Bermuda-based insurance giant XL Capital warned on Friday that third-quarter earnings will be less than half current estimates as a result of a $160 million after-tax charge to boost loss reserves.

The company has said that its profits will be about 57 percent below analysts forecasts as a result of potential claims in medical malpractice and professional liability policies dating back to the late 1990s.

According to chief executive officer Brian O'Hara, this period was “among the worst in the industry's history” given “the marked expansion of liability in the US tort system.”

Mr. O'Hara, in a release, pledged an intensive audit designed to quantify the firm's exposure, but investors thought charges taken in recent years had already accomplished that goal, according to reports from the Reuters news agency.

Following the announcement shares fell as much as 12 percent, their biggest one-day decline since a 12.1 percent drop in July 2002.

XL said it expects third-quarter net income to fall about $1.16 per share below forecasts because of the charge, which would put profit at about 89 cents per share. Analysts expected the company to earn $2.05 a share this quarter.

Insurer said it is increasing reserves for new claims from 1997 to 2000 at NAC Re, a US reinsurer with which XL merged in 1999. It said these claims mainly concern general liability, medical malpractice, professional lines and surety.

Mr. O'Hara said in the statement: “As we have previously noted, the underwriting years in the late 1990s were among the worst in the industry's history for North American casualty business. Many primary insurers are continuing to see loss development beyond historical patterns due to the marked expansion of liability in the U.S. tort system. The claims stem from the former NAC Re book, primarily from general liability, medical malpractice, professional lines and surety.”

Earlier this year, O'Hara acknowledged that many insurers were hurt badly by rising loss costs in casualty lines in the latter half of the 1990's and expected that to continue for the “foreseeable future.”

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

“The announcement is extremely disappointing given the multi-year effort to get reserves right in the company's casualty reinsurance business,” Merrill Lynch & Co. analyst Jay Cohen said in a research report printed by Reuters.

The news agency reported he cut his rating for XL shares to “neutral” from “buy,” and said the shares “will not rebound quickly”.

Standard & Poor's said it may cut XL's “A-plus” credit and senior unsecured debt ratings, its fifth highest investment grade. A downgrade might increase XL's borrowing costs.

Mr. O'Hara said he hopes to finish claims audit by year-end so that claims will not adversely affect results after this year.

XL said its charge is equal to about $184 million before taxes. The company said it expects to report third-quarter results on Oct. 29.

XL shares traded Friday afternoon on the New York Stock Exchange at $70.55, down $8.85, or 11.1 percent, after falling as low as $69.90. Through Thursday, the shares had risen 2.8 percent this year.

XL will hold an analyst conference call at 10 a.m. Bermuda time today to discuss these developments. This call will be simultaneously webcast and can be accessed through XL's website at www.xlcapital.com.