On a day when shares in XL Capital plummeted $5 before staging a recovery, Bermuda's second biggest insurer and reinsurer revealed how it has now taken the sting out of its exposure to the US subprime market by reducing its holdings in lower-rated securities.

The turmoil in the subprime mortgage market was one of the primary reasons the company recorded a 13 percent drop in its third quarter profits, which came in at $371.6 million.

In a conference call to investors, XL's chief investment officer Sarah Street explained the company has, in the past three months, reduced its $90 million exposure to lower-rated subprime securities to less than $10 million.

By doing so XL has accepted the pain of investment losses but avoided potentially heavier losses had it hung on to the deteriorating securities.

XL's net income for the quarter slipped from $425.9 million year-on-year, a fall of just over $50 million. The profit drop would have been substantially worse but for gains made in other areas.

The net realised losses on investments was $160 million, primarily driven by subprime-related factors, and on derivatives a further $58.2 million.

XL realised losses of approximately $48 million through selling off subprime securities during the third quarter.

Ms Street explained: "Working closely with our mortgage specialist manager as part of their normal review process and delinquent reports we felt further deterioration in certain lower rated 2005/2006-vintage subprime securities was likely. We therefore sold these securities at a loss but avoided further deterioration, which ultimately did transpire.

"We owned $90 million of these lower-rated subprime securities at the end of the second quarter and had less than $10 million at the end of Q3."

She said the company also recognised $111 million of charges, primarily on subprime-related paper, inparticular subprime asset-backed CDOs (collaterised debt obligations)and subprime collateral and 2nd Lien (second mortgages).

Giving more detail Ms Street said: "What started as a correction in the US subprime mortgage market quickly spread to CDOs and broader structured credit asset class. Many investors in asset-backed financial paper questioned every instance of exposure and significantly reduced their holdings.

"We have actively reduced our exposure to lower rated 2005/2006-vintage subprime securities in a concern about future deterioration. We will remain vigilant because we expect volatility to stay high for the foreseeable future."

Approximately 70 percent of XL's CDOs are backed by highly diversified corporate loans, according to Ms Street, who said this gave the company comfort regarding the quality of the portfolio and "the subordination levels that are available to absorb credit events in the future."

She said: "We have $4.5 billion in commercial mortgage-backed securities where potentially all of our holdings are AAA-rated.

"Our residential mortgage holdings total $7.4 billion, of this $2.7 billion is AAA-rated agency guaranteed assurities. We have $2.3 billion of whole loan CMOs (collatorised mortgage obligations) representing fundamentally sound issues to high-quality borrowers of which 80 percent are AAA-rated.

"We have $1.2 billion exposure to non-agency, residential subprime securities. Our remaining exposure to BBB and below is quite limited with our net realised loss of these securities at $1 million."

XL also has investment exposure to 2nd Lien - or second mortgages - valued at $128 million, with around $77 million of those featuring some form of subprime collateral. The company has further areas of exposure to asset-backed CDOs with an element of subprime collateral which total $115 million.

"Our exposure in these areas are nearly entirely AAA and above and our exposure to the lower grade securities is diminuative. Our remaining unrealised loss is only $7 million," said Ms Street.

"Finally our Alt A exposure totals $992 million. These are generally loans to private borrowers, albeit written with lower levels of supporting documentation. Our exposure in this area are generally AAA and above. Our net unrealised losses on these securities totals $19 million."