The classic issue with this winch is rust and corrosion inside the motor housing. It would be nice to catch that before it becomes a problem. Check to make sure the downward-facing drain is open. If it's plugged, or there's evidence of a lot of rust, you may want to open the motor to clean it out. If you do, then definitely check/replace the brushes and clean/resurface the contact area on the armature while you're there.
Just to clarify: There are two drain passages to let moisture out of the motor. They are right where you describe, where the motor meets the the drum mechanism. Depending on how you've mounted the winch (feet down or feet forward), one passage will be at the 3-o'clock position and one at 9-o'clock. Whichever faces downward should be open, the other should be sealed with some silicone. Get it wrong and water can get in but not out.
If you want to go whole-hog, get the service manual from Warn's site and open up the gearbox. All the critical parts are serviceable: get replacement gaskets, drum bushings, thrust washer, and grease from your local Warn service center. Use some brake cleaner spray to get the old gunk off the gears and put some new, fresh gunk on there! (Apply liberally but don't pack the housing.)
As far as the drum: it sounds like moisture got under the paint and now it's flaking off. The drum surface takes a lot of pressure from the cable and I'm not sure what kind of finish can survive that -- maybe powder coating? Anyway, probably not a big worry. There are a million winches out there with rusty drums that work just fine. (As long as there are no sharp edges to dig into your line.)
hope that helps
BTW: Apparently you can upgrade an XP winch to an XP-S by swapping out a few parts (motor, drum, contactor, and controller).