Determination of Fair Value:

When available, Ambac uses quoted active market prices specific to the financial instrument to determine fair value, and classifies such items within Level 1. The determination of fair value for financial instruments categorized in Level 2 or 3 involves judgment due to the complexity of factors contributing to the valuation. Third-party sources from which we obtain independent market quotes also use assumptions, judgments and estimates in

determining financial instrument values and different third parties may use different methodologies or provide different values for financial instruments. In addition, the use of internal valuation models may require assumptions about hypothetical or inactive markets. As a result of these factors, the actual trade value of a financial instrument in the market, or exit value of a financial instrument position by Ambac, may be significantly different from its recorded fair value.

Ambac’s financial instruments carried at fair value are mainly comprised of investments in fixed maturity securities, equity interests in pooled investment funds, derivative instruments, certain variable interest entity assets and liabilities and interests in Ambac sponsored special purpose entities. Valuation of financial instruments is performed by Ambac’s finance group using methods approved by senior financial management with consultation from risk management and portfolio managers as appropriate. Preliminary valuation results are discussed with portfolio managers quarterly to assess consistency with market transactions and trends as applicable. Market transactions such as trades or negotiated settlements of similar positions, if any, are reviewed to validate fair value model results. However, many of the financial instruments valued using significant unobservable inputs have very little or no observable market activity. Methods and significant inputs and assumptions used to determine fair values across portfolios are reviewed quarterly by senior financial management. Other valuation control procedures specific to particular portfolios are described further below.

Fixed Maturity Securities:

The fair values of fixed maturity investment securities are based primarily on market prices received from broker quotes or alternative pricing sources. Because many fixed maturity securities do not trade on a daily basis, pricing sources apply available market information through processes such as matrix pricing to calculate fair value. Such prices generally consider a variety of factors, including recent trades of the same and similar securities. In those cases, the items are classified within Level 2. For those fixed maturity investments where quotes were not available or cannot be reasonably corroborated, fair values are based on internal valuation models. Key inputs to the internal valuation models generally include maturity date, coupon and yield curves for asset-type and credit rating characteristics that closely match those characteristics of the specific investment securities being valued. Items valued using valuation models are classified according to the lowest level input or value driver that is significant to the valuation. Thus, an item may be classified in Level 3 even though there may be significant inputs that are readily observable. Longer (shorter) expected maturities or higher (lower) yields used in the valuation model will, in isolation, result in decreases (increases) in fair value. Generally, lower credit ratings or longer expected maturities will be accompanied by higher yields used to value a security. At June 30, 2021, approximately 2%, 95% and 3% of the fixed maturity investment portfolio (excluding variable interest entity investments) was valued using broker quotes, alternative pricing sources and internal valuation models, respectively. At December 31, 2020, approximately 2%, 95% and 3% of the fixed maturity investment portfolio (excluding variable interest entity investments) was valued using broker quotes, alternative pricing sources and internal valuation models, respectively.

Ambac performs various review and validation procedures to quoted and modeled prices for fixed maturity securities, including price variance analyses, missing and static price reviews, overall valuation analysis by portfolio managers and finance managers and reviews associated with our ongoing impairment analysis. Unusual prices identified through these procedures will be evaluated further against alternative third party quotes (if available), internally modeled prices and/or other relevant data,

and the pricing source values will be challenged as necessary. Price challenges generally result in the use of the pricing source’s quote as originally provided or as revised by the source following their internal diligence process. A price challenge may result in a determination by either the pricing source or Ambac management that the pricing source cannot provide a reasonable value for a security or cannot adequately support a quote, in which case Ambac would resort to using either other quotes or internal models. Results of price challenges are reviewed by portfolio managers and finance managers.

Information about the valuation inputs for fixed maturity securities classified as Level 3 is included below:

Other asset-backed securities: This security is a subordinated tranche of a securitization collateralized by Ambac-insured military housing bonds. The fair value classified as Level 3 was $80 and $78 at June 30, 2021 and December 31, 2020, respectively. Fair value was calculated using a discounted cash flow approach with expected future cash flows discounted using a yield consistent with the security type and rating. Significant inputs for the valuation at June 30, 2021 and December 31, 2020 include the following:


June 30, 2021:
a. Coupon rate:			5.97%
b. Average Life:			14.48 years
c. Yield:			10.00%

December 31, 2020:
a. Coupon rate:			5.97%
b. Average Life:			14.83 years
c. Yield:			10.50%

Other Investments:

Other investments primarily relate to investments in pooled investment funds. The fair value of pooled investment funds is determined using dealer quotes or alternative pricing sources when such investments have readily determinable fair values. When fair value is not readily determinable, pooled investment funds are valued using NAV as a practical expedient as permitted under the Fair Value Measurement Topic of the ASC. Refer to Note 9. Investments for additional information about such investments in pooled funds that are reported at fair value using NAV as a practical expedient.

At December 31, 2020, other investments also included Ambac's equity interest in the Corolla Trust, a non-consolidated VIE created in connection with Ambac's monetization of AAC junior surplus notes. This equity interest was carried under the equity method and its fair value was internally calculated using a market approach classified as Level 3. As further described in Note 1. Background and Business Description, on January 22, 2021, AAC completed the Corolla Note Exchange transaction whereby it acquired 100% of the outstanding obligations and the owner trust certificate of, and subsequently dissolved, the Corolla Trust.

Derivative Instruments:

Ambac’s derivative instruments primarily comprise interest rate swaps, credit default swaps and exchange traded futures contracts. Fair value is determined based upon market quotes from independent sources, when available. When independent quotes are not available, fair value is determined using valuation models. These valuation models require market-driven inputs, including contractual terms, credit spreads and ratings on underlying referenced obligations, yield curves and tax-exempt interest ratios. The valuation of certain derivative contracts also require the use of data inputs and assumptions that are determined by management and are not readily observable in the market. Under the Fair Value Measurement Topic of the ASC, Ambac is required to consider its own credit risk when measuring the fair value of derivatives and other liabilities. Factors considered in estimating the amount of any Ambac credit valuation adjustment ("CVA") on such contracts include collateral posting provisions, right of set-off with the counterparty, the period of time remaining on the derivative and the pricing of recent terminations. The aggregate Ambac CVA impact reduced the fair value of derivative liabilities by less than a million dollars at both June 30, 2021 and December 31, 2020, respectively

Interest rate swaps that are not centrally cleared are valued using vendor-developed models that incorporate interest rates and yield curves that are observable and regularly quoted. These models provide the net present value of the derivatives based on contractual terms and observable market data. Generally, the need for counterparty (or Ambac) CVAs on interest rate derivatives is mitigated by the existence of collateral posting agreements under which adequate collateral has been posted. Certain of these derivative contracts entered into with financial guarantee customers are not subject to collateral posting agreements. Counterparty credit risk related to such customer derivative assets is included in our determination of their fair value.

Ambac's credit derivatives ("CDS") are valued using an internal model that uses traditional financial guarantee CDS pricing to calculate the fair value of the derivative contract based on the reference obligation's current pricing, remaining life and credit rating and Ambac's own credit risk. The model calculates the difference between the present value of the projected fees receivable under the CDS and our estimate of the fees a financial guarantor of comparable credit quality would charge to provide the same protection at the balance sheet date. Unobservable inputs used include Ambac's internal reference obligation credit ratings and remaining life, estimates of fees that would be charged to assume the credit derivative obligation and Ambac's CVA. Ambac is party to only one remaining credit derivative with an internal credit rating of AA at June 30, 2021. Ambac has not made any significant changes to its modeling techniques or related model inputs for the periods presented.

Financial Guarantees:

Fair value of net financial guarantees written represents our estimate of the cost to Ambac to completely transfer its insurance obligation to another market participant of comparable credit worthiness. In theory, this amount should be the same amount that another market participant of comparable credit worthiness would hypothetically charge in the marketplace, on a present value basis, to provide the same protection as of the balance sheet date. This fair value estimate of financial guarantees is presented on a net basis and includes direct and assumed contracts written, net of ceded reinsurance contracts.

Long-term Debt:

Long-term debt includes AAC surplus notes and junior surplus notes (cancelled in January 2021 as part of the Corolla Note Exchange as described in Note 1. Background and Business Description), the LSNI Ambac Note (refinanced by the Sitka AAC Note on July 6, 2021 as described in Note 1. Background and Business Description), Tier 2 Notes issued in connection with the Rehabilitation Exit Transactions and the Ambac UK debt issued in connection with the Ballantyne commutation. The fair values of surplus notes, LSNI Ambac Note and Tier 2 Notes are classified as Level 2. The fair value of junior surplus notes and Ambac UK debt are classified as Level 3.

Other Financial Assets and Liabilities:

Included in Other assets are Loans and Ambac’s equity interest in an Ambac sponsored VIE established to provide certain financial guarantee clients with funding for their debt obligations. The fair values of these financial assets are estimated based upon internal valuation models and are classified as Level 3.

Variable Interest Entity Assets and Liabilities:

The financial assets and liabilities of FG VIEs consolidated under the Consolidation Topic of the ASC consist primarily of fixed maturity securities and loans held by the VIEs, derivative instruments and notes issued by the VIEs which are reported as long-term debt. As described in Note 3. Variable Interest Entities, these FG VIEs are securitization entities which have liabilities and/or assets guaranteed by AAC or Ambac UK.

The fair values of FG VIE long-term debt are based on price quotes received from independent market sources when available. Such quotes are considered Level 2 and generally consider a variety of factors, including recent trades of the same and similar securities. For those instruments where quotes were not available or cannot be reasonably corroborated, fair values are based on internal valuation models. Comparable to the sensitivities of investments in fixed maturity securities described above, longer (shorter) expected maturities or higher (lower) yields used in the valuation model will, in isolation, result in decreases (increases) in fair value liability measurement for FG VIE long-term debt.

FG VIE derivative asset and liability fair values are determined using vendor-developed valuation models, which incorporated observable market data related to specific derivative contractual terms including interest rates, foreign exchange rates and yield curves.

The fair value of FG VIE fixed maturity securities and loan assets are generally based on Level 2 market price quotes received from independent market sources when available. Typically, FG VIE asset fair values are not readily available from market quotes and are estimated internally. Internal valuation of each FG VIE’s fixed maturity securities or loan assets are derived from the fair values of the notes issued by the respective VIE and the VIE’s derivatives, determined as described above, adjusted for the fair values of Ambac’s financial guarantees associated with the VIE. The fair value of financial guarantees consist of: (i) estimated future premium cash flows discounted at a rate consistent with that implicit in the fair value of the VIE’s liabilities and (ii) estimates of future claim payments discounted at a rate that includes Ambac’s own credit risk. Estimated future premium payments to be paid by the VIEs were discounted at a weighted average rate of 2.6% and 2.4% at June 30, 2021 and December 31, 2020, respectively. At June 30, 2021, the range of these discount rates was between 2.2% and 3.3%.

Additional Fair Value Information for Financial Assets and Liabilities Accounted for at Fair Value:

The following tables present the changes in the Level 3 fair value category for the periods presented in 2021 and 2020. Ambac classifies financial instruments in Level 3 of the fair value hierarchy when there is reliance on at least one significant unobservable input to the valuation model. In addition to these unobservable inputs, the valuation models for Level 3 financial instruments typically also rely on a number of inputs that are readily observable either directly or indirectly. Thus, the gains and losses presented below include changes in the fair value related to both observable and unobservable inputs.


Level 3 - Financial Assets and Liabilities Accounted for at Fair Value
							VIE Assets
	Investments(1)		Other Assets(2)		Derivatives		Investments		Loans		Total
Three Months Ended June 30, 2021:
Balance, beginning of period	$	76	$	1	$	65	$	3,103	$	2,948	$	6,194

Total gains/(losses) realized and unrealized:
Included in earnings	—		—		11		87		65		164
Included in other comprehensive income	4		—		—		5		5		14
Purchases	—		—		—		—		—		—
Issuances	—		—		—		—		—		—
Sales	—		—		—		—		—		—
Settlements	—		(1)		(2)		(19)		(76)		(98)



Balance, end of period	$	80	$	—	$	74	$	3,175	$	2,943	$	6,273
The amount of total gains/(losses) included in earnings attributable to the change in unrealized gains or losses relating to assets and liabilities still held at the reporting date	$	—	$	—	$	11	$	87	$	65	$	164
The amount of total gains/(losses) included in other comprehensive income attributable to the change in unrealized gains or losses relating to assets and liabilities still held at the reporting date	$	4	$	—	$	—	$	5	$	5	$	14

Three Months Ended June 30, 2020:
Balance, beginning of period	$	66	$	3	$	77	$	2,806	$	2,932	$	5,884

Total gains/(losses) realized and unrealized:
Included in earnings	—		—		11		128		(67)		72
Included in other comprehensive income	—		—		—		(11)		(11)		(22)
Purchases	—		—		—		—		—		—
Issuances	—		—		—		—		—		—
Sales	—		—		—		—		—		—
Settlements	—		—		(2)		(17)		(67)		(86)



Balance, end of period	$	66	$	2	$	86	$	2,907	$	2,787	$	5,848
The amount of total gains/(losses) included in earnings attributable to the change in unrealized gains or losses relating to assets and liabilities still held at the reporting date	$	—	$	—	$	10	$	128	$	(67)	$	71
The amount of total gains/(losses) included in other comprehensive income attributable to the change in unrealized gains or losses relating to assets and liabilities still held at the reporting date	$	—	$	—	$	—	$	(11)	$	(11)	$	(22)

(1) Investments classified as Level 3 consist of a single other asset-backed security.

(2) Other assets carried at fair value and classified as Level 3 relate to an equity interest in an Ambac sponsored VIE.



Level 3 - Financial Assets and Liabilities Accounted for at Fair Value
							VIE Assets
	Investments		Other Assets		Derivatives		Investments		Loans		Total
Six Months Ended June 30, 2021:
Balance, beginning of period	$	78	$	1	$	84	$	3,215	$	2,998	$	6,376

Total gains/(losses) realized and unrealized:
Included in earnings	1		—		(6)		(50)		74		18
Included in other comprehensive income	3		—		—		31		30		63
Purchases	—		—		—		—		—		—
Issuances	—		—		—		—		—		—
Sales	—		—		—		—		—		—
Settlements	(1)		(1)		(4)		(19)		(160)		(185)



Balance, end of period	$	80	$	—	$	74	$	3,175	$	2,943	$	6,273
The amount of total gains/(losses) included in earnings attributable to the change in unrealized gains or losses relating to assets and liabilities still held at the reporting date	$	1	$	—	$	(6)	$	(50)	$	74	$	18
The amount of total gains/(losses) included in other comprehensive income attributable to the change in unrealized gains or losses relating to assets and liabilities still held at the reporting date	$	3	$	—	$	—	$	31	$	30	$	63

Six Months Ended June 30, 2020:
Balance, beginning of period	$	72	$	3	$	66	$	2,957	$	3,108	$	6,207

Total gains/(losses) realized and unrealized:
Included in earnings	1		(1)		23		158		20		201
Included in other comprehensive income	(6)		—		—		(192)		(201)		(398)
Purchases	—		—		—		—		—		—
Issuances	—		—		—		—		—		—
Sales	—		—		—		—		—		—
Settlements	(1)		—		(3)		(17)		(141)		(162)



Balance, end of period	$	66	$	2	$	86	$	2,907	$	2,787	$	5,848
The amount of total gains/(losses) included in earnings attributable to the change in unrealized gains or losses relating to assets and liabilities still held at the reporting date	$	—	$	(1)	$	23	$	158	$	20	$	201
The amount of total gains/(losses) included in other comprehensive income attributable to the change in unrealized gains or losses relating to assets and liabilities still held at the reporting date	$	(6)	$	—	$	—	$	(192)	$	(201)	(398)

The table below provides roll-forward information by class of derivatives measured using significant unobservable inputs.


Level 3 - Derivatives by Class
	Three Months Ended June 30, 2021						Three Months Ended June 30, 2020
	Interest Rate Swaps		Credit Derivatives		Total Derivatives		Interest Rate Swaps		Credit Derivatives		Total Derivatives
Balance, beginning of period	$	66	$	—	$	65	$	79	$	(2)	$	77

Total gains/(losses) realized and unrealized:
Included in earnings	11		—		11		10		1		11
Included in other comprehensive income	—		—		—		—		—		—
Purchases	—		—		—		—		—		—
Issuances	—		—		—		—		—		—
Sales	—		—		—		—		—		—
Settlements	(2)		—		(2)		(2)		—		(2)



Balance, end of period	$	75	$	—	$	74	$	87	$	(1)	$	86
The amount of total gains/(losses) included in earnings attributable to the change in unrealized gains or losses relating to assets and liabilities still held at the reporting date	$	11	$	—	$	11	$	10	$	1	$	10
The amount of total gains/(losses) included in other comprehensive income attributable to the change in unrealized gains or losses relating to assets and liabilities still held at the reporting date	$	—	$	—	$	—	$	—	$	—	$	—



Level 3 - Derivatives by Class
	Six Months Ended June 30, 2021						Six Months Ended June 30, 2020
	Interest Rate Swaps		Credit Derivatives		Total Derivatives		Interest Rate Swaps		Credit Derivatives		Total Derivatives
Balance, beginning of period	$	85	$	—	$	84	$	67	$	—	$	66

Total gains/(losses) realized and unrealized:
Included in earnings	(6)		—		(6)		23		(1)		23
Included in other comprehensive income	—		—		—		—		—		—
Purchases	—		—		—		—		—		—
Issuances	—		—		—		—		—		—
Sales	—		—		—		—		—		—
Settlements	(4)		—		(4)		(3)		—		(3)



Balance, end of period	$	75	$	—	$	74	$	87	$	(1)	$	86
The amount of total gains/(losses) included in earnings attributable to the change in unrealized gains or losses relating to assets and liabilities still held at the reporting date	$	(6)	$	—	$	(6)	$	23	$	(1)	$	23
The amount of total gains/(losses) included in other comprehensive income attributable to the change in unrealized gains or losses relating to assets and liabilities still held at the reporting date	$	—	$	—	$	—	$	—	$	—	$	—

Invested assets and VIE long-term debt are transferred into Level 3 when internal valuation models that include significant unobservable inputs are used to estimate fair value. All such securities that have internally modeled fair values have been classified as Level 3. Derivative instruments are transferred into Level 3 when the use of unobservable inputs becomes significant to the overall valuation. There were no transfers of financial instruments into or out of Level 3 in the periods disclosed.

Gains and losses (realized and unrealized) relating to Level 3 assets and liabilities included in earnings for the affected periods are reported as follows:


	Net Investment Income		Net Gains (Losses) on Derivative Contracts		Income (Loss) on Variable Interest Entities		Other Income or (Expense)
Three Months Ended June 30, 2021:
Total gains (losses) included in earnings for the period	$	—	$	11	$	152	$	—
Changes in unrealized gains (losses) relating to financial instruments still held at the reporting date	—		11		152		—

Three Months Ended June 30, 2020:
Total gains (losses) included in earnings for the period	$	—	$	11	$	61	$	—
Changes in unrealized gains (losses) relating to financial instruments still held at the reporting date	—		10		61		—

Six Months Ended June 30, 2021:
Total gains or losses included in earnings for the period	$	1	$	(6)	$	24	$	—
Changes in unrealized gains or losses included in earnings relating to the assets and liabilities still held at the reporting date	—		(6)		24		—

Six Months Ended June 30, 2020:
Total gains or losses included in earnings for the period	1		23		179		(1)
Changes in unrealized gains or losses included in earnings relating to the assets and liabilities still held at the reporting date	—		22		179		(1)