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Financial Guarantee Insurance Contracts
 3 Months Ended
Mar. 31, 2014
Insurance [Abstract]  
Financial Guarantee Insurance Contracts
FINANCIAL GUARANTEE INSURANCE CONTRACTS
Amounts presented in this Note relate only to Ambac’s non-derivative insurance business for insurance policies issued to beneficiaries, including VIEs, for which we do not consolidate the VIE.
Net Premiums Earned:
Gross premiums are received either upfront (typical of public finance obligations) or in installments (typical of structured finance obligations). For premiums received upfront, an unearned premium revenue (“UPR”) liability is established, which is initially recorded as the cash amount received. For installment premium transactions, a premium receivable asset and offsetting UPR liability is initially established in an amount equal to: (i) the present value of future contractual premiums due (the “contractual” method) or (ii) if the underlying insured obligation is a homogenous pool of assets which are contractually prepayable, the present value of premiums to be collected over the expected life of the transaction (the “expected” method). An appropriate risk-free rate corresponding to the weighted average life of each policy and currency is used to discount the future premiums contractually due or expected to be collected. For example, U.S. dollar exposures are discounted using U.S. Treasury rates while exposures denominated in a foreign currency are discounted using the appropriate risk-free rate for the respective currency. The weighted average risk-free rate at March 31, 2014 and December 31, 2013, was 2.9% and 3.0%, respectively, and the weighted average period of future premiums used to estimate the premium receivable at March 31, 2014 and December 31, 2013, was 9.7 years and 9.6 years, respectively.
Insured obligations consisting of homogeneous pools for which Ambac uses expected future premiums to estimate the premium receivable and UPR include residential mortgage-backed securities. As prepayment assumptions change for homogenous pool transactions, or if there is an actual prepayment for a “contractual” method installment transaction, the related premium receivable and UPR are adjusted in equal and offsetting amounts with no immediate effect on earnings using new premium cash flows and the then current risk-free rate.
Generally, the priority for the payment of financial guarantee premiums to Ambac, as required by the bond indentures of the insured obligations, is very senior in the waterfall. Additionally, in connection with the allocation of certain liabilities to the Segregated Account, trustees are required under the Segregated Account Rehabilitation Plan and related court orders to continue to pay installment premiums, notwithstanding the Segregated Account Rehabilitation Proceedings. In evaluating the credit quality of the premium receivables, management evaluates the transaction waterfall structures and the internal ratings of the transactions underlying the premium receivables. As of March 31, 2014 and December 31, 2013, approximately 45% and 44% of the premium receivables related to transactions with non-investment grade internal ratings, comprised mainly of non-investment grade RMBS, student loan transactions and a certain asset-backed transaction, which comprised 6%, 7%, and 17% of the total premium receivables at March 31, 2014 and 7%, 7% and 17% of the total premium receivables at December 31, 2013, respectively. At March 31, 2014 and December 31, 2013, $16,336 and $15,262, respectively, of premium receivables were deemed uncollectable. Past due premiums on policies insuring non-investment grade obligations amounted to less than $500 at March 31, 2014.
Below is the gross premium receivable roll-forward (direct and assumed contracts) for the affected periods:
 
Successor Ambac
 
 
Predecessor Ambac
 
Period from January 1
through March 31, 2014
 
 
Period from January 1
through March 31, 2013
Beginning premium receivable
$
1,453,021

 
 
$
1,620,621

Premium receipts
(33,128
)
 
 
(35,115
)
Adjustments for changes in expected life of homogeneous pools and actual changes to contractual cash flows
(15,062
)
 
 
(14,524
)
Accretion of premium receivable discount
10,370

 
 
11,190

Uncollectible premiums
(1,074
)
 
 
(201
)
Other adjustments (including foreign exchange)
3,987

 
 
(38,873
)
Ending premium receivable
$
1,418,114

 
 
$
1,543,098


 
Similar to gross premiums, premiums ceded to reinsurers are paid either upfront or in installments. Premiums ceded to reinsurers reduce the amount of premiums earned by Ambac from its financial guarantee insurance policies.
When a bond issue insured by Ambac Assurance has been retired, including those retirements due to refundings or calls, any remaining UPR is recognized at that time to the extent the financial guarantee contract is legally extinguished, causing accelerated premium revenue. For installment premium paying transactions, the recognition of any remaining UPR is offset by the reduction of the related premium receivable to zero (as it will not be collected as a result of the retirement), which may cause negative accelerated premium revenue. Successor Ambac’s accelerated premium revenue for retired obligations for the three months ended March 31, 2014 was $25,114. Predecessor Ambac’s accelerated premium revenue for retired obligations for the three months ended March 31, 2013 was $29,360. Certain obligations insured by Ambac have been legally defeased whereby government securities are purchased by the issuer with the proceeds of a new bond issuance, or less frequently with other funds of the issuer, and held in escrow (a pre-refunding). The principal and interest received from the escrowed securities are then used to retire the Ambac-insured obligations at a future date either to their maturity date or a specified call date. Ambac has evaluated the provisions in certain financial guarantee insurance policies issued on legally defeased obligations and determined those insurance policies have not been legally extinguished and, therefore, premium revenue recognition has not been accelerated.
The effect of reinsurance on premiums written and earned was as follows:
 
 
Successor Ambac
 
 
Predecessor Ambac
 
Three months ended March 31, 2014
 
 
Three months ended March 31, 2013
 
Written
 
Earned
 
 
Written
 
Earned
Direct
$
(5,766
)
 
$
86,183

 
 
$
(3,530
)
 
$
107,079

Assumed
—

 
68

 
 
—

 
24

Ceded
456

 
3,704

 
 
(1,014
)
 
6,847

Net premiums
$
(6,222
)
 
$
82,547

 
 
$
(2,516
)
 
$
100,256

The table below summarizes the future gross undiscounted premiums to be collected, and future premiums earned, net of reinsurance by Successor Ambac at March 31, 2014:
 
 
Future premiums
to be collected (1)
 
Future expected
premiums to
be earned, net of reinsurance (1)
 
 
Three months ended:
 
 
 
June 30, 2014
$
30,303

 
$
46,925

September 30, 2014
34,189

 
45,450

December 31, 2014
31,942

 
44,000

Twelve months ended:
 
 
 
December 31, 2015
127,738

 
164,127

December 31, 2016
121,100

 
151,279

December 31, 2017
114,752

 
140,766

December 31, 2018
109,588

 
131,819

Five years ended:
 
 
 
December 31, 2023
488,119

 
548,548

December 31, 2028
373,791

 
375,657

December 31, 2033
250,704

 
225,360

December 31, 2038
120,724

 
101,581

December 31, 2043
41,501

 
34,429

December 31, 2048
12,595

 
12,126

December 31, 2053
2,262

 
3,334

December 31, 2058
31

 
83

Total
$
1,859,339

 
$
2,025,484

 
(1)
Future premiums to be collected relates to the discounted premium receivable asset recorded on Ambac's balance sheet. Future premiums to be earned, net of reinsurance relate to the unearned premium liability and deferred ceded premium asset recorded on Ambac’s balance sheet. The use of contractual lives for many bond types which do not have homogeneous pools of underlying collateral is required in the calculation of the premium receivable as described above, which results in a higher premium receivable balance than if expected lives were considered. If installment paying policies are retired early, premiums reflected in the premium receivable asset and amounts reported in the above table for such policies may not be collected in the future.
Loss and Loss Expense Reserves:
A loss reserve is recorded on the balance sheet on a policy-by-policy basis for the excess of: (a) unpaid claims plus the present value of expected net cash flows required to be paid under an insurance contract, over (b) the UPR for that contract. Below is the loss reserve roll-forward, net of subrogation recoverable and reinsurance, for the affected periods:
 
Successor Ambac
 
 
Predecessor Ambac
 
Period from January 1
through March 31, 2014
 
 
Period from
January 1 through
March 31, 2013
Beginning loss and loss expense reserves, net of subrogation recoverable, gross of reinsurance
$
5,470,234

 
 
$
6,122,140

Less reinsurance on loss and loss expense reserves
122,357

 
 
147,409

Beginning balance of loss and loss expense reserves, net of subrogation recoverable and reinsurance
$
5,347,877

 
 
$
5,974,731

Changes in the loss and loss expense reserves due to:

 
 

Current year:


 
 


Establishment of new loss and loss expense reserves, gross of RMBS subrogation and net of reinsurance
151

 
 
4,083

Claim and loss expense payments, net of subrogation and reinsurance
—

 
 
(58
)
Establishment of RMBS subrogation recoveries, net of reinsurance
—

 
 
(188
)
Total current year
151

 
 
3,837

Prior years:


 
 


Change in previously established loss and loss expense reserves, gross of RMBS subrogation and net of reinsurance
(117,692
)
 
 
(129,090
)
Claim and loss expense (payments)recoveries, net of subrogation and reinsurance
(9,375
)
 
 
12,365

Change in previously established RMBS subrogation recoveries, net of reinsurance
(18,331
)
 
 
34,617

Total prior years
(145,398
)
 
 
(82,108
)
Net change in loss and loss expense reserves
(145,247
)
 
 
(78,271
)
Ending loss and loss expense reserves, net of subrogation recoverable and reinsurance
$
5,202,630

 
 
$
5,896,460

Add reinsurance on loss and loss expense reserves
111,303

 
 
148,749

Ending loss and loss expense reserves, net of subrogation recoverable, gross of reinsurance
$
5,313,933

 
 
$
6,045,209


The positive development in loss reserves established in prior years for the three months ended March 31, 2014 was primarily due to improved performance of the RMBS portfolio and higher commutation probabilities for student loan exposures, including with regards to student loan positions held within our investment portfolio. The positive development in loss reserves established in prior years for the three months ended March 31, 2013 was primarily due to improved performance of the RMBS portfolio.
The net change in net loss and loss expense reserves are included in losses and loss expenses in the Consolidated Statement of Total Comprehensive Income. For Successor Ambac, reinsurance recoveries of losses included in losses and loss expenses in the Consolidated Statements of Total Comprehensive Income were $10,559, an expense for the three months ended March 31, 2014. For Predecessor Ambac, reinsurance recoveries of losses included in losses and loss expenses in the Consolidated Statements of Total Comprehensive Income were $3,881, a benefit for the three months ended March 31, 2013.
The tables below summarize information related to policies currently included in Ambac’s loss reserves or subrogation recoverable at March 31, 2014 and December 31, 2013. The weighted average risk-free rate used to discount loss reserves at March 31, 2014 and December 31, 2013 was 2.9% and 3.2%, respectively.
Successor Ambac – Surveillance Categories (at March 31, 2014)
 
I/SL
 
IA
 
II
 
III
 
IV
 
V
 
Total
Number of policies
27

 
29

 
66

 
70

 
171

 
1

 
364

Remaining weighted-average contract period (in years)
12

 
13

 
16

 
19

 
11

 
6

 
14

Gross insured contractual payments outstanding:
 
 
 
 
 
 
 
 
 
 
 
 
 
Principal
$
760,825

 
$
964,929

 
$
4,057,893

 
$
5,232,627

 
$
10,993,947

 
$
47

 
$
22,010,268

Interest
415,417

 
485,353

 
2,765,425

 
2,168,384

 
2,460,360

 
19

 
8,294,958

Total
$
1,176,242

 
$
1,450,282

 
$
6,823,318

 
$
7,401,011

 
$
13,454,307

 
$
66

 
$
30,305,226

Gross undiscounted claim liability
$
5,408

 
$
17,697

 
$
245,484

 
$
2,616,809

 
$
7,861,495

 
$
62

 
$
10,746,955

Discount, gross claim liability
(747
)
 
(1,456
)
 
(29,272
)
 
(1,006,627
)
 
(1,027,085
)
 
(3
)
 
(2,065,190
)
Gross claim liability before all subrogation and before reinsurance
$
4,661

 
$
16,241

 
$
216,212

 
$
1,610,182

 
$
6,834,410

 
$
59

 
$
8,681,765

Less:
 
 
 
 
 
 
 
 
 
 
 
 
 
Gross RMBS subrogation (1)
—

 
—

 
—

 
(2,513
)
 
(2,232,718
)
 
—

 
(2,235,231
)
Discount, RMBS subrogation
—

 
—

 
—

 
9

 
10,927

 
—

 
10,936

Discounted RMBS subrogation, before reinsurance
—

 
—

 
—

 
(2,504
)
 
(2,221,791
)
 
—

 
(2,224,295
)
Less:
 
 
 
 
 
 
 
 
 
 
 
 
 
Gross other subrogation (2)
—

 
—

 
(22,213
)
 
(117,755
)
 
(695,971
)
 
—

 
(835,939
)
Discount, other subrogation
—

 
—

 
9,694

 
33,024

 
45,005

 
—

 
87,723

Discounted other subrogation, before reinsurance
—

 
—

 
(12,519
)
 
(84,731
)
 
(650,966
)
 
—

 
(748,216
)
Gross claim liability, net of all subrogation and discounts, before reinsurance
$
4,661

 
$
16,241

 
$
203,693

 
$
1,522,947

 
$
3,961,653

 
$
59

 
$
5,709,254

Less: Unearned premium reserves
(3,195
)
 
(9,270
)
 
(108,203
)
 
(275,241
)
 
(99,097
)
 
—

 
(495,006
)
Plus: Loss adjustment expenses reserves
—

 
11

 
2,275

 
1,462

 
95,937

 
—

 
99,685

Claim liability reported on Balance Sheet, before reinsurance (3) (4)
$
1,466

 
$
6,982

 
$
97,765

 
$
1,249,168

 
$
3,958,493

 
$
59

 
$
5,313,933

Reinsurance recoverable reported on Balance Sheet
$
55

 
$
872

 
$
2,795

 
$
110,712

 
$
(2,992
)
 
$
—

 
$
111,442

 
(1)
RMBS subrogation represents Ambac’s estimate of subrogation recoveries from RMBS transaction sponsors for representation and warranty breaches.
(2)
Other subrogation represents subrogation, including subrogation from RMBS transactions, other than subrogation as defined in (1) above.
(3)
Claim liability reported on the Balance Sheet, before reinsurance includes unpaid claims of $3,962,531.
(4)
Claim liability reported on the Balance Sheet, before reinsurance is included in the Consolidated Balance Sheets as follows:
Losses and loss expense reserve (net of potential subrogation recoveries of $1,803,582)
$
5,826,168

Subrogation recoverable (includes gross potential recovery of $1,168,929)
(512,235
)
 
$
5,313,933


Successor Ambac – Surveillance Categories (at December 31, 2013)
 
I/SL
 
IA
 
II
 
III
 
IV
 
V
 
Total
Number of policies
18

 
23

 
52

 
76

 
169

 
1

 
339

Remaining weighted-average contract period (in years)
13

 
19

 
17

 
19

 
11

 
6

 
14

Gross insured contractual payments outstanding:
 
 
 
 
 
 
 
 
 
 
 
 
 
Principal
$
834,708

 
$
1,125,284

 
$
3,464,420

 
$
5,597,387

 
$
11,184,943

 
$
47

 
$
22,206,789

Interest
506,903

 
871,751

 
2,130,271

 
2,331,222

 
2,556,968

 
18

 
8,397,133

Total
$
1,341,611

 
$
1,997,035

 
$
5,594,691

 
$
7,928,609

 
$
13,741,911

 
$
65

 
$
30,603,922

Gross undiscounted claim liability
$
7,447

 
$
54,398

 
$
221,321

 
$
3,029,891

 
$
7,963,137

 
$
65

 
$
11,276,259

Discount, gross claim liability
(1,225
)
 
(6,726
)
 
(32,630
)
 
(1,299,032
)
 
(1,112,829
)
 
(6
)
 
(2,452,448
)
Gross claim liability before all subrogation and before reinsurance
$
6,222

 
$
47,672

 
$
188,691

 
$
1,730,859

 
$
6,850,308

 
$
59

 
$
8,823,811

Less:
 
 
 
 
 
 
 
 
 
 
 
 
 
Gross RMBS subrogation (1)
—

 
—

 
—

 
(4,516
)
 
(2,211,333
)
 
—

 
(2,215,849
)
Discount, RMBS subrogation
—

 
—

 
—

 
15

 
9,236

 
—

 
9,251

Discounted RMBS subrogation, before reinsurance
—

 
—

 
—

 
(4,501
)
 
(2,202,097
)
 
—

 
(2,206,598
)
Less:
 
 
 
 
 
 
 
 
 
 
 
 
 
Gross other subrogation (2)
—

 
—

 
(20,367
)
 
(116,145
)
 
(710,187
)
 
—

 
(846,699
)
Discount, other subrogation
—

 
—

 
9,522

 
36,125

 
45,666

 
—

 
91,313

Discounted other subrogation, before reinsurance
—

 
—

 
(10,845
)
 
(80,020
)
 
(664,521
)
 
—

 
(755,386
)
Gross claim liability, net of all subrogation and discounts, before reinsurance
$
6,222

 
$
47,672

 
$
177,846

 
$
1,646,338

 
$
3,983,690

 
$
59

 
$
5,861,827

Less: Unearned premium reserves
(4,060
)
 
(22,901
)
 
(95,550
)
 
(280,245
)
 
(100,228
)
 
—

 
(502,984
)
Plus: Loss adjustment expenses reserves
—

 
11

 
2,257

 
$
1,658

 
107,465

 
—

 
111,391

Claim liability reported on Balance Sheet, before reinsurance (3) (4)
$
2,162

 
$
24,782

 
$
84,553

 
$
1,367,751

 
$
3,990,927

 
$
59

 
$
5,470,234

Reinsurance recoverable reported on Balance Sheet
$
146

 
$
2,271

 
$
2,273

 
$
119,795

 
$
(3,236
)
 
$
—

 
$
121,249

(1)
RMBS subrogation represents Ambac’s estimate of subrogation recoveries from RMBS transaction sponsors for representation and warranty breaches.
(2)
Other subrogation represents subrogation, including subrogation from RMBS transactions, other than subrogation as defined in (1) above.
(3)
Claim liability reported on the Balance Sheet, before reinsurance includes unpaid claims of $3,904,315.
(4)
Claim liability reported on the Balance Sheet, before reinsurance is included in the Consolidated Balance Sheets as follows:
Losses and loss expense reserve (net of potential subrogation recoveries of $1,797,805)
$
5,968,712

Subrogation recoverable (includes gross potential recovery of $1,164,179)
(498,478
)
 
$
5,470,234



Ambac records estimated subrogation recoveries for breaches of representations and warranties by sponsors of certain RMBS transactions utilizing Adverse and Random Sample approaches. Ambac has recorded RMBS subrogation recoveries of $2,224,295 ($2,201,983 net of reinsurance) and $2,206,598 ($2,183,652 net of reinsurance) at March 31, 2014 and December 31, 2013, respectively. The balance of RMBS subrogation recoveries and the related claim liabilities, by estimation approach, at March 31, 2014 and December 31, 2013, are as follows:
 
Successor Ambac - March 31, 2014
 
 
 
Gross loss reserve
before subrogation recoveries (1)
 
Subrogation recoveries (2)  (3)
 
Gross loss reserve
after subrogation recoveries
Approach
Count
 
 
 
Adverse samples
27
 
$
2,009,647

 
$
(1,218,681
)
 
$
790,966

Random samples
21
 
1,076,695

 
(1,005,614
)
 
71,081

Totals
48
 
$
3,086,342

 
$
(2,224,295
)
 
$
862,047

 
 
Successor Ambac - December 31, 2013
 
 
 
Gross loss reserve
before subrogation recoveries (1)
 
Subrogation recoveries (2) (3)
 
Gross loss reserve
after subrogation recoveries
Approach
Count
 
 
 
Adverse samples
27
 
$
2,084,911

 
$
(1,252,773
)
 
$
832,138

Random samples
21
 
1,078,861

 
(953,825
)
 
125,036

Totals
48
 
$
3,163,772

 
$
(2,206,598
)
 
$
957,174

 
(1)
Includes unpaid claims on policies allocated to the Segregated Account.
(2)
The amount of recorded subrogation recoveries related to each securitization is limited to ever-to-date paid and unpaid losses plus projected losses for each policy. To the extent significant losses have been paid but not yet recovered, the recorded amount of RMBS subrogation recoveries may exceed the unpaid claims in addition to the expected future claims for a given policy. The net cash inflow for these policies is recorded as a “Subrogation recoverable” asset. For those transactions where the subrogation recovery is less than the sum of unpaid claims and the expected future claims, the net cash outflow for these policies is recorded as a “Losses and loss expense reserve” liability.
(3)
The sponsor’s repurchase obligation may differ depending on the terms of the particular transaction and the status of the specific loan, such as whether it is performing or has been liquidated or charged off. The estimated subrogation recovery for these transactions is based primarily on loan level data provided through trustee reports received in the normal course of our surveillance activities or provided by the sponsor. While this data may not include all the components of the sponsor’s contractual repurchase obligation we believe it is the best information available to estimate the subrogation recovery.
Below is the rollforward of RMBS subrogation, by estimation approach, for the affected periods:
 
Random
sample
 
Number of
transactions
 
Adverse
sample
 
Number of
transactions
 
Total
Successor Ambac:
 
 
 
 
 
 
 
 
 
Rollforward:
 
 
 
 
 
 
 
 
 
Discounted RMBS subrogation (gross of reinsurance) at January 1, 2014
$
953,825

 
21

 
$
1,252,773

 
27

 
$
2,206,598

Changes recognized in 2014:


 


 


 


 


Additional transactions reviewed
—

 
n/a

 
—

 
n/a

 
—

Additional adverse sample loans reviewed
—

 
n/a

 
—

 
n/a

 
—

Adverse loans repurchased by the sponsor
—

 
n/a

 
—

 
n/a

 
—

Impact of Sponsor Actions (1)
—

 
n/a

 
—

 
n/a

 
—

All other changes (2) 
51,789

 
n/a

 
(34,092
)
 
n/a

 
17,697

Discounted RMBS subrogation (gross of reinsurance) at March 31, 2014
$
1,005,614

 
21

 
$
1,218,681

 
27

 
$
2,224,295

 
Random
sample
 
Number of
transactions
 
Adverse
sample
 
Number of
transactions
 
Total
Predecessor Ambac
 
 
 
 
 
 
 
 
 
Discounted RMBS subrogation (gross of reinsurance) at January 1, 2013
$
1,080,408

 
22

 
$
1,442,817

 
27

 
$
2,523,225

Changes recognized in 2013:
 
 
 
 
 
 
 
 
 
Additional transactions reviewed
—

 
n/a

 
—

 
n/a

 
—

Additional adverse sample loans reviewed
—

 
n/a

 
—

 
n/a

 
—

Adverse loans repurchased by the sponsor
—

 
n/a

 
—

 
n/a

 
—

Impact of sponsor actions (1)
(54,195
)
 
(2
)
 
—

 
n/a

 
(54,195
)
All other changes (2) 
(22,570
)
 
n/a

 
40,909

 
2

 
18,339

Discounted RMBS subrogation (gross of reinsurance) at March 31, 2013
$
1,003,643

 
20

 
$
1,483,726

 
29

 
$
2,487,369

 
 
(1)
Sponsor actions include loan repurchases, direct payments to Ambac, and other contributions from sponsors.
(2)
Other changes which may impact RMBS subrogation recoveries include changes in actual or projected collateral performance, changes in the creditworthiness of a sponsor, and/or the projected timing of recoveries. For the three months ended March 31, 2013, Predecessor Ambac added 2 transactions to the Adverse Sample population; however, the impacts on RMBS subrogation disclosed in the Adverse Sample column relate to those, as well as other transactions.

Insurance intangible asset:
The insurance intangible amortization expense for the three months ended March 31, 2014 was $31,714 and is included in insurance intangible amortization on the Consolidated Statements of Total Comprehensive Income for Successor Ambac. As of March 31, 2014 and December 31, 2013, the insurance intangible asset was $1,570,070 and $1,597,965, respectively. The March 31, 2014 and December 31, 2013 insurance intangible asset is net of accumulated amortization of $132,688 and $100,767, respectively.
The estimated future amortization expense for the insurance intangible asset is as follows:
2014
$
98,796

2015
119,906

2016
109,388

2017
100,904

2018
94,857

Thereafter
1,046,219