XL FINANCIAL ASSURANCE LTD.

INTERIM 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 Financial Assurance Ltd.                                    
|Interim Balance Sheets                                         
|(U.S. dollars in thousands, except share and per share amounts)
|                                                               

|                                                                                                            |  |                                         |           |                          |   |           |  
|----------------------------------------------------------------------------------------------------------- |  | --------------------------------------- | --------- | ------------------------ | - | --------- | -
|                                                                                                            |  | (unaudited)
  As of
  September 30,2006 |           | As of
  December 31,2005 |  
|                                                                                                            |  |                                         |           |                          |  
|                                                                                                            |  |                                         |           |                          |   |           |  
|Assets                                                                                                      |  |                                         |           |                          |   |           |  
|Investments                                                                                                 |  |                                         |           |                          |   |           |  
|Debt securities, available for sale, at fair value (amortized cost:
2006 - $1,365,764;
  2005 - $1,054,356) |  | $                                       | 1,352,159 |                          | $ | 1,036,606 |  
|Short-term investments, at fair value (amortized
cost: 2006 - $64,963;
  2005 - $23,772)                    |  |                                         | 63,580    |                          |   | 23,569    |  
|                                                                                                            |  |                                         |           |                          |   |           |  
|Total investments                                                                                           |  |                                         | 1,415,739 |                          |   | 1,060,175 |  
|                                                                                                           
|Cash and cash equivalents                                                                                   |  |                                         | 67,206    |                          |   | 22,256    |  
|Accrued investment income                                                                                   |  |                                         | 10,449    |                          |   | 9,197     |  
|Deferred acquisition costs                                                                                  |  |                                         | 129,533   |                          |   | 100,784   |  
|Prepaid reinsurance premiums                                                                                |  |                                         | 34,364    |                          |   | 63,034    |  
|Reinsurance balances receivable                                                                             |  |                                         | 25,090    |                          |   | 2,736     |  
|Unpaid losses and loss expenses recoverable                                                                 |  |                                         | 66,550    |                          |   | 66,394    |  
|Amounts due from parent and affiliates                                                                      |  |                                         | 50        |                          |   | 39,572    |  
|Funds withheld                                                                                              |  |                                         |          |                          |   | 15,859    |  
|Net receivable for investments sold                                                                         |  |                                         | 197       |                          |   | 191       |  
|Derivative assets                                                                                           |  |                                         | 10,227    |                          |   | 13,482    |  
|Other assets                                                                                                |  |                                         | 44        |                          |   | 401       |  
|                                                                                                            |  |                                         |           |                          |   |           |  
|Total assets                                                                                                |  | $                                       | 1,759,449 |                          | $ | 1,394,081 |  
|                                                                                                            |  |                                         |           |                          |   |           |  
|Liabilities, Redeemable Preferred Shares and
  Shareholders Equity                                         |  |                                         |           |                          |   |           |  
|Liabilities:                                                                                                |  |                                         |           |                          |   |           |  
|Unpaid losses and loss expenses                                                                             |  | $                                       | 141,883   |                          | $ | 134,044   |  
|Deferred premium revenue                                                                                    |  |                                         | 633,725   |                          |   | 535,112   |  
|Reinsurance balances payable                                                                                |  |                                         | 4,020     |                          |   | 15,116    |  
|Accounts payable and accrued liabilities                                                                    |  |                                         | 1,572     |                          |   | 1,770     |  
|Amounts due to parent and affiliates                                                                        |  |                                         | 1,631     |                          |   | 14,656    |  
|Derivative liabilities                                                                                      |  |                                         | 2,548     |                          |   | 1,864     |  
|Dividend payable on preferred shares                                                                        |  |                                         | 1,139     |                          |   | 1,445     |  
|                                                                                                            |  |                                         |           |                          |   |           |  
|Total liabilities                                                                                           |  |                                         | 786,518   |                          |   | 704,007   |  
|                                                                                                            |  |                                         |           |                          |   |           |  
|Redeemable Preferred Shares:                                                                                |  |                                         |           |                          |   |           |  
|Series A Redeemable preferred shares (par value of
$120 per share:                                          |  |                                         |           |                          |   |           |  
|10,000
    shares authorized; 363 issued and outstanding as at September
  30, 2006 and December 31, 2005)  |  |                                         | 44        |                          |   | 44        |  
|Additional paid-in capital                                                                                  |  |                                         | 38,956    |                          |   | 38,956    |  
|Accumulated undeclared dividends on Series A
Redeemable preferred
  shares                                  |  |                                         | 15,016    |                          |   |          |  
|                                                                                                            |  |                                         |           |                          |   |           |  
|Total redeemable preferred shares                                                                           |  |                                         | 54,016    |                          |   | 39,000    |  
|                                                                                                            |  |                                         |           |                          |   |           |  
|Shareholders Equity                                                                                        |  |                                         |           |                          |   |           |  
|Common shares (par value of $120 per
share:                                                                 |  |                                         |           |                          |   |           |  
|10,000 shares authorized; 2,449 issued and
outstanding as at September
  30, 2006 and December 31, 2005)    |  |                                         | 294       |                          |   | 294       |  
|Additional paid-in capital                                                                                  |  |                                         | 536,589   |                          |   | 345,606   |  
|Accumulated other comprehensive loss                                                                        |  |                                         | (14,988   | )                        |   | (17,953   | )
|Retained earnings                                                                                           |  |                                         | 397,020   |                          |   | 323,127   |  
|                                                                                                            |  |                                         |           |                          |   |           |  
|Total shareholders equity                                                                                  |  |                                         | 918,915   |                          |   | 651,074   |  
|                                                                                                            |  |                                         |           |                          |   |           |  
|Total liabilities, redeemable preferred shares and
shareholders  equity                                    |  | $                                       | 1,759,449 |                          | $ | 1,394,081 |  
|                                                                                                            |  |                                         |           |                          |   |           |  

See notes to interim financial statements.

1

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|                                                         
|---------------------------------------------------------
|XL Financial Assurance Ltd.                              
|Interim Statements of Operations and Comprehensive Income
|(U.S. dollars in thousands)                              
|                                                         

|                                                           |  |                                                   |        |                                                  |   |         |   |      |         |   |   |         |  
|---------------------------------------------------------- |  | ------------------------------------------------- | ------ | ------------------------------------------------ | - | ------- | - | ---- | ------- | - | - | ------- | -
|                                                           |  | (unaudited)
  Three Months Ended 
  September 30, |        | (unaudited)
  Nine months ended 
  September 30, |  
|                                                           |  |                                                   |        |                                                  |   |         |   |      |         |   |   |         |  
|                                                           |  | 2006                                              |        | 2005                                             |   | 2006    |   | 2005 |        
|                                                           |  |                                                   |        |                                                  |   |         |   |      |        
|                                                           |  |                                                   |        |                                                  |   |         |   |      |         |   |   |         |  
|Revenues                                                   |  |                                                   |        |                                                  |   |         |   |      |         |   |   |         |  
|Net premiums earned                                        |  | $                                                 | 41,534 |                                                  | $ | 35,317  |   | $    | 126,647 |   | $ | 93,464  |  
|Net investment income                                      |  |                                                   | 16,292 |                                                  |   | 9,858   |   |      | 40,065  |   |   | 27,228  |  
|Net realized losses on
  investments                       |  |                                                   | (133   | )                                                |   | (772    | ) |      | (15,149 | ) |   | (2,153  | )
|Fee and other income                                       |  |                                                   |       |                                                  |   |        |   |      | 1,228   |   |   | 674     |  
|Net realized and
  unrealized losses on credit derivatives |  |                                                   | (2,838 | )                                                |   | (1,706  | ) |      | (5,903  | ) |   | (3,545  | )
|                                                           |  |                                                   |        |                                                  |   |         |   |      |         |   |   |         |  
|Total revenues                                             |  |                                                   | 54,855 |                                                  |   | 42,697  |   |      | 146,888 |   |   | 115,668 |  
|                                                           |  |                                                   |        |                                                  |   |         |   |      |         |   |   |         |  
|Expenses                                                   |  |                                                   |        |                                                  |   |         |   |      |         |   |   |         |  
|Net losses and loss
  adjustment expenses                  |  |                                                   | 4,497  |                                                  |   | 1,056   |   |      | 10,651  |   |   | 12,404  |  
|Acquisition costs                                          |  |                                                   | 14,822 |                                                  |   | 11,085  |   |      | 38,124  |   |   | 29,768  |  
|Operating expenses                                         |  |                                                   | 1,676  |                                                  |   | 1,716   |   |      | 5,824   |   |   | 5,367   |  
|                                                           |  |                                                   |        |                                                  |   |         |   |      |         |   |   |         |  
|Total expenses                                             |  |                                                   | 20,995 |                                                  |   | 13,857  |   |      | 54,599  |   |   | 47,539  |  
|                                                           |  |                                                   |        |                                                  |   |         |   |      |         |   |   |         |  
|Net
  income                                               |  | $                                                 | 33,860 |                                                  | $ | 28,840  |   | $    | 92,289  |   | $ | 68,129  |  
|                                                           |  |                                                   |        |                                                  |   |         |   |      |         |   |   |         |  
|Comprehensive
  income                                     |  |                                                   |        |                                                  |   |         |   |      |         |   |   |         |  
|Net income                                                 |  | $                                                 | 33,860 |                                                  | $ | 28,840  |   | $    | 92,289  |   | $ | 68,129  |  
|Unrealized gains (losses)                                  |  |                                                   | 24,219 |                                                  |   | (14,378 | ) |      | (12,184 | ) |   | (14,179 | )
|Less: reclassification for
  losses realized in income     |  |                                                   | (133   | )                                                |   | (772    | ) |      | (15,149 | ) |   | (2,153  | )
|                                                           |  |                                                   |        |                                                  |   |         |   |      |         |   |   |         |  
|Comprehensive income                                       |  | $                                                 | 58,212 |                                                  | $ | 15,234  |   | $    | 95,254  |   | $ | 56,103  |  
|                                                           |  |                                                   |        |                                                  |   |         |   |      |         |   |   |         |  

See notes to interim financial statements.

2

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|                                                     
|-----------------------------------------------------
|XL Financial Assurance Ltd.                          
|Interim Statements of Changes in Shareholders Equity
|(U.S. dollars in thousands, except share amounts)    
|                                                     

|                                                                           |  |                                                     |         |                                |   |         |  
|-------------------------------------------------------------------------- |  | --------------------------------------------------- | ------- | ------------------------------ | - | ------- | -
|                                                                           |  | (unaudited)
  Nine Months
  EndedSeptember 30, 2006 |         | Year Ended
  December 31, 2005 |  
|                                                                           |  |                                                     |         |                                |  
|                                                                           |  |                                                     |         |                                |   |         |  
|Common
  Shares - Number issued                                            |  |                                                     |         |                                |   |         |  
|Number of shares -
  beginning of year                                     |  |                                                     | 2,449   |                                |   | 2,449   |  
|                                                                           |  |                                                     |         |                                |   |         |  
|Number of shares - end of period                                           |  |                                                     | 2,449   |                                |   | 2,449   |  
|                                                                           |  |                                                     |         |                                |   |         |  
|Common
  Stock - Issued at par                                             |  |                                                     |         |                                |   |         |  
|Balance - beginning of year                                                |  | $                                                   | 294     |                                | $ | 294     |  
|                                                                           |  |                                                     |         |                                |   |         |  
|Balance - end of period                                                    |  |                                                     | 294     |                                |   | 294     |  
|                                                                           |  |                                                     |         |                                |   |         |  
|Additional
  Paid-In Capital                                               |  |                                                     |         |                                |   |         |  
|Balance - beginning of year                                                |  |                                                     | 345,606 |                                |   | 345,606 |  
|Capital contributions                                                      |  |                                                     | 190,983 |                                |   |        |  
|                                                                           |  |                                                     |         |                                |   |         |  
|Balance - end of period                                                    |  |                                                     | 536,589 |                                |   | 345,606 |  
|                                                                           |  |                                                     |         |                                |   |         |  
|Accumulated
  Other Comprehensive Loss                                     |  |                                                     |         |                                |   |         |  
|Balance - beginning of year                                                |  |                                                     | (17,953 | )                              |   | (1,819  | )
|Other comprehensive income
  (loss)                                        |  |                                                     | 2,965   |                                |   | (16,134 | )
|                                                                           |  |                                                     |         |                                |   |         |  
|Balance - end of period                                                    |  |                                                     | (14,988 | )                              |   | (17,953 | )
|                                                                           |  |                                                     |         |                                |   |         |  
|Retained
  Earnings                                                        |  |                                                     |         |                                |   |         |  
|Balance - beginning of year                                                |  |                                                     | 323,127 |                                |   | 231,714 |  
|Net income                                                                 |  |                                                     | 92,289  |                                |   | 98,389  |  
|Dividends on Series A
  Redeemable preferred shares                        |  |                                                     | (3,380  | )                              |   | (6,976  | )
|Accumulated undeclared dividends on Series A Redeemable preferred
  shares |  |                                                     | (15,016 | )                              |   |        |  
|                                                                           |  |                                                     |         |                                |   |         |  
|Balance - end of period                                                    |  |                                                     | 397,020 |                                |   | 323,127 |  
|                                                                           |  |                                                     |         |                                |   |         |  
|Total shareholders equity                                                 |  | $                                                   | 918,915 |                                | $ | 651,074 |  
|                                                                           |  |                                                     |         |                                |   |         |  

See notes to interim financial statements.

3

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|                                
|--------------------------------
|XL Financial Assurance Ltd.     
|Interim Statements of Cash Flows
|(U.S. dollars in thousands)     
|                                

|                                                                                            |  |                                                  |          |      |   |          |  
|------------------------------------------------------------------------------------------- |  | ------------------------------------------------ | -------- | ---- | - | -------- | -
|                                                                                            |  | (unaudited)
  Nine Months Ended 
  September 30, |         
|                                                                                            |  |                                                  |         
|                                                                                            |  | 2006                                             |          | 2005 |  
|                                                                                            |  |                                                  |          |      |  
|                                                                                           
|Cash flows provided by operating activities                                                 |  |                                                  |          |      |   |          |  
|Net income                                                                                  |  | $                                                | 92,289   |      | $ | 68,129   |  
|Adjustments to reconcile net income to net cash provided by operating
  activities          |  |                                                  |          |      |   |          |  
|Realized losses on sale of
investments                                                      |  |                                                  | 2,484    |      |   | 2,153    |  
|Amortization of premium on fixed
maturities                                                 |  |                                                  | 2,252    |      |   | 2,532    |  
|Net realized and unrealized losses on credit
derivatives excluding
  cash received and paid |  |                                                  | 3,939    |      |   | 1,816    |  
|Accrued investment income                                                                   |  |                                                  | (1,252   | )    |   | (1,724   | )
|Unpaid losses and loss adjustment expenses,
net                                             |  |                                                  | 7,839    |      |   | 22,697   |  
|Deferred premium revenue                                                                    |  |                                                  | 98,613   |      |   | 79,406   |  
|Unpaid losses and loss expenses
recoverable                                                 |  |                                                  | (156     | )    |   | (11,588  | )
|Deferred acquisition costs                                                                  |  |                                                  | (28,749  | )    |   | (13,174  | )
|Amounts due from parent and affiliates                                                      |  |                                                  | 39,522   |      |   | (7,608   | )
|Accounts payable and accrued liabilities                                                    |  |                                                  | (198     | )    |   | (1,242   | )
|Amounts due to parent and affiliates                                                        |  |                                                  | (13,025  | )    |   | 1,462    |  
|Prepaid reinsurance premiums                                                                |  |                                                  | 28,670   |      |   | (6,749   | )
|Funds withheld                                                                              |  |                                                  | 15,859   |      |   |         |  
|Reinsurance balances receivable                                                             |  |                                                  | (22,354  | )    |   | 24,893   |  
|Reinsurance balances payable                                                                |  |                                                  | (11,096  | )    |   | 5,221    |  
|Other assets                                                                                |  |                                                  | 357      |      |   | 32       |  
|                                                                                            |  |                                                  |          |      |   |          |  
|Total adjustments                                                                           |  |                                                  | 122,705  |      |   | 98,127   |  
|                                                                                            |  |                                                  |          |      |   |          |  
|Net cash provided by operating activities                                                   |  |                                                  | 214,994  |      |   | 166,256  |  
|                                                                                            |  |                                                  |          |      |   |          |  
|Cash flows used in investing activities                                                     |  |                                                  |          |      |   |          |  
|Proceeds from sale of debt securities and short-term
investments                            |  |                                                  | 205,433  |      |   | 642,036  |  
|Proceeds from maturity of debt securities and short-term
investments                        |  |                                                  | 33,783   |      |   | 35,030   |  
|Purchase of debt securities and short-term investments                                      |  |                                                  | (596,558 | )    |   | (841,766 | )
|                                                                                            |  |                                                  |          |      |   |          |  
|Net cash used in investing activities                                                       |  |                                                  | (357,342 | )    |   | (164,700 | )
|                                                                                            |  |                                                  |          |      |   |          |  
|Cash flows
      provided by (used in) financing activities                                 |  |                                                  |          |      |   |          |  
|Capital contribution                                                                        |  |                                                  | 190,983  |      |   |         |  
|Dividends paid on Series A redeemable preferred shares                                      |  |                                                  | (3,685   | )    |   | (7,481   | )
|                                                                                            |  |                                                  |          |      |   |          |  
|Net cash provided by (used in) financing
activities                                         |  |                                                  | 187,298  |      |   | (7,481   | )
|                                                                                            |  |                                                  |          |      |   |          |  
|                                                                                            |  |                                                  |          |      |   |          |  
|Increase (decrease) in cash and cash
equivalents                                            |  |                                                  | 44,950   |      |   | (5,925   | )
|Cash and cash equivalents                                                                   |  |                                                  |          |      |   |          |  
|Beginning of year                                                                           |  |                                                  | 22,256   |      |   | 13,210   |  
|                                                                                            |  |                                                  |          |      |   |          |  
|End of period                                                                               |  | $                                                | 67,206   |      | $ | 7,285    |  
|                                                                                            |  |                                                  |          |      |   |          |  

See notes to interim financial statements.

4

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|                                                                                   
|-----------------------------------------------------------------------------------
|XL Financial Assurance Ltd. 
  Notes to Interim Financial Statements 
  (UNAUDITED)
|                                                                                   

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|-- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|1. | Organization and Ownership                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|   | XL Financial Assurance
  Ltd. (the Company) was incorporated with limited liability under the
  Bermuda Companies Act 1981 on October 14, 1998 and is registered as a Class 3
  insurer under The Insurance Act 1978, amendmentsthereto and related regulations (The Act). Except for its preferred
    stock interests discussed further below, through July 1, 2006, the Company
    was a wholly owned subsidiary of XL Insurance (Bermuda) Ltd (XLI), 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 reinsurance businesses to
    SCA and selling an interest therein to the public through an initial public
    offering (IPO) of SCAs common shares. The aforementioned businesses
    consisted of the Company and XL Capital Assurance Inc. (XLCA), a New York
    domiciled financial guaranty insurance company. In connection with the
    planned IPO, effective July 1, 2006 all of XL Capitals ownership interests
    in the Company and XLCA were contributed to SCA. On August 4, 2006, SCAs IPO
    was consummated. 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.                                                                                                                
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|   | The Company is primarily
  engaged in the business of providing reinsurance of financial guaranties on
  asset-backed and municipal obligations underwritten by XLI, XLCA, and
  Financial Security Assurance Inc. (FSA), a New York domiciled financial
  guaranty insurance company, as well as other monoline and multiline insurance
  companies. FSA, through its parent and affiliates, own all of the Companys
  preferred shares, but otherwise is independent of the Company and XL Capital
  and its affiliates. Guaranties reinsured by the Company may be in the form of
  traditional financial guaranty insurance or credit default swaps. The
  Companys underwriting policy is to provide reinsurance of asset-backed and
  municipal obligations that would be of a lower investment-grade quality
  without the benefit of the Companys reinsurance. The asset-backed
  obligations reinsured by the Company are generally issued in structured
  transactions and are backed by pools of assets such as residential mortgage
  loans, consumer or trade receivables, securities or other assets having
  ascertainable cash flows or market value. The municipal obligations reinsured
  by the Company consist primarily of general obligation bonds that are
  supported by the issuers taxing power and of special revenue bonds and other
  special obligations of states and local governments that are supported by the
  issuers ability to impose and collect fees and charges for public services
  or specific projects. Substantially all the Companys reinsurance is written
  on a proportional basis. Accordingly, in the event of a payment default on a
  reinsured obligation, the Company is generally required to pay its proportionate
  share of the principal, interest or other such amounts due in accordance with
  the insured obligations original payment schedule or, at the ceding
  companies option, to pay such amounts on an accelerated basis. The Company
  conducts surveillance on its exposures to try and ensure early identification
  of any loss events. In addition, in the normal course of business, the
  Company seeks to reduce the loss that may arise from such events by
  retroceding certain levels of risks in various areas of exposure with other
  insurance enterprises or reinsurers.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|   | Pursuant to an agreement
  on April 5, 2006 with Financial Security Assurance Holdings Ltd. (FSAH),
  the parent company of FSA, the Company restructured the terms of its Series A
  Redeemable Preferred Shares and changed its bye-laws accordingly. In
  accordance with the agreement, the participating dividend and redemption
  provisions of the preferred shares were                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

5

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|                                                                                  
|----------------------------------------------------------------------------------
|XL Financial Assurance Ltd. 
  Notes to Interim Financial Statements
  (UNAUDITED)
|                                                                                  

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   | eliminated, the stated
  value of the preferred shares held by FSAH were increased to $54.0 million,
  and the fixed dividend rate of the preferred shares was increased from 5.00%
  to 8.25%.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|2. | Basis of Presentation                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   | These unaudited interim
  financial statements 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 interim 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 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. These statements should be read in
  conjunction with the Companys December 31, 2005 audited 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
  reinsured 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 balance sheets.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   | The fair value of credit
  default swaps is determined using a model which 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 reinsurance premiums
  received by the Company from the reinsurance of such contracts are recorded
  in the line item caption entitled net premiums earned in the accompanying
  interim 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 reinsured contracts are recorded in the
  line item caption entitled net losses and loss adjustment expenses in the
  accompanying interim statements of operations, and the remaining
  components of the change in fair value of reinsured 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
  losses on credit derivatives in the accompanying interim statements
  of operations. This presentation is applicable only to credit default swaps
  reinsured by the Company where the underlying ceding company has the intent                                                                                                                                                                                                                                                                                                                                                                                                  

6

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|                                                                                   
|-----------------------------------------------------------------------------------
|XL Financial Assurance Ltd. 
  Notes to Interim Financial Statements 
  (UNAUDITED)
|                                                                                   

| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | and ability to hold such
  contracts to maturity and is consistent with practices in the financial
  guaranty insurance industry for reporting the results of such instruments.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | The Companys reinsured
  credit default swap in-force portfolio generally requires the Company to meet
  its proportionate share of 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 Companys reinsured credit default swap in-force portfolio
  consists 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 97.7% of the Companys reinsured credit default
  swap in-force portfolio was rated AAA with the remaining 2.3% rated at or
  above investment-grade. The weighted average term of the contracts in-force
  was 12.7 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                                        |  | $                                                 | 4,969  |      | $ | 3,831  |  
|Net losses and loss
  adjustment expenses                  |  |                                                   | (115   | )    |   | (328   | )
|Net realized and
  unrealized losses on credit derivatives |  |                                                   | (2,838 | )    |   | (1,706 | )

|                                                           |  |                                                  |        |      |   |        |  
|---------------------------------------------------------- |  | ------------------------------------------------ | ------ | ---- | - | ------ | -
|                                                           |  | (unaudited)
  Nine Months Ended 
  September 30, |       
|                                                           |  |                                                  |        |      |   |        |  
|                                                           |  | 2006                                             |        | 2005 |  
|                                                           |  |                                                  |        |      |  
|Statements
  of Operations                                 |  |                                                  |        |      |   |        |  
|Net premiums earned                                        |  | $                                                | 15,354 |      | $ | 11,473 |  
|Net losses and loss
  adjustment expenses                  |  |                                                  | 808    |      |   | (644   | )
|Net realized and
  unrealized losses on credit derivatives |  |                                                  | (5,903 | )    |   | (3,545 | )

7

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|                                                                                  
|----------------------------------------------------------------------------------
|XL Financial Assurance Ltd.
  Notes to Interim Financial Statements 
  (UNAUDITED)
|                                                                                  

|                                                    |  |                                            |        |                             |   |        | 
|--------------------------------------------------- |  | ------------------------------------------ | ------ | --------------------------- | - | ------ | 
|(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 |  | $                                          | 1,007  |                             | $ | 787    | 
|Derivative assets                                   |  |                                            | 10,227 |                             |   | 13,482 | 
|                                                    |  |                                            |        |                             |   |        | 
|Total assets                                        |  | $                                          | 11,234 |                             | $ | 14,269 | 
|                                                    |  |                                            |        |                             |   |        | 
|                                                    |  |                                            |        |                             |   |        | 
|Liabilities                                         |  |                                            |        |                             |   |        | 
|Unpaid losses and loss
  adjustment expenses        |  | $                                          | 11,376 |                             | $ | 10,348 | 
|Derivative liabilities                              |  |                                            | 2,548  |                             |   | 1,864  | 
|                                                    |  |                                            |        |                             |   |        | 
|Total liabilities                                   |  | $                                          | 13,924 |                             | $ | 12,212 | 
|                                                    |  |                                            |        |                             |   |        | 

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   | The Company is also a
  party to a put option agreement with Twin Reefs Asset Trust (the Asset
  Trust). The put option agreement provides the Company with the irrevocable
  right to require the Asset Trust at any time and from time to time to
  purchase the Companys non-cumulative perpetual Series B Preferred Shares
  with an aggregate liquidation preference of up to $200 million. To the extent
  that any Series B Preferred Shares are put to the Asset Trust and remain
  outstanding, a corresponding portion of such fees and ordinary expenses will
  be payable by the Company. The put option agreement is perpetual but would terminate
  on delivery of notice by the Company on or after December 10, 2009, or under
  certain defined circumstances, such as the failure of the Company to pay the
  put option premium when due or bankruptcy. The put option is recorded by the
  Company at fair value with changes in fair value recognized in the line items
  caption entitled Net realized and unrealized losses on credit derivatives.
  For the nine months ended September 30, 2006, the fair value adjustment was
  not significant. The put option premiums for the nine month periods ended
  September 30, 2006 and 2005 were $2.0 million and $1.8 million, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                       
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|4. | New Accounting Pronouncements and Developments                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   | In June 2005, at the
  request of the Securities and Exchange Commission, the 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 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
  guarantee 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 Statement of Financial Accounting
  Standards No. 5, Accounting for Contingencies (SFAS No. 5) and Emerging
  Issues Task Force (EITF) Issue No. 85-20, Recognition of Fees for
  Guaranteeing a Loan. The FASB arrived at a 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 financial statements as of
  December 31,

8

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|                                                                                   
|-----------------------------------------------------------------------------------
|XL Financial Assurance Ltd. 
  Notes to Interim Financial Statements 
  (UNAUDITED)
|                                                                                   

| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 2005 and 2004 and for 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 Company adopted
  the guidance in this FSP as of July 1, 2006 and it did not 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.
  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 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                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      

9

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|                                                                                   
|-----------------------------------------------------------------------------------
|XL Financial Assurance Ltd. 
  Notes to Interim Financial Statements 
  (UNAUDITED)
|                                                                                   

|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   | 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 assessing the impact of the adoption of SFAS 157.                                      
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|5. | Premiums Earned from Refunded and Called Bonds                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   | Net premiums earned include $0.3 million and $23.1 million for the three and nine month periods ended September 30, 2006, respectively, and $3.8 million and $4.0 million for the three and nine month periods ended September 30, 2005, respectively, related to refunded and called bonds.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|6. | Related Party Transactions                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   | Capital Transactions                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   | In connection with SCAs
  IPO on August 4, 2006, XLI contributed $15.0 million to the Company. In
  addition, SCA contributed $175.0 million to the Company
  from the proceeds of its IPO. The Company intends to use such contribution
  support its continued growth and for general corporate purposes.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   | Services
  Arrangements                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   | The Company purchased
  various services from affiliates of XL Capital prior to the IPO under various
  agreements and continues to purchase certain services indirectly through SCA
  Administrative Bermuda Ltd, a wholly owned subsidiary of SCA. Such services
  principally include: (i) information technology support, (ii) actuarial,
  finance, legal, internal audit services and certain investment management services
  and (iii) certain advertising services. For the three and nine month periods ended September 30, 2006, the Company incurred costs for such services aggregating $0.6 million and $2.8 million, respectively, compared to $0.5 million and $2.6 million for the three and nine month periods ended September 30, 2005, respectively, and are components of operating expenses in the accompanying statements of operations.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   | Reinsurance
  Treaties with Affiliates                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  | The Company has a
  facultative quota share reinsurance treaty (Treaty) with XLCA. Under the
  terms of the the Treaty, XLFA agrees to reinsure up to 75% of business
  written by XLCA provided it meets certain specified parameters. Prior to July
  1, 2006, XLFA had agreed under the Treaty to reinsure up to 90% of such
  business. In addition, pursuant to the Treaty XLCA 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. 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.

10

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|                                                                                   
|-----------------------------------------------------------------------------------
|XL Financial Assurance Ltd. 
  Notes to Interim Financial Statements 
  (UNAUDITED)
|                                                                                   

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   | 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 has entered
  into the following reinsurance agreements with XLI:                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |   | (a)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | Effective October 1, 2001,
  the Company entered into an excess of loss reinsurance agreement with XLI.
  This agreement covers a portion of the Companys liability arising as a
  result of losses on policies reinsured by the Company that are in excess of
  certain limits and are not covered by other reinsurance agreements. This
  agreement provides indemnification only for the portion of any loss covered
  by this agreement in excess of 10% of XLFAs surplus, up to an aggregate
  amount of $500 million. For the three and nine month periods ended September
  30, 2006, the Company incurred expense under this agreement of
  approximately $0.1 million and $0.4 million, respectively, compared to approximately $0.1 million and $0.4 million for the three and nine month periods ended September 30, 2005, respectively.
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |   | (b)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | Effective August 17, 2001,
  the Company entered into a facultative quota share reinsurance treaty with
  XLI. This treaty allows the Company to propose to cede to XLI a portion of a
  risk, which risk XLI may then accept or reject in its sole discretion. Under
  this treaty, XLI pays the Company a ceding commission of 30% on the premiums
  ceded under this treaty unless otherwise specified. On August 4, 2006, the
  Company and XLI terminated certain reinsurance cessions ceded under this
  agreement to XLI. As a result of the termination of the aforementioned
  cessions, XLI returned $26.5 million of premiums to the Company, the Company
  returned ceding commissions of $7.8 million to XLI, and XLI paid the Company
  $18.7 million.                                                                                 
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |   | (c)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | Effective December 31,
  1999, the Company entered into a facultative quota share reinsurance treaty
  with XLI. This treaty allows XLI to propose to cede to the Company a portion
  of a risk it insured, which risk XLFA may then accept or reject in its sole
  discretion. Under this treaty, the Company pays XLI a ceding commission of
  12% on the premiums ceded under this treaty unless otherwise specified. On
  August 4, 2006, the Company and XLI agreed to cancel from inception the
  reinsurance of certain business ceded under this arrangement. As a result of
  this cancellation, the Company paid XLI $0.2 million, XLI assumed the
  Companys obligation for $1.2 million of reserves for losses and loss
  adjustment expenses, and the Company recorded a capital contribution of $1.0
  million.                       
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        | In addition, on August 4,
  2006, the Company entered into certain reinsurance cessions with XLI pursuant
  to the aforementioned facultative quota share reinsurance treaty. As a result
  of these cessions, the Company recorded assumed premiums of approximately
  $8.0 million, ceding commissions of approximately $1.0 million and received
  cash from XLI of approximately $7.0 million.                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |   | (d)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | Effective August 4, 2006,
  XLI, at no cost to the Company, indemnfied the Company 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).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |  | The Company has entered
  into the following reinsurance agreements with certain subsidiaries and
  affiliates of FSAH. Premiums assumed from FSAH affiliates represented 55.2%
  and 52.0% of the Companys total reinsurance premiums assumed for the three
  and nine month periods ended September 30,2006, respectively, as compared to
  82.4% and 77.7% for the comparable periods in 2005. All of the agreements
  discussed below may be terminated under certain conditions, as defined in the
  agreements:

11

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|                                                                                   
|-----------------------------------------------------------------------------------
|XL Financial Assurance Ltd. 
  Notes to Interim Financial Statements 
  (UNAUDITED)
|                                                                                   

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   | (a)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | Effective November 3,
  1998, the Company entered into a master facultative reinsurance agreement
  with FSA. This agreement allows FSA to propose to cede a portion of a risk
  insured by it to the Company, which risk the Company may then accept or
  reject solely in its discretion. The ceding commission that the Company pays
  FSA on the premiums ceded under this agreement is determined on a
  case-by-case basis. The Companys obligations under this agreement are guaranteed by XLI. 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.
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |   | (b)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | Effective January 1, 2004,
  the Company entered into a reinsurance treaty with FSA to reinsure certain
  policies they issued insuring the timely payment of the principal of and
  interest on certain asset-backed securities and pools of consumer debt
  obligations.                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |   | (c)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | Effective January 1, 2004,
  the Company entered into a reinsurance treaty with FSA to reinsure certain
  policies they issued insuring the timely payment of the principal and
  interest on securities and obligations that provide financing for
  governmental or public purpose infrastructure projects located outside of the
  United States and its territories, excluding certain countries.                                                                                                                                                                                                                                                                                                                 
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |  | The Company has guarantied
  certain of XLIs obligations in connection with certain transactions where
  XLIs customer required such credit enhancement. Each of these transactions
  has a double trigger structure, meaning that the Company does not have to
  pay a claim unless both the underlying transaction and XLI default. For each
  of these transactions, the Company has entered into a reimbursement agreement
  with XLI, pursuant to which XLI pays the Company a fee for providing its
  guaranty and XLI grants the Company a security interest in a portion of the
  payments received by it from its client. As of September 30, 2006 and
  December 31, 2005, the Companys aggregate net par outstanding relating to
  such guaranties was $526.8 million.

12

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|                                     
|-------------------------------------
|XL Financial Assurance Ltd.          
|Notes to Interim Financial Statements
|(UNAUDITED)                          
|                                     

|   |                                                                                                                                                   
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------
|7. | Reinsurance                                                                                                                                       
|   |                                                                                                                                                   
|   | The effect of reinsurance
  on premium written and earned for the three and nine month periods ended September 30,
  2006 and 2005 is shown below:
|   |                                                                                                                                                   
|   | (U.S.
  dollars in thousands)                                                                                                                     

| |                                         |  |             |         |       |   |         |   |   |         | 
| | --------------------------------------- |  | ----------- | ------- | ----- | - | ------- | - | - | ------- | 
| |                                         |  | (Unaudited) |        
| |                                         |  |             |        
| |                                         |  | Assumed     |         | Ceded |   | Net     |  
| |                                         |  |             |         |       |   |         |  
| | Three
  months ended September 30, 2006 |  |             |         |       |   |         |   |   |         | 
| | Premium Written                         |  | $           | 72,014  |       | $ | 23,412  |   | $ | 95,426  | 
| | Premium earned                          |  |             | 42,260  |       |   | (726    | ) |   | 41,534  | 
| | Losses and loss adjustment expenses     |  |             | 358     |       |   | 4,139   |   |   | 4,497   | 
| |                                         |  |             |         |       |   |         |   |   |         | 
| | Three
  months ended September 30, 2005 |  |             |         |       |   |         |   |   |         | 
| | Premium Written                         |  | $           | 71,651  |       | $ | (7,594  | ) | $ | 64,057  | 
| | Premium earned                          |  |             | 40,953  |       |   | (5,636  | ) |   | 35,317  | 
| | Losses and loss adjustment expenses     |  |             | 476     |       |   | 580     |   |   | 1,056   | 
| |                                         |  |             |         |       |   |         |   |   |         | 
| | Nine
  months ended September 30, 2006  |  |             |         |       |   |         |   |   |         | 
| | Premium Written                         |  | $           | 242,470 |       | $ | 11,459  |   | $ | 253,929 | 
| | Premium earned                          |  |             | 143,857 |       |   | (17,210 | ) |   | 126,647 | 
| | Losses and loss adjustment expenses     |  |             | 7,322   |       |   | 3,329   |   |   | 10,651  | 
| |                                         |  |             |         |       |   |         |   |   |         | 
| | Nine
  months ended September 30, 2005  |  |             |         |       |   |         |   |   |         | 
| | Premium Written                         |  | $           | 190,662 |       | $ | (24,542 | ) | $ | 166,120 | 
| | Premium earned                          |  |             | 111,256 |       |   | (17,792 | ) |   | 93,464  | 
| | Losses and loss adjustment expenses     |  |             | 24,358  |       |   | (11,954 | ) |   | 12,404  | 

|   |                                                                                                                                                                                                                             
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|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:

13

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|                                     
|-------------------------------------
|XL Financial Assurance Ltd.          
|Notes to Interim Financial Statements
|(UNAUDITED)                          
|                                     

|                                                                                                             |  |                      |         |                       |   |          |   |             |         |   |   |         |  
|------------------------------------------------------------------------------------------------------------ |  | -------------------- | ------- | --------------------- | - | -------- | - | ----------- | ------- | - | - | ------- | -
|                                                                                                             |  | (Unaudited)          |         |                       |  
|                                                                                                             |  | As at and
  for the  |         | As at and
  for the   |  
|                                                                                                             |  | Nine
  Months Ended  |         | Twelve
  Months Ended |  
|                                                                                                             |  | September
  30, 2006 |         | December
  31, 2005   |  
|                                                                                                             |  |                      |         |                       |  
|(U.S. dollars in thousands)                                                                                  |  | Case                 |         | Unallocated           |   | Case     |   | Unallocated |        
|                                                                                                             |  | Reserves             |         | Reserves              |   | Reserves |   | Reserves    |        
|                                                                                                             |  |                      |         |                       |   |          |   |             |         |   |   |         |  
|Unpaid losses and loss adjustment expenses at
beginning of year                                              |  | $                    | 64,746  |                       | $ | 69,298   |   | $           | 50,810  |   | $ | 58,341  |  
|Unpaid losses and loss adjustment expenses
recoverable                                                       |  |                      | (52,316 | )                     |   | (14,078  | ) |             | (42,151 | ) |   | (13,290 | )
|                                                                                                             |  |                      |         |                       |   |          |   |             |         |   |   |         |  
|Net unpaid losses and loss adjustment expenses at
beginning of year                                          |  |                      | 12,430  |                       |   | 55,220   |   |             | 8,659   |   |   | 45,051  |  
|Increase (decrease) in net losses and loss
adjustment expenses incurred
  in respect of losses occurring in: |  |                      |         |                       |   |          |   |             |         |   |   |         |  
|Current year                                                                                                 |  |                      |        |                       |   | 8,670    |   |             |        |   |   | 10,169  |  
|Prior years                                                                                                  |  |                      | 1,980   |                       |   |         |   |             | 6,683   |   |   |        |  
|Less net losses and loss adjustment expenses paid                                                            |  |                      | (2,967  | )                     |   |         |   |             | (2,912  | ) |   |        |  
|                                                                                                             |  |                      |         |                       |   |          |   |             |         |   |   |         |  
|Net unpaid losses and loss adjustment expenses at
end of period                                              |  |                      | 11,443  |                       |   | 63,890   |   |             | 12,430  |   |   | 55,220  |  
|Unpaid losses and loss adjustment expenses
recoverable                                                       |  |                      | 52,430  |                       |   | 14,120   |   |             | 52,316  |   |   | 14,078  |  
|                                                                                                             |  |                      |         |                       |   |          |   |             |         |   |   |         |  
|Unpaid losses and loss expenses at end of
period                                                             |  | $                    | 63,873  |                       | $ | 78,010   |   | $           | 64,746  |   | $ | 69,298  |  
|                                                                                                             |  |                      |         |                       |   |          |   |             |         |   |   |         |  

| |                                                                                                            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | ---------------------------------------------------------------------------------------------------------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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:
| |                                                                                                            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | a.                                                                                                         | During the year ended
  December 31, 2004, the Company recorded a provision for losses of
  approximately $42.1 million representing the present value of losses expected
  to be incurred in the future with respect to an insured project financing,
  which the Company reinsured under its facultative quota share reinsurance
  treaty with XLCA (see Note 6).  As
  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 XLI 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
  $13.5 million ($5.6 million after reinsurance to XLI), on a net present value
  basis to reflect certain adverse developments. There has been no further
  development in such loss reserve through September 30, 2006.  The total remaining par reinsured by the
  Company in connection with this transaction (net of applicable carried case
  reserves), which amortizes over the next 12 years, aggregated approximately
  $197.4 million ($115.8 million net of reinsurance to XLI) 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 if necessary, as new information
  becomes available. Pursuant to an agreement entered into with XL Capital,
  which became effective on the date of the IPO, XL Capital 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 6).
| |                                                                                                            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | b.                                                                                                         | In 2005, the Company
  recorded funds withheld of $15.9 million pursuant to its Treaty with XLCA in
  respect of notes (the Insured Notes) issued pursuant to a structured
  financing of                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    

14

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|                                     
|-------------------------------------
|XL Financial Assurance Ltd.          
|Notes to Interim Financial Statements
|(UNAUDITED)                          
|                                     

| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | loans to medical
  providers, which were insured in 2001, and which defaulted upon their
  maturity. In December 2005, XLCA received a claim notice from the trustee on
  behalf of the holders of such insured notes in the amount of $20.2 million,
  representing the outstanding principal of the Insured Notes plus accrued
  interest thereon at the date of default (the Claim Amount). Pursuant to the
  terms of the insurance arrangement, XLCA had the option of satisfying the
  claim by either paying, in cash, the Claim Amount to the holders of the
  Insured Notes or purchasing the Insured Notes from such holders for an
  amount, in cash, equal to the Claim Amount.
  XLCA elected to purchase the Insured Notes in satisfaction of the
  claim. The purchase of the Insured Notes was recorded as an investment on
  XLCAs balance sheet at an estimated fair value of $19.5 million. The
  difference between the estimated fair value and the consideration paid to acquire
  the Insured Notes was recorded as a net paid loss of $0.1 million. Pursuant
  to the Treaty, XLCAs purchase of the Insured Notes was in furtherance of
  defending or compromising a claim and, accordingly, XLCA billed the Company
  for its share of the cost of purchasing the notes and received consideration
  from the Company in satisfaction thereof of $17.6 million. Subsequent to the
  purchase of the Insured Notes, a principal payment was received by XLCA
  thereon in the amount of $1.7 million, which reduced the funds withheld
  balance to $15.9 million. The Company was also billed $0.6 million for its
  share of the initial loss.                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | The estimate of fair value
  of the Insured Notes was based on XLCA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 Inc. and
  certain of its affiliates (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 and in connection
  therewith, XLCA accepted preferred stock of Intrepid in exchange for the
  cancellation of a portion of the Insured Notes. 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 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, XLCA expects that it would be required to completely write-off the
  carrying value of this investment and, accordingly, XLFA would incur a loss
  equal to its proportionate share thereof under its reinsurance arrangement
  with XLCA.  During the three months
  ended March 31, 2006, XLCA received a return of principal of $0.5 million and
  recognized an impairment charge on its investment in Intrepid and the
  remaining Insured Notes which aggregated $4.9 million.  Of these amounts, the Company received
  $0.4 million of the funds withheld relating to the return of principal and
  reinsured $4.5 million of the loss which was reflected as an impairment
  charge and included in net realized losses on investments during the three
  month period ended March 31, 2006.  As
  a result of the impairment charge and aforementioned return of capital, the
  funds held balance referred to above was reduced to $11.0 million at March
  31, 2006.
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | 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, XLCA recognized an
  impairment charge of approximately $9.0 million ($8.1 million of which was
  reinsured by the Company) 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  

15

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|                                     
|-------------------------------------
|XL Financial Assurance Ltd.          
|Notes to Interim Financial Statements
|(UNAUDITED)                          
|                                     

| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          | 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, XLCA wrote-off the remaining carrying value of its investment in
  Intrepid of approximately $1.1 million.
  Because XLCA is  fully
  indemnified for this charge by an affiliate of XL Capital pursuant to an
  agreement entered into at the effective date of the IPO, the Company has no
  further liability with respect to the preferred shares of Intrepid or the
  Insured Notes.  Also during the three
  months ended September 30, 2006 XLCA received payment in full on the Insured
  Notes.  All funds held by XLCA on XLFAs behalf were returned as of September 30, 2006.                                                                                                                                                                                                                                                          
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | c.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | During the year ended
  December 31, 2005, the Company recorded a provision for loss of $4.3 million
  ($2.6 million after reinsurance) representing the present value loss expected
  to be incurred in the future with respect to an insured residential mortgage
  securitization insured by XLCA.  There
  has been no development in such loss reserve since its initial establishment
  through September 30, 2006.  The total
  remaining par reinsured by the Company in connection with this transaction
  (net of applicable carried case reserves) aggregated approximately $150.1
  million ($89.2 million net of reinsurance) at September 30, 2006.  The underlying insured par amortizes over
  many years into the future. Accordingly, 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.
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | In addition to the matters
  discussed above, at September 30, 2006 the XLFA had case basis loss
  adjustment expense reserves of $1.4 million ($0.9 million net of
  reinsurance), 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.

16

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