Consolidation of Variable Interest Entities

The Company provides financial guaranties with respect to debt obligations of special purpose entities, including VIEs. AGC and AGM do not sponsor any VIEs when underwriting third party financial guaranty insurance or credit derivative transactions, nor has either of them acted as the servicer or collateral manager for any VIE obligations that it insures. The transaction structure generally provides certain financial protections to the Company. This financial protection can take several forms, the most common of which are overcollateralization, first loss protection (or subordination) and excess spread. In the case of overcollateralization (i.e., the principal amount of the securitized assets exceeds the principal amount of the structured finance obligations guaranteed by the Company), the structure allows defaults of the securitized assets before a default is experienced on the structured finance obligation guaranteed by the Company. In the case of first loss, the financial guaranty insurance policy only covers a senior layer of losses experienced by multiple obligations issued by special purpose entities, including VIEs. The first loss exposure with respect to the assets is either retained by the seller or sold off in the form of equity or mezzanine debt to other investors. In the case of excess spread, the financial assets contributed to special purpose entities, including VIEs, generate cash flows that are in excess of the interest payments on the debt issued by the special purpose entity. Such excess spread is typically distributed through the transaction’s cash flow waterfall and may be used to create additional credit enhancement, applied to redeem debt issued by the special purpose entities, including VIEs (thereby, creating additional overcollateralization), or distributed to equity or other investors in the transaction.

AGC and AGM are not primarily liable for the debt obligations issued by the VIEs they insure and would only be required to make payments on these debt obligations in the event that the issuer of such debt obligations defaults on any principal or interest due. AGL’s and its Subsidiaries’ creditors do not have any rights with regard to the collateral supporting the debt issued by the FG VIEs. Proceeds from sales, maturities, prepayments and interest from such underlying collateral may only be used to pay Debt Service on VIE liabilities. Net fair value gains and losses on FG VIEs are expected to reverse to zero at maturity of the VIE debt, except for net premiums received and receivable, and net claims paid and expected to be paid by AGC or AGM under the financial guaranty insurance contract. The Company’s estimate of expected loss to be paid for FG VIEs is included in Note 5, Expected Loss to be Paid.

As part of the terms of its financial guaranty contracts, the Company obtains certain protective rights with respect to the VIE that are triggered by the occurrence of certain events, such as failure to be in compliance with a covenant due to poor deal performance or a deterioration in a servicer or collateral manager's financial condition. At deal inception, the Company typically is not deemed to control a VIE; however, once a trigger event occurs, the Company's control of the VIE typically increases. The Company continuously evaluates its power to direct the activities that most significantly impact the economic performance of VIEs that have debt obligations insured by the Company and, accordingly, where the Company is obligated to absorb VIE losses or receive benefits that could potentially be significant to the VIE. The Company obtains protective rights under its insurance contracts that give the Company additional controls over a VIE if there is either deterioration of deal performance or in the financial health of the deal servicer. The Company is deemed to be the control party under GAAP, typically when its protective rights give it the power to both terminate and replace the deal servicer, which are characteristics specific to the Company's financial guaranty contracts. If the Company’s protective rights that could make it the control party have not been triggered, then it does not consolidate the VIE. As of September 30, 2013, the Company had issued financial guaranty contracts for approximately 1,000 VIEs that it did not consolidate.

Consolidated FG VIEs

Number of FG VIE's Consolidated



	As of September 30, 2013		As of December 31, 2012

Beginning of the period	33		33
Consolidated(1)	11		2
Deconsolidated(1)	(3	)	—
Matured	(1	)	(2	)
End of the period	40		33

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(1)	Net loss on consolidation and deconsolidation was $7 million in Nine Months 2013 and $6 million in 2012, respectively, and recorded in “fair value gains (losses) on FG VIEs” in the consolidated statement of operations.

The total unpaid principal balance for the FG VIEs’ assets that were over 90 days or more past due was approximately $791 million at September 30, 2013. The aggregate unpaid principal of the FG VIEs’ assets was approximately $2,117 million greater than the aggregate fair value at September 30, 2013, excluding the effect of R&W settlements. The change in the instrument-specific credit risk of the FG VIEs’ assets for Third Quarter 2013 and Nine Months 2013 were gains of $83 million and $252 million, respectively. The change in the instrument-specific credit risk of the FG VIEs’ assets for Third Quarter 2012 and Nine Months 2012 were gains of $65 million and $235 million, respectively.

The aggregate unpaid principal balance was approximately $1,725 million greater than the aggregate fair value of the FG VIEs’ liabilities as of September 30, 2013.

The table below shows the carrying value of the consolidated FG VIEs’ assets and liabilities in the consolidated financial statements, segregated by the types of assets that collateralize their respective debt obligations.

Consolidated FG VIEs

By Type of Collateral



	As of September 30, 2013					As of December 31, 2012
	Number of FG VIEs	Assets		Liabilities		Number of FG VIEs	Assets		Liabilities
	(dollars in millions)
With recourse:
First lien	25	$	620	$	799	14	$	618	$	825
Second lien	14	456		671		16	633		915
Other	1	358		358		3	350		350
Total with recourse	40	1,434		1,828		33	1,601		2,090
Without recourse	—	1,081		1,047		—	1,087		1,051
Total	40	$	2,515	$	2,875	33	$	2,688	$	3,141

Unpaid Principal for FG VIEs’ Liabilities

with Recourse



	As of September 30, 2013		As of December 31, 2012
	(in millions)
Unpaid principal for FG VIEs’ liabilities with recourse (1)	$	2,385	$	2,808

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(1)	FG VIE liabilities with recourse will mature at various dates ranging from 2025 to 2047.

The consolidation of FG VIEs has a significant effect on net income and shareholder’s equity due to (1) changes in fair value gains (losses) on FG VIE assets and liabilities, (2) the elimination of premiums and losses related to the AGC and AGM FG VIE liabilities with recourse and (3) the elimination of investment balances related to the Company’s purchase of AGC and AGM insured FG VIE debt. Upon consolidation of a FG VIE, the related insurance and, if applicable, the related investment balances, are considered intercompany transactions and therefore eliminated. Such eliminations are included in the table below to present the full effect of consolidating FG VIEs.

Effect of Consolidating FG VIEs on Net Income

and Shareholders’ Equity



	Third Quarter						Nine Months
	2013			2012			2013			2012
	(in millions)
Net earned premiums	$	(14	)	$	(17	)	$	(47	)	$	(50	)
Net investment income	(3		)	(3		)	(10		)	(9		)
Net realized investment gains (losses)	0			0			2			4
Fair value gains (losses) on FG VIEs	40			34			253			161
Loss and LAE	11			2			26			14
Total pretax effect on net income	34			16			224			120
Less: tax provision (benefit)	12			5			78			42
Total effect on net income (loss)	$	22		$	11		$	146		$	78



	As of September 30, 2013			As of December 31, 2012
	(in millions)
Total (decrease) increase on shareholders’ equity	$	(209	)	$	(348	)

Fair value gains (losses) on FG VIEs represent the net change in fair value on the consolidated FG VIEs’ assets and liabilities. During Third Quarter 2013, the Company recorded a pre-tax net fair value gain of consolidated FG VIEs of $40 million. The gain was primarily driven by price depreciation on the Company’s FG VIE liabilities. During the quarter, market participants gave less value to the guarantee provided by monoline insurers as a result of exposure to specific countries. The primary driver of the $253 million pre-tax fair value gain of consolidated FG VIEs during Nine Months 2013 was a result of R&W benefits received on several VIEs as a result of settlements with various counterparties during the first and second quarters. These settlements resulted in a gain of $213 million. During Third Quarter 2013, one of the Company's financial guaranty insurance policies was canceled, resulting in deconsolidation of one FG VIE. During the first half of the year the Company signed an agreement that resulted in the deconsolidation of two FG VIEs.

During Third Quarter 2012, the Company recorded a pre-tax net fair value gain of consolidated FG VIEs of $34 million. While prices appreciated slightly during the period on the Company's FG VIE assets and liabilities, the gain for Third Quarter 2012 was primarily driven by large principal paydowns made on the Company's FG VIE assets. This was also the primary driver of the $161 million pre-tax fair value gain of consolidated FG VIEs during Nine Months 2012. The majority of this gain, $163 million, is a result of a R&W settlement with Deutsche Bank that closed during second quarter 2012.

Non-Consolidated VIEs

To date, the Company’s analyses have indicated that it does not have a controlling financial interest in any other VIEs and, as a result, they are not consolidated in the consolidated financial statements. The Company’s exposure provided through its financial guaranties with respect to debt obligations of special purpose entities is included within net par outstanding in Note 3, Outstanding Exposure.