAS 155), which amends SFAS No. 133, Accounting for Derivative
  Instruments and Hedging Activities (SFAS 133) and SFAS No. 140,
  Accounting for Transfers and Servicing of Financial Assets and
  Extinguishments of Liabilities (SFAS 140), and addresses issues raised in
  SFAS 133 Implementation Issue No. D1, Application of Statement 133 to
  Beneficial Interests in Securitized Financial Assets. The primary objectives
  of SFAS 155 are: (i) with respect to SFAS 133, to address the accounting for
  beneficial interests in securitized financial assets and (ii) with respect to
  SFAS 140, to eliminate a restriction on the passive derivative instruments
  that a qualifying special purpose entity may hold. SFAS 155 is effective for
  all financial instruments acquired or issued after the beginning of an
  entitys first fiscal year that begins after September 15, 2006. The Company
  will adopt SFAS 155 on January 1, 2007 and is currently evaluating the implications
  of SFAS 155 on its financial statements.
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | In April 2006, the FASB
  issued FSP FIN 46(R)-6, Determining the Variability to be Considered in
  Applying FIN 46(R), which states that the variability to be considered when
  applying FIN 46(R) should be based on an analysis of the design of an entity
  which entails analyzing the nature of the risks in the entity and determining
  the purpose for which the entity was created and determining the variability
  the entity is designed to create and pass along to its interest holders.
  Typically, assets and operations of the entity create the variability (and
  thus are not variable interests), while liabilities and equity interests
  absorb that variability (and thus, are variable interests). The role of a
  contract or arrangement in the design of the entity, regardless of its legal
  form or accounting classification, shall dictate whether that interest should
  be treated as creating or absorbing variability for the entity. The guidance
  in this FSP must be applied as of July 1, 2006 and it did not have a material
  effect on the Companys financial condition or results of operations.                            
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | In July 2006, the FASB
  issued FASB Interpretation No. 48, Accounting for Uncertainty in Income
  Taxes  an interpretation of FASB Statement No. 109 (FIN 48). FIN 48
  prescribes a recognition threshold and measurement attribute for financial
  statement recognition and measurement of a tax position taken or expected to
  be taken in a tax return, and also provides guidance on de-recognition, classification,
  interest and penalties, accounting in interim periods, disclosure, and
  transition. FIN 48 is effective for fiscal years beginning after December 15,
  2006. The adoption of FIN 48 is not expected to have a material effect on the
  Companys financial condition or results of operations.                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | In September 2006, the
  FASB issued proposed FSP FAS 123(R)-e, Amendment of FASB Staff Position FAS
  123(R)-1, which addresses whether the modification of an instrument in
  connection with an equity restructuring or a business combination should be
  considered a modification for purposes of applying FSP FAS 123(R)-1,
  Classification and Measurement of Freestanding Financial Instruments
  Originally Issued in Exchange for Employee Services under FASB Statement No.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     

8

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|                                                  
|--------------------------------------------------
|XL Capital Assurance Inc. and Subsidiary          
|Notes to Interim Consolidated Financial Statements
|(UNAUDITED)                                       
|                                                  

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   | 123(R). The FASB staff
  has taken the position that for instruments that were originally issued as
  employee compensation and then exchanged or changed, where the only change is
  a change to the terms of an award to reflect an equity restructuring or a
  business combination that occurs when the holders are no longer employees,
  then no change in the recognition and measurement (due to a change in
  classification) of these instruments will result if, there is (i) no increase
  in value to the holders of the instrument or (ii) the exchange or change in
  the terms of the award is not made in contemplation of an equity
  restructuring or a business combination and (iii) all holders of the same
  class of equity instruments (for example, stock options) are treated in a
  similar manner. These provisions must be applied in the first reporting
  period beginning after the date the final FSP is posted to the FASBs
  website. This guidance is not expected to have a significant impact on the
  Companys financial condition or results of operations.                                            
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|   | In September 2006, the
  Securities and Exchange Commission (the SEC) issued Staff Accounting
  Bulletin No. 108 (SAB 108), Considering the Effects of Prior Year
  Misstatements when Qualifying Misstatements in Current Year Financial
  Statements, which provides interpretive guidance on the consideration of the
  effects of prior year misstatements in quantifying current year misstatements
  for the purpose of a materiality assessment. SAB 108 is effective for
  companies with fiscal years ending after November 15, 2006 and is required to
  be adopted by the Company in its fiscal year ending December 31, 2006.
  However, early application is encouraged in any report for an interim period
  filed after the publication of this guidance. The Company is currently
  assessing the impact of the adoption of SAB 108. The Company does not
  anticipate a significant impact as a result of adopting this standard.                                                                                                                                                                                           
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|   | In September 2006, the
  FASB issued SFAS No. 157, Fair Value Measurements (SFAS 157) which
  defines fair value, establishes a framework for measuring fair value in
  generally accepted accounting principles, and expands disclosures about fair
  value measurements. This Statement is applicable in conjunction with other
  accounting pronouncements that require or permit fair value measurements,
  where the FASB previously concluded in those accounting pronouncements that
  fair value is the relevant measurement attribute. Accordingly, this Statement
  does not require any new fair value measurements. SFAS No. 157 will be
  effective for interim and annual financial statements issued after January 1,
  2008. The Company is currently evaluating the impact of the adoption of SFAS
  157.                                                                                                                                                                                                                                                                                                                     
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|5. | Premiums Earned from Refunded and Called Bonds                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|   | Net premiums earned include $0.1 million and $2.5 million for the three and nine months ended September 30, 2006, respectively, and $0.3 million and $0.3 million for the three and nine months ended September 30, 2005, respectively, related to refunded and called bonds.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|6. | Tax Sharing Agreement                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|   | The Company will file two
  separate short period U.S. Federal income tax returns for 2006, one will
  include the pre-ownership change period and the second will include the
  post-ownership change period. For the pre-ownership change period, the
  Companys federal income tax return will be consolidated with XL America, Inc
  (XLA) and its subsidiaries. For the post-ownership change period, XLCA will
  file a consolidated tax return with its parent company, SCA Holdings U.S. Inc. (a
  U.S. based holding company) and its subsidiaries. For the pre-ownership
  change period filing, XLA maintains a tax sharing agreement with its
  subsidiaries, whereby the consolidated U.S. Federal income tax liability is
  allocated among affiliates in the ratio that each affiliates separate return
  liability bears to the sum of the separate return liabilities of all
  affiliates that are members of the consolidated group. For the post-ownership
  change period, XLCA will maintain a similar tax sharing agreement with US
  affiliates that are a member of the SCA Holdings US Inc. consolidated tax
  filing.

9

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|                                                  
|--------------------------------------------------
|XL Capital Assurance Inc. and Subsidiary          
|Notes to Interim Consolidated Financial Statements
|(UNAUDITED)                                       
|                                                  

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   | In addition, a
  complementary method is used which results in reimbursement by profitable
  affiliates to loss affiliates for tax benefits generated by loss affiliates.
  As of September 30, 2006 and December 31, 2005, the Company had a federal
  income tax payable of $2,285,000 and $1,023,000, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   | As of September 30, 2006
  and December 31, 2005, the Company had deferred federal income tax assets of
  $15.8 million and $18.8 million, respectively. As of December 31, 2005, the
  Company established a valuation allowance relating to net unrealized capital
  losses and a net realized capital loss carry forward. The valuation allowance
  at September 30, 2006 of $1,731,000 relates to net unrealized capital losses
  and a net realized capital loss carry forward that may not be realized within
  a reasonable period. At September 30, 2006, XLCA has net unrealized capital
  losses and a net realized capital loss carry forward of approximately $3.1
  million and $1.9 million respectively, against which a valuation allowance
  has been established. The net realized capital loss carry forward will expire
  in 2011.                                                                                                                                                                                                                                                                                                                      
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   | Management believes it is
  more likely than not that the tax benefit relating to the Companys deferred
  tax assets, net of the valuation allowance discussed above, will be realized.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|7. | Treaties and Agreements with Affiliates                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   | Capital
  Transactions                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   | Subsequent to the IPO, the
  Company received a $25,000,000 capital contribution from its parent Company.
  The funds will be used to support the Companys continued growth and for
  general corporate purposes.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   | Services
  Agreements with Affiliates                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   | Prior to the IPO,
  substantially all of the Companys personnel services were provided by
  employees of affiliates of XL Capital. In connection with the IPO, such
  employees have become employees of SCA. In addition, the Company purchased
  various services from affiliates of XL Capital prior to the IPO under various
  agreements and continues to purchase such services under new agreements that
  became effective at the date of the IPO. Such services principally include:
  (i) information technology support, (ii) reinsurance and retrocessional
  consulting and management services, (iii) actuarial, finance, legal, internal audit
  services and certain investment management services and (iv) certain advertising
  services. The Company incurred costs under the aforementioned agreements aggregating $15.5 million and $42.3 million for the three and nine months ended September 30, 2006, respectively, compared to $8.4 million and $46.2 million for the three and nine months ended September 30, 2005, respectively, which are reflected in Net operating expenses in
  the accompanying consolidated statements of operations.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   | Employee
  Benefit Plans                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   | Prior to the IPO, XLA
  maintained a qualified defined contribution pension plan for the benefit of
  all eligible employees and a non-qualified deferred compensation plan for the
  benefit of certain employees (collectively, the Plans). Discretionary
  contributions to both Plans were based on a fixed percentage of employee
  contributions and compensation as defined by the Plans. Such plans were
  converted to the SCAs plans on the effective date of the IPO. The terms and
  provisions of the SCAs plans are substantially the same as the
  aforementioned plans of XLA. The Company incurred costs under the aforementioned agreements aggregating $0.7 million and $1.8 million for the three and nine months ended September 30, 2006, respectively, compared to $0.3 million and $1.6 million for the three and nine months ended September 30, 2005, respectively, which are reflected in Net operating expenses in the
  accompanying consolidated statements of operations.                                                                                                                                                              

10

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|                                                  
|--------------------------------------------------
|XL Capital Assurance Inc. and Subsidiary          
|Notes to Interim Consolidated Financial Statements
|(UNAUDITED)                                       
|                                                  

| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Reinsurance
  Treaties with Affiliates                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | The Company has a
  facultative quota share reinsurance treaty (Treaty) with XLFA. Under the
  terms of the this Treaty, XLFA agrees to reinsure up to 75% of the guaranty
  business written by the Company provided it meets certain specified parameters.
  Prior to July 1, 2006, the XLFA agreed to reinsure up to 90% of the Companys
  acceptable risks. In addition, the Company is allowed up to a 30% ceding
  commission (or such other percentage on an arms-length basis) on ceded
  premiums written under the agreement.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | The Company has a
  facultative reinsurance arrangement (the XL Re Treaty) with XL Reinsurance
  America, Inc. (XL RE AM). Under the terms of the XL Re Treaty, XL RE AM
  agrees to reinsure risks on a facultative basis for the risks insured by the
  Company under financial guaranty insurance policies up to the amount
  necessary for the Company to comply with single risk limitations set forth in
  Section 6904(d) of the New York Insurance Laws. Such reinsurance was on an
  automatic basis prior to the effective date of the IPO and on a facultative
  basis on and after the effective date of the IPO. The reinsurance provided by
  XL RE AM may be on an excess of loss or quota share basis. The Company is
  allowed up to a 30% ceding commission (or such other percentage on an
  arms-length basis) on ceded premiums written under the terms of this
  agreement.                                                                                                                                                                                                                                                                                                                                                                                                            
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | Effective August 4, 2006,
  XLCA entered into a reinsurance arrangement with XL RE AM. Under the terms of
  the reinsurance arrangement, XL RE AM agreed to indemnify
  XLCA for all losses and loss adjustment expenses incurred in excess of its
  retained reserves at the effective date of the agreement relating to an
  insured project financing described in Note 8 (a). In consideration for the reinsurance
  provided by XL RE AM to XLCA, XLCA is obligated to pay XL RE AM a reinsurance
  premium of approximately $9.8 million on an installment basis over the life of the
  underlying reinsured transaction. As this premium is due irrespective of any
  early termination of the underlying insurance transaction, the Company
  recorded a liability of approximately $7.0 million, representing the present
  value of the obligation discounted at 5.0%, which reflects the treasury rate
  on obligations with a term to maturity commensurate with the liability and
  corresponding deferred cost, which are reflected in the accompanying
  consolidated balance sheets in Reinsurance premiums payable and Prepaid
  reinsurance premiums. For the three months ended September 30, 2006 the
  Company incurred costs under the aforementioned agreements aggregating
  $158,116.
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | Effective August 4, 2006,
  XLA provided an indemnity to XLCA. Under the terms of the arrangement, XLA
  has undertaken to indemnify XLCA for any dimunition in value below their
  carrying value at June 30, 2006 of the notes and preferred shares described
  in Note 8 (b), which notes and preferred shares were acquired in connection
  with the satisfaction of a claim under a financial guaranty insurance policy
  issued by XLCA. In addition, pursuant to the aforementioned indemnity, XLA
  agreed to indemnify XLCA for any costs arising out of any litigation or
  future claim in connection with the aforementioned insurance policy. This
  indemnity was provided by XLA at no cost to XLCA.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               

11

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|                                                  
|--------------------------------------------------
|XL Capital Assurance Inc. and Subsidiary          
|Notes to Interim Consolidated Financial Statements
|(UNAUDITED)                                       
|                                                  

| |                                                        
| | -------------------------------------------------------
| | Amounts ceded to affiliate
  reinsurers are as follows:

|                                                    |  |                                                  |         |                             |   |         | 
|--------------------------------------------------- |  | ------------------------------------------------ | ------- | --------------------------- | - | ------- | 
|(U.S. dollars in thousands)                         |  | (Unaudited)
  Three Months Ended
  September 30, |        
|Statements
  of Operations                          |  | 2006                                             |         | 2005                        |  
|                                                    |  |                                                  |         |                             |  
|                                                   
|Ceded premiums written                              |  | $                                                | 51,907  |                             | $ | 53,543  | 
|Ceded premiums earned                               |  |                                                  | 35,311  |                             |   | 33,594  | 
|Ceding commission revenue                           |  |                                                  | 13,022  |                             |   | 12,939  | 
|Ceded losses and loss
  adjustment expenses         |  |                                                  | 4,293   |                             |   | 3,742   | 
|                                                    |  |                                                  |         |                             |   |         | 
|                                                    |  | (Unaudited)
  Nine Months Ended
  September 30,  |        
|Statements
  of Operations                          |  | 2006                                             |         | 2005                        |  
|                                                    |  |                                                  |         |                             |  
|                                                   
|Ceded premiums written                              |  | $                                                | 203,210 |                             | $ | 154,746 | 
|Ceded premiums earned                               |  |                                                  | 123,567 |                             |   | 89,598  | 
|Ceding commission revenue                           |  |                                                  | 37,992  |                             |   | 35,308  | 
|Ceded losses and loss
  adjustment expenses         |  |                                                  | 11,175  |                             |   | 29,175  | 
|                                                    |  |                                                  |         |                             |   |         | 
|(U.S. dollars in thousands)Balance Sheets           |  | (Unaudited)
  As at
  September 30,
  2006       |         | As at
  December 31,
  2005 |  
|                                                    |  |                                                  |         |                             |  
|Assets                                              |  |                                                  |         |                             |   |         | 
|Prepaid reinsurnace
  premiums                      |  | $                                                | 522,353 |                             | $ | 435,316 | 
|Reinsurance Balances
  recoverable on unpaid losses |  |                                                  | 131,252 |                             |   | 120,077 | 
|                                                    |  |                                                  |         |                             |   |         | 
|Total assets                                        |  | $                                                | 653,605 |                             | $ | 555,393 | 
|                                                    |  |                                                  |         |                             |   |         | 
|                                                    |  |                                                  |         |                             |   |         | 
|Liabilities                                         |  |                                                  |         |                             |   |         | 
|Deferred ceding
  commissions, net                  |  |                                                  | 119,371 |                             |   | 104,295 | 
|Reinsurance premiums
  payable                      |  |                                                  | 24,635  |                             |   | 794     | 
|                                                    |  |                                                  |         |                             |   |         | 
|Total liabilities                                   |  | $                                                | 144,006 |                             | $ | 105,089 | 
|                                                    |  |                                                  |         |                             |   |         | 

| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Related
  Party Guarantees                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | Effective May 1, 2004, XLI
  entered into an agreement with XLCA which unconditionally and irrevocably
  guaranties to XLCA the full and complete payment when due of all of XLFAs
  obligations under its facultative quota share reinsurance agreement with
  XLCA, under which agreement XLFA has assumed business from XLCA since
  December 19, 2000. The par value of business guarantied by XLI under this
  agreement was approximately $93.8 billion as of September 30, 2006. Effective upon the IPO,
  this guaranty terminated with respect to all new business assumed by XLFA under this agreement,
  but the guaranty remains in effect with respect to past cessions under the agreement.
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | The Company provides
  financial guaranty insurance policies insuring timely payment of investment
  agreements issued by XL Asset Funding Company I LLC (XLAF), an affiliate of
  the Company. As of September 30, 2006 and December 31, 2005, the aggregate
  face amount of such investment agreements insured by the Company before
  reinsurance was $4.0 billion ($404.3 million after                                                                                                                                                                                                                                                                                                            

12

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|                                                  
|--------------------------------------------------
|XL Capital Assurance Inc. and Subsidiary          
|Notes to Interim Consolidated Financial Statements
|(UNAUDITED)                                       
|                                                  

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   | reinsurance to XLFA) and
  $3.7 billion ($366.7 million after reinsurance to XLFA), respectively. In
  addition, the Company insures XLAFs obligation under certain derivative
  contracts issued and purchased by XLAF. As at September 30, 2006 the total
  notional value of such contracts insured was $179.1 million. For the three
  month period ended September 30, 2006 and 2005, the company recorded earned
  premiums of $1.0 million and $0.8 million, respectively. For the nine month
  period ended September 30, 2006 and 2005, the Company recorded earned
  premiums of $2.9 million and $2.2 million, respectively.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|   | XLI guarantees the
  obligations of XLCA in connection with certain transactions insured by
  XLCA-UK. As of September 30, 2006 and December 31, 2005, the gross par
  outstanding related to these transactions were approximately $989.1 million
  ($57.1 million net of reinsurance) and $913.3 million ($53.7 million net of
  reinsurance), respectively.                                                                                                                                                                                                                                                                          
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|8. | Liability
  for Losses and Loss Adjustment Expenses                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|   | The Companys liability
  for losses and loss adjustment expenses consists of case basis reserves and
  unallocated reserves. Activity in the liability for losses and loss
  adjustment expenses is summarized as follows:                                                                                                                                                                                                                                                                                                                                                                                                             

|                                                                                                             |  |                                                                          |         |                                                             |   |                 |   |                        |         |   |   |         |  
|------------------------------------------------------------------------------------------------------------ |  | ------------------------------------------------------------------------ | ------- | ----------------------------------------------------------- | - | --------------- | - | ---------------------- | ------- | - | - | ------- | -
|                                                                                                             |  | (Unaudited)
  As at and for the
  Nine Months Ended
  Septemebr 30, 2006 |         | As at and for the
  Twelve Months Ended
  December 31, 2005 |  
|                                                                                                             |  |                                                                          |         |                                                             |  
|(U.S. dollars in thousands)                                                                                  |  | Case
  Reserves                                                          |         | Unallocated
  Reserves                                      |   | Case
  Reserves |   | Unallocated
  Reserves |        
|                                                                                                             |  |                                                                          |         |                                                             |   |                 |   |                        |        
|Unpaid losses and loss adjustment expenses at beginning of
year                                              |  | $                                                                        | 66,190  |                                                             | $ | 65,412          |   | $                      | 45,550  |   | $ | 49,774  |  
|Unpaid losses and loss adjustment expenses recoverable                                                       |  |                                                                          | (62,518 | )                                                           |   | (59,555         | ) |                        | (45,588 | ) |   | (45,523 | )
|                                                                                                             |  |                                                                          |         |                                                             |   |                 |   |                        |         |   |   |         |  
|Net unpaid losses and loss adjustment expenses at beginning of
year                                          |  |                                                                          | 3,672   |                                                             |   | 5,857           |   |                        | (38     | ) |   | 4,251   |  
|Increase (decrease) in net losses and loss adjustment expenses
  incurred in respect of losses occurring in: |  |                                                                          |         |                                                             |   |                 |   |                        |         |   |   |         |  
|Current year                                                                                                 |  |                                                                          |        |                                                             |   | 1,247           |   |                        | 12      |   |   | 1,606   |  
|Prior years                                                                                                  |  |                                                                          | 163     |                                                             |   |                |   |                        | 3,676   |   |   |        |  
|Less net losses and loss adjustment expenses (paid) recoverable
  received                                   |  |                                                                          | (1,809  | )                                                           |   |                |   |                        | 22      |   |   |        |  
|                                                                                                             |  |                                                                          |         |                                                             |   |                 |   |                        |         |   |   |         |  
|Net unpaid losses and loss adjustment expenses at end of
period                                              |  |                                                                          | 2,026   |                                                             |   | 7,104           |   |                        | 3,672   |   |   | 5,857   |  
|Unpaid losses and loss adjustment expenses recoverable                                                       |  |                                                                          | 64,004  |                                                             |   | 69,719          |   |                        | 62,518  |   |   | 59,555  |  
|                                                                                                             |  |                                                                          |         |                                                             |   |                 |   |                        |         |   |   |         |  
|Unpaid losses and loss expenses at end of period                                                             |  | $                                                                        | 66,030  |                                                             | $ | 76,823          |   | $                      | 66,190  |   | $ | 65,412  |  
|                                                                                                             |  |                                                                          |         |                                                             |   |                 |   |                        |         |   |   |         |  

| |                                                                                                           
| | ----------------------------------------------------------------------------------------------------------
| | Case
  Basis Reserves for Losses and Loss Adjustment Expenses                                             
|
| | Set forth below is a
  discussion of certain significant case basis reserves established by the
  Company:

13

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|                                                  
|--------------------------------------------------
|XL Capital Assurance Inc. and Subsidiary          
|Notes to Interim Consolidated Financial Statements
|(UNAUDITED)                                       
|                                                  

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a. | During the year ended
  December 31, 2004, the Company recorded a provision for losses of
  approximately $42.1 million, representing the present value loss expected to
  be incurred in the future with respect to an insured project financing.
  Because this loss represented a full limit loss to the subordinated tranche
  of the insured transaction, the remaining unearned premium pertaining to such
  tranche, which aggregated approximately $23.3 million, was fully earned
  resulting in a net loss, before reinsurance, of approximately $18.8 million.
  The portion of the insured exposure to which this loss relates was fully
  reinsured on a first-loss basis by an affiliate of the Company and,
  accordingly, there was no net impact on the Companys results of operations
  from this loss provision. During 2005, the Company recorded an additional
  provision for loss relating to this transaction of $16.7 million ($2.8
  million after reinsurance to affiliates), on a net present value basis, to
  reflect certain adverse developments. There has been no development in such
  loss reserve since such provision through September 30, 2006. The total
  remaining par insured by the Company in connection with this transaction (net
  of applicable carried case reserves), which amortizes over the next 12 years,
  aggregated approximately $237.7 million ($40.4 million net of reinsurance to
  affiliates) at September 30, 2006. The estimate of loss was necessarily based
  on assumptions and estimates extending over many years into the future. There
  is currently no payment default with respect to this transaction. Management
  continues to monitor the exposure and will revise its loss estimate as
  necessary, as new information becomes available. Pursuant to a reinsurance agreement
  entered into with XL RE AM, which became effective on the date of the IPO, XL
  RE AM agreed to indemnify the Company for all losses and loss adjustment
  expenses relating to this insured transaction in excess of its carried
  reserve at the effective date of the agreement (see note 7).
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | b. | In December 2005, certain
  notes which were insured by the Company and collateralized by loans to
  medical providers (the Insured Notes) defaulted upon their maturity. In
  satisfaction of the resulting claim, the Company purchased the Insured Notes
  for $20.2 million, which represented the remaining outstanding principal and
  accrued interest on the Insured Notes. The Insured Notes were recorded as an
  investment at their estimated fair value of $19.5 million at the date of
  acquisition and are reflected in the accompanying consolidated balance sheets
  under the caption, Other invested assets. The difference between the
  estimated fair value of the Insured Notes at the date they were acquired and
  the consideration paid to acquire the notes was recorded as a paid loss of
  $0.7 million ($0.1 million, net of reinsurance to XLFA). At December 31,
  2005, the Company had a receivable from XLFA in the amount of $7.7 million
  with respect to the remaining amount uncollected for the Insured Notes, which
  was fully paid shortly thereafter. In addition, the Company had a Funds
  held liability to XLFA at September 30, 2006 and December 31, 2005 in the
  amount of $0.0 million and $15.9 million, respectively. The Funds held
  liability accrues interest at the same rate of the Insured Notes.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    | The estimate of fair value
  of the Insured Notes was based on the Companys estimate of the fair value of
  the underlying collateral which, as previously discussed, consisted of loans
  to medical providers. Certain of these loans were made to Intrepid USA
  Healthcare Services (Intrepid), a national provider of home nursing
  services to patients with acute illnesses. Intrepid declared bankruptcy in
  2004. On February 3, 2006, Intrepid emerged from bankruptcy. In connection
  therewith, in February 2006, the Company accepted preferred stock of Intrepid
  in exchange for the cancellation of a portion of the Insured Notes. This
  preferred stock represented a 49% ownership interest in Intrepid. In
  connection with, and critical to, Intrepids emergence from bankruptcy was
  certain exit financing obtained by Intrepid. Pursuant to the terms of the
  related credit agreement, Intrepid must achieve certain financial targets
  over certain periods of time. In certain                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

14

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|                                                  
|--------------------------------------------------
|XL Capital Assurance Inc. and Subsidiary          
|Notes to Interim Consolidated Financial Statements
|(UNAUDITED)                                       
|                                                  

| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          | cases, if such targets are
  not met, the provider of such financing may foreclose on all ownership
  interest in Intrepid. If the provider of the financing foreclosed on all
  ownership interest in Intrepid, the Company would be required to write-off
  the carrying value of this investment.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          | In June 2006, in
  recognition of the challenges facing Intrepid in achieving the aforementioned
  financial targets, the Company and other equity holders and creditors in
  Intrepid, negotiated an agreement in principle to effect a restructuring of
  Intrepids capitalization. Pursuant to the restructuring, the Companys
  ownership interest in Intrepid was reduced from 49% to approximately 12%
  Accordingly, the Company recognized an impairment charge of approximately
  $9.0 million ($0.9 million, net of reinsurance to XLFA) on its investment in
  Intrepid as of June 30, 2006 reflecting managements best estimate of the
  value of such investment at that date, which considered the aforementioned
  restructuring and an updated forecast of Intrepids expected future operating
  performance, as well as a valuation of the Companys investment in Intrepid
  by an outside valuation consulting firm.
  During the three months ended
  September 30, 2006, one of Intrepids creditors (the provider of its
  bankruptcy exit financing) rejected the agreement in principle and foreclosed
  on the Companys preferred shares. As a result, the Company wrote-off the
  remaining carrying value of its investment in Intrepid of $1.0 million. The
  Company will be fully indemnified for this charge by XLA pursuant to an
  agreement entered into at the effective date of the IPO (see note 7). Also
  during the three months ended September 30, 2006 the Company received payment
  in full on its Insured Notes.
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | c.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | During the year ended
  December 31, 2005, the XLCA recorded a provision for loss of $5.2 million
  ($0.9 million after reinsurance to affiliates) representing the present value
  loss expected to be incurred in the future with respect to two insured
  residential mortgage securitizations. There has been no development in such
  loss reserve since its initial establishment through September 30, 2006. The
  total insured exposure to which this loss relates was 82.6% reinsured by an
  affiliate of the Company on a pro rata basis. The total remaining par insured
  by XLCA in connection with this transaction (net of applicable carried case
  reserves) aggregated approximately $176.4 million ($26.3 million net of
  reinsurance to affiliates) at September 30, 2006, and amortizes over many
  years into the future. The estimate of loss was necessarily based on
  assumptions and estimates extending over many years into the future. There is
  currently no payment default with respect to these insurance transactions. Management
  continues to monitor the exposure and will revise its loss estimate as
  necessary, as new information becomes available                                                                                                                                                                                                                                                                                                                                                                 
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | In addition to the matters
  discussed above, at September 30, 2006 the Company had case basis loss
  adjustment expense reserves of $2.0 million, which primarily relate to
  remediation efforts associated with the aforementioned transactions.                                                                                                                                                                                                                                                                                                                                                                     
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | The financing vehicles
  through which the insured exposures referred to above were issued are
  variable interest entities, as defined under FASB Interpretation 46/46R,
  Consolidation of Variable Interest Entities; however, the Company is not
  the primary beneficiary of such entities. If the transactions are
  restructured or if the Company exercises its contractual rights under such
  transactions in the event of a default, the primary beneficiary in such
  transactions may have to be reconsidered. If such events occur, the Company
  may be required to consolidate the financing vehicles.

15

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