Reinsurance and Other Monoline Exposures

The Company assumes exposure on insured obligations (“Assumed Business”) and cedes portions of its exposure on obligations it has insured (“Ceded Business”) in exchange for premiums, net of ceding commissions.

Assumed and Ceded Business

The Company is party to reinsurance agreements as a reinsurer to other monoline financial guaranty insurance companies. Under these relationships, the Company assumes a portion of the ceding company’s insured risk in exchange for a premium. The Company may be exposed to risk in this portfolio in that the Company may be required to pay losses without a corresponding premium in circumstances where the ceding company is experiencing financial distress and is unable to pay premiums. The Company’s facultative and treaty agreements are generally subject to termination:

(a) at the option of the primary insurer if the Company fails to maintain certain financial, regulatory and rating agency criteria that are equivalent to or more stringent than those the Company is otherwise required to maintain for its own compliance with state mandated insurance laws and to maintain a specified financial strength rating for the particular insurance subsidiary, or

(b) upon certain changes of control of the Company.

Upon termination under these conditions, the Company may be required (under some of its reinsurance agreements) to return to the primary insurer all unearned premiums calculated on a statutory basis of accounting, less ceding commissions, attributable to reinsurance ceded pursuant to such agreements after which the Company would be released from liability with respect to the Assumed Business. Upon the occurrence of the conditions set forth in (a) above, whether or not an agreement is terminated, the Company may be required to obtain a letter of credit or alternative form of security to collateralize its obligation to perform under such agreement or it may be obligated to increase the level of ceding commission paid.

With respect to a significant portion of the Company’s in-force financial guaranty Assumed Business, due to the downgrade of AG Re to A1, subject to the terms of each policy, the ceding company may have the right to recapture Assumed Business ceded to AG Re and assets representing substantially all of the statutory unearned premium (net of ceding commissions) and loss reserves (if any) associated with that business. As of June 30, 2012, if all of AG Re’s Assumed Business was recaptured, it would result in a corresponding one-time reduction to net income of approximately $0.8 million. In the case of AGC, some of its in force financial guaranty Assumed Business is subject to recapture at AGC’s current ratings. Subject to the terms of each reinsurance agreement, upon recapture the ceding company typically is owed assets representing substantially all of the statutory unearned premium (net of ceding commissions) and loss reserves (if any) associated with that business. As of June 30, 2012, if all of AGC’s Assumed Business was recaptured, it would result in a corresponding one-time reduction to net income of approximately $10.1 million.

The Company has Ceded Business to non-affiliated companies to limit its exposure to risk. Under these relationships, the Company cedes a portion of its insured risk in exchange for a premium paid to the reinsurer. The Company remains primarily liable for all risks it directly underwrites and is required to pay all gross claims. It then seeks reimbursement from the reinsurer for its proportionate share of claims. The Company may be exposed to risk for this exposure if it were required to pay the gross claims and not be able to collect ceded claims from an assuming company experiencing financial distress. A number of the financial guaranty insurers to which the Company has ceded par have experienced financial distress and been downgraded by the rating agencies as a result. In addition, state insurance regulators have intervened with respect to some of these insurers. The Company’s ceded contracts generally allow the Company to recapture Ceded Business after certain triggering events, such as reinsurer downgrades.

Over the past several years, the Company has entered into several commutations in order to reassume previously ceded books of business from BIG financial guaranty companies and its other reinsurers. The Company has also cancelled assumed reinsurance contracts. There were no commutations in Second Quarter 2012. These commutations of ceded and cancellations of assumed business resulted in gains of $8.1 million, $83.3 million and $32.2 million for Second Quarter 2011 and Six Months 2012 and 2011, respectively, which were recorded in other income. While certain Ceded Business has been reassumed, the Company still has significant Ceded Business with third parties.

Net Effect of Commutations of Ceded

Reinsurance Contracts



	Second Quarter					Six Months
	2012		2011			2012		2011
	(in millions)
Increase (decrease) in net unearned premium reserve	$	—	$	(22.4	)	$	106.1	$	(20.1	)
Increase (decrease) in net par outstanding	—		(1,045		)	19,073		(780		)

Effect of Reinsurance on Statement of Operations



	Second Quarter						Six Months
	2012			2011			2012			2011
	(in millions)
Premiums Written:
Direct	$	45.0		$	26.9		$	106.9		$	57.4
Assumed(1)	(14.3		)	(9.9		)	12.2			(51.9		)
Ceded(2)	0.8			0.4			87.8			4.4
Net	$	31.5		$	17.4		$	206.9		$	9.9
Premiums Earned:
Direct	$	245.0		$	238.6		$	451.1		$	514.9
Assumed	12.0			21.0			26.2			31.0
Ceded	(37.7		)	(29.6		)	(64.3		)	(61.9		)
Net	$	219.3		$	230.0		$	413.0		$	484.0
Loss and LAE:
Direct	$	91.8		$	129.4		$	400.5		$	136.5
Assumed	45.7			7.2			63.0			(5.8		)
Ceded	(15.0		)	(12.7		)	(94.2		)	(32.3		)
Net	$	122.5		$	123.9		$	369.3		$	98.4

____________________

(1) Negative assumed premiums written were due to changes in expected debt service schedules.

(2) Positive ceded premiums written were due to commutations and changes in expected debt service schedules.

Reinsurer Exposure

In addition to assumed and ceded reinsurance arrangements, the Company may also have exposure to some financial guaranty reinsurers (i.e., monolines) in other areas. Second-to-pay insured par outstanding represents transactions the Company has insured that were previously insured by other monolines. The Company underwrites such transactions based on the underlying insured obligation without regard to the primary insurer. Another area of exposure is in the investment portfolio where the Company holds fixed maturity securities that are wrapped by monolines and whose value may decline based on the rating of the monoline. At June 30, 2012, based on fair value, the Company had $713.9 million of fixed maturity securities in its investment portfolio wrapped by National Public Finance Guarantee Corporation, $538.5 million by Ambac and $39.9 million by other guarantors.

Exposure by Reinsurer



	Ratings at August 1, 2012		Par Outstanding as of June 30, 2012
Reinsurer	Moody’s Reinsurer Rating	S&P Reinsurer Rating	Ceded Par Outstanding(1)		Second-to- Pay Insured Par Outstanding		Assumed Par Outstanding
	(dollars in millions)
American Overseas Reinsurance Company Limited(2)	WR(3)	WR	$	10,716	$	—	$	24
Tokio	Aa3(4)	AA-(4)	8,995		—		937
Radian	Bal	B+	5,441		45		1,776
Syncora Guarantee Inc.	Ca	WR	4,082		2,079		213
Mitsui Sumitomo Insurance Co. Ltd.	A1	A+	2,294		—		—
ACA Financial Guaranty Corp.	NR	WR	843		7		1
Swiss Reinsurance Co.	A1	AA-	458		—		—
Ambac	WR	WR	85		7,162		21,743
CIFG Assurance North America Inc.	WR	WR	65		258		5,821
MBIA Inc.	(5)	(5)	—		11,510		9,283
Financial Guaranty Insurance Co.	WR	WR	—		3,711		2,095
Other	Various	Various	1,011		2,005		96
Total			$	33,990	$	26,777	$	41,989

____________________

(1) Includes $4,405 million in ceded par outstanding related to insured credit derivatives.

(2)Formerly RAM Reinsurance Company Ltd.

(3)Represents “Withdrawn Rating.”

(4)The Company has structural collateral agreements satisfying the triple-A credit requirement of S&P and/or Moody’s.

(5)MBIA Inc. includes various subsidiaries which are rated BBB by S&P and Baa2, B3, WR and NR by Moody’s.

Amounts Due (To) From Reinsurers



	As of June 30, 2012
	Assumed Premium Receivable, net of Commissions		Ceded Premium Payable, net of Commissions			Assumed Expected Loss and LAE			Ceded Expected Loss and LAE
	(in millions)
American Overseas Reinsurance Company Limited	$	—	$	(12.2	)	$	—		$	23.2
Tokio	—		(25.2		)	—			88.1
Radian	—		(18.8		)	—			28.0
Syncora Guarantee Inc.	—		(38.0		)	0.5			0.6
Mitsui Sumitomo Insurance Co. Ltd.	—		(4.6		)	—			28.3
Swiss Reinsurance Co.	—		(3.4		)	—			22.7
Ambac	81.7		—			(100.3		)	—
CIFG Assurance North America Inc.	0.1		—			—			1.2
MBIA Inc.	0.5		—			(16.4		)	—
Financial Guaranty Insurance Co.	9.9		—			(27.1		)	—
Other	—		(43.4		)	—			—
Total	$	92.2	$	(145.6	)	$	(143.3	)	$	192.1

Excess of Loss Reinsurance Facility

On January 22, 2012, AGC and AGM entered into an aggregate excess of loss reinsurance facility, effective as of January 1, 2012. At AGC’s and AGM’s option, the facility will cover losses occurring from January 1, 2012 through December 31, 2019 or from January 1, 2013 through December 31, 2020. The contract terminates, unless AGC and AGM choose to extend it, on January 1, 2014. The facility covers U.S. public finance credits insured or reinsured by AGC and AGM as of September 30, 2011, excluding credits that were rated non-investment grade as of December 31, 2011 by Moody’s or S&P or internally by AGC or AGM and subject to certain per credit limits. The facility attaches when AGC’s or AGM’s net losses (net of AGC’s and AGM other reinsurance, other than pooling reinsurance provided to AGM by AGM’s subsidiaries and net of recoveries) exceed in the aggregate $2 billion and covers a portion of the next $600 million of losses, with the reinsurers assuming pro rata in the aggregate $435 million of the $600 million of losses and AGC and AGM jointly retaining the remaining $165 million of losses. The reinsurers are required to be rated at least AA-(Stable Outlook) through December 31, 2014 or to post collateral sufficient to provide AGM and AGC with the same reinsurance credit as reinsurers rated AA-. AGM and AGC are obligated to pay the reinsurers their share of recoveries relating to losses during the coverage period in the covered portfolio. This obligation is secured by a pledge of the recoveries, which will be deposited into a trust for the benefit of the reinsurers. The Company has paid approximately $21.8 million of premiums during Six Months 2012. The remaining $21.8 million of premiums, which are due in January 2013, have been deposited into a trust for the benefit of the reinsurers as of June 30, 2012.

Re-Assumption and Reinsurance Agreements with Radian Asset Assurance Inc.

On January 24, 2012, AGM reassumed $12.9 billion of par it had previously ceded to Radian and reinsured approximately $1.8 billion of U.S. public finance par from Radian. The Company received a payment of $86 million from Radian for the re-assumption, which consisted 96% of public finance exposure and 4% of structured finance credits; additionally, the Company projects it will receive an incremental $1.9 million present value from future installment premiums. In connection with the reinsurance assumption, the Company received a payment of $22 million. Both the reassumed and reinsured portfolios were composed entirely of selected credits that met the Company’s underwriting standards.

Tokio Marine & Nichido Fire Insurance Co., Ltd. Agreement

Effective as of March 1, 2012, AGM and Tokio entered into a Commutation, Reassumption and Release Agreement for a portfolio consisting of approximately $6.2 billion in par of U.S. public finance exposures outstanding as of February 29, 2012. Tokio paid AGM the statutory unearned premium outstanding as of February 29, 2012 plus a commutation premium.